Reintegrating India with the World Economy

I N S T I T U T E F O R I N T E R N AT I O N A L E C O N O M I C S

REINTEGRATING INDIA

R E I N T E G R AT I N G

INDIA

with the World Economy

T. N . S r i n i v a s a n S u r e s h D . Te n d u l k a r

R EINTEGRATING

I NDI A

w i t h t h e Wo r l d Economy

R EINTEGRATING

I NDI A

w i t h t h e Wo r l d Economy

T. N . S r i n i v a s a n S u r e s h D . Te n d u l k a r Institute for International Economics Washington, DC March 2003

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T.N. Srinivasan, visiting fellow, is the Samuel C. Park, Jr. Professor of Economics and former chairman of the department of economics at Yale University, where he has taught since 1980. He is also a visiting fellow at the Center for Research on Economic Development and Policy Reform, Stanford University. He was a special adviser to the Development Research Center at the World Bank from 1977 to 1980 and has taught at numerous academic institutions over the past four decades, including MIT, Stanford University, and the Indian Statistical Institute. He has authored a prolific collection of books and articles on econometrics, world trade, and developing-country economics. He is a fellow at the Econometric Society, American Academy of Arts and Sciences, and American Philosophical Society; and a foreign associate of the US-based National Academy of Sciences. Suresh D. Tendulkar, visiting fellow, is a professor of economics at the Delhi School of Economics, University of Delhi, India, where he is also executive director of the Center for Development Economics. He was head of the department of economics (1986–89) and director of the school (1995– 98). Before joining the Delhi School, he taught at the Delhi center of the Indian Statistical Institute (1968–78). He has written extensively on Indian development issues and policies, including those on liberalization and globalization. He has been closely associated with the Indian Statistical System including the National Sample Survey Organization and the Advisory Committee on National Accounts of which he is currently the chairperson. He was also a parttime member of the National Statistical Commission (2000–01), the first Disinvestment Commission (1996–99), and the Fifth Central Pay Commission (1994–97) appointed by the government of India.

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INSTITUTE FOR INTERNATIONAL ECONOMICS 1750 Massachusetts Avenue, NW Washington, DC 20036-1903 (202) 328-9000 FAX: (202) 659-3225 http://www.iie.com C. Fred Bergsten, Director Valerie Norville, Director of Publications and Web Development Brett Kitchen, Director of Marketing and Foreign Rights Typesetting by BMWW Printing by Kirby Lithographic Company, Inc. Copyright © 2003 by the Institute for International Economics. All rights reserved. No part of this book may be reproduced or utilized in any form or by any means, electronic or mechanical, including photocopying, recording, or by information storage or retrieval system, without permission from the Institute. For reprints/permission to photocopy please contact the APS customer service department at CCC Academic Permissions Service, 27 Congress Street, Salem, MA 01970. Printed in the United States of America 05 04 03 5 4 3 2 1 Library of Congress Cataloging-inPublication Data Srinivasan, T.N., 1933– Reintegrating India with the world economy / T.N. Srinivasan, Suresh Tendulkar. p. cm. Includes bibliographical references and index. ISBN 0-88132-280-6 1. India—Foreign economic relations. 2. India—Economic policy—1980– 3. India—Economic conditions—1947– 4. Globalization—Economic aspects—India. I. Tendulkar, Suresh D. II. Title. HF1589 .S69 2002 337.54—dc21

2002017253

The views expressed in this publication are those of the authors. This publication is part of the overall program of the Institute, as endorsed by its Board of Directors, but does not necessarily reflect the views of individual members of the Board or the Advisory Committee.

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Contents

Preface Acknowledgments 1 Introduction: Macroeconomic Crisis and Radical Reforms Polity and Society Economic Development Strategy and Performance: An Overview

ix xiii 1 2 4

2 India in the World Trading System: A Quantitative Assessment Economic Nationalism and Autarchic Industrialization, 1950–73 Piecemeal Deregulation, 1974–91 The Crisis of 1991: A Turning Point India’s Exports in Asian Perspective Invisibles in India’s Current Account and Software Exports

11 13 20 27 53 58

3 India in the GATT and the WTO The Uruguay Round TRIPS and India India and the New Round of Multilateral Trade Negotiations The Failed Ministerial at Seattle Labor, Environmental Standards, and the WTO: Key Misconceptions India and Multilateral Trade Negotiations after Doha Appendix 3.1 Origins and Founding of the GATT

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4 Domestic Constraints on International Participation Macroeconomic Management of the Economy Physical Infrastructure Constraints Financial Intermediation Enhancing Flexibility for Industrial Restructuring Conclusion

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5 Conclusions and the Tasks Ahead The First Generation of Reforms: Achievements and Problems Tasks Ahead India and the Global Trading Environment Conclusion

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References

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Index

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Tables Table 2.1 Table 2.2 Table 2.3 Table 2.4 Table 2.5 Table 2.6 Table 2.7 Table 2.8 Table 2.9 Table 2.10 Table 2.11 Table 2.12 Table 2.13 Table 2.14

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Indicators of aggregate economic performance for India, 1950–51 to 2001–02 Selected indicators of the external sector for India, 1990–91 to 2000–01 India’s GDP growth, 1981–2001 Composition of capital account inflows to India, 1990–91 to 2000–01 India’s tariff structure, 1990–91 to 1999–2000 Types of nontariff barriers imposed on India’s imports, 1996–2001 International comparison of tariff barriers Foreign investment inflows to India by various categories Total long-term resource flows to selected developing countries, 1990–2000 Foreign direct investment flows to selected developing countries, 1990–2000 Portfolio investment flows to selected developing countries, 1990–2000 Official debt flows to selected developing countries, 1990–2000 Private debt flows to selected developing countries, 1990–2000 Average imports to India of selected principal commodities, prereform and postreform triennia

26 28 31 32 35 38 39 41 42 43 44 45 46 49

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Table 2.15 Table 2.16 Table 2.17 Table 2.18

Table 2.19 Table 2.20 Table 2.21 Table 2.22 Table 2.23 Table 2.24 Table 2.25

Table 4.1

Figures Figure 2.1 Figure 2.2 Figure 2.3

Figure 2.4

Figure 2.5 Figure 2.6 Figure 2.7 Figure 2.8 Figure 2.9

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Average exports of selected principal commodities, prereform and postreform triennia 51 Percentage shares of major economies in exports of selected commodities 54 The direction of India’s trade, prereform and postreform triennia 56 India’s incremental total exports and extended manufacturing exports along with their major contributing categories, 1987–90 to 1993–96 57 Invisibles in India’s current account and software exports in the 1990s 59 India’s top 10 manufacturing export earners in 1993–94, along with shares in gross output 67 India’s input-output sectors with export share in gross output exceeding 20 percent in 1993–94 69 India’s input-output sectors with export share in gross output between 10 and 20 percent in 1993–94 70 Percentage share of wages and exports in total sales for selected industries in India 71 Number of workers in the factory segment of manufacturing at the 2-digit industry code level in India 72 Exponential trend growth rate and partial elasticities for variables associated with factory manufacturing in India 73 Indicators of macroeconomic management of the Indian economy, 1980–81 to 2002–03 108

Export volume indices for the world and India, 1951–73 India’s trade and exports as percentages of GDP, 1951–74 India’s gross domestic savings, gross domestic capital formation, and net capital inflow as percentages of GDP, 1950–51 to 1973–74 India’s gross domestic savings, gross domestic capital formation, and net capital inflow as percentages of GDP, 1870–71 to 1998–99 India’s real and nominal effective exchange rates, 1976–2000 India’s receipts from private transfers and invisibles India’s trade and exports as percentages of GDP, 1971–99 Export volume indices for the world and India, 1970–97 India’s gross fiscal deficit as a percentage of GDP

17 17

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INSTITUTE FOR INTERNATIONAL ECONOMICS 1750 Massachusetts Avenue, NW, Washington, DC 20036-1903 (202) 328-9000 Fax: (202) 659-3225 C. Fred Bergsten, Director BOARD OF DIRECTORS *Peter G. Peterson, Chairman *Anthony M. Solomon, Chairman, Executive Committee Leszek Balcerowicz Conrad Black Chen Yuan George David *Jessica Einhorn Stanley Fischer Maurice R. Greenberg *Carla A. Hills Nobuyuki Idei Karen Katen W. M. Keck II Lee Kuan Yew William McDonough Donald F. McHenry Minoru Murofushi Karl Otto Pöhl *Joseph E. Robert, Jr. David Rockefeller David M. Rubenstein Renato Ruggiero *Stephan Schmidheiny Edward W. Scott, Jr. George Soros Lawrence H. Summers Peter D. Sutherland Jean Claude Trichet Laura D’Andrea Tyson Paul A. Volcker *Dennis Weatherstone Edward E. Whitacre, Jr. Marina v.N. Whitman Ernesto Zedillo Ex officio *C. Fred Bergsten Nancy Birdsall Richard N. Cooper Honorary Directors Alan Greenspan Reginald H. Jones Frank E. Loy George P. Shultz

*Member of the Executive Committee

ADVISORY COMMITTEE Richard N. Cooper, Chairman Isher Judge Ahluwalia Robert Baldwin Barry P. Bosworth Susan M. Collins Wendy Dobson Juergen B. Donges Barry Eichengreen Jeffrey A. Frankel Jacob A. Frenkel Daniel Gros Stephan Haggard David D. Hale Dale E. Hathaway Takatoshi Ito John Jackson Peter B. Kenen Anne O. Krueger Paul R. Krugman Roger M. Kubarych Jessica T. Mathews Rachel McCulloch Sylvia Ostry Tommaso Padoa-Schioppa Jacques J. Polak Dani Rodrik Kenneth Rogoff Jeffrey D. Sachs Nicholas Stern Joseph E. Stiglitz Alan Wm. Wolff

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Preface

India has both the world’s second largest population (about 1 billion people) and one of its most rapidly growing economies, expanding at an annual rate averaging about 6 percent over the past two decades. Yet the country has been widely viewed as one of the more disappointing development stories, having remained extremely poor on a per capita income basis ($450 in 2001), particularly in comparison with its even more populous neighbor China and a number of other Asian countries such as Korea and Taiwan, which were about as poor as India 50 years ago but are vastly richer today, and in comparison with the potential for much faster growth that many believe it possesses. Moreover, India has played a very minor role in international economic affairs. The decline in its share of world trade has been dramatic, and its own trade protection, while reduced substantially over the past decade, remains very high. In some instances, particularly in the World Trade Organization, its role has been widely viewed (including by this book) as destructive and counterproductive in terms of its own interests. India’s ambivalence, or in some periods hostility, to trade and especially increased foreign investment also set it apart from many of its neighbors. Sharp contrasts are again evident between the behavior of India and that of numerous other countries in Asia, especially East Asia. This book addresses both India’s economic performance and its position on global policy (especially trade) issues and traces the interactions between them. How have the development strategies chosen by India helped or hindered its ability to play a major role in international economic negotiations and institutions? Why has it not used those negotiations and institutions to promote more aggressive domestic reforms as ix

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China, Mexico, and other successful developing countries have? What are the prospects for both faster growth and more active international participation by India in the years ahead as its size alone inexorably propels it into greater global prominence? The coauthors of this study are two of India’s leading economists. T. N. Srinivasan, the Samuel C. Park Professor of Economics at Yale since 1980 and former chairman of the department of economics there, has spent much of his professional career in the United States and is one of the world’s leading experts on the international trading system, particularly with respect to its impact on development and the poorer countries. Suresh Tendulkar is professor of economics at the Delhi School of Economics at Delhi University and was a former director of that school. Both have served on numerous advisory commissions to the government of India over the years and have been active consultants to a number of international economic institutions. They are uniquely qualified to write this book and I deeply appreciated their gracious acceptance of my invitation to do so. Substantial credit for the completion of this volume also belongs to the Indian Council for Research on International Economic Relations (ICRIER), especially under its dynamic former director, Dr. Isher Ahluwalia. ICRIER hosted several seminars for the authors in Delhi. Our thanks also go to the Center for Research on Economic Development at Stanford University, where Dr. Srinivasan spent several months as a visiting fellow and whose former director, current First Deputy Managing Director of the International Monetary Fund Anne Krueger, is a veteran student of the Indian economy and contributed helpful comments on the study. The Institute for International Economics is a private nonprofit institution for the study and discussion of international economic policy. Its purpose is to analyze important issues in that area and to develop and communicate practical new approaches for dealing with them. The Institute is completely nonpartisan. The Institute is funded largely by philanthropic foundations. Major institutional grants are now being received from the William M. Keck, Jr. Foundation and the Starr Foundation. A number of other foundations and private corporations contribute to the highly diversified financial resources of the Institute. About 31 percent of the Institute’s resources in our latest fiscal year were provided by contributors outside the United States, including about 18 percent from Japan. The Board of Directors bears overall responsibility for the Institute and gives general guidance and approval to its research program, including the identification of topics that are likely to become important over the medium run (one to three years), and which should be addressed by the Institute. The director, working closely with the staff and outside Advisory Committee, is responsible for the development of particular projects and makes the final decision to publish an individual study. x

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The Institute hopes that its studies and other activities will contribute to building a stronger foundation for international economic policy around the world. We invite readers of these publications to let us know how they think we can best accomplish this objective. C. FRED BERGSTEN Director February 2003

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Acknowledgments

We owe our thanks to many institutions and individuals who contributed to our effort. Dr. C. Fred Bergsten, director of the Institute for International Economics, invited us to spend a few weeks in the summer of 1999 at the Institute while working on this monograph and to present our preliminary findings at the Institute’s traditional lunch seminars. His hospitality and suggestions, as well as the comments of participants at the seminars, were very helpful to us. Catherine Mann and John Williamson also provided written comments and suggestions. We thank them both. Dr. Isher Ahluwalia, the former director and CEO of the Indian Council for Research in International Economic Relations (ICRIER), was a source of constant encouragement and occasional prodding. Comments of Dr. Ahluwalia, Dr. Shankar Acharya, and other participants at our presentations at ICRIER were invaluable. Incisive comments from Anne Krueger, current first deputy managing director of the International Monetary Fund and former director of Stanford University’s Center for Research on Economic Development and Policy Reform, also substantially improved our drafts. Samrat Bhattacharya and Geetu Wallecha provided tireless and excellent research assistance to Suresh Tendulkar. We are indebted to Farah Zahir of the New Delhi office of the World Bank for providing us comparable data on indicators of India’s fiscal management since 1980–81. Jessica Wallack, a graduate student at Stanford’s Graduate School of Business, not only assisted Srinivasan in his research but also cheerfully agreed to read the entire manuscript, editing it to bring uniformity in style among the chapters written by us individually. This involved a significant amount of rewriting and drafting of invariably better alternatives for what xiii

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we had written. We owe Jessica a great deal for her substantive and editorial assistance. We also thank the publications team at the Institute for International Economics—former director of publications Brigitte Coulton, Marla Banov, Madona Devasahayam, and Katie Sweetman—for preparing the manuscript for publication. Although we are both responsible for the study and its findings and conclusions, Srinivasan took primary responsibility for drafting chapters 1, 3, and 5 and Tendulkar for chapters 2 and 4. Each read and commented on the other’s drafts. Both of us are jointly responsible for any errors of fact and analysis.

T.N. SRINIVASAN SURESH D. TENDULKAR

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1 Introduction: Macroeconomic Crisis and Radical Reforms

India entered the last decade of the twentieth century with a severe macroeconomic and balance of payments crisis. The consolidated gross fiscal deficit of its central and state governments in fiscal year 1990–91 was as high as 9.4 percent of GDP, and the current account deficit was 3.1 percent of GDP.1 The inflation rate was more than 10 percent, and by the summer of 1991, foreign exchange reserves were below two weeks’ worth of imports. The debt-led growth of the 1980s came to a sudden and tumultuous halt: industrial growth was a paltry 0.7 percent, and GDP growth was 1.3 percent in the crisis year 1991–92 (Ministry of Finance, Government of India, Economic Survey, 2002, tables 0.1 and 1.6). The crisis, coming at the same time as the collapse of the Soviet Union, India’s ally and implicit economic role model, appears to have been a cathartic moment for Indian economic policymakers. Prime Minister Narasimha Rao’s administration—prompted by the spectacular failure of the effort to maintain both high growth and an inward-oriented centrally planned industrialization strategy, as well as by the obvious growth of China since its opening to the world economy and of India’s other 1. S. Acharya, “India’s Medium-Term Growth Prospects,” Economic and Political Weekly, July 13, 2002, 2897–906; the figures in the text are taken from tables 5 and 8. The figures quoted in Acharya’s essay might differ from the figures cited in subsequent discussion from publications of the Government of India, the International Monetary Fund, and the World Bank. The differences arise from differences in the definition of a fiscal deficit, as well as from revisions in the data, particularly of the GDP series, which was rebased to 1993–94 prices from the earlier series with 1980–81 prices. 1

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outward-oriented East Asian neighbors—launched systemic reforms across the board covering foreign trade and investment, exchange rate management, and industrial policies, as well as the role of the public sector in production and distribution. The process of reforms faltered with political complications in the middle and late 1990s, but India’s move toward international integration resumed after a more cohesive coalition with a larger majority came to power in 1999.2 This book documents the background and explores the consequences of India’s shift in 1991 from an inward-oriented, state-led development strategy to a policy of active reintegration with the world economy. The remainder of this chapter provides general background on India’s economy, polity, and society. Chapter 2 traces the evolution of India’s participation in world trade for commodities, services, capital, and technology and evaluates the achievements of economic policy reforms since July 1991. India’s inward-looking development strategy did not preclude its participation in international economic negotiations, and it has frequently acted as a leading representative in voicing developing-country concerns in international forums. Chapter 3 focuses on this participation, in particular on India’s role in the General Agreement on Tariffs and Trade (and its successor, the World Trade Organization). Chapters 4 and 5 turn to the reform agenda. Chapter 4 addresses the domestic constraints on India’s greater integration with the global economy in a broad sense. Chapter 5 is devoted to the tasks ahead in pursuing the integration process and in achieving rapid and sustained growth.

Polity and Society India has the physical, cultural, and economic dimensions of a mediumsized continent. It is the second most populous country in the world (after only China), with an estimated population of 1.027 billion in 2000. Only 6 countries have land areas exceeding India’s 2.97 million square kilometers, and India is endowed with a very high proportion of arable land in total land (56 percent). India’s climate ranges from tropical in the South to temperate in the Himalayan foothills to a desert climate in parts of the North. The nation is culturally diverse. About 70 percent of India’s population is Hindus. With 12 percent of its population being Muslims, India is the fourth largest Muslim country in the world, after only Indonesia, Pakistan, and Bangladesh. The Jewish and Christian communities of Kerala 2. After the defeat of the Congress Party in the 1996 elections, two unstable coalitions, one with Deve Gowda as prime minister and another with Inder Kumar Gujral as prime minister, held power for brief periods. 2

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are ancient. Although the date of their arrival is uncertain, legend has it that Jews arrived and settled around Cochin during the period of King Solomon and that Saint Thomas the Apostle brought Christianity to India. Zoroastrians (Parsis) came to India after the Muslim conquest of Iran in the eighth century. There are 15 major language groups in the country. The overall dimensions of the country’s economy are equally imposing, though per capita income is low. According to the World Bank (World Development Indicators 2002, table 1.1), in 2000 India ranked 12th among 210 countries and territories in gross national income. In per capita terms, however, in 2000 the country ranked 153rd if incomes are valued using exchange rates based on purchasing power parity, and 159th if incomes are valued using the World Bank’s “atlas” method.3 India became independent from British colonial rule on August 15, 1947. It is a republic with a parliamentary system of government, an indirectly elected president who serves as the head of state, and the leader of a party or coalition of parties that commands a majority in the lower house of Parliament who serves as the prime minister and head of the government. It consists of 28 states and 7 union (federal) territories, including the national capital region of Delhi. Its administrative and political system evolved mostly during British rule of roughly a century and a half, beginning in the late eighteenth century when the East India Company gained control over coastal areas and ending with direct rule by the British Crown during the period 1828–1947. India adopted a republican constitution in 1950, with a Westminster form of parliamentary government based on universal adult suffrage. The Constitution is federal but has strong unitary features, such as provisions allowing the central government to invoke emergency powers and dismiss duly elected state governments. It also contains certain unique features, such as a list of Fundamental Rights of the People and a set of (nonjusticiable) Directive Principles for state policy.4 The relationship between state and central governments has undergone substantial changes since Independence. Before the death of the first prime minister, Jawaharlal Nehru, in 1964, most of the state and the central governments were under the control of the Congress Party, and conflicts between the center and states were resolved within the Congress

3. The “atlas” method converts national currency units to dollars at prevailing exchange rates, adjusted for inflation and averaged over three years. A dollar at purchasing power parity (i.e., an international dollar) buys the same amount of goods and services in a country’s domestic market as a (domestic) dollar would buy in the United States. 4. These, inter alia, enjoined the state to secure a social order in which social, economic, and political justice informed all institutions of national life, to minimize social and economic inequalities among individuals and groups, and to ensure that the operation of the economic system did not lead to the concentration of wealth and that all citizens were entitled to work, education, and public assistance while sick or unemployed. INTRODUCTION

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Party, in which some state leaders were influential. Indira Gandhi, during her long tenure as prime minister, systematically eliminated challenges to her leadership from any independent-minded state leader of her own party. With the disintegration of the Congress Party and the emergence of regional parties, however, the possibility of a single party ruling at the center, let alone at the center and in most states, is becoming less and less likely. The economic power of the central government has also eroded with the dismantling of central government’s control of the economy since the reforms. India’s 28 states, some of which have populations exceeding those of most countries, have come into their own in the post1991 reform era. We discuss the policy challenges associated with this political decentralization in the final chapter of the book.

Economic Development Strategy and Performance: An Overview That India was desperately poor, and that rapid economic development was essential for alleviating poverty, were realities evident to the leaders of the country’s struggle for independence. The traumatic partition of colonial India at Independence along religious lines delayed efforts to address this situation, but the nation embarked on development planning once the immediate tasks of resettling refugees,5 integrating hundreds of erstwhile princely states into the Indian Union, and rehabilitating the economic infrastructure that had become rundown during World War II had been accomplished. Nationalists have often argued that British imperialism destroyed the economy and prevented industrialization and rapid development. Others, however, have claimed that without British rule there would not have been a nation-state and a subcontinental common market called India or Pakistan. Clearly, the legacy from British rule of legal, administrative, and political institutions (albeit limited in their decision-making power and in their representativeness) was very important for post-Independence India. However, the integrity, efficiency, and equity of these institutions regrettably have deteriorated since Independence. The economic achievements of the British era were decidedly mixed. The population of the Indian subcontinent was estimated by the demographer Kingsley Davis to have been 125 million in 1750. It doubled to 255 million in 1871, the year of the first population census, and to 389 million 5. Almost the entire community of Hindus and Sikhs from Western Pakistan and a large part from Eastern Pakistan (now Bangladesh) came to India as refugees. Although there was a substantial emigration of Muslims to Pakistan, particularly from Eastern Punjab, an overwhelming majority chose to stay in India. 4

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in 1941, the year of the last census under the British (Visaria and Visaria 1983). Real per capita income (index: 1920 = 100) rose from 73 in 1868–69 to 104 in 1930 and fell to 101 by 1945 (Heston 1983). Maddison (2002) estimates that in terms of 1990 international dollars India’s per capita income was higher than that of the United States in 1600, but it fell to 42 percent of that of the United States in 1820. The ratio of per capita Indian income to that of the United States fell steadily thereafter, reaching 6 percent in 1950 and a low of 5 percent in 1973, and then recovering to 6 percent in 1998 (Maddison 2002, table C). India’s early industrial growth followed a similar pattern. Morris points out that “between the 1850s, when the first major industries started, and 1914, India had created the world’s largest jute manufacturing industry, the fourth- or fifth-largest cotton textile industry . . . and the third-largest railway network” (1983, 553). Even after 1914, Indian industrial growth was rapid—the index of India’s manufacturing production, with 1913 as the base, was 239.7 in 1938. Only Japan’s production index at 552.0 exceeded that of India—others, including Canada, Chile, Italy, Germany, the United States, and the world as a whole, had a lower index of production (Lal 1988, table 8.5B). Yet at the time of Independence, India was still largely nonindustrialized and one of the world’s poorest areas (Morris 1983, 553). The reasons for this early growth and later stagnation are not entirely clear. Lal (1988, 218), for example, argues that neither free trade nor laissezfaire held back Indian industrialization, but the inadequate provision of social overhead capital did. Indigenous entrepreneurs were, after all, able to mobilize capital and establish a modern textile industry under the colonial policy regime. Nevertheless, nationalist leaders, intellectuals, and businessmen agreed “that laissez-faire was the root of all evil and central planning the new panacea” (Lal 1988, 229). We turn next to this consensus and the roots of the post-Independence development strategy. The foundations of India’s first development strategy were laid in the pre-Independence era, when several individuals and groups published their plans presenting their vision of India’s future development.6 The engineer and statesman Sir Mokshagundam Visvesvaraya’s plan, published in 1934, was one of the earliest. The Indian National Congress’s National Planning Committee was next. The committee, under the chairmanship of future Prime Minister Nehru, completed its work in 1938, when most of its members were put in prison by the colonial authorities. As World War II was coming to a close, a group of businessmen from Bombay published their plan, which came to be called the Bombay Plan (Thakurdas et al. 1944). The Indian Federation of Labor, representing the organized labor unions, published its own plan, called The People’s Plan (Banerjee, 6. Even the colonial government had prepared economic plans to be implemented once World War II had ended. INTRODUCTION

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Parikh, and Tarkunde 1944). And the followers of Mahatma Gandhi, who was the champion of handicrafts and village industries, also put out their plan (Agarwal 1960). All the plans except that of the Gandhians advocated industrialization and import substitution, with the state taking a dominant role in the economy. The planners—impressed by what they perceived as the success of the Soviet Union in transforming a backward agricultural economy into an industrial one in a single generation and also by the economic rejuvenation of Nazi Germany under state direction—all accepted centralized planning as the framework for economic management.7 The world economy during the interwar period was marked by high tariff barriers, competitive devaluations, and a global depression that resulted in a collapse of world trade and private capital flows. This disastrous experience naturally led to the belief that foreign trade and capital could no longer be engines of growth. Free markets and free trade were also perceived as economic arrangements imposed on India by its colonial masters for their own benefit. Achieving self-reliance, particularly in manufactured goods, and restricting foreign trade to the bare minimum became dominant objectives. Although India was predominantly an agricultural economy and an overwhelming majority of India’s population was poor and rural, the consensus (again with the notable exception of the Gandhians) was that industrialization with an emphasis on large-scale plants and the production of capital goods and intermediates was the only appropriate development strategy for India. Visvesvaraya asserted that “India cannot prosper except through industrialization [which] has to be organized, planned and worked for . . . India may be an industrially developed country or it may be a market for manufactured goods from outside and not both” (1934, 351–53). Nehru’s National Planning Committee concluded that “the problems of poverty and unemployment, of national defense and of economic regeneration in general cannot be solved without industrialization” (Nehru 1946, 401). It further explained: The three fundamental requirements of India, if she is to develop industrially and otherwise, are a heavy engineering and machine-making industry, scientific research institutes and electric power. (Nehru 1946, 416) The objective for the country as a whole was the attainment, as far as possible, of national self-sufficiency. International trade was certainly not excluded, but we were anxious to avoid being drawn into the whirlpool of economic imperialism. The first charge on the country’s produce should be to meet the domestic

7. Although the enormous human cost of Soviet industrialization under Joseph Stalin was not then known, it is interesting that the businessmen’s plan did hint at the possibility that the human cost was high. 6

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needs. . . . Surplus production would not be dumped abroad but be used for exchange of commodities as we might require. To base our national economy on export markets might lead to conflicts with other nations and to sudden upsets when those markets were closed to us. (Nehru 1946, 403)

The businessmen’s and the labor unions’ plans also endorsed the emphasis on industrialization and self-sufficiency. With the establishment of the Planning Commission in March 1950, India turned to planning to translate the goals of social and economic policy prescribed in the Directive Principles of the Constitution into a national program based upon an assessment of needs and resources. During World War II, the colonial government had established an elaborate administrative machinery to allocate scarce commodities and foreign exchange. A system of rationing in urban areas of cloth, food grains, sugar, kerosene, and other essential commodities had been set up as well. India accumulated claims denominated in UK pounds sterling during this period, because imports were severely restricted and there were large exports in support of the United Kingdom’s war effort. The accumulated current account surpluses, known as sterling balances, were sizable at the end of the war. Although the United Kingdom’s agreement was needed to draw on them (at that time sterling was not convertible), the availability of these balances as part of foreign exchange reserves provided a sizable cushion for an expansionary policy. At the dawn of planning for development, the government thus had in place a system of administrative controls on the economy to use if it chose. Not only did it choose to use, expand, and tighten these controls over the years, it justified the policy as essential for promoting rapid economic development.8 The First Five-Year Plan (1951–56) was more of a compendium of investment projects that had been initiated earlier than a fully articulated and forward-looking development strategy. The analytical underpinning of the first plan was a simple one-sector Harrod-Domar model for consistently projecting growth, savings, and investment rates. It turned out— with the dominant agricultural sector performing well because of good weather, with the growth targets being modest, and with a comfortable 8. In its very first 5-year plan, the Planning Commission claimed: “Control and regulation of exports and imports, and in the case of certain commodities state trading, are necessary not only from the point of view of utilizing to the best advantage the limited foreign exchange resources available but also for securing an allocation of productive resources of the country in line with targets defined in the Plan. . . . Viewed in the proper perspective, controls are but another aspect of the problem of incentives, for to the extent that controls limit the freedom of action on the part of certain classes, they provide correspondingly an incentive to certain others and the practical problem is to balance the loss of satisfaction in one case against the gain in the other. For one to ask for fuller employment and more rapid development and at the same time to object to controls is obviously to support two contradictory objectives” (GOI-PC 1951, 42–43; emphasis added). INTRODUCTION

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balance of payments situation arising from the boom in exports due to the Korean War—that the first plan was successful in achieving its targets without creating any significant fiscal or balance of payments problem. The successful completion of the modest first plan was followed by a very ambitious Second Five-Year Plan. The plan’s author, P.C. Mahalanobis, provided an analytical foundation for it with a closed-economy growth model with two sectors, one of which produced consumer goods and the other investment goods, with sector-specific capital as the only factor of production9 (Mahalanobis 1955). The fundamental insight of this model was that the greater the proportion of investment devoted to increasing the capacity of the investmentgoods sector, the faster the long-run growth in consumption and investment. In the strategy based on this model, rapid long-run growth was to be achieved without much sacrifice of short-run consumption by concentrating scarce investment in expanding capital-goods-producing (and intermediate-goods-producing) heavy industry. Current consumption demand was to be met by employing abundant labor resources to manufacture consumer goods using labor-intensive methods that required little capital. The massive step-up in investment envisaged in the second plan resulted in a severe balance of payments crunch in 1957 that led to the institution of a regime of import controls. However, much of the investment in heavy industries took place in the 1960s and 1970s, and subsequent plans did not emphasize these industries as much and somewhat deviated from the Mahalanobis strategy. These deviations were more in the nature of ad hoc responses to emerging circumstances than the consequences of a deliberate reconsideration of the strategy. Briefly stated (for a more detailed discussion, see chapter 2), Indian economic performance under this development strategy was poor. For three decades until 1980–81 the average annual rate of growth of real GDP was 3.75 percent. With the population growing at nearly 2.25 percent a year, income per head grew at about 1.50 percent. With such a low rate of growth, it is no surprise there was little reduction in poverty—the proportion of the population with consumption below a very modest poverty line fluctuated around an average of more than 50 percent. The economy was insulated from world markets—India’s share of world merchandise exports declined from about 2.2 percent in 1948 to 0.5 percent in the early 1980s. The 1979 share of foreign trade (exports and imports) in GDP, 16 percent, was probably no higher than it had been in the early 1950s, having declined in between to 10 percent. The fiscal expansionism of the 1980s, accompanied by some liberalization of controls on economic activity, generated real GDP growth of more 9. Although the model had been articulated in 1928 by Fel’dman (1928) for the Soviet Union, Mahalanobis arrived at it independently (see Mahalanobis 1955). 8

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than 5.8 percent a year, and the country’s proportion of poor people declined significantly. Macroeconomic policies were conservative up to the 1980s. In the early 1980s, conservatism gave way to an expansionist fiscal policy, which resulted in rising fiscal deficits that were financed by borrowing at home and abroad at commercial rates, as we discuss in later chapters. This expansionism, however, was not sustainable and led to the macroeconomic crisis of 1991.10 India’s post-1991 era of reforms stands in sharp contrast to the earlier period of its postcolonial economic history. The 1950s’ legacy of publicsector-dominated, centrally planned, autarkic industrialization has given way to promarket, prointernational trade policies designed to promote the cross-border flow of goods, services, and factors of production. We firmly believe that the continuation of India’s reformist agenda of liberalizing domestic markets and opening up its economy will not only help India but also benefit the world economy by enlarging mutually beneficial and gainful avenues of exchange. The expected benefits for both India and the world will be even greater if India’s unilateral efforts are matched by further liberalization of the international economic environment. We explore these important issues in the subsequent chapters of the book.

10. Although the overall fiscal deficit as a proportion of GDP climbed back to its 1991–92 crisis level by 2001–02, there was no increase in the current account deficit and no sense of a macroeconomic crisis. The main reason for this is the poor domestic investment climate since 1996–97. INTRODUCTION

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2 India in the World Trading System: A Quantitative Assessment

India’s participation in world markets declined steadily during the second half of the twentieth century, with only a marginal improvement following the reforms of the 1990s. Its share of world merchandise exports was 2.2 percent in 1948, higher than China’s 0.9 percent or Japan’s 0.4 percent. It fell to one-fifth its initial level, 0.5 percent, in 1983 and recovered only marginally to 0.7 percent in 2000. Japan, in contrast, progressively increased its share from 0.4 percent in 1948 to a peak of 10.0 percent in 1993. China’s share first increased to a high of 1.3 percent in 1963, then fell to a low of 1.0 percent in 1973, later recovering dramatically after its opening to the world economy in 1978 to 4.0 percent in 2000.1 There is no widely accepted single quantitative indicator that captures the depth and degree of integration of a given country with the world economy, but the ratio of exports plus imports to GDP is a commonly used measure. India’s ratio was a mere 16.6 percent in 1980, compared with China’s 22.3 percent, Malaysia’s 112.5 percent, South Korea’s 75.5

1. These data are from World Trade Organization, International Trade Statistics 2001, table II.2. Chinese export growth is particularly impressive, given that China ceased to be a contracting party to the General Agreement on Tariffs and Trade (GATT) in 1950 and thus did not receive the most-favored-nation nondiscriminatory treatment from all Contracting Parties of the GATT. The United States accorded most-favored-nation status to China on an annual basis from the time of the reestablishment of diplomatic relations in the late 1970s until China’s accession to the World Trade Organization in 2002.

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percent, and Thailand’s 54.4 percent.2 India has become more integrated with the world economy since then, but not as much as its neighboring countries. India’s trade ratio increased to 24.2 percent in 1999, while China’s trade ratio more than doubled during the same period, increasing to as high as 49.2 percent. India’s inward orientation has had significant economic costs in lower overall growth and stagnating living standards. Japan’s rapid export growth was associated with very rapid GDP growth and improvements in living standards. Its export sector became more efficient over time. Its image as a producer of low-cost, low-quality imitative products shifted to that of a world leader in producing high-quality high-technology goods. Though China’s internal market is large, international trade has played a powerful instrumental role in its growth process. The country achieved an average annual growth rate of more than 10 percent during the period 1980–2000 (World Bank 2002, table 4.1), and its real GDP and exports have grown even more rapidly since 1980. India’s GDP growth rate, in contrast, averaged 3.75 percent a year from 1950 to 1980, putting it in the category of a low-income, slow-growing economy among the 41 “Third World” countries examined by Reynolds (1985). Its growth rate increased to 5.8 and 6 percent respectively during the 1980s and 1990s (World Bank 2002, table 4.1). Its growth in the 1980s, however, was fueled by unsustainable fiscal expansionism—a policy that culminated in a severe macroeconomic crisis in 1991. The following sections describe the domestic policies and international circumstances that have shaped India’s long period of insulation and its more recent efforts to become integrated with the world economy. We first outline the early phases of centralized planning of autarchic industrialization during the 1950–73 period and then examine the 1974–91 period of gradual deregulation in response to exogenous shocks. We analyze the background to, and politico-economic consequences of, the 1991 economic crisis, a major turning point in India’s attitude toward the international economy. The crisis created an impetus and an opportunity for a series of important reforms to India’s trade regime as well as increased openness to foreign capital flows. The final section focuses on the effects of the 1990s reforms on trade patterns, industrial efficiency, growth, employment, and poverty.

2. The international comparisons presented here are based on the data cited in GOI-MoF (1998). Of course, for small open economies, the trade ratio is expected to be high. The fact that a larger economy, China, had a trade ratio one-third higher than that of India had in 1980—even before the effects of its opening to the world economy in 1978—could be seen as indicative of India’s insulation from world markets. 12

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Economic Nationalism and Autarchic Industrialization, 1950–73 This was the period when the Indian leadership embarked on giving a concrete shape to the development strategy based on the pre-Independence vision of economic self-reliance and evolving a regulatory policy regime that became increasingly more restrictive and inward oriented toward the end.

Development Strategy The origins of economic nationalism in India can be traced to the beliefs held by those fighting for independence from British rule. They perceived the British colonial policy of laissez-faire and free trade to be the major causes of India’s economic underdevelopment. Their thoughts about economic development strategies and vision of a state-guided closed economy were heavily influenced by Soviet planning. They viewed international trade as a “whirlpool of economic imperialism” (Nehru 1946, 546) rather than as a positive instrument for achieving rapid economic growth. We noted in chapter 1 that a formal underpinning for India’s development strategy is provided by Mahalanobis (1955), the author of the Second Five-Year Plan (1956–61). His two-sector analytical model, almost the same as that of Fel’dman (1928) for the Soviet Union, rationalized the Second Five-Year Plan’s emphasis on basic and heavy industry. The strategy was implemented via a policy regime with two main goals. The first was to gain state control over the “commanding heights” of the economy through a progressive expansion of public ownership of the means of production. Basic and heavy industries were exclusively reserved for development in the public sector. Fiscal and monetary policy instruments were deployed to mobilize private financial savings for public investment. Life insurance companies and commercial banks were nationalized in 1955 and 1969 respectively. The government appropriated a very large part of the private deposits of commercial banks by setting high statutory liquidity and cash reserve ratio levels, which together preempted as much as 51 percent of deposits. Commercial banks were also required to allocate credit to specified priority sectors. The second goal was to get the private sector to conform to plan priorities through quantitative restrictions on private investment, capital issues, and foreign collaborations, as well as imports of technology, capital goods, and intermediate inputs. At least three features of the policy regime distorted market price signals and the private sector’s response to them. First, the criteria for evaluating applications were broad, with significant room for discretion on the part of the licensing authorities. Bureaucrats were under constant pressure from politicians and license seekers. INDIA IN THE WORLD TRADING SYSTEM

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Politicized decisions and corruption were inevitable outcomes. Second, although the authorities could deny a license to a private entrepreneur for an investment that he found profitable, they could not induce him to apply for a license and invest if he did not find it profitable, regardless of its worth from a social perspective. Third, the authorities had no system to keep track of the implementation of the licenses granted. Licensees were not obliged to invest, and frequently would not invest, if there was the possibility of changes in the economic environment that would adversely affect the profitability of investments. Aggregate capacity to be licensed was also capped by plan targets, giving firms an incentive to take licenses and thus foreclose competition by preventing other firms from getting them. The link between capacity increases targeted in a plan and their actual realization through licensing became extremely tenuous. The attempt to control market forces in the public interest and to direct the private sector to conform to priorities of the 5-year plans failed to serve the public interest and degenerated into a tool for political and other patronage dispensation. Licensing, by limiting capacity and awarding licenses to a chosen few, precluded competition in domestic markets for products manufactured by large-scale producers. The complex licensing procedures delayed licenses and created persistent supply shortages, which were accentuated further by restrictive trade policy (discussed below). Firms were able to sell practically anything that they produced in the domestic market and thus had little incentive to improve their international competitiveness and export industrial products. India’s international trade policy had the direct effect of limiting its participation in world trade. It sought to minimize imports by supporting indigenous production and according priority to domestic use in the disposition of production. Import tariffs, based on the recommendations of the Tariff Commission, were initially used to provide infant-industry protection to selected industries. The ambitious investment in heavy industries at the start of the Second Five-Year Plan (1956–61) led to a significant spurt in import demand and a rapid depletion of foreign exchange reserves, and it precipitated a balance of payments crisis in 1957. Quantitative restrictions (QRs) on imports were initially imposed to meet the crisis but continued until early 2001 in varying intensities. Graded import tariffs (highest on “least essential” consumer goods, lower on industrial intermediate inputs, and the lowest on capital goods deemed “essential” for development) were also introduced in the 1960s in an effort to contain balance of payments deficits. According to Reddy (1997), (nominal) exchange rate policy in India “has evolved from the rupee being pegged to the pound sterling until 1975, pegged to an undisclosed currency basket until 1992 and after a

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year’s experience with a dual exchange rate system to a market-related system by 1993.” Joshi and Little (1994, chap. 11) provide a detailed discussion of the evolution until the reforms of 1991. Their econometric analysis for the period 1960–90 and an extension of it by Srinivasan (1998b) and Seddon and Srinivasan (2001) showed that India’s supply of and demand for exports are both responsive in the long run to changes in the real effective exchange rate (REER) and that the relevant elasticities are more than adequate for a real depreciation to improve the current account—even with a zero price elasticity of demand for imports. They raise “the crucial question . . . whether the nominal exchange rate in India was managed in such a way as to produce the appropriate real exchange rate [with] the latter . . . defined as that value of the REER which would produce a sustainable current account deficit consistently with internal balance and low inflation” (Joshi and Little 1994, 280). Joshi and Little do concede that determining the appropriate time path for the REER is a very complicated problem. But they get around it by restating it as one of determining the direction of movement of the REER, starting from an initial position that is deemed appropriate. Thus, unless there are permanent real changes in the internal environment that affect external competitiveness, the REER should be kept constant. Their assessment, with which we concur, is that Indian policymakers have been reluctant to vary the nominal exchange rate actively to manage the current account. In fact, until it was overruled by a decision of the World Trade Organization’s (WTO’s) Dispute Settlement Body in 2000, India continued to use QRs on imports as main tools for containing pressures on the current account balance by invoking the balance of payments exception under Article XVIII(B) of the General Agreement on Tariffs and Trade (GATT). The main objective of India’s exchange rate policy in the postreform era of managed float, according to Reddy (1997), is to ensure that economic fundamentals are reflected in the external value of the rupee. In practice, market interventions have been guided by three purposes: first, to redress excess volatility in exchange rate movements; second, to maintain an adequate level of foreign exchange reserves; and third, to contribute to the development of a healthy foreign exchange market. Leaving aside the apparently successful management of the exchange rate in the short period of 9 years since 1993, it is fair to say that the period from 1947 to 1993 was one in which, except for occasional and dramatic episodes of devaluation (as in 1949 and 1966), there was no active use of changes in the nominal exchange rate as a tool of macroeconomic management. Indeed for most of this period, the exchange rate was overvalued. The overvalued exchange rate provided cheap foreign exchange for priority uses (particularly by the government), discriminated against ex-

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ports, and generated excess demand for imports restricted by QRs. Export subsidization measures were introduced to correct in part for the distortions. Several studies of these measures by Bhagwati and Srinivasan (1975), Rao (1985), and the World Bank (1992) showed that these policies were inadequate. The effective exchange rate (rupees per dollar) for exporters, inclusive of subsidies, was lower than that for the importers both in the aggregate as well as at the level of individual industries. The absence of correction for exchange rate overvaluation and its bias against exports even in nominal terms led to an export stagnation while boosting demand for imports. The interlinked trade and exchange rate policies became more complicated as the government faced the task of financing the ever-growing import requirements of industrialization in the face of stagnant or slowgrowing export earnings. Persistent deficits in the balance of payments were mitigated by increases in tariff levels and in the severity of QRs rather than by devaluation of the rupee. Bilateral and multilateral external assistance (1955–80), barter trade agreements with Eastern Europe and the Soviet Union (1965–90), and external commercial borrowing and deposits by nonresident Indians (1980– 90) also helped to prop up the exchange rate and limit the external payments deficit. The options of exchange rate adjustment and the aggressive use of trade policies to promote exports were not seriously considered.

Economic Performance India became increasingly insulated from the world economy under this development strategy. The volume of world exports expanded at an average rate of 7.9 percent annually from 1950 to 1973, but India’s exports grew by only 2.7 percent annually. Figure 2.1 shows the widening gap during the period between world and Indian exports. The ratio of exports to GDP also showed a declining trend from a high of 7.3 percent in 1951 to the lowest level of 3 percent in 1965 and remained below 4 percent until 1973 (figure 2.2). A similar trend is also visible in the figure with regard to the ratio of exports plus imports to GDP. The trends in rates of gross domestic savings (GDS) and gross domestic capital formation (GDCF) in this period are depicted in figures 2.3 and 2.4. The two rates were in balance from 1952 to 1955. Both rose from around 8 to 13 percent until the beginning of the Second Five-Year Plan in 1956. From 1956 to about the mid-1960s, both GDS and GDCF fluctuated. GDCF thereafter increased to about 17 percent of GDP in the decade 1965– 75. The deficit of domestic savings over investment was financed mostly from concessional foreign aid. The average annual growth rate of GDP at constant 1993–94 prices was a respectable 3.87 percent from 1950 to 1964 in comparison with the vir16

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Figure 2.1 Export volume indices for the world and India, 1951–73 (base: 1951 = 100) index 600

500

World

400

300

200 India 100

0 1951

1953

1955

1957

1959

1961

1963

1965

1967

1969

1971

1973

Source: Authors’ calculations.

Figure 2.2

India’s trade and exports as percentages of GDP, 1951–74

percent 20

TR/GDP

15

10

5 EXP/GDP 0 1951

1956

1961

1966

1971

TR/GDP = trade (value of exports and imports) as a percentage of GDP EXP/GDP = value of exports as a percentage of GDP Source: CSO (2001a and 2001b).

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Figure 2.3 India’s gross domestic savings, gross domestic capital formation, and net capital inflow as percentages of GDP, 1950–51 to 1973–74 percent 20 GDCF

15

GDS

10

5 NCI 0

–5 1950–51

1955–56

1960–61

1965–66

1970–71

1973–74

GDS = gross domestic savings GDCF = gross domestic capital formation NCI = net capital inflow Note: NCI is net capital inflow as a percentage of GDP; it is the difference between GDCF and GDS as a percentage of GDP.

Source: CSO (2000b).

tual stagnation in real GDP during the first half of the 20th century.3 Reductions in foreign assistance in the mid-1960s put great pressure to mo3. In retrospect, it appears that the mid-1960s would have been the right time to have shifted from import substitution to export orientation in policy. The spectacularly successful economies of South Korea and Taiwan embarked on their export-oriented growth strategy at this time. India’s less costly import substitution had been completed and investment in infrastructure had matured by this time. The external environment was also favorable: a rising volume of world exports, steady growth with full employment in the industrialized countries generating labor scarcity, and the absence of any competitors except Japan for exports of labor-intensive manufactured products. In the Indian context, detailed analysis pertaining to the 1950s by Singh (1964), who was to become finance minister in 1991, and Cohen (1964) and MacDougall (1964) had presented persuasive arguments in favor of export orientation. However, apart from the grip of economic nationalism that still persisted, exogenous events intervened. The war with Pakistan in 1965 resulted in the suspension of US foreign aid, which had provided major balance of payments support. Two successive and severe agricultural droughts during the period 1965–67 and the political fallout from the perceived failure of the June 1966 devaluation (which coincided with the high rate of inflation induced by harvest failure but which was blamed on the politically unacceptable devaluation) also derailed the process of deregulation that had started with devaluation (Bhagwati and Srinivasan 1975).

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Figure 2.4 India’s gross domestic savings, gross domestic capital formation, and net capital inflow as percentages of GDP, 1970–71 to 1998–99 percent 30 GDCF 25 20 GDS 15 10 5 NCI 0 –5 1970–71

1975–76

1980–81

1985–86

1990–91

1995–96

1998–99

GDS = gross domestic savings GDCF = gross domestic capital formation NCI = net capital inflow Note: NCI is net capital inflow as a percentage of GDP; it is the difference between GDCF and GDS as a percentage of GDP.

Source: CSO (2000b).

bilize domestic resources. However, these efforts had little effect on the aggregate growth performance of the economy. A broad sense of the efficiency of capital utilization can be gained from the implicit incremental capital output ratio (ICOR).4 The realized ICOR during the first 15 years of planning turned out to be about 4.6 in comparison with the 3.0 assumed in the plan calculations. The next decade from 1964, leading up to the oil price hike of 1973–74, saw an increase in average GDCF at constant prices from about 16.8 to 21.7 percent of GDP, but a lower GDP growth rate of 3.3 percent annually, and an implicit ICOR of as high as 6.6. Indian planners succeeded in domestic resource mobilization with the more than doubling of GDS and in4. Implicit ICOR is derived from an ex-post growth identity: the growth rate equals the rate of investment divided by ICOR.

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Figure 2.5 India’s real and nominal effective exchange rates, 1976–2000 export-based weights 150

100

REER 50 NEER

0 1976

1979

1982

1985

1988

1991

1994

1997

2000

REER = real effective exchange rate NEER = nominal effective exchange rate

Source: Handbook of Statistics on the Indian Economy 2001, Reserve Bank of India.

vestment rates during the years 1950–51 and 1980–81. Nevertheless, the lack of domestic and international competition resulting from industrial and trade policies took their toll on the efficiency of capital utilization. This was particularly unfortunate for a low-income country like India, where capital was scarce relative to labor.

Piecemeal Deregulation, 1974–91 The collapse of the Bretton Woods system of fixed exchange rates in 1971 and the oil price hikes of 1973 and 1979 brought about several changes in India’s external-sector policies. India was almost totally dependent on oil imports, and the first oil price rise increased the current account deficit and led to a deterioration of the terms of trade. Still, the impact of the shock was not disastrous. India’s current account deficit was initially very low—about 1 percent of GDP. Concessional foreign aid from international agencies also helped soften the immediate adverse impact. These exogenous shocks turned out to be favorable for India’s economy in several ways. First, even without an active nominal exchange rate policy, some REER depreciation (figure 2.5) resulted from linking the ex20

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Figure 2.6 India’s receipts from private transfers and invisibles millions of US dollars 40,000 35,000 Invisibles receipts 30,000 25,000 Invisibles payments 20,000 15,000 10,000 5,000

Private transfers receipts

0 1971

1981

1991

2001

Source: Authors’ calculations.

change rate of the rupee initially with the UK pound and later with an undisclosed basket of currencies. The exchange rate of the pound and other currencies depreciated with respect to the US dollar, and the rupee also depreciated in tandem. This arrangement allowed the rupee to depreciate as the pound-dollar exchange rate increased. It avoided an explicit formal exchange rate devaluation, which would have been politically unacceptable after the perceived failure of the devaluation of the rupee in June 1966 (see Bhagwati and Srinivasan 1975). The de facto devaluation of the rupee slowed, however, when the exchange rate was linked to a basket of currencies because these currencies no longer depreciated with respect to the dollar. Second, the steep hikes in international oil prices led to massive income transfers to the oil-rich Persian Gulf countries that favorably spilled over into the Indian economy in two ways. One, the newly affluent oil-producing nations provided ideal markets for India’s exports of agricultural products because of locational advantage. Two, the Organization of Petroleum Exporting Countries development efforts generated demand for middle-level skills that was met by the migration of Indian workers. The migrants’ remittances to their families at home (a major component of private transfers in the invisible account) averaged $185.8 million during the period 1971–75 and rose sharply to an annual average of $1.9 billion in the next 10 years (figure 2.6). INDIA IN THE WORLD TRADING SYSTEM

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These earnings contributed to increases in foreign exchange reserves in the second half of the 1970s and helped the country finance the increased cost of oil after the second oil price hike of 1979–80 without resorting to enhanced import controls. Figure 2.6 also shows the invisible receipts and payments, which indicate that a major source of surplus on the invisible account in most years has been receipts from private transfers. The first half of the 1970s also saw the discovery and exploitation of oil in the Arabian Sea near Bombay that reduced oil imports. During the mid1970s, a succession of favorable agricultural harvests in combination with an agricultural price policy that offered attractive prices to producers resulted in an accumulation of public stocks of food grains that provided a cushion against potential food price inflation. Armed with comfortable public stocks of food grains and foreign exchange reserves, the government did not adopt contractionary policies in response to the second oilprice hike in 1979–80. Instead, it relaxed counterproductive regulations on domestic and international transactions during the 1980s. These actions were based on the recommendations of several official committees that looked into possibilities for the simplification, rationalization, and liberalization of the policy regime. The committees included one on import and export policies, another to examine a possible shift from physical to financial controls, and a third on industrial policies. They recommended cautious and selective deregulation and rationalization. Relaxation of industrial licensing consisted of several measures. Licensees were permitted to diversify in interrelated areas without seeking a fresh license. A minimum efficient scale of capacity was announced for several industries. Automatic expansion of already licensed capacity and production in excess of the licensed capacity were allowed without penalty under stipulated conditions. Public-sector term-lending institutions were also established to provide convertible debt finance for private-sector projects. These measures provided limited but additional flexibility to the private industrial units in adjusting supplies to changes in market demand. Trade policy was set for 3-year terms to reduce the uncertainties of year-to-year policy changes. The export-import policy began to be announced for 3-year periods in place of the annual or semiannual statements before 1985. Complexity, however, persisted. As in the past, the import-licensing system divided imports into three categories, in ascending order of “essentiality”: consumer goods, intermediate goods (raw materials, components, and parts), and capital goods. Imports of nonessential consumer goods were banned, whereas those seen as essential (food grains, edible oils, sugar, and certain drugs and pharmaceuticals) were imported exclusively through state agencies. Other imports were divided into the following categories: nonpermissible (banned), limited permissible (with mandatory certification from another agency regarding essentiality as well as mandatory clearance from

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the controller general of imports and exports, or CGI&E), automatic permissible (without mandatory certification but with clearance from CGI&E), and open general license (without certification, without clearance from CGI&E). An elaborate administrative machinery was established for the allocation of permissible imports by sector of use (private and public), by type of goods (consumer, intermediate, capital), and by industries and categories of firms within industries. Sixty items came to be canalized by public-sector agencies. Licenses to import items (e.g., dried fruits) that fetched substantial price premiums on the domestic market were granted to exporters as an incentive. Not all profitable exports were allowed. The 1988–91 policy statement mentioned nonpermissible (67 products) and restricted exports (105 products). The crucial difference between the import and export policies, however, was that importing an item not on one of the lists was illegal, whereas exports of anything were legal, except the 172 items on the list. The selective deregulation of the policy regime did not change its basic character. There was indeed some rationalization (reducing distortions) and extension of coverage of export incentives. This rationalization involved simply substituting one form of control for another in some cases and even increased the regime’s restrictiveness in others. Apparent tariff levels actually increased as procedural simplifications of QRs on imports shifted mostly noncompetitive importable items from nonpermissible (or automatic permissible) lists to the open general license category with high tariffs. These measures did not fully offset the handicaps faced by exporters, and the profitability of selling on the domestic market remained consistently higher than selling on the international market. In sum, the policy regime remained distorted and restrictive in character, despite some piecemeal deregulation, until 1991. India’s exports increased over this period of piecemeal reforms, but this was more due to a real exchange rate depreciation mostly as a result of exogenous forces than due to an active policy of nominal devaluation or due to explicit policy reforms aimed at reducing trade barriers. Growth performance was also distinctly better in the 1980s than in the earlier period. This surge in growth, however, was supported on the demand side by unsustainable fiscal policies, and it ended with an economic crisis in 1991. Although the trade control regime continued to penalize exportable activities despite deregulation, Indian exports in dollar terms doubled from $8.9 billion in 1985–86 to $18.1 billion in 1990–91. The export ratio showed an upward trend after 1986, following the flattening in the first half of the decade (figure 2.7). Although the growth in volume of world merchandise exports slowed down from nearly 8 percent a year during the period from 1951 to 1973 to 2.7 percent a year between 1973 and 1986, the growth in the volume of India’s merchandise exports in the latter period increased to 4.4 percent from 2.8 percent in the earlier period. During the period

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Figure 2.7 India’s trade and exports as percentages of GDP, 1971–2001 percent 25

20 TR/GDP 15

10 EXP/GDP 5

0 1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

TR/GDP = trade (value of exports and imports) as percent of GDP EXP/GDP = value of exports as percent of GDP

Source: CSO (2001a and 2001b).

1986–91, India managed to keep pace with the resumption of growth in world merchandise exports (figure 2.8). Two factors contributed to this outcome. First, there was a cumulative depreciation in REER to the extent of 26.9 percent between 1984 and 1990, compared with 7.6 percent appreciation in the previous 6 years (see figure 2.5).5 Second, there was a resumption of growth in the volume of world exports after 1986, when the world economy completed its adjustment to the two oil-price hikes. The sensitivity of Indian exports to REER changes has been pointed out by Joshi and Little (1994), Srinivasan (1998b), and Seddon and Srinivasan (2001). The average annual growth rate of GDP at constant (1993–94) prices increased to 5.7 percent in the 1980s from just 3.75 percent from 1950 to 1980. Efficiency of capital use improved as well, with a fall in the average implicit ICOR from 5.7 during the period 1950–80 to 3.7 in the 1980s (table 2.1). 5. Index of REER in figure 2.5 (downward movement reflecting depreciation) is based on India’s exports to 36 partner countries as weights and base 1985=100. 24

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Figure 2.8 Export volume indices for the world and India, 1970–97 (base: 1951 = 100) index 1,800 1,600 World

1,400 1,200 1,000 800 600

India

400 200 0 1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

Source: Authors’ calculations.

This growth performance proved to be unsustainable. The piecemeal deregulation did contribute to greater capacity utilization, but did not go far enough to improve India’s international competitiveness. Export volume growth, at about 6.5 percent a year during the 1980s, was not much higher than output growth of 5.7 percent a year. The increased production was absorbed by increased domestic demand, which was stimulated by fiscal expansion. The gross fiscal deficit of the central government as a proportion of GDP averaged 3.2 percent during the first half of the 1970s and 4.3 percent during the second half.6 It increased continuously in the 1980s to 7.8 percent by 1990–91 (see figure 2.9). This movement coincided with an increase in the cost of public borrowing, as interest rates rose from low and administered values in the earlier period to higher and variable marketdetermined levels later. Rising fiscal deficits crowded out private investment, and inflationary pressures started asserting themselves.

6. Recall footnote 1 of chapter 1. INDIA IN THE WORLD TRADING SYSTEM

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Table 2.1

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Indicators of aggregate economic performance for India, 1951–55 to 2001–02

Series numbera (1)

Yearb (2)

Rate of GDCF at current pricesc (3)

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

1951–55 1956–60 1961–65 1966–70 1971–73 1974–80 1981–85 1986–90 1990–91 1991–92 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 1999–2000 2000–01 2001–02

8.96 13.22 14.22 15.00 15.50 18.46 19.70 22.60 26.30 22.50 23.60 23.10 26.00 26.80 24.50 25.00 23.00 24.30 24.00 —

Rate of GDS at current pricesd (4) 8.74 11.10 11.96 13.18 14.67 18.60 18.36 20.26 23.10 22.00 21.80 22.50 24.80 25.10 23.20 23.50 22.00 23.20 23.40 —

Rate of net capital inflow (+) at current pricese (5) 0.22 2.12 2.26 1.82 0.83 –0.14 1.34 2.34 3.20 0.50 1.80 0.60 1.20 1.70 1.30 1.50 1.00 1.10 0.60 —

Rate of GDCF at constant 1993–94 prices (6)

Rate of growth of GDPFC at Implicit 1993–94 ICOR pricesf (column 6/7) (7) (8)

14.72 19.02 19.28 22.04 21.00 22.73 20.72 21.96 25.40 22.00 22.90 23.10 26.40 27.20 25.10 26.40 25.40 26.70 26.30 —

3.85 3.83 3.38 5.63 5.00 3.86 2.90 7.60 1.90 11.05 3.40 6.69 5.66 3.61 5.84 3.75 5.30 1.30 5.10 5.90 7.30 7.30 7.90 4.80 6.60 6.0 (P)g 4.0 (Q)g 5.4 (RA)g

GDCF = gross domestic capital formation GDS = gross domestic savings ICOR = incremental capital output ratio a. Lines 1 to 9 and 19 to 20 are simple averages of the annual figures. b. 1951 refers to fiscal year (April–March) 1950–51 and so on. c. Rate of GDCF = gross domestic capital formation as a percentage of GDP at market prices. d. Rate of GDS = gross domestic savings as a percentage of GDP at market prices. e. Rate of net capital inflow = net capital inflow (+) / outflow (–) as a percentage of GDP at market prices. This equals the difference between the rate of GDCF and the rate of GDS. f. Rate of growth of GDPFC = rate of growth of GDP at factor cost at constant 1993–94 prices. g. P means a provisional estimate, Q means a quick estimate, and RA means a revised advance estimate. Sources: CSO (2001a, 2001b); Press Information Bureau, “Revised Estimates of Annual National Income and Quarterly Estimates of Gross Domestic Product, 2001–02,” Press Note, June 28, 2002.

Political and external factors exacerbated the tenuous fiscal situation. Frequent changes in the central government toward the end of the 1980s created political uncertainty and eroded confidence in the government’s ability to manage the economy and maintain stable economic policies. With the collapse of the centrally planned economies of Eastern Europe and the Soviet Union, barter trade with these economies broke down. The

26

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Figure 2.9 India’s gross fiscal deficit as a percentage of GDP percent 14 12 NFPSD 10 GGFD 8 6

CGFD

4

SGFD

2 0 1980– 1982– 1984– 1986– 1988– 1990– 1992– 1994– 1996– 1998– 2000– 81 83 85 87 89 91 93 95 97 99 01 (revised estimate) CGFD = central government fiscal deficit GGFD = gross government fiscal deficit (central and states combined) NFPSD = nonfinancial public-sector debt SGFD = state governments fiscal deficit

Source: Data provided by the World Bank.

Gulf War of 1990 hit India hard. First, the war-induced oil-price rise substantially increased the import bill. Second, stranded Indian migrant workers had to be repatriated, and these costs added to invisibles imports at the same time that the loss of their remittances reduced invisibles earnings. This deteriorating balance of payments added to the fiscal problems.

The Crisis of 1991: A Turning Point The current account deficit rose to a record 3.2 percent of GDP in 1990, and debt-service payments amounted to as much as 35.3 percent of current foreign exchange receipts (table 2.2). Foreign exchange reserves were down to a level barely enough to finance imports for 21⁄2 months. Shortterm debts amounted to a dangerously high level of 146.5 percent of

INDIA IN THE WORLD TRADING SYSTEM

27

28

Series number 1 2

4 5

7

Growth of exports (DGCI&S) 9.2 Growth of imports (DGCI&S) 13.5 (a) excluding petroleum, oil, and lubricants 3.4 Exports/imports (balance of payments percent) 66.2 Import cover of FER (months) 2.5 Percentage growth rate of volume index of total exports 11.0 Percentage growth rate of volume index of total imports 4.4 Percentage growth rate of volume index of imports of machinery and transport equipment –9.3 Short-term debt/FER (percent) 146.5 Debt-service payments as a percentage of current receipts 35.3

As a percentage of GDPMP 10 Exports 11 Imports 12 Trade balance 13 Invisibles balance (net) 14 Current account balance 15 External debt 16 Debt-service payments

5.8 8.8 –3.2 –0.1 –3.2 28.7 2.8

1991–92

1992–93

1993–94

1994–95

1995–96 1996–97

1997–98

1998–99 1999–2000 2000–01

–1.5 –19.4

3.8 12.7

20.0 6.5

18.4 23.0

20.8 28.0

5.3 6.7

4.6 6.0

–5.1 2.2

10.8 17.2

21.0 1.9

–21.9

12.0

11.2

29.5

28.3

–0.2

15.5

8.0

3.0

–5.9

86.7 5.3

77.6 4.9

84.8 8.6

74.8 8.4

74.0 6.0

69.7 6.5

69.7 6.9

72.1 8.2

67.8 8.2

75.8 8.6

7.5

6.9

15.5

13.7

31.3

7.2

–6.3

3.4

15.5

22.2

4.1

23.7

16.7

24.1

26.1

–0.6

9.8

14.6

9.5

–1.0

–3.6 76.7

34.6 64.5

25.0 18.8

130.1 16.9

15.2 23.2

–13.6 25.5

–21.3 17.2

1.6 13.2

7.9 10.3

3.6 8.2

30.2

27.5

25.6

26.2

24.3

21.2

19.1

18.0

16.2

17.1

6.7 7.7 –1.0 0.6 –0.3 37.7 3.0

7.1 9.4 –2.3 0.6 –1.7 36.6 2.9

8.3 9.8 –1.5 1.1 –0.4 33.8 3.1

8.4 11.1 –2.8 1.8 –1.0 30.9 3.4

9.2 12.3 –3.1 1.6 –1.7 27.0 3.4

8.9 12.7 –3.8 2.7 –1.2 24.5 3.2

8.7 12.5 –3.8 2.4 –1.4 24.3 2.7

8.3 11.5 –3.2 2.2 –1.0 23.6 2.6

8.4 12.4 –4.0 3.0 –1.1 22.2 2.5

9.8 13.0 –3.2 2.6 –0.5 22.3 2.9

FER = foreign exchange reserves DGCI&S = Director General of Commercial Intelligence and Statistics GDPMP = GDP at current market prices Note: Rupee equivalents of balance of payments components are used to arrive at GDP ratios. Percentages and growth rates shown in the upper panel are based on US dollar values except rows 5 to 7, which are based on quantum indices published by DGCI&S. Sources: Reserve Bank of India, Handbook of Statistics on the Indian Economy, 2001, for rows 1, 2, 2(a), and 5 to 7. Government of India, Ministry of Finance, Economic Survey 2001–02 and earlier years, for remaining rows.

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8 9

1990–91

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6

Indicator

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3

Selected indicators of the external sector for India, 1990–91 to 2000–01

02--Chapter 2--11-78

Table 2.2

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foreign exchange reserves by the end of March 1991. The rate of inflation soared, exceeding 10 percent in 1990. Expectations of an imminent devaluation of the rupee led to the withdrawal of deposits by nonresident Indians. A specter of default on short-term loans and a downgrading of India’s credit rating loomed. Although the external payments crisis provided the immediate impetus for change, other political factors had been pushing India toward radical policy reforms. First, the country’s cautious and limited deregulation of the 1980s had delivered more rapid growth. Although this growth turned out not to be sustainable, it made further liberalization of the policy regime politically acceptable. Second, the collapse of the Soviet Union not only eroded crucial external support for India’s position on matters of its security and national interest but also reduced the country’s access to defense supplies on concessional terms. More important, the collapse of the world’s leading centrally planned economy undermined India’s faith in central planning. Several perceptive observers—some in government (see Jha 1980 and Dhar 1990), others independent academics (the earliest being Bhagwati and Desai 1970 and Bhagwati and Srinivasan 1975)—had drawn attention to the fact that state controls on economic activity and inward orientation had cost India dearly in slow growth. Their voices would have continued to be ignored had it not been for the collapse of the Soviet Union and, equally important, China’s spectacular growth after the 1978 reforms that opened its planned economy to the rest of the world and allowed a greater role for markets. The fear of being left behind by China led policymakers to realize that this crisis, unlike the earlier ones, could not be handled without bringing about radical changes in the economic policy regime. The severity of the economic crisis of 1991 provided an opportunity for the government to undertake major microeconomic policy reforms of long-standing restrictive domestic investment and international trade policies even though it did not have an absolute majority in Parliament. Until then, those who received economic rents from the discretionary control regime, predictably, resisted change. As long as there was no economic pressure to force the government’s hand, those in power did not wish to take a politically risky task of changing the status quo. The 1991 crisis demonstrated clearly that the status quo was not a viable option. As we discuss below, the reforms indeed heralded a major change in the country’s development strategy. India gradually abandoned the use of quantitative controls in economic management in favor of market-based instruments. There was a decisive move away from inward orientation and toward greater integration with the global economy. Finally, the reforms signaled a shift away from an overstretched, overextended, rigid, and inefficient public sector and toward greater reliance on the private sector. The hallmark of the pre-1991 policy regime was that there were few economic activities except for those in agriculture and the unorganized INDIA IN THE WORLD TRADING SYSTEM

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sector that could be undertaken without government permission. The Indian economy was correctly regarded as one of the most regulated economies in the world. The post-1991 policy regime, in sharp contrast, restricted the requirement of government permission for private investment to a few explicitly specified activities. All other activities were implicitly left free from the purview of government approval.

The Immediate Response to the Crisis Manmohan Singh, a professional economist and an experienced technocrat, assumed charge of the finance portfolio after the mid-1991 parliamentary elections and immediately began the process of macroeconomic stabilization. The gross fiscal deficit of the central government fell from 7.9 percent of GDP in 1990 to 5.6 percent by 1992, nonoil imports declined by 22 percent in 1991, and the current account deficit dropped from 3.2 percent of GDP in 1990 to 0.3 percent in 1991. The stock of short-term debt was reduced from 146.5 percent of foreign exchange reserves in March 1991 to 76.7 percent by 1992 and 64.5 percent by 1993 (table 2.2). Real GDP growth dipped from 5.6 percent in 1990 to 1.3 percent in 1991 during this period of fiscal contraction but recovered quickly to 5.1 percent in 1992 (table 2.3). Table 2.2 shows that most of the key indicators of the external sector had also improved by 1993. The import cover of foreign exchange reserves rose to more than 8 months from 2.5 months in 1990–91. The debtservice ratio fell from 35.3 percent in 1990–91 to 25.6 percent in 1993–94. The average current account deficit in the 1990s was about 1 percent, compared with more than 2 percent in the 1980s. Private capital inflows increased as external assistance organized by the World Bank and International Monetary Fund decreased. In 1991, nearly 78 percent of $3.9 billion in total capital inflows came from external assistance. In contrast, nondebt-creating private capital inflows formed a little more than half of the total $10.2 billion in capital inflows in the period 1999–2000 (table 2.4). The fiscal situation showed less progress. The gross fiscal deficit of the central government drifted downward in the first half but climbed upward in the second half of the 1990s, and inflation fell into the single digits. But the fiscal position of the states deteriorated progressively (figure 2.9).

Longer-Term Reforms Stabilization measures to tackle the immediate macroeconomic crisis naturally focused on aggregate demand management alone. Once the crisis eased, the deeper problem of perverse microeconomic incentives for private economic agents that had been generated by the highly restrictive and heavily distortionary policy regime of the pre-1991 period had to be 30

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02--Chapter 2--11-78

India’s GDP growth, 1981–2001 (percent per year, at constant 1993–94 prices)

Sector or measure

1991–92

5.75 4.4 8.6 7.0 7.9

5.6 4.1 10.7 6.1 5.0

1.3 –1.5 3.7 –3.6 –2.3

5.1 5.8 1.2 4.1 3.1

9.0 4.8 6.5

7.4 11.8 5.3

10.4 2.1 4.8

7.0

1.3

2.1

1992–93 1993–94

1996–97 1997–98 1998–99

1999– 2000a

2000–01b

1994–95

1995–96

5.9 4.1 1.4 8.5 11.5

7.3 5.0 9.3 11.9 14.4

7.3 –0.9 5.9 14.9 14.7

7.9 9.6 0.5 9.7 10.8

4.8 –2.4 9.8 1.5 –1.0

6.6 7.1 1.3 2.5 1.9

6.0 0.5 3.5 4.4 4.0

4.0 –0.2 3.3 6.7 6.9

7.0 3.5 5.4

7.4 0.6 7.7

9.4 5.5 7.1

6.8 6.2 10.5

5.4 2.1 7.2

7.9 10.2 9.8

6.4 6.1 8.2

6.7 8.2 9.7

6.2 5.3 4.8

4.9

2.6

1.3

6.8

4.1

14.5

10.3

12.2

4.3

a. Provisional estimate. b. Quick estimate. Sources: CSO (2001a, 2001b); Press Information Bureau, “Revised Estimates of Annual National Income and Quarterly Estimates of Gross Domestic Product, 2001–02,” Press Note, June 28, 2002.

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1990–91

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GDP at factor cost Agriculture and allied Mining and quarrying Manufacturing, of which Registered Electricity, gas, and water Construction Services, of which Public administration and defense

1981–90 average

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Table 2.3

31

Composition of capital account inflows to India, 1990–91 to 2000–01

Variable Total capital inflows (millions of US dollars)

1993–94 1994–95 1995–96

1996–97 1997–98

1998–99

1999–2000

2000–01

7,056

3,910

3,876

8,895

8,502

4,089

12,006

9,844

8,565

10,242

9,023

1.5

3.4

14.3

47.6

57.9

117.5

51.3

54.8

28.2

50.7

56.6

1.4

3.3

8.1

6.6

15.8

52.4

23.7

36.2

29.0

21.2

26.0

0.1

0.1

6.2

41.0

42.1

65.1

27.6

18.6

–0.8

29.5

30.6

83.3

77.5

39.9

21.3

25.0

57.7

61.7

52.4

62.7

29.5

69.3

31.3

77.7

48.0

21.4

17.9

21.6

9.2

9.2

9.6

8.8

4.7

31.9

37.2

–9.2

6.8

12.1

31.2

23.7

40.6

50.9

3.1

44.5

15.2

–13.1

–27.8

–8.6

4.6

1.2

7.0

–1.0

–8.7

3.7

1.2

27.0

27.9

11.4

20.3

20.9

25.7

(2) Debt-creating inflows (percent) a. External assistance (percent) b. External commercial borrowingsa (percent) c. Short-term credits (percent) d. NRI dollar depositsb (percent) e. Rupee debt service (percent)

21.8

7.4

51.6

13.5

2.0

–16.9

–31.7

–22.7

–11.8

–11.6

–23.3

–6.1

–7.8

–9.4

–6.9

–6.8

(3) Other capitalc (percent) Total (1 to 3)

15.2 100.0

19.1 100.0

45.8 100.0

31.1 100.0

17.1 100.0

–75.2 100.0

–13.0 100.0

–7.2 100.0

9.1 100.0

19.8 100.0

–25.9 100.0

84.7

112.9

121.6

67.6

53.3

33.7

65.4

82.4

109.5

66.8

68.2

Stable inflowsd (percent) NRI = nonresident Indians

a. Refer to medium- and long-term borrowings. b. Includes NRI deposits. c. Includes delayed export receipts, advance payments against imports, loans to nonresidents by residents, and banking capital. d. Stable inflows are defined to represent capital inflows excluding portfolio flows and short-term trade credits. Source: Reserve Bank of India, Handbook of Statistics on the Indian Economy, 2001.

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1992–93

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1991–92

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Of which: (1) Non-debt-creating inflows (percent) a. Foreign direct investment (percent) b. Portfolio investment (percent)

1990–91

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32

Table 2.4

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reformed as well. There were three major areas of reform: domestic industrial investment policy, foreign investment regulations, and foreign trade.

Liberalization of Industrial Investment The industrial policy statement of July 1991 abolished the requirement of prior government approval for all private investments except those in 18 industries and allowed large industrial houses to expand, diversify, and merge without prior government approval.7 Only 421 of the 9,227 approvals granted between 1988 and 1991 for industrial investment to domestic firms would have required approval under the post-1991 policy (World Bank 1992). This comparison does not take into account the number of the rejected applications that could have been automatically approved under the new policy. The pre-1991 restriction of foreign investment to certain priority sectors (then only 40 percent of equity) was relaxed, with automatic approval granted to new foreign investments of up to 51 percent of equity and permits for foreign technology agreements in 34 core sectors. Permission for foreign investment outside the domain of the automatic route was also granted liberally in most cases. Indian firms in good standing have also been allowed (since February 1992), with government approval, to issue equity and convertible bonds abroad through Global Depository Receipts (GDRs) and American Depository Receipts (ADRs) respectively in European and US capital markets. Registered foreign institutional investors have also been permitted to purchase limited numbers of equity and debt securities directly on the local market since September 1992. The effective deregulation, however, is not as marked for foreign private investment as for domestic private investment. Of the 1,637 approvals on foreign investment during the 2-year period 1988–90, as many as 888 (nearly 54 percent) would still have required government approval under the post-1991 policy (World Bank 1992). Thus, in comparison with the liberalization of industrial investment by domestic firms, foreign private investment was not liberalized to the same extent.

Trade and Exchange Rate Reforms The pre-1991 trade and exchange rate regime protected domestic manufacturing industries through restrictive import policy. Sixty-five percent of all imports (and 90 percent of manufacturing imports) were subject to nontariff barriers (NTBs) in 1990. The import-weighted average tariff was 87 percent, and the unweighted average tariff rate was 128 percent, with

7. Several of the industries on the list of 18 restricted industries were included on it for environmental or security reasons, whereas others were put on it because investment in these would require imports and thus worsen the balance of payments. INDIA IN THE WORLD TRADING SYSTEM

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a wide dispersion of 41 percent (table 2.5)—the highest tariff rate was 355 percent.8 Customs revenue in 1990–91 accounted for as much as 4 percent of GDP and about 71 percent of the customs revenue accrued from tariff rates ranging between 60 and 110 percent (World Bank 1992). The net results were a bias against exports and distortions in the allocation of resources. In 1991, the nominal exchange rate of the rupee was devalued by 22.8 percent relative to a trade-weighted basket of currencies. The resulting effective devaluation was only 16.3 percent because the Indian inflation rate was higher than that in trading partner countries. Temporary measures to deal with the balance of payments (e.g., foreign exchange licensing, import compression, export-linked imports, and a dual exchange rate system introduced in the context of the external payments crisis of 1991) were withdrawn soon thereafter. Market forces began to play a larger role in determining the exchange rate when partial convertibility of the rupee for current account transactions (i.e., convertibility under IMF Article VIII) was introduced in 1993. The deliberate depreciation of the rupee undertaken to correct prereform overvaluation got eroded in the second half of the 1990s despite some adjustment during the East Asian crisis. Extension by Seddon and Srinivasan (2001) of Srinivasan’s (1998b) work on the relationship between exports and the exchange rates finds that the negative elasticity of exports with respect to exchange rate movements did not change significantly from the 1980s to the 1990s. We can thus attribute at least part of the slowdown in the US dollar value of exports in the last 4 years of the 1990s to REER appreciation. All export subsidies and most of the QRs on intermediate and capital goods imports were withdrawn in 1991. The long list of imports subject to QRs and other restrictions was replaced in 1991 by a considerably narrower (though still long) list of mostly consumer goods. The office of the chief controller of imports and exports was superseded by that of the director general of foreign trade, whose principal mandate is to promote exports rather than control both imports and exports. The ambit of periodical export and import policy was extended from 3 to 5 years. The level and dispersion of tariffs have been reduced in phases. In the prereform period (about the end of 1980s), QRs protected goods amount8. These figures are from A. Panagariya, “Doha and India: Retrospect and Prospect,” Economic and Political Weekly 37, no. 4: 279–84 (January 26–February 1, 2002). There is no single satisfactory way to measure protection for domestic import-competing industries from a variety of simultaneous import restrictions. Thus, NTBs, when binding, provide unlimited protection without reference to costs. An import-weighted average tariff rate tends to understate the degree of protection, especially when prohibitively high tariff rates are common. An unweighted average partially corrects for this bias but does not take account of differing impacts of nonuniform tariff rates on imports. The standard deviation of tariff rates gives an idea of the degree of distortions in relative prices resulting from nonuniform tariff rates. 34

REINTEGRATING INDIA WITH THE WORLD ECONOMY

India’s tariff structure, 1990–91 to 1999–2000 (percent; standard deviation in parentheses) 1994–95

1995–96

1996–97

1997–98b

1998–99

1999–2000

106 (48) n.a.

59 (49) n.a.

142 (33) 133 (42) 109 (32)

92 (42) 104 (25) 86 (26)

39 (39) 71 (24) 76 (36) 77 (22) 58 (24)

31 (30) 48 (25) 59 (33) 59 (17) 42 (20)

25.1 (24.9) 30.0 (15.6) 45.4 (26.0) 43.7 (13.5) 33.1 (12.4)

25.6 (21.1) 24.8 (11.9) 45.4 (27.1) 38.8 (13.2) 33.8 (12.2)

24.6 (17.7) 24.4 (11.9) 39.8 (20.5) 34.7 (10.3) 29.7 (9.4)

29.6 (18.8) 29.4 (12.3) 45.9 (20.7) 40.7 (11.1) 35.3 (10.2)

29.2 (16.6) 26.6 (12.1) 42.9 (18.9) 41.2 (10.5) 35.3 (8.2)

Import-weighted average Whole economy Agricultural products Mining

87 70 n.a.

64 30 n.a.

47 25 33

33 17 31

27.2 14.9 27.6

24.6 14.7 22.0

25.4 14.0 21.9

29.7 16.1 19.5

30.2 17.7 17.7

Consumer goods Intermediate goods Capital goods

164 117 97

144 55 76

33 40 50

48 31 38

43.1 25.0 28.7

39.0 21.9 28.8

33.8 26.1 24.7

39.3 31.5 30.1

32.1 31.9 32.2

Mean Agricultural products Mining Consumer goods Intermediate goods Capital goods

n.a. = not available a. In 1990–91 and 1992–93, mining is included in intermediates. b. Figures for 1997–98 include the 3 percent special duty imposed in September 1997. Note: The total customs duty is calculated as the sum of the basic customs duty, a surcharge of 10 percent on the basic customs duty, and the special additional duty. The special additional duty is levied on the value of imports as well as the basic duty value, the surcharge value, and the additional duty value. Source: World Bank (2000a).

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1993–94

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1992–93a

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1990–91a

Sector

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Table 2.5

35

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ing to as much as 93 percent of total tradable GDP and 90 percent of manufacturing (Pursell and Sharma 1996). Pursell and Sharma’s study of 13 broad product categories in 26 developing countries found that India’s actually applied rate ranked highest or second highest for all of the product categories as of 1993. India’s average tariff rate in absolute terms was more than twice as high as the average of actually applied rates for all product categories. The post-Uruguay Round bound rate negotiated by India was invariably higher and for some products much higher than the average of the bound rates in the study after Uruguay. The average applied tariff rate of 51.6 percent for India for all of the product categories combined was not only the highest but also nearly three times as high as the average level of 19.2 percent for 28 developing countries. The share of QR-protected goods in total tradable GDP had come down to 66 percent by May 1995, whereas that for manufacturing GDP dropped to 36 percent (most of it accounted for by QRs on consumer goods) by May 1996. The peak tariff rate was reduced to 45 percent in 1997 from 355 percent in 1990 and came down further to 35 percent in the budget for 2002– 03. The finance minister announced in his budget speech on February 28, 2002, that by 2004–05 only two basic rates of customs duties—10 percent on raw materials parts and components and 20 percent on final products— would be levied (GOI-MoF 2002b). It is interesting that China’s import-weighted tariff after its accession to the WTO in 2002 was 6.8 percent on its entire merchandise trade (Ianchovichina and Martin 2002, table 3). It is much lower than India’s current import-weighted tariff, as well as its projected rates. While standard deviation of tariff rates showed a steady decline, unweighted as well as import-weighted average tariff rates decreased during the 1990–96 period but began to rise again after 1996 (table 2.5, upper panel). The reduction in the standard deviation during the period 1990–99, indicative of a corresponding reduction in the degree of distortions in resource allocation, was greatest for intermediate and capital goods (from 42 to 10.5 and 32 to 8.2, respectively) and least for consumer goods (from 33 to 18.9). There has also been a decline in the number of exemptions (or use-based concessions) on tariff rates. The list of restricted or banned exports has been shortened significantly, and taxes on some mineral and agricultural exports have been abolished. Agriculture alone remained highly protected after the initial round of reforms; the mean 1995 share of 84 percent was only marginally lower than its prereform level of 94 percent. Quotas and stipulations of minimum export prices for agricultural exports persist.9

9. A Cabinet decision to remove quotas on wheat, wheat products, coarse grain, butter, and non-basmati rice was announced on February 5, 2002 (Times of India, New Delhi, February 6, 2002).

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The latest Export-Import Policy Statement for 2002–07, announced on March 31, 2002, proposes to remove all QRs on exports except for a few sensitive items. There were also several changes in NTBs on imports. The monopoly of government agencies on most canalized imports was abolished as of April 2001. Domestic content requirements on foreign investors have been removed. The official government preference for domestic producers in procurement has been dropped. Table 2.6 documents coverage on NTBs in the late 1990s. The available evidence, albeit scanty, on international comparisons of tariffs is presented in table 2.7. The unweighted average and maximum tariffs can be treated as crude indicators of openness across countries. A comparison across 13 developing countries for 1994 by Chopra et al. (1995) showed that India had the second highest level of the maximum tariff (65 percent), next only to Egypt, and the highest level of average tariff (55 percent). The average tariff level, in contrast, ranged between 10 and 15 percent for Argentina, Brazil, Chile, Malaysia, South Korea, and Thailand. World Bank (2000a, annex table 6.3) provides the sectoral shares of imports affected by NTBs.10 NTBs covered 95 percent of the imports in sectors covered in the study in 1988, compared with 24 percent in 1999.11 NTB coverage varied across sectors—from 56 percent in consumer nondurables to 27 percent for consumer durables, 16 percent for basic goods, and 14 percent for capital goods in 1999. There has been some reversal of this liberalizing trend in recent years, however, particularly in the case of intermediate goods. The tariff on these increased from 21.9 percent in 1996 to 31.9 percent in 1999 (table 2.5, lower panel). A more recent international comparison at the economywide level for 2000 or thereabouts shows that India has the highest weighted average tariff rate of 28.5 percent with nearly all (93.1 percent) tariff lines attracting tariffs exceeding 15 percent (World Bank, Global Development Finance 2002: Analysis and Summary Tables, table 6.6). India also reserved itself some room to raise applied tariffs by binding tariffs at much higher rates than those being applied as part of the Uruguay Round agreement. Mostly, peak tariff rates replaced the removal of QRs in two installments in April 2000 and April 2001 mostly on consumer goods. Six hundred of 10. This is a less satisfactory indicator than the QR-protected shares of tradable GDP, because imports are directly affected by the QRs as well as by tariff rates. 11. Annex table 6.3 in World Bank (2000a) presents two estimates, which vary because of the method of dealing with different types of NTBs. For each method, the weighted as well as the simple (unweighted) average is presented. Because the direction of change does not differ, we present only one set, namely, the weighted average where all NTBs have been assigned an equal weight of 100 percent.

INDIA IN THE WORLD TRADING SYSTEM

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Table 2.6

Types of nontariff barriers (NTBs) imposed on India’s imports, 1996–2001 (number of tariff lines, 10-digit level) As of April 1, 1997

As of April 1, 1998

As of April 1, 1999

As of April 1, 2000

As of April 1, 2001

Number Percentage Number Percentage Number Percentage Number Percentage Number Percentage Number Percentage of lines share of lines share of lines share of lines share of lines share of lines share

Prohibited Restricted Canalized SIL Free Total

59 2,984 127 765 6,161 10,096

0.6 29.6 1.2 7.6 61.0 100.0

59 2,322 129 1,043 6,649 10,202

0.6 22.8 1.3 10.2 65.1 100.0

59 2,314 129 919 6,781 10,202

0.6 22.7 1.3 9.0 66.4 100.0

59 1,183 37 886 8,055 10,220

0.6 11.5 0.4 8.7 78.8 100.0

n.a. = not available SIL = Sterlite Industries (India) Limited a. Includes 29 tariff lines shifted to state trading. Note: Tariff lines are per the Harmonized System of India Trade Classification for exports and imports. Source: Ministry of Finance, Government of India, Economic Survey, 2002, box 6.3, p. 142.

59 968 34 226 8,854 10,141

0.6 9.5 0.3 2.2 87.3 100.0

59 479 n.a. n.a. 9,611a 10,149

0.5 4.7 n.a. n.a. 94.7 100.0

Page 38

Type of NTB

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As of April 1, 1996

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Table 2.7

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Page 39

International comparison of tariff barriers

Standard deviation

Importweighted mean tariff (percent)

Percentage share of tariff lines with tariffs above 15 percent

Country

Year

Simple mean tariff (percent)

India

1990 1999

79.0 32.5

43.6 12.3

49.6 28.5

97.0 93.1

Bangladesh

1989 2000

106.6 21.3

79.3 13.6

88.4 21.0

98.2 51.8

China

1992 2000

41.0 16.3

30.6 10.7

33.2 14.7

77.6 4.2

Indonesia

1989 2000

21.9 8.4

19.7 10.8

13.0 5.2

50.3 11.2

South Korea

1988 1999

14.8 8.6

5.3 5.9

10.5 5.9

12.5 0.7

Malaysia

1988 1997

17.0 9.3

15.1 33.3

9.4 6.0

46.7 24.7

Nepal

1993 2000

21.9 17.9

17.8 20.9

15.9 17.7

58.9 18.7

Pakistan

1995 1998

50.9 46.6

21.5 21.2

46.4 41.7

91.4 86.3

The Philippines

1989 2000

28.0 7.6

14.2 7.7

22.4 3.8

77.2 8.8

Sri Lanka

1990 2000

28.3 9.9

24.5 9.3

26.9 7.4

51.7 22.0

Thailand

1989

38.5

19.6

33.0

72.8

Source: World Bank, Global Development Finance 2002: Analysis and Summary Tables, table 6.

nearly 800 of the 1,556 tariff lines (mostly consumer goods) under various restrictive lists of imports in April 1999 were freed by April 2000 and the remaining by April 1, 2001 (table 2.6).12 Despite wide-ranging trade liberalization during the past decade in comparison with the pre-1991 situation, Indian tariff rates continue to be much higher than those in the rapidly growing countries of East and Southeast Asia.

12. QRs have been replaced by often peak tariff rates. According to a calculation by the Indian Planning Commission, the weighted average duty on consumer goods increased from 37.4 percent in 1999–2000 to 56.2 percent in 2001–02 and 67.1 percent in 2001–02, that on agricultural products from 24.4 percent (1999–2000) to 58.7 percent (2000–01) and 57.7 percent (2001–02). See GOI-PC (2001b). By the way, the term “peak tariff rate” as used in Indian official documents is peculiar because the same documents often cite individual tariffs that exceed the peak! INDIA IN THE WORLD TRADING SYSTEM

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Outcomes of Reforms India has had some limited success in attracting foreign direct investment (FDI) since the reforms of the 1990s. FDI (based on Indian definition and data source) has increased from an annual average of only about $200 million between 1985 and 1991 to a peak of $3.6 billion in 1997 and has slowed down since then to under $2.5 billion (table 2.8). Recent data suggest that FDI inflow increased by 66 percent to $4.06 billion in 2001– 02 compared with $2.46 billion in 2000–01 (The Hindu, National Section, July 24, 2002; http://www.hinduonnet.com/thehindu/2002/07/24/stories/ 200207240434110.htm). FDI flows remain highly regulated. Seven-tenths came from the nontransparent case-by-case discretionary approval route of the Foreign Investment Promotion Board and very little through the automatic route open mostly for infrastructure and other industries deemed essential by the policymakers. In addition, the relatively more stable component of private foreign investment accounted for only 43 percent of total nondebt private flows (comprising FDI and portfolio flows), which amounted to $38.9 billion during the 9-year period 1992–2000. Data from Indian and international sources do not exactly match in magnitude because of definitional differences, though broad trends are similar. They are relevant for placing the Indian performance in an international perspective. This is attempted in tables 2.9 to 2.13 for different types of long-term capital flows. Total long-term resource flows to developing countries more than doubled after 1992 and peaked at $341 billion in 1997 before declining in the aftermath of the Asian currency crisis (table 2.9). FDI flows to developing countries (table 2.10), after showing a dramatic rise from $47 billion in 1992 to $172.5 billion in 1997, slowed down considerably during the next 3 years. Portfolio investment flows to developing countries (table 2.11) have been fluctuating from year to year, but in magnitude have been much less important than FDI. Official debt flows to developing countries (table 2.12), somewhat higher in magnitude than portfolio flows, varied between $30 and $56 billion without showing any trend. Finally, private debt flows to developing countries (table 2.13), which have been replacing official debt flows in financing infrastructure investment, more than doubled between 1992 and 1996 before slowing down to a trickle in 1999 and 2000. Indian policymakers have sought these long-term external resource flows to complement domestic resources. How did India perform in international comparisons? A large share (from 24 to 34 percent) of FDI—the dominant and relatively most stable component in long-term resource flows to developing countries—went to China in the 1990s. The peak Indian share was just 2 percent in 1995 and again in 1997. India’s share of the more fluctuating private portfolio investment was, interestingly, higher than its share of FDI, but even in this component, barring 4 out of 40

REINTEGRATING INDIA WITH THE WORLD ECONOMY

Foreign investment inflows to India by various categories (millions of US dollars)

Type of investment

1992–93

1993–94

1994–95

1995–96

1996–97

1997–98

1998–99

1999–2000

Cumulative, 1992–93 to 2000–01a 2000–01

1,314 171 701 442 n.a.

2,144 169 1,249 715 11

2,821 135 1,922 639 125

3,557 202 2,754 241 360

2,462 179 1,821 62 400

2,155 171 1,410 84 490

2,365 454 1,456 67 362

16,894 15,354 11,815

B. Portfolio investment FIIsc GDRs/ADRsd Offshore funds and others

244 1 240 3

3,567 1,665 1,520 382

3,824 1,503 2,082 239

2,748 2,009 683 56

3,312 1,926 1,366 20

1,828 979 645 204

–61 –390 270 59

3,026 2,135 768 123

2,760 1,847 831 82

21,248

Total A + B Share of SIA/FIPB in FDI Share of FDI in total

559 70.5 56.4

4,153 47.8 14.1

5,138 53.3 25.6

4,892 58.3 43.8

6,133 68.1 46.0

5,385 77.4 66.1

2,401 74.0 102.5

5,181 65.4 41.6

5,125 61.5 46.1

38,142 69.9 44.3

1,072

n.a. = not available FDI = foreign direct investment FIIs = foreign institutional investors GDRs/ADRs = Global Depository Receipts and American Depository Receipts NRIs = nonresident Indians RBI = Reserve Bank of India SIA = Secretariat for Industrial Approval FIPB = Foreign Investment Promotion Board a. Preliminary estimate. b. Acquisition of shares in foreign direct investment relates to the acquisition of shares of Indian companies by nonresidents under section 29 of the Foreign Exchange Regulation Act and section 5 of the Foreign Exchange Management Act of 1999. c. FII portfolio investments represent fresh inflow/outflow of funds by FIIs. d. GDRs/ADRs represent GDR amounts raised abroad by Indian corporates. 41

Source: Ministry of Finance, Government of India, Economic Survey, 2001–02, and earlier years.

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586 89 280 217 n.a.

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315 42 222 51 n.a.

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A. Direct investment RBI automatic route SIA/FIPB route NRIs (40 and 100 percent) Acquisition of sharesb

02--Chapter 2--11-78

Table 2.8

02--Chapter 2--11-78

42

Total long-term resource flows to selected developing countries, 1990–2000 (billions of US dollars)

Country or group

1993

1994

1995

1996

1997

1998

1999

2000a

99.3 4.719 10.082 5.901 4.672 1.184 1.351

153.7 5.204 23.969 7.945 4.175 6.093 7.753

220.9 7.264 44.434 3.622 8.226 10.923 8.603

222.4 8.722 47.847 9.594 4.888 8.680 12.244

260.2 4.437 51.902 12.901 10.638 10.542 13.045

306.6 7.450 54.745 15.560 14.228 12.031 19.359

341.4 6.925 65.407 11.588 9.777 9.187 22.383

336.7 7.621 45.299 –0.420 9.381 5.695 13.199

271.8 3.355 42.550 –4.685 5.399 3.618 9.361

261.1 9.928 60.525 –9.156 –0.525 3.411 13.875

4.75

3.39

3.29

3.92

1.70

2.42

2.03

2.26

1.23

3.80

10.15

15.42

20.11

21.51

19.95

17.86

19.16

13.45

15.65

23.18

a. Preliminary estimate. Sources: World Bank (2000b); World Bank, Global Development Finance 2002: Analysis and Summary Tables.

Page 42

Percentage share of India in all developing countries Percentage share of China in all developing countries

1992

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All developing countries India China Indonesia Thailand Malaysia South Korea

1990

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Table 2.9

02--Chapter 2--11-78

Foreign direct investment flows to selected developing countries, 1990–2000 (billions of US dollars) 1992

1993

1994

1995

1996

1997

1998

1999

2000a

All developing countries India China Indonesia Thailand Malaysia South Korea

24.3 0.162 3.487 1.093 2.444 2.333 0.788

47.1 0.277 11.156 1.777 2.113 5.183 0.727

66.6 0.550 27.515 2.004 1.804 5.006 0.588

90.0 0.973 33.787 2.109 1.366 4.342 0.810

106.8 2.144 35.849 4.346 2.068 4.178 1.776

130.8 2.426 40.180 6.194 2.336 5.078 2.326

172.5 3.577 44.236 4.677 3.895 5.137 2.844

178.3 2.635 43.751 –0.356 7.315 2.163 5.412

184.4 2.169 38.753 –2.745 6.213 1.533 9.333

166.7 2.315 38.399 –4.550 3.366 1.660 9.283

0.67

0.59

0.83

1.08

2.01

1.85

2.07

1.48

1.18

1.39

14.35

23.68

41.31

34.72

33.57

30.72

25.64

24.54

21.02

23.03

Percentage share of India in all developing countries Percentage share of China in all developing countries a. Preliminary estimate.

Sources: World Bank (2000b); World Bank, Global Development Finance 2002: Analysis and Summary Tables.

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1990

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Country or group

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Table 2.10

43

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Table 2.11

Portfolio investment flows to selected developing countries, 1990–2000 (billions of US dollars) 1992

1993

1994

1995

1996

1997

1998

1999

2000a

All developing countries India China Indonesia Thailand Malaysia South Korea

3.70 0.105 0 0.312 0.449 0.293 0.518

14.10 0.241 1.194 0.119 0.004 0.385 3.045

51.00 1.840 3.818 2.452 3.117 3.700 6.029

35.20 4.729 3.915 3.672 –0.538 1.320 2.525

36.10 1.517 2.807 4.873 2.154 2.299 3.559

48.90 4.938 3.466 3.099 1.551 4.353 3.700

30.10 2.116 8.457 0.298 –0.308 –0.489 1.257

15.60 0.342 1.273 0.250 2.341 0.592 4.096

34.50 1.302 3.732 1.273 2.527 0.522 12.426

50.90 2.117 22.198 0.379 10.044 0.542 7.784

2.84

1.71

3.60

13.43

4.20

8.99

7.03

2.19

3.77

4.16

0

8.47

7.49

11.12

0.80

7.09

28.10

8.16

10.82

43.61

Percentage share of India in all developing countries Percentage share of China in all developing countries a. Preliminary estimate.

Sources: World Bank (2000b); World Bank, Global Development Finance 2002: Analysis and Summary Tables.

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1990

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Country or group

02--Chapter 2--11-78

Official debt flows to selected developing countries, 1990–2000 (billions of US dollars)

Country or group

1993

1994

1995

1996

1997

1998

1999

2000a

55.90 4.044 6.346 0.422 –1.115 –1.899 0.601

54.30 4.158 11.095 2.647 0.222 –1.095 2.071

53.40 3.823 12.500 1.198 0.666 0.444 –0.266

46.00 1.664 9.808 2.081 0.248 0.286 1.562

54.10 –0.811 12.371 0.951 0.871 2.450 2.191

30.30 –0.508 10.725 –0.595 1.284 0.264 3.300

40.70 –0.911 11.138 0.594 6.929 1.699 11.989

53.40 3.946 2.497 3.243 3.926 0.489 9.760

47.40 1.517 2.038 0.605 1.627 0.686 –7.976

35.30 4.979 1.769 –0.297 –0.038 0.869 –10.983

7.23

7.66

7.16

3.62

–1.50

–1.68

–2.24

7.39

3.20

14.10

11.35

20.43

23.41

21.32

22.95

34.60

27.37

4.68

4.30

–0.84

a. Preliminary estimate. Sources: World Bank (2000b); World Bank, Global Development Finance 2002: Analysis and Summary Tables.

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Percentage share of India in all developing countries Percentage share of China in all developing countries

1992

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All developing countries India China Indonesia Thailand Malaysia South Korea

1990

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Table 2.12

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Table 2.13

Private debt flows to selected developing countries, 1990–2000 (billions of US dollars)

Country or group

1993

1994

1995

1996

1997

1998

1999

2000a

15.700 –0.104 0 3.791 2.702 0.415 –0.561

38.200 –0.053 0.198 3.105 1.675 1.570 1.907

50.000 0.565 0.332 –2.252 2.538 1.714 2.248

51.200 0.744 0 1.515 3.706 2.697 7.347

63.300 1.023 0.544 2.481 5.446 1.604 5.514

96.500 0.545 0.129 6.067 8.959 2.329 10.032

98.100 1.594 1.311 5.821 –0.827 2.828 6.921

89.400 0.208 –2.558 –3.826 –4.282 2.429 –6.073

5.600 –0.608 –2.820 –4.238 –5.034 0.845 –4.425

8.200 0.051 –2.144 –5.050 –4.935 0.331 7.790

–0.66

–0.14

1.13

1.45

1.63

0.55

1.62

0.23

–10.86

0.62

0.0

0.52

0.66

0.0

0.86

0.13

1.34

–2.86

–50.36

–26.15

a. Preliminary estimate. Sources: World Bank (2000b); World Bank, Global Development Finance 2002: Analysis and Summary Tables.

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1992

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All developing countries India China Indonesia Thailand Malaysia South Korea

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9 years covered in table 2.11, China’s share has been higher. The same holds true for official flows. India fared better only in private debt flows. Not just China, however, but also even smaller Southeast Asian economies like Indonesia, Malaysia, and Thailand often managed to attract more in all the categories of long-term resource flows than India until they were hit by the recent East Asian currency crisis. In fact, even since the crisis, Thailand has continued to attract more FDI than India. India’s limited success in long-term capital inflows, particularly FDI, despite its declared intentions in this regard, might be attributed to three factors. First, heavy regulations have not completely gone after liberalization. Second, there is resistance to FDI by domestic industry in competing areas. Third, inadequacies in physical and legal infrastructure limit India’s absorptive capacity, and hence its attractiveness to private foreign investors. This assessment of India’s limited absorptive capacity is confirmed by the Reserve Bank of India (RBI 2001, para. 6.52). Between 1992 and 2000, India received cumulative total net capital inflows of $79 billion. The cumulative current account deficit (averaging about 1 percent of GDP) during the same period works out to $36.5 billion, so that $42.5 billion was added to the foreign exchange reserves. Although some additions to reserves were indeed prudent, it is arguable that the still continuing additions—total reserves were close to $60 billion in mid-July 2002 (The Hindu, Business Section, July 28, 2002; http://www.hinduonnet.com/ thehindu/2002/07/28/stories/2002072801351500.htm)—are excessive and reflects the poor domestic investment climate. Had the climate been more buoyant, more machinery, equipment, raw material, and components would have been imported, leading to a larger current account deficit during this period. India’s poor investment climate has resulted in lower corporate investment and lower overall growth since the period 1996–97. Leaving China aside, much smaller countries than India like Indonesia, Malaysia, and Thailand have absorbed larger magnitudes of net capital inflows in most years to step up investment and maintain higher growth rate. Even though the tempo of their growth suffered in the aftermath of the currency crisis, their living standards remained much higher than India’s and they recovered quickly to resume their growth path. Their experience highlights the imperative of relaxing domestic constraints on absorptive capacity (to be discussed in chapter 5).

Effects on the Level and Composition of Trade The aggregate value of exports (in US dollar terms) grew at an average rate of 19.7 percent annually from 1993 to 1995 before falling dramatically to average 1.6 percent a year during the period 1996–99. There has been some recovery since then, with growth rates being 10.8 and 21 percent respectively in the subsequent 2 years. Non-POL (mostly production INDIA IN THE WORLD TRADING SYSTEM

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related) imports followed a similar pattern: growing at 23 percent in 1993–96 and falling to 7.8 percent in 1999–2000 but without recovery in the subsequent two years (GOI-MoF Economic Survey 2002a, table 2.1). Postliberalization growth of exports and imports encouraged competition and innovation in addition to shifting domestic resources toward higherproductivity uses. Tables 2.14 and 2.15 present more disaggregated customs data on the commodity composition of merchandise imports and exports. Nonbulk imports13 increased after reform as the share of canalized bulk imports14 decreased from 40.5 percent in 1988–90 to 34.6 percent in 1998–2000. The reform-driven increase in domestic investment can be seen in the increase of the share of capital goods from 26.2 percent in 1988–90 to 27.3 percent in 1994–96. The share of capital goods in imports decreased, however, to 21.3 percent in the latest triennium for which data are available as a result of a slowdown in investment. The effect of remaining restrictions can be seen as well; there was very little change in the imports of machine tools that competed with domestic production. These imports remained under QRs even after liberalization. Trade liberalization appears to have encouraged exports in new areas, and export-related imports declined after the reform even as overall exports increased. The “others” category of imports rose consistently throughout the 1990s. The effects of the reforms can again be seen in the changing composition of imports across subcategories. The share of coal, coke, and briquettes in total imports nearly doubled. This share, though small, is noteworthy; the increased share of imports reflected the steep reduction in import duties, which introduced external competition for the state monopoly Coal India Limited. Also, users (especially in coastal states) found that, compared with coke sold by Coal India, imported coke was cheaper and of a better quality. Manufactured products accounted for a major share of the postreform rise in aggregate exports. Within this group, the share of leather, leather manufactures, and handicrafts declined steeply while the share of readymade garments in exports remained stable. Exports of chemical and allied products (including pharmaceuticals), textile yarn, fabrics, and engineering 13. Following the pre-1991 policy, nonbulk imports are classified into three broad categories: capital goods; input items that are mainly export related; and a residual category, “others.” These were controlled through various lists, such as limited permissible, automatic permissible, and open general license. 14. Bulk imports are classified into three broad categories according to the pre-1991 policy: petroleum, oil, and lubricants (POL), which constitute almost entirely importable universal energy inputs and are hence indispensable for growth; bulk consumption goods, which consist of agricultural commodities such as cereals, pulses, edible oils, and sugar that were imported to meet shortages arising out of domestic crop failures; and other bulk items, which are mostly noncompeting raw materials and intermediates such as fertilizer. These were deemed essential and hence canalized through the state-owned procurement agencies. 48

REINTEGRATING INDIA WITH THE WORLD ECONOMY

Commodity (2)

1988–90a (3)

1994–96b (4)

1998–2000c (5)

Ratio of 1994–96 to 1988–90 (6)

Ratio of 1998–2000 to 1988–90 (7)

7,814.9 (40.5)

11,582.4 (39.2)

15,097.5 (34.6)

3,767.5 (36.7)

7,282.5 (29.8)

I.1

Petroleum, oil, and lubricants

3,298.2 (17.1)

6,402.4 (21.7)

8,348.2 (19.1)

3,104.2 (30.3)

5,050.0 (20.7)

I.2

Bulk consumption goods

1,000.2 (5.2)

813.5 (2.8)

2,100.7 (4.8)

–186.7 (–1.82)

1,100.5 (4.5)

I.3

Other bulk items, of which:

3,516.5 (18.2)

4,366.5 (14.8)

4,648.5 (10.6)

850.0 (8.3)

1,132.0 (4.6)

I.3.1

Fertilizers: crude and manufactured, of which:

706.5 (3.7)

1,187.0 (4.0)

1,193.1 (2.7)

480.5 (4.7)

486.6 (2.0)

408.7 (2.1)

925.7 (3.1)

911.3 (2.1)

517.0 (5.0)

502.4 (2.1)

I.3.1.1

Manufactured fertilizer

I.3.2

Iron and steel

1,235.1 (6.4)

1,134.9 (3.8)

1,164.5 (2.7)

–100.2 (–1.0)

–70.6 (–0.3)

II

Nonbulk imports, of which:

11,475.8 (59.5)

17,962.9 (60.8)

28,977.6 (66.3)

6,487.1 (63.3)

17,501.8 (71.7)

II.1

Capital goods, of which:

5,051.6 (26.2)

8,070.4 (27.3)

9,310.3 (21.3)

3,018.8 (29.4)

4,258.7 (17.5)

176.3 (0.9)

246.7 (0.8)

343.0 (0.8)

70.4 (0.7)

166.7 (0.7)

1,918.6 (9.9)

2,844.7 (9.6)

3,142.2 (7.2)

926.1 (9.0)

1,223.6 (5.0)

II.1.1

Machine tools

II.1.2

Machinery, except electrical and electronic

49

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Bulk imports

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Series number (1)

Average imports to India of selected principal commodities, prereform and postreform triennia (millions of US dollars; numbers in parentheses are percentages of the total, I + II)

02--Chapter 2--11-78

Table 2.14

50

Average imports to India of selected principal commodities, prereform and postreform triennia (millions of US dollars; numbers in parentheses are percentages of the total, I + II) (continued)

n.a.

n.a.

1,955.9 (6.6)

1,770.6 (4.1)

801.8 (7.1)

616.5 (2.5)

3,424.9 (17.8)

4,653.8 (15.8)

7,660.0 (17.5)

1,228.9 (12.0)

4,235.1 (17.4)

Pearls and precious and semiprecious stones

2,101.4 (10.9)

2,123.4 (7.2)

4,159.5 (9.5)

22.0 (0.2)

2,058.1 (8.4)

Organic and inorganic chemicals

1,098.7 (5.7)

2,024.4 (6.9)

2,839.6 (6.5)

925.7 (9.0)

1,740.9 (7.1)

2,999.3 (15.5)

5,238.7 (17.7)

11,627.3 (26.6)

2,239.4 (21.8)

8,628.0 (35.4)

265.5 (1.4)

700.1 (2.4)

1,054.3 (2.4)

434.6 (4.2)

788.8 (3.2)

1,036.9 (5.4)

2,747.3 (8.4)

8,222.7 (18.8)

1710.4 (16.7)

7,185.8 (29.4)

19,290.7 (100.0)

29,545.3 (100.0)

43,695.1 (100.0)

10,254.6 (100.0)

24,404.4 (100.0)

1998–2000c

(3)

(4)

(5)

n.a.

1,297.6 (4.4)

1,154.1 (6.0)

Mainly export-related items of which:

II.2.1 II.2.2

Commodity (2)

II.1.3

Electronic goods

II.1.4

Project goods

II.2

II.3

Others, of which:

II.3.1

Coal, coke, briquettes, etc.

II.3.2

Miscellaneous “others”

Total of I + II n.a. = not available

a. Fiscal years 1987–88 to 1989–90: prereform triennium. b. Fiscal years 1993–94 to 1995–96: triennium of rapid growth. c. Fiscal years 1997–98 to 1999–2000: most recent available triennium. Note: Midpoint-to-midpoint compound annual growth rates of total exports: 1988–90 to 1994–96, 11.12 percent per year over 6 years; 1988–90 to 1998–2000, 9.51 percent per year over 10 years. Source: Reserve Bank of India, Handbook of Statistics on the Indian Economy, 2000.

Page 50

2,381.4 (5.5)

1994–96b

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Ratio of 1998–2000 to 1988–90 (7)

1988–90a

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Ratio of 1994–96 to 1988–90 (6)

Series number (1)

02--Chapter 2--11-78

Table 2.14

Commodity (2)

1988–90a (3)

1994–96b (4)

1998–2000c (5)

Ratio of 1994–96 to 1988–90 (6)

Ratio of 1998–2000 to 1988–90 (7)

3,428.7 (24.1)

5,795.7 (21.6)

7,006.6 (19.9)

2,367.0 (18.8)

3,577.9 (17.0)

I.1

Agriculture and allied products

2,610.2 (18.4)

4,778.5 (17.8)

6,052.8 (17.2)

2,168.3 (17.3)

3,442.6 (16.4)

I.2

Ores and minerals

818.5 (5.8)

1,017.2 (3.8)

953.8 (2.7)

198.7 (1.6)

135.3 (0.6)

II

Manufactured products, of which:

10,092.3 (71.0)

20,187.3 (75.4)

27,270.7 (77.3)

10,095.0 (80.3)

1,7178.4 (81.6)

II.1

Leather and manufactures

1,062.3 (7.5)

1,554.1 (5.8)

1,618.6 (4.6)

491.8 (3.9)

556.3 (2.6)

II.2

Chemicals and allied products, of which:

857.2 (6.0)

1,930.8 (7.2)

3,099.7 (8.8)

1,073.6 (8.5)

2,242.5 (10.7)

Drugs, pharmaceuticals, and fine chemicals

363.0 (0.3)

819.9 (3.1)

1,491.9 (4.2)

456.9 (3.6)

1,128.9 (5.4)

II.2.1 II.3

Engineering goods

1,583.8 (11.1)

3,645.7 (13.6)

4,920.8 (13.9)

2,061.9 (16.4)

3,337.0 (15.9)

II.4

Ready-made garments

1,597.6 (11.2)

3,181.2 (11.9)

4,347.7 (12.3)

1,583.6 (12.6)

2,650.1 (12.6)

(table continues on next page)

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Primary products

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Series number (1)

Average exports from India of selected principal commodities, prereform and postreform triennia (millions of US dollars; numbers in parentheses are percentages of the total, I + II + III)

02--Chapter 2--11-78

Table 2.15

51

Average exports from India of selected principal commodities, prereform and postreform triennia (millions of US dollars; numbers in parentheses are percentages of the total, I + II + III) (continued)

Textile yarn, fabrics, made-ups, etc., of which:

II.5.1

Handicrafts, of which:

II.6.1 III

Gems and jewelry Petroleum products and others

Total of I + II + III

1988–90a (3)

1994–96b (4)

1998–2000c (5)

Ratio of 1994–96 to 1988–90 (6)

1,123.7 (7.9)

2,902.6 (10.8)

4,109.2 (11.6)

1,778.9 (14.2)

2,985.5 (14.2)

861.8 (6.1)

2,115.8 (7.9)

3,058.4 (8.7)

1,254.0 (10.0)

2,196.6 (10.4)

3,223.8 (22.7)

5,408.5 (20.2)

7,356.3 ( 20.8)

2,184.7 (17.4)

4,132.5 (19.6)

2,742.8 (19.3)

4,590.4 (17.1)

6,303.6 (17.9)

1,847.6 (14.7)

3,560.8 (16.9)

702.9 (4.9)

804.9 (3.0)

997.3 (2.8)

102.0 (0.8)

294.4 (1.4)

14,223.9 (100.0)

26,787.9 (100.0)

35,274.6 (100.0)

12,564.0 (100.0)

21,050.7 (100.0)

a. Fiscal years 1987–88 to 1989–90: prereform triennium. b. Fiscal years 1993–94 to 1995–96: triennium of rapid growth. c. Fiscal years 1997–98 to 1999–2000: most recent available triennium. Note: Midpoint-to-midpoint compound annual growth rates of total exports: 1988–90 to 1994–96, 11.12 percent per year over 6 years; 1988–90 to 1998–2000, 9.51 percent per year over 10 years. Source: Reserve Bank of India, Handbook of Statistics on the Indian Economy, 2000.

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II.6

Cotton yarn, fabrics, made-ups, etc.

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II.5

Commodity (2)

Ratio of 1998–2000 to 1988–90 (7)

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Series number (1)

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52

Table 2.15

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goods increased from 25 percent on the average in 1988–90 to 41 percent in incremental exports between 1988–90 and 1998–2000 as import liberalization and exchange rate depreciation increased the profitability of selling on international markets.

Changes in Trading Patterns India’s trading patterns appear to have shifted as well in the postreform period (table 2.16). Exports of textiles—ready-made garments as well as more basic yarn, fabrics, made-ups,15 and the like—to countries that imposed quotas under the Multi-Fiber Arrangement decreased in the 1990s. Exports of engineering goods became more concentrated in industrialized countries as outsourcing by Germany, the United Kingdom, and the United States increased. Bangladesh’s share of engineering exports, meanwhile, decreased. Exports of chemicals and allied products have diversified, and the share of “other” countries has increased markedly. Table 2.17 presents the changes in the direction of trade. Eastern Europe’s share of imports and exports has predictably declined, as the share of non-South Asian Association for Regional Cooperation (SAARC)16 Asian developing economies in trade has increased. The United States’s and European Union’s shares of exports have increased, but their shares of imports have declined. Neighboring SAARC countries account for a negligible share of trade, despite their proximity. The direction of India’s trade reflects greater participation in the trade of the non-SAARC Asian economies, but unfortunately not with neighboring South Asia.

India’s Exports in Asian Perspective Table 2.18 presents international comparisons of incremental exports between the average annual levels for the 4 prereform years (1987–90) and 4 postreform years (1993–96) for Bangladesh, China, Indonesia, Malaysia, South Korea, Pakistan, Taiwan, and Thailand.17 Exports are divided into five broad categories of extended manufacturing: resource-intensive products (mainly processed agricultural and mineral products); laborintensive products (light manufactures); scale-intensive products (mostly homogeneous, standard quality) products; differentiated products (mostly machinery and transport equipment); and mainly high-technology, sciencebased products.18 15. The category “made-ups” includes such items as curtains, table linen, sacks and bags, and bed linen. 16. SAARC’s members are Bangladesh, Bhutan, India, the Maldives, Nepal, Pakistan, and Sri Lanka. 17. The discussion in this section is based on the findings of Tendulkar’s (2000b) analysis of Indian export performance. 18. The classifications are based on the 3-digit Standard International Trade Classification. INDIA IN THE WORLD TRADING SYSTEM

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02--Chapter 2--11-78

Table 2.16

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Percentage shares of major economies in exports of selected commodities

Economy Cotton yarn, fabrics, made-ups, etc. Germany Italy United Kingdom United States Quota countries Bangladesh Hong Kong Japan South Korea Mauritius United Arab Emirates Others Total Total exports (millions of US dollars) Annual percentage growth rate Percentage share in total exports Ready-made garments Canada France Germany United Kingdom United States Quota countries Commonwealth of Independent States Italy Japan Netherlands United Arab Emirates Others Total Total exports (millions of US dollars) Annual percentage growth rate Percentage share in total exports Export of chemicals and allied products Commonwealth of Independent States Chinese Taipei Germany Hong Kong Italy Japan Netherlands United Arab Emirates United Kingdom United States Others Total Total exports (millions of US dollars) Annual percentage growth rate Percentage share in total exports

1988–90a

1994–96b

1998–2000c

7.3 5.8 10.8 13.3 37.3 8.6 2.2 4.1 2.4 1.1 3.5 40.9 100.0 861.8

6.5 4.8 10.4 12.4 34.1 11.1 3.4 4.0 3.2 2.7 3.6 37.9 100.0 2,115.8 16.1 7.9

4.7 4.7 7.0 13.6 30.0 6.1 6.9 3.4 4.1 3.0 3.1 43.4 100.0 3,058.4 13.5 8.7

3.2 6.8 12.1 9.8 30.7 66.0 2.6 3.4 3.4 4.3 3.8 19.9 100.0 3,181.2 12.2 11.9

4.0 7.3 8.4 7.7 32.3 62.8 4.2 3.0 1.7 3.2 8.1 20.0 100.0 4,347.7 10.5 12.3

8.2 3.4 8.0 3.6 2.8 3.0 3.9 3.0 4.3 12.3 47.5 100.0 1,930.8 14.5 7.2

4.6 2.6 6.5 3.9 3.1 2.5 4.4 3.8 5.2 11.2 52.2 100.0 3,099.7 13.7 8.8

6.1 2.9 6.1 14.3 10.9 29.1 67.4 10.5 4.1 2.9 4.2 2.0 13.0 100.0 1,597.6 11.2 31.8 2.0 8.7 2.4 2.5 2.7 2.6 1.4 4.2 11.4 30.3 100.0 857.2 6.1

(table continues on next page)

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REINTEGRATING INDIA WITH THE WORLD ECONOMY

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Table 2.16

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Percentage shares of major economies in exports of selected commodities (continued)

Economy Engineering goods Bangladesh Germany Italy Japan Malaysia Singapore Sri Lanka United Arab Emirates United Kingdom United States Others Total Total exports (millions of US dollars) Annual percentage growth rate Percentage share in total exports

1988–90a 3.8 2.7 1.0 3.9 1.3 4.3 2.0 2.2 4.8 9.9 64.2 100.0 1,583.8 11.1

1994–96b

1998–2000c

4.2 4.3 1.5 3.7 2.9 6.6 3.9 4.5 6.5 13.7 48.2 100.0 3,645.7 14.9 13.6

2.8 4.4 3.0 2.2 2.8 4.4 3.2 6.3 6.6 17.6 46.7 100.0 4,920.8 12.0 13.9

a. Fiscal years 1987–88 to 1989–90: prereform triennium. b. Fiscal years 1993–94 to 1995–96: triennium of rapid growth. c. Fiscal years 1997–98 to 1999–2000: most recent available triennium. Note: Percentage shares relate to the triennial average level of exports given in the third-tolast row. Growth rates given in the second-to-last row are midpoint-to-midpoint compound annual rates (i.e., over 6 years for the first and over 10 years for the second postreform triennium with the prereform triennium base). Sources: Reserve Bank of India, Handbook of Statistics on the Indian Economy, 2000; Reserve Bank of India, Annual Report, 2000.

India’s share of world incremental extended-manufacturing exports was a tiny 0.8 percent (row 4 of table 2.18) compared with 5.8 percent for China, with shares ranging between 1.3 percent (Indonesia) and 3.5 percent (South Korea). The double-digit aggregate export growth rate of the early 1990s (noted earlier in this chapter), though impressive in relation to India’s past performance, pales in significance beside the export growth rates of its neighbors China and Indonesia. India also lags behind other countries in moving into differentiated products. Countries with smaller populations such as Malaysia, South Korea, Taiwan, and to some extent Thailand have been penetrating this expanding market. India’s performance in traditional labor-intensive products—3.0 percent of incremental world labor-intensive exports—was better than its performance in aggregate extended-manufacturing exports (row 6 of table 2.18). Nevertheless, this share is lower than Thailand’s 3.4 percent, Indonesia’s 4.9 percent, and China’s 22.2 percent. It is clear that although trade liberalization during the post-1991 period has improved India’s export performance, it is still lagging behind other rapidly growing Asian countries. Even though India started the industriINDIA IN THE WORLD TRADING SYSTEM

55

56

The direction of India’s trade, prereform and postreform triennia (millions of US dollars; numbers in parentheses are percentages of the total)

Series number (1) I.

1988–90 Country or group (2) OECD, of which:

I.2

United States

I.3

Australia

I.4

Japan OPEC

III.

Eastern Europe

IV.

Developing countries, of which:

IV.1

SAARC

IV.2

Non-SAARC Asian countries

V.

Africa

VI.

Latin America

VII. Total (I to VI)

Imports (4)

Exports (5)

Imports (6)

Exports (7)

Imports (8)

8,180 (57.51) 3525 (24.78) 2,504 (17.61) 174 (1.23) 1,457 (10.24) 890 (6.26) 2,507 (17.62) 2,219 (15.60) 373 (2.62) 1,491 (10.48) 281 (1.98) 74 (0.52) 14,224 (100.00)

11,628 (60.28) 6,331 (32.82) 2,114 (10.96) 472 (2.45) 1,716 (8.90) 2,640 (13.68) 1,588 (8.23) 3,428 (17.77) 80 (0.41) 2,367 (12.27) 571 (2.96) 410 (2.13) 19,291 (100.00)

15,266 (56.99) 7,179 (26.80) 4,847 (18.09) 322 (1.20) 1,994 (7.45) 2,631 (9.82) 1,133 (4.23) 7,321 (27.33) 1,278 (4.77) 4,691 (17.51) 1,017 (3.80) 334 (1.25) 26,788 (100.00)

15,675 (53.05) 8,140 (27.55) 3,168 (10.72) 865 (2.93) 2,010 (6.80) 6308 (21.35) 1,068 (3.62) 6,492 (21.97) 182 (0.62) 4,848 (16.41) 915 (3.10) 547 (1.85) 29,545 (100.00)

20,138 (57.09) 9276 (26.30) 7,512 (21.30) 410 (1.16) 1,751 (4.96) 3,699 (10.49) 1,214 (3.44) 10,025 (28.42) 1,568 (4.44) 6,114 (17.33) 1,669 (4.73) 675 (1.91) 35,275 (100.00)

21,460 (49.11) 10,760 (24.63) 3,662 (8.38) 1,337 (3.06) 2,322 (5.31) 6,108 (13.98) 995 (2.28) 8,195 (18.75) 351 (0.80) 8,085 (18.50) 2,611 (5.98) 724 (1.66) 43,695 (100.00)

OECD = Organization for Economic Cooperation and Development OPEC = Organization of Petroleum Exporting Countries SAARC = South Asian Association for Regional Cooperation Sources: Reserve Bank of India, Handbook of Statistics on the Indian Economy, 2000; Reserve Bank of India, Annual Report, 2000.

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II.

Exports (3)

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European Union

1998–2000

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I.1

1994–96

02--Chapter 2--11-78

Table 2.17

India’s incremental total exports and extended manufacturing exports along with their major contributing categories, 1987–90 to 1993–96 (the increment is for the average of annual exports during the periods 1987–90 and 1993–96)

Increment between 1987–90 and 1993–96

World

India

China

Taiwan

Indonesia

Malaysia

Thailand

1.6

47.4

39.4

22.1

41.4

28.5

1,519.9

13.2

77.7

2

Extended-manufacturingproduct exports (billions of US dollars)

1,288.0

10.6

74.9

3.3

1.5

44.6

37.8

16.6

38.6

18.1

3

Percentage share of (2) in (1)

85.0

80.0

96.0

100.0

94.0

94.0

96.0

75.0

93.0

64.0

4

Percentage share of economy in world extended-manufacturingproduct exports

100.0

0.8

5.8

0.3

0.1

3.5

2.9

1.3

3.0

1.4

5

Labor-intensive exports (billions of US dollars)

150.0

4.5

33.3

3.1

1.3

2.0

1.9

7.3

3.0

5.1

6

Percentage share of economy in world extendedmanufacturing labor-intensive exports

100.0

3.0

22.2

2.1

0.9

1.3

1.3

4.9

2.0

3.4

7

Percentage composition of increment in extendedmanufacturing products 22.6

10.2

27.2

94.7

89.6

4.4

5.0

43.8

7.8

28.2

15.8

63.3 10.8

36.0 7.2

3.3

7.1

Resource-intensive

7.2

Labor-intensive

11.8

6.2 42.4

44.5

7.3

Scale-intensive

15.7

35.3

19.1

16.3

14.1

7.4 7.5

Differentiated Science-based

54.0 9.8

23.6

68.9

68.3

57

Note: Extended manufacturing products includes—in addition to the standard definition of manufacturing exports (Standard International Trade Classification or SITC 5, 6, 7, 8, minus 68)—SITC 4 and 68. Source: Tendulkar (2000b).

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Total exports (billions of US dollars)

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South Korea

Pakistan Bangladesh

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Table 2.18

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alization process earlier, its rapidly growing Asian neighbors liberalized their trade and switched from import substitution to export orientation earlier than India. Their early trade liberalization helped East Asian and Southeast Asian economies diversify exports into faster growing machinery and transport equipment. They successfully exploited international trade to achieve a higher growth rate and motivate the development of a competitive industrial sector.

Invisibles in India’s Current Account and Software Exports An exclusive focus on merchandise trade in the preceding discussion is dictated by its dominant share in total trade, as well as by the ready availability of internationally comparable data. In the last two decades of the twentieth century, the role of so-called invisibles (nonmerchandise) transactions was on the rise. However, as the WTO comments, “Recorded trade figures [in invisibles transactions] still lack comparability across countries and are subject to significant distortions” (International Trade Statistics 2001, 216). India had net surpluses in invisibles transactions in most years, and receipts from these transactions showed a steeply upward trend in the 1990s (see figure 2.6), providing a significant support in meeting the rising deficits on merchandise trade. Invisibles transactions are subdivided into nonfactor (commercial) services, income (investment income and compensation of employees), and current transfers on private and official accounts. Nonfactor services are further subdivided into transport, travel, and other (miscellaneous) commercial services, including software services, which have come into prominence in recent years. Of these, travel is not specific service but an assortment of goods and services consumed by travelers. India has had a net surplus in nonfactor services, current transfers, travel, and miscellaneous commercial services for 13 of the 21 years since 1980–81. However, India has had a net deficit in most years since 1980–81 in income and transport. International comparisons (based on GATT 1994 and WTO, International Trade Statistics 2001, for the 1980s and 1990s) point to two interesting trends for India with regard to commercial services. First, in contrast to the rapidly growing economies of East and Southeast Asia, India’s share of world exports of commercial services exceeded that of world merchandise exports in most years. Second, and more interesting, India’s share of world exports of commercial services was as high as 0.87 percent in 1983 (as compared with 0.57 percent of world merchandise exports) but declined steadily to 0.57 percent in 1996 (0.62 percent for merchandise exports) and has since shown a dramatic acceleration to 1.22 percent in 2000 (0.67 percent for merchandise exports). 58

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Invisibles in India’s current account and software exports in the 1990s (billions of US dollars unless otherwise indicated) Annual average

Description 1. Total receipts from invisibles 2. Of which, receipts from nonfactor services 3. Of which, receipts from miscellaneous services 4. Estimated software exportsa 5. Row 2 as a percentage of row 1 6. Row 3 as a percentage of row 2 7. Row 4 as a percentage of row 3 8. Current account deficit (balance of payments) 9. Trade account deficit (balance of payments) 10. Current private transfers (net) (balance of payments) 11. Merchandise exports (balance of payments)

1993–94 to 1996–97

1997–98 to 2000–01

16.481 6.555 2.038 0.665 39.8 31.1 32.6 3.739 9.820 8.558 28.996

28.433 14.299 8.738 3.690 50.3 61.1 42.2 4.123 15.241 11.791 38.103

a. Software exports include on-site and offshore professional services, consultancy and training, products and packages and more recently information-technology-enabled services. Sources: Reserve Bank of India, Handbook of Statistics on the Indian Economy, 2001; for row 4, National Association of Software and Service Companies, http://www.nasscom.org.

We focus on the last 8 years of the decade 1991–2001, of which the last 4 (1997–98 to 2000–01) are marked by an acceleration in exports of commercial services. Table 2.19 presents annual averages for the two 4-year periods. The impact of surpluses in the invisibles account on the current account can be easily seen by the difference between rows 9 and 8 in table 2.19. It may be noted that an annual increase of nearly $12 billion in the average foreign exchange receipts from invisibles during the last 4 years (row 1) exceeded the annual increase in merchandise export earnings by $3 billion (row 11). In other words, the slowdown in growth of exports of goods did not affect invisibles. More important, nonfactor commercial services and private transfers (net) exchanged their relative shares of total exports of invisibles. A rise in the share of nonfactor services from nearly 40 percent in the first period to a little more than 50 percent in the second mirrors the corresponding decline in the share of private transfers (row 10) in total receipts from invisibles. India’s rising share in world exports of nonfactor services along with the increasing importance of these exports in India’s current account suggests the intriguing possibility that India could become a leading exporter of nonfactor services. Implicit in this is also the pessimism that India cannot become a major player in world merchandise exports—not because of a lack of potential but because of domestic infrastructural and institutional (labor and capital) constraints. Within the group of nonfactor commercial services, it is the miscellaneous group (row 3 of table 2.19) that increased its annual average reINDIA IN THE WORLD TRADING SYSTEM

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ceipts more than fourfold, thereby almost doubling its share of nonfactor services (row 6). Interestingly, net earnings from miscellaneous services had been in deficit continuously from 1992–93 to 1996–97 before turning to surpluses in the following 4 years, perhaps reflecting the growth of software exports. Unfortunately, India’s balance of payments data as yet do not explicitly show the exports of software as a separate category. The Reserve Bank of India draws on the National Association of Software and Service Companies (NASSCOM) for this purpose. To assess the importance of software in the current account, we have given the NASSCOM estimates of software exports (row 4 of table 2.19). Two facts stand out. First, the annual average export revenue from software expanded nearly six times from the first to the second periods. Second, its share of miscellaneous receipts increased by nearly 10 percent but remained nondominant at 42 percent (row 7 of table 2.19). It appears that, although software exports may have become the single largest item in the exports of miscellaneous commercial services, they do not fully explain the dramatic increase in total receipts from this source. Other services, as yet unidentified, contributed significantly to the surge in exports of nonfactor services in the last 4 years of the decade. Software exports started from a very low base of $126 million in 1990– 91 and experienced an annual average growth of more than 50 percent to reach $6.32 billion in 2000–01. Export earnings include revenue from on-site and offshore high-end professional services, consultancy and training, data processing, support and maintenance services, products and packages, and more recently low-end information technology (IT) services comprising remote processing and servicing transactions such as call centers, accounting services, medical transcripts, and back-office operations. Software offers an interesting case of the rapid growth of an exportoriented industry, a growth that was largely market driven without direct government intervention or support. The industry was mainly export oriented, with the share of exports in progressively growing total sales going up from 41 percent in 1987–88 to 70 percent in 2000–01. One factor explaining its export orientation was the slow adoption and low spending on IT by domestic industry, which has been dominated by the public sector, has operated in a long-protected market, and has had little interest in improving the quality of its product or reducing its cost of production. It had little incentive to spend on IT. However, the relatively lower wages of readily available skilled IT personnel, and the widespread use of English in India, have made outsourcing operations profitable for companies abroad who face rising wages of similarly skilled labor in their domestic markets. The practically unbounded international market has induced domestic and transnational

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firms (which would otherwise be competing for the limited domestic market) to form mostly mutually complementary high-technology clusters. These started in Bangalore in the mid-1980s and then spread to Hyderabad and Chennai (Madras) in the South, Pune in the West, and Gurgaon in the North. The industry has also become fiercely competitive over time.19 The Bangalore cluster alone now has more than 140 transnational development centers, which, along with large Indian IT firms, are exclusively oriented toward exports. In addition, there are 750 large and small IT firms in Bangalore alone. Clustering has the obvious advantage of the economics of agglomeration. Further, it has enabled this industry not only to overcome infrastructural constraints on telecommunication facilities but also to exploit the spillover effects of diffusing new technologies and ideas, in which transnational companies have played a catalytic role. A study by McKinsey and Company (2001, vol. 3, 143–60) forecasts an export market (excluding on-site services) of $25 billion and a domestic market of $21 billion by 2010, with a tenfold growth in the requirement of software professionals to 2.1 million. The estimated labor power is derived from an assumption of 30 percent annual growth in demand for software decomposed into 7 percent average growth in productivity and 23 percent in employment. Slower growth in productivity is attributed to increasing competition, an increasing share of unsophisticated domestic end users, and higher growth in the resulting demand for entry-level workers. Productivity growth and hence growth in skilled wages in the companies catering to the high end of the international market is expected to be considerably higher than average. More recent data from NASSCOM (2002a) project exports of between $57 and $65 billion and a domestic market in the range of $13 to $15 billion by 2008. The industry also claims to employ more than a million persons as of March 2002. Of course, realizing the export prospects would depend on India’s remaining competitive in the face of challenges from other emerging players in the field, particularly China. We expect the domestic market for the IT sector to grow faster in the future as end-user industries, themselves facing increasing competition from imports, strive to raise productivity by adopting new technologies including IT. Are there other services like software where India could expect a competitive advantage? Travel and tourism suggests itself as an eminently suitable candidate. The Task Force on Employment Opportunities (GOIPC 2001b) reports, citing the WTO as a source, that India was forty-third 19. For an interesting analytical narrative on the evolution of this industry based on case studies of 30 Indian and transnational firms, see Patibandla and Petersen (2002) and the references cited there.

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on the list of tourist destinations worldwide, with just 2.2 million tourist arrivals compared with 23 million in China (12 million excluding visitors from Hong Kong), a few more than 7 million in Malaysia and Thailand, and 5 million in Indonesia. There is clearly a tremendous potential for India to tap this market. But to do so, the problems of inadequate investment in tourism infrastructure have to be addressed. Better transport and other infrastructural facilities would be needed as well. The Task Force Report correctly recommends investment in tourism infrastructure, including total development of each tourism circuit as a unit for investment, as well as improving the quality of airports, airlines, railways, roads, tourist bases, and hotels. As was mentioned above, tourism is not a specific service but an assortment of goods and services purchased by international travelers. The indirect semiskilled and unskilled employment growth that would result from tourism is expected to be substantial. Two other services are likely to emerge as significant contributors to invisibles earnings. The first is related to higher education. Already students from India’s neighbors such as Bangladesh come to India in significant numbers for higher education, particularly in technical fields such as IT, engineering, business management, and medicine. Provided this segment of the education sector in India is reformed—both by charging appropriate tuition and other fees that reflect costs and, equally important, by allowing greater involvement of the private sector (including the nonresident Indian academic community)—it can train far more students from India and abroad. Already, an innovative step has been taken with the establishment of a school of management in Hyderabad with the involvement of reputable foreign business schools and nonresident Indian scholars. The Indian Institutes of Technology (IITs) and Indian Institutes of Management (IIMs), which were initially established in collaboration with foreign institutions, have long been recognized as premier institutions whose graduates pioneered India’s success in software. The proposal to start many more such institutions, implemented with substantial contributions from the alumni of IITs and IIMs, would be another major step. Clearly, given their current abysmal state, the state’s resources have to be concentrated on the efficient provision of primary and secondary education. This being the case, major reforms of the highereducation sector would be needed to ensure that resources for investment in higher education are mobilized largely from the private sector. The second service is related to health care. In this sector, in the past decade or longer, many hospitals have been established in the private sector with the active involvement of nonresident Indian physicians. These hospitals also serve patients from Bangladesh and West Asia. There is a significant potential for attracting more foreign patients. Also, with the growing scarcity of nursing personnel in industrial countries, experienced Indian nurses are being recruited to serve abroad. Clearly, the growth in 62

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the number of nurses being trained in India has to be adequate both to supply domestic hospitals and to meet external demand if a rapid rise in the cost of nursing is to be avoided. Moreover, India’s tradition of alternative systems of medicine and health care could attract foreign patients. It is also possible to set up retirement and nursing homes to attract foreign retirees. Again, given the poor state of India’s health care systems for poor people, any investment to set up more hospitals, train nurses, or create retirement homes and health care facilities has to be financed by private initiative. The skill content of the heterogeneous tertiary services in the economy has grown with overall economic growth. The average triennial share of this sector in national income has increased by 8 percentage points from 45 percent (at the end of the 1980s) to nearly 53 percent (at the end of the 1990s), compared with just a 3-percentage-point increase in the previous decade. India also is competitive in as yet untapped areas like courier services, accounting services, and architectural and engineering services, where technical personnel is available in India at competitive wages and advances in telecommunications are expected to open up possibilities of offshore services. It is clear that India has a vital interest in ensuring that the ongoing negotiations in the WTO on services succeed in further liberalizing the sector in terms of market access, most-favored-nation access, and national treatments. Above all, a liberal multilateral agreement on the movement of natural persons20 is essential.

Challenges and Policies in Managing the Capital Account in the 1990s In the 1990s, capital account transactions in the balance of payments posed interesting new challenges for the macroeconomic management of the Indian economy. India’s policy stance was shaped by the experience of the 1980s and by the new complexities of liberalizing the financial sector. Until the end of the 1970s, capital account transactions consisted mostly of official bilateral or multilateral concessional flows, which went toward financing the current account deficit because private capital flows were severely restricted under the autarkic ideology of economic nationalism. As official concessional development assistance declined worldwide and was found less and less adequate to bridge the rising current account deficits of the 1980s, Indian policymakers responded by resorting to ex-

20. The phrase “movement of natural persons” is an arcane GATT phrase meaning temporary migration of workers from one GATT Contracting Party to another. The word “natural” is used to distinguish human beings from corporate entities who are also termed “persons” in a legal sense. INDIA IN THE WORLD TRADING SYSTEM

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ternal commercial borrowing and attracting deposits from nonresident Indians by offering attractive interest rates. Thus, while annual average net concessional assistance increased from $1.4 billion in the first half of the 1980s to $2.3 billion in the second half, the average current account deficits almost doubled from $3.0 to $5.8 billion during the same periods. In comparison, annual average external commercial borrowing increased by 2.6 times, from $0.7 to $1.9 billion, and net nonresident Indians’ deposits increased almost fourfold, from $0.6 to $2.3 billion. The pressure on the exchange rate from rising current account deficits was exacerbated toward the end of 1980s by the uncertainty caused by political instability and the spike in oil prices following the war in the Persian Gulf. As was noted above, these events led to capital flight in the expectation of imminent devaluation and resulted in the crisis of 1991. Early in 1991, foreign exchange reserves had dwindled to a level one-third the magnitude of short-term debt and offered an import cover for just 15 days. In response to this macroeconomic and balance of payments crisis, there was a sharp fiscal contraction in 1991 and 1992 followed by a liberalization of controls on external trade and investment. The fear that excessive reliance on private debt flows could lead to crises led Indian policymakers to be very cautious in liberalizing capital account transactions. Their caution was also driven in part by pressure from wellentrenched domestic industrialists who were reluctant to face foreign competition (we will say more on this in chapter 5). After meeting the immediate crisis of 1991 by negotiating structural adjustment loans from the International Monetary Fund and the World Bank, Indian policymakers had to contend with new challenges in macroeconomic management. The first challenge was posed by the surge in total net capital inflows from $3.9 billion in 1992 to nearly $9.0 billion and $8.5 billion in the next 2 years (table 2.4). The upsurge, unless offset by an increase in imports and/or sterilization, threatened to cause the currency to appreciate and stoke inflation through an increase in the money supply. Both would have harmed exports, which had risen following sharp devaluations in 1991 and 1992—of 22.8 and 17 percent in the nominal exchange rate.21 The policy response consisted of a mix of measures—including further liberalizing of imports, retiring short-term debt, allowing some appreciation of the exchange rate and controls on debt capital (consisting of ceilings on external commercial borrowing), reducing the attractiveness of nonresident Indians’ deposits, and asking borrowers to park borrowed funds abroad until they were committed to specific domestic uses. The next challenge was posed by the volatility in international financial flows following the Mexican crisis (1995–96), the aftermath of the East

21. The reader may refer to table 4.1. 64

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Asian currency meltdown in 1996 and 1997, and the international sanctions following India’s nuclear tests in 1998. Indian policymakers handled this situation by allowing moderate depreciation, modulating intervention in the debt market, and taking restrictive monetary measures (Joshi 2001). The nominal exchange rate was depreciated by 8.2 percent in 1995 and, after holding its level for the next 2 years during the Asian currency crisis, was allowed to depreciate again by 9 percent in 1998. The REER, however, showed some moderate appreciation. According to the Reserve Bank of India (RBI 2001, chap. 6), the capital account control regime in India aims to avoid volatility in the exchange rate, ensuring a well-diversified capital account that includes portfolio investments, and changing the composition of capital flows in favor of nondebt liabilities and a higher share of long-term debt in total debt. For this purpose, it adopted an asymmetric treatment between inflows (liberal), outflows associated with inflow (free), and other outflows (restricted)— along with differential restrictions on residents (restricting outflows) visà-vis nonresidents (liberal) and individuals vis-à-vis corporate bodies and financial institutions. In implementing this regime, a variety of market-based and direct instruments have been deployed. They include quantitative annual ceilings on external commercial borrowing, shifting FDI gradually from caseby-case to automatic routes, portfolio investments being restricted to approved foreign institutional investors and nonresident Indians, taxing short-term capital gains at a higher rate than long-term gains, giving Indian companies access to international capital market through GDRs and ADRs (subject to specific guidelines), and, recently, permitting FDI abroad by Indian companies (joint ventures and acquisitions) through both automatic and case-by-case routes. The policy seems to have succeeded to a large extent in achieving its stated objectives, as is evident from the composition of net capital inflows presented in table 2.4. The composition of long-term flows has shifted, from debt-creating inflows in 1990 and 1992 to non-debt-creating FDI and portfolio flows and a considerable reduction in short-term debt. As a result, the share of short-term debt in the stock of total external debt came down from 10 percent by the end of March 1991 to 3.4 percent by the end of March 2001. Joshi (2001) has analyzed the various explanations for the fact that India escaped the East Asian currency turmoil. He concludes that, even though India was no different from the affected countries in vulnerability indicators, the presence of capital controls and tight control over short-term debt enabled India to avoid the crisis and the contagion of the 1990s. Though conceding the advantages of capital account convertibility (CAC) for India to exploit its long-term comparative advantage in the export of some financial services and software, given the weaknesses in the Indian financial sector, his judgment is that “CAC would increase the potential INDIA IN THE WORLD TRADING SYSTEM

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for macroeconomic crises that could disrupt the country’s large and unfinished reform agenda” (p. 318). We do agree that weaknesses in the Indian financial sector need to be corrected. Among the corrective actions, greater involvement of the private sector (particularly foreign-based firms) in banking, if not the withdrawal of the public sector altogether, would be needed. It is arguable that the lesson of India’s escaping the Asian currency crisis is not that tight capital controls and an absence of CAC were appropriate but rather that because of both, India was not a major player in the market for capital flows and, not being a major player, did not experience the crisis. Further, a commitment to remove capital controls and move toward CAC by a specified date in the near future would increase the pressure to reform the financial sector. China (OECD 2002b, chaps. 7, 8, 14, and 15), for example, has committed to opening its financial sector fairly rapidly as part of the WTO accession agreement. Chinese policymakers hope to use the imminent opening of the financial sector to accelerate the reform of the sector. Clearly, considerable risk is involved in this strategy. The weaknesses of domestic banks can be remedied only slowly, and the entry of foreign banks could exacerbate these weaknesses. Chinese policymakers appear to be more willing than their Indian counterparts to take the risks involved.

Effects on Domestic Competitiveness Trade liberalization, by removing distortions in investment incentives, is expected to increase efficiency and hence the international competitiveness of the production structure. In this section, we attempt to capture the extent to which India’s reforms have increased international competitiveness in two ways. First, we examine input-output flow matrices for 115 sectors of the Indian economy to assess macrosectoral export orientation in manufacturing. Four such matrices are available: for 1978, when Indian exports started responding to the depreciating exchange rate of the rupee in the mid-1970s; for 1983, when REER appreciation had begun after the second oil shock; for 1989, the last of the prereform years of the late 1980s, when sustained REER depreciation had given a boost to exports; and finally, for 1993, the first of the 3 postreform boom years. Because the main focus of the above-mentioned policies was on the manufacturing sector, we concentrate on 64 (mostly 3-digit-level) manufacturing sectors out of the 115 distinguished in the input-output flow matrices. We interpret a high and rising share of exports in gross output as indicative of the increasing importance of international markets in domestic production and as evidence of a change in the incentive structure. The behavior of sectoral export shares in gross output over time, shown in table 2.20, can be classified according to three broad patterns. First, 66

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Table 2.20

India’s top 10 manufacturing export earners in 1993–94, along with shares in gross output

1

98

Sector description (3) Miscellaneous manufactures

Percentage share in sectoral gross output (6)

2,343.41

14.63

36.85

71

Other nonmetallic mineral products

1,990.72

12.43

91.20

48

Ready-made garments

1,917.76

11.97

75.62

4

42

Cotton textiles

755.17

4.71

9.57

5

55

Leather and leather products

605.62

3.78

49.50 17.00

6

36

Edible oils, other than vanaspati

522.15

3.26

7

38

Miscellaneous food products

515.29

3.22

7.30

8

66

Soaps, cosmetics, and glycerin

454.05

2.83

20.56

9

54

Leather footwear

393.36

2.46

36.31

61

Organic heavy chemicals

356.54

2.23

23.89

9,854.07

61.52

—

10 11

Total contribution to manufacturing export earnings

Note: The exchange rate used is $1 = Rs31.36. Source: CSO (2000a).

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2 3

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Input-output sector number (2)

Percentage share in manufacturing exports (5)

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Series number (1)

Export earnings (millions of US dollars) (4)

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“other nonmetallic mineral products” (essentially gems and jewelry), ready-made garments, and miscellaneous manufactured products were internationally competitive even under the earlier restrictive trade policy regime. Their export shares rose over time, and they remained major export earners in all years. Second, leather footwear; organic heavy chemicals; soaps, cosmetics, and glycerin (table 2.21); paints, varnishes, and lacquer; industrial machinery; and edible oils other than vanaspati (table 2.22) are sectors where export shares were low in 1978–79 but rose over time. They did not contribute significantly to manufacturing export earnings but are likely to be major export earners in the future as they increase their share of exportoriented output and establish international competitiveness. Third, traditional industries such as carpet weaving; leather and leather products; silk textiles (table 2.21); tea and coffee processing; jute, hemp, and mesta textiles; and miscellaneous textile products—as well as some apparently nontraditional industries, such as miscellaneous metal products (table 2.22), bicycles and cycle rickshaws, and other industrial machinery (table 2.22)—have fluctuating or declining sectoral export shares over time. The export performance of the corporate sector provides a second means of assessing the impact of reforms on international competitiveness. The prereform protected economy provided little incentive to produce for international markets. Many labor-intensive, and hence exportable, products had been reserved for exclusive production in small-scale units. The liberalization of imports, market-determined exchange rates, and the removal of entry barriers following the post-1991 reforms introduced both domestic and external competition, which have brought about a more efficient utilization of resources. We draw on recent studies by the National Council of Applied Economic Research (NCAER 1999) and Tendulkar (2000a) to examine these issues. We focus on two summary indicators from the NCAER study: the shares of wages and exports in total sales (table 2.23). In general, the export orientation of the corporate units has indeed increased during the postreform period. The export ratio, a sign of increased international competitiveness, has increased in all the industry groups, except electrical machinery. The wage share has declined, to varying degrees, in all of the 17 industries covered by the NCAER study. This is consistent with increased export orientation, which is associated with higher productivity per worker and more efficient utilization of labor. We turn to a factory segment of India’s manufacturing industry to address the impact of reforms on output and employment growth. The removal of domestic entry barriers and QRs on imports of most of the intermediate and capital goods, as well as import tariff reductions, has led to faster growth in real manufacturing output and employment in the more productive factory segment. 68

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India’s input-output sectors with export share in gross output exceeding 20 percent in 1993–94 (numbers in parentheses are percentages of total manufacturing exports) Share of exports in gross output (percent) 1978–79 (4)

1983–84 (5)

1989–90 (6)

1993–94 (7)

1

71

Other nonmetallic mineral products

38.08 (15.5)

51.28 (16.2)

53.08 (13.1)

91.20 (12.4)

2

48

Ready-made garments

40.48 (10.7)

36.38 (10.6)

70.26 (10.7)

75.62 (12.0)

3

47

Carpet weaving

63.31 (2.7)

60.34 (3.1)

65.40 (3.4)

65.77 (0.9)

4

55

Leather and leather products

73.47 (6.7)

41.78 (3.7)

51.72 (4.8)

49.50 (3.8)

5

54

Leather footwear

23.97 (7.9)

33.03 (15.8)

36.20 (12.9)

36.85 (14.6)

6

98

Miscellaneous manufacturing

3.98 (0.4)

19.15 (2.1)

35.53 (2.3)

36.31 (2.5)

7

87

Electrical appliances

18.49 (1.4)

13.60 (1.7)

10.07 (1.2)

28.49 (0.6)

8

61

Organic heavy chemicals

6.15 (0.4)

2.64 (0.4)

9.20 (1.6)

23.89 (2.2)

9

44

Silk textiles

5.95 (0.3)

6.17 (0.7)

24.81 (0.9)

21.92 (0.5)

10

66

Soaps, cosmetics, and glycerin

9.24 (1.4)

8.17 (2.0)

17.63 (2.7)

20.56 (2.8)

11

Total percentage contribution to manufacturing exports (serial nos. 1 to 10)

12

Value of export earnings (millions of US dollars)

69

Note: Growth rates are compound annual rates from the previous point in time. Sources: CSO (1981, 1990, 1997, 2000a).

47.4

56.3

53.6

52.3

5,380.41

7,146.63

13,865.81

16,021.88

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Sector description (3)

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Input-output sector number (2)

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Serial number (1)

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Table 2.21

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Table 2.22

India’s input-output sectors with export share in gross output between 10 and 20 percent in 1993–94 (numbers in parentheses are percentages of total manufacturing exports)

1

37

2

Share of exports in gross output (percent) 1983–84 (5)

1989–90 (6)

1993–94 (7)

Tea and coffee processing

29.79 (5.3)

23.95 (6.4)

25.36 (3.7)

17.35 (2.0)

36

Edible oils, other than vanaspati

5.57 (2.5)

2.81 (2.1)

8.92 (2.0)

17.00 (3.3)

3

64

Paints, varnishes, and lacquers

5.74 (0.7)

5.23 (0.7)

11.33 (1.4)

15.35 (1.6)

4

95

Bicycles and cycle rickshaws

14.80 (0.4)

14.54 (0.5)

8.28 (0.1)

15.35 (0.3)

5

89

Other electrical machinery

8.21 (0.5)

6.68 (0.5)

4.14 (0.1)

14.85 (0.8)

6

49

Miscellaneous textile products

11.97 (2.1)

3.28 (0.1)

4.91 (1.1)

13.08 (1.4)

7

46

Jute, hemp, and mesta textiles

16.24 (2.0)

15.80 (2.0)

13.48 (1.0)

13.01 (0.5)

8

80

Industrial machinery (other than food and textile machinery)

2.79 (0.2)

3.66 (0.3)

12.08 (1.0)

10.67 (0.5)

9

77

Miscellaneous metal products

7.35 (1.5)

3.43 (1.1)

1.70 (0.8)

10.58 (1.4)

15.2

13.7

11.2

11.8

Total percentage contribution to manufacturing exports (serial nos. 1 to 9)

Note: Growth rates are compound annual rates from the previous point in time. Sources: CSO (1981, 1990, 1997, 2000a).

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1978–79 (4)

10

Sector description (3)

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Input-output sector number (2)

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Serial number (1)

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Table 2.23

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Percentage share of wages and exports in total sales for selected industries in India (rank is in parentheses) Wage share

Serial number (1)

Sector (2)

1980–90 (3)

1991–96 (4)

Export share 1980–90 (5)

1991–96 (6)

1

Leather products

20.0

(1)

15.7 (1)

14.4 (2)

25.5 (1)

2

Publishing and printing

16.0

(2)

13.2 (2)

0.9 (15)

1.9 (16)

3

Machinery and equipment

13.1

(4)

10.0 (3)

5.6 (4)

7.1 (11)

4

Motor vehicles

12.5

(6)

9.5 (4)

3.8 (10)

7.2 (10)

5

Basic metal products

11.0 (10)

8.6 (5)

3.1 (11)

11.5 (4)

6

Nonmetallic mineral products

11.8

(8)

8.6 (6)

2.7 (12)

9.0 (6)

7

Textiles

14.5

(3)

8.4 (7)

6.5 (3)

12.1 (3)

8

Paper products

10.7 (11)

8.3 (8)

0.7 (16)

3.8 (14)

9

Wood products

11.5

8.1 (9)

2.0 (14)

5.8 (13)

(9)

10

Chemical products

9.1 (13)

7.5 (10)

4.8 (7)

7.5 (8)

11

Fabricated metal products

9.6 (12)

7.5 (11)

2.2 (13)

6.1 (12)

12

Rubber and plastic products

8.8 (14)

7.5 (12)

5.0 (5)

9.9 (5)

13

Tobacco products

12.8

(5)

7.4 (13)

19.1 (1)

19.5 (2)

14

Electrical machinery

11.8

(7)

7.1 (14)

5.0 (6)

2.4 (15)

15

Other transportation machinery

8.6 (15)

6.5 (15)

3.8 (9)

7.5 (8)

16

Food products

6.7 (16)

5.4 (16)

4.2 (8)

8.1 (7)

17

Petroleum products

4.4 (17)

3.6 (17)

0.0 (17)

1.3 (17)

18

All companies

8.3

4.8

8.6

11.3

Source: NCAER (2001: part 1, table C.VIII.1, for columns 3 and 4; part 1, table C.VIII.7, for columns 5 and 6).

We first focus on the relative shares of labor in an unorganized, predominantly small-scale, nonfactory segment and the organized, more productive, factory segment during the past three decades. According to the quinquennial National Sample Surveys (NSSs) of employment and unemployment, the share of factory plus nonfactory manufacturing employment in the total workforce increased only marginally from 9.0 percent in 1972 to 11.1 percent in 1999. Combining NSSs with the Annual Survey of Industries for the factory manufacturing sector shows that the share of the more productive factory segment in total manufacturing employment has stagnated at about 17 percent during the same period, despite respectable annual growth of about 7 percent in real manufacturing output. Labor market rigidities (to be discussed in chapter 5) constitute the major factor for the relative stagnation of factory-sector employment. INDIA IN THE WORLD TRADING SYSTEM

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Table 2.24

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Number of workers in the factory segment of manufacturing at the 2-digit industry code level in India Average number of workers

Twodigit codea (1)

1980–81 to 1982–83, period I (2)

1988–89 to 1990–91, period II (3)

1995–96 to 1997–98, period III (4)

Change between periods I and II (5)

Change between periods II and III (6)

Percentage composition of column 6 (7)

20–21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 20–38

1,003,917 389,893 920,280 196,030 234,239 81,383 64,027 221,490 50,639 137,485 337,526 313,039 446,511 151,701 293,754 218,543 377,624 51,470 5,489,550

841,512 440,774 729,380 231,167 189,043 129,342 56,768 207,520 83,969 312,553 251,871 353,578 464,682 168,529 294,784 251,101 364,991 66,188 5,437,754

1,019,154 532,601 736,656 285,914 212,790 295,523 61,643 251,038 106,574 525,008 253,583 366,623 518,163 214,906 328,251 296,148 438,183 107,801 6,550,562

–162,404 50,882 –190,900 35,137 –45,195 47,959 –7,259 –13,970 33,330 175,068 –85,655 40,539 18,171 16,828 1,030 32,558 –12,633 14,719 –51,796

177,642 91,827 7,276 54,747 23,747 166,182 4,876 43,518 22,605 212,455 1,711 13,046 53,481 46,377 33,467 45,048 73,192 41,613 1,112,808

15.96 8.25 0.65 4.92 2.13 14.93 0.44 3.91 2.03 19.09 0.15 1.17 4.81 4.17 3.01 4.05 6.58 3.74 100.00

a. Description of the 2-digit industry codes: 20–21, food products; 22, beverages, tobacco, etc.; 23, cotton textiles; 24, wool, silk, etc.; 25, jute textiles; 26, textile products; 27, wood, furniture, etc.; 28, paper and printing, etc.; 29, leather and fur products; 30, chemicals, etc.; 31, rubber, petroleum, etc.; 32, nonmetallic products; 33, basic metal industries; 34, metal products; 35, nonelectrical machinery; 36, electrical machinery; 37, transport equipment; 38, other manufacturing. Source: Tendulkar (2000a).

The 1980s, in particular, were described as a decade of “jobless growth,” because there was a virtual stagnation of employment in the factory segment. There was a net decline of about 52,000 in the average number of factory workers (table 2.24). Seven out of 18 industry groups suffered job losses amounting to 518,000, which were not offset by the job gains of the remaining groups. Employment in the factory sector grew, however, at 2.9 percent annually in the 1990s. The latest available postreform triennium 1995–97 marked a net increase of 1.11 million jobs over the prereform triennium 1988–90. The crucial differences between the 1980s and 1990s with regard to employment growth were that there was a 2 percent annual rise in real output growth and a 2 percent annual decline in the growth rate of labor costs (table 2.25). Employment growth was equally responsive to real output growth in both decades, once the impact of growth in labor costs is netted out. Reduced distortions and greater competition during the postreform 72

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Table 2.25

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Exponential trend growth rates (percent) and partial elasticities for variables associated with factory manufacturing in India

Series number (1)

Description (2)

1980–81 to 1990–91 (3)

1990–91 to 1997–98 (4)

1

Number of workers

–0.12 (0.016)

2.92 (0.89)

2

Gross value added at 1993–94 prices

7.13 (0.97)

9.09 (0.94)

3

Wholesale price index for all commoditiesa

6.56 (0.99)

8.43 (0.98)

4

Implicit deflator for aggregate gross value added in manufacturingb

6.83 (0.99)

6.83 (0.99)

5

Consumer price index for industrial workersc

8.29 (0.99)

9.05 (0.99)

6

Real consumption wage per workerd

3.02 (0.92)

1.29 (0.56)

7

Real product wage per worker

4.48 (0.93)

2.62 (0.80)

8

Partial elasticity of employment with respect to real outpute

0.85 (27.96)

0.90 (25.92)

9

Partial elasticity of employment with respect to product wagee

–0.83 (–15.43)

–0.97 (–21.30)

a. The wholesale price index for all commodities is the average of months for a fiscal year (April–March). b. The implicit deflator for aggregate gross value added (AGVA) in manufacturing is derived as a ratio of AGVA at current prices divided by real AGVA at constant prices derived as a sum of 2-digit industryspecific real gross value added (defined as part of the definition of gva in note e below). c. The Consumer Price Index for Industrial Workers (CPIIW) is the average of the months in a fiscal year (April–March). d. The real consumption wage is the average wage per worker deflated by CPIIW (defined in note c). e. The partial elasticities in rows 8 and 9 (t-values in parentheses) are from cross-sectional regressions across 18 two-digit industry groups given below for 1981–91 (equation 1) and 1991–98 (equation 2): ge = –8.98 + 0.8516gva – 0.8307gpw + 8.4257 (–9.19) (27.96) (–15.43) (8.07)

adjusted R 2 = 0.9830

(1)

ge = –15.53 + 0.8959gva – 0.9705gpw + 16.2980 (16.80) (25.92) (–21.30) (16.48)

adjusted R 2 = 0.9825

(2)

where ge = the growth rate of the number of employed workers; gva = the growth rate of real value added, defined as the gross value added at current prices deflated by the wholesale price index for output (1993–94 = 100) for each industry group; gpw = the growth rate of product wage, defined as the average wage per worker at current prices deflated by the wholesale price index of output for each industry group; and  = the elasticity of the nominal wage bill (NWB) with respect to the nominal gross value added (NGVA), derived by dividing the growth rate of NWB by the growth rate of NGVA. Note: Growth rates in rows 1 through 7 are slope coefficients of semi-log trend equations with squared product-moment correlation coefficients (r 2) in parentheses. Source: Tendulkar (2000a).

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1990s thus were associated with a higher rate of labor absorption as well as higher growth in the real manufacturing output of the more productive factory manufacturing segment.

Growth Performance in the 1990s Economic reforms and stabilization since 1991 have aimed to put the Indian economy on a path of sustainable fiscal and current account deficits and more rapid growth. The growth performance of the Indian economy in the 1990s was, therefore, closely linked to variations in fiscal discipline and the pace of the economic reform process. To correct the fiscal profligacy of the 1980s, a sharp fiscal contraction of 2.3 percent of GDP was undertaken by the central government in 1991 and 1992. This was accompanied by a two-step devaluation of the currency and savage import compression to bring the current account deficit within manageable limits. Predictably, the growth rate dipped to 1.3 percent in 1991 (table 2.3) but recovered quickly to 5.1 percent the next year. It remained below 5.6 percent recorded in the immediate prereform year of 1990. The next 4 years, the period 1993–96, posted steadily rising growth rates, peaking at 7.9 percent in 1996 and averaging 7.1 percent during the period. This growth performance was unprecedented. As was noted above, this was the period of wide-ranging liberalization of controls on private economic activities, the removal of entry barriers, and the introduction of external competition through the rationalization and gradual reduction of import tariffs. There was a fair amount of corporate restructuring through mergers, acquisitions, joint ventures, strategic alliances, and so on. After a spike in the fiscal deficit in 1993, the gross fiscal deficit (center and states combined) in relation to GDP reached its minimum for the decade in the period 1995–96. The double-digit inflation rate of the early 1990s also declined to 4.4 percent in 1997 (see table 4.1 below). With a congenial macroeconomic environment and the removal of controls, gross domestic capital formation (at constant 1993–94 prices) rose by 2 percent of GDP in 1990 to reach a maximum for the decade at 27.2 percent. The consequent surge in growth was led by the manufacturing sector in general, in particular registered factory manufacturing. The latter was affected most by policy reforms and posted an impressive average growth of 12.9 percent for the 4-year period. Still outside the reform process, but helped by favorable monsoons, the agricultural sector maintained its average growth rate of 4.4 percent during the 1980s, whereas services increased their average growth rate to 8.1 percent compared with the 1980s (table 2.3). The last 4 years of the decade saw the gradual dilution of discipline in central—and especially state—budgets. What is worse, the consolidated fiscal deficit of the public sector (figure 2.9) again crossed the 2-digit level 74

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of the 1990s, and two-thirds of the gross fiscal deficit arose from mostly unproductive current expenditures. The reform process also slowed down, with average import tariff levels again on the rise with the removal of QRs on imports of consumer goods in 2000 and 2001. There was also some appreciation of the real effective exchange rate following the Asian currency crisis (see table 4.1). As a result, the overall growth rate slowed down to 5.4 percent on average during the period 1997–2000, following a considerable slowdown in industrial growth to barely 3 percent in the registered manufacturing sector. The latest data suggest that after further declining to 4 percent in 2000–01, the GDP growth rate recovered to 5.4 percent in 2001–02.22 An official analysis of the slowdown (Ministry of Finance, Economic Survey, 2001–02, box 7.1, 169) attributes the slowdown to domestic demand (from a slowdown in agricultural growth to an average of 1.3 percent) and to supply factors, including high interest rates (a consequence of rising fiscal deficits); infrastructural bottlenecks; restricted labor laws; high costs; and an inadequate, unreliable supply of transport, communications, and electricity. With the relaxation in the pace of reforms and fiscal discipline, the economy appears to be in danger of relapsing to a lower growth path. If this happens, it will indeed be unfortunate, because it will slow the process of poverty reduction that had gained some momentum in the 1990s.

The Employment and Poverty Situation in the 1990s: A Brief Assessment Our analysis above of the factory sector was based on disaggregated 2digit industry-level data that are available only until 1997. For the later 2 years, the available aggregate employment figures indicate declines in employment of about 1.2 million in 1998 and 84,000 in 1999.23 This was the result of a very sharp decline in the annual growth in real output of registered manufacturing to barely 2 percent on average between 1997 and 1999. In comparison, the previous four years (1993–96) of the industrial boom were associated with an annual trend growth of nearly 3 percent in factory employment (table 2.18).24 This growth should not be 22. Press Information Bureau, “Advance Estimates of National Income, 2001–02,” Press Note, February 5, 2002. 23. This is based on a personal communication from the Central Statistical Organization. The national industrial classification (NIC) scheme changed from NIC 1987 to NIC 1998, effective from 1998. Therefore, disaggregated data will have to be adjusted when available to compare with our analysis in Tendulkar (2000a). 24. See table 2.3. Registered manufacturing in National Accounts corresponds to the factory manufacturing segment in our discussion above. INDIA IN THE WORLD TRADING SYSTEM

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interpreted to mean that there were no job losses due to industrial restructuring consequent upon increased competition during 1990–97. It merely brought out what is expected during the episode of acceleration in real industrial output, that is, the new employment opportunities created far exceeded job losses from weeding out and restructuring inefficient units. The situation was reversed during the episode of growth deceleration during the period 1997–99. Factory employment, however, accounted for merely 17 percent of total (factory plus nonfactory) manufacturing employment, which itself was just 11 percent of the total workforce in 1999. Our discussion of it was prompted by the focus of economic reforms being on the factory segment. But the question still remains about the overall employment situation in the 1990s. This can be assessed from the NSSs on employment and unemployment for 1993–94 and 1999–2000 (July–June25). As was noted above, this period experienced a growth boom in the first half and a growth deceleration in the second half. However, taking the entire period, the average compared with any 6-year period annual growth rate in real GDP on the average was 6.5 percent, the highest over any 7-year period in post-Independence history (table 2.3). From a comparison of the sectoral composition of the workforce in 1961, 1983, 1993–94, and 1999–2000, Sundaram and Tendulkar (2002b) found that, unlike the earlier years, the last 6 years of the 1990s’ rapid growth were marked by major changes in the incremental composition of the total, as well as the female, workforce. These changes include the following positive outcomes:  the beginning of a long-awaited absolute decline in the total, as well as the female, workforce engaged in agriculture and allied services (these are sectors with lower than average productivity per worker at the national level);  an increase in rural nonfarm (mostly manufacturing) employment, with higher average productivity per worker than workers in agriculture and related activities;  an absolute decline in employment in the grossly overstaffed and mostly unproductive bureaucracy, public-sector undertakings, as also in mostly unskilled and low-productivity community and personal services; and  an increase in skilled educational and health workers, as well as those in transportation and construction services.

25. The survey periods of the NSSs referred here spanned the 12-month period from July 1 to June 30 (which coincides with the seasonal agricultural cycle and hence is commonly referred to as agricultural year) and differs from the fiscal year (April 1–March 31) or calendar year (January 1 to December 31). An earlier NSS had the calendar year as the survey period. 76

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In labor market outcomes, there was a healthy annual growth of nearly 3 percent in real daily wage rates, both in rural and urban areas. The NSSs cover all workers, that is, those engaged in formal as well as informal or unorganized activities—the latter accounting for 90 percent of total workers. Consequently, growth in real daily wage rates is representative of the numerically dominant workers in informal economic activities. Given that the real wage rate growth is a joint consequence of a rise in demand for work and a rise in productivity, this healthy growth clearly reflects a welcome tightening of the rural as well as urban labor markets. K. Sundaram26 shows that the real wage growth was strong enough to offset a reduction in the number of days worked per worker per year (for males) as well as a decline in the worker-population ratio across all the age groups. Thus, average annual wage earnings grew in real terms for the rural and the urban workforces separately. An extension of this exercise (Sundaram and Tendulkar 2002b) exclusively to agricultural laborers leaves the conclusion broadly unchanged. There was distinct improvement, then, not only on average for rural and urban workers but also for the most vulnerable segment of agricultural laborers. The conclusion is an unambiguous one: overall improvement in the employment situation, even though there was a reduction in factory employment in 1998 and 1999 (as was noted above). The discussion about trends in poverty in the postreform 1990s has been plagued by problems of comparability in NSS data on consumer expenditure, on which poverty estimates are based for 1993–94 and 1999– 2000.27 After suggesting an empirical resolution of problems of comparability in NSS, Sundaram and Tendulkar (2002b) conclude that there was more than an average 1 percent a year decline in poverty (head count ratio) between the years 1993–94 and 1999–2000 and that this was faster than that in the previous decade before reform. The last 6 years of the 1990s thus present a mutually consistent picture of rapid growth, an improvement in overall employment, and a reduction in poverty. In view of these three crucial aggregate indicators, the reforms— including the increasing integration of India with the world economy— seem to have paid off.

26. K. Sundaram, “Employment-Unemployment Situation in the Nineties: Some Results from NSS 55th Round Survey,” Economic and Political Weekly 35, no. 32 (August 11, 2001): 931–41; “Employment and Poverty in 1990s: Further Results from the NSS 55th Round EmploymentUnemployment Survey, 1999–2000,” Economic and Political Weekly 35, no. 11 (March 17, 2001): 3039–49. 27. Abhijit Sen, “Estimates of Consumer Expenditure and Its Distribution: Statistical Priorities After the NSS 55th Round,” Economic and Political Weekly (December 16, 2000): 4499–518. INDIA IN THE WORLD TRADING SYSTEM

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3 India in the GATT and the WTO

India was one of the 23 founding Contracting Parties to the General Agreement on Tariffs and Trade (GATT) that was concluded in October 1947. The country’s leaders served as spokesmen for developing-country concerns in the discussions that led to the GATT, and India has often led groups of less developed countries in subsequent rounds of multilateral trade negotiations (MTNs) under the auspices of the GATT.1 India’s participation in these international economic negotiations is illustrative of its (and other developing countries’) ambivalence toward the importance of trade and of the world trading system in accelerating development. This history (recapitulated in detail in an appendix at the end of this chapter) provides a broader sense of why India, along with other developing countries, avoided international integration for decades. The legacy of the colonial era as described in chapter 1 as a determinant of India’s distrust of the international economy is but one part of the history. We begin this chapter with a discussion of the Uruguay Round, the eighth and last round of MTNs under the auspices of the GATT, and assess the wide-ranging agreements of that round, including the creation of the World Trade Organization (WTO) to subsume the GATT in 1995. This assessment leads us to make recommendations for India’s role in the new round of MTNs launched by the Fourth Session of the Ministerial of the Conference of the WTO at Doha, Qatar, in November 2001. India’s reluc1. We have drawn extensively from Srinivasan (1998a) in writing this chapter. In the World Trade Organization (WTO) context, multilateral agreements are those to which all members of the WTO are parties, whereas plurilateral agreements are those to which some but not all members are parties. 79

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tance to endorse this new round until the concluding plenary of the Doha session stemmed from its dissatisfaction with the agreement that concluded the Uruguay Round and also from vestiges of its inward-oriented development strategy from decades before the 1992 reforms.

The Uruguay Round The Uruguay Round, which turned out to be far-reaching in its scope and coverage of negotiating agenda compared to the earlier rounds, had a bumpy start.

Events Leading to the Round The GATT ministerial meeting of 1982 was called to examine the functioning of the multilateral trading system since the conclusion of the Tokyo Round in 1979. The preparatory committee for the meeting had compiled a long list of items for the consideration of ministers. The list grew in part because the GATT Contracting Parties felt free to add issues concerning their own parochial interests (e.g., services). Although the United States would have liked the meeting to be the first step toward a new round of MTNs, it did not attract much support at the meeting. Brazil and India led a group of developing countries that were strongly opposed on the ground that they were not ready to negotiate on services on an equal footing with industrialized countries. These countries’ second objection was that the industrialized nations had not lived up to their obligations with regard to trade in textiles and agricultural products. They demanded commitments from industrialized countries to rescind existing GATT-inconsistent measures (the so-called rollback demand) and not to introduce new ones (the so-called stand-still demand). The drafting of a ministerial declaration at the conclusion of the meeting proved contentious, and the final text that emerged at the end of 5 days of the meeting (2 days beyond its scheduled closing) was not a consensus document. The operational part of the final text enunciated a 2year work program for the GATT (until its next ministerial meeting in 1984) involving 17 topics. Even before the work program was completed, Japanese prime minister Yasuhiro Nakasone broached the idea of a new round of MTNs in 1983, and the leaders of seven industrialized countries (the so-called Group of Seven or G-7) in their meeting in 1984 agreed to consult among their trading partners about the objectives and timing of a new round. Developing countries, led by Brazil and India, continued to criticize industrialized countries’ policies, and the European Commission’s (EC’s) reservations had not dissipated either. 80

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Nevertheless, informal discussions in the GATT on a new round began in early 1985, and a special meeting of the Contracting Parties was called. The EC, Brazil, and India lessened their opposition and agreed informally to start the new round before the parties met in November 1985. At the meeting, the parties decided to establish a formal preparatory committee to put together a set of recommendations by mid-July 1986 for adoption at the ministerial meeting at Punta del Este, Uruguay, in September 1986. The preparatory committee ran into many conflicts. The topics before the committee had expanded from the 17 in the work program of 1982 to 31, of which only 19 eventually became the subject of specific negotiation mandates. Four others came to be mentioned in the preamble to the ministerial declaration launching the Uruguay Round. Apart from the committee, individual countries and overlapping groups of countries began to circulate draft texts for the ministerial declaration. These included Australia, Canada, Japan, the Group of Nine (G-9, consisting of Australia, Canada, New Zealand, and the members of the European Free Trade Area); and the Group of Ten (G-10) developing countries, led by Brazil and India and also including Argentina, Cuba, Egypt, Nicaragua, Nigeria, Peru, Tanzania, and Yugoslavia. Three main texts were presented at the meetings. The G-10 did not attract more members and presented a minority text to the preparatory committee. The G-9, in contrast, was able to attract a group of 20 developing countries to meet with it. The G-9 eventually came to include them and other major industrialized countries, growing to a membership of 40 countries. This Group of Forty, or G-40, chaired by Colombia and Switzerland, presented the majority text. Argentina on its own presented a third text (Low 1993, chap. 10). Winham (1989) provides a fascinating description of the drama of the Punta del Este ministerial meeting. Without a single agreed-on text from the preparatory committee, the meeting began with three texts, but the main contention was between the G-10 and G-40 texts. The G-10 texts reflected the resistance of some developing countries—India and Brazil foremost among them—to the US demand to include new issues: services, intellectual property, and investment measures. But the G-10 position eroded, and a growing consensus emerged around the US position once the United States, in effect, gave an ultimatum that it would withdraw from the conference altogether if these issues were not included. The EC did not fully accept the position of the G-40 text on agriculture. After three days of meetings and creative efforts to foster agreements, the negotiation chairman, Enrique Iglesias (then minister of foreign affairs of Uruguay) restricted the debate. Iglesias created a small consultation committee, with membership by invitation only, of 20 nations representing the contending positions at the meeting. In addition, two substantive groups on services and agriculture were established to work simultaneously with the consultation committee. Iglesias, on his own initiative, deINDIA IN THE GATT AND THE WTO

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cided to treat the G-40 text as the basis for discussion in the consultation committee over the protests of those developing countries supporting the G-10 text. He allowed amendments to the G-40 text that in turn drew protests from industrialized countries. Thirty-one amendments were initially offered, and they were subsequently reduced to 14. Nothing substantial had been decided when the consultation committee met for the last time, less than a day before the ministerial meeting was to end. With the US delegation announcing with great fanfare that it would depart for the United States the next morning with or without a final declaration and threatening to call a vote in the committee rather than achieve a consensus, other members of the committee felt pressured to come to an agreement. India and the United States came to an agreement that the negotiation on services would be undertaken separately. Other disputed items on the negotiating agenda of the round, such as trade-related intellectual property and investment measures, were quickly settled. An agreement was also reached on agriculture. With the settlement of these major issues, the 14 amendments to the G-40 text were discussed and withdrawn—except for a statement that was included in the objectives section of the final text. It called on nations to link actions on trade liberalization with efforts to improve the functioning of the international monetary system. The draft agreed to by the consultation committee was approved by the full plenary. Brazil and India, the leaders of the G-10, did not attract more adherents to their main points of view in the prenegotiation phase of the Uruguay Round. Brazil’s approach to the issues being negotiated subsequently shifted, reflecting a change of heart about the virtues of inward-oriented development strategies.2 In fact, Brazil and India lagged behind other developing countries that had already started down the path toward international integration. Brazil adopted a series of liberalizing reforms only in mid-1991. India, the other major bastion of inward orientation in the G-10 group, initiated, also in 1991, a major dismantling of its barriers to trade and foreign direct investment after facing a severe macroeconomic crisis. Many developing countries had at last come to understand that for their reforms to succeed, a liberal world trading order was essential, and their full participation in the Uruguay Round was a means of ensuring it. With the realization on all sides that too much was at stake for the round to be allowed to fail, an agreement was eventually reached.

2. Edwards (1995) argues that soul-searching about development began in Latin America in the early 1980s. It was driven by the failure of heterodox stabilization programs in Argentina, Brazil, and Peru; a realization of the contrast between Latin America’s failure, by and large, with inward-oriented policies and the rapid growth of East Asia with outward-oriented policies; and a better appreciation of the Chilean experience with market orientation.

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The Uruguay Round Agreement, India, and Developing Countries The Uruguay Round Agreement (URA) as a single undertaking includes agreement on traditional GATT issues such as reductions of tariffs and tariff bindings, a not completely successful attempt to bring agricultural trade under multilateral disciplines, a major revamping and strengthening of the Dispute Settlement Mechanism (DSM), phasing out of the Multi-Fiber Arrangement (MFA) that was an egregious violation of GATT principles, an agreement on Trade-Related Investment Measures (TRIMs) and Trade-Related Aspects of Intellectual Property Rights (TRIPS), and a new General Agreement on Trade in Services (GATS). Since the conclusion of the Uruguay Round as envisaged, multilateral agreements on Financial Services and Telecommunications have been concluded as part of the GATS. In accord with the built-in agenda of the URA, a review of the agreements on agriculture and TRIPS was initiated in 2000. Negotiations on leftover items of the GATS (e.g., movement of natural persons and maritime services) have been folded into the post-Doha negotiation. We return below to the balance, from the perspective of developing countries, of the benefits and costs of implementing the commitments undertaken by the signatories of the URA. The DSM of the WTO is stronger than the one in the GATT that it replaced. The GATT process was essentially political. A country against which a complaint was lodged could prevent the establishment of a panel to examine the complaint or veto the acceptance of the panel’s report if one were established. The DSM of the WTO is a legal process: no member can prevent the establishment of a panel, and a consensus is needed to overturn the report of its Appellate Body if a party to a dispute appeals against the decision of the panel. Although it is a good sign that many developing countries, including India, are using the process and that powerful countries such as the United States and the European Union members are abiding by its decisions, there is a serious danger of the DSM becoming inequitable. Because the dispute settlement process is more legal than political, an adversarial system has become its operating framework. Only those countries that can afford the costs of recognizing and litigating the violation of their rights by others, as well as defending themselves in cases brought against them make use of the system. Also, the DSM’s Appellate Body has become very powerful, and in its interpretations of the GATT articles, particularly of Article XX, seems to have gone beyond what the GATT founders intended. Besides, it has chosen to accept amicus briefs from parties that do not represent WTO members. These are disturbing developments. India stands to gain significantly if the market access commitments of the URA are implemented in full and in good faith. Bergsten (1999) cites

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estimates of gains, ranging from 0.5 percent to more than 4.5 percent of GDP for South Asia. Canonero and Srinivasan (1995) estimate that India’s bilateral trade with the United States and the European Union in textiles and apparel will increase by 2.6 percent and 4.3 percent respectively once the MFA is phased out. François et al. (1996) estimate gains to South Asia in the range of 0.44 to 4.10 percent of GDP from the phaseout of the MFA. Much of the gain to South Asia is likely to accrue to its dominant economy, India. However, these estimates do not take into account the likely impact of China’s accession to the WTO in 2002. Ianchovichina and Martin (2002) estimate the impact on India’s per capita income during a 12-year period (1995–2007) after the start of the implementation of the URA as minus 0.4 percent, with most of the loss coming from India’s losing a large part of its textile and apparel exports to China after the phaseout of the MFA on January 1, 2005. China’s deeper tariff cuts also contributed to India’s loss. However, the overall loss is small and could easily be reversed if India were to open its economy beyond its commitments under the URA. The realization of these potential gains will depend on two factors: on Indian producers continuing to be or, if necessary, becoming internationally competitive; and on industrialized countries not circumventing the phaseout of the MFA through other means. There are reasons to worry on both grounds. India has not in the past utilized its MFA quotas in full in several products and has recently been losing its market share to its competitors. As the estimates of Ianchovichina and Martin (2002) indicate, China’s being internationally competitive means that once it is in the WTO, India will lose its share even more, unless India takes steps to become competitive. The industrialized countries are attempting to circumvent their commitment to liberalize trade in textiles and apparel by using WTO legal antidumping measures. For example, the EC recommended the imposition of antidumping duties on gray cotton cloth exports from India and a few other countries. This is egregious—after all, an exporter with a binding quota on exports has nothing to gain by dumping. Fortunately, the EU Council of Ministers rejected the EC’s recommendation. India’s full integration with world markets could potentially have significant effects on world prices of certain agricultural commodities (e.g., rice, vegetable oils, and fats). Also the needed adjustment—in the form of shifting cultivated area away from crops in which India is unlikely to have comparative advantage and toward those in which it has— would be painful in the short run. There is the further problem that there is substantial variation across states in India in the productivity of crops, and shifts in cultivated areas across crops will also imply that in some states cultivation of certain crops might have to be abandoned altogether. Notwithstanding the possible terms of trade effects and adjustments, Indian farmers will benefit from full integration with world markets, assuming that industrialized countries, including the members of the Euro84

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pean Union and the United States, will phase out their distortionary interventions in the market for agricultural commodities. In our view, it is in India’s own interest to join with other major agricultural traders of the Cairns Group in any future negotiations to press for the complete elimination of interventions in agricultural trade and for bringing such trade fully under the WTO disciplines that apply to trade in manufactured goods.3 Uruguay Round commitments by India have begun to affect its trade policies, but there is still substantial trade protection in place. India increased the proportion of tariff lines it bound from 6 percent before the Uruguay Round to 67 percent as part of its commitments in the agreement concluding the round. Tariffs for nonagricultural goods, with few exceptions, were bound at 40 percent for finished goods and 25 percent on intermediate goods, with the reductions from applied levels to the bounds to be completed by 2005. After some hesitation, and after having been ruled against by the WTO’s Dispute Settlement Mechanism (DSM) on a complaint from the United States, India has finally brought its domestic patent laws into conformity with what is required under the TRIPS agreement. Under the TRIMs agreement, India notified the TRIMs maintained by it and has since eliminated them. Under the Information Technology Agreement, India is committed to eliminating tariffs on 95 tariff lines by 2000, on 4 lines by 2003, on 2 lines by 2004, and on the remaining 116 lines by 2005. Reforms have been slow, however. India invoked the balance of payments provision of Article XVIII(B) of the GATT in an effort to delay the implementation of its commitment to phase out its existing quantitative restrictions (QRs) on about 2,300 tariff lines consisting mostly of consumer goods. It entered into bilateral agreements with Australia, Canada, Japan, and the European Union for the pace of phaseout of QRs after these countries had filed a complaint against India with the WTO. The United States, however, persisted with its complaint, and the DSM ruled against India. India appealed against the ruling on the grounds that the DSM has no jurisdiction for ruling on the use of balance of payments provisions and that the WTO balance of payments committee should handle the matter. India lost this appeal, and all the QRs were phased out (partly in fiscal 2000 and partly in 2001). The GATS, unlike the GATT, allows greater freedom to exempt particular services from the principles of the most favored nation (MFN) and national treatments (NT). It allows countries to choose sectors in which they take on commitments. India has made commitments in 233 activities. 3. The Cairns Group is named after Cairns, the town in Australia where it first met. As of March 2001, it included Argentina, Australia, Bolivia, Brazil, Canada, Chile, Cambodia, Costa Rica, Fiji, Guatemala, Indonesia, Malaysia, New Zealand, Paraguay, Philippines, South Africa, Thailand, and Uruguay. INDIA IN THE GATT AND THE WTO

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India’s unweighted average of bound tariffs on manufactured imports was as high as 51 percent (Mattoo and Subramanian 2000, table 2). In agriculture, like most other countries, India has participated in the shameful exercise of “dirty tariffication” and bound its rates at 100 percent on primary commodities, 150 percent on processed goods, and 300 percent on edible oil products. According to Mattoo and Subramanian (2000, table 4) the difference between bound rates and applied rates in 2000 exceeded 50 percent in 656 out of 673 tariff lines. Before the URA, India had bound its tariff at zero for some commodities. Since the URA, these bounds have been renegotiated and set at much higher levels. India, as a developing country, has availed itself of the full range of allowed exceptions and has made no commitments whatsoever with respect to market access or reduction of subsidies or tariffs.

TRIPS and India In our view, it was a major mistake to have brought intellectual property issues into the WTO through the TRIPS agreement. As the late Nobel laureate Jan Tinbergen (Tinbergen 1952 and 1956) argued in his well-known work on policy assignment, there has to be at least one policy instrument per objective, and trying to use the same policy instrument to achieve more than one objective is a sure prescription for achieving none of the objectives efficiently and in full measure. The same logic applies equally to assignment of responsibility to international institutions such as the International Monetary Fund, the World Bank, the International Labor Organization, the World Intellectual Property Organization, and the agencies of the United Nations. The World Bank and the International Monetary Fund have their own mandates. So does the WTO. Going beyond the mandates of each to achieve unrelated objectives is inappropriate. There were already the World Intellectual Property Organization and the Paris and Bern conventions in the arena of intellectual property. There is the International Labor Organization for labor, and there is the United Nations Environment Program for the environment. There is no reason why these specialized agencies cannot be used as forums for negotiating and creating effective multilateral disciplines on intellectual property, labor, and environmental standards. It is not too late to take TRIPS out of the WTO and put it into a redesigned World Intellectual Property Organization with a less legalistic and more economic focus as well as a more effective enforcement mechanism—although it is extremely unlikely to happen. We will return to possible amendments to TRIPS to make it more beneficial to India and other developing countries. Apart from the lack of rationale for TRIPS in the WTO, there is no compelling theoretical or empirical argument in favor of a uniform minimum life of 20 years for all patents regardless of 86

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the nature of the invention—or, for that matter, for monopoly rights through patents as necessarily the cost-effective means for encouraging innovation (Srinivasan 2001). Bhagwati (2001) points out that unlike traditional trade liberalization, in which a liberalizer and its trading partners gain, intellectual property protection through TRIPS involves an unrequited transfer of royalties from user (developing) to producer (industrialized) countries. Maskus (2000, table 6.1) estimates a transfer of $8.3 billion to just four industrial countries. If one uses a broader measure, namely, net receipts from royalty and license fees, in 2000 only France, Sweden, the United Kingdom, and the United States had positive net receipts. The net outflow on this score from low- and middle-income countries amounted to $9.2 billion (World Bank 2002, table 5.11). India has a vital interest in ensuring that any future agreement reached on the movement of natural persons is very liberal. It is likely to have comparative advantage in labor-intensive services as well as in certain skill-intensive ones such as software. Software is one of India’s fastest growing industries in the electronics sector. Software exports grew by an impressive 43 percent a year between the periods 1991–92 and 1996–97 and by 68 percent in 1997–98. Even in 2001–02, when there was a recession in export markets (particularly the United States), export growth was 23 percent above the previous year. The industry expects export growth of 22 percent in 2002–03 (NASSCOM 2002b). Although exports of software from a domestic base will continue to grow, provided the industry remains competitive, providing in situ services in foreign markets and keeping up with technological developments require Indian software technicians to have the opportunity to work abroad, without necessarily having to migrate permanently. Most of the Indian engineers entered the United States under a special category of nonimmigrant visas. In 1999, nearly 55,000 visas were issued to Indians, as compared with 6,700 to Chinese. But there is strong pressure to restrict the number of such visas issued. A liberal agreement on the movement of natural persons would facilitate such temporary migration. Although India is a significant player in the world software market, there are reasons to believe that it may not realize its vast potential unless major policy changes are made. We noted in chapter 2 that a study by McKinsey and Company (2001, vol. 3, 143–61) highlighted this potential. It projects annual revenues of $87 billion, 2.2 million jobs, and a market capitalization of $225 billion for the Indian information technology sector by 2010. By the same year, that sector could account for 35 percent of India’s exports, attract $5 billion in foreign direct investment each year, and contribute more than 7.5 percent to the growth of GDP. In contrast to this potential, the actual situation as of 2001 is sobering: India accounts for less than 2 percent of the world software market. The industry’s focus is on proprietary work for foreign organizations, which INDIA IN THE GATT AND THE WTO

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is only a small part of the global market. Indian industry has not penetrated the large off-the-shelf software market. India’s cost advantage of having inexpensive software professionals will be eroded as other players with similar or lower costs enter the market. The benefits from an efficient software industry are not simply greater export earnings and foreign direct investment but the significant gains in the productivity of resource use in the domestic economy. The single most urgent policy action needed for India to realize the potential of its software industry is to ensure that a vibrant and efficient world-class telecommunications infrastructure is in place. Unfortunately, a conflict between the Department of Telecommunications (DOT) and the Telecommunications Regulatory Authority of India (TRAI), as it was initially constituted, hampered progress toward an efficient telecom infrastructure. A national telecom policy was announced in 1999. TRAI was reconstituted in 2000, and its dispute resolution powers are now vested in a new quasi-judicial agency. The conflict of interest arising from DOT being both a policymaker for the industry and also a service producer through its overall control of public-sector telecom enterprises is also resolved. DOT as a service provider has been corporatized and separated from its policymaking role. There is reason for cautious optimism that an efficient telecom infrastructure will develop in the near future, as we discuss in chapter 4. In customized software, India’s recent share is a commanding 16 percent. In California’s Silicon Valley, almost 3000 of the region’s high-tech companies are run by Chinese and Indian engineers. . . . Apart from generating annual sales of almost $17 billion last year and providing 58,000 jobs in California’s high-tech zone, Asian entrepreneurs have established long-distance business networks especially with Taiwan and India, which offer valuable openings for investment and trade. . . . Chinese and Indian chief executives ran 13 percent of the Silicon Valley technology companies started between 1980 and 1984 and 29 percent of those launched between 1995 and 1998. (Financial Times, July 3–4, 1999, 3)

With a liberal multilateral agreement on the movement of natural persons, India could potentially increase its share.

India and the New Round of Multilateral Trade Negotiations Reminiscent of its lack of enthusiasm for the Uruguay Round, India was reluctant, for several reasons, to endorse the start of a new round of MTNs in the preparatory meetings for the Third Session of the Ministerial of the Conference of the WTO in Seattle during late November 1999. First of all, unlike agreements on earlier rounds of MTNs that largely covered com88

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mitments on measures at the border such as tariffs and quotas, the URA involved domestic policy commitments. Implementing the required behindthe-border commitments entailed institutional development—more than merely changing a duty rate in the customs code. The Uruguay Round “overlooked the costs of the institutional construction needed for the least developed countries” (Odell 2002, 403). Signatories undertook several “unprecedented obligations not only to reduce trade barriers, but to implement significant reforms both on trade procedures (e.g., import licensing procedures customs valuation) and on many areas of regulation that establish the basic business environment in the domestic economy (e.g., technical, sanitary and phytosanitary standards, intellectual property law).”4 Ostry has aptly described the shift from the GATT to the WTO system: “the inclusion of the new issues and the creation of the new institution, the WTO, was to transform the multilateral trading system. . . . The most significant feature of the transformation was the shift in policy focus from the border barriers of the GATT to domestic regulatory and legal systems—the institutional infrastructure of the economy. . . . Implicit in this shift . . . is a move away from a model of negative regulation—what governments must not do—to positive regulations, or what governments must do” (2002, 287–88; emphases added). Under the single undertaking rule, participating countries had to accept all the multilateral agreements related to goods and services, and also TRIPS understandings on dispute settlement and on trade policy review mechanisms. Thus they had no option to pick and choose among the many agreements for acceptance. In fact, there were only four plurilateral agreements (on civil aircraft, government procurement, dairy, and bovine meat) that did not form part of the single undertaking. Second, a fairly strong case can be made that the URA was unbalanced: developing countries undertook many costly commitments and obtained only a few commitments in return. Industrialized countries agreed to phase out MFA quotas and undertake a limited liberalization of agricultural trade. In fact, on balance, there was virtually no liberalization of agricultural trade in the URA. Although subsidies on exports of manufactures (which some developing countries offered to their infant manufactured exports) were made WTO-inconsistent, agricultural export subsidies (which were used mainly by industrialized countries, particularly the members of the European Union) were reduced, but not eliminated. It is true that developing countries were given a longer time to implement their commitments as compared with industrialized countries. As the implementation began, however, many developing countries found that even the longer implementation periods might not be long enough. India wanted the issues of imbalance and implementation to be addressed before the start of any new round. 4. Finger and Schuler (2000, 511).

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Third, in India’s view the mandated review of the agreements on agriculture in the Uruguay Round, TRIPS, services, and the yet to be initiated negotiations on maritime services, would occupy negotiators for some time to come. Also, an agreement on the movement of natural persons is yet to be reached. Fourth, given the problems of implementation of Uruguay Round commitments, India felt that it was too soon to add commitments from a new round of negotiations. India’s opposition to the start of a new round of MTNs continued even after the failure of the Seattle ministerial in the period before the fourth ministerial meeting opened in Doha in November 2001. Before turning to India’s role at Doha, it is useful to explore the reasons for the failure of the Seattle ministerial.

The Failed Ministerial at Seattle The first point is that there was no agreement at preparatory meetings on a draft of a ministerial statement for discussion at Seattle. Agricultural protection, in particular, was a divisive issue; agricultural exporters of the Cairns Group, Japan, the European Union, and the United States were deeply divided on the elimination of export subsidies and import restrictions. As was noted above, there was no agreed-on draft at the start of the Punta del Este ministerial—the division on agriculture among the European Union, Japan, and the United States then was equally wide, and developing countries were against the inclusion of new issues such as services in the negotiating agenda. Yet at the last minute, a compromise was reached that launched the Uruguay Round. However, this did not happen in Seattle. Why? Although the demonstrations and the violence on the streets of Seattle did disrupt the meetings, they had little to do with the failure of the ministerial. It was clear that the demonstrators were merely exploiting for their own purposes the genuine unease in industrialized and developing countries over the impact of the forces of globalization. They did not represent the majority of the population of workers of the United States, let alone of the world as a whole. The position taken by the AFL-CIO labor organization in the United States, a participant in the Seattle demonstration, on linking trade with the observance of “core” labor standards, was not shared by some major labor unions in developing countries, including India. The AFL-CIO represents no more than 15 percent of US workers, and it certainly does not represent organized or unorganized workers in developing countries. To say that demonstrators represented narrow segments of world opinion is not to say, of course, that all the concerns of the demonstrators were without merit. Indeed, the demand for greater transparency in the processes of decision making in the WTO, particularly of its dispute settlement mechanism, is not without merit. Nevertheless, the allegation that 90

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the WTO is a supranational agency that tramples over the sovereignty of its members to serve the interests of transnational corporations at the expense of the world’s workers and the environment had no merit whatsoever. It was, in fact, based on a complete misunderstanding, if not a willful misrepresentation, of the fact that the WTO is simply a facilitating forum for its member governments to ensure that the agreements and commitments into which they have voluntarily entered are kept. The reasons for failure are elsewhere. The experience of the Uruguay Round encouraged a cautious approach. Many developing countries had concluded that, in retrospect, the URA was unbalanced in that it included TRIPS and TRIMs agreements that overall certainly did not benefit them in the short run (and probably not in the long run) in return for a backloaded phaseout of the MFA. In terms of market access, even after the URA commitments on reductions were allowed for, tariff peaks and tariff evaluation remained—and they mostly affected the exports of developing countries. It is plausible that most developing countries did not anticipate the outlines of the eventual TRIPS agreement when they consented to include intellectual property in the Uruguay Round agenda. There was genuine concern among developing countries that the distinction between discussions leading to an agenda for negotiations and substantive negotiations on items to be included on the agenda had become blurred. Further, they were being pressured to bring labor and environmental standards into the WTO. Developing countries justifiably feared that any compromise on their part on issues to be included in the negotiating agenda would hurt them in subsequent negotiations. With the high perceived cost to them of the final TRIPS agreement very much in mind, they were less willing to compromise on including items (e.g., the so-called Singapore issues relating to investment, competition policy, trade facilitation, and transparency in government procurement) in the agenda of any future round for fear that an eventual agreement on some might be costly to them. Many developing countries also felt that they had no voice in the socalled green room process in which a select group of countries participated in the negotiations and decided on an agenda that they later presented to the plenary. The fact that the leader of the delegation of the most powerful trading nation also chaired the ministerial did not help. The single most important reason for the failure, however, was the statement by then-US president Bill Clinton that trade sanctions could be used to enforce core labor standards. It ruled out any compromise on the part of developing countries. It is evident that domestic political considerations, particularly ensuring the support of the labor unions for the Democratic Party in the 2000 presidential elections, weighed heavily in his decision to make such a statement. He insisted on linking trade with labor standards from the Seattle meeting until the end of his term. It remains to be seen whether President George W. Bush will also do the same. We hope INDIA IN THE GATT AND THE WTO

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that as a self-proclaimed free trader, he would see through the deceptively appealing notion that lower labor standards in a country relative to those of its trading partners confer on it an unfair competitive advantage.5

Labor, Environmental Standards, and the WTO: Key Misconceptions The inclusion of labor standards in international trade agreements dates back to the charter of the International Trade Organization. Article 7 of the stillborn organization stated, “The members recognize that unfair labor conditions, particularly in the production for export, create difficulties in international trade, and accordingly, each member shall take whatever action may be appropriate and feasible to eliminate such conditions within its territory.” The articles of the GATT, however, did not deal with labor standards except to prohibit trade in goods made with prison labor. Various administrations in the United States, both Democratic and Republican, unsuccessfully proposed the inclusion of a labor standards article in the GATT during several rounds of MTNs. Political parties have made similar proposals in national parliaments in several European countries and also in the European Parliament. The demand for the formal inclusion of a “social” clause in the mandate of the WTO was raised after the painful and lengthy negotiations of the Uruguay Round had been completed and almost held the negotiated agreement hostage. The agreement was signed, but with an understanding that the topic of labor standards could be discussed by the preparatory committee for the WTO. At the first two ministerial meetings of the WTO in Singapore and Geneva, in 1996 and 1998 respectively, the ministers firmly shut the door against a social clause in the WTO, a decision that they reaffirmed at Doha. Still, with the United States continuing to push for a social clause—and in fact including clauses relating to labor standards in its bilateral trade agreements—it would be unwise to assume that the issue has lost its salience. The fact that the demand for a social clause is unlikely to be given up by its powerful protagonists such as the United States does not necessarily make it legitimate. Indeed, if ethical considerations were the only factor behind this recent interest in labor standards, there would be no rea5. Unfortunately, by recently imposing tariffs on steel on the grounds that imports were hurting domestic industry and signing a bill providing large subsidies to agriculture, he has tarnished this image. However there are hopeful signs of change. The recent proposal of the Bush administration in the WTO negotiations on agriculture seeks a “ban on export subsidies, payments provided to increase foreign sales and sharp cuts in domestic support [capping it] at 5 percent of a country’s total farm output, a [cut in] tariffs on farm products from a worldwide average of 62 percent to 15 percent in five years” (New York Times, July 24, 2002, A6). 92

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son for demanding a social clause. There are better ways to promote them. Srinivasan (1998c) has examined the arguments for the use of trade policy instruments for enforcing labor standards and human rights more generally and does not find them persuasive. It is frequently argued that fair trade or level playing fields constitute a precondition for free trade and therefore that the harmonization of domestic policies across trading countries is necessary before free trade can be embraced to one’s advantage. This argument is most manifest and compelling in its policy appeal in the area of environmental standards. It can be shown (Bhagwati and Srinivasan 1996), however, that the arguments in favor of free trade and diversity of environmental standards across countries are essentially robust. This follows from a straightforward extension of the proposition that, under standard assumptions ensuring perfect competition in all relevant markets, free trade is globally Pareto optimal. The introduction of environmental externalities (both domestic and international) necessitates the use of appropriate taxes, subsidies, and transfers to internalize the externality but does not call for a departure from free trade to achieve a globally Pareto-optimal outcome. Although some policy problems do arise in the context of transborder externalities, it suffices here to say that trade policy remedies are rarely the appropriate ones with which to address them.6 Although there are far better means than trade sanctions to protect the environment, promote better working conditions, and keep children in school rather than allowing them to work in poor countries, the demonstrators in Seattle—namely, the nongovernmental organizations (NGOs) and unions—were either unaware of them or worse still deliberately ignored them so as to create the impression that they held the moral high ground in agitating for a social clause. By contrast, the traditional protectionist lobbies in industrialized countries could not justify their transparently selfish protectionist objective on ostensibly moral grounds. Bhagwati (2001) suggests that the moral ground claimed for the social clause made it difficult for developing-country delegations to have their voices of opposition heard.

India and Multilateral Trade Negotiations after Doha Although many of the concerns of India and other developing countries discussed above are legitimate and have some force, it is our view that these concerns are unlikely to be addressed except as part of a new round of MTNs. There are also many other substantial reasons for India (and de-

6. We refer the reader to Bhagwati and Srinivasan (1996) for an elaboration of these problems. INDIA IN THE GATT AND THE WTO

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veloping countries) to be in favor of a new negotiating round. Yet, as Panagariya (2002) points out, India joined the Fourth Session of the Ministerial of the Conference of the WTO in Doha in November 2001 with a rather extreme position. India’s commerce minister and leader of the Indian delegation at Doha, Murasoli Maran, in his opening statement said, “Rather than charting a divisive course in unknown waters, let this conference provide a strong impetus to the on-going negotiations on agriculture and services, and the various mandated reviews that by themselves form a substantial work program and have implicit consensus . . . [on Singapore issues]. . . . Questions remain even on the need for a multilateral agreement” (quoted in Panagariya 2002, 280). Though agreeing that India’s opposition to the inclusion of Singapore issues is defensible, Panagariya (2002) found India’s stance disturbing on three aspects: (1) a failure to lend unequivocal support to liberalization in industrial products and, indeed, outright opposition to such liberalizations where India was concerned; (2) unduly large dispensation of the negotiating capital on the virtually empty box of implementation issues; and (3) posturing that seemed to convey the impression that India was opposed to the launch of the new round altogether. We concur with Panagariya’s assessment. India did not succeed in halting the launch of a new round at Doha. The ministerial declaration at the conclusion of the Doha session not only launched it but also enunciated a work program for the WTO involving the negotiation agenda and steps for meeting the challenges of the multilateral trading system. On the Singapore issues of environment, investment, and competition, the ministers agreed that negotiations would take place on the basis of a decision made by explicit consensus on modalities at the next ministerial conference in Cancún, Mexico, in 2003. India had to content itself with the clarification by the chair of the conference that the phrase “decision to be taken, by explicit consensus” applied to both the start of negotiations and their modalities. The legal standing of this clarification is doubtful; for all intents and purposes, only modalities of negotiations will be decided at Cancún, and negotiations will start thereafter. In the end, Maran joined other ministers in supporting the decision to launch a new round. In fact, he even claimed that the decision is a victory for India! Briefly stated, on issues of implementation of the Uruguay Round commitments on which India expended so much negotiating capital in insisting that they be resolved—more or less as a “down-payment up front,” before the start of any new round of MTNs—the Doha ministerial declaration did not announce any substantive decisions other than the easing of procedural constraints, appeals to members to use restraint in exercising their rights in relation to developing countries, and requests to WTO bodies to examine proposals that may help them (e.g., a request to the council on trade in goods to examine the proposal that when calculating 94

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the quote levels for the remaining years of the MFA, members will apply the most favorable methodologies available). On agriculture, the ministers, “without prejudging the outcome of negotiations,” committed themselves to “comprehensive negotiations aimed at substantial improvements in market access; reduction of, with a view to phasing out, all forms of export subsidies; and substantial reductions in trade distorting domestic support” (WTO 2001, para. 13 and 14; emphasis added). If these new commitments and earlier ones to establish a fair and market-oriented trading system that is free of distortions in agricultural markets were kept, the gains to India and other developing countries would be substantial. On nonagricultural products, the ministers agreed to reduce or eliminate tariff peaks, high tariffs, and tariff escalations on products of urgent interest to developing countries. On TRIPS, the ministers, in their declaration of public health, clarified its compulsory licensing provisions. It is evident that, tactically, there is very little India (or developing countries that even together do not account for a significant share of world trade) could do to stop a new round if major world trading powers wish to start one. The Uruguay Round drove home this fact. Winham (1989, 54) attributed to one official who was involved in the negotiations that led to the Uruguay Round the following description of those negotiations: “It was a brutal but salutary demonstration that power would be served in that nations comprising five percent of world trade were not able to stop negotiation sought by nations comprising ninety-five percent of world trade.” This being the case, India’s negotiating capital could have been more wisely deployed to ensure that the negotiating agenda was in its interest rather than to attempt to forestall a new round. After all, India has to remain actively engaged in the multilateral trading negotiations and system in its own interests (Mattoo and Subramanian 2000). Such engagement facilitates and “locks in” domestic reforms, provides a means of making commitments to the pursuit of good policies credible, ensures and expands India’s access to world markets, and above all strengthens the multilateral process against threats of regionalism.7 Bergsten (1999) identifies several issues that are of great interest to India and that, in his view, India could present for inclusion in the negotiating agenda of the new round:  ensuring that high tariffs will not replace, especially in the United States, the MFA quotas on many Indian apparel and textile exports after the phaseout of the MFA;

7. China is in fact using the commitments that it has made in its WTO accession agreement as a means of accelerating and deepening domestic reforms. INDIA IN THE GATT AND THE WTO

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 ensuring elimination of the very high tariffs on agricultural imports in many industrialized countries, especially on products of export interest to India (e.g., rice);  reaching new agreements on foreign direct investment that would both expand its levels and help India achieve a fair share of its benefits;  instituting tougher disciplines on the use of antidumping duties, especially by the United States and the European Union;  liberalizing the movement of natural persons, where India has a strong competitive advantage, under the GATS;  eliminating preferential tariffs in regional arrangements, including the European Union and the North American Free Trade Agreement (NAFTA), that discriminate against Indian exports; and  further strengthening of the DSM to help protect the rights of countries with lower trade levels. We would, however, strengthen a few of Bergsten’s suggestions and add some of our own. First, we would suggest that India focus on obtaining greater commitment on the part of industrialized countries to maintain liberal market access. Tariff peaks and tariff escalation continue to limit developing countries’ access to industrialized-country markets. In particular, markets for agricultural products, textiles, and apparel have remained closed despite the stated aim of the URA to lower border protection.8 Many countries have also resorted to antidumping measures and other nontariff barriers to protect their markets, and India is a frequent target of these trade-preventing tactics. According to the WTO (Annual Report 2001, tables IV.5 and IV.6), between July 1, 1999, and June 1, 2000, products exported from India were subject to 11 antidumping investigations, the seventh largest in number. The EU Commission has also recommended the imposition of antidumping duties on gray cotton cloth exports from India and a few other countries, a suggestion that could be attributed only to crass protectionist motives. Unfortunately, India appears to be emulating the worst practices of industrialized countries. Between the establishment of the WTO in January 1995 and the end of 2001, it initiated 248 antidumping actions, the second 8. According to a recent report by the Organization for Economic Cooperation and Development, or OECD (Financial Times, April 11, 2001, 11), the URA has had limited impact— subsidies to producers accounted for as much as 40 percent of farm income in 30 OECD countries, and for more than two-thirds in Japan, Norway, South Korea, and Switzerland. The OECD report concludes that agricultural protection in rich countries is largely responsible for the stagnation at 40 percent of developing countries’ share of global agricultural trade, whereas their share of manufactured trade has doubled from 14 to 29 percent in the past two decades. 96

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largest number after the United States (255), and slightly larger than the 246 initiated by the EC. There were 69 antidumping measures initiated against India during the same period (http://www.wto.org, July 2002).9 We deplore this trend and would recommend that India commit to eliminating the use of antidumping measures and to reducing its own tariffs (still high in comparison to those of other Asian developing economies) in return for market access. Second, India and other developing countries have to be united in ensuring that the use of trade sanctions—for enforcing non-trade-related objectives such as intellectual property rights, human rights, and labor and environmental standards—do not get legitimized by expanding the mandate of the WTO in any future round. As was mentioned above, the TRIPS agreement has imposed high costs on India and other developing countries. The Trade and Environment Committee of the WTO could also be costly for India because the current linkage between market access and the enforcement of labor standards may offset the comparative advantage of India and other labor-abundant countries in labor-intensive products.10 These agreements are unlikely to be renegotiated or removed from the international agenda, however, and thus our advice focuses more on ways to mitigate their impact. The Doha ministerial declaration on public health, besides clarifying the compulsory licensing provisions of TRIPS, has extended the time period of implementation for least-developed countries. These are useful steps. More could be done to benefit poor countries. For example, India could propose two amendments to TRIPS: first, to extend for all developing countries the period allowed to bring national patent regimes into compliance with TRIPS requirements and to institute a peace clause precluding the use of the WTO’s DSM for TRIPS disputes for 10 years; and second, to expand the scope of the compulsory licensing provisions to allow countries (mainly very poor ones) that have no production capacity of their own to license to producers in other developing countries with such capacity to produce life-saving drugs under patents for their own use. The Doha declaration, while taking note of this health issue, left the decision on it to the General Council of the WTO. India, a developing country with production capacity for drugs and pharmaceuticals, would potentially benefit from such an amendment. India should also emphasize its willingness to negotiate on environmental and labor standards in other arenas, such as the International Labor Organization or the United Nations Environment Program. 9. Imports from China were most frequently targeted, with 255 initiations. In May 2001, antidumping duties were imposed by India on imports of phosphoric acid from China, polyester film from Indonesia and South Korea, and ferrocyanide from the European Union. 10. I have elsewhere (Srinivasan 1998c) analyzed the economics of linking market access with the enforcement of labor standards. INDIA IN THE GATT AND THE WTO

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Third, India should place negotiations toward further liberalization of movement of natural persons high on its agenda. It has a comparative advantage in labor-intensive services and in some skill-intensive services such as computer software. Though exports of software from its domestic base will continue to grow—to be able to provide in situ services in foreign markets and to keep up with technological developments—it is essential that Indian software technicians have the opportunity to work abroad without necessarily having to migrate permanently. Most Indian engineers entered the United States under a special category of nonimmigrant visas, but there is strong pressure to restrict the number of such visas issued. A liberal agreement (as part of the GATS of the WTO) on natural persons would facilitate such temporary migration. Fourth, India like many other developing countries is moving in the wrong direction by championing regional agreements such as the South Asian Preferential Trade Agreement (SAPTA) and clamoring to become a member of other regional agreements. As happened when the Uruguay Round negotiations were stalled, the failure at Seattle to launch a new round has in part encouraged initiatives for negotiating preferential trade agreements (PTAs) in many parts of the world. India has to recognize that if progress in multilateral liberalization is slow, regional liberalization will become a serious, though much less desirable, alternative to multilateral liberalization. The threat to the multilateral trading system from the proliferation of PTAs on a regional basis cannot be underestimated. As of mid-2000, there were 114 such agreements in effect and notified to the WTO by one or more WTO members (WTO, Annual Report 2001, 37). Virtually all WTO members, other than China (including Hong Kong and Macau), Japan, and Mongolia, were partners in at least one regional trade agreement (RTA). The European Union is a partner in the largest number of agreements, encompassing Europe, Africa, Asia, and, as of 2000, Latin America. The WTO recognizes that “the trend to the conclusion of RTAs, which took off in the 1990s, continued to be very strong in 2000; indeed, perhaps the term ‘regional’ is increasingly superfluous to describe the plethora of new agreements linking countries around the globe” (WTO, Annual Report 2001, 39). In April 2001, US President George W. Bush and the leaders of 33 other nations met in Quebec City, Canada, at a summit. They instructed their ministers to conclude, no later than January 2005, negotiations on a free trade area extending from the high Arctic in the north to Tierra del Fuego in the south. Finally, the expansion of the European Union, with the admission of some Central and Eastern European countries, is likely to take place in the very near future. It has been claimed (World Bank 2000b) that contemporary RTAs involve benefits from “deeper” integration through the harmonization of standards, competition and investment rules, and so on, and that there are political benefits such as greater national security, greater bargaining 98

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power in global negotiations, and the possibility of “locking in” domestic reforms by invoking commitments undertaken in an RTA. However, no convincing case or evidence has been offered as to why preferential trading is a perquisite for reaping these unconventional benefits. The argument that preferential trade liberalization on a discriminatory regional basis and on a multilateral, nondiscriminatory basis are mutually reinforcing is utterly convincing. The fact that the results of preferential regional liberalization in South Asia through SAPTA have been very disappointing, and that no other regional agreements appear to be open for India, suggests that India should now become an active promoter, rather than a staller as in the past, of wider and deeper liberalization of trade in the new round of MTNs launched at Doha. In our judgment, the discriminatory and trade-diverting aspects of PTAs, regardless of whether they are “open” or not, far outweigh any benefits to be reaped. “Open regionalism” is almost an oxymoron—either a trading arrangement is open in the only relevant sense, namely, it does not discriminate among trading partners, or it is regional and discriminates against nonmembers outside the region. It cannot be both. Allowing membership in a PTA to be open for anyone to join it does not eliminate its discriminatory features and cannot make it acceptable in a nondiscriminatory trading system. The bargaining strength of large trading nations in bilateral and regional negotiation, moreover, is enhanced in comparison with multilateral negotiation. This is already seen in agreements like NAFTA and the United States–Jordan Free Trade Agreement—the United States has been able to incorporate labor and environmental standards into them. For these reasons, India should push to replace Article XXIV of the GATT dealing with customs unions and free trade areas with the requirement that preferences granted to partners in any PTA should be extended on an MFN basis to all members of the WTO within a specified period, say, 5 to 10 years. It should not devote energy to asking for the elimination of preferential tariffs against Indian exports in RTAs and PTAs of which India is not a member. Fifth, India and other developing countries also have a vital interest in reforming the WTO’s decision-making procedures. It is now a body of 142 members. Satisfying the principles of transparency and representation— while ensuring an orderly and efficient decision-making process in such a large body whose members have diverse interests and resources—is a challenge. Clearly, requiring consensus among all members for any decisions, though it bestows bargaining power to otherwise weaker members of the body, could paralyze decision making in a large body. Other means, such as requiring an appropriately specified majority (e.g., two-thirds of the members of which the proportion of developing-country members exceeds a threshold) could be used to give bargaining power to weaker members. INDIA IN THE GATT AND THE WTO

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Sixth, as we noted above, the WTO’s dispute settlement mechanism replaced the political process of the GATT with a costly adversarial legal process in which the DSM’s Appellate Body has become very powerful. By accepting amicus briefs from groups that do not represent members of the WTO, it has moved into uncharted waters. India could propose a review and rethinking of the DSM. The possibility of allowing NGOs to be represented in the decisionmaking bodies of the WTO, of which acceptance of amicus briefs by the DSM’s Appellate Body is just one example, is a second important procedural issue to resolve. An affirmative answer implies that national governments do not adequately represent the views of the private groups in their own countries. The NGOs claim “that national pursuit of environmental, labor, and human rights goals are being deflected by economic considerations.” Business interests, however, claim “that the government’s pursuit of the nation’s economic interests is being unduly restrained by concerns about more ephemeral political interests” (Hudec 1999, 47). We do not deny that the legitimacy of rules, procedures, and practices of the WTO as a body created by treaties among governments ultimately rests on whether such treaties are entered into and ratified by a domestic process in each country that is perceived to be legitimate. But we feel that granting NGOs representation could have potentially serious consequences and that India should strongly oppose it. We take this position for several reasons. First, allowing groups to override their failure in domestic processes through their participation in intergovernmental bodies dulls incentives either to push for sustainable democratic processes or for participation to emerge. Any concession toward participation granted to domestic groups by their government, purely in response to being pressured by such groups in international bodies, is unlikely to be sustained. Second, allowing nongovernmental participation in international affairs is likely to exacerbate inequalities between citizen groups. India is a pluralistic and participatory democracy and is home to a large number of NGOs involved in social, economic, religious, and charitable activities. A few of them, such as labor unions and lobbying groups, are formally organized, with a constitution, rules for membership, and procedures for making decisions. Most are informal, however, and there is no way of judging whom they represent and whether in any sense their own internal organization is participatory. Even if some reasonably well-defined and verifiable criteria are applied to which organizations will be entitled to send observers to meetings of the WTO, the World Bank, or another comparable body, it is almost certain that governments in power will have to face them at two levels, in the domestic political arena and in an international organization. Third, the possibility that governments’ actions taken after due debate at home will be challenged again in international bodies by opponents who failed in the domestic arena is likely to have a significant paralyzing effect on the governments. 100

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Appendix 3.1 Origins and Founding of the GATT The origins of the GATT can be traced to the Proposals for an Expansion of World Trade and Employment (hereafter, the Proposals) circulated by the United States in December 1945. The United States subsequently invited 15 countries, including India, to participate in negotiations to reduce trade barriers and sponsored a resolution in the United Nations Economic and Social Council calling for a Conference on Trade and Employment with the Proposals as a possible agenda. This conference, prepared by Chile, Lebanon, and Norway as well as the United States and the original 15 invitees, was held in Havana from November 1947 to March 1948. Four more countries—Burma, Ceylon (Sri Lanka), Southern Rhodesia, and Syria—later joined the negotiations on reducing trade barriers. A discussion on a draft charter for an international trade organization (ITO) to be presented to the Havana conference and the negotiations on tariff reduction went on simultaneously in Geneva. From the outset, in the preparatory committee for the Havana conference, Brazil, Cuba, and India criticized the US proposals as being motivated by a desire of industrialized countries to keep developing countries dependent on them. Development issues inspired the most violent and protracted controversies at the conference itself. The draft charter for the ITO drawn up by the preparatory committee for the Conference was almost unanimously denounced by the developing countries, including India, as being against their interests. Nonetheless, after a prolonged deadlock and a series of compromises, a charter was adopted with only three countries—Argentina, Poland, and Turkey—dissenting (Wilcox 1949). After all this, however, the ITO did not come into being, mainly because some countries (including the United States) did not ratify the charter. Meanwhile, the Geneva negotiations for reductions in tariffs were successfully concluded with the GATT even before the opening of the Havana conference in November 1947. Some of the signatories to the GATT feared that the trade concessions agreed to in the GATT might unravel if their implementation were delayed until the GATT could be subsumed in the ITO after the Havana conference. Other signatories wished to avoid going through the ratification process twice, once for the GATT and then for the ITO.11 As a compromise, the GATT was brought into force through a provisional protocol of application that was adopted and signed by 23 Contracting Parties, including India, and the newly created Pakistan in October 1947. From October 1947 until the establishment of the WTO in January 1995, the GATT operated under its provisional protocol. The

11. Signatories are “Contracting Parties” in GATT parlance, denoting independent customs jurisdictions such as Hong Kong as well as countries. INDIA IN THE GATT AND THE WTO

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attempt in 1955 by the Contracting Parties to create an organization for trade cooperation failed. In the words of the eminent legal scholar John Jackson (1989, 89), “The GATT has limped along for nearly 40 years with almost no ‘basic constitution’ designed to regulate its organizational activities and procedures.” The convention of arriving at decisions through consensus has given each party near-veto power and has imparted a remarkable stability to the agreement. The only substantial formal amendment to the GATT was a protocol to the articles of agreement adopted in 1965 to add a fourth part dealing with trade and development. The fundamental principle of nondiscrimination among its Contracting Parties was enshrined in Articles I and III respectively on most favored nations and on the national treatment requirement of the GATT. The first required that any tariff concessions granted by one Contracting Party on imports from another be automatically extended to imports from all other Contracting Parties. The second ensured that once imports from one party entered another party’s markets after the payment of applicable customs duties and other charges at the border, such imports were treated on par with domestic output with respect to domestic tax and nontax measures. Although derogations from this principle were already in the GATT (e.g., exceptions for customs unions and free trade areas), they did not seriously compromise it.

The GATT and Developing Countries The GATT appears to have contributed significantly to the growth of world trade. Eight successful rounds of MTNs on reducing barriers to trade have been concluded under the GATT’s auspices. The volume of world trade grew at an unprecedented average rate of 8 percent a year between the founding of the GATT in 1947 and the first oil shock in 1973. Although the annual rate of growth declined significantly during the period of adjustment to the two oil shocks to 3.7 percent during the period 1973–80 and 4.3 percent during the period 1980–90, it recovered to 6.5 percent during the period 1990–99. In all periods, it still exceeded the rate of growth of world output. In fact, during the period 1950–94 as a whole, the volume of merchandise trade grew to nearly 15 times its level in 1950, while output grew to six times its level in 1950. Against this background, however, India’s share of world trade declined from more than 2 percent in the early 1950s to about 0.7 percent in 2000. India and other developing countries with inward-oriented development strategies have not taken full advantage of this growth in world trade and have acted to counter some of the GATT’s trade-opening influence. In retrospect, it could be argued that the fact that the ITO did not come into existence was fortunate because it would have allowed devel102

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oping countries to easily exempt themselves from trade agreements. Wilcox (1949, 148) points out that more than three-fourths of the economic development chapter, consisting of Articles 13 and 15, “[was] devoted to an elaboration of methods by which underdeveloped countries may obtain release from commitments assumed under trade agreements and under the charter with respect to commercial policy.” This conditional and temporary release was considered inadequate at the time by developing countries. Provisions within the original charter of the GATT have nevertheless allowed developing countries to retain trade restrictions. Article XVIII, a holdover from the above-mentioned Article 13 of the ITO charter, was the principal provision in the GATT dealing with trade problems of developing countries until the adoption of Part IV on trade and development in 1964. Given the consultations, annual reporting requirements, and reviews needed for taking advantage of most sections of Article XVIII for imposing trade-restricting measures for any extended period of time, few developing countries made major use of them. Instead, they availed themselves of its provision under Section B that allowed the use of QRs for containing balance of payments deficits. India invoked this provision as late as in 1998, after 7 years of reforms, to justify its slow pace of phasing out QRs on imports of consumer goods. This was challenged in the WTO by the United States among others, and the Dispute Settlement Mechanism ruled against India. As was noted above, India lost its appeal against this ruling in the DSM’s Appellate Body and had to remove all its QRs in 2000 and 2001. Developing countries also succeeded later in formally incorporating “a differential and more favorable treatment” for themselves into the GATT in the agreement concluding the Tokyo Round of multilateral trade negotiations. This treatment included not having to reciprocate any tariff concessions by industrialized countries. By demanding and receiving an apparently differential and more favorable treatment, developing countries including India triply hurt themselves: once through the direct costs of their being able to continue their counterproductive import-substitution strategies without fear of retaliation by their trading partners; a second time by having to accept blatantly GATT-inconsistent trade barriers erected by industrialized countries, for example in textiles and apparel, through the MFA; and a third time by giving the opportunity to the industrialized countries to maintain higher than average MFN tariffs on goods of export interest to themselves.

Incorporation of Part IV of the GATT In 1958, a decade after the GATT’s coming into force, a panel of GATTappointed experts chaired by Gottfried Haberler examined the trade relaINDIA IN THE GATT AND THE WTO

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tions between less developed and industrialized countries.12 Their report concluded that barriers of all kinds in industrialized countries to the import of products from developing countries contributed significantly to the trade problems of developing countries. The GATT responded to the Haberler report by establishing the so-called Committee III, which was to review the trade measures restricting less-developed-country exports and to recommend a program for trade expansion by reducing trade barriers. The response of industrialized countries to the Committee III report, although positive, did not result in substantial reductions in barriers. Indeed, some of the barriers identified by Committee III, such as significant tariffs on tropical products, tariff escalation, QRs, and internal taxes, continued to exist nearly three decades later at the start of the Uruguay Round negotiations. They have not been completely eliminated even after the reductions in trade barriers agreed to in the round. Twenty-one developing countries, including India—disappointed with the response of industrialized countries to the report of Committee III— introduced a resolution in the GATT in 1963 calling for an action program. This consisted of a standstill on all new tariff and nontariff barriers, elimination within 2 years of all GATT-illegal QRs, removal of all duties on tropical primary products, elimination of internal taxes on products wholly or mainly produced in developing countries, and adoption of a schedule for the reduction and elimination of tariffs on semiprocessed and processed products. The GATT ministerial meeting of 1963, in response to the demand for an action program, appointed a committee to draft amendments to the GATT to provide a legal and institutional framework within which the GATT Contracting Parties could discharge their responsibilities toward developing countries. Dam (1970) remarks that this step was also a reaction to the preparations already in progress for the first United Nations Conference on Trade and Development. The proposed amendments were approved in 1964 and became Part IV of the GATT, entitled “Trade and Development.” Dam concludes that apart from its symbolic importance in sensitizing the Contracting Parties to the new role of the GATT in development, lessdeveloped countries achieved little by way of precise commitments (and even these were highly qualified) but a lot in terms of verbiage. Among the major provisions of Part IV is that on reciprocity (or more precisely, nonreciprocity): the industrialized countries decided not to require reciprocity for their commitments to reduce tariff and other barriers from developing countries. Far from benefiting developing countries, this provision actually placed them in a weaker bargaining position to combat GATTinconsistent barriers in industrialized countries against their exports. 12. The other members of the panel were Oswaldo Campos, James Meade, and Jan Tinbergen.

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The Generalized System of Preferences After the incorporation of Part IV in 1964, the next major GATT event from the perspective of developing countries was the grant of a 10-year waiver from the MFN clause with respect to tariffs and other preferences favoring the trade of developing countries. Under the waiver, any Contracting Party could deviate from MFN for a period of 10 years and charge a lower tariff on imports from developing-country Contracting Parties than on similar imports from other Contracting Parties. The waiver specified that such preferences must be nondiscriminatory. This so-called Generalized System of Preferences (GSP) was later included under the rubric of the enabling clause of the Tokyo Round (1973–79), which formalized the “differential and more favorable treatment” of developing countries in the GATT. Contrary to the provisions of the waiver, industrialized countries chose the countries to be favored, the commodities to be covered, the extent of tariff preferences, and the period for which the preferences were granted when implementing the GSP. Some countries, in fact, linked the granting of preferences to the performance of a developing country in non-trade-related areas. The United States, for example, withdrew GSP status from Chile in 1987 because Chile did not provide its workers “internationally accepted” rights. Some of the more advanced developing countries benefited to a greater extent from the GSP and expanded their exports to industrialized countries. This led industrialized countries to demand the “graduation” of such countries from the ranks of those entitled to the GSP. As was the case with reciprocity, the benefits, if any, from the GSP for developing countries were far outweighed by the cost in terms of weakening their case against other GATT-inconsistent barriers in industrialized countries to their exports.

Developing Countries and the GATT: Two Opposite Interpretations The experience of developing countries in the GATT up to the conclusion of the Tokyo Round in 1979 could be interpreted in two diametrically opposed ways. On the one hand, it could be said that from the Havana conference to now, developing countries again and again have been frustrated in getting the GATT to reflect their concerns. Tariffs and other barriers in industrialized countries on their exports were reduced to a smaller extent than those on exports of industrialized countries in each round of the MTNs. Products in which they had a comparative advantage, such as textiles and apparel, were taken out of the GATT discipline altogether. Agriculture, a sector of great interest to developing countries, largely remained outside the GATT framework. “Concessions” granted to developing countries, such as the inclusion of Part IV on trade and develINDIA IN THE GATT AND THE WTO

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opment and the Tokyo Round enabling clause on special and differential treatment, were mostly rhetorical. Others, such as the GSP, were always heavily qualified and quantitatively small. In sum, one interpretation is that the GATT was indifferent, if not actively hostile, to the interests of developing countries. The other interpretation is that developing countries, in their relentless but misguided pursuit of the import-substitution strategy of development, in effect opted out of the GATT. If they had participated fully, vigorously, and on equal terms with industrialized countries in the GATT negotiations and unilaterally adopted an outward-oriented development strategy, they could have achieved far faster and better growth than that achieved by demanding and receiving crumbs—such as the GSP and a permanent status of inferiority under the “special and differential” treatment clause—from the rich man’s table. The experience of rapidly growing economies of East Asia, notwithstanding the financial crisis that engulfed them in 1997, provides evidence in support of this view. Given India’s early start in industrialization before the East Asian countries, India certainly would have grown faster under an outward-oriented policy regime.

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4 Domestic Constraints on International Participation

India was one of the fastest growing economies in the developing world in the 1990s; its annual GDP growth averaged 6.1 percent from 1992 to 2000 (table 4.1). This simple average, however, obscures the fact that GDP growth slowed during the period 1997–2000 as the gross domestic saving rate fell from its peak of 25.5 percent of GDP in 1995 to 22.0 percent in 1997–99 before partially recovering to 23.4 percent in 2000–01. The public sector has dissaved to the tune of 1, 0.9, and 1.7 percent of GDP in 1998– 99, 1999–00, 2000–01 respectively. The dissaving also coincided with the dilution of fiscal discipline (table 4.1). India will have to accelerate and deepen integration with the global economy to reverse the slowdown in growth during 1997–2000 and sustain its rapid growth and further improve living standards. First, the simultaneous fall in public- and private-sector saving and investment rates (especially in the corporate sector) will need to be reversed and foreign capital inflows augmented.1 Second, the surge in private fixed investment after the removal of entry restrictions on both domestic and foreign private investment in 1991 resulted in high growth rates of more than 7 percent annually in the first half of the decade, but for the investment to be justified ex post, the increased output has to be absorbed without depressing profits. Clearly, this situation implies that unless increasing output is accompanied by reductions in cost, it is unlikely to be absorbed by domestic and 1. See Ministry of Finance, Government of India, Economic Survey, 2001–02, tables 1.5 and 1.6. 107

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Table 4.1

1980–81 to 1989–90

1990–91

1991–92

Economy: Growth performance and macroeconomic balances Growth rate of GDPFCe 5.7 5.6 1.3 5.1 GDCFcurrf 21.2 26.3 22.5 23.6 GDScurrg 19.3 23.1 22.5 21.8 Net inflowcurrh 0.6 3.2 0.5 1.8 i GDCFconst 21.3 25.4 22.0 22.9

5.9 23.1 22.5 0.6 23.1

7.3 26.0 24.8 1.2 26.4

Government: Fiscal management 7.2 7.9 GFD/GDP, center j GFD/GDP, states j 2.8 3.2 GFD/GDP, combined j 8.4 9.2 RD/GFD, center k 24.3 41.5 k RD/GFD, states –4.5 29.6

7.0 2.4 8.2 54.3 18.5

5.6 2.8 7.3 44.1 24.5

Key variables reflecting macroeconomic management Rate of inflation WPI l 8.0 10.3 13.7 10.1 CPIIW m 9.0 11.6 13.5 9.6 Exchange rate NEER (percentage change) n –7.6 –22.8 –17.3 REER o (percentage change) –5.2 –16.3 –11.3 Prime lending rate IDBI 14.0– 18.0– 17.0– 15.0 20.0 19.0 ICICI

14.0– 15.0

18.0– 20.0

17.0– 19.0

1995–96

1999– 2000a 2000–01b 2001–02c 2002–03d

1996–97

1997–98

1998–99

7.3 26.8 25.1 1.7 27.2

7.9 24.5 23.2 1.3 25.1

4.8 25.0 23.5 1.5 26.4

6.6 23.0 22.0 1.0 25.4

6.0 24.3 23.2 1.1 26.7

4.0 24.0 23.4 0.6 26.3

5.4 n.a. n.a. n.a. n.a.

n.a. n.a. n.a. n.a. n.a.

6.3 2.7 7.5 48.9 22.9

5.0 2.6 6.4 48.2 26.1

4.8 2.7 6.2 48.5 43.0

5.8 2.8 7.1 51.7 37.0

6.8 4.3 9.3 56.2 58.4

5.5 4.7 9.3 63.5 58.9

5.8 4.6 10.0 64.0 53.9

5.7 3.8 9.3 67.1 56.4

5.8 3.9 9.2 64.7 55.7

8.4 7.5

12.5 10.1

8.1 10.2

4.6 9.4

4.4 7.0

5.9 13.1

3.3 3.4

7.2 3.8

n.a. n.a.

n.a. n.a.

2.8

–2.9

–8.2

–1.7

2.2

–9.3

–2.9

–0.2

n.a.

n.a.

8.6

7.1

–3.2

0.3

4.2

–5.7

–0.7

4.6

n.a.

n.a.

14.5– 17.5

15.0

16.0– 19.0

16.2

13.3

13.50

13.6– 17.1

14.0

n.a.

n.a.

14.5– 17.5

14.5– 17.5

14.0

16.5

14.0– 14.5

13.0

12.5

13.0

n.a.

n.a.

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1994–95

10:15 AM

1993–94

6.0 2.8 7.3 41.3 33.5

1992–93

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Indicator

Indicators of macroeconomic management of the Indian economy, 1980–81 to 2002–03 (percent)

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a. Provisional estimate. b. Quick final estimate. c. Revised advance estimate. d. Budget estimate. e. GDPFC: Gross domestic product at factor cost at 1993–94 prices. f. GDCFcurr: Gross domestic capital formation (percentage of GDP at market prices) at current prices (CSO 2000b). g. GDScurr: Gross domestic savings (percentage of GDP at market prices) at current prices (CSO 2000b). h. NetInflowcurr: Net capital inflow (percentage of GDP at market prices) at current prices equals the difference between GDCFcurr and GDScurr (CSO 2000b). i. GDCFconst: GDCF (percentage of GDP at market prices) at 1993–94 prices (CSO 2000b). j. GFD/GDP: Gross fiscal deficit as a percentage of GDP at market prices (Reserve Bank of India, Handbook of Statistics on the Indian Economy, 2000). Gross fiscal deficit figures for the center, consolidated states, and combined (center and states)—rows 1, 2, and 3 in panel B—were obtained from the World Bank. For the central government they relate to the new definition with adjustment for the states’ share in small savings. k. RD/GFD: Revenue deficit as a percentage of gross fiscal deficit. l. WPI: Wholesale Price Index (average of the weeks) (Reserve Bank of India, Handbook of Statistics on the Indian Economy, 2001, table 205). m. CPIIW: Consumer Price Index for Industrial Workers (average of the months) (Reserve Bank of India, Handbook of Statistics on the Indian Economy, 2000, table 206). n. NEER: Nominal effective exchange rate (36-country bilateral export weights) change in annual average index (1985 = 100) (negative for depreciation) (Reserve Bank of India, Handbook of Statistics on the Indian Economy, 2001, table 132). o. REER: Real effective exchange rate (36-country bilateral export weights) change in annual average index (1985 = 100) (negative for depreciation) (Reserve Bank of India, Handbook of Statistics on the Indian Economy, 2001, table 132).

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ICICI = Industrial Credit and Investment Corporation of India IDBI = Industrial Development Bank of India n.a. = not available

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international markets without a lowering of prices and profits. Because global markets are far larger than the domestic one, this underscores the need for international competitiveness to be able to sell growing output on global markets and sustain high rates of investment and savings. This chapter focuses on the domestic constraints on international competitiveness in the ongoing integration of the Indian economy with global markets. India has a comparative advantage in labor-intensive commodities as well as in human-capital-intensive activities associated with the information technology revolution. Efforts to translate this advantage into concrete export performance and integration into world factor flows are, however, constrained by the existing physical, legal, and social infrastructure. The domestic constraints not only choke the growth-promoting impulses in the economy but also undercut the efficiency gains from resource reallocation resulting from trade liberalization and limit the capacity of the economy to absorb private international capital flows. There is increasing evidence from rapidly growing economies that long-term foreign capital inflows help expand exports and stimulate growth through technological spillovers as well as supplement domestic savings efforts. Sustained rapid growth and rapid poverty eradication are unlikely without dramatic improvements in the efficiency, quality, and reliability of infrastructure. The following sections discuss several domestic constraints on international integration. A stable macroeconomic environment is the first main prerequisite for increased integration, followed by an attractive investment climate and access to adequate transport, communications, energy, and financial infrastructures. Without these changes, the high transaction costs associated with transporting and exchanging goods and services in India relative to its competitors will outweigh any advantage the country has in production costs. At the firm level, improvements in product quality and increases in productivity across the spectrum of export-oriented and export-related activities are required for sustained cost-competitiveness. Increasing firms’ flexibility in resource allocation is clearly important in this context. A legacy of protection for workers and highly regulated labor markets handicap the kinds of rapid adjustments that are needed to improve efficiency. Bankruptcy laws also constrain restructuring toward more efficient activities. The continued reservation of certain industries for smallscale production, a legacy of Gandhian economics, impedes movement toward a more efficient scale of operation for several exportable activities. Reducing overextended state participation by disinvesting from commercial public-sector undertakings would not only yield efficiency gains and fiscal benefits but also enable the government to focus on core areas of long-neglected social sectors.

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Macroeconomic Management of the Economy A stable macroeconomic environment is particularly important for countries like India that are seeking to attract private capital flows. India’s main challenges in macroeconomic management are to improve fiscal management at all levels of government, maintain a low inflation rate, and implement an active exchange rate policy that supports sustainable current account deficits as well as a desirable mix of foreign capital inflows.

Fiscal Management The central government’s gross fiscal deficit relative to GDP decreased after the fiscal adjustment undertaken in the early 1990s, but state government finances deteriorated during the same period. The central government’s average gross fiscal deficit during the period 1992–2000 of 5.8 percent of GDP was about 2 percent lower than the deficit in the crisis year 1990, and about 1.4 percent less than the average for the 1980s (table 4.1). For the states, however, the corresponding average of 3.3 percent was higher than the prereform decade. The combined fiscal deficit of the central and the state governments in 2000 was 10 percent, higher than its level in the crisis year 1990 and 1.6 percentage points higher than the average for the 1980s. The proportion of revenue deficit (defined as the excess of current expenditures over current receipts of the government) in the total deficit has also increased during the 1990s, suggesting that as much as two-thirds of central-government borrowing and three-fifths of the state governments’ borrowing was to finance current consumption expenditures (table 4.1).2 The latest data from the budget for 2002–03 and other sources suggest that the fiscal deficit of the center will remain in excess of 5.5 percent of GDP and that of the states is unlikely to fall below 4.5 percent of GDP in 2000– 01 and 2001–02. Revenue deficit as a proportion of gross fiscal deficit for the central government is likely to be about 65 percent; and for the states, 56 percent (table 4.1). Thus no end is in sight yet for fiscal profligacy. 2. The Eleventh Finance Commission had recommended setting up an Incentive Fund of Rs106.07 billion for the next 5 years to encourage states to monitor fiscal reforms. Rs42.43 billion were provided for this purpose during the period 2001–02. Medium-term fiscal reform programs (with upfront reforms in the power sector) of eight states (Karnataka, Andhra Pradesh, Arunachal Pradesh, Himachal Pradesh, Kerala, Nagaland, Orissa, and West Bengal) have been discussed in the Monitoring Committee meeting. The governments of Orissa, Karnataka, and Nagaland have entered into memorandums of understanding with the Ministry of Finance, and through February 2002, Rs12.37 billion had been released (GOI-MoF 2002a, item 94, 16).

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The increasing borrowing requirements of the government have contributed to higher interest rates for other investors. The inflation rate came down in the second half of the 1990s, but the decline in the nominal prime-lending rate was much slower, indicating that real interest rates increased. The previously discussed slowdown in private investment (see table 4.1, panel A) is thus at least partly attributable to the high real interest rates that resulted from an inability to manage government finances.

Persistent Inflation Although the rate of inflation came down to single-digit levels in the second half of the 1990s, it is still higher than in India’s trade partners. This is a second cause for concern in the macroeconomic environment. Panel C of table 4.1 provides two indicators of annual changes in nominal and real effective exchange rates (with negative magnitudes representing depreciation). An examination of this panel suggests that the rate of currency depreciation in nominal terms has been, with few exceptions, higher in absolute magnitude than that in real terms, indicating that India’s rate of inflation has been higher than that of its trading partners.

Physical Infrastructure Constraints The industrial and trade policy reforms discussed in chapter 2 reduced the relative profitability of selling to the domestic market, thus encouraging more attention to export markets. The surge in industrial growth as well as in aggregate growth from 1993 to 1996 suggests that domestic producers responded to these changes. Poor infrastructure, however, constrains continued growth and expansion into international markets. There are several key challenges in updating and augmenting India’s basic energy, telecommunications, and transport infrastructures. In the short term, the key is to get the most out of existing capacity by improving maintenance, focusing on the efficiency and quality of operations, and managing demand carefully. Infrastructure services, being nontradable, cannot be imported to relieve domestic shortages. In the long run, therefore, there is no alternative to undertaking large-scale expansions of capacities in infrastructure. Given past neglect, capacity shortfalls and the investments needed to close them are large and recognized to be well beyond the domestic savings and financing capacity. However, new technological and organizational innovations have enlarged the choices with respect to ownership (both public and private, and domestic and foreign); modes of organization and financing; scale of operation; and range, quality, and cost of services.

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Difficult policy decisions remain. To what extent and by what modalities can the entry of the private sector into state-owned public utilities be facilitated? What should be the role of market competition and government regulation in reshaping these industries, and what kind of regulatory institutions are likely to perform most effectively? What is the best method to generate revenues for the government from the sale and future operation of these industries? India is yet to arrive at satisfactory answers to any of these questions for any of the infrastructure sectors. The following discussion concentrates on some of the more critical emerging issues in critical sectors and is not meant to be comprehensive and exhaustive.

Energy Shortages Persistent power shortages and unpredictable supply quality are the most serious infrastructure constraints on production. Years of inadequate addition to capacity, inefficient generation, and unsatisfactory or poor maintenance of transmission networks have led to high transmission and distribution losses, frequent interruptions in supply, and common voltage and frequency fluctuations.3 The pricing, staffing, and operational decisions of state electricity boards (SEBs) were made more on political than economic considerations. An inattention to economics led to persistent losses and a poor allocation of resources. And the parlous fiscal position of state governments precluded their ability to finance additional investment to expand the power sector. The pricing policy of SEBs continues to distort usage because the prices charged to industry for low-quality power supply are kept high to subsidize power used by farmers and nonfarm households. The high cost of power erodes any cost advantages Indian firms may have relative to their foreign competitors. Power subsidies also encourage wasteful use by farmers and households. There have been several attempts to reform the energy sector in the past. The first was the steady expansion of the generating capacity owned and operated by the corporatized, central-government-owned National Thermal Power Corporation (NTPC) and National Hydroelectric Power Corporation (NHPC). These two public-sector undertakings, which controlled 25 percent of the country’s generating capacity in the late 1990s, have been relatively better managed and freer from political pressures than the SEBs that control 70 percent of the capacity or the private industrial enterprises that control the captive plants producing the remaining

3. Power supply interruptions became so frequent and of such long duration over time that households, offices, and shops began investing in small power generators.

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5 percent. The 73.6 percent plant load factor in the relatively newer thermal plants operated by the central public-sector undertakings in 1999 was higher than that of privately operated plants, and as much as 10 percent higher than that of plants operated by SEBs.4 However, because SEBs were the sole distributors of electricity, NTPC and NHPC as generators had to sell what they generated to SEBs, which predictably ran to arrears in their payments to generators! Besides increasing supply from non-SEB generators, this also reduced the pressure on SEBs to reform. The second solution attempted was to permit captive power generation, especially in highly power-intensive, continuous-process metalliferous industries. Captive power plants, however, were inefficiently small in scale and used more expensive fuels (e.g., fuel oil) than the cheaper coal used by SEB plants. The use of higher-cost power reduced the competitiveness (at the going exchange rate) of Indian producers relative to those of their competitors abroad, including China, which did not face this problem. The third reform effort was to encourage the use of such unconventional energy sources as solar and wind power. During the past 5 years, the central government and multilateral and bilateral lending agencies have entered into several memorandums of agreement with state governments to restructure the SEBs. The Central Electricity Regulatory Commission has been developing guidelines for tariff fixation and a grid code. Eighteen states have established state electricity regulatory commissions, of which 10 (Andhra Pradesh, Delhi, Gujarat, Haryana, Karnataka, Madhya Pradesh, Maharashtra, Orissa, Rajasthan, and Uttar Pradesh) have issued tariff orders. Eight states (Andhra Pradesh, Delhi, Haryana, Karnataka, Madhya Pradesh, Orissa, Uttar Pradesh, and West Bengal) have amended the Electricity Act of 1948, effectively transferring tariff fixation powers to state electricity regulatory commissions. Six states have unbundled power generation, transmission, and distribution and moved toward corporatization. The central government progressively increased the allocation to the Accelerated Power Development Program from Rs10 billion in 2000 to Rs15 billion in 2001 and to Rs35 billion in 2002. The funds are to be allocated among states as an incentive to accelerate reforms of the SEBs. An Expert Group was appointed by the prime minister, state chief ministers, and state electricity ministers to address two basic problems: the settlement of debts owed by SEBs to the central public-sector utilities and the future financial viability of SEBs. For the first problem, the Expert Group suggested a waiver of 50 percent of the surcharge and interest on delayed payments and securitization of the principal plus the remaining 50 percent of the surcharge and inter-

4. Ministry of Finance, Government of India, Economic Survey, 2001–02, table 9.3.

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est through tax-free bonds issued by state governments. These bonds would be repayable during a period of 15 years with a moratorium on principal payments for the first 5 years.5 It remains to be seen if the state governments and the SEBs are willing to adhere to the strict discipline required by the package in return for the one-time settlement of debts.6 The Expert Group also suggested SEB reforms aimed at maintaining their continuing viability. Efforts have also been made, not very successfully so far, to attract private foreign investment (Ahluwalia 1998). Enron, the only foreign company to set up and operate a large plant in Dabhol, Maharashtra, ran into several disputes with the state’s electricity board and government even before the parent company filed for bankruptcy in the United States in 2001. The plant is currently idle. According to Mukherjee (2002), “Most of the foreign companies who had planned massive investments in Indian power projects have pulled out.” The latest pullouts by Minant Asia Pacific, Daewoo, Bayerwerk, and Ogden Energy follow earlier ones by Cogentrix, Electricité de France, and others. Although each company had idiosyncratic reasons for its pullout, a common reason was insecurity about the recovery of dues from sales of electricity to SEBs. It is no surprise that private investors would shy away from investing in power generation as long as they are forced to sell electricity to bankrupt SEBs. (Other reasons for pullout included failure to secure fuel supply to the plants and to agree on implementation schedules and transmission services.) The basic sources of the bankruptcy of SEBs have been the politically determined (and economically unviable) pricing of electricity, cross-subsidization of one class of users by others, and transmission and distribution losses (including the outright theft of electricity). These sources are being addressed belatedly by the evolving regulatory framework and through the privatization of distribution. As the World Bank (2000a, chap. 5) correctly noted, regulation is an imperfect alternative to competition wherever competition can be introduced. The first step of privatization of distribution of electricity was effective on July 1, 2002, in Delhi, where theft accounts for the bulk of the incredible 50 percent transmission and distribution losses. The central government is also bringing out a power tariff policy document to lay down guidelines for setting tariffs by powersector regulators.7

5. See GOI-MoP (2001). 6. For the details, see Ministry of Finance, Government of India, Economic Survey, 2001–02, box 9.3. 7. MSN Business Web site, http://www.msn.co.in/business/economy (June 2002).

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Telecommunications The telecommunications sector, unlike the power sector, has exceeded most of the planned targets for investment as well as network expansion. Technological advances worldwide have not only drastically reduced the costs, improved the quality, and extended the range of telecom services but also have allowed competition in a sector hitherto regarded as a natural monopoly. India’s low telecom density could be turned into an excellent opportunity for technological leapfrogging because the sunk costs in existing equipment using obsolete technologies are small. The telecom sector has been better run than power generation. The pricing of telecom services, entirely under the purview of the central government, was less subject to political pulls and pressures. Low-volume local users were charged tariffs below cost, but the Department of Telecommunications exploited its monopoly position by overcharging for longdistance traffic to ensure internal resource generation. Thus there has been a substantial surplus for reinvestment and expansion. Hesitant steps toward privatization were taken in the 1980s. The first manufacture of subscriber terminal equipment by private producers was allowed in 1984. Metropolitan and international telecom services were corporatized in 1986. A Telecom Commission was created in 1989. Further liberalization on a somewhat larger scale has been attempted since July 1991. Telecom equipment manufacturing has been opened to the private sector, including multinational corporations in 1991. Value-added services, such as fax and cellular mobile telephones, were opened for private competition in 1992, and permission was given for private networks in industrial areas a year later. The first National Telecommunication Policy, announced in May 1994, ended the public-sector monopoly and permitted private-sector entry into basic services (with foreign equity allowed up to 49 percent). Finally, the Telecom Regulatory Authority of India (TRAI) was formed in January 1997 and reorganized in 1999 after the announcement of the second Telecommunication Policy. The pace of liberalization in the telecom sector accelerated in 1999, but state intervention continues to constrain modernization of the telecom infrastructure. The question of where the jurisdiction of TRAI as a regulator begins and that of the Ministry of Telecommunications as a policymaker ends has not been fully resolved. The government continues to control the number and location of new companies. Its regulation of entry and the use of an auction to grant the license to operate appears to be a means of generating and transferring windfall monopoly rents to the Ministry of Telecommunications. The creation of TRAI has been perhaps the most successful part of the reforms, but the agency’s reputation as an independent regulator is still being established and the boundaries of its regulatory powers are being defined.

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The initial government decision to control the number and location of private companies prevented the industry from serving the interests of the users of the telephone system. The government arbitrarily prevented some entrants from offering long-distance service and decided on the boundaries of each metropolitan and circle system rather than leaving these decisions to be made according to the cost of service and the intensity of demand for it. State intervention eliminated opportunities to create a seamless national wireless network that might have facilitated private provision of service to less populous areas. The government direction of investment also precluded the possibility of true competition among multiple carriers emerging in at least some parts of the nation. The second decision, to auction the licenses, seemed solely driven by a desire to generate a short-term financial windfall to the treasury. Licenses were auctioned so as to create monopolies, even though there were no obvious economic reasons such as economies of scale in wireless telephony technology to justify this market structure. Limiting the number of private entrants to one in each telecom circle seemed designed to extract monopoly profits from consumers that could then be transferred back to the government through an auction. Whatever the motivation for the auction, the high price of licenses set an implicit tax on telecom that may have impeded the growth of the industry. However, after the auctions, the successful bidders found that they had overbid and wanted to renegotiate the fees. Eventually, the myopic revenue-maximizing, fixed-license-fee regime had to be replaced with revenue-sharing arrangements for private-sector basic and cellular service operators. The best decision in the reform process was to create TRAI, an independent regulatory authority. TRAI’s early days were marked by conflict with the Department of Telecommunications when its jurisdiction included the department’s service-providing units. But the two agencies have been reorganized to avoid further infighting. TRAI’s tariff regulatory function has been separated from its adjudicative powers. The latter have now been vested in a separate quasi-judicial authority. The department was also initially reorganized, with policy formulation assigned to a Telecom Commission and responsibility for service provision given to the Department of Telecom Services and Department of Telecom Operations, which were later corporatized in October 2000 into Bharat Sanchar Nigam Limited. The Department of Telecom has now taken over some functions of policy formulation, licensing, wireless, spectrum management, and research and development. Entry restrictions into cellular and basic service operations have also been slightly relaxed to permit additional basic service operators along with the existing duopoly structure and a fourth cellular operator. Fixedservice providers can also provide wireless services within their local loop. Unrestricted entry has been allowed in domestic long-distance ser-

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vice, and the termination date for the monopoly for international longdistance services has been moved to March 2002 from March 2004.8 TRAI rebalanced the tariff in two phases. Domestic and international tariffs were reduced by about 23 percent on the average in the first phase, which took effect in May 1999. At the same time, the Department of Telecommunications decided not to raise rental and call charges for rural subscribers and low-calling urban subscribers (those making up to 200 calls). In the second phase, domestic long-distance rates have been cut further by an average of 13 percent and international station (long-distance) dialing rates by about 17 percent as of October 2000. More recent (April 2002) cuts in domestic and international long-distance rates, resulting from increased competition, have been much more dramatic. The government has issued guidelines for two categories of licenses for infrastructure providers. Type I licenses are for providers of assets such as dark fiber, right of way, and duct space and towers. Type II licenses are for firms leasing, renting, and selling such products and services as end-toend bandwidth. By November 2000, 430 licenses had been issued to Internet service providers. Fifty of these providers have also been given approval to use satellites as a medium, and the government has solicited applications for licenses to set up submarine cable landing stations as international gateways for Internet access.9 Although the steps outlined here are indeed rapid in comparison to the past, they are not adequate for India to catch up with its neighbors. Ten years ago, China and India had equivalent information technology infrastructures. China’s information technology penetration since then has far outpaced that of India. China’s “teledensity” in 2000 was 112 telephone main lines per 1,000 people, compared with India’s 32. There were 15.9 personal computers per 1,000 Chinese, compared with 4.5 per 1,000 Indians. Mobile phone density also showed similar disparities: 6.6 per 1,000 in China compared with 4 per 1,000 in India.10

Transport Network: Railways, Roads, and Ports Railways and roads have been the two major means of transporting exportable goods to seaports or airports across India’s continental expanse.

8. The state-owned monopoly Videsh Sanchar Nigam Limited has since been privatized, and several private- and public-sector firms have entered the area of international station dialing services. Competition is also getting more intense in domestic long-distance and cellular phone services. In addition, 25 new basic service license agreements have been signed by private operations (Ministry of Finance, Government of India, Economic Survey, 2001–02). 9. Ministry of Finance, Government of India, Economic Survey, 2001–02, 179. 10. World Bank, World Development Indicators 2002, tables 5.9 and 5.10. Indian “teledensity” as of December 31, 2001, was reported to be 39.5 per 1,000 people (GOI-MoF 2002a, 5). 118

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Neither is currently able to ensure the timely delivery of exportables, creating a critical competitive disadvantage in international markets. The lack of transportation infrastructure is particularly worrisome for countries of continental size such as India, which could export perishable agricultural and horticultural products.

Railways In track length, India compares favorably with rapidly growing Asian countries, with 12.4 kilometers of track per 1,000 square kilometers of land area and 42 kilometers of track per million people (McKinsey & Company 2001, vol. 1, appendix 5E). Railways accounted for 89 percent of the freight traffic and 68 percent of the passenger traffic after Independence. Over the years, however, the railways’ share has decreased—to 40 percent (freight) and 20 percent (passengers) by 1995—and road use has increased accordingly. The reasons have been obvious. Railways are state monopolies that depend on budgetary allocations for financing investment. Populism, rather than an economic rationale, continues to drive their staffing and pricing decisions. They employ more labor than needed, are unable to recover operational costs through user charges, and cross-subsidize passenger traffic by freight traffic—the former accounted for 59 percent of total rail traffic but contributed only 30 percent of the revenue in 1999. Consequently, they are unable to invest in track renewal and rolling stock and deliver poor-quality, irregular service. Poor service quality has been particularly harmful for goods traffic, because passenger traffic has been accorded priority over goods movement by successive populist ministers of railways. The growth in wagon utilization (a measure of freight being transported) slowed down in the 1990s, from 4.8 percent annually during 1990 and 1995 to 3.1 percent annually during the subsequent 4 years until 1999. The ratio of average earnings per ton-kilometer from freight to average earnings per passengerkilometer, a measure of the extent of cross-subsidization, hovered around 2 during the 20 years from 1950 to 1970. It deteriorated to 2.6 in 1980 and reached 3.3 in 1999. Given the rising costs of moving goods by rail combined with uncertain and irregular scheduling, it is no wonder that even long-haul goods traffic, which would be most efficiently handled by railways, is moved more and more by road.

Roads As with rail track, length of Indian roads compares very well with the rapidly growing countries of Asia, with 280 kilometers of paved roads per 1,000 square kilometers of land area and 950 kilometers per million population (McKinsey & Company 2001). Poor maintenance and overuse resulting from increasing demand and inadequate traffic-carrying capacity DOMESTIC CONSTRAINTS ON INTERNATIONAL PARTICIPATION

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in terms of road width and lanes have been the key problems. The World Bank (2000a) cites a study for India that estimates the cost to the country from inadequate road expenditure and maintenance as on the order of Rs30 billion per year in 1988 (about $2.2 billion at the 1988 exchange rate) in excess wear and tear of vehicles, accidents, fuel costs, and so on. The situation is likely to have worsened with the increasing volume of traffic stemming from faster GDP growth in the 1990s. A massive highway-building program is clearly warranted in the face of increasing demand and long neglect in the past. The demands on road transport have been rising progressively due to a relative cost advantage as well as the convenience of control over the timing and delivery schedule. Nevertheless, investment in and the maintenance and improvement of India’s road network, the third largest in the world, has long been neglected. The central government appears to have recognized the urgency of this task. The National Highway Authority of India, with initial capital contributed by the central government, has been in charge of improving interstate infrastructure since February 1995. Its mandate has been expanded to include implementing the National Highways Development project that will augment the carrying capacity of national highways. The high-traffic-density Golden Quadrilateral connecting the four major cities of Chennai (Madras), Delhi, Kolkata (Calcutta), and Mumbai (Bombay), for example, has been widened from four to six lanes under this program. The government has also established a dedicated Central Road Fund for the development of all roads (from national highways to state highways to rural roads) that has been financed with a duty of Rs1 per liter on petrol since June 1998 and on high-speed diesel since March 1999. Some steps have also been taken to attract the private sector to build and operate toll roads. Foreign equity participation of up to 100 percent for projects of under $400 million is automatically approved. By the end of December 2000, 20 “build, operate, and transfer” contracts were awarded, costing about a modest $250 million rather than the estimated investment requirement of $20 billion.11 It is clear that to go beyond these modest beginnings swiftly and to make a significant impact, it is necessary to devise innovative schemes with built-in incentives for the private sector to develop commercial facilities along the highways, quickly remove the legal and institutional obstacles to private-sector participation, and establish a credible regulatory framework for setting tolls. It is also important that investment in constructing feeder roads, particularly rural roads, not be neglected. Apart from their intrinsic value in linking rural residents and producers to urban facilities—including educational and health care institutions and markets—the return from the in11. Ministry of Finance, Government of India, Economic Survey, 2001–02, 182.

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vestment national highways would be enhanced by investment in feeder roads connecting them to the rural hinterland.

Ports India’s 11 major ports are effectively controlled by the central government and handle 90 percent of the country’s port throughput. The cargo shipping facilities at these and the 139 minor ports operating under the control of the state governments were neglected under the restrictive import and export policy of the past. Even with improvements in the indicators of port productivity since the mid-1980s, Indian ports are hopelessly inefficient in comparison with other Asian ports like Colombo and Singapore. The average output per (ship-berth) day slowly crept up by 2.7 percent annually, from 3,942 tons in 1991 to 4,497 tons in 1996, and rose by 5.9 percent annually to 5,338 tons in 1999. Average preberthing waiting time, after hovering around 1.7 days in the first half of the 1990s, came down to 0.9 days in 1998, where it remained a year later. Average turnaround time for ships was as high as 11.9 days in 1984. This came down to 7.5 days in 1996 and further to 4.7 days in 1999.12 However, this improvement compared very poorly with average turnaround time in other countries’ ports (as short as 6 to 8 hours for container ships in Singapore). Indian cargo has come to be predominantly transshipped through the hub ports of the region, such as Colombo and Singapore. The cost of transshipment adversely affects the competitiveness of Indian merchandise exports and provides an additional layer of protection (over and above tariff and nontariff barriers) for import substitutes. The unionization of labor, combined with age-old labor-intensive methods and antiquated equipment, has resulted in high labor costs for most major ports.13 Labor requirements are likely to go down with the introduction of containerization and automatic cargo handling, but government policy does not allow retrenchments and the termination of services before retirement—unless a person retires voluntarily and accepts a generous compensation. A policy for private investment in ports was announced in 1997, but the overprotective labor laws and unionized labor practices that would apply 12. See GOI-PC 2000. 13. The Mid-term Appraisal of the Ninth Five-Year Plan (vol. 2, para. 7.1.183, 813) mentioned that 88 percent of wharf cranes, 66 percent of mobile cranes, and 31 percent of forklift trucks were still being used beyond their economic life. McKinsey & Company (2001) estimates that the currently massively overstretched capacity of Indian ports can be increased almost fivefold by focusing on the right equipment to remove bottlenecks to existing capacity and through better organization of functions and tasks.

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to even these privatized entities make the investment less attractive. The finance minister’s 2001 budget proposed several amendments in labor legislation to address the problem of low labor productivity and inflexible labor practices. Obviously, this is a small but desirable step in the right direction, but it has yet to be acted upon.

Financial Intermediation Government interference in the financial system has been extensive, but current reforms meant to reduce the transaction costs of financial intermediation are not proceeding at a rapid pace. Financial institutions in India came under government ownership with the nationalization of banks in 1969. Life insurance companies were nationalized earlier, and the general insurance business was nationalized in the 1970s. Stock exchanges (of which Bombay’s is the oldest) have existed for more than a century, but these have also been very tightly regulated and their importance in financing corporate investments has been greatly reduced by the expanding operations of public-sector term-lending institutions. The government used financial repression to mobilize savings for priority investments and played a large role in the allocation of funds throughout the 1970s. Government-owned term-lending institutions, the main providers of long-term finance, had no choice but to invest in approved public- and private-sector investment projects. Commercial banks, the providers of short-term working capital, were directed to lend to priority sectors. Public-sector commercial banks and other financial institutions were forced to hold low-interest, long-term government debt in reserves of up to 38 percent of deposits. Interest rates on both long- and short-term loans were often set low enough so that the real interest rate was negative and the cost of capital was lower than its social opportunity cost in an economy where labor was abundant, capital was scarce, incomes were low. There was little incentive to use capital efficiently. Government control was relaxed slightly in the 1980s and at a faster pace in the 1990s. Starting in the 1980s, over time the issuance of government bonds for long maturities (5 to 30 years), at fixed interest rates, and in predetermined “notified” amounts was replaced by the issuance of bonds with shorter maturities, floating interest rates, and an auction system. The capital market also emerged as an important source of funds for corporate units in the private sector. The 1990s also saw the gradual deregulation of interest rates, recapitalization of public-sector commercial banks, steady improvement in risk-weighted asset ratios, and enforcement of prudential accounting norms. Two government committees appointed in the 1990s made several recommendations for strengthening the banking system, improving the asset quality, and tightening the prudential norms and disclosure require122

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ments. Their major proposal for structural reform was to end the segmentation of financial institutions according to function (short- and longterm lending) and to bring about the convergence of activities between banks and development financing institutions. This will require major changes in the regulatory and legal framework, supervisory practices, and statutory obligations applicable to financial institutions. The Ministry of Finance reports a significant decline in the ratio of incremental nonperforming assets to total gross advances, from 15.9 percent in 1998 to 12.4 percent in 2000, as well as an increase in the number and strength of debt-recovery tribunals (Economic Survey, 2001–02, 60–69). Bank supervision and regulatory practices regarding an increasing array of financial intermediation have moved closer to international best practice standards. Increased competition from the entry of the private sector and the partial privatization of public-sector financial institutions are forcing improvements in efficiency that are expected to further reduce the transaction costs of financial intermediation. The progress, however, is painfully slow and needs to be accelerated in view of the critical role of financial intermediation in an export-oriented economy.

Enhancing Flexibility for Industrial Restructuring The availability of efficient and inexpensive financial and infrastructural services facilitates improvements in international competitiveness of domestic industry. However, if enterprises do not have the flexibility to reallocate capital and labor swiftly in response to changing domestic and international market conditions, better financial and physical infrastructure in and of itself can only have a limited effect on competitiveness. Unfortunately, labor and bankruptcy laws continue to constrain the flexibility of enterprises.

Labor Market Reforms Rapid growth requires continuous adjustment to changes in domestic demand, technology, and opportunities for international expansion. A regulatory framework that allows for the mobility of labor and capital away from inefficient uses and into efficient uses is absolutely critical. The legacy of the activist government’s intervention in labor and capital markets has yet to be undone. Two pieces of legislation provide the defining characteristics of the pre1991 policy regime that was designed to protect the laborer’s rights. First, the precolonial Trade Union Act of 1925 fragmented the trade union movement by permitting any seven workers to come together and form a DOMESTIC CONSTRAINTS ON INTERNATIONAL PARTICIPATION

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trade union eligible for recognition in collective bargaining.14 There were no restrictions that these “unions” had to represent the majority of workers in a given industry. The second major law, the Industrial Disputes Act of 1948, closely follows the Defense of India rules formulated by the colonial government during the emergency situation created by World War II. This legislation, which is still on the books, aimed to provide employment security by including a “no retrenchment” guarantee and restricting employers’ flexibility regarding production techniques as well as placements, transferability, and the allocation of labor. Production units of more than 100 workers must secure government permission for closure. Elaborate compulsory arbitration and adjudication procedures laid down in the act discourage voluntary settlements through bilateral collective bargaining. Along with this law, comprehensive labor legislation has been enacted to ensure minimum labor standards with regard to wages, other benefits, safety standards, and conditions of employment. Judicial interpretations have further expanded the scope of labor legislation and labor security regulations. This regulatory framework, far from promoting social justice, has constrained job growth and exacerbated inequalities among formal- and informal-sector workers. The relatively high cost of overprotected labor led the organized sector to choose capital-intensive technology and limit labor absorption. Industrial and trade policies exacerbated this misallocation of resources and contributed to artificially high capital-output ratios in the factory sector. The protective labor laws, which effectively apply to fewer than 10 percent of the total workforce of 374 million, have also increased inequalities between formal- and informal-sector workers. P.C. Mahalanobis, the architect of India’s development strategy, pointed out long ago that India’s labor laws imitated those in advanced industrialized countries and were out of tune with Indian labor market realities. Not only do they protect only a small proportion of workers and their families but they also get in the way of more rapid and efficient growth.15 There has been little connection between wages and market forces. The industry-level wage boards that are occasionally appointed to help labor secure reasonable wage levels do not consider the commercial viability of individual enterprises. The mandatory minimum bonus payment prevents the bonus from rewarding workers’ productivity and reinforcing the viability of productive units. 14. The Trade Union (Amendment) Act of 2001 came into existence in September 2001. This act proposes to bring about reforms in the trade union movement, apart from curbing the multiplicity of trade unions (Times of India, New Delhi, September 19, 2001). 15. E.g., see P.C. Mahalanobis, “Asian Drama: An Indian Perspective,” Economic and Political Weekly 4, nos. 28, 29, 30 (July 1969): 1119–32. 124

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The net result of these legislative provisions and judicial interpretations has been to increase hiring costs, require companies to carry surplus labor power, and prevent them from adjusting the workforce in response to demand fluctuations. Labor in the organized segment of the economy has thus been legislatively transformed into a fixed factor of production at par with fixed capital. These state interventions in the labor market have also affected producers’ behavior. The labor code has discouraged new investors from entering into the highly productive organized segment of the manufacturing sector. Resources are wasted as private-sector employers look for legal loopholes that enable them to evade the legal provisions by subcontracting to producers in the unregulated informal sector, by giving workers limited contracts, or by artificially fragmenting their productive capacity. Employers have also bypassed the employment security provisions by using prolonged lockouts, inducing closure by not paying electricity bills, and forcing separations by linking pay to production and then stopping output. We have dwelt at some length on the evolution of overprotective labor market legislation because of the strong reaction that it evokes among the Indian intelligentsia and the fact that discussing it has been politically taboo until recently. Recently, the Prime Minister’s Economic Advisory Council’s report (GOI-PM-EAC 2001, 19–20), the Planning Commission’s Mid-Term Appraisal of the Ninth Five-Year Plan (GOI-PC 2000, vol. 2, 508), and the Ministry of Finance’s Economic Survey for 2000–01 (p. 29) all have emphasized the need to amend labor legislation to introduce flexibility in the labor market. The most concrete proposal has appeared in the finance minister’s budget speech on February 28, 2001. He proposed that Section V.B of the Industrial Disputes Act of 1948 relating to prior government permission for layoff, retrenchment, and closure should apply to industrial establishments employing not fewer than 1,000 workers16 instead of the existing limit of 100 workers. As a compromise, separation compensation will be increased from 15 to 45 days for every completed year of service. Although 16. The industrially advanced state government of Maharashtra raised the mandatory limit for prior government clearance from the existing 100 to 300 workers in December 2001 (The Times of India, December 21, 2001). This change has been reportedly endorsed by the Second National Labor Commission (SNLC), which submitted its report to the Indian prime minister on June 30, 2002 (Economic Times, July 4, 2002). The SNLC recommended (a) doing away with the mandatory prior government permission with respect to layoffs and retrenchment and (b) full protection of workers’ dues in case of closure, with no employment size limit for both (a) and (b). (Government of India, Ministry of Labor, Agenda for the 38th Session of the Indian Labor Conference (ILC), New Delhi, September 28–29, 2002, page 69). The annual tripartite ILC that took place on September 28–29 sought a consensus on labor-market reforms among employers, workers, and the government. The labor minister at the post-ILC press conference admitted failure to reach a consensus as all the central trade unions opposed amendments to labor laws recommended by SNLC (Business Standard, September 30, 2002). DOMESTIC CONSTRAINTS ON INTERNATIONAL PARTICIPATION

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this compromise sounds reasonable, most firms (including those in the public sector) have been strapped for cash, so there is clearly a need for a contributory fund for voluntary retirement, retrenchment, and layoffs— with the initial funding coming from the center, but over time contributions also coming from workers and employers. Under economic pressures for maintaining bottom lines in an increasingly competitive environment, the process of downsizing has picked up in recent years in the public-sector banks and central public-sector undertakings. More recently, a very modest beginning has also been made in reducing the bureaucracy in the central government by the abolition of long-vacant posts. As was noted in chapter 2, layoffs and retrenchments were reflected in aggregate industrial employment in 1999 and 2000, in addition to the impact of a significant slowdown in industrial growth after 1997. Barring cash-rich private corporations that offer attractive separation packages, most of the layoffs and retrenchments might be taking place on terms less attractive than those offered by the finance minister, because the bill incorporating the proposed changes into the Industrial Dispute Act is still “under consideration” by the Group of (central-government) Ministers, which is chaired by the deputy chair of the Planning Commission (GOI-MoF 2002a, item 59, 9). Trade unions face painful short-run decisions between increasingly shaky protection of a limited number of existing jobs versus permitting orderly layoffs and flexibility in expectation of future growth in job opportunities. The industrial boom during the period 1993–96 immediately following the economic reforms provided sufficient evidence that even limited international integration and industrial restructuring accelerate growth in real output and generate new employment opportunities far exceeding the job losses.

Industrial Restructuring and Bankruptcy Laws Post-1991 liberalization has resulted in the removal of barriers to entry into some economic activities. However, in the absence of a speedy legal framework for restructuring or exits, the resource reallocation will be slow, resulting in lower industrial growth and less new employment. The transfer of resources is complicated in India because, unlike in most countries, the procedures for reorganization, bankruptcy, and liquidation are governed by separate laws. The Companies Act of 1956 governs bankruptcy and liquidation, and the judicial proceedings take place in the relevant High Court. Industrial revival and reorganization, however, are covered by the Sick Industrial Companies Act of 1985 (SICA), and the authority in this respect is vested with the quasi-judicial Board for Industrial and Financial Restructuring (BIFR). SICA was originally applicable only to private-sector units, but since 1991 public-sector units have also been referred to BIFR under SICA. 126

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The existing two-step procedure is explained in the report of the Prime Minister’s Economic Advisory Council (GOI-PM-EAC 2001). A sick company (according to criteria defined in SICA) has to report to BIFR under SICA. BIFR then explores reorganization and restructuring for revival. If revival is deemed infeasible, closing down the company is recommended, and the issue is referred to the relevant High Court under the Companies Act. The High Court appoints the official liquidator to look into the affairs of the company and to enable the subsequent bankruptcy and liquidation proceedings. This process can often take 20 years or more. The Economic Advisory Council describes the system as “dilatory and fundamentally flawed” (GOI-PM-EAC 2001, 18). The Mid-Term Appraisal of the Ninth Five-Year Plan (GOI-PC 2000) also notes several drawbacks, including the fact that BIFR takes a “rather long time to come up with an appropriate revival plan.” The report goes on to observe that “it has not been possible to close down a single unit in the private or public sector, based on BIFR’s recommendations” (para 23, 116). Both the Planning Commission and the Advisory Council recommend the repeal of SICA and the winding up of BIFR because it creates an incentive to induce sickness in order to keep creditors at bay and attract low-interest funds allegedly for revival. The council has also recommended amending the Companies Act to allow for reorganization and revival where feasible and rapid bankruptcy and liquidation where necessary. The finance minister proposed repealing SICA in his 2001 budget speech. A bill repealing SICA was introduced in Parliament on September 30, 2001, and has been referred to the Standing Committee on Home Affairs for its examination and report (GOI-MoF 2002a, item 58, 9).

Reservation of Production for Small-Scale Industries The reservation of the production of certain commodities for small-scale industrial units is another constraint on reallocating resources to efficiently produce exports. Modern small-scale industrial (SSI) units, defined by an investment ceiling (varying over time) on the value of plant and machinery, have been given a variety of promotional concessions to help them overcome genuine handicaps arising from the small scale of operation.17 The additional preferential measures (to protect them from larger competing units) include excise tax concessions, preferred access to government procurement contracts, and subsidized priority credit from the nationalized commercial banks. Several industrial products (more than 800 in number) have also been reserved for exclusive production in SSI units. These protective concessions penalize efficiency and success by giving firms strong incentives to stay small. The benefits of the concessions out17. See Tendulkar and Bhavani (1997) for the details. DOMESTIC CONSTRAINTS ON INTERNATIONAL PARTICIPATION

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weigh the increase in profitability from a higher scale of operation that would take the unit beyond the SSI investment ceiling and make it ineligible for the concessions. The World Bank (1998) also points out that some Indian joint ventures abroad (e.g., in Nepal) were established in response to the domestic reservation policy. Large Indian firms in effect circumvented the reservation policy by moving abroad where there are no reservations and by producing there for exports to India. They also have an incentive to fragment production in several small firms rather than produce in one large firm. These are avoidable costs imposed on large firms, and the benefits, if any, in employment generated in the small-scale sector do not seem to outweigh the costs. A government committee concluded in a 1997 report that “the case for reservation is fundamentally flawed and self-contradictory . . . the policy crippled the growth of several industrial sectors, restricted exports and has done little for the promotion of small-scale industries.”18 As the World Bank (1998) points out, only large domestic firms are prevented from entering sectors reserved for small-scale production. Large foreign firms can now export to India and compete with domestic small-scale firms. In fact, according to the Hussain Committee report, as many as 563, or 54 percent, of the 1,045 tariff lines that corresponded to products reserved for smallscale production are now under a free import regime. There is also redundancy in reservation: there is no small-scale production for roughly a fifth of the reserved items. Many of the reserved products, including ready-made garments (which remained reserved until January 1, 2001, when, except for knitted garments, the reservation was abolished for the rest), are significant current or potential export items. One victim of this policy, the cotton textile industry, was a major exporter competing with Japan in the 1950s. The reservation of domestic production for the handloom sector and restrictive technology import policies contributed to its demise. Ironically, the intended benefits of the government intervention did not accrue to the handloom sector but were cornered instead by the power loom sector. The prospective phaseout of the Multi-Fiber Arrangement in 2005 increases the importance of removing the reservation policy. India will lose its share in world markets unless its garment sector can compete effectively with other efficient producers in the world. The requisite evolution—in which successful small enterprises consolidate and expand while large domestic and foreign firms enter the sector—will not take place unless the reservation policy changes. A recent study by Bhavani and Tendulkar (2000) on the reserved smallscale garment and apparel units in Delhi (India) finds two types of SSI units: a few catering to competitive export markets and a large number of

18. Hussain (1997, 130), as quoted in World Bank (1998, 27). 128

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very small units catering to the domestic market to take advantage of protective measures. The study indicates that exporting units tend to be larger than nonexporting units, have better access to capital and technology, and be more able to afford the marketing costs essential for operating in international competitive markets. The exporting industries were also more efficient users of labor in terms of having a lower share of wages and salaries in gross output but higher productivity per worker. The higher productivity per worker in exporting writs allowed them to pay higher wages and employ more workers on the average per establishment. The analysis indicates that the employment objective of absorbing more workers at a higher wage per worker can be more effectively served by inducing greater efficiency through competition rather than restricting competition through the policy of reservation of products for exclusive production in the small-scale units. The Prime Minister’s Economic Advisory Council as well as the Planning Commission’s Mid-Term Appraisal of the Ninth Five-Year Plan recommended phased abolition of the reservation policy for small-scale industries. More recently, the Task Force on Employment Opportunities appointed by the Planning Commission has suggested a two-stage abolition by first raising the investment ceiling and then phasing out the ceiling.19 Progress, however, has been painfully slow. Salvation is coming in small trickles; 15 items were dereserved in April 1997, 9 in December 1999, 14 in May 2001, and 50 more in May 2002. These include leather goods, toys, shoes, agricultural components, and some drugs and chemicals.20 The investment limit defining small-scale production was raised on October 9, 2001, from Rs10 million to Rs50 million for knitted garments. A new Study Group was appointed by the Planning Commission in May 1999 to look into the SSI policy (GOI-PC 2001a). The recommendations of this group were at odds with those of the 1997 Hussain Committee mentioned above. The Hussain Committee recommended abolition of reservation on all of the 800-odd products reserved exclusively for SSI units, while the Study Group recommended continuation of the reservation policy. The Hussain Committee recommended raising the investment ceiling from Rs6.0 million for small and Rs7.5 million for ancillary SSI units to a uniform Rs30 million. This was implemented by the government of Inder Kumar Gujral, but the ceiling reverted back to Rs10 million in December 1999 with the new National Democratic Alliance government. The Study Group’s recommendation to maintain the Rs10 million limit has been followed as of this writing.21 19. See GOI-PM-EAC (2001); GOI-PC (2000, 2001b). 20. GOI-MoF (2002a); Economic Times, June 14, 2002. 21. On 41 out of 849 reserved items (mainly textiles and hand tools), the investment ceiling for reservation was raised to Rs50 million as of October 9, 2001, according to a communication from the Department of Industrial Policy and Promotion of the Ministry of Industry. DOMESTIC CONSTRAINTS ON INTERNATIONAL PARTICIPATION

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Industrial Policies: Disinvestment versus Privatization Disinvestment of public equity in the commercial public-sector undertakings (PSUs) incorporated under the Companies Act of 1956 is a second priority for reform. As was noted in chapter 2, government ownership was extended beyond the conventional public goods and services to basic and heavy industries in the Mahalanobis strategy (the Second Five-Year Plan, 1956–61) to accelerate the process of industrialization. Over the years, the scope of the public sector has expanded indiscriminately and moved well beyond the administrative, organizational, and managerial capabilities of the government. The public sector was also looked upon as an instrument of employment generation and has thus absorbed more than the limits dictated by commercial viability. The incentives facing managers of PSUs bear little resemblance to those in a competitive commercial enterprise. The provisions of section 617 of the Companies Act of 1956 bring PSUs under Article 12 of the Indian Constitution so that, among other procedural requirements imposed on the government, they are accountable to Parliament and subject to public audit by the comptroller and auditor general. PSU managers can be accused of corruption and subjected to investigations applicable to civil servants, a chain of accountability that limits their willingness to take commercial risks. Even in exceptional cases of well-run PSUs, the rate of return on employed capital is low because managers have little freedom to set the prices of their output according to market forces. Matters have been made worse by political and bureaucratic interference and by pressure to create jobs rather than operate efficiently. Experience in other countries shows that public ownership need not necessarily be inimical to commercial operation. Nevertheless, autonomous commercial operation of PSUs in the Indian political and bureaucratic culture does not appear possible. Reforms applying to the private sector have only increased the PSUs’ drain on the public treasury. Private-sector units have been freed from license-permit restrictions since 1991, but PSUs remain shackled by a procedure-driven bureaucracy, a need to gain administrative clearances in commercial investment and operational decisions, and fast vanishing budgetary support owing to fiscal constraints. PSUs’ ability to compete with less regulated, more modern private-sector units is fast decreasing, along with any commercial success that they may have had. The rapid privatization of commercial PSUs is imperative not just for efficiency gains in production but also to refocus the government on its role of supporting a liberalized and globalized economy. The PSUs overload the public sector, distracting the state from core functions of basic governance, such as cost-effective supply of public goods and social services like basic health and primary education. Concrete (but still piece-

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meal and hesitant) action has emerged only in the period 2001–02, with the trade sale of Modern Food Industries Limited and the strategic sale of Bharat Aluminum Company (BALCO). The strategic sale of BALCO on March 2, 2001, though not significant in terms of the magnitude of proceeds (less than $110 billion) may prove to be a landmark in institutionalizing and building consensus on the process of disinvestment and privatization. The Government of India sold 51 percent of its equity in BALCO to the private company Sterlite Industries (India) Limited. In protest, the workers went on a 67-day strike. The Congress Party, which governed the state of Chattisgarh (newly carved out of Madhya Pradesh), backed the protest. This party initiated the economic reform process in 1991 and is currently the main opposition party in Parliament. It had opposed the privatization of profit-making, public-sector enterprises. Three writ petitions were filed against the government decision in the Delhi and Chattisgarh High Courts and were transferred to the Supreme Court. In its order dated December 10, 2001, the Supreme Court, while validating the BALCO disinvestment and dismissing the petitions, observed: “Thus, apart from the fact that the policy of disinvestment cannot be questioned as such, the facts herein show that fair, just and equitable procedure has been followed in carrying out disinvestment” (GOI-MoF 2002a, 168). This case is important for at least three reasons. First, it established the principle that government policy on disinvestment cannot be questioned. Second, legitimization of this case by the highest court of the land would blunt the political opposition to disinvestment. Third, what happened subsequent to the Supreme Court decision is most important. The state government has since signed a memorandum of understanding with BALCO for a fresh investment of Rs5.515 billion in one of the smelter plants.22 The government has also reduced its stake to a minority share in the state-owned international telecommunications monopoly Videsh Sanchar Nigam Limited by passing its control to Tata Industries. It has also issued letters of intent for international station dialing services to nine private companies. Two state-owned and incorporated basic telephone service providers—Bharat Sanchar Nigam Limited and Mahanagar Telephone Nigam Limited—have also entered the race for these services. This follows a drastic reduction last year in domestic long-distance tariffs by these same two state-owned firms, which are the major basic service providers. These developments are important not only for privatization of infrastructure service provision but also for the introduction of competition in all segments of telephone service.

22. Economic Times, May 29, 2002.

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The most recent case of passenger car producer Maruti Udyog Limited marked the government’s seriousness in moving out of noncore areas and privatizing profit-making concerns. It sold a part of its equity shares in Maruti to its joint-venture partner Suzuki Motor Company, which increased its share to 54.2 percent, thus giving it a controlling stake. Suzuki has also agreed to underwrite a further 20 percent in equity, to be offloaded during the period 2002–03 with a mutually agreed-on floor price per share.23 These cases of privatization—of BALCO, which was in what had been regarded as a basic industry exclusively reserved for the public sector under the earlier industrialization strategy; Videsh Sanchar Nigam, an infrastructure monopoly service provider; and Maruti, producing a profitable consumer product—may be expected to accelerate the process of disinvestment and privatization. However, the continuing problem with divestment in state-owned Air India and Indian Airlines suggests some caution.

Conclusion India’s further integration in world markets for factor and goods flows is necessary to improve efficiency, make up for shortfalls in domestic savings, provide an export outlet for increased production, and sustain further high growth. This chapter has outlined the most important impediments to this integration: macroeconomic instability, weaknesses in infrastructure, labor market rigidities, and restrictive laws and policies regarding resource use. Efforts to reform these policies and rebuild infrastructure will have to be made at both central and state levels. We have noted several serious problems with the operation of state electricity boards as well as their obvious adverse implications for industrial production and exports, but there are also many other infrastructure facilities and services whose supply depends on efficient and corruption-free state administrations. These include, for example, the acquisition of land, the provision of water supply and construction of access roads, the availability of an educated and disciplined workforce, and the prevalence of law and order.

23. Times of India, India Business Online, http://www.timesofindia.indiatimes.com/cms.dll/ articleshow?articl=1197822785type=1 (May 2002). 132

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5 Conclusions and the Tasks Ahead

India’s decades-long pursuit of an inward-oriented development strategy— rationalized both by a wary, if not an altogether hostile, attitude toward foreign trade, technology, and investment and by pessimism about export markets—inevitably marginalized the country in world trade and private foreign capital flows. India’s share of world exports declined from 2.2 percent in 1948 to a low of 0.5 percent in 1983 and then recovered to 0.7 percent in 2000 (WTO, International Trade Statistics 2001, table II.2). India shared only modestly in the phenomenal growth of private capital flows in the 1980s and 1990s to the so-called emerging-market economies. The economic reforms of 1991 abandoned the inward-oriented development strategy and initiated a process of reintegration of the Indian economy with the world economy. But challenges remain. The inward-oriented development strategy was implemented through an extensive system of discretionary, rather than rules-based, state controls over economic activity. Over time, the coverage of the system of controls was expanded and became more intrusive. The scope and discretion embodied in the controls also fostered administrative and political corruption. With the exception of a brief period of liberalization after the macroeconomic crisis of 1966,1 attempts to moderate the rigors and unintended

1. This liberalization was abandoned by then-Prime Minister Indira Gandhi in part because of strong political opposition from her own party, let alone from parties in the opposition. The failure of the World Bank to deliver the substantial nonproject assistance that was promised in support of liberalization (because of pressure by the United States, which was unhappy with India’s opposition to the war in Vietnam) played a role in the demise of this reform effort. 133

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side effects as well as distributional consequences of the control system generally involved additional government interference. Export incentives were introduced in an effort to alleviate the penalty imposed by import controls on exporters. Import tariffs were often raised to mop up the premiums accruing to import licensees. Some liberalizing actions were taken, particularly in the 1980s, on the basis of the recommendations of several government committees that looked into various functional aspects of the control system. There was increasing use of the market mechanism to allocate critical materials such as steel and cement; these two were completely decontrolled in the 1980s. With Rajiv Gandhi’s succession as prime minister after his mother’s assassination in 1984, a number of young economists were appointed at senior levels of economic ministries and in the prime minister’s office. They were open to experimenting with the liberalization of economic controls. Though these liberalizing actions and tendencies did not amount to significant departures from the development strategy, when combined with an unsustainable fiscal expansion financed by costly domestic and external borrowing, they delivered a relatively rapid growth of GDP at 5.8 percent a year in the 1980s (World Bank, World Development Indicators 2002, table 4.1). By the end of the 1990–91 period, the fiscal deficit of the central and state governments together exceeded 9 percent of GDP and, as was discussed in chapter 2, serious imbalances in external accounts gave cause for concern. The ensuing crisis, coupled with the collapse of the centrally planned economies of the Soviet Union and Eastern Europe in 1991, led to a reexamination of the development strategy and the associated centralized industrial planning. Moreover, the spectacular growth after the late 1960s of the open East Asian economies, and particularly China after its opening in 1978, undermined the other foundation of India’s economic policy, namely, inward orientation. The reexamination of the strategy led to major policy reforms in 1991 toward greater integration with the global economy, greater reliance on private initiatives, and the use of marketbased instruments in economic management.

The First Generation of Reforms: Achievements and Problems The economic reforms removed policy-induced entry barriers, relaxed constraints on private-sector initiatives, and led to the emergence of domestic as well as external competition. The reforms resulted in several favorable outcomes. The composition as well as direction of imports and exports shifted away from barter trade with the former Soviet bloc. Shares of exports in domestic production increased. Output and employment in the factory segment of the manufacturing sector expanded. Finally, the 134

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GDP growth rate in the first 3 postreform years exceeded 7 percent for the first time since Independence. The beneficial effects on the economy, though significant, have been modest. Still more reforms are needed to put India on a path of sustained, rapid growth. For example, although the postreform Indian export performance was superior to that of the prereform era, it was vastly outdone by that of both small economies (in terms of population) like Malaysia, South Korea, Taiwan, and Thailand, and large economies like China and Indonesia. After reaching a peak of 7.8 percent in 1996–97, the growth rate fluctuated between 4 and 6.6 percent in the subsequent 5 years. Political and external factors played a role in the slowdown. However, the failure to bring the overall fiscal deficit of the central and state governments, as well as those of nonfinancial public enterprises, significantly below what it was as a proportion of GDP in 1990–91 just before the crisis was a major contributing factor. The persistent deficit led to a rise in real interest rates on borrowed capital and crowded out private investment. The burden of the fiscal adjustment that has occurred since the reform has fallen in large part on public investment, particularly in infrastructure. The lack of adequate investment in additional capacity, and the poor maintenance and inefficient operation of infrastructure facilities and services, have acted as a drag on growth. Although there have been improvements in the performance indicators in power, telecommunications, railways, road transport, and ports, concrete progress has been too slow to meet the progressively demanding requirements of the globalizing economy. Two factors constrain investment for creating needed additional capacity. The public sector, as a whole, has become a net dissaver. More public borrowing at market rates, not only for investment but also to sustain public consumption, would exacerbate the already serious issue of fiscal solvency besides crowding out private investment. The alternative—attracting significant private investment (domestic and foreign) into infrastructural sectors—is impossible as long as investors have to absorb, in effect, the cost of subsidized sales to privileged users. Besides adding capacity through investment, the efficient operation of already existing capacity is essential. The regulation of the infrastructure sectors is also a key concern. Scale economies and network externalities are clearly significant in infrastructure sectors. Atomistic competition among price-taking enterprises is unlikely, because there are few (private and/or public) firms of significant size relative to the market in such sectors. Regulation of their operation is common around the world, although the nature and scope of regulation have changed. In these circumstances, a well-formulated and effectively enforced competition law could be better social policy than regulation. India’s experience with regulation is very recent. The Telecom Regulatory Authority of India had to be reconstituted twice within its short life. The states and the central government have set up regulatory agencies for electricity, but the CONCLUSIONS AND THE TASKS AHEAD

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legislation defining their functions and interrelation was approved by the Central Cabinet only in August 2001. Whether the newly created regulatory agencies will resist political pressures and escape capture by those regulated remains to be seen.

Tasks Ahead It is evident that the series of reforms initiated in 1991 (the so-called “firstgeneration” reforms) are yet to be completed. Several problems had arisen as they were being implemented. Further, the first-generation reforms have to be extended to other areas and deepened.

Completing the First Generation of Reforms Even after substantial reductions in import tariffs, and the removal on April 1, 2001, of all quantitative restrictions (QRs) on imports, there is still a long way to go before India’s trade barriers are as low as those of its neighbors. All finance ministers in the postreform era have declared their intention of bringing down average tariff rates to the levels prevailing in East Asia. The Mid-Term Appraisal of the Ninth Five-Year Plan argues for a clear time frame for a phased reduction of import tariffs to 10 percent (GOI-PC 2000, 1120). The report of the Prime Minister’s Economic Advisory Council suggests a 5-year phased transition, from 34 to 12 percent (GOI-PM-EAC 2001, 14). The more quickly these intentions are translated into concrete actions, the more quickly will Indian industry become internationally competitive and better placed to receive the benefits of expanding trade opportunities. Unfortunately, by replacing the QRs that were removed with high tariffs and by imposing antidumping duties on some imports from China, the government seems to have taken a step away from acting on its intentions. The first generation of reforms is also not complete with regard to the power sector. Draft legislation for the power sector allows for the unbundling of generation, transmission, and distribution and also permits private enterprises to undertake some of these functions. The unbundled functions of state electricity boards (SEBs) should be corporatized as an interim measure, because privatization is unlikely anytime soon. This would formally distance them from government and may be expected to improve the efficiency of operations, rationalize the structure of tariffs, and bring revenues in line with costs. The finance minister, in his budget for 2001–02, has provided central assistance to states with a clearly monitorable agenda for restructuring SEBs. The progressive deterioration of the fiscal situation of the central government and states after some correction in the initial year of reform is a 136

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third major concern. The introduction of a Fiscal Responsibility Act in Parliament in 2001 and the central government’s intention to adhere to its provisions even before it is passed are welcome steps. The provisions include the elimination of the central government’s revenue deficit and the reduction of the overall deficit to 2 percent of GDP in 5 years.

Launching the Second Generation of Reforms The first generation of reforms, which were initiated in 1991 and are still in various stages of completion after a decade, attracted broadly based, though by no means universal, political support. As such, although there is some resistance to their completion, it is unlikely they will be reversed. The second generation of reforms are those yet to be undertaken in any significant measure but which are critical for restoring and sustaining rapid growth. Unfortunately, they do not command as much political support. Not only do the policy preferences of the National Democratic Alliance (or NDA, the central government’s ruling coalition) differ from those of the main opposition Congress Party but there are also differences even among members of the NDA, some of which are regional parties. There are four critical second-generation reforms of domestic policies and institutions: reform of the labor laws; privatization of enterprises that have no compelling social rationale to be in the public sector; reform of laws for bankruptcy and liquidation, so as to allow for an orderly exit of failing private enterprises; and restructuring of center-state economic relations, by amending the Constitution if necessary. There is synergy among the four, so that failure to enact one could detract from the benefits accruing from enacting the others. In addition to these four, there is the as yet barely begun task of integrating India’s agriculture sector with world markets.

The Labor Market An overwhelming majority (60 percent) of the Indian labor force is engaged in agriculture. The inefficient functioning of the market for land constrains the movement of labor out of agriculture into more productive activities. The labor market has a dual structure: a few large enterprises have a dominant share of output and a much smaller share of industrial employment, and a large number of small enterprises have a large share of employment but only a small share of output. Productivity per worker between the two segments differs significantly, being higher in large enterprises due to their use of more capital per worker. Large enterprises substituted relatively cheap capital for labor as labor laws increased the cost of hiring and firing. Although large private corporate enterprises managed to get around the provisions of the labor laws (albeit at some cost), public-sector undertakings (PSUs) could CONCLUSIONS AND THE TASKS AHEAD

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not do so. Their high labor costs have contributed to their poor financial performance. Although reforming the labor laws has been on the agenda since 1991, not much has happened. The proposal offered by the finance minister in his 2001–02 budget is a notable exception: to increase compensation to retrenched workers while restricting the requirement of mandatory prior government permission for layoffs, retrenchments, and closure to large units employing 1,000 or more workers. It appears very unlikely, however, that the legislation amending the labor laws to implement this proposal will be passed by Parliament, if it is introduced at all. Trade unions that are affiliated with the ruling NDA and the opposition comprising the Congress Party and the left-wing parties all are adamantly opposed to it.

Entry, Exit, and Privatization The first generation of reforms freed PSUs from intrusive government interference, but their parent ministries still effectively control them. They can no longer count on budgetary support for financing their operating losses and investment, even as they face competition from leaner and more efficient domestic and foreign PSUs. Although such competition provides a desirable impetus for PSUs to become more efficient, the ability of their managers to act on the impetus is severely constrained by bureaucratic controls, political interference, and inhibitions arising from their being subject to auditing by the comptroller and auditor general of India and oversight by Parliament. What is needed is a thorough examination of the social rationale for existing enterprises to continue to be in the public sector. Those for which there is no such compelling rationale should be privatized, regardless of whether they are making profits. The policy of disinvestment—consisting for a long time of a sale of a part of the equity in an enterprise (not necessarily to private agents)—has not been a meaningful substitute for a wellthought-out policy of privatization. The percentage of disinvested equity has typically not been enough to give buyers control over operations and management and thus has not brought in market incentives. Political support for privatization is unlikely, however, until the labor laws are reformed and workers that would be likely to be laid off from overstaffed PSUs after privatization are reasonably confident that they can secure alternative and equally remunerative employment in a rapidly growing economy. But as we noted in chapter 4, the successful privatization of Bharat Aluminum Company, and the sale of significant shares of equity in Videsh Sanchar Nigam Limited as well as Maruti Udyog Limited and other firms to private investors, appears to have significantly changed the climate for privatization. As a recent observer notes: “Long a source of controversy, privatization is rapidly becoming a matter of routine. Since the start of the year, India has sold more government-run firms 138

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than it did in the previous decade. No fewer than 17 companies—some large, some small—have moved from public to private hands, bringing the government an expected $2 billion” (J. Slater, “Privatization Is Routine in Once Socialist India,” Wall Street Journal, July 5, 2002). The policy environment for efficient and rapid restructuring needs to allow not only entry into potentially profitable activities but also exit from activities that have become unprofitable and are likely to remain so in the future. First-generation reforms have removed entry barriers to domestic and foreign private capital and introduced greater competition. Yet as was discussed in chapter 4, exit on reasonable terms still continues to be very difficult, if not impossible. It will remain so until there is a serious overhaul of the Sick Industrial Companies Act of 1985 (which deals with the reorganization of failing firms) and the Companies Act of 1956 (which deals with bankruptcy and liquidation).

Center-State Economic Relations Unstable coalitions of national and state political parties have been in power since the defeat of the Congress Party in the parliamentary elections of 1996. The ruling NDA, which came to power after the 1999 elections, is a coalition consisting of a single national party, the Bharatiya Janata Party, and several state-level parties. Clearly, this shift toward coalition rule has meant that the states have gained a much greater say in policymaking at the center. The first-generation reforms, by abolishing central controls on investment and imports, have also greatly expanded the role of policy action by states in influencing their own industrial development. It is fair to say that the Central Planning Commission has lost its raison d’être in the postreform era despite getting the approval of the National Development Council on September 1, 2001, for its paper on the approach to the Tenth Five-Year Plan (2002–07).2 The plan has much less meaning as an operational document, even for the public sector, than it had in the prereform days. The states’ increasing influence on their own development in the postreform and coalition politics era could have a profound effect on their own development as well as on India’s integration with global commodity and financial markets, for several reasons. First, the reforms provide an enabling environment for better performance that at least some states appear to be taking advantage of. Actual performance depends on the response to reforms. The response, in turn, depends on the initial conditions, such as the skills and discipline of the labor; the cost and quality of the infrastructure; and, most important, the quality of governance. States that are better endowed in these dimensions initially (partly because of

2. See http://planningcommission.nic.in/plans/planrel/appdraft.pdf. CONCLUSIONS AND THE TASKS AHEAD

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their policy choices in the prereform era) appear to respond more effectively and quickly to the opportunities opened up by reform. Coastal southern and western states have been growing faster since 1991 than the large interior states. In principle, this could induce lagging states to invest in human capital and infrastructure to a greater extent, improve their governance, and thus catch up with the faster-growing states. Conversely, one cannot rule out inadequate, if not perverse, policy responses by the laggard states. Were this to happen, disparities among states could increase and threaten the stability of India as a federal nation.3 The evidence regarding the extent of catch-up and convergence is at present ambiguous. Different researchers come to different conclusions.4 The fact that the poorer and more slowly growing states also happen to be the ones with a sizable share of India’s population and electorate is disturbing; if they fail to catch up with their richer counterparts, the stability of India’s federal polity could be threatened. Second, the states are actively competing to attract domestic and especially foreign investment. If the policy instruments used in this competition consist of concessions in taxes and the subsidized provision of infrastructure rather than better-quality and less-expensive infrastructure or a better-skilled and -disciplined labor force relative to other states, the competition could take the form of a race toward the bottom. Competition that involves each state offering more and more tax concessions in a futile effort to attract investment will merely transfer public resources to investors without influencing the final locational decisions of investors. Third, the states’ fiscal situations not only affect their ability to provide public goods and services to their residents but could also affect their (as well as the rest of India’s) attractiveness to foreign investors. At present, the states cannot borrow, even at home, without the permission of the central government—though this requirement has been evaded by state enterprises resorting to borrowing from the market. Just as credit agencies now rate India’s creditworthiness in part on the basis of the central government’s fiscal situation, states’ debt will also be subject to credit rating if they access capital markets at home and abroad. Such agencies not only 3. Apart from the response of state governments, there is also the response of individuals, households, and enterprises to opportunities opened up by reform. Again, these responses could be heterogeneous and dependent on their initial endowments. The policy environment, including the actual response of each state to the postreform environment, could either help or hinder initially lagging private agents in catching up. It is possible that disparities among private agents within states, as well as those between the average performances of states, would increase in the postreform era, at least in the short to medium run. Indeed, this also happened in China after its opening in 1978. 4. Marjit and Mitra (1996); Abler and Das (1998); Bajpai and Sachs (1996); Cashin and Sahay (1996, 1997); Ghosh, Marjit, and Neogi (1998); Nagaraj, Vroudakis, and Vganzones (2000); Iyer (2001).

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look at governments’ actual liabilities but also at their contingent liabilities arising from their guarantees of private debt and implicit commitments to bail out failing large (particularly financial) enterprises.5 The states also create contingent liabilities for the central government when foreign investors insist on guarantees that the enterprises they invest in will be paid in full and on time for the output they sell to state enterprises. Enron Corporation’s experience in India is a prime illustration of this. Because the Maharashtra State Electricity Board (MSEB), the sole buyer of power generated by the power plant in which Enron invested, was fiscally weak, Enron insisted that Maharashtra State, the owner of MSEB, guarantee that it would pay if MSEB failed to pay. Because Maharashtra State itself was in dire fiscal straits, Enron insisted on and got a counterguarantee of payment by the central government, in case Maharashtra State was unable to fulfill its guarantee. It is clear that the existing center-state economic relations relating to tax and expenditure assignments, as well as responsibilities regarding social and physical infrastructure and regulation, need to be reexamined (Singh and Srinivasan 2002). This would partly involve rethinking constitutional provisions for revenue sharing and transfers, as determined by quinquennial Finance Commissions, and also for transfers, as determined by the Planning Commission. If India is to succeed in achieving rapid growth through greater interaction with a more and more competitive world economy, such a reexamination is imperative.

Integrating India’s Agriculture with World Markets We noted above that in their declaration after the Doha meeting of the World Trade Organization (WTO), the world’s trade ministers committed to negotiate substantial reductions in major distortions of agricultural trade, such as export subsidies and domestic support. The extent of those distortions as of 2001 was large: Support to agricultural producers accounted for 31% of farm receipts in the OECD [Organization for Economic Cooperation and Development] area, compared to 32% in 2000 and 38% in 1986–88. Three-quarters of support to producers in OECD countries distort production and trade, and prices received by farmers in 2001 were still an average of 31% above world prices, compared with 58% in the mid80s, shielding farmers from world market signals. Significant differences nevertheless remain across countries and commodities. Producer support levels range from 1% of farm receipts in New Zealand . . . to

5. We do not wish to exaggerate the analytical capabilities of these agencies, particularly in anticipating problems. After all, they failed to downgrade the debts of South Korea and Thailand, for example, until they were in the middle of the Asian financial crisis. Conversely, they rushed to downgrade Japanese debt in 2002, even though Japan’s large stock of foreign assets and high savings rates would suggest that its chances of defaulting on its debt are rather low.

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over 60% in Iceland, Japan, Korea, Norway and Switzerland. Producer support is 21% of farm receipts in the US and 35% in the EU. Rice, sugar, milk and wheat are the most supported commodities. (OECD 2002a)

It is unfortunate that US President George W. Bush recently signed a farm bill that will further add to trade-distorting domestic support in the United States. But as we noted above, there have been some encouraging signs in recent US proposals at WTO negotiations on agriculture. India and other developing countries rightly criticize the excessively distortionary agricultural subsidies in rich industrialized countries. However, the fact that rich countries subsidize their agricultural exports is cited as an argument, particularly by Indian policymakers, for developing countries to adopt similar distortionary policies. This is a non sequitur. Adding another distortion to an existing distortion will not improve the situation, particularly in world markets where India does not have market power. It is true that there are difficult adjustment problems in integrating India with world agricultural markets, but maintaining or increasing distortions and insulating Indian agriculture from world markets is not the right response to agricultural protection and subsidization in rich countries. The right response is to address the adjustment problems in a serious way.

The Political Economy of Reform Reforms of any significance affect the welfare of various socioeconomic groups differently, with some gaining and others losing from the reforms. Moreover, the relative political clout of each group influences the content and pace of the reform process in a multiparty democracy such as India’s. As we noted above, there were relatively few losers in the reforms of the first decade. But the situation does not appear to be so conflict free for the remaining reforms. In assessing the prospects for these reforms being undertaken, it is useful to identify four significant interest groups. The first three are large industrialists, bureaucrats, and large farmers, as identified by Bardhan (1984) in his celebrated study of India’s political economy. The fourth group, organized labor, has been vocal in its opposition to several major items on the reform agenda.

Large Industrialists The reforms of the first decade are unlikely to be reversed because most of them did not involve significant political costs for the reforming governments of the Congress Party, the coalitions that succeeded it, or the opposition parties. There is no agreement, however, among political parties on whether—and if so, how—to proceed further with reforms.

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In analyzing the attitudes of political parties toward reforms, we have to analyze the reforms’ impact on their supporters, the interest groups. Limited but imaginative liberalization of industrial capacity licensing (initiated by the Congress Party regime of Rajiv Gandhi in 1985–86) allowed firms to diversify into related products within their overall licensed capacity and to produce 25 percent above their capacity. Firms with sales of less than Rs10 billion, in contrast to the earlier limit of Rs1 billion, were exempted from the requirement to obtain government approval for expansion. These measures were welcomed by industrialists and indeed resulted in an industrial boom in the period 1985–88. After this experience, industrialists were receptive to a virtual abolition of capacity licensing in the reforms of 1991. Abolition of licensing of imports other than of consumer goods once again did not run into opposition. This was primarily because domestic producers did not immediately face increased competition from imports. The devaluation of the rupee in July 1991 and high tariffs still restricted imports. The progressive reduction of tariffs before 1995 and appreciation of the rupee in response to substantial increases in flows of foreign capital have eroded protection margins. Thus it is not surprising that producers of import substitutes oppose further trade liberalization. The unrestricted availability of cheaper intermediates and capital goods benefited user industries. In particular, with imports of consumer goods (especially consumer durables) still banned, effective protection for the producers of substitutes for such imports rose even above the already high levels that existed before the reforms. The increased profitability of the QR-protected production of automobiles resulted in significant flows of foreign direct investment (FDI) to the automotive sector. India’s reluctance to phase out the QRs on consumer goods imports until forced to do so by a ruling of the WTO’s Dispute Settlement Body can, to a certain extent, be attributed to the pressure of the vested interests of producers of import substitutes—which include the PSUs and organized trade unions entrenched in the PSUs. With the removal of QRs and with greater penetration of competitive imports, in particular from China, domestic producers demanded the imposition of antidumping duties against such imports rather than face the task of becoming internationally competitive. Their response to import competition is no different from their counterparts in the US steel industry and elsewhere. Unfortunately, the government caved in and imposed antidumping duties on some imports from China. This outcome illustrates the well-known worldwide phenomenon that governments accord greater weight to producer than consumer interests in such decisions. Even the Bush administration, which ideologically is against trade restrictions, ordered an investigation to determine whether

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steel producers have been injured by import competition and, having satisfied itself that they have been, has provided tariff protection. The Indian government’s ambivalence about the reforms and the slow pace of liberalization of FDI could be in part attributed to the conflicts within the group of large industrialists. Liberalization benefited some by enabling them to increase their market share with foreign participation. Others faced a loss of market share due to competition from foreign producers. In any case, large industrialists in India have been traditionally against foreign investment. Desai (1998, 38) argues that the liberalization of foreign portfolio investment in 1992 was a compromise between the industrialists’ fear of competition from FDI and the pressure from the IMF to expand opportunities for non-debt-creating foreign capital inflows. By allowing foreign institutional investors to buy equity in Indian companies—but restricting any individual investor initially to 5 percent (and later to 10 percent) of the equity of a company, and in the aggregate to 24 percent—India opened the door to foreign investment, but not wide enough for foreign investors to take over Indian companies. At the same time, Indian companies were allowed, subject to government approval, to tap foreign capital markets by selling equity through global and US depository receipts. Because such equity did not have voting rights, there was once again no threat of foreign control. Much FDI came in through the discretionary and nontransparent channel of approvals by the Foreign Investment Promotion Board (FIPB). Desai (1998, 29) points out that the FIPB, consisting of the secretaries of the economic ministries, was set up to override the Secretariat for Industrial Approvals (set up in the 1970s) because this body had approved very few of the proposals that had come before it. The FIPB made its recommendations to the ministers in the Foreign Investment Coordination Committee. In response to increasing opposition from domestic industry to its liberal attitude toward FDI, the FIPB was transferred to the Ministry of Industrial Development in 1995. This institution simply filed applications received without acting on them. After the election of 1996, however, the newly appointed minister for industries resumed the liberal grant of approvals. Although FDI for up to 51 percent of equity was given “automatic approval” by the Reserve Bank of India in 34 “priority” industries, Desai (1998, 31) suggests that foreign companies preferred the flexibility of negotiating terms face-to-face with the FIPB rather than the rules-based approval process of the Reserve Bank. This process involved inflexible conditions on the priority status of the industry and the proportion of equity held by foreigners. The substantial initial enthusiasm among foreign investors for portfolio investment in India subsided once they became sufficiently informed to assess the potential of different Indian firms and their own vulnerability to malpractice by players in the Indian equity markets. This disenchant144

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ment was naturally greater among those who invested in equity in Indian firms through Global Depository Receipts. These factors led to a decline in portfolio investment by the mid-1990s and to a shortage of equity funds among Indian companies, which forced some that had formed joint ventures to reduce their share of equity or sell out to foreign partners. It is not surprising, as Desai notes, that large industrialists became averse to foreign investment. Desai also correctly suggests that the incomplete, illplanned liberalization of foreign capital inflows while the domestic capital market was still riddled with imperfections and malpractices has given rise to xenophobia, even among those powerful industrialists who initially supported opening up (Desai 1998, 47–48).

Farm Interest Groups It is a complex task to assess the impact on large, medium-sized, and small farmers, tenants and agricultural laborers, and consumers of integrating Indian agriculture with world markets. In India, as in most countries, government interventions in markets for agricultural outputs and inputs are extensive and nontransparent. Not only is it virtually impossible to assess the net impact of the myriad interventions (and changes in them following trade liberalization) on different groups, but these groups also overlap and the same person could be in different groups at various times during a year. For example, small farmers sell food grains at harvest and buy them later because they have a limited capacity to store them. As such, they would benefit (or lose) from high (or low) prevailing market prices at harvest times when they sell their produce, but lose (or benefit) from high prices when they buy. Integrating domestic markets for agricultural outputs (both raw and processed) and inputs with world markets is most likely to have significant, but not easily estimated, distributional effects. Intervention in agricultural markets affects several groups. They include large farmers who are primarily sellers of produce, consumers (particularly poor people), suppliers of inputs (e.g., seeds, fertilizers, electricity and petroleum products, and irrigation), and user industries (e.g., textiles). Rural poor people—who are mostly tenants and landless agricultural laborers, many of whom belong to socially disadvantaged groups such as the scheduled castes and tribes—have not been politically influential except in the states where the communists rule (West Bengal) or have ruled or shared power (Kerala) and more recently in Uttar Pradesh, where the Bahujan Samaj Party of lower caste members is in the ruling coalition. The large farmers are politically well represented in all parties except those on the extreme left. Large farmers have received subsidized supplies of inputs—namely, fertilizers, electricity, petroleum fuels for irrigation pumps, and credit from nationalized banks—since the introduction in the late 1960s of high-yielding varieties of rice, wheat, and a few other crops CONCLUSIONS AND THE TASKS AHEAD

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that for profitable cultivation require irrigation and the use of chemical fertilizer. Electricity was supplied free to agriculturists in some states, and charges for canal irrigation did not even cover the cost of maintenance. In addition to subsidizing inputs, the government intervened in output markets, particularly of food grains. Foreign trade in agricultural commodities was canalized through state trading agencies. The net effect of the insulation from the world markets on the one hand, and various domestic subsidies on the other, appears to have been one of implicit taxation of agriculture as a whole, and also of a number of commodities, especially some food grains. Because the cropping pattern naturally varies across states, reflecting differences in agroclimatic conditions and in the extent of irrigation, the removal of all state interventions from agriculture and fully integrating it with world markets will affect different states differently. Self-sufficiency in food grains and other essential agricultural commodities has long been a national-security-motivated objective of Indian policymakers. Their interest in it was reinforced by the country’s searing experience with imports of food grains from the United States under Public Law 480 when India faced serious food shortages caused by the harvest failure of 1965–67. President Lyndon Johnson threatened to withhold food aid in an attempt to change India’s opposition to the Vietnam War. In part because of this experience and the coincidental availability of Green Revolution technology, India devoted greater resources to agricultural production. A policy of domestic price support, insulation from world markets, and subsidization of inputs was instituted. The policy succeeded in making India self-sufficient in food grains. Therefore, both the removal of QRs on agricultural imports and the integration of Indian agriculture with world markets are seen as threatening this hard-won “food security.” This view is unfounded, however. If food security is appropriately redefined as ensuring that poor people have access to food at prices they can afford, nothing in the Uruguay Round Agreement on agriculture would preclude the Indian government from reforming the Public Distribution System for food grains and maintaining the buffer stocks necessary to achieve security. Integrating Indian agriculture with world markets will necessarily involve comprehensive reform, which will have to be sold to diverse groups of large farmers and consumers across states. Large farmers do not appear to be united on the issue. Although Sharad Joshi, a leading farm lobbyist, has been strongly in favor of eliminating subsidies and integration with world markets, such other leaders as M.D. Nanjundaswamy in the South and Mahender Singh Tikait in the North have not been. Some farm lobbyists have also been opposed to India signing the Agreement on TradeRelated Aspects of Intellectual Property Rights, the opening up of the seed industry to multinationals, and the entry of foreign fast food chains. The conflict of interest between farmers supplying agricultural inputs to 146

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industry (e.g., over the price of raw cotton) and industries supplying inputs to agriculture (e.g., fertilizers and pesticides) also has to be resolved.

Bureaucrats Bureaucrats’ resistance to reforms is understandable. Cabinet ministers who are politicians make policy decisions, but the distribution of any rents associated with the decisions remains in large part in the hands of bureaucrats. Although ministers can exercise control through their power over the appointment, transfer, and promotion of bureaucrats, this power is not absolute and is constrained by civil service rules and by the judiciary. Moreover, bureaucrats have held the top management positions in public enterprises, giving them yet another source of patronage. The system of foreign trade and other controls have provided sources of income (outside of their regular pay and perquisites) that bureaucrats and politicians stand to lose with liberalization. Bureaucrats have been the major losers from the dismantling of the direct discretionary control regime in the firstgeneration reforms. They have been trying to regain their discretionary powers under the guise of “regulating” natural monopolies.

Labor Unions Finally, there are the politically important labor unions of workers in government and the organized manufacturing enterprises (both private and public). These unions represent a microscopic minority of aristocrats in the labor force. They enjoy high wages, security of employment, and other perquisites that are not available to the vast majority of workers. All unions have opposed privatization and any reduction in public employment, because private management will almost surely reduce the bloated payrolls of public enterprises once they are privatized. This fear is understandable given the slow growth in employment outside the public sector in the past. Workers have to be convinced that with further reforms the economy will grow faster and the demand for labor will grow much faster than in the past. Being retrenched from one enterprise, then, need not necessarily mean becoming unemployed. The reform of the labor laws should provide suitable assistance for retrenched workers for retraining and job searches. To sum up, the domestic political economy of the reform in the Indian context is very complex. There is continuing pressure from the World Bank and the IMF to push reforms further. India has also undertaken many commitments as a signatory of the Uruguay Round Agreement and will almost surely undertake others as a signatory of any future agreements. By imaginatively using these external commitments and pressures as levers, as China is apparently doing successfully, it is to be hoped that the government, whatever its party affiliation, will be able to push the reforms further. CONCLUSIONS AND THE TASKS AHEAD

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India and the Global Trading Environment Most of the actions needed to integrate India’s economy fully with the world economy are domestic. India would reap significant benefits from globalization by unilaterally taking these actions even if there is no further liberalization of the world trading and financial systems. The benefits of integration will be significantly higher, however, if the global trading environment becomes more liberal and the growth of market demand in the industrialized world is sustained. For this reason, India needs to engage constructively in the negotiations to set the agenda for the next round of multilateral trade negotiations. As was discussed in chapter 3, the country’s inward-looking development strategy has not in the past precluded such involvement in international economic negotiations. Now, after a series of domestic reforms to enhance integration, India has even fewer reasons to eschew political engagement. The country’s interests will be better served if, through such engagement, it can enhance the chances of including on the agenda those items that potentially will benefit it and excluding those that potentially will cause harm (e.g., the social clause in the WTO). India has a vital interest in seeing that the incentives for preferential liberalization are eliminated in the post-Doha negotiations for multilateral liberalization. There is a real danger that the already evident and unfortunate rush to enter into bilateral and regional preferential trade agreements (e.g., the Free Trade Area of the Americas and expansion of the European Union) could turn into a stampede. Notwithstanding some loose talk about an India-United States free trade agreement, it is unlikely that India will be assiduously sought out by many countries to join in forming a new agreement or to become a member of an existing one. Moreover, the attempt to form a South Asian Free Trade Area (SAFTA) also is unlikely to succeed, given the political reality of the conflict between India and Pakistan. As an indicator of relations between the countries, Pakistan has obtained a waiver—permitted first under the rules of the General Agreement on Tariffs and Trade (GATT) and now under those of the WTO—to the granting of most-favored-nation status to India on national security grounds. Even if SAFTA were to be implemented, the resulting gains from the liberalization of South Asian trade would be limited compared with the liberalization of trade with all global regions on a multilateral, MFN basis. Antidumping measures (ADMs) constitute another area of concern. Unlike safeguard measures permitted by the GATT and later the WTO to deal with temporary surges of imports, ADMs do not have to be applied on a nondiscriminatory basis to all suppliers of imports and with compensation to them. ADMs can, in contrast, be targeted at imports from individual countries and even at individual suppliers within such countries.

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ADMs are, therefore, very attractive and handy tools for protectionists everywhere, whether they be perpetually whining US steel firms or their more recent counterparts in India that have succeeded in having ADMs imposed on imports from China.6 In our view, India should not only cease using ADMs—which in effect coddle internationally noncompetitive domestic producers at the expense of users of imports—but should also go further and urge WTO members to exclude ADMs from the list of permissible trade policy instruments under WTO rules. India has a vital interest in ensuring that world markets remain open both for its traditional exports and also for new goods and services, such as software and other kinds of information technology, in which it has an apparent comparative advantage. It is in the country’s interest to unilaterally reduce tariffs and nontariff barriers. This is so even in the absence of the adoption of a suggested negotiating rule that would give credit at the next round of trade negotiations for unilateral liberation undertaken after the conclusion of the Uruguay Round. Even in the traditional negotiating process of exchanging concessions in the form of reducing one’s own barriers if reductions are made in the other’s barriers, India would be in a stronger position to demand reduced barriers to its exports (including information technology) in other markets if it reduced its own barriers.7 It is also in India’s interest that the WTO continue to be a forum for negotiations. However, there is increasing evidence that the WTO is overextended and in danger of losing its legitimacy as an apolitical, rules-based organization. Paradoxically, this is a result of the Uruguay Round’s success in extending the WTO’s mandate far beyond that of the GATT. In particular, the General Agreement on Trade in Services, involving rules for trade in services of banks, insurance firms, telecommunications, and so

6. Although the announcement in 2002 by the US government of its intention to impose tariffs on certain categories of steel was preceded by an inquiry, as required under the safeguard clause, to establish that imports have caused material injury to domestic industry, the facts that some exporters have been exempted and that no compensation has been offered to any affected exporter suggest violations of the provisions of the clause. The US intention has been challenged by the European Union and others in the WTO’s Dispute Settlement Mechanism. Regardless of how the WTO’s panels and its Appellate Body rule on the challenge, it is unfortunate that the United States took this step as the Doha round of negotiations continues. It sends the wrong signal about the US commitment to free trade. 7. Mattoo and Olarreaga (2000) argue that the effect of such a credit rule would be primarily distributional, in favoring those that have undertaken such liberalization, and that its acceptance would depend on the generosity of those that have not liberalized. They argue in favor of a rule that would be part of an agreement at the conclusion of a round and that would grant credit in the next round for any further unilateral liberalization beyond what is included in the agreement itself.

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on, requires the WTO to delve deeply into the economic and social structures of its member states. There are also serious concerns that the WTO’s purely legalistic Dispute Settlement Mechanism will sooner or later become politically unsustainable (see Barfield 2002 for an incisive analysis). As we noted in chapter 3, the WTO’s Appellate Body is also, in effect, beginning to legislate. The difficulty of amending WTO rules creates a great temptation to bypass the need to renegotiate rules and to reinterpret them and even use domestic law in member states as a precedent. A case in point is the Appellate Body’s decision to overturn the panel decision against the United States and to decide in favor of Thailand and India in the Shrimp-Turtle case, essentially by overly expanding the scope of Article XX(8). Moreover, the Appellate Body has decided on its own to accept amicus curiae briefs offered by individuals and nongovernmental organizations. India’s minister for commerce and industry, Murasoli Maran, raised his objection to this at a February 22, 2001, Round Table in Delhi on the Dispute Settlement System on the grounds that such a decision is beyond the competence of the Appellate Body and that only the WTO’s General Council is competent to deal with it (The Hindu, February 23, 2001; http://www. hinduonnet.com/2001/02/23/stories/01230002.htm). Whether or not acceptance and consideration of amicus briefs improve the quality of the decisions of the Appellate Body, Maran’s objection about the process by which the decision to accept was arrived at needs to be addressed. His concerns reflect the more serious argument that the political sustainability of the WTO system itself will be seriously threatened unless the decision-making processes of the system become more transparent and participatory. India could and should take the initiative in increasing the effectiveness with which less-developed countries can participate in WTO decision making. To the extent that the old GATT convention of consensus decisions for all important matters has lost its force in the WTO, the WTO’s weaker members have lost some of their bargaining power. They now have to be persuaded that their views get a hearing so that they get a sense of involvement in the decision-making process of the organization. One caveat is that conceding the demand for participation to any and all groups around the world is not in India’s best interest. Not only would the WTO become paralyzed and nonfunctional as an institution if such broad participation were allowed, but conceding such participatory rights would certainly destroy the fundamental character of the WTO as an intergovernmental organization. We discussed this controversial matter in more detail in chapter 3. Finally, the introduction of a social clause on labor standards into the mandate of the WTO—as well as any expansion of the consideration of environmental standards in the WTO beyond the Committee on Trade and Environment—would be against India’s interests. In the absence of 150

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multilateral agreements on these matters, they have been incorporated in some form into preferential trade agreements such as the North American Free Trade Agreement and the United States-Jordan Free Trade Agreement. While resisting the introduction of a social clause, India should make it clear that it is willing to discuss labor and environmental standards at relevant forums, such as the International Labor Organization for labor standards and the United Nations Environment Program for environmental standards.

Conclusion Indian economic policy since Independence has had many obvious flaws, but lack of ambition has not been one of them. The closure of the economy over the four decades from Independence in 1947 to the macroeconomic crisis of 1991 was an integral part of a planned effort to force rapid growth and industrial development. A complex series of controls, regulations, and detailed five-year plans were based on volumes of statistics that are perhaps more comprehensive than those collected by any other developing country. India’s interaction with the world economy through international economic forums such as the GATT reflected its inward-oriented development strategy, one that most developing countries also pursued to varying degrees. It is no surprise that India’s leaders often acted as spokespersons for developing-country interests in such forums. The current move toward market opening is an equally ambitious development plan, not the least because it will require dismantling an intentionally created economic infrastructure as well as constructing a new set of market-supporting institutions. The combination of international economic events, such as the collapse of the Soviet Union and the rise of China, with internal market pressures from entrepreneurs has done much to weaken the old economic regime. But there are still many who cling to the protection that Indian economic policy offered. Removing the remaining components of the old economic regime will require a concerted effort with regard to both international and domestic policies. On the international level, we argue that India should become more actively engaged in further multilateral trade negotiations through the WTO to offset the resurgence of protectionism in industrialized countries. On the domestic level, policies to improve the physical and regulatory infrastructure for investment are at the top of the list. We are cautiously optimistic, however, about the reforms. The removal of tariffs, the relaxation of industrial policies, and the extrication of the government from the business sector have been slow and subject to political obstacles and bureaucratic inertia. But the cumulative changes during the past decade have had a noticeable impact on job growth and productivity. The efforts to attract foreign investment have been hampered by an CONCLUSIONS AND THE TASKS AHEAD

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inadequate physical infrastructure, but they nevertheless led to a tenfold increase in FDI from the 1980s to the 1990s. The pace of reform slowed in the multiparty governments of the early 1990s, but it has resumed as political conflicts have lessened since 1999. We have been evaluating India’s economy from the vantage point of just one decade after the beginning of a new economic trajectory; the achievements thus far are promising, and the future prospects are bright—provided that the reform process is extended and deepened, particularly in its international dimensions. It is heartening that the need for this extension and deepening is being realized by the parties in power and by the opposition.

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agricultural laborers, 76–77, 137 agricultural sector, growth rate of, 31t, 73 agriculture economy based on, 6 international integration of, 137, 141–42, 145–47 multilateral negotiations on, 80–82, 83, 84–86, 90, 94, 95–96, 96, 96n, 105, 146 and oil shocks, 12 price policy, and economic nationalism, 22 protection of, 36, 36n Air India, 132 alternative medicine, 63 American Depository Receipts (ADR), 33 Annual Survey of Industries, 71 antidumping measures (ADMs), 84, 96–97, 136, 143, 148–49 Asian currency crisis, 34, 64–65, 66, 75, 141n Asian perspective, India’s exports in, 53–58, 57t–58t “atlas” method (World Bank), 3, 3n automatic permissible imports, 23 automobiles, 132, 143 balance of payments 1957 crisis, 8, 14 and economic nationalism, 16 following 1991 crisis, 34 GATT provisions on, 15, 85 and invisibles transactions, 60 Bangladesh, 53, 57t–58t banking system, 122–23

bankruptcy, of state electricity boards, 115 bankruptcy laws, 110, 126–27, 137, 139 banks. See also Reserve Bank of India; World Bank nationalization of, 13, 122 banned (nonpermissible) imports, 22–23 Bharat Aluminum Company (BALCO), 131, 138 Bharatiya Janata Party, 139 Bharat Sanchar Nigam Limited, 117, 131 Board for Industrial and Financial Restructuring (BIFR), 126–27 Bombay Plan, 5 bonds, government, 33, 122 Brazil, 81–82, 101 Bretton Woods system, collapse of, 20 British colonial rule, 3–4 economic policies of, 4–5, 7, 13, 79, 124 end of (See Independence) bureaucrats, resistance to reform, 147 Bush, George W., 91–92, 98, 142–44 capital account, management of, 63–66 capital account convertibility (CAC), 65–66 capital flight, causes of, 64 capital goods import licensing of, 22 share of, following post-crisis reforms, 48 tariff reform, 36 capital inflows 1990–2001, 30, 32t and capital account management, 32t, 64–65 foreign (See foreign direct investment (FDI))

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capital inflows—continued long-term, to developing countries, 40, 42t, 47 net, 16, 18f–19f, 26t, 47 private, 133 capital market, 122 capital utilization, efficiency of, 19–20, 24–25, 26t cargo shipping facilities, 121–22 Central Cabinet, 136 Central Electricity Regulatory Commission, 114 central government changes in, and piecemeal deregulation, 26–27 contingent liabilities for, 141 current consumption expenditures, 108t–109t, 111 economic power of, 4, 13, 29 fiscal deficit, 1, 9n, 25, 27f, 30, 74–75, 108t–109t, 111, 134–37 relationship between state government and, 3–4, 137, 139–41 centralized planning, as economic framework, 6–7, 12, 29, 134 Central Planning Commission, 139 Central Road Fund, 120 chemicals, 53 China antidumping measures, 97n, 136, 143, 149 economic growth of, 12, 29, 134, 147, 151 export share, 53, 55, 57t–58t financial sector reform in, 66 foreign direct investment in, 40, 44t import-weighted tariff, 36 information technology sector, 61, 118 most-favored-nation status, 11n population of, 2 power supply, 114 ratio of imports plus exports to GDP, 11 share of world merchandise exports, 11, 11n tourism, 62 trade ratio, 12, 12n WTO accession, 84, 95n climate, 2 closed-economy growth model, 8 clustering, 61 Coal India Limited, 48 collective bargaining, 124 colonial rule. See British colonial rule commercial banks, 13, 122 commercial services, exports of, 58–60, 59t Committee III (GATT), 104 Companies Act of 1956, 126–27, 130, 139 comparative advantage in agricultural products, 84 in labor-intensive products, 87–88, 110 and WTO negotiations, 97–98, 105, 149 competition among state governments, 140 cost, 110 domestic, 66–74 competition law, 135–36

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competitive advantage, and WTO negotiations, 92, 94 competitive disadvantage, and physical infrastructure, 119 Congress Party, 2n, 3–4, 131, 137, 138, 139, 142–43 Constitution, 3, 137 Article 12, 130 Directive Principles, 3, 7 consumer goods, 34 import licensing of, 22, 143 quantitative restrictions on, 75, 143 tariff reforms, 36, 37, 143 consumer interests, versus producer interests, 143–44 contingent liabilities, for government, 141 convertible bonds, 33 corporate restructuring, 74, 123–32, 137, 139 cost-competitiveness, 110 credit rating, 29 crisis of 1991. See macroeconomic crisis (1991) cultural diversity, 2–3 current account impact of invisibles transactions on, 58–77, 59t surpluses, during World War II, 7 current account deficit 1990–91, 1, 27, 28t, 30 and capital inflows, 47 and growth performance, 74 and oil shocks, 20 current consumption expenditures, 108t–109t, 111 customs code, WTO, 89 customs duties, 34 basic rates of, 36 following post-crisis reforms, 48 debt flows, to developing countries, 40, 45t debt securities, 33 debt-service payments, 1990, 27, 28t, 30 Defense of India rules, 124 demand, for imports, zero price elasticity of, 15 Democratic Party (US), 91–92 demonstrations, Seattle, 90, 93 Department of Telecommunications (DOT), 88, 116, 118 Department of Telecom Operations, 117 Department of Telecom Services, 117 deregulation. See also liberalization; reforms of investment, 33 piecemeal (1974–91), 20–27 in response to shocks, 12 developing countries. See also specific country debt flows to, 40, 45t, 46t foreign direct investment in, 40, 41t, 43t and GATT, 80–82, 102–03, 105–06, 150–51 long-term resource flows to, 40, 42t, 47 portfolio investment flows to, 40, 41t, 44t trade relations between industrialized countries and, 104 and Uruguay Round Agreement, 83–86 development, role of GATT in, 104–06

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development strategy 1950–73, 13–16 cooperation of private sector with, 13–14 first, 5–6, 134–47 historical overview of, 4–9 inward-looking, 2, 9–10, 12, 12n, 16, 29, 80, 133, 148 influence of GATT on, 102–03 longer-term, following 1991 crisis, 30–39 outcome of, 40–53 reform of, 29–30 Directive Principles, 3, 7 dirty tariffication, 86 disinvestment, 110, 113, 116, 135 versus privatization, 130–32, 138–39 Dispute Settlement Mechanism (DSM), 15, 83, 85, 96–97, 100, 103, 143, 149n, 150 Doha ministerial (WTO), 79–80, 90, 92, 141 multilateral negotiations after, 93–100 domestic competition, 66–74 downsizing, 126 drugs, patents for, 97 East Asian crisis, 34, 47, 64–65, 66, 75, 141n Eastern Europe, barter trade with, 16, 26, 53, 134 Economic Advisory Council, 125–27, 129, 136 economic conservatism, 2, 9–10, 12, 12n, 16, 29, 80, 133, 148 influence of GATT on, 102–03 economic expansionism, 9–10, 29–30, 133–34. See also deregulation; liberalization; reforms and economic nationalism, 12, 18n economic integration active policy of, 2, 133, 148–51 of agriculture, 137, 141–42, 145–47 domestic constraints on, 107–32 indicators of, 11–12 and Uruguay Round Agreement, 84–85 economic nationalism, 4, 13–20 economic performance and, 16–20 origins of, 13 economic performance and economic nationalism, 16–20 under first five-year plans, 8 indicators of, 24, 26t, 107, 108t–109t and piecemeal deregulation, 23 during 1990s, 74–75 economic strategy. See also development strategy historical overview of, 4–9 education, higher, 62 electricity supply, 113–15, 136 Eleventh Finance Commission, Incentive Fund, 111n employment. See also labor; workers in agricultural sector, 76–77, 137 effect of trade liberalization on, 68, 71–74, 72t–73t legislation, 124–25, 137–38, 147 in manufacturing sector, 75–76, 125 during 1990s, 75–77

employment security, 124 energy supply, 113–15, 136 engineering goods, 53 engineers, 87 Enron episode, 141 environmental standards, and WTO negotiations, 91–94, 97, 150–51 equity bonds, 33 ethical considerations, in WTO negotiations, 92–93, 150–51 European Free Trade Area, 81 European Union antidumping measures, 97 export share, 53 in multilateral negotiations, 80–81, 83–85, 90, 92, 96 in regional trade agreements, 98–99, 148 exchange rate 1976–2000, 20, 20f and capital account management, 65 devaluation, 15, 18n, 20–27, 29, 34, 66, 74 and economic nationalism, 14–16 effective, 16 fixed, Bretton Woods system of, 20 overvalued, 15–16 and persistent inflation, 108t–109t, 112 real effective (REER), 15, 20, 20f, 24, 24n, 34, 65, 66 reform of, following 1991 crisis, 33–39 Export-Import Policy Statement, 37 exports agricultural (See agriculture) Asian perspective on, 53–58, 57t–58t of commercial services, 58–60, 59t commodity composition of, following postcrisis reforms, 48, 51t–52t, 134 effect of trade liberalization on, 66–68, 67t, 69t–71t manufacturing sector, 66–68, 67t, 71t plus imports, ratio to GDP, 11–12 policy on, versus import policy, 23 quantitative restrictions on, 37 ratio of GDP to, 16, 17f, 23–24, 24f restricted, 23, 36 software, invisibles transactions in, 58–77, 59t subsidization of, 16, 34 supply and demand for, 15 taxes on, 36 export volume, 133 1951–73, 16, 17f 1970–97, 24, 25f 1990–2001, 27, 28t following post-crisis reforms, 47–48, 66–68, 67t, 69t–70t external sector indicators, during 1991 crisis, 28t, 30 factory segment, of manufacturing sector, 68, 71–72, 72t, 73t, 74–76 farm bill (US), 142

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farm interest groups, 145–47 Finance Commissions, 141 financial institutions, 122–23. See also banks; insurance companies financial services, multilateral agreements on, 83 First Five-Year Plan (1951–56), 7–8 fiscal deficit central government, 1, 9n, 25, 27f, 30, 74–75, 108t–109t, 111, 134–37 state government, 1, 111, 134–37 fiscal management, 111–12 fiscal responsibility, government, 136–37, 140–41 Fiscal Responsibility Act, 137 Five-Year Plans, 151 First (1951–56), 7–8 Second (1956–61), 8, 13, 14, 16, 130 Ninth, 121n, 125, 127, 129, 136 Tenth (2002–07), 139 private sector involvement in, 14 food grains Public Distribution System for, 146 self-sufficiency in, 6–7, 145–46 food price inflation, 22 foreign assistance, and economic nationalism, 18, 18n, 20 foreign direct investment (FDI) to developing countries, 40, 41t, 43t liberalization of, 33, 107, 144–45, 152 multilateral negotiations on, 96 in physical infrastructure, 115 since 1990 reforms, 40, 41t foreign exchange reserves 1990–91, 1 and capital account management, 64 during 1991 crisis, 28t, 30 and economic nationalism, 22 historical, 7 Foreign Investment Promotion Board (FIPB), 40, 144 free trade, under British colonial rule, 13 Free Trade Area of the Americas, 148 free trade areas, 98–99. See also specific area Fundamental Rights of the People, 3 Gandhi, Indira, 4, 133n Gandhi, Mahatma, 6 Gandhi, Rajiv, 134, 143 GATT. See General Agreement on Tariffs and Trade (GATT) GDP ratio of exports to, 16, 17f, 23–24, 24f ratio of imports plus exports to, 11–12 GDP growth, 12 during 1991 crisis, 30, 31t under first five-year plans, 8, 19, 135 during 1980s, 134 during 1990s, 1, 16–19, 24–25, 26t, 31t, 74–75, 107, 108t–109t

162

General Agreement on Tariffs and Trade (GATT), 2. See also World Trade Organization (WTO) Article I, 102 Article III, 102 Article XIII, 103 Article XV, 103 Article XVIII, 15, 85, 103 Article XX, 83, 150 Article XXIV, 99 China in, 11n Committee III, 104 and developing countries, 80–82, 102–03, 105–06, 150–51 India in, 79–106, 148–51 labor standards under, 92, 150–51 ministerial meetings 1963, 104 1982, 80 Punta del Este (September 1986), 81–82, 90 origin and founding of, 101–06 Part IV of, incorporation of, 103–05 political nature of, 83, 92, 100, 150 role in development, 104–06 shift to WTO from, 89–90 Tokyo Round, 80, 103, 105–06 Uruguay Round (See Uruguay Round) General Agreement on Trade in Services (GATS), 83, 85, 149 Generalized System of Preferences (GSP), 105 Geneva ministerial (WTO), 92 Global Depository Receipts (GDR), 33, 145 government. See also central government; state government colonial, 3–4 economic role of, 6–7, 13, 29 involvement in financial system, 122–23 government bonds, 33, 122 Gowda, Deve, 2n Green Revolution technology, 146 green room process, 91 gross domestic capital formation (GDCF), 16, 18f–19f, 19, 26t, 74 gross domestic savings (GDS), 16, 18f–19f, 26t, 107 gross national income, 3 Group of Seven (G-7), 80 Group of Nine (G-9), 81–82 Group of Ten (G-10), 81–82 Group of Forty (G-40), 81 Gujral, Inder Kumar, 2n, 129 Haberler, Gottfried, 103 Harrod-Domar model, 7 Havana conference (1947–48), 101 health care sector, 62–63, 97 heavy industries, investment in, 14 highway-building program, 120 hospitals, 62–63 Hussain Committee, 128, 129

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Iglesias, Enrique, 81 implicit incremental capital output ratio (ICOR), 19, 19n, 24, 26t imports categorization of, 22–23, 48n commodity composition of, following postcrisis reforms, 48, 49t–50t, 134 control regime for, institution of, 8 demand for, zero price elasticity of, 15 licensing of, 143 categorization of, 22–23 nontariff barriers imposed on, 37–39, 38t “others” category of, 48 plus exports, ratio to GDP, 11–12 policy on deregulation of, 22–23 versus export policy, 23 quantitative restrictions on, 14, 23, 34, 75, 136 tariffs on, 14 volume of, 1990–2001, 27, 28t Incentive Fund (Eleventh Finance Commission), 111n Independence economic performance immediately following, 9–10 political system since, 3–4 Indian Airlines, 132 Indian Federation of Labor, The People’s Plan, 5 Indian Institutes of Management (IIMs), 62 Indian Institutes of Technology (IITs), 62 Indonesia capital inflow, 47 export share, 53, 55, 57t–58t tourism, 62 Industrial Disputes Act of 1948, 124, 125–26 industrialists, large, and political economy of reform, 142–45 industrialization, 1, 5, 75 autarchic, 12–20 emphasis on, 6–7, 13 human cost of, 6, 6n import requirements of, 16 investment in, liberalization of, 33 industrial licensing, 22, 143 industrial policies, 130–32 industrial restructuring, 123–32, 137, 139 and bankruptcy laws, 126–27, 139 industries. See also specific industry restricted, 33, 33n small-scale, reservation of production for, 127–29 inflation food price, 22 persistent, 112 inflation rate, 74 following 1991 crisis, 34 1990s, 1, 29, 74 Information Technology Agreement, 85 information technology (IT) services, 60–61, 110. See also telecommunications

infrastructure, physical, 112–22, 135. See also public-sector undertakings (PSUs) insurance companies, nationalization of, 13, 122 intellectual property, agreement on. See TradeRelated Aspects of Intellectual Property Rights (TRIPS) interest groups farm, 145–47 and reform efforts, 143 interest rates, 25, 112, 122, 135 intermediate goods import licensing of, 22 tariff reforms, 35t, 36, 37 International Labor Organization, 86, 97, 151 International Monetary Fund, 30, 64, 86 International Trade Organization (ITO), 92, 101 investment agreement on (See Trade-Related Investment Measures (TRIMS)) deregulation of, 33 domestic climate for, 47 emphasis on, 8 foreign (See foreign direct investment (FDI)) GATT negotiations on, 81–82, 85 industrial, liberalization of, 33 licensing of, 14, 33, 33n, 144 portfolio, 40, 41t, 44t, 144–45 public, 13, 14, 115, 120–21 (See also public-sector undertakings (PSUs)) rates of, 107 in small-scale production, 129, 129n invisibles transactions, 21f, 21–22, 27 impact on current account, 58–77, 59t and software exports, 58–77, 59t Japan debt downgrading, 141n export growth, 12 in GATT negotiations, 81, 85, 90 production index, 5 jobless growth, 72 Joshi, Sharad, 146 labor. See also employment; workers costs of, for ports, 121 effect of trade liberalization on, 68, 71–74, 72t–73t legislation, 124–25, 137–38, 147 software professionals, 60–61 travel and tourism, 61–62 labor-intensive services comparative advantage in, 87–88, 110 performance in, 55, 57t and WTO negotiations, 97–98 labor market reform of, 123–26 and second generation reforms, 137–38 labor standards, 110 and WTO negotiations, 90–93, 97, 97n, 150–51 labor unions. See trade unions

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laissez-faire, 5, 13 Latin America. See also specific country in GATT negotiations, 81–82, 82n liberalization, 9, 133–34. See also deregulation; reforms and capital account management, 64 effect on domestic competition, 66–74 of foreign direct investment, 144–45 of industrial investment, 33 politics and, 29 and tariff rates, 39 trade composition following, 48, 49t–52t, 134 licensing import, 22–23, 143 industrial, 22, 143 intellectual property, 87, 97 investment, 14, 33, 33n, 144 of telecommunications sector, 116, 118 life insurance companies, nationalization of, 13, 122 limited permissible imports, 22–23 liquidation, 126, 137, 139 macroeconomic crisis (1991), 1, 12, 23, 27–53 immediate response to, 30 longer-term reforms following, 30–39, 133 outcome of, 40–53 macroeconomic management, 111–12 indicators of, 107, 108t–109t “made-ups,” 53n Mahalanobis, P. C., 8, 13, 124, 130 Mahanagar Telephone Nigam Limited, 131 Maharashtra State, 125n, 141 Maharashtra State Electricity Board (MSEB), 141 Malaysia capital inflow, 47 export share, 53, 55, 57t–58t tourism, 62 manufacturing sector Asian perspective on, 53, 57t–58t categories of, 53, 53n effect of trade liberalization on, 66–68, 67t, 71t employment in, 75–76, 125 factory segment of, 68, 71–72, 72t, 73t, 74–76 following post-crisis reforms, 48–53, 51t–52t growth in, during 1990s, 57t, 75–76 historical, 5 Maran, Murasoli, 94, 150 maritime services, multilateral agreements on, 83, 90 market access, and Uruguay Round Agreement, 83–84 market-based instruments, versus quantitative controls, 29–30, 136 market forces, control of, for public interest, 13–14 Maruti Udyog Limited, 132, 138 means of production, public ownership of. See public-sector undertakings (PSUs) medicine, alternative, 63 Mexican crisis (1995–96), 64

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migration, of Indian workers, 21, 21f, 27, 87, 98 mineral exports, taxes on, 36 Ministry of Finance, 123, 125 Ministry of Industrial Development, 144 Modern Food Industries Limited, 131 monsoons, 74 most favored nation (MFN) status, 85, 105, 148 movement of natural persons, 63n, 83, 87, 96, 98 Multi-Fiber Agreement (MFA), 53, 83, 84, 91, 95, 128 multilateral trade negotiations (MTNs), 79, 79n. See also General Agreement on Tariffs and Trade (GATT); World Trade Organization (WTO) Nanjundaswamy, M. D., 146 National Association of Software and Service Companies (NASSCOM), 60 National Congress, National Planning Committee, 5, 6 National Council of Applied Economic Research (NCAER), 68 National Democratic Alliance (NDA), 129, 137, 138–39 National Development Council, 139 National Highway Authority of India, 120 National Highways Development project, 120 National Hydroelectric Power Corporation (NHPC), 113–14 national industrial classification (NIC) scheme, 75n nationalism. See economic nationalism nationalization of commercial banks, 13 of life insurance companies, 13 National Planning Committee (National Congress), 5, 6 National Sample Surveys (NSSs), 71, 76n, 76–77 National Telecommunication Policy, 116 National Thermal Power Corporation (NTPC), 113–14 national treatments (NT), 85 Nehru, Jawaharlal, 3, 5, 6, 13 Ninth Five-Year Plan, 121n, 125, 127, 129, 136 nondiscrimination, principle of, 101 nonfactor services, 58–60 nongovernmental organizations (NGOs), 93, 100 nonmerchandise transactions. See invisibles transactions nonpermissible (banned) imports, 22–23 nontariff barriers (NTBs), 33–34, 34n international comparison of, 37, 39t types of, 37–39, 38t “no retrenchment” guarantee, 124 North American Free Trade Agreement (NAFTA), 96, 99, 151 nuclear tests, 65 oil exploration, 22 oil prices, and Persian Gulf War, 27, 64

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oil shocks (1973–74), 19, 20–21, 24, 102 (1979–80), 22, 24, 66, 102 open general import license, 23 open regionalism, 99 Organization for Economic Cooperation and Development (OECD), 96n, 141 Organization of Petroleum Exporting Countries, 21 outsourcing operations, 60 Pakistan, 4, 4n export share, 53, 57t–58t war with, 18n in WTO negotiations, 101 patents, 87, 97 peak tariff rate, 39n The People’s Plan (Indian Federation of Labor), 5 per capita income, 3, 5, 8, 84 Persian Gulf countries, 21, 27 Persian Gulf War (1990), 27, 64 pharmaceuticals, 97 physical infrastructure, 112–22, 135. See also public-sector undertakings (PSUs) Planning Commission, 7, 7n, 125, 129, 141 plurilateral agreements, 89 political economy and 1991 crisis, 29 and economic nationalism, 14 and GATT process, 83, 92, 100, 150 and piecemeal deregulation, 26–27 and privatization, 138–39 of reform, 135, 137–38, 142–47 political system, 3–4 population, 2, 4–5, 8 portfolio investment, 40, 41t, 44t, 144–45 ports, 121–22 poverty reduction, 4, 6, 75–77, 110 power supply, 113–15, 136 preferential trade agreements (PTAs), 96, 98–99, 148 priority sectors, relaxation of, 33 private sector cooperation with development plans, 13–14 investment from (See foreign direct investment (FDI)) reliance on, 29–30 private transfers, receipts from, 21f, 21–22, 27 privatization. See also specific sector versus disinvestment, 130–32, 138–39 procedural issues, WTO, 99–100, 150 producer interests, versus consumer interests, 143–44 productivity, 110, 129, 137 product quality, 110 Proposals for an Expansion of World Trade and Employment, 101 public borrowing, 25, 135 Public Distribution System, for food grains, 146 public health, 62–63, 97

public investment, 13. See also public-sector undertakings (PSUs) licensing of, 14 private financial savings for, 13, 113, 120–21 Public Law 480 (US), 146 public-sector undertakings (PSUs) disinvestment from, 110, 113, 116, 130–32, 135, 138–39 and labor laws, 137–38 Punta del Este ministerial (GATT), 81–82, 90 purchasing power parity, 3 quantitative controls, versus market-based instruments, 29–30, 136 quantitative restrictions (QRs), 14, 23, 34, 37, 39n, 75, 85, 103, 136, 143 Quebec city summit (April 2001), 98 railways, 5, 119 Rao, Narasimha, 1 rationalization, 23 real effective exchange rate (REER), 15, 20, 20f, 24, 24n, 34, 65, 66 reciprocity, 104 reforms. See also deregulation; liberalization first generation of, 134–36 completion of, 136–37 foundations of, 2, 5–6 longer-term, following 1991 crisis, 30–39 outcome of, 40–53 political economy of, 135, 137–38, 142–47 second generation of, launching of, 137–42 regional trade agreements (RTAs), 96, 98–99 reorganization, procedures for, 126 representation, WTO principles of, 99 Reserve Bank of India, 47, 60, 65, 144 reserved products, small-scale industries, 127–29 resource flows, long-term, to developing countries, 40, 42t, 47 roads, 119–21 roll-back demand, 80 royalty fees, 87 rupee. See exchange rate savings, private, for public investment, 13, 113, 120–21 saving rate, 107 Seattle ministerial (WTO), 88–93 Second Five-Year Plan (1956–61), 8, 13, 14, 16, 130 Secretariat for Industrial Approvals, 144 securities, equity and debt, 33 self-sufficiency, emphasis on, 6–7, 146 services. See also specific service agreements on (See General Agreement on Trade in Services (GATS)) nonfactor, 58–60 Shrimp-Turtle case, 150 Sick Industrial Companies Act of 1985 (SICA), 126–27, 139 Singapore issues, 91, 94

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Singapore ministerial (WTO), 92 Singh, Manmohan, 30 single undertaking rule, 89 small-scale industries (SSIs), 127–29 social clause, in WTO negotiations, 92–93, 150–51 society, 2–4 software exports comparative advantage in, 87–88 invisibles transactions in, 58–77, 59t and WTO negotiations, 98 South Asian Association for Regional Cooperation (SAARC), 53, 53n South Asian Preferential Trade Agreement (SAPTA), 98–99 South Korea debt downgrading, 141n export orientation of, 18n export share, 53, 55, 57t–58t Soviet Union barter trade with, 16, 26, 134 collapse of, 1, 26, 134, 151 as economic role model, 6n, 6–7, 8n, 13 “special and differential” treatment clause, 106 Stalin, Joseph, 6n stand-still demand, 80 state electricity boards (SEBs), 113–15, 136, 141 state governments competition among, 140 current consumption expenditures, 108t–109t, 111 disparities among, 140, 140n fiscal situation, 1, 111, 134–37, 140–41 policy structure, 3 relationship between central government and, 3–4, 137, 139–41 steel industry, 92n, 143–44, 149, 149n sterling balances, 7 Sterlite Industries (India) Limited, 131 stock exchanges, 122 Supreme Court, 131 Suzuki Motor Company, 132 Taiwan, 18n, 53, 55, 57t–58t tariffs import, 14 international comparison of, 37, 39t preferential, in regional agreements, 96, 98–99, 148 reform of, 33–36, 35t, 136, 143 and Uruguay Round Agreement, 85 Task Force on Employment Opportunities, 61–62, 129 Tata Industries, 131 taxes, export, 36 telecommunications infrastructure, 88, 116–18, 131 multilateral agreements on, 83 Telecommunications Regulatory Authority of India (TRAI), 88, 116–17, 135–36 Tenth Five-Year Plan (2002–07), 139

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textile industry, 5, 53, 80, 84, 95, 105, 128 Thailand capital inflow, 47 debt downgrading, 141n export share, 53, 55, 57t–58t in GATT negotiations, 150 tourism, 62 Tikait, Mahender Singh, 146 Tinbergen, Jan, 86, 104n Tokyo Round, 80, 103, 105–06 tourism, 61–62, 62 trade balance of, 12 1990–2001, 27, 28t under first five-year plans, 8 composition of, 47–53, 134 flow of, 53, 54t–56t, 56t volume of 1951–73, 16, 17f 1990–2001, 27, 28t effects of reforms on, 47–48, 47–53 trade policy reform of, 12 following 1991 crisis, 33–39 outcome of, 40–53 3-year terms for, 22 5-year terms for, 34 Trade-Related Aspects of Intellectual Property Rights (TRIPS), 83, 86–88, 90–91, 95, 97, 146 Trade-Related Investment Measures (TRIMS), 83, 91 Trade Union Act of 1925, 123 Trade Union (Amendment) Act of 2001, 124n trade unions, 90, 123–24, 126, 138 development plans, 5, 7 resistance to reform, 147 transnational corporations, 91 transparency, WTO principles of, 99 transport infrastructure, 118–22 invisibles transactions in, 58 travel, 58, 61–62 unemployment effect of trade liberalization on, 71–74, 72t–73t during 1990s, 76–77 United Kingdom. See British colonial rule United Nations Conference on Trade and Development, 104 Economic and Social Council, 101 Environment Program, 86, 97, 151 United States antidumping measures, 97 export share, 53 farm bill, 142 food grain imports from, 146 foreign aid from, 18n in GATT negotiations, 80–84, 90, 92–93, 105, 150 Indian migrants to, 87, 98 most-favored-nation status to China, 11n

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presidential elections (2000), 91–92 steel industry, 92n, 143–44, 149, 149n and Vietnam War, 133n, 146 United States-Jordan Free Trade Agreement, 99, 151 Uruguay Round, 79–86, 149 events leading to, 80, 95 and tariff reforms, 37 Uruguay Round Agreement (URA) agricultural issues, 96, 96n, 146 and developing countries, 83–86 unbalanced nature of, 89–91 Videsh Sanchar Nigam Limited, 118n, 131–32, 138 Vietnam War, Indian opposition to, 133n, 146 Visvesvaraya, Sir Mokshagundam, 5, 6 wages, 77 effect of trade liberalization on, 68, 71t legislation on, 124–25 wagon utilization, 119 workers. See also employment; labor effect of trade liberalization on, 68, 71–74, 72t–73t, 76 migration of, 21, 21f, 27, 87, 98 productivity of, 110, 129, 137 protection for (See labor standards) World Bank, 64, 86, 133n “atlas” method, 3, 3n external assistance from, 30

World Intellectual Property Organization, 86 world trade, volume of, 102 World Trade Organization (WTO), 2. See also General Agreement on Tariffs and Trade (GATT) accession of China to, 84, 95n creation of, 79 decision-making procedures, 99–100, 102, 150 Dispute Settlement Mechanism (DSM), 15, 83, 85, 96–97, 100, 103, 143, 149n, 150 and environmental standards, 90–93, 97, 150–51 General Council, 97 India in, 79–106, 148–51 issues important to, 95–96, 149–50 and labor standards, 90–93, 97, 97n, 150–51 ministerial meetings Cancun (2003), 94 Doha (November 2001), 79–80, 90, 92, 141 multilateral negotiations after, 93–100 Geneva (1996), 92 Seattle (November 1999), 88–93 Singapore (1996), 92 shift from GATT to, 89–90 Trade and Environment Committee, 97, 150 World War II, 7, 124 zero price elasticity, of demand for imports, 15

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