The Republic of India at Sixty

January 25, 2010

On January 26, 2010, the Republic of India will celebrate its 60th anniversary. Though India had won its independence on August 15, 1947, it was not until January 26, 1950 that it adopted its permanent constitution. The 60th anniversary of the republic offers an appropriate occasion to take stock of its economic accomplishments.

While India began by implementing sound institutions—a robust parliamentary democracy, independent judiciary, well-functioning bureaucracy and fiercely independent press—the economic policy framework it adopted was deeply flawed. By imposing licensing restrictions on products to be produced and imported, their quantity, selling prices and allocation among buyers, the government scuttled private initiative. It also reserved economic activity in a number of sectors exclusively for public enterprises. And, beginning in the late 1960s, the government went on to nationalize the largest banks, insurance sector, oil companies and coalmines. With such straitjacketing, even the sound institutions and India’s talented entrepreneurs could deliver only modest growth: the economy grew at the average annual growth rate of 3.8 percent during financial years 1951-52 to 1987-88 (India’s financial year begins on April 1 and ends on March 31).

Modest liberalization and fiscal expansion, financed by incurring debt abroad, had begun to improve growth performance in small measures in the 1980s. The growth rate shifted up to 4.6 percent between 1981-82 and 1987-88 from 3.7 percent over the preceding 15 years. With liberalization receiving some impetus under Prime Minister Rajiv Gandhi in the mid-1980s, and fiscal expansion continuing apace, a bigger spurt in the growth rate occurred in the late 1980s. But a mounting external debt to finance the fiscal deficits also culminated in a balance-of-payments crisis in June 1991. That crisis paved the way for systematic and systemic reforms beginning in July 1991. Prime Minister Narasimha Rao during 1991 to 1996 and Prime Minister Atal Bihari Vajpayee during 1998 to 2004 presided over wholesale economic reforms, which eventually led to an unprecedented economic boom.

Even though the command and control regime during the first four decades had led to corruption in virtually every governmental agency—thus, worsening the quality of institutions—improved policy regime resulted in superior overall governance and economic outcomes. Entrepreneurs no longer needed a license for setting up manufacturing units or for importing the necessary machinery and inputs. Entry of private operators in telecommunications meant consumers could buy phones instantly rather than wait for years in the queue, thanks to the Department of Telecommunications monopoly. Entry of private airlines meant the customers were no longer hostage to Indian Airlines monopoly for securing seats on flights. Entry of new Indian and foreign private banks gave customers considerable options, forcing better service even from public sector banks.

For a long time, skeptics had argued that democracy was a barrier to East Asian style miracle-level growth. Until the early 2000s, only authoritarian regimes such as those in South Korea, Taiwan, Singapore and Hong Kong in the 1960s and 1970s and the People’s Republic of China in the 1980s and beyond had grown at rates exceeding 8 percent on a sustained basis. Chile had been regarded as a highly successful case of development under democracy but it too had not grown faster than 6 percent on a sustained basis.

But Indian democracy has now cracked the myth of incompatibility of democracy and miracle-level growth. Its growth rate shifted to approximately 6 percent in the 1990s and early 2000s and then jumped to 8.5 percent between 2003-04 and 2008-09. Alongside, poverty has declined as well. The proportion of those living below the poverty line fell from 36 percent in 1993-94 to 27.5 percent in 2004-05.

What has been remarkable about years 2003-04 to 2008-09 is that with rare exceptions all states, whether rich or poor, have grown faster than in any other period. Likewise, poverty has declined in virtually all states between 1993-94 and 2004-05. One other important indicator reinforces these observations: the spread of telephones. As late as the end of March 1999, India had a total of just 23 million phones, translating into 2.3 telephones per hundred individuals. Within 10.5 years, at the end of September 2009, the two indicators had climbed up to 509 million and 43.5, respectively. Even in rural India, on the average, there now exists one phone per household. Bihar, the poorest state in India, can boast of 23 telephones per 100 individuals.

The Indian economy has shown remarkable resilience to the recent global financial crisis. During the crisis year of 2008-09, the country managed to grow at 6.7 percent. During July-September 2009, the second quarter of financial year 2009-10, the economy has already recovered to 7.9 percent growth over the corresponding quarter of the last financial year. In large part, the credit for weathering the crisis without much damage goes to Y. V. Reddy, the former governor of the Reserve Bank of India, who resisted the pressures from virtually all corners, including the Finance Ministry, to rapidly liberate the investment activity of Indian banks. Thanks to him, Indian banks had virtually no investments in the toxic assets and did not require significant infusion of capital to survive.

Increased incomes made possible by accelerated growth have placed ever-increasing amounts of tax revenues in the hands of the government. The present United Progressive Alliance (UPA) government has chosen to take advantage of these revenues to beef up social programs. The central plank of these programs has been the National Rural Employment Guarantee Scheme, which guarantees one member of each rural household 100 days of employment at the minimum wage.

While this acceleration of social programs is to be applauded, the downside is that economic reforms have come to a standstill under the UPA government. Indeed, there are signs of a creeping return to the past interventionism. For example, a decision was recently made to require all ultra-mega power projects to buy their equipment domestically. Likewise, a move is under way to extend the minimum wage legislation to 340 million workers in the unorganized sector and, thus, bring the inspector raj to the doorstep of even the tiniest enterprises and to households employing domestic servants. Resort to indirect and distortionary instruments such as this, rather than targeted instruments such as direct transfers to help the poor, is a source of worry if India is to sustain and accelerate the pace of growth and poverty alleviation.