It is the Reforms, Stupid!

Arvind Panagariya

Is the Indian economy as immune to the current slowdown in the global economy as some press reports and commentaries suggest?  And should we be thanking our policy makers for holding back reforms, rapidly approaching inaction, to bring about the presumed stability?

To be sure, for a long time, the Indian economy was totally immune to booms and busts in the external markets.  These were the dark days of autarkic trade policies when virtually all imports were subject to strict licensing and virtually no link between external and internal prices existed.  These were also the days when growth rates in real per-capita income failed to cross the 2 percent mark over any continuous five-year period save 1974-79.

Thanks to the partial opening of the economy, we are no longer completely insulated from the good (and bad) things that happen in the world markets.  Make no mistake: we are still the most protected emerging-market economy.  Nevertheless, the protective wall is now made of tariffs rather than licensing, which allows some bonding of internal and external markets.  As a result, if the U.S. IT sector booms, the Indian IT sector also booms and if the world steel industry catches cold, the Indian steel industry does sneeze.

Not surprisingly, in the absence of offsetting reforms by the Vajpayee government, the global slowdown is beginning to impact the economy adversely.  Estimated growth rate in real GDP in the year 2000-01 is now placed at 5.2 percent.  This is well below the 6.4 and 6.6 per cent growth rates achieved in 1999-2000 and 1998-99, respectively.  The news for the first quarter of fiscal year 2001-02 is even grimmer: the real GDP grew at 4.4 percent compared with 6.1 percent during the corresponding period in 2000-01.  Growth rate of manufacturing during the same quarter has dropped down to a meager 2.3 per cent compared with 7 percent last fiscal year.  Growth rates of the mining and construction sectors have declined to zero and 2.5 percent compared with 5 and 8.4 percent, respectively, last year.

Many analysts, nevertheless, take comfort in two facts: the Indian economy has not suffered the debacle that some other economies in Asia have and the growth rate of 4.4 percent is still well above the Hindu rate of growth to which we had become so accustomed for decades.  I fear these analysts set the bar too low.  Times have changed and much more is expected of the Indian economy today.

Consider first the argument that India has survived the global slowdown far better than many Asian economies.  To be sure, three of the four Newly Industrialized Economies (NIEs), Hong Kong, Singapore and Taiwan, are expected to register negative growth rates during 2001.  The remaining NIE, the Republic of Korea, and four major ASEAN economies, Indonesia, Malaysia, Philippines and Thailand, are expected to grow at approximately 3 percent or less.  When judged against this performance, India’s 4.4 percent growth does look good.

But probe deeper.  Despite the 1997-98 financial crises, in the year 2000, many of these same economies had managed to register growth rates far higher than we ever have.  Hong Kong and Singapore grew approximately 10 percent, Korea 9 percent and Malaysia 8 percent.  More importantly, having enjoyed the fruits of open world markets much longer than us, these economies today boast of living standards many times ours.  Negative or near zero growth rates during one or two years is a small price to pay for such prosperity in perpetuity.  Indeed, is there any doubt that despite prolonged growth recession, an average Japanese citizen is economically far better off than an average Indian citizen today.

Rather than take refuge behind the thought that our gradualist approach to reforms has protected us from the fate suffered by countries such as Singapore and Hong, the question we must ask is why has our growth rate never reached the highest levels of these countries?  And why, during the current global slowdown, it has fallen by almost one third when the Chinese economy has continued to grow at robust 7 to 8 percent?  After all, China is twice as dependent on exports as India!

The answer to both questions lies in our stop-go strategy of reforms, which has lately turned into a “stop and no go” strategy.  This is a pity since we are still far away from the true efficiency frontier and the potential growth rate as we journey towards the latter is very high—in the double digits.  By failing to move the reforms forward at a steady pace, we are not only foregoing this growth rate but also yielding the momentum we have achieved to the global slowdown.  China, on the other hand, has kept moving forward with reforms and, despite the worsening external environment, maintained its high growth rate.

Some argue that if we could sail through the rough waters of the 19997-98 financial crises, why should the current global slowdown be any different.  But the parallel is treacherous.  India was spared a financial crisis because it had little foreign capital waiting to exit and, moreover, domestically owned capital was denied exit by strict capital controls.  Equally important, at the time, the U.S. economy was booming.  But the current slowdown is different: it can readily make inroads into the economy through trade, which is no longer subject to physical controls.  This has already begun to happen: exports have declined by 2.3 per cent during April-August, 2001 compared with a growth of 21.1 per cent in the corresponding period in 2000.

If we wish to get back to the high growth rates of 7 to 8 percent we had achieved during mid 1990s, we have no choice but to aggressively re-launch reforms.  Rather than fear the world markets, we must conquer them.  As in early 1990s, we could begin with a bold program of trade liberalization.

Outlook, December 17, 2001