India Trade Liberalization

Governing the Global Economy India: Liberalize in the Face of Crisis? The Prime Minister of India, P.V. Narasimha Rao, reviews a petition from representatives in the country’s steel industry. The petition makes a stark appeal to maintain trade protection in steel products.1 This was June 1991, and India was in the midst of a currency and balance of payments crisis the likes the country had not seen since independence in 1947. At the end of the previous year, the country’s foreign exchange reserves had nosedived to $1.2 billion, barely enough to finance 13 days worth of imports.2 This was the closest the Indian government had come to going bankrupt and reneging on its international financial commitments. In the face of crisis, the Prime Minister was forced to consider external help from the International Monetary Fund (IMF), which was accompanied by market-oriented conditionalities. The prospect of IMF support was a double-edged sword: on the one hand, restoration of finances and a viable path to economic recovery, but on the other, forced trade liberalization that would upend decades of centralized planning and inward- oriented growth. The IMF’s adjustment plan would touch nearly every citizen, firm, and industry in the country. Liberalization, in theory, could stimulate long-term growth in the economy, yet it could also impose substantial adjustment costs in the form of firm closures and job losses. Rao had just made a televised speech to the nation, stating that “the government and the country cannot keep living beyond their means year after year…there are no soft options left.”3 But a growing chorus of constituents, industry groups, and labor unions were demanding that the government resist liberalization. The Prime Minister’s political position was precarious. His minority government needed the support of leftist parties in to order to remain in power. And just a few months earlier, the previous government had been forced to resign after only eleven months in office because its coalition partners had withdrawn support amidst policy gridlock. The Prime Minister is evaluating the costs and benefits of acquiescing to IMF conditions and obtaining loans to stave off the crisis on the one hand, and rejecting the IMF offer by entertaining the appeals of politically pivotal domestic constituents on the other. Accepting the deal risked political blowback and the possibility of a parliamentary “vote of no confidence.” Rejecting the deal raised the likelihood of a currency crisis that would tie the government’s hands and preclude future spending on national security, welfare schemes, and domestic subsidies. Should the Prime Minister accept the IMF deal, reject the IMF deal, or pursue some other alternate path? He must weigh several considerations that are central to this decision. India’s Planned Economy At independence from British rule in 1947, India’ political leaders embraced an inward- oriented economic growth and development approach. This approach was in part a reaction to India’s experience with colonialism, during which unequal terms of trade with 1 Britain reversed the country’s relative position of strength in the global economy and “de-industrialized” domestic production. Mahatma Gandhi’s struggle for independence was centered on the doctrine of swadeshi, or economic self-sufficiency; his calls to boycott British textile imports and produce homespun cotton became potent symbols of anticolonial resistance and shaped a generation of nationalist political leaders. India’s first Prime Minister, Jawaharlal Nehru, espoused an industrial strategy that was similarly rooted in inward-oriented growth. Nehru firmly believed that rapid industrialization held the key to growth and development, yet worried that India would forever specialize in agriculture and raw materials if it entered the global economy with its heavily agrarian economy and workforce. The early successes of the Soviet Union’s planned economy further bolstered the viewpoint that centralized planning could jumpstart industrial production in nations that were late entrants to international trade. Indian policymakers believed that because infant industries would find it challenging to compete with established international manufacturers, government protection and support could help make them become competitive. Consequently, India’s postcolonial economic policies featured state involvement in domestic industrial promotion and increasing reliance on import substitution as a vehicle for growth and development. Many industries—including steel, mining, machinery, telecommunications, insurance, and power—received heavy forms of public investment beginning in the 1950s. The late 1960s and 1970s witnessed the pinnacle of the statist and socialist model of development. Faced with increasing electoral competition, political elites embraced new brands of populist, pro-poor politics that resonated with the masses. Indira Gandhi’s 1971 election slogan of garibi hatao (“abolish poverty”) awarded her a landslide victory, for example, and ushered in an era of government intervention in the economy. During this period, income tax levels rose to a maximum of 97.5 percent, major banks were nationalized, the private sector was increasingly regulated, and trade barriers were raised. India’s economic growth averaged 3.5 percent between 1950 and 1980, and was derisively dubbed the “Hindu Growth Rate” when compared to the high rates of growth registered by the East Asian Tiger economies. Economic policy gradually shifted course in the 1980s, when the government began downplaying redistributive concerns, and prioritizing economic growth based on private sector development.4 A number of pro-business policy reforms were initiated: Licensing restrictions were eased, firms were accorded tax relief, and private sector investment was promoted. Businesses were encouraged to expand in core industrial sections such as chemicals, drugs, and power generation. The government’s pro-business shift was associated, in part, with an IMF loan that India accepted in 1981. More crucially, however, the reforms were a response to changes in the country’s electoral landscape. Economic growth in certain sectors had created new pro-business constituent groups that were becoming increasingly politicized in the pivotal states of Uttar Pradesh and Bihar in northern India.5 In the latter half of the decade, the government introduced additional policy reforms, lowering some import barriers and quotas, and de-licensing a third of industries.6 However, these policy changes were intended to appease big domestic business groups, rather than initiate external liberalization in a systematic manner.7 2 The Role of Tariffs A central way in which governments can protect domestic industries from international competition is by placing tariffs on goods imported from foreign producers. Tariffs serve effectively as taxes on imports, thereby raising the domestic prices of foreign goods and increasing the competitiveness of local producers. Following independence, India relied heavily on tariff measures to protect its domestic economy. Apart from tariffs, the government also implemented non-tariff barriers, import licenses, and government purchase preferences for domestic producers, as means to restrict foreign imports. From an administrative perspective, the Indian government regulated tariffs at the central level, subdividing the economy into approximately 5,000 product categories. These categories ran the gamut of agricultural and manufacturing products, from refrigerators to sugar cane to textiles of various shapes and sizes. In 1990, average tariffs were just over 90 percent. Average tariffs had risen steadily over the past four decades: 20 percent in 1950, 43 percent in 1960, 72 percent in 1970, and 76 percent in 1980. After peaking at approximately 100 percent in 1986, tariffs started to decline under Rajiv Gandhi’s decision to ease the trading regime in the late 1980s. Figure 1 charts trends in India’s imports, exports, and trade balance from independence till 1991, and shows that India remained a relatively closed economy—with almost no movement in its trading relations with the rest of the world—for much of its early postcolonial history. Trade increased in the 1980s, however, with imports steadily outpacing exports. Lead-up to Crisis India began experiencing balance of payments pressures in 1985. Balance of payments is the record of all monetary transactions between a country’s residents, firms, and public sector entities, and the rest of the world. These transactions span exports and imports of goods, services, money, and capital transfers. The roots of India’s balance of payments concerns can be traced to its ballooning fiscal deficits in the 1980s, which resulted from governing expenditures that steadily outpaced both GDP and government revenues. When the government borrowed money from the Reserve Bank of India to meet its expenses, expansionary pressure on the money supply triggered high rates of inflation. By 1991, the government’s budget deficit had risen to a record high of 8.4 percent of the country’s GDP, and the country was experiencing inflation averaging 17 percent (see Appendix Table 1).8 These fiscal deficits, in turn, fueled an expanding current account deficit in the country’s balance of payments. India’s balance of payments concerns amplified during the Gulf War, when global oil prices skyrocketed and remittances from Indian workers in the Middle East plummeted.9 Political instability—four Prime Ministers

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