Download Arun Shurie and the privatization of India`s economy

15.227B Special Seminar in International Management-India-Spring 2004
Jerome Poupon, MBA, Class of 2005
May 2004
Aroun Shurie and the privatization of
India’s economy
Three decades of closed economy
From 1950 to 1980, India’s development strategy came to be known as Nehruvian
socialism. The aim was to develop a national industrial base and to achieve economic
self-sufficiency.
Nationalization
Under this strategy, the state controlled the most influential sectors through the
proliferation of large scale public enterprises. Some 70% of the work force was employed
by the state, and the trade unions became extremely powerful. State workers resisted
productivity improvements, and technological or structural change which might
undermine their job security. The government continued to defend the state enterprises
even though they grew increasingly inefficient, many incurring losses. This was an
important reason for the low 3.5% per year average for GDP growth between 1950 and
1980.
Heavy agricultural subsidies
Overall, the government faced two conflicting objectives: to subsidize the urban
population with cheap food and at the same time provide sufficiently high prices to
guarantee farmers’ revenues.
The first objective was achieved at the expense of the second: the bias was in favor of the
urban population, penalizing farmers. Agricultural prices were kept below world market
levels in order to supply food at an affordable rate to people in the towns and cities. In an
attempt to compensate farmers, the government heavily subsidized the agricultural sector,
but not enough to overcome the bias.
Very high trade barriers
Industrial prices were kept high by trade barriers erected to obstruct imports. These
included a system of import licenses designed to shield domestic manufacturers against
competition from abroad. As a negative consequence, much-needed industrial spare parts
were not available for industrial production. Protecting domestic producers meant
exporters suffered, and so India’s share of world trade declined steadily from 2.5% in
1938, to 0.5% in the 1980s.
A continuous deterioration of the economic competitiveness
The extensive use of agricultural subsidies and industrial licenses prevented the efficient
allocation of resources via market forces and foreign competition.
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15.227B Special Seminar in International Management-India-Spring 2004
Jerome Poupon, MBA, Class of 2005
May 2004
Under the system of government licensing, the private sector was stifled by restrictions
which led to oligopolistic and uncompetitive practices, inefficiency, misallocation of
resources and corruption.
Agriculture suffered from a series of severe droughts in the 1960s. The economic
situation was made worse by the withdrawal of foreign aid in the 1970s.
The 1980s: deterioration of the economic situation
All through the 1980s, there was growing support for increased liberalization. For
example, attempts to liberalize the economy were made by the Janata Party as early as
1977 and at the beginning of Rajiv Gandhi’s administration in 1984 (as the state started
borrowing from the World Bank). The Janata government fell after reducing some
industrial and import controls, and Rajiv Gandhi’s administration quickly became mired
in scandal and lost the power to override party members who enjoyed the benefits of
control. In all cases, resistance from powerful interest groups (bureaucrats, politicians and
industrialists) and the lack of strong political leadership meant that little was done.
Throughout the decade, central government borrowing exceeded 5% of GDP as public
expenditure grew faster than revenue. The problem was aggravated by subsidies, which
reached 12% of GDP in 1990.
The gap between savings and investment widened, along with the budget deficit. The
Gulf crisis triggered confidence crisis, and entailed capital flight, and a virtual cessation
of foreign lending.
In 1991, the economy was on the verge of bankruptcy, with only two weeks worth of
foreign exchange reserves and a current account deficit of 3% of GDP.
1990 reforms
The crisis was resolved with financial assistance from the IMF, which lent approximately
$2.3bn between 1991 and 1993. The conditions of the loans included fiscal correction
and trade liberalization.
In July 1991, Manmohan Singh’s government embarked on a liberalization policy, which
was actually more radical than what was required by the IMF. The reformers took
advantage of the macroeconomic crisis to push through some major changes which had
long been resisted. They aimed at curbing trade deficits, by attracting foreign direct
investment and increasing exports. Increasing export would allow earning foreign
currency, which in turn could be used for paying for energy (India is a net importer of
natural gas and oil), investment goods and imports in general. It would also allow
servicing the debts and becoming competitive internationally.
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15.227B Special Seminar in International Management-India-Spring 2004
Jerome Poupon, MBA, Class of 2005
May 2004
Despite their slow pace, the cumulative reforms since 1991 have been substantial. The
reforms can be summarized as follows.
 Progressively more sectors were opened to private investment, including power, steel,
oil refining and exploration, road construction, air transport, telecom, ports, mining,
pharmaceuticals and the finance sector. Sectors such as garments and textiles that were
previously reserved for small-scale industries were also delicensed.
 Policymakers sought to encourage FDI with majority equity (except in a few
“strategic” sectors, among which defense, nuclear energy, railways) and portfolio
investment. Red tape was significantly reduced.
 Most industries were delicensed to encourage competition.
 Trade policy was liberalized. Some imports quotas were converted into tariffs, and
the tariffs system was simplified to reduce the number of bands and achieve a reduction
in overall rates imposed. From April 2001 remaining quotas on imports were removed,
although tariffs remain high.
 Some aspects of business decision making, such as the location of new enterprises
and technology transfer were taken out of the state’s control. (Labor relations and the
shutting down of loss-making enterprises remains strictly regulated).
 The exchange-rate regime was liberalized, with the devaluation of the rupee by 22%
against the US dollar in two installments in July 1991. A market determined exchange
rate was introduced in March 1993, and current account convertibility began in August
1994. Since July 1995, all official foreign debt service payments have been channeled
through the interbank market. However the rupee is not yet fully convertible on the
capital account.
 Capital markets were reformed. Private mutual funds, foreign institutional investors
and country funds are active investors, and the stock market is subject to more rigorous
regulation, although scandals every couple of years suggests there is still some way to go.
Officials are pointing to the National Stock Exchange as the model market.
As central controls have receded, states have acquired more freedom to maneuver. Some
states, such as Andhra Pradesh, Karnataka and Maharashtra, have shown considerable
initiative in raising additional finance, including issuing bonds and encouraging private
investment in irrigation, roads, bridges, software development, and agricultural projects.
However, most states have made little progress. During 1997/98, 16 states resorted to
overdrafts with the Reserve Bank of India; three of them had payments on their behalf
halted when they failed to clear their accounts. In 1999, there was a radical change of
policy and overdrafts were linked to economic reforms, including pricing reforms and
disinvestment.
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15.227B Special Seminar in International Management-India-Spring 2004
Jerome Poupon, MBA, Class of 2005
May 2004
A mixed result
A result of the reforms, the recovery in foreign exchange reserves has been particularly
marked. During the 1991 balance of payments crisis, India’s foreign exchange reserves
had fallen to an all time low of $1bn. By the end of 1996, with increasing capital flows
foreign exchange reserves rose to $20bn.
The reforms have allowed a spectacular growth over the last years, and the rapid
burgeoning of a new middle class (300 millions people). However, the reforms have also
resulted in some pain in certain sectors of the economy.
Not everyone has benefited from the reforms. In particular, liberalization has led to
significant increases in the prices of fertilizers, rice, sugar, cotton and gasoline. Further
inflation and increases in the prices of key agricultural commodities have accentuated
fears that the reforms have raised the costs of living for the poor, especially the small
farmers and urban workers.
More to come?
Still, the liberalization process is far from over. The IMF advocates further reforms, such
as the removal of quotas and export licensing controls, and privatizing remaining state
enterprises. Investment is needed to provide adequate infrastructure and bulk storage
facilities.
The integration of textiles and clothing into normal WTO rules and the elimination of
quotas will provide wider market access for Indian exports in an industry that enjoys
considerable comparative advantages. On the other hand, it could also increase
competition from more efficient manufacturers elsewhere, such as in South and Southeast
Asia.
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15.227B Special Seminar in International Management-India-Spring 2004
Jerome Poupon, MBA, Class of 2005
May 2004
Mr. Aroun Shurie
The Sloan trip to India gave us the immense chance of meeting with Mr. Aroun Shurie,
possibly the most influential person in India’s ongoing liberalization process at the time
of our trip.
Mr. Aroun Shurie surrounded by students of the MIT Sloan School, April 2004
A well-known author and journalist, Aroun Shourie joined the Bharatiya Janata Party
(BJP) in 1998 and was minister in charge of IT and “disinvestment” in the BJP-led
coalition government from November 1998 on. During his time in office, Mr. Shourie led
six major privatization issues, the latest being the offer on the Indian stock market of 10%
of the shares in ONGC, an oil exploration and production company, for $2.2bn.
Like reform itself, the minister has suffered his share of setbacks. One came in September
2003, when the Indian Supreme Court ruled that the privatization of two state oil
companies required a vote in parliament. This had the effect of stalling Mr. Shourie’s
favored method of disposing of the government's assets—selling control to strategic
investors, rather than minority chunks to the market. At the time, Mr. Shourie vented his
frustration by saying the ruling showed the difference between India and China: “In
India, everybody has a veto.”
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15.227B Special Seminar in International Management-India-Spring 2004
Jerome Poupon, MBA, Class of 2005
May 2004
In addition to “disinvestment”, Mr. Shourie was in charge of two industries closely
related to the recent “Indian miracle”: communications and information technology. The
government's hands-off approach to the IT business has allowed it to grow spectacularly,
with the emergence of international players such as Infosys or Wipro. In telecoms,
liberalization has sparked a boom—India has been adding nearly 2m mobile-phone
connections a month since 2003. Yet even there, Mr. Shourie faced setbacks. In January
2004, he failed to gain cabinet approval to open the telecoms sector to majority foreign
ownership. He ran into resistance from a wing of his party that is suspicious of
globalization.
Both for “disinvestment” and IT, Mr. Shourie –like the other unelected economic
liberals- relied heavily on the support of the Prime Minister, Atal Behari Vajpayee.
Shortly prior to the April 20th, 2004 election, Mr Shourie was hoping that the next
government would continue reforming, even if Congress, the main opposition party, won.
Mr Shourie tended to show optimism on this issue. “Everybody opposes reform in
opposition”, argued Mr Shourie, “but in office, finds it the only option”. To confirm his
say, it should be remembered the liberalization process was launched by the Congress
party in 1991, on the impulsion of Manmohan Singh.
Now that BJP has lost the recent election, and Mr Singh is presumed to take over the job
of finance minister, the future will tell if Mr. Shourie was right.
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