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Students Corner - A Decade of Economic
Reforms in India - A Review

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As mentioned earlier, the programme of macroeconomic stabilisation and the structural reforms introduced since 1991 encompassed the areas of industry, trade, foreign direct investment, public enterprises and the financial sector. This brought about an improved growth performance during the first phase of reform period, i.e., 1992-93 to 1996-97. The overall growth in this period was led by a marked acceleration in the industrial growth. The growth momentum, however, slackened in the latter phase of reforms, i.e., 1997-98 to 2002-03, with the slowdown exacerbated by the global recessionary conditions. This pulled down the trend growth for the period of reforms (i.e., 1992-93 to 2002-03) to 6.1 per cent, which was moderately higher than the trend growth of 5.6 per cent recorded during the pre-reform decade ( i.e., 1981-82 to 1990-91). Although the services sector provided some resilience to the overall growth process, the pronounced deceleration in manufacturing activities during the second phase of the reform period posed a major challenge for sustaining the growth momentum. Against this backdrop, the present section examines three crucial macro-economic aggregates, viz., growth, saving and investment.

With improvement in the overall growth rate, the real per capita income exhibited an increasing trend. The per capita income grew at a higher average rate of 3.9 per cent during the reform period compared with 3.2 per cent during the pre-reform decade. This was aided by a distinct deceleration in the compound growth rate of population from 2.14 per cent during the decade ending 1991 to 1.96 per cent during the decade ending 2001. The positive outcome of the growth process during the reform period also seems to have been reflected in reduction in the poverty ratio to 26.1 per cent in 1999-2000 from 36.0 per cent in 1993-94 and 38.9 per cent in 1987-88 (Government of India, 2003).

The real sector is presently confronted with a number of challenges. First, the recent deceleration in economic growth, particularly the sharp deceleration in the rate of industrial growth is worrisome. Second, there has been a distinct downturn in domestic investment during the second half of the decade of reforms, involving both the public sector and the private corporate sector. Third, public sector saving have fallen drastically and have become negative for the first time from 1998-99 onwards.

As mentioned before, the economic performance during the reform period reflected an improvement in real Gross Domestic Product (GDP) growth. The growth process responded favourably to the initial productivity gains arising from deregulation of trade, industry and finance. The overall growth during the reform period was marked by higher services sector growth (8.0 per cent as compared with 6.7 per cent during the 1980s), while agriculture and industry witnessed some deceleration.

This change in the growth process resulted in shifts in the production structure. The services sector (including construction) with high growth rate emerged as the ‘lead’ sector contributing over 50 per cent of GDP in the period of reforms as compared with 44.4 per cent in the pre-reform decade. The deceleration in agricultural growth led to a decline in its share to 27.0 per cent in the reform period from 35.7 per cent during the pre-reform decade. The shifting output structure reflects the impact of relative sectoral productivity growth on the one hand, and changing demand pattern on the other.

The growth performance of the Indian economy during the reform period provides encouraging evidence when compared with the growth performance of some other emerging market economies during the same period. Among select emerging market economies, India ranked high during the 1990s in terms of average real GDP growth. Similar trends were evident at the sectoral level as well. However, unlike India, the growth momentum in most other emerging market economies was led by the industrial sector rather than the services sect

Besides acceleration in growth, another important aspect that characterised the growth process in India during the 1990s was the reduced variability in annual growth rates. Among the three sectors of economy, the variability in growth has traditionally been the highest for the agricultural sector, owing to its dependence on the monsoon. Its variability, as measured by the coefficient of variation, however, showed a decline to 130.2 per cent during the period of reforms from 150.7 per cent in the preceding decade, reflecting a favourable impact of the successive normal monsoons. This contributed to a reduction in variability of overall GDP growth to 23.0 per cent from 39.1 per cent during the same period.

The decadal analysis presented above masks some important aspects of the growth process within the decade. For a meaningful comparison, the period of reforms can be sub-divided into two phases viz., Phase I (1992-93 to 1996-97) and Phase II (1997-98 to 2002-03). The entire period of Phase I can be further divided into two sub-periods based on the growth performance of the economy. The first sub-period (1992-93 to 1993-94) was the period of recovery from the crisis while the second sub-period (1994-95 to 1996-97) was marked by high growth of the economy. During the crisis year of 1991-92, the rate of growth of real GDP had dipped to 1.3 per cent, engendered to a large extent by sharp credit containment and fiscal as well as import contraction. Both, agriculture and industrial sectors recorded negative rates of growth, the former primarily emanating from the occurrence of drought. However, the speed of recovery of the economy during the first sub-period of Phase I was quite impressive with the real GDP growth improving to an average of 5.5 per cent per annum spread over all the sectors.

With the economic recovery gathering momentum in the first sub-period of Phase I, the economy was placed on a higher growth trajectory in the subsequent period. During the second sub-period of the first phase, the growth rate of GDP averaged as much as 7.5 per cent per annum. This was the only period in India’s economic history during which real GDP growth exceeded 7.0 per cent consecutively over a period of three years. The sharp acceleration in the rate of growth of overall GDP was largely the result of the phenomenal growth of 10.8 per cent per annum in the industrial sector. The upswing in industrial growth during this sub-period can be regarded as an outcome of removal of various constraints in the form of licensing and other restrictions as a part of the liberalisation initiatives. The growth of GDP, however, moderated in 1997-98, which marks the beginning of phase II.

The phase from 1997-98 to 2002-03 was marked by a deceleration in growth with the average rate of growth during this period turning out to be 5.3 per cent, which was much lower than the average growth of 7.5 per cent per annum recorded during the period of high growth from 1994-95 to 1996-97.The most disturbing feature of this phase was the steep decline in industrial growth, led by a severe slowdown in the manufacturing sector. The average rate of growth of manufacturing decelerated by as much as eight percentage points during this phase as compared with the second sub-period of the first phase. Within the second phase, real GDP growth, after dipping to 4.8 per cent in 1997-98, recovered during the years 1998-99 and 1999-2000 to over 6.0 per cent. One of the factors contributing to this recovery was the high growth emanating from services sector, and within the services sector, the growth of ‘community, social and personal services’, particularly ‘public administration and defence’. The Fifth Pay Commission Award led to an increase in GDP originating from the sub-sector of ‘public administration and defence’ in 1997-98, with its lagged effect persisting till 1999-2000. These years witnessed a striking increase in the weighted contribution of ‘community, social and personal services’ to the growth of GDP originating from the services sector. The period from 1997-98 to 1999-2000 also witnessed steady growth in other components of the services sector. In the more recent period, growth of overall GDP dipped to 4.4 per cent in 2000-01. This was a result of poor performance of agriculture, coupled with a significant deceleration in the growth rate of GDP from the services sector, particularly ‘financing, insurance, real estate and business services’. The same rate of growth of 4.4 per cent has also been registered in 2002-03, as per the latest Advance Estimates, which has been an outcome of a sharp fall in agricultural growth to a negative of 3.1 per cent owing to the drought conditions.

A combination of structural and cyclical factors can be identified for explaining the deceleration in growth during the second phase. Structural factors include, among others, the lack of appropriate reforms in the agricultural sector, infrastructure gaps, labour market rigidities, weak bankruptcy and exit procedures, while the cyclical factors primarily include decline in aggregate demand. The cyclical fluctuations in real economic activity are captured by the measure of output-gap; the impact of structural factors on the growth process can be gauged from the underlying potential output. The potential output indicates the capacity output of the economy as represented by the steady state level that is associated with long-run supply curve under full utilisation of capacity.

Although the growth process of the economy during the reform period seems to have been influenced, to some extent, by cyclical factors, their impact as reflected in differences between potential and actual output growth was found to have diminished in magnitude in the post-1991 period as compared with the previous four decades (Donde and Saggar, 1999). An updated empirical estimate of the output-gap for India covering the most recent period also reveals that the output gap has come down significantly in the decade of reforms vis-ŕ-vis the preceding decade. Furthermore, within the 1990s, there has been a significant narrowing down of the output gap during the latter half. In other words, the cyclical factors seem to have had a diminished impact on the growth process in the recent years. This may have been the result of fortuitous monsoon, more stable growth in services sector and more effective counter-cyclical policies. A combination of these factors may have had a stabilising influence on output fluctuations. Contemporaneously, the potential growth rate exhibited somewhat decelerating trend during the latter phase of the 1990s as against the first phase. This corroborates the persistence of structural constraints and may have implications for medium term growth outcome. Despite the declining role of domestic cyclical sources of growth variability, progressive globalisation has enhanced the importance of global cyclical factors. In fact, during the current phase of global slowdown, such factors have weakened India’s growth prospects despite its moderate degree of globalisation.

Sectoral analysis of the growth process can be supplemented by an assessment of aggregate demand. The growth process during the 1990s can be analysed in terms of autonomous, exogenous and policy-induced components of aggregate demand, which broadly relate to private, net external and government demand, respectively. Several stylised facts emerge from the analysis of sources of aggregate demand during the reform period. During the first phase of reforms, particularly in its second sub-period, improvement in growth emanated mainly from investment demand, with private consumption demand providing a strong support. Second, during the second phase of reforms, the positive demand-pull stemmed from a high growth in the Government consumption expenditure. This increase reflected the rise in GDP originating from ‘public administration and defence’, owing to the effect of the Fifth Pay Commission. Third, the slowdown in the economic activity during the second phase seems to have been a result of a rapid deceleration in investment demand coupled with a relatively lower growth in private consumption demand. These two components showed contraction in terms of annual growth during the second phase. During this phase, a decline can also be noted in the case of the contributions of these two components to growth in overall aggregate demand. In view of these developments, there is a need to revive the aggregate demand especially by accelerating investment in order to stimulate the overall growth performance of the economy.