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Indian Economic Policy Making: Successes and Challenges

Indian Economic Policy Making: Successes and Challenges . Indira Rajaraman IGIDR Silver Jubilee Conference on Development: Successes and Challenges Mumbai 3 December 2012. Did Design Defects in the 1991 Reform Package Carry the Seeds of Today’s Growth Slowdown?. Revisiting reforms of 1991.

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Indian Economic Policy Making: Successes and Challenges

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  1. Indian Economic Policy Making: Successes and Challenges IndiraRajaraman IGIDR Silver Jubilee Conference on Development: Successes and Challenges Mumbai 3 December 2012

  2. Did Design Defects in the 1991 Reform Package Carry the Seeds of Today’s Growth Slowdown?

  3. Revisiting reforms of 1991 • Product markets reformed (policy wedges eliminated; price discovery enabled – principally, the price of the rupee) • BUT • Factor markets (land, labour) not reformed! • This made the design of the 1991 reform package fundamentally defective, since reform is centrally about freeing factors to flow into their most productive uses

  4. Why were factor markets neglected? • Reason (not amounting to justification): • land and labour are on the concurrent or state lists of the Constitution • fiscal wedges in the land market (stamp duty on transfer of land) are in the state fiscal domain • Failure to shepherd factor market reform by states in concert led to sharp regional variations in the benefits of reform • Research focus has mostly focused on variation across states in labour market reform (PetiaTopalova, AEJ Applied, Oct 2010) but the far greater problem today is the unreformed market for land

  5. Today… • These factor markets remain hugely imperfect and remain the sources of today’s • supply constraints; resulting inflation; political scams • failure of trickle down since growth benefits accrued as abnormally high rents to owners of scarce, highly priced, land • The intellectual fathers of the 1991 package quite simply failed to take into account the requirements of reform in a federal setting

  6. Second core deficiency of the 1991 reform package • In the national financial accounting structure before 1999-2000, small savings were routed through the national exchequer, and routinely on-lent to states by jurisdiction (uncapped) • There was state pressure for high deposit rates on small savings, raising the floor of the interest rate structure, because onlending rates were unrelated to deposit rates

  7. Finally corrected in 1999-2000 • The creation of the NSSF in the Public Account in 1999-2000 linked on-lending to deposit rates, and so eliminated the pressure for high deposit rates • This gradually brought down the cost of credit and led to the growth spurt after 2003 • BUT credit continues to remain grotesquely costly for those outside the formal financial system

  8. Third core deficiency of the 1991 reform package • Fiscal consequences of trade liberalisation neglected • The need for compensating revenue not foreseen (my paper in Global Policy, September 2012) • The Centre’s gross tax revenue remained: • below 10 percent of GDP during 1992-2006 • below 9 percent of GDP during 1998-2003

  9. Growth cost of third deficiency • Foregone public investment at both Central and state levels • Despite that, PMGSY started in 2000, a far-seeing public investment initiative by the Central government, for last mile connectivity • Finally, over 2000-01, moves initiated towards tax revenue enhancement at the Centre; and at the level of states (VAT finally in place by 2005)

  10. Conclusions • Growth has stalled in India because of three major defects in the 1991 reform package, which overlooked the need: • To facilitate factor flows • To bring down the cost of credit (until accounting correction in 1999-2000 brought down the interest rate floor) • For compensating revenue from loss of trade tax revenue (until ~2000-01) • The first defect remains uncorrected: factor markets (land, labour) remain hugely obstructed • Credit remains very costly for those outside the formal financial system

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