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Thursday, February 12, 1998 Published at 13:42 GMT

India: the economy

India's vibrant entrepreneurial culture was stifled by restrictive economic policies

For the first 45 years after independence, economic growth and development in India was poor. One explanation, known as 'The Hindu rate of growth' argued that Indian culture prevented it developing in the way other nations did. In reality, India's vibrant entrepreneurial culture was stifled by restrictive economic policies that seriously undermined development. Recent reforms have injected a new sense of life into India's sluggish economy. Gordon Corera reports.

While India has in recent years been growing at a reasonable pace, it has been left behind by many of Asia's other economies, including countries that were as poor as India 50 years ago.

[ image: Many children work to help support their families]
Many children work to help support their families
In 1947, living standards in China were much the same as those in India. By the mid-1990s, China's were roughly double. As China undergoes rapid economic growth, it is still unclear whether India will be able to follow and become the economic power that its size suggests.

Up to 1990, India's GDP grew by an average of a little under 4% a year. Over the same period, Indonesia grew by 6%, Thailand 7%, Taiwan 8% and South Korea 9%. In 1960, South Korean income was around four times bigger than India's, but by 1990, it was 20 times larger. After the reforms, India's growth rate now looks set to stabilise at a healthier 6-7%.

Before the reforms

[ image: Bombay: the financial capital now courts western investment]
Bombay: the financial capital now courts western investment
Before the process of reform began in 1991, the government attempted to close the Indian economy to the outside world. The Indian currency, the rupee, was inconvertible and high tariffs and import licensing prevented foreign goods reaching the market. India also operated a system of central planning for the economy, in which firms required licenses to invest and develop.

The labyrinthine bureaucracy often led to absurd restrictions - up to 80 agencies had to be satisfied before a firm could be granted a licence to produce and the state would decide what was produced, how much, at what price and what sources of capital were used. The government also prevented firms from laying off workers or closing factories.

The central pillar of the policy was import substitution, the belief that India needed to rely on internal markets for development, not international trade - a belief generated by a mixture of socialism and the experience of colonial exploitation. Planning and the state, rather than markets, would determine how much investment was needed in which sectors.

Powerful business empires

The main outcome was that there would be only a limited number of producers in each industry, only four or five licences would be given for steel, power and communications and those with licences would be able to build up huge powerful empires.

The energies of investors were directed towards winning licences, rather than capturing markets or producing superior goods, and profits tended to be guaranteed irrespective of quality or efficiency. External regulation, major controls on foreign direct investment and a high tariff wall then protected companies from foreign competition. Restrictions on consumer goods were the tightest, thanks to the belief that precious foreign exchange should not be wasted on consumer goods.

Public sector waste

[ image: New Delhi: even the capital is affected by powercuts]
New Delhi: even the capital is affected by powercuts
A huge public sector also developed which recorded huge losses, but which could not be shut down. Between 1986 and 1991, state owned enterprises made 39% of gross investment, but generated only 14% of GDP. Monopolies and controls also prevented the much-needed development of the country's infrastructure - power cuts remain a serious problem for many parts of India.

Only around 10% of the labour force with jobs in the public sector or certain large companies had job security and enjoyed the fruits of the system. The system was also maintained by bribes and kickbacks for public officials, a problem that still plagues India and has caused a recent wave of scandals at the very top of the political system.

Causes of reform

[ image: Prime Minister Rajiv Gandhi was blocked in his attempt to liberalise the economy]
Prime Minister Rajiv Gandhi was blocked in his attempt to liberalise the economy
Tentative attempts at liberalisation in 1986 by Prime Minister Rajiv Gandhi were blocked by those opposing change, and India had to wait until 1991 for real reform. Growth quickened in the 1980s but proved unsustainable and the reforms of 1991 were caused by a serious macro-economic crisis, in both fiscal and foreign exchange sectors of the economy.

By June 1991, India found that it did not have enough dollars left to pay for imports and had lost its creditworthiness in international markets. The collapse of the Soviet Union and other command economies, as well as the rise of the Asian Tigers, cemented the belief that India would finally have to change. The crisis was also an opportunity - and the process of reform began under Prime Minister, Narasimha Rao and Finance Minister Manmohan Singh.


[ image: Fewer licences are needed to set up business]
Fewer licences are needed to set up business
The main elements of reform included a bonfire of licensing. Instead of 80 licences to start a firm, people found they only needed 4 or 5, often environmental, licences. Only the defence industry remained protected as most firms were given far more control over decision making.

Tariffs were also cut rapidly on most goods apart from in the consumer sector. Average tariffs fell from 87% in 1990 to 25% in 1995. The economy was also opened up to foreign direct investment. In the 1980s, annual average foreign direct investment was $100 million. In 1992-3, it rose to $300 million, 1993-4 to $600 million, 1994-5 to $1 billion and 1995-6, to $2 billion.

[ image: Foreign exchange controls helped boost the black market]
Foreign exchange controls helped boost the black market
India devalued the seriously overvalued rupee and introduced a market-determined exchange rate in 1993. Foreign exchange reserves rose from $2.2 billion in 1990-1 to 21.7 billion by the end of 1996-7. Capital markets were also liberalised and the tax system was reformed with lower rates.

As a result, after growing by only 0.8% in 1991-2, GDP grew by 5.1% in 1992-3. India's real annual export growth has almost doubled since the pre-reform period, from 8.6% real growth over 1985-90 to an average 10.7% over 1991-93, and 15.6% over 1994-96.

Investment opportunities

[ image: Getting around in Calcutta: transport is an investment opportunity]
Getting around in Calcutta: transport is an investment opportunity
The estimated size of India's middle class, 200-250 million people, offers a huge market for potential investors. The key areas of investment at the moment include the telecom sector. India currently has about one telephone line per 100, but the target is for a sixfold increase in the next 10 years to bring it up to the developing world average of six per 100. The market is projected to be worth $30 billion in the next 5-10 years and the US is moving in.

Power and transport are also likely to be important. Already, Mercedes largest investment outside of Germany is in India. Computers and computer software have also been growing rapidly, especially around the city of Bangalore, into which US companies have been investing large sums.


[ image: 70% of the population depends on agriculture]
70% of the population depends on agriculture
Around 70% of the Indian population depends directly on agriculture. Before the 1960s, India relied on trying improve agricultural productivity through greater equality in land distribution and attempts to undermine traditional feudal relationships with invectives to own land. But by the 60s, production shortfalls had increased and Nehru began to admit that the strategy was not working.

The mid-1960s saw a 'Green Revolution' in India, led by the technocratic wing of the Congress Party who used new technological investment, high yield crops and new price incentives for farmers. The revolution, which led to a food surplus, was concentrated initially in eastern and northwest India and especially the Punjab. In recent years it has spread into the northeast and into Tamil Nadu. As a result, droughts no longer turn into famines and India has not seen a serious famine since 1942. But despite this, rural poverty remains a serious problem and agricultural growth has not been as good as hoped.

Widspread poverty

[ image: India is home to nearly a third of the world's poor]
India is home to nearly a third of the world's poor
Despite attempts to manage 'balanced development' (keeping rural incomes growing in line with urban), poverty remains a serious problem for India. According to the UN, India is home to nearly a third of the world's poor. The World Bank estimates that 328 million Indians fall below the poverty line - having an income of less than $25 a month. There are estimated to still be 300-350 million people who do not get enough calories per day for an adequate diet.

Poverty has been falling in India over the last 40 years, but the fall has been modest compared to other Asian countries, such as Indonesia, whose headcount index was 58% in 1970, about the same as India, but by 1993 had fallen to only 8%, about one fifth of India's.

There have been improvements in infant mortality and life expectancy, but health care and literacy remain extremely low. According to a recent report, 130 million people have no access to basic health facilities and 226 million have no safe drinking water.

Causes of poverty

Much of the problem is caused by India's massive population growth, with some projections seeing India overtake China in the next 50 years as the most populous nation. Poverty also tends to be regionally concentrated, the northern states of Rajasthan, Madhya Pradesh, Uttar Pradesh, Bihar and Orissa have 45% of the population and the majority of the poverty. Other states, notably Kerala, have done much better with near universal literacy and lower fertility rates.

The weak assault on poverty at a national level has partly been because the poor have tended to vote more on ethnic and caste lines rather than as a single bloc. There were signs of rural mobilisation in the 1980s, but this was displaced in the latter part of the decade by political mobilisation on a religious basis. The continued strength of caste, ethnic and religious identities make a form of 'class politics' and a strong voice for issues of poverty less likely.


Despite including communists, the 13-party United Front coalition did commit itself to continuing the process of deregulating the Indian economy and a number of positive steps were taken. The appointment of P Chidambaram was also welcomed as a positive sign, and his budget in 1997 saw a reduction of the top rate of income tax to 30% and other changes.

Because the process of reform was caused by a macro-economic crisis, rather than a general collapse of the economy, the ideological conversion to market policies has been shallower than sometimes perceived, but even so, it is unlikely that they could be reversed. The current political instability in India risks slowing the process of reform.

Obstacles remain

[ image: The labour market still needs to be reformed]
The labour market still needs to be reformed
There remains much to be done to open up the Indian economy, especially in the fields of privatisation, labour market reform, fiscal reform and agriculture. The main obstacles to privatisation tend to be political rather than economic, centring on the traditional power of India's overstaffed public bureaucracies and their influence in politics and the country, and their fear of the mass lay-offs that privatisation would bring.

There also remains frustration internationally at the pace of liberalisation, especially the plan to liberalise import controls on areas like consumer and agricultural goods over the next 5-7 years rather than over a shorter period.

Some parts of Indian society also fear that economic liberalisation will undermine traditional values and ways of life and introduce an unwanted level of materialism and commercialism into Indian culture. The country is still deeply ambivalent about large-scale foreign investment.

Gates over Gandhi

[ image: Younger Indians may see Bill Gates as a hero]
Younger Indians may see Bill Gates as a hero
Others feel liberated by the economic freedom reform has brought, believing that reform has unlocked the potential and the spirit of enterprise that had been latent in India. Where before, joining the government bureaucracy was a route to prestige and power, now business and wealth are the avenues to success as the new middle class grows in size and confidence. Where Gandhi used to be the hero and idol of India's young, now many prefer Bill Gates.

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