What has ailed India through the decades?

1991: A pivotal year in independent India’s history

1991 was a pivotal year in the history of independent India. The economic model that preceded 1991 could best be described as “Nehruvian Socialism.” After 1991, we moved towards a more “Free market-oriented economy” — albeit, in a very limited sense of the phrase “Free markets.”

The key characteristics of the “Nehruvian Socialism” economic model (I am consciously desisting from using the word “development”) are as below:

• Structure of state-owned and run enterprises, especially in banking, infrastructure, mining, education, and other services.
• The private sector had a limited role, and that too with extensive controls, quotas, and inspections.
• Though the intent was on free social services such as education, medical care, and food rations for the overwhelming majority, the limited returns of the public sector enterprise investments ensured that the availability of funds limited the scope and gamut of these services.
• Fiscal deficits were the norm from a policy perspective, with a loose monetary policy enabling it. Between 1947 and 1991, the rupee’s exchange rate depreciated from Rs.4.16 to Rs.22.74. This equates to an annualized fall of 3.96% in the rupee’s value vis-à-vis the US Dollar.

The above was a very unsustainable model, and our economy came into a crisis in 1991 with the foreign exchange reserves sufficient to cover just three weeks of imports. That was the backdrop behind the 1991 reforms initiated by the then Prime Minister Shri. P V Narasimha Rao. For lack of a better word, I would describe this model as “Manmohan Socialism,” and the key attributes are as below:

• The private sector plays a more significant role in most industries, though the government continues to operate in these segments with a declining market share.
• Quotas in most industries were abolished, and markets/ competition determined these outcomes. Greater foreign participation ensured the flow of technology and process controls, and India started offering world-class products and services.
• The growth of the private sector ensured greater tax collections and the government promptly extended the ambit of economic doles. Good examples of these extensions are MNREGA and PM-USP. Whatever the government wishes to market these schemes as (i.e., creation of rural infrastructure and investment in girls’ education, respectively), they are essentially handouts.
• From a policy perspective, fiscal deficits continued to be the norm, with loose monetary policy enabling them. Between 1991 and 2024, the exchange rate of the Rupee depreciated from Rs.22.74 to Rs.85.1. This equates to an annual fall of 4.08% in the value of the Rupee vis-à-vis the US Dollar.

Of the 32 years since we initiated the reforms in 1991, about 50% has been under the BJP rule and 50% under the Congress rule. Despite the seemingly very disparate political parties, there has been remarkable consistency in the economic policy as outlined by the 4 points above. Seen from the perspective of the “Free Markets” ideology (i.e. limited governments and balanced budgets), there is little difference in the economic policies of these two political formations.

What were the results? Quite obviously, we made reasonable progress on the economic front, and the growth in Per Capita GDP accelerated to 6.78% for the period 1991 to 2023 as compared to 4.2% for the period 1960 to 1991. If we were at the Hindu rate of growth prior to 1991, we moved to 1.5 times the Hindu Rate of Growth. This is not a substantive change, especially when juxtaposed against China’s growth during the same period. This is even starker when we realize that our population size is virtually the same at 1.42 billion and our comparative advantages (availability of cheap labour and lack of exportable good quality natural resources like oil, coal, etc) were similar as well.

From the table above, the popular notion that a weak currency aids exports and curtails imports also doesn’t stand up to scrutiny. For the year 2023, China had a trade surplus of more than $800 billion, while India had a trade deficit of nearly $100 billion. That a perpetual weakening currency leads to trade deficits is a given and if we look at the history of countries with sustained Current Account surpluses, these would be countries with a stable currency.

What does it mean for us today? Before answering that, let me look into a very popular discussion topic initiated by the current Prime Minister Shri. Narendra Modi. I think it’s very important we work with defined objectives and goals and to that extent, a vision like Viksit Bharat is indeed a very important one.

The dream of Viksit Bharat by 2047? Firstly, it’s not clear what the goals of Viksit Bharat are. Whatever other dimensions one might want to consider, the singularly most important and non-negotiable indicator has to be economic prosperity. While China might still be considered a developing economy, for India to reach China’s current Per Capita GDP by 2047, a CAGR of 7.66% is required. Or the GDP should grow at at least 8% CAGR for the next 20+ years.

What are the chances of achieving that in the current policy framework? In my opinion, ZERO. For two important reasons outlined below:

1. As I had explained in my article, “The Keynesian Playbook – Eat Your Cake and Have it Too!!! Are we at the End of the Road?[1]”, the above period, starting from 1991, witnessed one of the most benign operating macroeconomic environments worldwide with continuously falling 30-year US Treasury rates. This meant that the monetary inflation created by the US Fed was masquerading as growth in the US with positive spill-over effects in the other economies as well. We are at the other part of the “interest rate cycle” since 2022 and interest rates are set to climb in the years and decades ahead. Growth in most parts of the world, especially the leveraged economies, is going to be muted at best.
2. More importantly, as I have explained in my book RIP USD: 1971-202X …and the Way Forward, the US economy is floating on a sea of asset bubbles, the bursting of which will send the US economy into an “Inflationary Depression”. India has created an economy based on servicing the US bubble economy. For example, more than 50% of India’s software exports are to the US, and finding a replacement for that market would be impossible. The bursting of the US bubbles would have immediate dramatic repercussions on the Indian economy at a time when we are quite ill-prepared to handle one.

So, barring a dramatic change in our economic policy framework, we can forget the 8% growth. But before addressing that, it’s important to understand how China was able to grow at nearly twice our Per capita GDP growth rates for such a long period.

What went wrong for India?

In the movie, The Usual Suspects, the protagonist, Verbal Kint, narrates a series of bizarre events and explanations to a US customs agent, Dave Kujan. It’s only in the final few seconds of the movie that Kujan realizes that the entire narrative is a fabrication.

Perhaps there are some differences between “Verbal Kint” and our “Economic Policy Framers,” primarily regarding intentions. While Verbal Kint was deliberately misleading, Keynes unwittingly bestowed upon Economists worldwide this fiscal-deficit-induced-growth model. Keynesian economics creates an illusion that works under conditions of falling interest rates. This has been aided by some accounting misrepresentations in calculating price inflation (a practice that has been institutionalized by the US government starting in the mid-1980s with other countries following the US example).

Somebody has to sit back and look at the entire economic model dispassionately i.e. the task done by Dave Kujan when the reality of the bluff hits him. Shri.P.V.Narasimha Rao did it in 1991. He was quite the scholar though not very well versed in Economics. To that extent, the reforms were very limited in nature.

Fortunately for the world today, we have a standing example, and that too is an Economics Professor turned politician who is practicing Free Markets Economics, i.e., Javier Milei, in Argentina. Even more incredible is that he was democratically elected, promising dramatic government downsizing. For a country that was on the verge of hyperinflation when he took over just 12 months ago, Milei presented the first balanced budget – a feat that has not been done for more than 120 years in the history of Argentina.

It’s not without reason that Elon Musk and Vivek Ramaswamy refer to Milei as their role model.

If Shri. Narendra Modi is interested in genuine economic advice on where India has blundered for the last few decades and why, 30+ years after initiating reforms, more than 50% of the population is dependent on the government for food and basic health care, Milei would be the person to provide the answers. For others who may not have direct access to Milei, here is a 2 hr interview where he talks about the reforms he has initiated – Javier Milei – Freedom, Economics, and Corruption.

An Indian Budget Wishlist for 2025

The explanations for why the following would push India in the direction of Viksit Bharat would be known to people who understand Free Market Economics. Given that almost all Indian Economists have been trained in the flawed Keynesian Economics, these recommendations would appear to be counter-productive measures. Indeed, we have been doing the very opposite on most counts. But to be remembered is that these recommendations were the very economic framework practiced by the US till 1913 and perhaps in a more limited way till 1971.

• Balance the Federal Budgets: The way to achieve a sound currency is to balance the budgets so that monetary inflation, which ultimately leads to currency debasement, is eliminated.
• Devolution of Economic Powers and a Greater Share of Revenues to the State Governments: Most economic activities happen at the state level, and it is inexplicable that we have centralized economic decision-making. For example, the strike by farmers demanding a Minimum Support Price for all crops was a moment this could have been done.
  • Firstly, the government’s fixing the price of agricultural outputs when it should be market-determined is very retrograde. Central governments making these decisions is all the more inexplicable.
  • Modi-ji should devolve these powers to the state governments. Ultimately, some Chief Ministers will see the merits of allowing markets to operate, and the farmers would benefit immensely as well.

Most activities – barring the army and the justice system, ought to be devolved to the states. Ultimately, some chief ministers will do what is correct and become a role model for other states to follow.

• Abolition of Income Taxes: There is an economic axiom that we get less of what the government taxes and more of what it subsidies. The US did not have an Income Tax till 1913 and even till WW-II, a very small fraction of the wage earners paid an Income tax. The boom in economic activity it would create and the savings it would generate will fuel the investments required for our growth.
  • Besides as Dr. Ron Paul (another politician whom Shri. Modi should meet) would explain, the government deciding what share of the income we generate we can retain is a very feudalistic system and should be abolished purely from the perspective of civil liberties alone.
• A Single Rate GST: Simplicity should be the core of a tax system and a single rate GST would resolve the bureaucratic nightmare we have created in the tax system. Bureacrtas exercising their judgments ultimately results in lobbies and defeats the very purpose of GST.

For people who understand the need for the above but think it’s difficult to do in one year, it is to be remembered that Milei has achieved far more in 1 year including permitting a multi-currency system within Argentina. And Milei started on a much worse platform than what India has today with monthly price inflation at 25%. Yes agreed, he campaigned and came to power on such a promise and hence had the political mandate to do what he has accomplished.

But as much as articulation has not been done to obtain the political mandate, the more important lacuna is the understanding among politicians and economic policymakers that “Limited Government and Balanced Budgets” offer the path to prosperity. Socialism, in whatever form and howsoever efficiently implemented, ultimately results in economic ruin.

Note:
1. Text in Blue points to additional data on the topic.
2. The views expressed here are those of the author and do not necessarily represent or reflect the views of PGurus.

Reference:

[1] The Keynesian Playbook – Eat your cake and have it too!! Are we at the end of the road? – Dec 12, 2024, PGurus.com

For all the latest updates, download PGurus App.

The post What has ailed India through the decades? appeared first on PGurus.