Rakesh Mohan
Moneycontrol Contributor
Former prime minister Atal Bihari Vajpayee, who passed away on August 16, was noted by his friends and political foes alike for his large-heartedness and ability to transcend ideological barriers across the political spectrum. It was these qualities, perhaps, that enabled him to carry out far-reaching economic reforms.
Such reforms could not have been implemented successfully without achieving the kind of broad consensus that he always sought across party lines, since his party did not enjoy an absolute majority at any time during his prime ministership.
I did not have the privilege of knowing Prime Minister Vajpayee personally, although I was appointed to a whole host of positions by him, including, among others, chief economic adviser to the finance ministry and deputy governor in the Reserve Bank of India (RBI). Having chaired the expert committee on infrastructure in the mid-1990s I was also associated with a number of initiatives carried out in the infrastructure sector by his government. In this piece I sketch out the broad sweep of economic reforms carried out his government. Let me start with infrastructure.
Infrastructure
The Vajpayee government undertook major infrastructure initiatives and the transformation of Indian roads can be attributed to him as a number of commentators have noted. The National Highway Development Project (NHDP), which began with the conceptualisation of the Golden Quadrilateral and the north-south and east-west highways, has already transformed the Indian transportation sector.
Investment in this expanded highway programme continues till today. As a complementary initiative, the Pradhan Mantri Gram Sadak Yojana (PMGSY) was also started almost at the same time. Thus the needs of the metropolitan national as well as the rural economy were addressed simultaneously. Both these ambitious programmes could be undertaken simultaneously because they were financed by the bold decision to introduce a fuel cess. Without the cess, funding for these investment programmes would not have been available.
Perhaps coincidentally, the infrastructure committee that I had chaired had recommended such a cess as the source of a non-lapsable fund for this purpose. Earmarking tax revenues for any purpose is against normal fiscal orthodoxy: I had argued that the cess was really a user charge, and that won the day against the fiscal purists.
Similarly, a number of commentators have recalled the very significant telecom reform carried out by Vajpayee’s government. Ironically, the problem that occurred in the late 1990s was not dissimilar to some of the problems in recent years.
In the initial auction for mobile telephony, a number of companies had bid clearly unrealistically high amounts in order to just capture the available licenses. It had become obvious that these companies would not be able to pay their committed obligations: if the government had insisted that they comply with their commitments they would have gone bankrupt and the progress of telecom connectivity would have suffered a severe setback. So the government was faced with a conundrum: re-contract with the same companies, giving rise to obvious moral hazard, or restart the telecom allocation process to new companies and set back the telecom rollout.
The actual bold solution implemented was to shift to a revenue sharing framework with the same companies: it is a measure of Vajpayee’s political skills that this could be done very smoothly without any accusations of corruption and wrongdoing. The result is now obvious with telecom being the most successful infrastructure story: tele-density in India now exceeds 90 percent, something that we could not even dream of at the turn of the century.
Membership of the Telecom Regulatory Authority of India (TRAI), among the various appointments that Vajpayee had bestowed on me, allows me to add a footnote to the story. Just after this episode, the issue of allotting licenses for new private sector landline companies arose.
Whereas the majority of TRAI voted to again recommend an auction for these new licenses, I issued a dissent note arguing for a fixed license fee and allotment of many licenses so that the new tariffs would not be burdened by the obligation of these new companies to pay-off high license fees. Vajpayee’s Prime Minister’s Office (PMO) agreed with my dissent note and that was the policy adopted.
This was perhaps the root of the later first-come-first-served policy with which the first United Progressive Alliance (UPA) government ran into great trouble in the 2G spectrum allocation process. The subsequent adoption of auction processes for spectrum allocation, once again, has resulted in excessively high bids which are now resulting in significant difficulties for the spectrum winners in the form of high debts. This is inhibiting new infrastructure investment in the sector.
The Vajpayee government initiated broad electricity reform with the enactment of the new Electricity Act 2003, which replaced an almost 100-year-old act. I was somewhat associated with this reform as well since the then electricity minister, the late Rangarajan Kumaramangalam, asked me as the director general of the National Council of Applied Economic Research (NCAER) to have the act drafted. Having no expertise in drafting legislation, the NCAER was reluctant. This was a bold departure from standard practice where almost all acts of drafted within the government.
Kumaramangalam, however, felt that his ministry’s bureaucracy was unwilling and incapable of an exercise that would result in significant reform, and insisted onNCAER taking up the exercise. We took up the challenge, with the help of the redoubtable Gajendra Haldea who conducted extensive consultations with all stakeholders, we submitted a draft to the ministry in less than two years. Unfortunately, Kumaramangalam passed away suddenly after a brief illness, but was ably succeeded by Suresh Prabhu who piloted the Bill successfully and got it passed in Parliament in 2003.
Among other far reaching provisions, this Act subsumed the earlier legislation that had established electricity regulatory commissions at both the central and state levels. This was yet another example of farsightedness and cross-party consultations which resulted in the enactment of forward-looking legislation that could modernise the power sector. Although the intentions of the Act have not been fully realised, it will remain a landmark legislation in the Indian infrastructure sector for decades to come.
The establishment of the Tariff Authority for Major Ports (TAMP), which set the stage for private investment in major ports, was another infrastructure initiative of the Vajpayee government. The tariffs levied by the port authorities had earlier been decided on by the central ministry of ports and shipping, and all investment in major ports was in the public sector. This initiative shifted the responsibility for setting tariffs to an independent authority, which was essential to attract private investment in major ports. Private investment has flourished since then. I was privileged to be a part-time member of the new authority. The 2001 budget speech announced the corporatisation of major ports, but this reform remains to be implemented by successor governments, and the archaic port trust structure persists.
All these infrastructure initiatives were examples of farsighted moves to make the Indian infrastructure sector more efficient, attractive to private investment and more independent from the government decision-making activities, particularly tariffs setting. It is notable that few such major game changing reforms have been carried out in subsequent years.
The most significant case in point is that of the Indian Railways. The expert group on Railways Reforms (which I had chaired) submitted comprehensive proposals to the Vajpayee government in 2001 for modernisation and expansion of the Indian Railways, including corporatisation. He was not able to muster up enough political consensus to even make a beginning. Despite at least three more major reports and many announcements, reforms remain to be carried out in the Indian Railways, including even the setting up of a tariff authority to free up rail tariff from political influence.
Fiscal reforms
The Vajpayee government was also very active in advancing the macro-economic reforms initiated by former Prime Minister Narasimha Rao and finance minister Manmohan Singh. The foundations for the Fiscal Responsibility and Budget Management (FRBM) Act were laid during this period. The continuity exhibited in the Indian economic reform process is signified by the fact that the FRBM Act was finally enacted by finance minister Chidambaram soon after the Manmohan Singh government came into power in 2004.
The original aim was to reduce the fiscal deficit to only 2 percent and the revenue deficit to zero within five years. However, the final Act did not have these provisions and we have not yet come anywhere near such objectives. The FRBM Act has, however, been very useful in providing a standard for identifying fiscal profligacy; especially since it proved to be ineffective in preventing the fiscal excesses of 2009-2013.
A noteworthy feature of the FRBM Act, which promotes the independence of RBI is its prohibition of the central bank subscribing directly to government securities. In the absence of this provision, the central government had resorted to automatic monetisation of its deficits almost continuously until the early 1990s.
The then ongoing excise tax reform begun after 1991 was taken forward through the establishment of the Central Value Added Tax (CENVAT) by the Vajpayee government which instituted a central rate of 16 percent which covered almost 90 percent of excise revenue. At the completion of this exercise in 2002, there were only a few items remaining at the 8 percent slab and some in the 24 percent slab.
This was a bold rationalisation that achieved tremendous simplification of a very complex excise tax structure. As a consequence, much of the annual lobbying for specific excise rates was eliminated over the following 15 years or so. The boldness of this reform can be appreciated from the use of multiple GST rates to achieve political consensus. Not surprisingly, the multiplicity of rates has renewed frantic lobbying once again for changing GST rates for very specific items.
Having achieved the CENVAT regime at the central excise level, the Vajpayee government, under finance minister Yashwant Sinha, embarked on a long drawn out process to carry out a similar simplification of state-level sales taxes.
The inspired innovation was the formation of the Empowered Committee of State Finance Ministers set up under the chairmanship of an opposition party finance minister from the then CPI(M)-governed West Bengal, Asim Dasgupta. This resulted in the announcement of the state VAT system finally implemented by the UPA I government under the stewardship of finance minister Chidambaram.
It is this process which has enabled the current GST tax regime to achieve an Indian common market. The GST council is a direct descendent of the empowered committee of state finance ministers originally reconstituted by the Vajpayee government. But the GST rate regime, unfortunately, failed to overcome the political pressures and abandoned the simplicity of the CENVAT rate structure.
Interest rates
Another major courageous reform undertaken during that period was the significant reduction in small savings interest rates. Whereas nominal levels of small savings interest rates had been changed over the 1990s, significant decline in inflation since the mid-1990s meant a large increase in real interest rates on these popular savings instruments widely used by the middle- and low-income classes. High real interest rates on savings accounts constrained the downward movement of both market and bank interest rates along with policy rates set by RBI, thereby severely constraining the resurgence of economic activity and investment.
Yashwant Sinha set up an expert committee, under then RBI deputy governor YV Reddy, which recommended the reduction of these rates based on a certain degree of market discipline. The government implemented these recommendations with alacrity, despite widespread popular and political opposition. This reform set in motion a low interest rate regime for the many following years, and also made the overall interest rate structure more market determined, making monetary policy-making and transmission much more effective.
Trade
On the trade front, the Vajpayee government continued the liberalisation process begun by Rao in 1991. Quantitative restrictions on imports, including consumer goods, were almost eliminated by 2004; and customs duties continued to be reduced. The “peak’ customs duty was reduced from 45 percent in 1998-99 budget speech to 20 percent in 2004-05 (It came to rest at 10 percent in 2008).
This continued throughout the Vajpayee regime even in the face of significant opposition from Indian business. The subsequent rapid expansion of Indian trade in the following eight years or so provides ample evidence to support the wisdom of this policy. Regrettably, some of these reforms have been reversed recently and protectionism has once again reared its ugly head.
In its quest to open the Indian economy and to promote trade, the Vajpayee government also began the process of participating in bilateral and other regional trade agreements. He set up the joint study group with the government of Singapore with the intention of establishing the India-Singapore Comprehensive Economic Cooperation Agreement (CECA), and another one with the government of Sri Lanka to establish a Comprehensive Economic Partnership Agreement. I was privileged to be appointed as the joint chair from the Indian side in both those study groups.
The India-Singapore CECA was later implemented by the UPA I government soon after coming to power. These initial discussions set the stage for later initiatives by successive governments on similar free-trade agreements with the ASEAN and others. They also served as a signal of India’s confidence and that it was open for business.
Some failed initiatives
Inevitably, there were also a number of failed reform announcements, some of which continue to hobble the Indian economy.
Few remember that the 2001 budget speech announced major labour market reforms through a proposed amendment of the Industrial Disputes Act that would have increased the floor level of firms subject to the provisions of the Act from 100 workers to 1,000. It had also provided for 45 days of wages for each year served as compensation to any workers who would have to be laid off. Had this announcement been implemented the course of Indian industry might have changed for the better, with increased investment in labour-using manufacturing. Employment in organised sector manufacturing may not have stagnated as it has and Indian exports could have exhibited a much greater presence in the world of trade.
Alas, this reform is yet to see the light of day. Similarly, petroleum price deregulation, decontrol of the sugar and fertiliser industries were also announced. Of these, only the petroleum price deregulation has been implemented by the current government; other reforms remain in abeyance.
The Vajpayee government exemplified the determined continuity of the economic reform process initiated by Rao in 1991, after the 1996-99 interregnum due to political instability.
Many of the reforms would not have succeeded without sagacious political leadership reaching out across the aisle to engage in consultation, discussion, and compromise. The design of the reforms was also aided by seeking out all available economic expertise. Economic technocrats were given the space to provide advice without fear or favor.
If the Indian economy is to move forward, a similar atmosphere of consultation, discussion and utilisation of technical expertise by the political and civil service leadership is indispensable.
The author is senior fellow, Jackson Institute for Global Affairs, Yale University, and distinguished fellow, Brookings India. The views expressed in this article are personal.
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