INDIA'S ECONOMY HAS MADE great strides in the years since independence. In 1947 the country was poor and shattered by the violence and economic and physical disruption involved in the partition from Pakistan. The economy had stagnated since the late nineteenth century, and industrial development had been restrained to preserve the area as a market for British manufacturers. In fiscal year (FY--see Glossary) 1950, agriculture, forestry, and fishing accounted for 58.9 percent of the gross domestic product (GDP--see Glossary) and for a much larger proportion of employment. Manufacturing, which was dominated by the jute and cotton textile industries, accounted for only 10.3 percent of GDP at that time.
India's new leaders sought to use the power of the state to direct economic growth and reduce widespread poverty. The public sector came to dominate heavy industry, transportation, and telecommunications. The private sector produced most consumer goods but was controlled directly by a variety of government regulations and financial institutions that provided major financing for large private-sector projects. Government emphasized self-sufficiency rather than foreign trade and imposed strict controls on imports and exports. In the 1950s, there was steady economic growth, but results in the 1960s and 1970s were less encouraging.
Beginning in the late 1970s, successive Indian governments sought to reduce state control of the economy. Progress toward that goal was slow but steady, and many analysts attributed the stronger growth of the 1980s to those efforts. In the late 1980s, however, India relied on foreign borrowing to finance development plans to a greater extent than before. As a result, when the price of oil rose sharply in August 1990, the nation faced a balance of payments crisis. The need for emergency loans led the government to make a greater commitment to economic liberalization than it had up to this time. In the early 1990s, India's postindependence development pattern of strong centralized planning, regulation and control of private enterprise, state ownership of many large units of production, trade protectionism, and strict limits on foreign capital was increasingly questioned not only by policy makers but also by most of the intelligentsia.
As India moved into the mid-1990s, the economic outlook was mixed. Most analysts believed that economic liberalization would continue, although there was disagreement about the speed and scale of the measures that would be implemented. It seemed likely that India would come close to or equal the relatively impressive rate of economic growth attained in the 1980s, but that the poorest sections of the population might not benefit.
Growth since 1980
The rate of growth improved in the 1980s. From FY 1980 to FY 1989, the economy grew at an annual rate of 5.5 percent, or 3.3 percent on a per capita basis. Industry grew at an annual rate of 6.6 percent and agriculture at a rate of 3.6 percent. A high rate of investment was a major factor in improved economic growth. Investment went from about 19 percent of GDP in the early 1970s to nearly 25 percent in the early 1980s. India, however, required a higher rate of investment to attain comparable economic growth than did most other low-income developing countries, indicating a lower rate of return on investments. Part of the adverse Indian experience was explained by investment in large, long-gestating, capital-intensive projects, such as electric power, irrigation, and infrastructure. However, delayed completions, cost overruns, and under-use of capacity were contributing factors.
Private savings financed most of India's investment, but by the mid-1980s further growth in private savings was difficult because they were already at quite a high level. As a result, during the late 1980s India relied increasingly on borrowing from foreign sources (see Aid, this ch.). This trend led to a balance of payments crisis in 1990; in order to receive new loans, the government had no choice but to agree to further measures of economic liberalization. This commitment to economic reform was reaffirmed by the government that came to power in June 1991.
India's primary sector, including agriculture, forestry, fishing, mining, and quarrying, accounted for 32.8 percent of GDP in FY 1991 (see table 17, Appendix). The size of the agricultural sector and its vulnerability to the vagaries of the monsoon cause relatively large fluctuations in the sector's contribution to GDP from one year to another (see Crop Output, ch. 7).
In FY 1991, the contribution to GDP of industry, including manufacturing, construction, and utilities, was 27.4 percent; services, including trade, transportation, communications, real estate and finance, and public- and private-sector services, contributed 39.8 percent. The steady increase in the proportion of services in the national economy reflects increased market-determined processes, such as the spread of rural banking, and government activities, such as defense spending (see Agricultural Credit, ch. 7; Defense Spending, ch. 10).
Despite a sometimes disappointing rate of growth, the Indian economy was transformed between 1947 and the early 1990s. The number of kilowatt-hours of electricity generated, for example, increased more than fiftyfold. Steel production rose from 1.5 million tons a year to 14.7 million tons a year. The country produced space satellites and nuclear-power plants, and its scientists and engineers produced an atomic explosive device (see Major Research Organizations, this ch.; Space and Nuclear Programs, ch. 10). Life expectancy increased from twenty-seven years to fifty-nine years. Although the population increased by 485 million between 1951 and 1991, the availability of food grains per capita rose from 395 grams per day in FY 1950 to 466 grams in FY 1992 (see Structure and Dynamics, ch. 2).
However, considerable dualism remains in the Indian economy. Officials and economists make an important distinction between the formal and informal sectors of the economy. The informal, or unorganized, economy is largely rural and encompasses farming, fishing, forestry, and cottage industries. It also includes petty vendors and some small-scale mechanized industry in both rural and urban areas. The bulk of the population is employed in the informal economy, which contributes more than 50 percent of GDP. The formal economy consists of large units in the modern sector for which statistical data are relatively good. The modern sector includes large-scale manufacturing and mining, major financial and commercial businesses, and such public-sector enterprises as railroads, telecommunications, utilities, and government itself.
The greatest disappointment of economic development is the failure to reduce more substantially India's widespread poverty. Studies have suggested that income distribution changed little between independence and the early 1990s, although it is possible that the poorer half of the population improved its position slightly. Official estimates of the proportion of the population that lives below the poverty line tend to vary sharply from year to year because adverse economic conditions, especially rises in food prices, are capable of lowering the standard of living of many families who normally live just above the subsistence level. The Indian government's poverty line is based on an income sufficient to ensure access to minimum nutritional standards, and even most persons above the poverty line have low levels of consumption compared with much of the world.
Estimates in the late 1970s put the number of people who lived in poverty at 300 million, or nearly 50 percent of the population at the time. Poverty was reduced during the 1980s, and in FY 1989 it was estimated that about 26 percent of the population, or 220 million people, lived below the poverty line. Slower economic growth and higher inflation in FY 1990 and FY 1991 reversed this trend. In FY 1991, it was estimated that 332 million people, or 38 percent of the population, lived below the poverty line.
Farmers and other rural residents make up the large majority of India's poor. Some own very small amounts of land while others are field hands, seminomadic shepherds, or migrant workers. The urban poor include many construction workers and petty vendors. The bulk of the poor work, but low productivity and intermittent employment keep incomes low. Poverty is most prevalent in the states of Orissa, Bihar, Uttar Pradesh, and Madhya Pradesh, and least prevalent in Haryana, Punjab, Himachal Pradesh, and Jammu and Kashmir.
By the early 1990s, economic changes led to the growth in the number of Indians with significant economic resources. About 10 million Indians are considered upper class, and roughly 300 million are part of the rapidly increasing middle class. Typical middle-class occupations include owning a small business or being a corporate executive, lawyer, physician, white-collar worker, or land-owning farmer. In the 1980s, the growth of the middle class was reflected in the increased consumption of consumer durables, such as televisions, refrigerators, motorcycles, and automobiles. In the early 1990s, domestic and foreign businesses hoped to take advantage of India's economic liberalization to increase the range of consumer products offered to this market.
Housing and the ancillary utilities of sewer and water systems lag considerably behind the population's needs. India's cities have large shantytowns built of scrap or readily available natural materials erected on whatever space is available, including sidewalks. Such dwellings lack piped water, sewerage, and electricity. The government has attempted to build housing facilities and utilities for urban development, but the efforts have fallen far short of demand. Administrative controls and other aspects of government policy have discouraged many private investors from constructing housing units.
Liberalization in the Early 1990s
Increased borrowing from foreign sources in the late 1980s, which helped fuel economic growth, led to pressure on the balance of payments. The problem came to a head in August 1990 when Iraq invaded Kuwait, and the price of oil soon doubled. In addition, many Indian workers resident in Persian Gulf states either lost their jobs or returned home out of fear for their safety, thus reducing the flow of remittances (see Size and Composition of the Work Force, this ch.). The direct economic impact of the Persian Gulf conflict was exacerbated by domestic social and political developments. In the early 1990s, there was violence over two domestic issues: the reservation of a proportion of public-sector jobs for members of Scheduled Castes (see Glossary) and the Hindu-Muslim conflict at Ayodhya (see Public Worship, ch. 3; Political Issues, ch. 8). The central government fell in November 1990 and was succeeded by a minority government. The cumulative impact of these events shook international confidence in India's economic viability, and the country found it increasingly difficult to borrow internationally. As a result, India made various agreements with the International Monetary Fund (IMF--see Glossary) and other organizations that included commitments to speed up liberalization (see United Nations, ch. 9).
In the early 1990s, considerable progress was made in loosening government regulations, especially in the area of foreign trade. Many restrictions on private companies were lifted, and new areas were opened to private capital. However, India remains one of the world's most tightly regulated major economies. Many powerful vested interests, including private firms that have benefited from protectionism, labor unions, and much of the bureaucracy, oppose liberalization. There is also considerable concern that liberalization will reinforce class and regional economic disparities.
The balance of payments crisis of 1990 and subsequent policy changes led to a temporary decline in the GDP growth rate, which fell from 6.9 percent in FY 1989 to 4.9 percent in FY 1990 to 1.1 percent in FY 1991. In March 1995, the estimated growth rate for FY 1994 was 5.3 percent. Inflation peaked at 17 percent in FY 1991, fell to 9.5 percent in FY 1993, and then accelerated again, reaching 11 percent in late FY 1994. This increase was attributed to a sharp increase in prices and a shortfall in such critical sectors as sugar, cotton, and oilseeds. Many analysts agree that the poor suffer most from the increased inflation rate and reduced growth rate.
The Role of Government
Early Policy Developments
Many early postindependence leaders, such as Nehru, were influenced by socialist ideas and advocated government intervention to guide the economy, including state ownership of key industries. The objective was to achieve high and balanced economic development in the general interest while particular programs and measures helped the poor. India's leaders also believed that industrialization was the key to economic development. This belief was all the more convincing in India because of the country's large size, substantial natural resources, and desire to develop its own defense industries.
The Industrial Policy Resolution of 1948 gave government a monopoly in armaments, atomic energy, and railroads, and exclusive rights to develop minerals, the iron and steel industries, aircraft manufacturing, shipbuilding, and manufacturing of telephone and telegraph equipment. Private companies operating in those fields were guaranteed at least ten years more of ownership before the government could take them over. Some still operate as private companies.
The Industrial Policy Resolution of 1956 greatly extended the preserve of government. There were seventeen industries exclusively in the public sector. The government took the lead in another twelve industries, but private companies could also engage in production. This resolution covered industries producing capital and intermediate goods. As a result, the private sector was relegated primarily to production of consumer goods. The public sector also expanded into more services. In 1956 the life insurance business was nationalized, and in 1973 the general insurance business was also acquired by the public sector. Most large commercial banks were nationalized in 1969. Over the years, the central and state governments formed agencies, and companies engaged in finance, trading, mineral exploitation, manufacturing, utilities, and transportation. The public sector was extensive and influential throughout the economy, although the value of its assets was small relative to the private sector.
Controls over prices, production, and the use of foreign exchange, which were imposed by the British during World War II, were reinstated soon after independence. The Industries (Development and Regulation) Act of 1951 and the Essential Commodities Act of 1955 (with subsequent additions) provided the legal framework for the government to extend price controls that eventually included steel, cement, drugs, nonferrous metals, chemicals, fertilizer, coal, automobiles, tires and tubes, cotton textiles, food grains, bread, butter, vegetable oils, and other commodities. By the late 1950s, controls were pervasive, regulating investment in industry, prices of many commodities, imports and exports, and the flow of foreign exchange.
Export growth was long ignored. The government's extensive controls and pervasive licensing requirements created imbalances and structural problems in many parts of the economy. Controls were usually imposed to correct specific problems but often without adequate consideration of their effect on other parts of the economy. For example, the government set low prices for basic foods, transportation, and other commodities and services, a policy designed to protect the living standards of the poor. However, the policy proved counterproductive when the government also limited the output of needed goods and services. Price ceilings were implemented during shortages, but the ceiling frequently contributed to black markets in those commodities and to tax evasion by black-market participants. Import controls and tariff policy stimulated local manufacturers toward production of import-substitution goods, but under conditions devoid of sufficient competition or pressure to be efficient.
Private trading and industrial conglomerates (the so-called large houses) existed under the British and continued after independence. The government viewed the conglomerates with suspicion, believing that they often manipulated markets and prices for their own profit. After independence the government instituted licensing controls on new businesses, especially in manufacturing, and on expanding capacity in existing businesses. In the 1960s, when shortages of goods were extensive, considerable criticism was leveled at traders for manipulating markets and prices. The result was the 1970 Monopolies and Restrictive Practices Act, which was designed to provide the government with additional information on the structure and investments of all firms that had assets of more than Rs200 million (for value of the rupee--see Glossary), to strengthen the licensing system in order to decrease the concentration of private economic power, and to place restraints on certain business practices considered contrary to the public interest. The act emphasized the government's aversion to large companies in the private sector, but critics contended that the act resulted from political motives and not from a strong case against big firms. The act and subsequent enforcement restrained private investment.
The extensive controls, the large public sector, and the many government programs contributed to a substantial growth in the administrative structure of government. The government also sought to take on many of the unemployed. The result was a swollen, inefficient bureaucracy that took inordinate amounts of time to process applications and forms. Business leaders complained that they spent more time getting government approval than running their companies. Many observers also reported extensive corruption in the huge bureaucracy. One consequence was the development of a large underground economy in small-scale enterprises and the services sector.
India's current economic reforms began in 1985 when the government abolished some of its licensing regulations and other competition-inhibiting controls. Since 1991 more "new economic policies" or reforms have been introduced. Reforms include currency devaluations and making currency partially convertible, reduced quantitative restrictions on imports, reduced import duties on capital goods, decreases in subsidies, liberalized interest rates, abolition of licenses for most industries, the sale of shares in selected public enterprises, and tax reforms. Although many observers welcomed these changes and attributed the faster growth rate of the economy in the late 1980s to them, others feared that these changes would create more problems than they solved. The growing dependence of the economy on imports, greater vulnerability of its balance of payments, reliance on debt, and the consequent susceptibility to outside pressures on economic policy directions caused concern. The increase in consumerism and the display of conspicuous wealth by the elite exacerbated these fears.
The pace of liberalization increased after 1991. By the mid-1990s, the number of sectors reserved for public ownership was slashed, and private-sector investment was encouraged in areas such as energy, steel, oil refining and exploration, road building, air transportation, and telecommunications. An area still closed to the private sector in the mid-1990s was defense industry. Foreign-exchange regulations were liberalized, foreign investment was encouraged, and import regulations were simplified. The average import-weighted tariff was reduced from 87 percent in FY 1991 to 33 percent in FY 1994. Despite these changes, the economy remained highly regulated by international standards. The import of many consumer goods was banned, and the production of 838 items, mostly consumer goods, was reserved for companies with total investment of less than Rs6 million. Although the government had sold off minority stakes in public-sector companies, it had not in 1995 given up control of any enterprises, nor had any of the loss-making public companies been closed down. Moreover, although import duties had been lowered substantially, they were still high compared to most other countries.
Political successes in the mid-1990s by nationalist-oriented political parties led to some backlash against foreign investment in some parts of India (see Political Parties, ch. 8). In early 1995, official charges of serving adulterated products were made against a KFC outlet in Bangalore, and Pepsi-Cola products were smashed and advertisements defaced in New Delhi. The most serious backlash occurred in Maharashtra in August 1995 when the Bharatiya Janata Party (BJP--Indian People's Party)-led state government halted construction of a US$2.8 million 2,015-megawatt gas-fired electric-power plant being built near Bombay (Mumbai in the Marathi language) by another United States company, Enron Corporation.
Finance
The early governments after independence operated with only modest budget deficits, but in the 1970s and 1980s the amount of the budget deficit as a proportion of GDP increased gradually, reaching 8.4 percent in FY 1990. Following economic reforms, the deficit declined to 6.7 percent by FY 1994. More than 80 percent of the public debt was financed from domestic sources, but the proportion of foreign debt rose steadily in the late 1980s. However, although foreign aid to India was substantial, it was much lower than most other developing countries when calculated on a per capita basis. Banking and credit were dominated by government-controlled institutions, but the importance of the private sector in financial services was increasing slowly.
Budget
India's public finance system follows the British pattern. The constitution establishes the supremacy of the bicameral Parliament--specifically the Lok Sabha (House of the People)--in financial matters. No central government taxes are levied and no government expenditure from public funds disbursed without an act of Parliament, which also scrutinizes and audits all government accounts to ensure that expenditures are legally authorized and properly spent. Proposals for taxation or expenditures, however, may be initiated only within the Council of Ministers--specifically by the minister of finance. The minister of finance is required to submit to Parliament, usually on the last day of February, a financial statement detailing the estimated receipts and expenditures of the central government for the forthcoming fiscal year and a financial review of the current fiscal year.
The Lok Sabha has one month to review and modify the government's budget proposals. If by April 1, the beginning of the fiscal year, the parliamentary discussion of the budget has not been completed, the budget as proposed by the minister of finance goes into effect, subject to retroactive modifications after the parliamentary review. On completion of its budget discussions, the Lok Sabha passes the annual appropriations act, authorizing the executive to spend money, and the finance act, authorizing the executive to impose and collect taxes. Supplemental requests for funds are presented during the course of the fiscal year to cover emergencies, such as war or other catastrophes. The bills are forwarded to the Rajya Sabha (Council of States--the upper house of Parliament) for comment. The Lok Sabha, however, is not bound by the comments, and the Rajya Sabha cannot delay passage of money bills. When signed by the president, the bills become law. The Lok Sabha cannot increase the request for funds submitted by the executive, nor can it authorize new expenditures. Taxes passed by Parliament may be retroactive.
Each state government maintains its own budget, prepared by the state's minister of finance in consultation with appropriate officials of the central government. Primary control over state finances rests with the state legislature in the same manner as at the central government level. State finances are supervised by the central government, however, through the comptroller and the auditor general; the latter reviews state government accounts annually and reports the findings to the appropriate state governor for submission to the state's legislature. The central and state budgets consist of a budget for current expenditures, known as the budget on revenue account, and a capital budget for economic and social development expenditures.
The national railroad (Indian Railways), the largest public-sector enterprise, and the Department of Posts and Telegraph have their own budgets, funds, and accounts (see Railroads; Telecommunications, this ch.). The appropriations and disbursements under their budgets are subject to the same form of parliamentary and audit control as other government revenues and expenditures. Dividends accrue to the central government, and deficits are subsidized by it, a pattern that holds true also, directly or indirectly, for other government enterprises.
During the eighth plan, the states were expected to spend nearly Rs1.9 trillion, or 42.9 percent of the public outlay. Because of its greater revenue sources, the central government shared with the states its receipts from personal income taxes and certain excise taxes. It also collected other minor taxes, the total proceeds of which were transferred to the states. The division of the shared taxes is determined by financial commissions established by the president, usually at five-year intervals. In the early 1990s, the states received 75 percent of the revenue collected from income taxes and around 43 percent of the excise taxes. The central government also provided the states with grants to meet their commitments. In FY 1991, these grants and the states' share of taxes collected by the central government amounted to 40.9 percent of the total revenue of state governments.
The states' share of total public revenue collected declined from 48 percent in FY 1955 to about 42 percent in the late 1970s, and to about 33 percent in the early 1990s. An important cause of the decline was the diminished importance of the land revenue tax, which traditionally had been the main direct tax on agriculture. This tax declined from 8 percent of all state and central tax revenues in FY 1950 to less than 1 percent in the 1980s and early 1990s. The states have jurisdiction over taxes levied on land and agricultural income, and vested interests exerted pressure on the states not to raise agricultural taxation. As a result, in the 1980s and early 1990s agriculture largely escaped significant taxation, although there has long been nationwide discussion about increasing land taxes or instituting some sort of tax on incomes of the richer portion of the farm community. The share of direct taxes in GDP increased from 2.1 percent in FY 1991 to 2.8 percent in FY 1994.
Since independence government has favored more politically palatable indirect taxes--customs and excise duties--over direct taxes. In the 1980s and early 1990s, indirect taxes accounted for around 75 percent of all tax revenue collected by the central government. State governments relied heavily on sales taxes. Overall, indirect taxes accounted for 84.1 percent of all government tax revenues in FY 1990. Total government tax revenues amounted to 17.1 percent of GDP in that year, up from 9.0 percent in FY 1960, 11.5 percent in FY 1970, and 14.9 percent in FY 1980. In FY 1990, the share of the public sector in GDP was 26.4 percent. In terms of rupees (in current prices), total government income rose from Rs259.8 billion in FY 1981 to Rs1.3 trillion in FY 1992 (see table 18, Appendix).
Comprehensive tax reforms were implemented with the FY 1985 budget. Corporate tax was cut, income taxes simplified and lowered for high-income groups, and wealth taxes reduced. Tax receipts in FY 1985 rose by 20 percent over FY 1984 as a result of tightened enforcement, and taxpayers responded to lower taxes with greater compliance. In FY 1986, another major change was made with the launching of a long-term program of tax reform designed to eliminate annual changes, which had produced uncertainty. However, in FY 1987, when the monsoon failed, the government raised taxes on higher income groups. The emergency budget of FY 1991, designed to cope with the nation's 1990 balance of payments crisis, increased indirect and corporate taxes, but the budgets for FY 1992 and FY 1993 reflected the policy of economic liberalization. They reduced and simplified direct taxes, removed the wealth tax from financial investments, and indexed the capital gains tax. The highest marginal rate of personal income tax was 42.5 percent in FY 1992.
Fiscal Administration
Historically, the Indian government has pursued a cautious policy with regard to financing budgets, allowing only small amounts of deficit spending. Budget deficits increased in the late 1980s, and the necessity of financing these deficits from foreign borrowing contributed to the 1990 balance of payments crisis. The central government budget deficit reached 8.4 percent of GDP in FY 1990, up from 2.6 percent in FY 1970, 5.9 percent in FY 1980, and 7.8 percent in FY 1989. The deficit was cut to 5.9 percent in FY 1991 and 5.2 percent in FY 1992, but widened to 7.4 percent in FY 1993. It was expected to recede to 6.2 percent in FY 1995.
The central government's budget deficits during the 1980s increased the total public debt rapidly until in FY 1991 it stood at Rs3.9 trillion. The bulk of this debt was owed to citizens and domestic institutions and firms, particularly the central bank. Readers of Indian monetary statistics should be alert to the use of the terms lakh (see Glossary) and crore (see Glossary), which are used to express higher numbers.
Monetary Process
The basic elements of the financial system were established during British rule (1757-1947). The national currency, the rupee, had long been used domestically before independence and even circulated abroad, for example, in the Persian Gulf region. Foreign banks, mainly British and including some from such other parts of the empire as Hong Kong, provided banking and other services. The Reserve Bank of India was formed in 1935 as a private bank, but it also carried out some central bank functions. This colonial banking system, however, was geared to foreign trade and short-term loans. Banking was concentrated in the major port cities.
The Reserve Bank was nationalized on January 1, 1949, and given broader powers. It was the bank of issue for all rupee notes higher than the one-rupee denomination; the agent of the Ministry of Finance in controlling foreign exchange; and the banker to the central and state governments, commercial banks, state cooperative banks, and other financial institutions. The Reserve Bank formulated and administered monetary policy to promote stable prices and higher production. It was given increasing responsibilities for the development of banking and credit and to coordinate banking and credit with the five-year plans. The Reserve Bank had a number of tools with which to affect commercial bank credit.
After independence the government sought to adapt the banking system to promote development and formed a number of specialized institutions to provide credit to industry, agriculture, and small businesses. Banking penetrated rural areas, and agricultural and industrial credit cooperatives were promoted. Deposit insurance and a system of postal savings banks and offices fostered use by small savers. Subsidized credit was provided to particular groups or activities considered in need and which deserved such help. A credit guarantee corporation covered loans by commercial banks to small traders, transport operators, self-employed persons, and other borrowers not otherwise effectively covered by major institutions. The system effectively reached all kinds of savers and provided credit to many different customers.
The government nationalized fourteen major private commercial banks in 1969 and six more in 1980. Nationalization forced commercial banks increasingly to meet the credit requirements of the weaker sections of the nation and to eliminate monopolization by vested interests of large industry, trade, and agriculture.
The banking system expanded rapidly after nationalization. The number of bank branches, for instance, increased from about 7,000 in 1969 to more than 60,000 in 1994, two-thirds of which were in rural areas. The deposit base rose from Rs50 billion in 1969 to around Rs3.5 trillion in 1994. Nevertheless, currency accounted for well over 50 percent of all the money supply circulating among the public. In 1992 the nationalized banks held 93 percent of all deposits.
In FY 1990, twenty-three foreign banks operated in India. The most important were ANZ Grindlays Bank, Citibank, the Hongkong and Shanghai Banking Corporation, and Standard Chartered Bank.
Public-sector banks are required to reserve their lending based on 40 percent of their deposits for priority sectors, especially agriculture, at favorable rates. In addition, 35 percent of their deposits have to be held in liquid form to satisfy statutory liquidity requirements, and 15 percent are needed to meet the cash reserve requirements of the Reserve Bank. Both these percentages represent an easing of earlier requirements, but only a small proportion of public-sector banks' resources can be deployed freely. In late 1994, the rate of interest on bank loans was deregulated, but deposit rates were still subject to ceilings.
More than 50 percent of bank lending is to the government sector. With the onset of economic reform, India's banks were experiencing major financial losses as the result of low productivity, bad loans, and poor capitalization. Seeking to stabilize the banking industry, the Reserve Bank of India developed new reporting formats and has initiated takeovers and mergers of smaller banks that were operating with financial losses.
India has a rapidly expanding stock market that in 1993 listed around 5,000 companies in fourteen stock exchanges, although only the stocks of about 400 of these companies were actively traded. Financial institutions and government bodies controlled an estimated 45 percent of all listed capital. In April 1992, the Bombay stock market, the nation's largest with a market capital of US$65.1 billion, collapsed, in part because of revelations about financial malpractice amounting to US$2 billion. Afterward, the Securities and Exchange Board of India, the government's capital market regulator, implemented reforms designed to strengthen investor confidence in the stock market. In the mid-1990s, foreign institutional investors took greater interest than ever before in the Indian stock markets, investing around US$2 billion in FY 1993 alone.
Despite increases in energy costs and other pressures from the world economy, for most of the period since independence India has not experienced severe inflation. The underlying average rate of inflation, however, has tended to rise. Consumer prices rose at an annual average of 2.1 percent in the 1950s, 6.3 percent in the 1960s, 7.8 percent in the 1970s, and 8.5 percent in the 1980s.
Three factors lay behind India's relative price stability. First, the government has intervened, either directly or indirectly, to keep stable the price of certain staples, including wheat, rice, cloth, and sugar. Second, monetary regulation has restricted growth in the money supply. Third, the overall influence of the labor unions on wages has been small because of the weakness of the unions in India's labor surplus economy.
Foreign Economic Relations
Aid
Since independence India has had to draw on foreign investments to finance part of its economic development. Although the government has attempted to be as self-reliant as possible, the absolute amount of foreign aid received has been high. In per capita terms, however, it has been much less than most other developing countries receive.
In August 1958, the World Bank (see Glossary) organized the Aid-to-India Consortium, consisting of the World Bank Group and thirteen countries: Austria, Belgium, Britain, Canada, Denmark, the Federal Republic of Germany (at that time, West Germany), France, Italy, Japan, the Netherlands, Norway, Sweden, and the United States. The consortium was formed to coordinate aid and establish priorities among India's major sources of foreign assistance and to simplify India's requests for aid based on its plans for development. Consortium aid was bilateral government-to-government aid from the thirteen consortium countries, and almost all of the aid, including that from the World Bank Group, was for specific projects judged to be valuable contributions to India's development. Of the Rs630 billion in aid authorized by all aid donors between FY 1974 and FY 1989, more than 60 percent was provided by the consortium.
Collectively, the Western nations have donated a substantial amount of aid to India. In 1980 this aid totaled nearly US$1.5 billion and reached US$2.5 billion in 1990. In 1992 Western aid reached a new height: US$3.9 billion, which represented 49.8 percent of all Western multilateral and bilateral aid given to South Asian nations that year. The largest bilateral donor is Japan. Between 1984 and 1993, Japan's official development assistance grants to India totaled US$337 million. Much greater than the outright grants has been Japan's large-scale loan program, which supports economic infrastructure development (power plants and delivery systems, and road improvement) and environmental protection. Between 1984 and 1993, Japanese loans to India totaled nearly US$2.4 billion. A ¥125 billion (US$1.2 billion) loan financing major projects was granted in December 1994, bringing Japanese loans to India since 1957 to a total of ¥1.6 trillion.
United States assistance was significant in the late 1950s and 1960s but, because of strained India-United States relations, fell off sharply in the 1970s (see United States, ch. 9). The United States accounted for 8.6 percent of all of the aid India received from independence through FY 1988, but for only 0.7 percent in FY 1989 and 0.6 percent in FY 1990. United States aid to India remained relatively insignificant in the early 1990s when it took the form of grants for food aid and consultants in a wide variety of economic growth areas, such as computers, steel, telecommunications, and energy production. In FY 1993, actual United States obligations through the United States Agency for International Development totaled almost US$161 million. The bulk of this aid was provided as United States Public Law 480 food aid grants with lesser amounts for development assistance (including energy and the environment, population control, child survival, acquired immune deficiency syndrome (AIDS) prevention, and economic growth) and housing guaranty loans. Germany and Britain also have substantial aid-to-India programs.
Among countries not in the World Bank consortium, the Soviet Union was the most important contributor, providing more than 16 percent of all aid between 1947 and FY 1988. Since 1991, however, Russia has provided little aid.
About 90 percent of all aid received by India has been in the form of loans. Aid disbursements from all providers for FY 1990 were Rs67 billion.
India maintains a small but well-established foreign aid program of its own. In FY 1990, Rs1.6 billion of aid was authorized, of which Rs582 million was for Bhutan and Rs578 million for Nepal. Bangladesh and Vietnam received significant amounts of aid during the 1980s, but, as the result of changing world political and economic conditions, these programs were small by the early 1990s (see South Asia; Southeast Asia, ch. 9).
Trade
Despite its size, India plays a relatively small role in the world economy. Until the 1980s, the government did not make exports a priority. In the 1950s and 1960s, Indian officials believed that trade was biased against developing countries and that prospects for exports were severely limited. Therefore, the government aimed at self-sufficiency in most products through import substitution, with exports covering the cost of residual import requirements. Foreign trade was subjected to strict government controls, which consisted of an all-inclusive system of foreign exchange and direct controls over imports and exports. As a result, India's share of world trade shrank from 2.4 percent in FY 1951 to 0.4 percent in FY 1980. Largely because of oil price increases in the 1970s, which contributed to balance of payments difficulties, governments in the 1970s and 1980s placed more emphasis on the promotion of exports. They hoped exports would provide foreign exchange needed for the import of oil and high-technology capital goods. Nevertheless, in the early 1990s India's share of world trade stood at only 0.5 percent. In FY 1992, imports accounted for 9.3 percent of GDP and exports for 7.7 percent of GDP.
Based on trends throughout the 1980s and early 1990s, it appears likely that the balance of trade will remain negative for the foreseeable future (see table 19, Appendix). The 1979 increase in the price of oil produced a Rs58.4 billion deficit in FY 1980, close to 5 percent of GNP. The deficit was barely reduced in nominal rupee terms over the next five years, although it improved considerably as a share of GNP (to 2.3 percent in FY 1984) and in dollar terms (from US$7.4 billion in FY 1980 to US$4.3 billion in FY 1984). Pressure on the balance of trade continued through the late 1980s and worsened with the attempted annexation of Kuwait by Iraq in August 1990, which led to a temporary but sharp increase in the price of oil. In FY 1990, the balance of trade deficit reached a record level in rupees (Rs106.5 billion) and in dollars (US$6 billion). Import controls and devaluation of the rupee allowed the trade deficit to fall to US$1.6 billion in FY 1991. However, it widened to US$3.3 billion in FY 1992 before falling to an estimated US$1 billion in FY 1993. However, one optimistic sign, noted by India's minister of finance in March 1995, was that exports had come to finance 90 percent of India's imports, compared with only 60 percent in the mid-1980s.
No one product dominates India's exports. In FY 1993, handicrafts, gems, and jewelry formed the most important sector and accounted for an estimated US$4.9 billion (22.2 percent) of exports. Since the early 1990s, India has become the world's largest processor of diamonds (imported in the rough from South Africa and then fabricated into jewelry for export). Along with other semiprecious commodities, such as gold, India's gems and jewelry accounted for 11 percent of its foreign-exchange receipts in early 1993. Textiles and ready-made garments combined were also an important category, accounting for an estimated US$4.1 billion (18.5 percent) of exports. Other significant exports include industrial machinery, leather products, chemicals and related products (see table 20, Appendix).
The dominant imports are petroleum products, valued in FY 1993 at nearly US$5.8 billion, or 24.7 percent of principal imports, and capital goods, amounting to US$4.2 billion, or 21.8 percent of principal imports. Other important import categories are chemicals, dyes, plastics, pharmaceuticals, uncut precious stones, iron and steel, fertilizers, nonferrous metals, and pulp paper and paper products (see table 21, Appendix).
India's most important trading partners are the United States, Japan, the European Union, and nations belonging to the Organization of the Petroleum Exporting Countries (OPEC). From the 1950s until 1991, India also had close trade links with the Soviet Union, but the breakup of that nation into fifteen independent states led to a decline of trade with the region. In FY 1993, some 30 percent of all imports came from the European Union, 22.4 percent from OPEC nations, 11.7 percent from the United States, and 6.6 percent from Japan. In that same year, 26 percent of all exports were to the European Union, 18 percent to the United States, 7.8 percent to Japan, and 10.7 to the OPEC nations (see table 22, Appendix).
Trade and investment with the United States seemed likely to experience an upswing following a January 1995 trade mission from the United States led by Secretary of Commerce Ronald H. Brown and including top executives from twenty-six United States companies. During the weeklong visit, some US$7 billion in business deals were agreed on, mostly in the areas of infrastructure development, transportation, power and communication systems, food processing, health care services, insurance and financing projects, and automotive catalytic converters. In turn, greater access for Indian goods in United States markets was sought by Indian officials.
In February 1995, in a bid to improve commercial prospects in Southeast Asia, India signed a four-part agreement with the Association of Southeast Asian Nations (ASEAN--see Glossary). The pact covers trade, investment, science and technology, and tourism, and there are prospects for further agreements on joint ventures, banks, and civil aviation.
India's balance of payments position is closely related to the balance of trade. Foreign aid and remittances from Indians employed overseas, however, make the balance of payments more favorable than the balance of trade (see Size and Composition of the Work Force, this ch.).
Foreign-Exchange System
The central government has wide powers to control transactions in foreign exchange. Until 1992 all foreign investments and the repatriation of foreign capital required prior approval of the government. The Foreign-Exchange Regulation Act, which governs foreign investment, rarely allowed foreign majority holdings. However, a new foreign investment policy announced in July 1991 prescribed automatic approval for foreign investments in thirty-four industries designated high priority, up to an equity limit of 51 percent. Initially the government required that a company's automatic approval must rely on matching exports and dividend repatriation, but in May 1992 this requirement was lifted, except for low-priority sectors. In 1994 foreign and nonresident Indian investors were allowed to repatriate not only their profits but also their capital. Indian exporters are also free to use their export earnings as they see fit. However, transfer of capital abroad by Indian nationals is only permitted in special circumstances, such as emigration. Foreign exchange is automatically made available for imports for which import licenses are issued.
Because foreign-exchange transactions are so tightly controlled, Indian authorities are able to manage the exchange rate, and from 1975 to 1992 the rupee was tied to a trade-weighted basket of currencies. In February 1992, the government began moves to make the rupee convertible, and in March 1993 a single floating exchange rate was implemented. In July 1995, Rs31.81 were worth US$1, compared with Rs7.86 in 1980, Rs12.37 in 1985, and Rs17.50 in 1990.
External Debt
India has frequently encountered balance of payments difficulties (see table 23, Appendix). The usual recourse has been to contract imports, thereby reducing production and economic growth, although the amount of foreign aid available has been an important factor in how harsh the restrictions have become. Following the first round of oil price increases in 1973-74, increased foreign aid and some belt-tightening overcame the country's balance of payments problems. The growth of exports and the increased remittances from Indians working abroad in the late 1970s permitted a buildup of substantial foreign-currency reserves. Toward the end of the 1970s, the country's external payments situation was more favorable than it had been for many years.
The second large oil price increase, in the 1979-80 period, quickly altered India's terms of trade and balance of payments situation. Between FY 1978 and FY 1980, India's oil bill increased threefold, by about US$4.6 billion. The deficit on the balance of trade rose from US$1.5 billion in FY 1979 to US$7.7 billion in FY 1980. Officials negotiated a substantial loan from the IMF, which, along with the foreign-exchange reserves, foreign aid, and export possibilities, made adjustments possible. The intent was to keep annual economic growth at 5 percent or more to reduce poverty, while making structural adjustments in the economy to compensate for the change in the external environment. Nonetheless, the external debt rose from US$20.6 billion in 1980 to nearly US$70.2 billion in 1990. In FY 1990, commercial loans accounted for 26.3 percent of the external debt; loans from international institutions, especially the World Bank, made up 45.2 percent; borrowing from foreign governments accounted for 28.5 percent. The largest sums were owed to Japan, Germany, and the United States. At the time of the economic crisis of 1990, external debt was increasing at around US$8 billion a year. By 1993-94, the annual increase had been cut to less than US$1 billion and was expected to be further reduced. India's foreign currency reserves, which stood at US$1 billion in June 1991, had reached a record level of US$20 billion by March 1995.
The Civil Service
During the colonial period, the British built up the elite Indian Civil Service, often referred to as the "steel frame" of the British Raj. Nehru and other leaders of the independence movement initially viewed the colonial civil service as an instrument of foreign domination, but by 1947 they had come to appreciate the advantages of having a highly qualified institutionalized administration in place, especially at a time when social tensions threatened national unity and public order.
The constitution established the Indian Administrative Service to replace the colonial Indian Civil Service and ensure uniform and impartial standards of administration in selected fields, promote effective coordination in social and economic development, and encourage a national point of view. In the early 1990s, this small elite accounted for fewer than 5,000 of the total 17 million central government employees. Recruits appointed by the Union Public Service Commission are university graduates selected through a rigorous system of written and oral examinations. In 1988 only about 150 out of a candidate pool of approximately 85,000 recruits received appointments in the Indian Administrative Service. Indian Administrative Service officers are primarily from the more affluent and educated classes. However, efforts to recruit women and individuals from the Scheduled Castes and Scheduled Tribes have enhanced the diversity of the civil service.
Recruits are trained as administrative generalists at an academy at Mussoorie (in Uttar Pradesh). After a period of apprenticeship and probation in the central and state governments, an Indian Administrative Service officer is assigned to increasingly more responsible positions, such as a district collector after six or seven years. Approximately 70 percent of all officers serve in state administrations; the rest serve in the central government.
A larger organization, the Central Public Services, staffs a broad variety of administrative bureaus ranging from the Indian Foreign Service to the Audits and Accounts Service and the Postal Service. The states (but not Delhi or the union territories) have independent services within their own jurisdictions that are regulated by local laws and public service commissions. The governor usually appoints members of the state public services upon the recommendation of the state public service commission. To a large extent, states depend upon nationwide bodies, such as the Indian Administrative Service and Indian Police Service, to staff top administrative posts.
Although the elite public services continue to command great prestige, their social status declined in the decades after independence. In the 1990s, India's most capable youths increasingly are attracted to private-sector employment where salaries are substantially higher. Public opinion of civil servants has also been lowered by popular perceptions that bureaucrats are unresponsive to public needs and are corrupt. Although the ranks of the civil service are filled with many dedicated individuals, corruption has been a growing problem as civil servants have become subject to intense political pressures.
India's new leaders sought to use the power of the state to direct economic growth and reduce widespread poverty. The public sector came to dominate heavy industry, transportation, and telecommunications. The private sector produced most consumer goods but was controlled directly by a variety of government regulations and financial institutions that provided major financing for large private-sector projects. Government emphasized self-sufficiency rather than foreign trade and imposed strict controls on imports and exports. In the 1950s, there was steady economic growth, but results in the 1960s and 1970s were less encouraging.
Beginning in the late 1970s, successive Indian governments sought to reduce state control of the economy. Progress toward that goal was slow but steady, and many analysts attributed the stronger growth of the 1980s to those efforts. In the late 1980s, however, India relied on foreign borrowing to finance development plans to a greater extent than before. As a result, when the price of oil rose sharply in August 1990, the nation faced a balance of payments crisis. The need for emergency loans led the government to make a greater commitment to economic liberalization than it had up to this time. In the early 1990s, India's postindependence development pattern of strong centralized planning, regulation and control of private enterprise, state ownership of many large units of production, trade protectionism, and strict limits on foreign capital was increasingly questioned not only by policy makers but also by most of the intelligentsia.
As India moved into the mid-1990s, the economic outlook was mixed. Most analysts believed that economic liberalization would continue, although there was disagreement about the speed and scale of the measures that would be implemented. It seemed likely that India would come close to or equal the relatively impressive rate of economic growth attained in the 1980s, but that the poorest sections of the population might not benefit.
Growth since 1980
The rate of growth improved in the 1980s. From FY 1980 to FY 1989, the economy grew at an annual rate of 5.5 percent, or 3.3 percent on a per capita basis. Industry grew at an annual rate of 6.6 percent and agriculture at a rate of 3.6 percent. A high rate of investment was a major factor in improved economic growth. Investment went from about 19 percent of GDP in the early 1970s to nearly 25 percent in the early 1980s. India, however, required a higher rate of investment to attain comparable economic growth than did most other low-income developing countries, indicating a lower rate of return on investments. Part of the adverse Indian experience was explained by investment in large, long-gestating, capital-intensive projects, such as electric power, irrigation, and infrastructure. However, delayed completions, cost overruns, and under-use of capacity were contributing factors.
Private savings financed most of India's investment, but by the mid-1980s further growth in private savings was difficult because they were already at quite a high level. As a result, during the late 1980s India relied increasingly on borrowing from foreign sources (see Aid, this ch.). This trend led to a balance of payments crisis in 1990; in order to receive new loans, the government had no choice but to agree to further measures of economic liberalization. This commitment to economic reform was reaffirmed by the government that came to power in June 1991.
India's primary sector, including agriculture, forestry, fishing, mining, and quarrying, accounted for 32.8 percent of GDP in FY 1991 (see table 17, Appendix). The size of the agricultural sector and its vulnerability to the vagaries of the monsoon cause relatively large fluctuations in the sector's contribution to GDP from one year to another (see Crop Output, ch. 7).
In FY 1991, the contribution to GDP of industry, including manufacturing, construction, and utilities, was 27.4 percent; services, including trade, transportation, communications, real estate and finance, and public- and private-sector services, contributed 39.8 percent. The steady increase in the proportion of services in the national economy reflects increased market-determined processes, such as the spread of rural banking, and government activities, such as defense spending (see Agricultural Credit, ch. 7; Defense Spending, ch. 10).
Despite a sometimes disappointing rate of growth, the Indian economy was transformed between 1947 and the early 1990s. The number of kilowatt-hours of electricity generated, for example, increased more than fiftyfold. Steel production rose from 1.5 million tons a year to 14.7 million tons a year. The country produced space satellites and nuclear-power plants, and its scientists and engineers produced an atomic explosive device (see Major Research Organizations, this ch.; Space and Nuclear Programs, ch. 10). Life expectancy increased from twenty-seven years to fifty-nine years. Although the population increased by 485 million between 1951 and 1991, the availability of food grains per capita rose from 395 grams per day in FY 1950 to 466 grams in FY 1992 (see Structure and Dynamics, ch. 2).
However, considerable dualism remains in the Indian economy. Officials and economists make an important distinction between the formal and informal sectors of the economy. The informal, or unorganized, economy is largely rural and encompasses farming, fishing, forestry, and cottage industries. It also includes petty vendors and some small-scale mechanized industry in both rural and urban areas. The bulk of the population is employed in the informal economy, which contributes more than 50 percent of GDP. The formal economy consists of large units in the modern sector for which statistical data are relatively good. The modern sector includes large-scale manufacturing and mining, major financial and commercial businesses, and such public-sector enterprises as railroads, telecommunications, utilities, and government itself.
The greatest disappointment of economic development is the failure to reduce more substantially India's widespread poverty. Studies have suggested that income distribution changed little between independence and the early 1990s, although it is possible that the poorer half of the population improved its position slightly. Official estimates of the proportion of the population that lives below the poverty line tend to vary sharply from year to year because adverse economic conditions, especially rises in food prices, are capable of lowering the standard of living of many families who normally live just above the subsistence level. The Indian government's poverty line is based on an income sufficient to ensure access to minimum nutritional standards, and even most persons above the poverty line have low levels of consumption compared with much of the world.
Estimates in the late 1970s put the number of people who lived in poverty at 300 million, or nearly 50 percent of the population at the time. Poverty was reduced during the 1980s, and in FY 1989 it was estimated that about 26 percent of the population, or 220 million people, lived below the poverty line. Slower economic growth and higher inflation in FY 1990 and FY 1991 reversed this trend. In FY 1991, it was estimated that 332 million people, or 38 percent of the population, lived below the poverty line.
Farmers and other rural residents make up the large majority of India's poor. Some own very small amounts of land while others are field hands, seminomadic shepherds, or migrant workers. The urban poor include many construction workers and petty vendors. The bulk of the poor work, but low productivity and intermittent employment keep incomes low. Poverty is most prevalent in the states of Orissa, Bihar, Uttar Pradesh, and Madhya Pradesh, and least prevalent in Haryana, Punjab, Himachal Pradesh, and Jammu and Kashmir.
By the early 1990s, economic changes led to the growth in the number of Indians with significant economic resources. About 10 million Indians are considered upper class, and roughly 300 million are part of the rapidly increasing middle class. Typical middle-class occupations include owning a small business or being a corporate executive, lawyer, physician, white-collar worker, or land-owning farmer. In the 1980s, the growth of the middle class was reflected in the increased consumption of consumer durables, such as televisions, refrigerators, motorcycles, and automobiles. In the early 1990s, domestic and foreign businesses hoped to take advantage of India's economic liberalization to increase the range of consumer products offered to this market.
Housing and the ancillary utilities of sewer and water systems lag considerably behind the population's needs. India's cities have large shantytowns built of scrap or readily available natural materials erected on whatever space is available, including sidewalks. Such dwellings lack piped water, sewerage, and electricity. The government has attempted to build housing facilities and utilities for urban development, but the efforts have fallen far short of demand. Administrative controls and other aspects of government policy have discouraged many private investors from constructing housing units.
Liberalization in the Early 1990s
Increased borrowing from foreign sources in the late 1980s, which helped fuel economic growth, led to pressure on the balance of payments. The problem came to a head in August 1990 when Iraq invaded Kuwait, and the price of oil soon doubled. In addition, many Indian workers resident in Persian Gulf states either lost their jobs or returned home out of fear for their safety, thus reducing the flow of remittances (see Size and Composition of the Work Force, this ch.). The direct economic impact of the Persian Gulf conflict was exacerbated by domestic social and political developments. In the early 1990s, there was violence over two domestic issues: the reservation of a proportion of public-sector jobs for members of Scheduled Castes (see Glossary) and the Hindu-Muslim conflict at Ayodhya (see Public Worship, ch. 3; Political Issues, ch. 8). The central government fell in November 1990 and was succeeded by a minority government. The cumulative impact of these events shook international confidence in India's economic viability, and the country found it increasingly difficult to borrow internationally. As a result, India made various agreements with the International Monetary Fund (IMF--see Glossary) and other organizations that included commitments to speed up liberalization (see United Nations, ch. 9).
In the early 1990s, considerable progress was made in loosening government regulations, especially in the area of foreign trade. Many restrictions on private companies were lifted, and new areas were opened to private capital. However, India remains one of the world's most tightly regulated major economies. Many powerful vested interests, including private firms that have benefited from protectionism, labor unions, and much of the bureaucracy, oppose liberalization. There is also considerable concern that liberalization will reinforce class and regional economic disparities.
The balance of payments crisis of 1990 and subsequent policy changes led to a temporary decline in the GDP growth rate, which fell from 6.9 percent in FY 1989 to 4.9 percent in FY 1990 to 1.1 percent in FY 1991. In March 1995, the estimated growth rate for FY 1994 was 5.3 percent. Inflation peaked at 17 percent in FY 1991, fell to 9.5 percent in FY 1993, and then accelerated again, reaching 11 percent in late FY 1994. This increase was attributed to a sharp increase in prices and a shortfall in such critical sectors as sugar, cotton, and oilseeds. Many analysts agree that the poor suffer most from the increased inflation rate and reduced growth rate.
The Role of Government
Early Policy Developments
Many early postindependence leaders, such as Nehru, were influenced by socialist ideas and advocated government intervention to guide the economy, including state ownership of key industries. The objective was to achieve high and balanced economic development in the general interest while particular programs and measures helped the poor. India's leaders also believed that industrialization was the key to economic development. This belief was all the more convincing in India because of the country's large size, substantial natural resources, and desire to develop its own defense industries.
The Industrial Policy Resolution of 1948 gave government a monopoly in armaments, atomic energy, and railroads, and exclusive rights to develop minerals, the iron and steel industries, aircraft manufacturing, shipbuilding, and manufacturing of telephone and telegraph equipment. Private companies operating in those fields were guaranteed at least ten years more of ownership before the government could take them over. Some still operate as private companies.
The Industrial Policy Resolution of 1956 greatly extended the preserve of government. There were seventeen industries exclusively in the public sector. The government took the lead in another twelve industries, but private companies could also engage in production. This resolution covered industries producing capital and intermediate goods. As a result, the private sector was relegated primarily to production of consumer goods. The public sector also expanded into more services. In 1956 the life insurance business was nationalized, and in 1973 the general insurance business was also acquired by the public sector. Most large commercial banks were nationalized in 1969. Over the years, the central and state governments formed agencies, and companies engaged in finance, trading, mineral exploitation, manufacturing, utilities, and transportation. The public sector was extensive and influential throughout the economy, although the value of its assets was small relative to the private sector.
Controls over prices, production, and the use of foreign exchange, which were imposed by the British during World War II, were reinstated soon after independence. The Industries (Development and Regulation) Act of 1951 and the Essential Commodities Act of 1955 (with subsequent additions) provided the legal framework for the government to extend price controls that eventually included steel, cement, drugs, nonferrous metals, chemicals, fertilizer, coal, automobiles, tires and tubes, cotton textiles, food grains, bread, butter, vegetable oils, and other commodities. By the late 1950s, controls were pervasive, regulating investment in industry, prices of many commodities, imports and exports, and the flow of foreign exchange.
Export growth was long ignored. The government's extensive controls and pervasive licensing requirements created imbalances and structural problems in many parts of the economy. Controls were usually imposed to correct specific problems but often without adequate consideration of their effect on other parts of the economy. For example, the government set low prices for basic foods, transportation, and other commodities and services, a policy designed to protect the living standards of the poor. However, the policy proved counterproductive when the government also limited the output of needed goods and services. Price ceilings were implemented during shortages, but the ceiling frequently contributed to black markets in those commodities and to tax evasion by black-market participants. Import controls and tariff policy stimulated local manufacturers toward production of import-substitution goods, but under conditions devoid of sufficient competition or pressure to be efficient.
Private trading and industrial conglomerates (the so-called large houses) existed under the British and continued after independence. The government viewed the conglomerates with suspicion, believing that they often manipulated markets and prices for their own profit. After independence the government instituted licensing controls on new businesses, especially in manufacturing, and on expanding capacity in existing businesses. In the 1960s, when shortages of goods were extensive, considerable criticism was leveled at traders for manipulating markets and prices. The result was the 1970 Monopolies and Restrictive Practices Act, which was designed to provide the government with additional information on the structure and investments of all firms that had assets of more than Rs200 million (for value of the rupee--see Glossary), to strengthen the licensing system in order to decrease the concentration of private economic power, and to place restraints on certain business practices considered contrary to the public interest. The act emphasized the government's aversion to large companies in the private sector, but critics contended that the act resulted from political motives and not from a strong case against big firms. The act and subsequent enforcement restrained private investment.
The extensive controls, the large public sector, and the many government programs contributed to a substantial growth in the administrative structure of government. The government also sought to take on many of the unemployed. The result was a swollen, inefficient bureaucracy that took inordinate amounts of time to process applications and forms. Business leaders complained that they spent more time getting government approval than running their companies. Many observers also reported extensive corruption in the huge bureaucracy. One consequence was the development of a large underground economy in small-scale enterprises and the services sector.
India's current economic reforms began in 1985 when the government abolished some of its licensing regulations and other competition-inhibiting controls. Since 1991 more "new economic policies" or reforms have been introduced. Reforms include currency devaluations and making currency partially convertible, reduced quantitative restrictions on imports, reduced import duties on capital goods, decreases in subsidies, liberalized interest rates, abolition of licenses for most industries, the sale of shares in selected public enterprises, and tax reforms. Although many observers welcomed these changes and attributed the faster growth rate of the economy in the late 1980s to them, others feared that these changes would create more problems than they solved. The growing dependence of the economy on imports, greater vulnerability of its balance of payments, reliance on debt, and the consequent susceptibility to outside pressures on economic policy directions caused concern. The increase in consumerism and the display of conspicuous wealth by the elite exacerbated these fears.
The pace of liberalization increased after 1991. By the mid-1990s, the number of sectors reserved for public ownership was slashed, and private-sector investment was encouraged in areas such as energy, steel, oil refining and exploration, road building, air transportation, and telecommunications. An area still closed to the private sector in the mid-1990s was defense industry. Foreign-exchange regulations were liberalized, foreign investment was encouraged, and import regulations were simplified. The average import-weighted tariff was reduced from 87 percent in FY 1991 to 33 percent in FY 1994. Despite these changes, the economy remained highly regulated by international standards. The import of many consumer goods was banned, and the production of 838 items, mostly consumer goods, was reserved for companies with total investment of less than Rs6 million. Although the government had sold off minority stakes in public-sector companies, it had not in 1995 given up control of any enterprises, nor had any of the loss-making public companies been closed down. Moreover, although import duties had been lowered substantially, they were still high compared to most other countries.
Political successes in the mid-1990s by nationalist-oriented political parties led to some backlash against foreign investment in some parts of India (see Political Parties, ch. 8). In early 1995, official charges of serving adulterated products were made against a KFC outlet in Bangalore, and Pepsi-Cola products were smashed and advertisements defaced in New Delhi. The most serious backlash occurred in Maharashtra in August 1995 when the Bharatiya Janata Party (BJP--Indian People's Party)-led state government halted construction of a US$2.8 million 2,015-megawatt gas-fired electric-power plant being built near Bombay (Mumbai in the Marathi language) by another United States company, Enron Corporation.
Finance
The early governments after independence operated with only modest budget deficits, but in the 1970s and 1980s the amount of the budget deficit as a proportion of GDP increased gradually, reaching 8.4 percent in FY 1990. Following economic reforms, the deficit declined to 6.7 percent by FY 1994. More than 80 percent of the public debt was financed from domestic sources, but the proportion of foreign debt rose steadily in the late 1980s. However, although foreign aid to India was substantial, it was much lower than most other developing countries when calculated on a per capita basis. Banking and credit were dominated by government-controlled institutions, but the importance of the private sector in financial services was increasing slowly.
Budget
India's public finance system follows the British pattern. The constitution establishes the supremacy of the bicameral Parliament--specifically the Lok Sabha (House of the People)--in financial matters. No central government taxes are levied and no government expenditure from public funds disbursed without an act of Parliament, which also scrutinizes and audits all government accounts to ensure that expenditures are legally authorized and properly spent. Proposals for taxation or expenditures, however, may be initiated only within the Council of Ministers--specifically by the minister of finance. The minister of finance is required to submit to Parliament, usually on the last day of February, a financial statement detailing the estimated receipts and expenditures of the central government for the forthcoming fiscal year and a financial review of the current fiscal year.
The Lok Sabha has one month to review and modify the government's budget proposals. If by April 1, the beginning of the fiscal year, the parliamentary discussion of the budget has not been completed, the budget as proposed by the minister of finance goes into effect, subject to retroactive modifications after the parliamentary review. On completion of its budget discussions, the Lok Sabha passes the annual appropriations act, authorizing the executive to spend money, and the finance act, authorizing the executive to impose and collect taxes. Supplemental requests for funds are presented during the course of the fiscal year to cover emergencies, such as war or other catastrophes. The bills are forwarded to the Rajya Sabha (Council of States--the upper house of Parliament) for comment. The Lok Sabha, however, is not bound by the comments, and the Rajya Sabha cannot delay passage of money bills. When signed by the president, the bills become law. The Lok Sabha cannot increase the request for funds submitted by the executive, nor can it authorize new expenditures. Taxes passed by Parliament may be retroactive.
Each state government maintains its own budget, prepared by the state's minister of finance in consultation with appropriate officials of the central government. Primary control over state finances rests with the state legislature in the same manner as at the central government level. State finances are supervised by the central government, however, through the comptroller and the auditor general; the latter reviews state government accounts annually and reports the findings to the appropriate state governor for submission to the state's legislature. The central and state budgets consist of a budget for current expenditures, known as the budget on revenue account, and a capital budget for economic and social development expenditures.
The national railroad (Indian Railways), the largest public-sector enterprise, and the Department of Posts and Telegraph have their own budgets, funds, and accounts (see Railroads; Telecommunications, this ch.). The appropriations and disbursements under their budgets are subject to the same form of parliamentary and audit control as other government revenues and expenditures. Dividends accrue to the central government, and deficits are subsidized by it, a pattern that holds true also, directly or indirectly, for other government enterprises.
During the eighth plan, the states were expected to spend nearly Rs1.9 trillion, or 42.9 percent of the public outlay. Because of its greater revenue sources, the central government shared with the states its receipts from personal income taxes and certain excise taxes. It also collected other minor taxes, the total proceeds of which were transferred to the states. The division of the shared taxes is determined by financial commissions established by the president, usually at five-year intervals. In the early 1990s, the states received 75 percent of the revenue collected from income taxes and around 43 percent of the excise taxes. The central government also provided the states with grants to meet their commitments. In FY 1991, these grants and the states' share of taxes collected by the central government amounted to 40.9 percent of the total revenue of state governments.
The states' share of total public revenue collected declined from 48 percent in FY 1955 to about 42 percent in the late 1970s, and to about 33 percent in the early 1990s. An important cause of the decline was the diminished importance of the land revenue tax, which traditionally had been the main direct tax on agriculture. This tax declined from 8 percent of all state and central tax revenues in FY 1950 to less than 1 percent in the 1980s and early 1990s. The states have jurisdiction over taxes levied on land and agricultural income, and vested interests exerted pressure on the states not to raise agricultural taxation. As a result, in the 1980s and early 1990s agriculture largely escaped significant taxation, although there has long been nationwide discussion about increasing land taxes or instituting some sort of tax on incomes of the richer portion of the farm community. The share of direct taxes in GDP increased from 2.1 percent in FY 1991 to 2.8 percent in FY 1994.
Since independence government has favored more politically palatable indirect taxes--customs and excise duties--over direct taxes. In the 1980s and early 1990s, indirect taxes accounted for around 75 percent of all tax revenue collected by the central government. State governments relied heavily on sales taxes. Overall, indirect taxes accounted for 84.1 percent of all government tax revenues in FY 1990. Total government tax revenues amounted to 17.1 percent of GDP in that year, up from 9.0 percent in FY 1960, 11.5 percent in FY 1970, and 14.9 percent in FY 1980. In FY 1990, the share of the public sector in GDP was 26.4 percent. In terms of rupees (in current prices), total government income rose from Rs259.8 billion in FY 1981 to Rs1.3 trillion in FY 1992 (see table 18, Appendix).
Comprehensive tax reforms were implemented with the FY 1985 budget. Corporate tax was cut, income taxes simplified and lowered for high-income groups, and wealth taxes reduced. Tax receipts in FY 1985 rose by 20 percent over FY 1984 as a result of tightened enforcement, and taxpayers responded to lower taxes with greater compliance. In FY 1986, another major change was made with the launching of a long-term program of tax reform designed to eliminate annual changes, which had produced uncertainty. However, in FY 1987, when the monsoon failed, the government raised taxes on higher income groups. The emergency budget of FY 1991, designed to cope with the nation's 1990 balance of payments crisis, increased indirect and corporate taxes, but the budgets for FY 1992 and FY 1993 reflected the policy of economic liberalization. They reduced and simplified direct taxes, removed the wealth tax from financial investments, and indexed the capital gains tax. The highest marginal rate of personal income tax was 42.5 percent in FY 1992.
Fiscal Administration
Historically, the Indian government has pursued a cautious policy with regard to financing budgets, allowing only small amounts of deficit spending. Budget deficits increased in the late 1980s, and the necessity of financing these deficits from foreign borrowing contributed to the 1990 balance of payments crisis. The central government budget deficit reached 8.4 percent of GDP in FY 1990, up from 2.6 percent in FY 1970, 5.9 percent in FY 1980, and 7.8 percent in FY 1989. The deficit was cut to 5.9 percent in FY 1991 and 5.2 percent in FY 1992, but widened to 7.4 percent in FY 1993. It was expected to recede to 6.2 percent in FY 1995.
The central government's budget deficits during the 1980s increased the total public debt rapidly until in FY 1991 it stood at Rs3.9 trillion. The bulk of this debt was owed to citizens and domestic institutions and firms, particularly the central bank. Readers of Indian monetary statistics should be alert to the use of the terms lakh (see Glossary) and crore (see Glossary), which are used to express higher numbers.
Monetary Process
The basic elements of the financial system were established during British rule (1757-1947). The national currency, the rupee, had long been used domestically before independence and even circulated abroad, for example, in the Persian Gulf region. Foreign banks, mainly British and including some from such other parts of the empire as Hong Kong, provided banking and other services. The Reserve Bank of India was formed in 1935 as a private bank, but it also carried out some central bank functions. This colonial banking system, however, was geared to foreign trade and short-term loans. Banking was concentrated in the major port cities.
The Reserve Bank was nationalized on January 1, 1949, and given broader powers. It was the bank of issue for all rupee notes higher than the one-rupee denomination; the agent of the Ministry of Finance in controlling foreign exchange; and the banker to the central and state governments, commercial banks, state cooperative banks, and other financial institutions. The Reserve Bank formulated and administered monetary policy to promote stable prices and higher production. It was given increasing responsibilities for the development of banking and credit and to coordinate banking and credit with the five-year plans. The Reserve Bank had a number of tools with which to affect commercial bank credit.
After independence the government sought to adapt the banking system to promote development and formed a number of specialized institutions to provide credit to industry, agriculture, and small businesses. Banking penetrated rural areas, and agricultural and industrial credit cooperatives were promoted. Deposit insurance and a system of postal savings banks and offices fostered use by small savers. Subsidized credit was provided to particular groups or activities considered in need and which deserved such help. A credit guarantee corporation covered loans by commercial banks to small traders, transport operators, self-employed persons, and other borrowers not otherwise effectively covered by major institutions. The system effectively reached all kinds of savers and provided credit to many different customers.
The government nationalized fourteen major private commercial banks in 1969 and six more in 1980. Nationalization forced commercial banks increasingly to meet the credit requirements of the weaker sections of the nation and to eliminate monopolization by vested interests of large industry, trade, and agriculture.
The banking system expanded rapidly after nationalization. The number of bank branches, for instance, increased from about 7,000 in 1969 to more than 60,000 in 1994, two-thirds of which were in rural areas. The deposit base rose from Rs50 billion in 1969 to around Rs3.5 trillion in 1994. Nevertheless, currency accounted for well over 50 percent of all the money supply circulating among the public. In 1992 the nationalized banks held 93 percent of all deposits.
In FY 1990, twenty-three foreign banks operated in India. The most important were ANZ Grindlays Bank, Citibank, the Hongkong and Shanghai Banking Corporation, and Standard Chartered Bank.
Public-sector banks are required to reserve their lending based on 40 percent of their deposits for priority sectors, especially agriculture, at favorable rates. In addition, 35 percent of their deposits have to be held in liquid form to satisfy statutory liquidity requirements, and 15 percent are needed to meet the cash reserve requirements of the Reserve Bank. Both these percentages represent an easing of earlier requirements, but only a small proportion of public-sector banks' resources can be deployed freely. In late 1994, the rate of interest on bank loans was deregulated, but deposit rates were still subject to ceilings.
More than 50 percent of bank lending is to the government sector. With the onset of economic reform, India's banks were experiencing major financial losses as the result of low productivity, bad loans, and poor capitalization. Seeking to stabilize the banking industry, the Reserve Bank of India developed new reporting formats and has initiated takeovers and mergers of smaller banks that were operating with financial losses.
India has a rapidly expanding stock market that in 1993 listed around 5,000 companies in fourteen stock exchanges, although only the stocks of about 400 of these companies were actively traded. Financial institutions and government bodies controlled an estimated 45 percent of all listed capital. In April 1992, the Bombay stock market, the nation's largest with a market capital of US$65.1 billion, collapsed, in part because of revelations about financial malpractice amounting to US$2 billion. Afterward, the Securities and Exchange Board of India, the government's capital market regulator, implemented reforms designed to strengthen investor confidence in the stock market. In the mid-1990s, foreign institutional investors took greater interest than ever before in the Indian stock markets, investing around US$2 billion in FY 1993 alone.
Despite increases in energy costs and other pressures from the world economy, for most of the period since independence India has not experienced severe inflation. The underlying average rate of inflation, however, has tended to rise. Consumer prices rose at an annual average of 2.1 percent in the 1950s, 6.3 percent in the 1960s, 7.8 percent in the 1970s, and 8.5 percent in the 1980s.
Three factors lay behind India's relative price stability. First, the government has intervened, either directly or indirectly, to keep stable the price of certain staples, including wheat, rice, cloth, and sugar. Second, monetary regulation has restricted growth in the money supply. Third, the overall influence of the labor unions on wages has been small because of the weakness of the unions in India's labor surplus economy.
Foreign Economic Relations
Aid
Since independence India has had to draw on foreign investments to finance part of its economic development. Although the government has attempted to be as self-reliant as possible, the absolute amount of foreign aid received has been high. In per capita terms, however, it has been much less than most other developing countries receive.
In August 1958, the World Bank (see Glossary) organized the Aid-to-India Consortium, consisting of the World Bank Group and thirteen countries: Austria, Belgium, Britain, Canada, Denmark, the Federal Republic of Germany (at that time, West Germany), France, Italy, Japan, the Netherlands, Norway, Sweden, and the United States. The consortium was formed to coordinate aid and establish priorities among India's major sources of foreign assistance and to simplify India's requests for aid based on its plans for development. Consortium aid was bilateral government-to-government aid from the thirteen consortium countries, and almost all of the aid, including that from the World Bank Group, was for specific projects judged to be valuable contributions to India's development. Of the Rs630 billion in aid authorized by all aid donors between FY 1974 and FY 1989, more than 60 percent was provided by the consortium.
Collectively, the Western nations have donated a substantial amount of aid to India. In 1980 this aid totaled nearly US$1.5 billion and reached US$2.5 billion in 1990. In 1992 Western aid reached a new height: US$3.9 billion, which represented 49.8 percent of all Western multilateral and bilateral aid given to South Asian nations that year. The largest bilateral donor is Japan. Between 1984 and 1993, Japan's official development assistance grants to India totaled US$337 million. Much greater than the outright grants has been Japan's large-scale loan program, which supports economic infrastructure development (power plants and delivery systems, and road improvement) and environmental protection. Between 1984 and 1993, Japanese loans to India totaled nearly US$2.4 billion. A ¥125 billion (US$1.2 billion) loan financing major projects was granted in December 1994, bringing Japanese loans to India since 1957 to a total of ¥1.6 trillion.
United States assistance was significant in the late 1950s and 1960s but, because of strained India-United States relations, fell off sharply in the 1970s (see United States, ch. 9). The United States accounted for 8.6 percent of all of the aid India received from independence through FY 1988, but for only 0.7 percent in FY 1989 and 0.6 percent in FY 1990. United States aid to India remained relatively insignificant in the early 1990s when it took the form of grants for food aid and consultants in a wide variety of economic growth areas, such as computers, steel, telecommunications, and energy production. In FY 1993, actual United States obligations through the United States Agency for International Development totaled almost US$161 million. The bulk of this aid was provided as United States Public Law 480 food aid grants with lesser amounts for development assistance (including energy and the environment, population control, child survival, acquired immune deficiency syndrome (AIDS) prevention, and economic growth) and housing guaranty loans. Germany and Britain also have substantial aid-to-India programs.
Among countries not in the World Bank consortium, the Soviet Union was the most important contributor, providing more than 16 percent of all aid between 1947 and FY 1988. Since 1991, however, Russia has provided little aid.
About 90 percent of all aid received by India has been in the form of loans. Aid disbursements from all providers for FY 1990 were Rs67 billion.
India maintains a small but well-established foreign aid program of its own. In FY 1990, Rs1.6 billion of aid was authorized, of which Rs582 million was for Bhutan and Rs578 million for Nepal. Bangladesh and Vietnam received significant amounts of aid during the 1980s, but, as the result of changing world political and economic conditions, these programs were small by the early 1990s (see South Asia; Southeast Asia, ch. 9).
Trade
Despite its size, India plays a relatively small role in the world economy. Until the 1980s, the government did not make exports a priority. In the 1950s and 1960s, Indian officials believed that trade was biased against developing countries and that prospects for exports were severely limited. Therefore, the government aimed at self-sufficiency in most products through import substitution, with exports covering the cost of residual import requirements. Foreign trade was subjected to strict government controls, which consisted of an all-inclusive system of foreign exchange and direct controls over imports and exports. As a result, India's share of world trade shrank from 2.4 percent in FY 1951 to 0.4 percent in FY 1980. Largely because of oil price increases in the 1970s, which contributed to balance of payments difficulties, governments in the 1970s and 1980s placed more emphasis on the promotion of exports. They hoped exports would provide foreign exchange needed for the import of oil and high-technology capital goods. Nevertheless, in the early 1990s India's share of world trade stood at only 0.5 percent. In FY 1992, imports accounted for 9.3 percent of GDP and exports for 7.7 percent of GDP.
Based on trends throughout the 1980s and early 1990s, it appears likely that the balance of trade will remain negative for the foreseeable future (see table 19, Appendix). The 1979 increase in the price of oil produced a Rs58.4 billion deficit in FY 1980, close to 5 percent of GNP. The deficit was barely reduced in nominal rupee terms over the next five years, although it improved considerably as a share of GNP (to 2.3 percent in FY 1984) and in dollar terms (from US$7.4 billion in FY 1980 to US$4.3 billion in FY 1984). Pressure on the balance of trade continued through the late 1980s and worsened with the attempted annexation of Kuwait by Iraq in August 1990, which led to a temporary but sharp increase in the price of oil. In FY 1990, the balance of trade deficit reached a record level in rupees (Rs106.5 billion) and in dollars (US$6 billion). Import controls and devaluation of the rupee allowed the trade deficit to fall to US$1.6 billion in FY 1991. However, it widened to US$3.3 billion in FY 1992 before falling to an estimated US$1 billion in FY 1993. However, one optimistic sign, noted by India's minister of finance in March 1995, was that exports had come to finance 90 percent of India's imports, compared with only 60 percent in the mid-1980s.
No one product dominates India's exports. In FY 1993, handicrafts, gems, and jewelry formed the most important sector and accounted for an estimated US$4.9 billion (22.2 percent) of exports. Since the early 1990s, India has become the world's largest processor of diamonds (imported in the rough from South Africa and then fabricated into jewelry for export). Along with other semiprecious commodities, such as gold, India's gems and jewelry accounted for 11 percent of its foreign-exchange receipts in early 1993. Textiles and ready-made garments combined were also an important category, accounting for an estimated US$4.1 billion (18.5 percent) of exports. Other significant exports include industrial machinery, leather products, chemicals and related products (see table 20, Appendix).
The dominant imports are petroleum products, valued in FY 1993 at nearly US$5.8 billion, or 24.7 percent of principal imports, and capital goods, amounting to US$4.2 billion, or 21.8 percent of principal imports. Other important import categories are chemicals, dyes, plastics, pharmaceuticals, uncut precious stones, iron and steel, fertilizers, nonferrous metals, and pulp paper and paper products (see table 21, Appendix).
India's most important trading partners are the United States, Japan, the European Union, and nations belonging to the Organization of the Petroleum Exporting Countries (OPEC). From the 1950s until 1991, India also had close trade links with the Soviet Union, but the breakup of that nation into fifteen independent states led to a decline of trade with the region. In FY 1993, some 30 percent of all imports came from the European Union, 22.4 percent from OPEC nations, 11.7 percent from the United States, and 6.6 percent from Japan. In that same year, 26 percent of all exports were to the European Union, 18 percent to the United States, 7.8 percent to Japan, and 10.7 to the OPEC nations (see table 22, Appendix).
Trade and investment with the United States seemed likely to experience an upswing following a January 1995 trade mission from the United States led by Secretary of Commerce Ronald H. Brown and including top executives from twenty-six United States companies. During the weeklong visit, some US$7 billion in business deals were agreed on, mostly in the areas of infrastructure development, transportation, power and communication systems, food processing, health care services, insurance and financing projects, and automotive catalytic converters. In turn, greater access for Indian goods in United States markets was sought by Indian officials.
In February 1995, in a bid to improve commercial prospects in Southeast Asia, India signed a four-part agreement with the Association of Southeast Asian Nations (ASEAN--see Glossary). The pact covers trade, investment, science and technology, and tourism, and there are prospects for further agreements on joint ventures, banks, and civil aviation.
India's balance of payments position is closely related to the balance of trade. Foreign aid and remittances from Indians employed overseas, however, make the balance of payments more favorable than the balance of trade (see Size and Composition of the Work Force, this ch.).
Foreign-Exchange System
The central government has wide powers to control transactions in foreign exchange. Until 1992 all foreign investments and the repatriation of foreign capital required prior approval of the government. The Foreign-Exchange Regulation Act, which governs foreign investment, rarely allowed foreign majority holdings. However, a new foreign investment policy announced in July 1991 prescribed automatic approval for foreign investments in thirty-four industries designated high priority, up to an equity limit of 51 percent. Initially the government required that a company's automatic approval must rely on matching exports and dividend repatriation, but in May 1992 this requirement was lifted, except for low-priority sectors. In 1994 foreign and nonresident Indian investors were allowed to repatriate not only their profits but also their capital. Indian exporters are also free to use their export earnings as they see fit. However, transfer of capital abroad by Indian nationals is only permitted in special circumstances, such as emigration. Foreign exchange is automatically made available for imports for which import licenses are issued.
Because foreign-exchange transactions are so tightly controlled, Indian authorities are able to manage the exchange rate, and from 1975 to 1992 the rupee was tied to a trade-weighted basket of currencies. In February 1992, the government began moves to make the rupee convertible, and in March 1993 a single floating exchange rate was implemented. In July 1995, Rs31.81 were worth US$1, compared with Rs7.86 in 1980, Rs12.37 in 1985, and Rs17.50 in 1990.
External Debt
India has frequently encountered balance of payments difficulties (see table 23, Appendix). The usual recourse has been to contract imports, thereby reducing production and economic growth, although the amount of foreign aid available has been an important factor in how harsh the restrictions have become. Following the first round of oil price increases in 1973-74, increased foreign aid and some belt-tightening overcame the country's balance of payments problems. The growth of exports and the increased remittances from Indians working abroad in the late 1970s permitted a buildup of substantial foreign-currency reserves. Toward the end of the 1970s, the country's external payments situation was more favorable than it had been for many years.
The second large oil price increase, in the 1979-80 period, quickly altered India's terms of trade and balance of payments situation. Between FY 1978 and FY 1980, India's oil bill increased threefold, by about US$4.6 billion. The deficit on the balance of trade rose from US$1.5 billion in FY 1979 to US$7.7 billion in FY 1980. Officials negotiated a substantial loan from the IMF, which, along with the foreign-exchange reserves, foreign aid, and export possibilities, made adjustments possible. The intent was to keep annual economic growth at 5 percent or more to reduce poverty, while making structural adjustments in the economy to compensate for the change in the external environment. Nonetheless, the external debt rose from US$20.6 billion in 1980 to nearly US$70.2 billion in 1990. In FY 1990, commercial loans accounted for 26.3 percent of the external debt; loans from international institutions, especially the World Bank, made up 45.2 percent; borrowing from foreign governments accounted for 28.5 percent. The largest sums were owed to Japan, Germany, and the United States. At the time of the economic crisis of 1990, external debt was increasing at around US$8 billion a year. By 1993-94, the annual increase had been cut to less than US$1 billion and was expected to be further reduced. India's foreign currency reserves, which stood at US$1 billion in June 1991, had reached a record level of US$20 billion by March 1995.
The Civil Service
During the colonial period, the British built up the elite Indian Civil Service, often referred to as the "steel frame" of the British Raj. Nehru and other leaders of the independence movement initially viewed the colonial civil service as an instrument of foreign domination, but by 1947 they had come to appreciate the advantages of having a highly qualified institutionalized administration in place, especially at a time when social tensions threatened national unity and public order.
The constitution established the Indian Administrative Service to replace the colonial Indian Civil Service and ensure uniform and impartial standards of administration in selected fields, promote effective coordination in social and economic development, and encourage a national point of view. In the early 1990s, this small elite accounted for fewer than 5,000 of the total 17 million central government employees. Recruits appointed by the Union Public Service Commission are university graduates selected through a rigorous system of written and oral examinations. In 1988 only about 150 out of a candidate pool of approximately 85,000 recruits received appointments in the Indian Administrative Service. Indian Administrative Service officers are primarily from the more affluent and educated classes. However, efforts to recruit women and individuals from the Scheduled Castes and Scheduled Tribes have enhanced the diversity of the civil service.
Recruits are trained as administrative generalists at an academy at Mussoorie (in Uttar Pradesh). After a period of apprenticeship and probation in the central and state governments, an Indian Administrative Service officer is assigned to increasingly more responsible positions, such as a district collector after six or seven years. Approximately 70 percent of all officers serve in state administrations; the rest serve in the central government.
A larger organization, the Central Public Services, staffs a broad variety of administrative bureaus ranging from the Indian Foreign Service to the Audits and Accounts Service and the Postal Service. The states (but not Delhi or the union territories) have independent services within their own jurisdictions that are regulated by local laws and public service commissions. The governor usually appoints members of the state public services upon the recommendation of the state public service commission. To a large extent, states depend upon nationwide bodies, such as the Indian Administrative Service and Indian Police Service, to staff top administrative posts.
Although the elite public services continue to command great prestige, their social status declined in the decades after independence. In the 1990s, India's most capable youths increasingly are attracted to private-sector employment where salaries are substantially higher. Public opinion of civil servants has also been lowered by popular perceptions that bureaucrats are unresponsive to public needs and are corrupt. Although the ranks of the civil service are filled with many dedicated individuals, corruption has been a growing problem as civil servants have become subject to intense political pressures.
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