Structural adjustment in India

NUMBER 113 * E Preciss VOperations Evaluation Department June 16 Structural Adjustment in India Econonic crises sometimes make pos- spending to finance growth. From tion (SAL), approved in December sible whlat had previously seemed 1980 to 1991 India's domestic pub- 1991 and closed in December 1993. impossible. In an open, democratic lic debt increased steadily, from 36 society, they can become a catalyst for percent to 56 percent of the GDP, Project goals converting an extensive policy debate while its external debt more than and implementation into action. And when debate is backed tripled to $70 billion. by informed dialogue and consenisus The SAL's objectives were two- building, it can result in a focused and Political changes, unrest in parts fold: (1) to help India address its successful program of reforms. Such of the country, and the 1990 Per- immediate balance of payments wvas the case in India, when in response sian Gulf crisis compounded the crisis and (2) to support a broad to the financial crisis of 1991, a new already volatile situation. The cri- set of policy reforms aimed at lib- government launched a radical set of sis caused oil prices to rise, sub- eralizing the Indian economy and market-friendly reforms, dismantling stantially increasing the cost of oil opening it up to more competition most of the interventionist policies imports, and foreign exchange both from within and abroad. The adopted over five decades of a com- earnings to drop. India's credit- SAL was complemented by an mand economny. In speed, scope, and worthiness, already under strain, IMF-supported stabilization pro- depth the reforms, which were sUp- became even more vulnerable as gram. And parallel financing was ported by the International Monetary Indians from abroad withdrew provided by other donors, as Fund (IMF), the World Bank, and do- their substantial foreign currency agreed at consortium meetings nors, zvere unlprecedenlted for India. deposits and commercial banks convened by the Bank. Results were dramatic. Foreign invest- reduced their exposure. Toward ment surged, hlelpinzg to rebuild de- the end of 1990, India's creditwor- The SAL proved to be the right pleted foreign exchange reserves; GDP thiness was downgraded, effec- response at the right time. The grozvth picked up, this time spurred by tively cutting its access to sources program it supported was bold investment rather than by borrozving; of commercial credit. By early but carefully sequenced to create a and exports increased. 1991, India was on the brink workable balance between eco- of default. nomic necessity and the realities of A recent OED audit* cautions India's political economy. The re- however that sustainability of India's As the crisis unfolded the de- economic recovery hinges on the bates in India's political and eco- -r-_-_- -_-_- completion of the unfinished agenda, nomic circles increasingly focused particularly fiscal reforms at both na- on reform. In India's large and sPet'rform1alnct audit report: tional and state levels, while safe- highly diverse democracy, those 'lini Struct url .-1diLstment guarding social services for the poor. debates proved important in Loalln/Credilt." by Robert P. building political consensus Arm5strong. forthcom,ing. Per- Background around the voices for reform. forl HI IICC' audit reports are Nevertheless, it took a new gov- a1'i,llable to Biiiik t'.e'CiithC Lb- In 1991, India faced an unprec- ernment, which came to power in rectors and .tafl tfroum thie Inter- edented balance of payments crisis. June 1991, to launch India's first iial Documenlst Units and frota For almost a decade the govern- comprehensive economic policy Regiolnail Information Serv0ices ment had borrowed heavily to sup- reform program, which the World Cenitets. Prtecii written bil port an economic strategy that Bank supported with a $500 mil- Farah/ Ebrahimi. relied on expansionary public lion structural adjustment opera-  from inflow of foreign investment, Actual versus projected outcomes of key macroeconomic reached nearly $20 billion by the indicators, 1991-94 ! end of 1994. The composition of growth was also encouraging, o 991-94 with growth in agriculture picking rInicator Projected rctual up (aided by an unprecedented j Grolu,th rates {,. per annzumJ) 38 3 4series of good monsoons) and in- GDP 3.8 3.4 dustrial production growing at Per capita GDP 1.6 2.1abu pecnayar Inflation 6.5 9.b about 8 percent a year. Exports 10.8 11.9 Imports 4.6 9.7 In other areas, covered by SAL Ratios (%. of GDP) conditions, progress was disap- Gross domestic investment 22.7 24.6 pointing, however: removal of re- Private 13.7 15.2 strictions on agricultural exports, Public 9.0 9.4 exit policy for industrial firms, Gross domestic savings 21.5 23.8 and, most important, restructuring Fiscal balance 4.5 6.3 or closing of unviable public enter- Current account balance -2.1 -0.9 prises. While not deemed critical External debt 34.5 36.3 at the time, these shortcomings Debt service ('c. of exports) 26.4 28.3 served as early warning of risks ! Valniues ($ mnillionl) to future sustainability of the Current account balance -5,161 -2,276 reforms. Total extemal debt 86,444 92,278 Foreign investment 489 3,207 The unfinished agenda Grant aid 604 409 ___________ _ ____ _______.____i The liquidity crisis of 1991 al- lowed the government to take forms focused first on the most to one whose openness to foreign bold steps in revising the 1991/92 binding constraints, which also investment compares favorably budget and in removing some of produced quick results, helping with that of most Asian countries. the policy distortions that had cre- to strengthen consensus around ated India's large fiscal imbal- the reforms. Results ances. During the initial phase the stabilization and structural reform Within weeks of announcing the The reforms produced immedi- components of the program were reform package, the government ate results. The timely provision of well integrated. But fiscal adjust- devalued the rupee by 23 percent, foreign exchange helped India ment slowed in 1993/94. Budget raised interest rates, and revised weather its balance of payments deficits at both state and central the 1991/92 union budget, making crisis and improve its creditworthi- government levels increased, lead- sharp cuts in subsidies and trans- ness. Several key macroeconomic ing to high inflation and straining fers to public enterprises. Over the indicators improved more than monetary policy. The public deficit next six months, it abolished the projected (see table). After declin- in 1993-94 averaged about 2 per- complex system of industrial and ing in the first year of the reforms, cent more of the GDP than import licensing, liberalized trade GDP growth resumed to 5 percent planned. Consolidated public sec- policy, and introduced measures in 1993/94 and 6.3 percent in 1994/ tor savings actually declined dur- to strengthen capital markets and 95. Exports increased almost 12 ing the reform period. Since 1994, institutions. The reform agenda, percent. Most important, there was the government has resumed fiscal though ambitious, was nearly fully a surge of foreign investment, adjustment, with the result that implemented during the 1991-93 which increased almost sevenfold the deficit declined from 7.5 per- SAL period. over projections. cent of GDP in 1993/94 to 6.1 per- cent in 1994/95. But the pressures These measures were followed Although the growth of imports to waver from fiscal discipline by additional reforms to liberalize was substantially greater than was remain. investment, further deregulate projected, the current account trade policy, improve tax adminis- deficit over the period was much India's balance of payments, tration, and strengthen the finan- smaller, due largely to the increase though much improved, remains cial sector. By 1995, India had in exports. There was also a rapid vulnerable. About $24 billion of moved from a regime in which accumulation of international re- India's $95 billion external debt is private investment was not al- serves. The reserve buildup, at a due to be repaid in the next four lowed in major economic sectors rate of nearly $1 billion a month years. This means that in addition June 1996  to the financing requirements of need clarification. Greater atten- the'current public expenditure tion needs to be given to institu- Box 1: Sustainability indicators deficits, India will need to mobi- tional and regulatory issues to lize more than $40 billion of ex- facilitate private investment, and A number of indicators can ternal financing to meet its to the operational and organiza- help assess the sustainabilit) of a debt-servicing requirements. tional efficiency of public infra- country's economic polico reformg. dtionale eficic. In India, these include public sav- structure firms. ings (at the central and the state Thus, the sustainability of the levels) and investments, revenue reforms hinges on the continua- * Social sector. The states are the deficits and debt burden, public tion of the agenda, at the heart primary source of financing for enterprise profits and productiv- of which are fiscal reforms. The such vital sectors as education and itv, labor market efficiency, and agenda's continuation raises four health. Yet social spending as a human capital development. issues important for sustainabil- proportion of their GDP declined Grouping these indicators as a set ity (see Box 1). from 6.6 percent in 1991 to 5.6 per- of "selected sustainabilitv indica- cent in 1995, largely because re- tors" in the overall assessment ot * Public enterprise reform. Many sources are being preempted for I progress in India's reform pro- public enterprises, particularly interest payments and current ex- gram can help to focus attention the utilities, continue to incur penditures. Unless the states com- on matters that are truly important large losses, imposing a serious prehensively reform their budgets, in the long run rather than merel, burden on the public budget and the crisis affecting the social sector urgent in the short run. tying up much of the country's will inevitably deepen, clouding I industrial capital. The govern- the prospects for medium-term Selected sustainability indicators ment cannot afford either to sup- growth and exacerbating social Fiscal indicators (% of GDP) port unprofitable enterprises or tensions. (See Box 2.) I Government saings-central, to step up investments to mod- ! ostate, total ernize or expand profitable ones. Role of the World Bank Debt service/lax revenues- The government needs to restruc- Dcentral, state, total ture, privatize, or close down The SAL and the program it unviable public enterprises. supported were designed and Investment (% of GDP) wholly owned by the government. I Public Labor markets. Public enterprise The Bank, through its policy dia- Private reform and the efficiency of the logue, economic and sector work, labor market are closely linked. role in aid consortium meetings, Public enterprise reform India's labor policies tend to and interactions with the IMF, f PE profits/losses protect bloated workforces, helped in preparing the ground- Rates of return to capital irrespective of the effect on the work. But that groundwork did Other efficiency indicators company's profitability and pro- not develop overnight. Over many Labor market indicators duction mix. These policies par- years of policy dialogue informed Productivitv ticularly hurt public enterprises, by a number of good analytic stud- Public sector employment since private firms can sometimes ies, the Bank contributed to India's negotiate around such policies. ongoing policy debate, helping to Human capital development More flexible labor markets will focus attention on major policy help increase employment oppor- distortions hampering economic tunities, particularly in labor-in- growth and on the interrelation- tensive industries where India ships among them. This process with its immediate balance of pay- has a comparative advantage. helped develop a high degree of ments crisis. congruence between the reform Infrastructure development. In- strategy advocated by the Bank Lessons frastructure is vital to economic and the one adopted by the gov- growth, yet public investment in ernment in response to the crisis. * Macroeconomic stabilization is cen- roads, power, communication, tral to the sustainability of reforms. and the like has declined. Even The Bank, through its support Without having reduced the fiscal profitable enterprises operate in- of the SAL, also helped raise the deficit, the government would not efficiently because of inadequate credibility of India's reform pro- have been able to lower custom investment. While the private gram, contributing to the willing- tariff rates, reduce reserve require- sector has responded enthusiasti- ness of other donors, notably ments for commercial banks, de- cally to the opening up of infra- Japan and the Asian Development regulate interest rates, or impose structure to investment, the rules Bank, to provide substantial addi- strict budget constraints on public for direct foreign investment still tional funds to help India cope enterprises. By the same token, the OED Precis  Box 2: Social dimensions of adjustment The government. with support improving the targeting ot the evpen- and (2) the design and implementa- from a $500 million IDA credit ditures. Central Plan expenditures on tion of employment generation, (approved in December 1IQ2 and education, health, family welfare, training, and counseling started closed in 19'4 i and assistance from women and children, and rural devel- relati -elv late. donors, e,tablhshed the Social Safe- opment increased from 0.9 percent of ty Net Sector Ad1justment Program GDP in 1991/92 to 1.2 percent in The government's Economic a year after the SAL. The program 1993/94. Surveil. prepared by the Ministry provided support in key sectors of Finance, provides some informa- dealing w i t h pri mary education * de%eloping the DistrictPrimary tion on the effects o(f India's reform and health care, disease control, Education lProgranm. which is now the program on poverty and the social and nutrition. It established a Na- main vehicle for helping primary edu- sectors. tional Renewal Fund as a tempo- cation become universal in India. The rary social safety net to cover the program hah become the unmbrella for During the first two years of costs of compensation or severance both national and international assis- the reforms, cuts in government pay, retraining and redeplo% meiit tance in dev-eloping primary educa- expenditures led to declines in em- of workers affected by the restruc- tion in India. ployment and real wages. But in turing of sick public enterprises, the past two years booth have re- and area emnploy ment regeneration * improving programs in prevention bounded, es.peciall% in the rural schemes in cities and states ad- and treatment ot lep[rosy, lllindness, areas, which have particularly ben- versely affected by the industrial ttiberculo.i-. and malaria, although in elutet trom several years of good and public sector enterprise re- the areas of primary health care and harvests. Social spending at the forms. Firm evaluative data on the nutrition, no far-reaching outccolmes central level has increased in real effectiveness of the program are not are yet evident. terms during the tour years of the yet available. Nev-ertheless the retorm program, although at the Bank's implementation completion * funding the National Renewal state level, spending has declined. report of June 1995 highlights the Fund, including providing paymentu Although the decline in infant mor- following from among the pro- to about 77.00- Vol Untarv retirees taIity rate pLaused in l'I PQ and 1992, gram's achievements: The role of the fund has been more it resumned in lQ93,and while aver- limited than e\pected, however. be- age a ?;gricultural real * ages fell * at the central level, increasing cause of two factors: (1) industrial re- during the crisis 'ear .,l 19910 42, expenditures in social sectors and ..ructuring ha-. progressed slow%l! tlhey increased subseqltlentlv. subsequent faltering in fiscal ad- ment, particularly in a large, diverse Through those instruments, the justment threatens India's ability democratic country like India, depends Bank contributed to India's eco- to deepen and intensify the struc- on previous groundwork. The Bank's nomic policy debate, helping to tural reforms and consequently to influence on India's reform pro- focus attention on the key con- accelerate growth and poverty gram and the SAL was indirect, straints on economic growth. alleviation. shaped more by the years of policy The process helped prepare the dialogue and analytic studies that groundwork for both the govern- * The quality and effectiveness of had preceded the crisis than the ment and the Bank's quick re- Bank assistance in structural adjust- work around the crisis itself. sponse to the crisis. OED Precis is produced by the Operations Evaluation Department of the World Bank to help disseminate recent evaluation findings to development professionals within and outside the World Bank. The views here are those of the Operations Evaluation staff and should not be attributed to the World Bank or its affiliated organizations. This and other OED publications can be found on the Internet, at http:// www.worldbank.org/html/oed. Please address comments and enquiries to the managing editor, Rachel Weaving, G-7137, World Bank, telephone 473-1719. Internet: rweaving@worldbank.org June 1996