Background

In 2003, India’s finance minister Mr. Jaswant Singh prepared to present the 2003-2004 Union
Budget. His task is to present a budget in congruence with the 10th Five Year plan while
ensuring his Party’s (BJP) political control and popularity among the populace. The 10th Five
year plan aimed to achieve a growth rate of 8%, create 550 million new jobs, increase FDI,
disinvest “sick units,” have better fiscal management, increase tax collections, focus on human
development, and extensive privatization to reduce government control on enterprises. Since
Independence, India has been battling external issues that are primarily political in nature and
internal issues that are multifaceted. Mr. Jaswant Singh wanted to bring in reforms which would
be for the welfare of the society in general but was worried that the general population of India,
who are dependent on government subsidies and employment, might not see these reforms in a
positive light, which may ultimately lead to hurting BJP’s prospects in 2004 General Elections.
On the other hand, increasing fiscal deficit and account deficit are forcing Mr. Singh to bring in
Economic reforms that would benefit the country in the long run. Even though previous Five-
year plans had tried to implement specific reforms to tackle such issues, their effect has mainly
been limited. With the General Elections approaching and with India embroiled in social,
political, and religious conflicts, Mr. Singh has to carefully weigh the ramifications of
introducing changes as per recommendations of the Planning Commission and Kelkar’s
committee.
Critical Challenges
The first challenge is corruption which has been hurting India’s image for a long time. Right
after Independence, the government instituted several controls in the form of licensing and trade
restrictions. Such regulations were infamously nicknamed Permit Raj. As per Mr. Manmohan
Singh, former Finance Minister of India, since the resources were scarce and demand for these
resources were too high, such regulations were necessary to ensure rationing. But after some
time this colossal bureaucracy became an instrument of inefficiency and corruption. Businesses
had to acquire special permissions through a complicated set of procedures that involved
appeasing multiple government officials and delays sometimes spanning years. For example, to
import an item, a company had to sufficiently prove that it is essential and cannot be
manufactured in India within a reasonable time frame. This often led to companies using poor-
quality and expensive domestic goods. With time, corruption became an integral part of Indian
bureaucracy and permeated all branches of the government. Poor people were often the victims
of corruption as the rich could always get away with the help of the power of money. While the
poor were receiving low-quality and spoilt food subsidies, almost 40% of India’s famine relief
stock ended up on the black market. People felt cheated due to a lack of transparency in the
bureaucracy. Minister of Disinvestment Mr. Arun Shourie commented that corruption is a
product of the third-rate quality of leadership. When a country is run by people with criminal
backgrounds and a corrupted mindset, the government is bound to fall. India was ranked 72 nd on
the Corruption Perception Index in 2002.
The second challenge is the High Fiscal Deficit the central government must tackle. In 2002-
2003, the fiscal deficit of India was 5.9% of its GDP. When combined with the deficit of the
states, the fiscal deficit exceeded 10% of India’s GDP. Half of the government spending was
used up to service the debts. This prevented both central and state governments from investing in
infrastructure projects and social welfare programs. The government planned to reduce the fiscal
deficit to 5.6% of GDP during the 2003-2004 period. However, lowering expenditures proved
more complex than previously thought because of increased military expenditure in response to
continuing problems with Pakistan. India’s military expenditure alone consumed 10% of total
expenditure in 2002. Moreover, natural calamities such as drought and earthquakes further
increased government expenditure. Agriculture, energy, and fertilizer subsidies further made up
12% of government expenditure. With the limited sectors the central government could tax and
the amount of subsidies in place, the government couldn’t reduce expenditure without losing the
majority support of the Indian populace.
The third challenge is various Social and Political Conflicts India was facing. India and Pakistan
have been at loggerheads since partition, and both countries came to a confrontation in 1999 over
the Kashmir dispute, which lasted for two months. Both countries tried to resolve the Kashmir
issue after terrorists held Indian Airlines passengers hostage for eight days, but the talks didn’t
work out. Now that India and Pakistan are nuclear-capable, any form of war-like situation raises
a threat of nuclear war breaking out. Life of 8-12 Million people will be wiped out if either side
starts the nuclear war between the two countries. Adding to external issues, internally, India had
to witness religious turmoil. The aftermath of the Ayodhya temple conflict threatened the
secularity of the nation. The Supreme court finally had to ban all religious activities in Ayodhya
to stop the escalation of the conflict. At the same time, the BJP government, under pressure from
its coalition parties, started petitioning to build a Hindu temple at the Ayodhya site.
Analysis and Interpretations
Before India, as a country, came into being under British rule, the Indian subcontinent was a
fragmented land of many kingdoms. Before Britain’s invasion, India already had a history of
invasions ranging from Alexander the Great to the Mughals. Britain was self-serving, utilizing
the rich resources of India to make Britain rich. In the process, Britain brought in some changes,
such as establishing Indian Civil Services and building a network of railroads and highways.
However, the Indian populace was angered by Britain's lack of representation in governance and
widespread exploitation. Under Mahatma Gandhi’s leadership, Indians united to start a civil
disobedience movement. Indians promoted ideals of “swadeshi” and boycotted British goods and
services. After almost 25 years of persistent pressure from Gandhi’s movement and rebellion
from other similar factions, Britain granted complete Independence to India in 1947.
Because of the bitter disputes between the Muslim League and the Indian National Congress,
which started in the 1930s, India was divided into two secular and democratic states- India and
East and West Pakistan. The partition forced ten to fifteen million Hindu and Muslim refugees to
move from one side to another based on their religion. Because of this, almost 600,000 lives
were lost. Nehru became the first Prime Minister of independent India while Gandhi focused on
easing the turmoil of partition until he was assassinated. After Independence, the Hindu ruler of
Kashmir signed over his state to India in return for protection. Pakistan opposed this move
saying most of the Kashmir population is Muslim and should be a part of Pakistan. Both
countries went to 2 major wars over the Kashmir issue, and both ended in stalemate. A third war
between India and Pakistan in 1971 resulted in the formation of Bangladesh. While conflicts
escalated with India accusing Pakistan of funding militants and terrorists for carrying out terror
activities in the Kashmir region, both countries got involved in a bitter nuclear arms race at the
same time.
On the domestic front, India never seemed to settle down too. Dissent of the Sikh community
over operation Blue Star led to the assassination of former Prime Minister Indira Gandhi. Her
son Rajeev Gandhi, also a former Prime Minister, was assassinated in suicide bombing because
of India’s efforts to end the dispute between Tamil separatists and the Sinhalese government in
Sri Lanka.
In 2002, India had a population of almost 1.05 billion and was growing at 1.5% every year. Life
expectancy was 62, and the overall literacy rate was 65%, even though the literacy rate varied a
lot with gender and region. India was heavily dependent on agriculture, and 72% of its
population resided in rural areas. High dependence on agriculture meant high sensitivity of GDP
to agricultural output, which depends on the weather. India had a large proportion of the world’s
poor and was mostly concentrated in the states of Uttar Pradesh, Bihar, and Madhya Pradesh.
India was culturally, linguistically, and religiously diverse. Discrimination based on religion and
caste was common. Indian government leveraged this gap in social status between different
factions to gain political support and to introduce reservations.
After Independence, India declared itself to be secular, republic and democratic in nature. India
was divided into 28 states and 7 union territories. A constitution was established, and
responsibilities and earnings were distributed among the state and central governments. India had
3 branches which governed it at Central as well as State level- Executive, Judicial and
Legislative. The Rajya Sabha and the Lok Sabha constituted the bicameral parliament. Whoever
had the majority support in Lok Sabha was appointed the Prime Minister of India by the
President.
The political canvas of India after Independence has not been pretty. The Congress Party enjoyed
majority support of Indian populace and stayed in power to form government for 33 of the 44
years following Independence. Most of this popularity was because of Nehru’s and Gandhi’s
association with the Congress Party before and during Independence. Soon, the popularity of the
Congress Party started to fizzle after unearthing of numerous scandals. Decision of Indira Gandhi
to declare emergency in 1975, withholding her opponents, and a scandal linking her son Rajiv
Gandhi to corrupt activities involving benefits from foreign arms suppliers started a dissent
among the Indian citizens against the incumbent Party. With the assassination of Rajiv Gandhi in
1991, the Congress Party was left searching for an influential leader. P. V. Narsimha Rao was
selected to fill the power gap and he did a tremendous job between 1991-1996 in bringing in
Free Market reforms. But, after Congress Party’s defeat in 1996 General Elections, Sonia
Gandhi, the foreigner wife of Rajiv Gandhi, emerged as the new leader of Congress Party.
However, this progress failed to bring back the old glory days of the Congress Party as the Party
was seen to be taking a neutral stance on most of the burning issues. Also, Sonia Gandhi’s
foreign origins limited her popularity among many groups. With the decreasing influence of
Congress in the political arena of India, many smaller regional and caste groups emerged. These
smaller groups often formed coalitions to fight elections and this coalitions became a norm going
forward. At the same time, BJP party was gaining lot of recognition with their wins in state
elections. The BJP government also formed a coalition with 25 other parties called National
Democratic Alliance, which ruled from 1996-2004. But such coalitions are often mired with
disparate interests and internal conflicts.
Now let’s analyze the economic conditions of India. India modeled itself as an industrialized and
a socialist state, gaining inspiration from Soviet Union. The government issued first Industrial
Policy Resolution in 1948 to gain exclusive authority over infrastructure operations like
telecommunication and railroads. The Planning Commission was established in 1951 and the
first Five Year plan was drafted same year to achieve India’s economic goals. With wounds of
hardship and slavery under British rule still fresh, India was cautious not to depend on foreign
investment for growth. So, self-sufficiency and self-dependency was the focus. With 72% of the
population employed in agriculture, the government allocated 45% of resources planned under
the First Five Year plan to agriculture. Industries received less than 5%. However, India’s GDP
grew by 3.6%. The Second Five Year plan resulted in Foreign Reserve crisis in 1957 after which
the government limited outflow of foreign currency and implemented strategy to replace imports
with domestic goods. The Plan was to provide opportunity for domestic industry to flourish by
making imports uncompetitive.
Since the domestically available resources were limited and imports were restricted, the available
resources were heavily regulated by the government to ensure rationing. The regulations became
complex over time and created a bureaucratic system that was known for inefficiency and
corruption. Nicknamed “Permit Raj”, this regulatory system required licenses to be obtained by
businesses through complex set of procedures often spanning multiple ministries. Private firms
often faced delays and unnecessary hurdles due to such regulations. Imports were highly
regulated with special permissions, high tariff rates and quotas. On the other hand, domestically
available substitute goods and technologies were of poor quality and outdated. Add to this the
special incentives that the government granted to the small enterprises, Industrial growth
declined during this period.
In 1956, the government issued a second Industrial Policy Resolution that gave the government
control over 12 more sectors- banking, insurance, fertilizer, mining, steel, chemical and oil. Still
focusing on growth of agriculture and industry, a complex industrial licensing program was
introduced to monitor these sectors. With such regulations and authority, the government tightly
controlled the Indian economy. Especially the private firms were highly regulated over what
business can a firm enter into, location, production, purchase of assets and employment. To curb
unemployment, government made it difficult for the companies to fire people. As a result
complacency crept in which led to such inefficient public-sector companies being deemed “sick-
units”. The government again highly subsidized such failing units to keep unemployment in
check. On the other and, the government primarily focused on agricultural growth in its Third
and Fourth Five Year plans. But the plans never met their goals owing to a major war with China
and 2 wars with Pakistan. However, with scientific developments in agriculture and availability
of high-yield seeds, India entered “Green Revolution” phase in 1967. By 1979, India became an
exporter of grains.
In 1970s, with balance-of-payments shortfalls, India tried to boost its Exports. The rupee was
devalued, and exports were made competitive. Cash Assistance Scheme and Registered
Exporters Policy were introduced to stimulate exports. After few hurdles along the way which
threatened India’s new Export policies, India formed military and economic partnerships with
the Soviet Union, which also served a secondary purpose of protection against US-Pakistan
partnership. With a relatively stable foreign Trade relationships, India looked successful in
achieving its export-led growth.
With the collapse of Soviet Union in 1991, India started rethinking its central planning structure.
In addition to losing its major trade partner, India faced social and political disturbances.
Because of large oil imports in face of rising oil prices and slacking exports, India faced balance-
of-payments crisis. Current account deficit stood at 3% of GDP with less than $1 billion in
foreign reserves. India requested help from IMF and in return India had to implement economic
reforms under the “Washington Consensus”, which included fiscal discipline, increased
expenditure on health and education, tax reforms, interest rate liberalization, competitive
exchange rate, ease of trade and foreign investment, privatization, deregulation, and secure
property rights.
Under the leadership of P. V. Narasimha Rao, FM Manmohan Singh brought economic reforms
which pushed India towards liberalization and deregulation. The Economy was allowed to be
regulated by market forces without much government interference. Import and capacity licensing
were removed, and subsidies and tariffs were simplified. A disinvestment committee was setup
to private most of the public sector in order to increase efficiency and decrease corruption. FDI
was promoted and attempt was made to reduce fiscal deficit by increasing tax earnings and
reducing expenditures.
Effects of these reforms was immediate and was quite visible from the 6% growth of the
Economy. Government’s investments in higher education started to pay-off as the technology
sector started growing. IT emerged as a leading sector at this time. With educated graduate
workers available and their low cost of labor, many American companies started outsourcing IT
and back-office operations to India. Many Indian IT firms like Infosys, TCS and Wipro were
born leveraging the technology growth and the low taxes on IT exports.
Foreign Direct Investments were not an exciting prospect for India owing to the prior bitter
experiences of foreign companies. Most FDIs were in the form of joint ventures with local
companies because of restrictions on foreign ownership. Even though India was open to free
trade, lack of basic infrastructures like adequate powers, transportation and communications
made investors skeptical of investing. Yet, the complex bureaucratic system of Indian
government was still the biggest deterrent to foreign investments. Some states took initiative to
minimize the set bureaucracy, which led to cities like Bangalore and Hyderabad emerging as
technology sectors of India. This same bureaucracy fostered corruption because of its basic
structure and was another reason for lack of trust of investors.
While India was bringing in liberal Economic reforms and had a healthy GDP growth, the Fiscal
Deficit was concerning. The amount of expenditure in form of subsidies, disaster funding, debt
servicing and military expenditure were a massive stress upon the economy which distracted the
government from spending on actual developmental works. Adding to that, the current tax base
hardly covered 2% of Indian population. It was the rich who were not paying their taxes. Tax
avoidance was at an all time high. All these factors were affecting the fiscal discipline of Indian
Economy, and it was high time that the government pursued rigorous privatization of its holdings
to come out of this pickle.
Application of Macroeconomic Theories
The case can be analyzed with the help of two Macroeconomic Theories-
1. International Trade
2. Fiscal Policy
International Trade- It is imperative for a country to maintain healthy relations with countries
which are favorable for trade and commerce. International Trade can sometimes become a sticky
subject because of the political situation of a region. After Independence, India was adamant not
to take help of foreign investments in any form. India wanted to be self-sufficient. What this
meant was restrictions on Imports and Exports with other countries. Since the Industries in India
were at a very nascent stage, the government wanted to provide them an opportunity to mature
and be competitive. So, the import regulations and subsidies came into effect. The import
regulation made it extremely difficult for private firms to procure goods and technology from
outside if similar goods or technology was already available locally. Even though the intention of
government was novel, the quality of domestic goods and technology was inferior. Furthermore,
the smaller industries didn’t want to grow because of lack of foreign competition and
incentivization by government in form of subsidies. On the export front, since India was
struggling to produce enough for even its own consumption, there was hardly any surplus to
export. Lack of Exports led to a shortfall in balance-of-payments and reduced the inflow of
foreign exchange. If India would have been more brave in opening up its borders to trade earlier,
then India would have been an exporter of lot many other goods and services other than
agricultural products. A liberal foreign trade policy would have seen much less corruption and
the Indian Rupee would not have been devalued 4 times after Independence. With acquisition of
better technologies, Indian industries, infrastructure and technical expertise would have been
much better than the current situation.
Fiscal Policy- Fiscal Policy deals with the earnings and expenditures of a country. Since
Independence, India has been mired with conflicts both internally and externally. Externally,
India must deal with Pakistan and China on two fronts actively. Thus, India’s military
expenditure takes up a large proportion of the yearly budget. Internally, India has to deal with
Maoist rebellion and religious conflicts. Also, India must spend a lot on disaster management
and debt servicing which add to its expenditure. But the biggest chunk of potential earnings go
into providing subsidies and bailing out public-sector sick units. Indian people are very much
used to getting subsidies whether its on LPG gas, Petrol, or grains. Government controlled public
sectors are often inefficient and require regular fundings to stop from going bankrupt. If the
Indian government can cut back the subsidies that general public enjoys, then it may risk getting
voted out in the next general elections. But it would only help the Economy in the long run.
Similarly, if the government sells off its sick public sector units to private entities, then the
government would show earnings instead of expenditures. Plus, these units will become much
more efficient and productive. Apart from reducing expenditures, government also has to
increase earnings. Only 2% of Indian population pays its direct taxes. Government is trying to
broaden its tax base to increase tax earnings. If any government succeeds in implementing such
disciplines through economic reforms, then the Fiscal Deficit will surely turn into Fiscal surplus.
Learnings
As per the discussions in the case, it is often advisable to not control the economic aspect of any
business. We should let the free market determine the demand and supply of goods and services.
The prices should be a result of healthy competition among domestic as well as foreign
companies. As a manager, we should be open to ideas of growth and investment, and not be
afraid of losing control. We must ensure that more powerful companies are not exploiting the
less powerful companies through undue influence. However, our interference should be limited
to that. As manager, we need to weigh all available options without any bias and choose the one
which most benefits our company/stakeholders in the long run. Yet, no matter how much we
plan, sometimes certain unprecedented conflicts might arise which will force us to detour from
our set plan. However, what’s important is how adaptable we are to accept the challenges and
keep growing. Lastly, as a manager of a private firm, if we may have to deal with the
government at any point of time, then the bureaucratic processes might take longer than expected
to be resolved. Even though the complex bureaucratic processes are getting replaced with faster
leaner ones, it will be quite sometime before the system matures. Till then, its at the discretion of
us managers to decide if we want to invest the time and resource to pursue such processes till the
end, or find an alternative solution.