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On 29 February, the Indian Finance Minister, Arun Jaitley, presented the central government’s budget for the fiscal year 2016/17. The budget showed the administration’s intent to continue its fiscal consolidation path. The government is targeting a reduction of the deficit from 3.9% of GDP in 2015/16 to 3.5% in 2016/17. The budget comes 25 years after the sweeping economic reforms of 1991, which revolutionised the Indian economy and generated significant gains for the following two decades. But while the current reforms of the Modi administration are being implemented more gradually than those of 1991, they are comparable in their scale and ambition. If successfully implemented, they could revitalise the Indian economy for the next two decades.

India implemented a broad set of reforms in 1991 in response to a severe balance of payments crisis. The crisis left India with foreign reserves barely sufficient to finance oil imports for two weeks. In response, the government devalued the currency, reduced regulation, dismantled bureaucratic control over licensing, opened up the economy to foreign investments and cut trade tariffs. The results were startling. India’s annual real GDP growth rose from an average of 4.1% in the four decades prior to 1991 to 6.8% in the subsequent two decades. This made India one of the growth engines for the global economy. Income per capita increased fivefold to USD6.2k today on a purchasing power parity (PPP) basis from USD1.2k in 1990. The share of people living below poverty (defined as USD1.9 per day on a PPP basis) was halved from 46.1% in 1993 to 21.3% in 2011.

But two decades after the 1991 reforms, the Indian economy was crippled by supply bottlenecks in the form of weak transport infrastructure and power shortages. India’s ranking in the World Bank’s Ease of Doing Business Index deteriorated from 120 out of 189 in 2007 to 140 in 2013, lagging behind Sri Lanka, Nepal, Bhutan and Pakistan. The persistent inflation problem, a result of supply bottlenecks, was further exacerbated by government policies aimed at increasing rural wages and easy monetary policy. India lost competitiveness and the current account balance deteriorated from a surplus of 2.3% of GDP in 2003 to a deficit of 4.8% in 2012. The weaknesses were exposed in the taper tantrum of 2013, when the tapering of US quantitative easing was announced, leading to capital flight from emerging markets (EMs). India was among the so-called Fragile Five of the worst-hit countries. It was in desperate need of a new wave of reforms to address its vulnerabilities and kick-start growth.

Ease of Doing Business Ranking

(1: most business-friendly, 189: least business-friendly)


Ease of Doing Business Ranking

Sources: World Bank, Haver Analytics and QNB Economics

The election of Narendra Modi to the prime minister’s office in May 2014, and the appointment of Raghuram Rajan as the governor of the central bank in September 2013 have helped initiate a new wave of reforms in India. Modi’s government has reduced energy subsidies, increased capital spending to boost India’s ailing infrastructure, eased restrictions to foreign direct investments, promoted further financial inclusion and have taken measures to introduce a uniform goods and services tax. Rajan adopted a coherent and explicit monetary policy framework based on inflation targeting and took steps to increase competition in the banking system. The reform drive currently underway has not only stabilised the Indian economy, but made it one of the rare bright spots among EMs, with annual growth reaching 7.3% in the last quarter of 2015. But more is needed to increase labour market flexibility, address land acquisition laws which have inhibited investment, and tackle bad assets and low capitalisation in the banking system.

In conclusion, the Modi’s reform agenda has been more gradual and piecemeal compared to 1991. But if successfully implemented, they could make India one of the fastest growing countries in the world, with potential GDP growth around 8-10%.

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