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The Economic History of Liberation

Revisiting India’s path-breaking budgets on the 25th anniversary of reforms

TCA Srinivasa Raghavan TCA Srinivasa Raghavan | 21 Jul, 2016

JULY 2016 IS being celebrated, at least by the media, as the 25th aniversary of India’s liberation from the dirigiste policies of the previous 40 years. The Budget of July 1991 has been made to go down in history as a ‘pathbreaking’ one, the Budget that set free, in then Finance Minister Manmohan Singh’s words, the ‘animal spirits’ of Indian businessmen. At the end of his speech, he quoted Victor Hugo to say that no one can stop an idea whose time has come. What people don’t know—or didn’t until a recent biography of the then Prime Minister set the record right—is that Singh’s first draft of the Budget was a socialist document. The Prime Minister, says his biographer, asked Singh, “Is this for what I chose you?” Singh came back a couple of days later with the Budget that is now being feted. And for the last 25 years, he has taken all the credit for it. But the spirit of free enterprise about which Singh waxed so eloquent—and to which he did not fully subscribe— has never constituted what Germans would call India’s zeitgeist, the driver of its inner spirit. That honour was long ago claimed by socialism, which believes that ‘animal spirits’ are best kept under check so that the state can work its magic in lifting the poor out of poverty. And, in varying degrees, this belief has permeated every Budget since the one of 1946, which was presented by Liaquat Ali Khan who went on to become the prime minister of Pakistan a year later.

Narendra Modi’s first Budget was not very different. And, for the very limited departure it showed from the past, his Government was excoriated for being a ‘suit-boot ki sarkar’. Modi and his Finance Minister have withdrawn hastily since then and gone back to the old, more politically acceptable style. His third Budget, in fact, truly revived the socialistic spirit and it became clear that the much hailed Budget of 1991 hadn’t expelled the gorilla from the room. The state would continue to dominate the economy, thank you very much.

As it happens, the Rao-Singh Budget of 1991 was not the first ‘pathbreaking’ one. Several previous budgets made a significant break with the past. More importantly, they came only after a political crisis, big or small. The bigger the crisis, the bigger was the break; but a crisis has been both a necessary and sufficient condition for every dramatic Budget. These crises were either political or economic, or, as has mostly been the case, a combination of the two.

Even though TT Krishnamachari was a successful businessman who thought Nehru was wrong, he fell in with the Prime Minister’s belief in planned socialist development

Arguably the only exception to this rule was the Budget of 1957 presented by TT Krishnamachari (TTK), but only in the sense that the political and economic crises were muted then. The political pressure on the Government, however, was enough to make a break with the previous six years, during which Sir Chintaman Deshmukh had presented six budgets in a row. In the words of a contemporary, he suffered “the consequences of good fortune”—low inflation, growing industrial and agricultural production.

In the meantime, TTK had convinced Nehru that quick growth could be achieved by large-scale imports. That policy almost wholly depleted India’s foreign exchange reserves. Later, even though he was a highly successful businessman who thought Nehru was wrong, he fell in with the Prime Minister’s belief in planned socialist development.

Results in the first half of the 1950s were slow in coming, at least in relation to the expectations that independence had raised. The growing discontent led to the Avadi Congress of 1955 in which the resolution was passed that India would adopt a ‘socialistic pattern of society’. As an excuse for this, the private sector was portrayed as being unwilling and unable to contribute to India’s economic growth. That resolution led to state intervention on a gigantic scale, intended to capture the ‘commanding heights’ of the economy. PC Mahalanobis, the great statistician, was asked to formulate the intellectual basis for the Second Five Year Plan. TTK, who had been made Finance Minister despite his failures as Commerce Minister, was asked to find the money for it.

India has never really broken free of the mindset that these two men engendered: the need to tax till the pips squeak. Today, in one way or another, the average Indian parts with almost half his or her income as some tax or the other. The other consequence was the gradual abandoning of fiscal rectitude. In 1979, it was jettisoned completely.

THE TTK-NEHRU BUDGET, 1957

As 1956 gave way to 1957, there was a buzz in India, comparable to the one 2014 generated, of change and hope. But there was also an air of crisis because, unknown to the country, the sterling balances were vanishing. However, thanks to the Cold War, foreigners were queuing up to help. Nehru, meanwhile, wanted a huge resource-raising effort for the Second Five Year Plan and turned to TTK, who was full of contradictions.

Thus, as someone who had run a business well, he knew that Nehru’s socialism was dangerous. Nevertheless, he authored the Industrial Policy Resolution of 1956 which neutered private industry by putting it in a straitjacket out of which it is yet to escape fully. As Commerce Minister, he had been an import enthusiast. As Finance Minister, he turned a vociferous import substitutionist. He believed implicitly in the importance of a sensible interest rate policy and the independence of the RBI. But it was he who distorted the former and destroyed the RBI’s autonomy.

It was hardly surprising, then, that his Budget for 1957-58 which set the tone for the next 13 years stood everything on its head. He had an excellent mentor: Lord Nicholas Kaldor, the British economist who was, if you will, a fiscal Robin Hood. Kaldor proposed that in addition to income tax, there should be a capital gains tax, a wealth tax, a gift tax and an expenditure tax. Since services were not very large those days, he missed that one. It would come 50 years later.

Officials in the Finance Ministry were aghast when they heard that TTK was proposing to adopt all of Kaldor’s ideas in his Budget. TTK heard them out, spent a few sleepless nights—and overruled them. India had brought in a tax regime that endures even now, despite occasional, feeble attempts to dismantle it. But the political mood turned euphoric, believing that the magic key to growth had been found. Nehru would deliver everything to everyone. It was just like Modi in 2014.

THE INDIRA GANDHI BUDGET, 1970

The 1960s were a complete washout for India. In 1962, it was comprehensively defeated by China in a short war in the Himalayas. In May 1964, Nehru died. In 1965, Pakistan attacked India twice: first in the summer in the Rann of Kutch and then in September in Kashmir. In January 1966, Prime Minister Lal Bahadur Shastri died of a heart attack. To top it all, in 1965 and 1966 the monsoon failed. In 1969, there was an internal battle in the Congress party and it split into two. Meanwhile, the rupee had been devalued by a massive 36 per cent in 1966, but the promised foreign aid in return for this failed to materialise.

IIndira Gandhi turned to the IMF for succour and promised fiscal rectitude in return. Low growth throughout the first half of the 1980s was the result

‘Crisis’ doesn’t even begin to describe the state of the nation then. India’s goose looked as if it was fully cooked. Into these depressing times, after nationalising 14 of India’s largest banks, stepped Indira Gandhi promising a new, socialist dawn because her minority Government was dependent on Communists—of the CPI, not CPM—for survival. In 1970, she presented her first and only Budget. It set the tone for the next 15 years:

“A balance has to be struck between outlays which may be immediately productive and those which are essential to create and sustain a social and political framework which is conducive to growth in the long run… no effort must be spared for raising resources for the purpose… If the requirements of growth are urgent, so is the need for some selective measures of social welfare. The fiscal system has also to serve the ends of greater equality of incomes, consumption and wealth, irrespective of any immediate need for resources (italics mine).”

The result: massive taxation, a huge expansion of the entire public sector, state capture of the banking system, and the insidious growth of corruption as patronage rather than merit became the operating principle. As ‘pathbreaking’ budgets go, Indira Gandhi’s 1970 Budget ranks with the 1957 one of TTK, never mind that it eventually led in the 1970s to virtual economic stagnation. At one point, the marginal rate went up to 97 per cent and along with the incidence of wealth tax, over a 100 per cent. Indirect taxes were also hiked, especially on things which the Government regarded as being luxuries or inessential. Outlays for rural development were increased sharply. Exchange control was tightened, as was industrial licensing. But thanks to the oil boom and inward remittances from the Gulf, foreign exchange reserves rose during this period.

In February 1979, Charan Singh, who later became Prime Minister for six months (in July), raised the uncovered budget deficit for the first time to over Rs 1,000 crore, to Rs 1,365 crore. By the end of the fiscal year, it had gone up to Rs 2,700 crore (worth perhaps Rs 25,000 crore in today’s money).

Manmohan Singh told a country shivering with fear that the time had come to forget the East India Company. Narasimha Rao got rid of the shackles that had held industry back

By the time the 1970s ended, thanks to the second oil crisis and drought, India was in crisis once again. This time it was an economic one. Inflation was running at 22 per cent. Forex reserves had again all but vanished. There was an unprecedented drought in the country—no famine though, a fact that went unnoticed then. The Sixth Five Year plan had to be finalised and resources found for it.

In January 1980, Indira Gandhi, after 22 months out of power, was re-elected Prime Minister once again. She turned to the IMF for succour and promised fiscal rectitude in return. Low growth throughout the first half of the 1980s was the result.

SINGH NO 1: BUDGET 1985

In October 1984, she was assassinated and in her place came her son, Rajiv, a commercial pilot who was impatient with the old policies. For some reason, he appointed VP Singh, who was as socialist as anyone else in the Congress, as his Finance Minister. Like TTK, Singh played along with Rajiv and together they crafted another ‘pathbreaking’ Budget in 1985 which reversed the policies of Nehru and TTK. They cut taxes, eased the rigours of industrial licensing, cut tariffs and looked to the markets for efficient resource allocation. So they had to adopt heavy deficit financing. The state, financed by massive fiscal deficits, remained the main player in the economy.

By the time his five years in office came to an end in 1989, the budget deficit had ballooned to Rs 11,750 crore. Over the 1980s, India had gone full circle—a huge budget deficit and little foreign exchange. The birds of profligacy were coming home to roost. The deficit for 1990 went up to Rs 11,430 crore, inflation stood at 15 per cent and forex reserves came down to just $1.1 billion, enough to cover, with every sort of import restriction, a mere five weeks of imports.

In the first half of 1991, India ran into its worst fiscal and balance of payments problem ever. To make it all infinitely worse, Rajiv Gandhi was assassinated in May. By June the fiscal deficit had gone to nearly 9 per cent of GDP, the current account deficit had gone to almost 3 per cent of it, and there was a massive flight of capital.

It was crisis time again. Another ‘pathbreaking’ budget was needed, and this time it came from two unlikely saviours: a wily politician from Andhra Pradesh, Narasimha Rao, and a civil servant called Manmohan Singh.

SINGH NO 2: BUDGET 1991

They devalued the rupee in two steps, by 16 and 6 per cent, in quick succession, slashed export subsides and mostly abolished industrial licensing. And all this was done even before the Budget had been presented. Then they cut the current account and fiscal deficits by cutting both imports and government expenditure. (But because of strong resistance within the Congress party, subsidies were soon restored). Customs duties and excise duties both were cut, direct taxes rationalised and foreign investment given an unmistakable come-hither invitation. Manmohan Singh told a country shivering with fear that the time had come to forget the East India Company. Narasimha Rao, in one bold stroke, got rid of the shackles that had held industry back.

Palaniappan Chidambaram brought down the maximum rate of income tax to 30 per cent and reduced the average level of tariffs to just a shade over 25 per cent

Over the next three years India took off, just as it had after TTK’s, Indira Gandhi’s and VP Singh’s ‘pathbreaking’ budgets. A crisis had worked its usual wonders.

PC’S MAGIC: 1997

Everything was going well until 1996 when Narasimha Rao lost the election. Once again, there was a crisis but this time it was entirely political. The BJP formed the Government as the single largest party but since it was far short of the 272 needed to form a stable government, it fell in just 13 days. A coalition government of disparate regional parties came into being, and, in the resulting ideological confusion, the ever ready Palaniappan Chidambaram pulled off a major coup in February 1997 with another path breaking budget. He brought down the maximum rate of income tax to 30 per cent, cut corporation tax to 40 per cent and reduced the average level of tariffs to just a shade over 25 per cent.

India had finally broken free of the Kaldor addiction and has since then plodded along this path with some minor tweaks here and there. It has learnt its lessons and avoided both political and economic crisis.

Perhaps the time for ‘path breaking’ budgets is finally over.

Indian economy Jawaharlal Nehru Manmohan Singh P Chidambaram PV Narasimha Rao Union Budget