Arvind Panagariya and Shruti Rajagopalan Talking Trade
Episode 7: India's Trade Policy (1965-1990) Part I
SHRUTI RAJAGOPALAN: Welcome to the discussion series on free trade and liberalization as part of The 1991 Project at the Mercatus Center. I’m Shruti Rajagopalan and in this conversation series, I will be talking trade with professor Arvind Panagariya, who is the director of the Deepak and Neera Raj Center on Indian Economic Policies and the Jagdish Bhagwati Professor of Indian Political Economy at Columbia University.
In the past, he has served as the first vice chairman of NITI Aayog in the government of India and also as the chief economist of the Asian Development Bank. He is the author of a number of books, but for today’s conversation, in particular, we will focus on his recent books, “Free Trade and Prosperity“ and “India: The Emerging Giant.” Arvind, welcome back. It is always such a pleasure to have you on the series.
ARVIND PANAGARIYA: My pleasure as well, Shruti, as always.
RAJAGOPALAN: In the last episode, which is episode six, we were talking about the 1966 experience of devaluation and the reasons, both political and circumstantial, that led to its failure. While we were discussing that, I had asked you about professor Bhagwati who was consulted, one among many other economists by Mrs. Gandhi, on his views of devaluation. Of course, he had published on this. I asked you about the in-person meetings and you said you will check. It’s lovely that you have professor Bhagwati in the adjoining office. Did you actually manage to ask him?
PANAGARIYA: I did, Shruti. I did speak with him. He has a very vivid memory. He could tell me back the story as it happened. Apparently, by his account, about a week or so before the actual devaluation took place, C. Subramaniam, who was the finance minister then, took him to Mrs. Gandhi. Jagdish had already met C. Subramaniam and given him some notes and so forth.
As he arrived, he tells me, to Mrs. Gandhi’s office—her secretary at the time was L.K. Jha. This was just around the time, by the way, that the PMO had begun to change its character a bit. Most of the power used to be with the cabinet secretary, actually, in the pre-Indira Gandhi era, certainly under Prime Minister Nehru, but L.K. Jha had been then appointed. There was no secretary, originally, and there was no real PMO unit. It used to be small office of the prime minister, but L.K. Jha was brought in for the first time as the secretary to the prime minister.
This idea of principal secretary, of course, that title came later. Anyway, L.K. Jha was now already there as the secretary to the prime minister, and he very quickly came and grabbed Jagdish and took him in because he was afraid that if there were photos, a person took any pictures, that is going to create a little bit of noise in the press and some speculation also that if professor Bhagwati was seen with Mrs. Gandhi, there might be something going on with the exchange rate and all. He wanted to avoid that completely.
They quickly grabbed him, took him to the prime minister’s office, and then the meeting between the two was very much a one-on-one meeting, nobody else present. By his recollection, Jagdish says that she was mainly asking for his opinion whether this would be a good thing to do, to which Jagdish replied in the affirmative. Then she was also concerned what the other senior economists are going to think about it. On that, Jagdish was a bit circumspect that he really couldn’t speak on behalf of them.
I think she was also trying to gauge, particularly about K.N. Raj, who had been involved throughout from the first five-year plan with the government. Apparently, later Jagdish found out that K.N. Raj had been explicitly consulted about this. What he advised was that devaluation would be a good idea, but don’t liberalize the imports. Jagdish’s account is that what he learned after this episode was that these nuanced advices don’t work because the political leaders are interested in the big issue, that is your answer to devaluation yes or no. The fact that K.N. Raj had qualified that don’t liberalize imports meant not very much to her.
She saw it as also K.N. Raj giving his opinion as being fine, go ahead, yes. So what happened was anyway, the meeting was relatively short between Jagdish and Mrs. Gandhi. He says basically she kept her head down, doodling something on a piece of paper or something at the time. He came out and all. Then what happened was that after devaluation, K.N. Raj repudiated that this was not a good thing to have done. In his mind, he perhaps thought that he has said, don’t liberalize imports, but they liberalized imports. Therefore, his advice was not for it.
He said Mrs. Gandhi was very furious. That came to Jagdish from Ramaswamy. At that time, Ramaswamy was the economic adviser, I think, in the ministry of industry. Jagdish said “Ramu told me this later on that she was furious that K.N. Raj had first advised for devaluation and then publicly repudiated it”. Anyway, that was roughly the episode.
RAJAGOPALAN: This is a great account. One, thank you so much for checking with Jagdish. The little bit that I know of him and him, he has just the most incredible memory and is a great storyteller of events like this. I’m glad that we have that as part of this discussion. Also, this tells us more broadly about the problem of politicizing economic decisions beyond a point, which is what socialism requires. It requires a certain degree of control in every aspect of society.
Once politics has to be involved in every single economic decision-making, politicians who don’t have that nuance or don’t have technocratic knowledge, like say, you’re Dr. Manmohan Singh, when he was finance minister or prime minister, then you run into a lot of trouble because you need to know enough, at least to take advice from technocrats. If that is also missing, then things can start going on shaky ground.
Aftermath of 1966 Devaluation
This is a good point to ask you about the aftermath of what happened with the failed devaluation. In particular, Indira Gandhi’s approach and the turn toward very highly restrictive imports regime, which happened after this. Can you talk us through the aftermath of this failed or botched-up devaluation, which just didn’t make anyone happy in one sense?
PANAGARIYA: A very critical factor in this was the fact that devaluation took place in the midst of two back-to-back droughts. ’65-’66 and ’66-’67 were both drought years. Given the very closed nature of the Indian economy and the fact that agriculture was such a large contributor to the GDP, it probably declined since 1950, but still—I haven’t checked the figures, but possibly it was easily still 40% of the economy.
Even the industrial output depended on what happened in agriculture because a lot of the raw material, supplies, etc. came from there. The agricultural failure also led to the industrial recession. Industrial recession meant that then you couldn’t really export very much either. And the failure on the export front was seen as a failure of devaluation. Also, in the socialist environment, of course, from the beginning, virtually everybody was opposed to devaluation. It was seen as having been externally imposed. All those factors contributed to the immense unpopularity of that action.
There was no constituency defending it largely. Among economists, there were only two: Jagdish Bhagwati was supportive. Then Manmohan Singh had written about it, but he was not in the system yet, as far as I remember. He’s, in any case, not very vocal about these things. He’s not that kind of a person. As a result, very quickly the reversals began to happen in the policy. Even soon after devaluation, in fact, on the export front, the incentives which had been withdrawn as a part of the full package returned.
Before that, let me point out one thing, that economically speaking, part of the problem was that at least one other economist who was obviously in support of devaluation had been, I think you know, the only economist who had been writing since the original balance of payments crisis in 1957, that was B.R. Shenoy.
He had written back in 1958, advocating devaluation when actually it could have been successful because the economy was vibrant. There was no food crisis. There was no drought. The basics of the economy were in place. There, actually, devaluation could have succeeded, but of course, Shenoy had nobody supporting him on that front, including Nehru himself who actually made a very clear statement saying that it’s nonsensical to talk about the devaluation of the rupee. Not his words probably, but basically, what he said amounted to saying that this whole talk of devaluation was nonsense. This was never in the cards.
Shenoy, in fact, said that, “Look, part of the problem of the ’66 devaluation was that it was not large enough.” It needed to be significantly larger because Shenoy had been also arguing persistently that what has happened over the years is that your exchange rate is fixed nominally, and your domestic inflation rate is much higher than the inflation of your competitor countries.
As a result, your domestic market is becoming, over time, more and more lucrative for sales and the foreign market is becoming less and less so. Also, your imports are becoming more and more attractive because, in real terms, the rupee has got greatly overvalued because throughout it was appreciating in real terms. It was already 15, 16 years since the economic development process started and some of the deficit financing, etc. was being done.
His view was that the devaluation was not large enough. On top of that, also, some of the calculations by Bhagwati and Srinivasan later on that were done concluded that the effective devaluation ended up being much less because of the withdrawal of the export subsidies and import liberalization. They calculated, apparently, Bhagwati and Srinivasan, that on the export side, effective devaluation, instead of the nominal devaluation was 36.5%, on the export side, it was reduced to about 17.8%. On the import side, it was reduced to about 29.7%.
That, again, reinforces the Shenoy argument as well, that given that even the effective devaluation itself was less than 36.5% of the nominal devaluation, overall, it was too little and too late. That was that factor. Droughts, I already mentioned to you.
Also, from the government of India’s viewpoint—and this is something that two economists who have written also about this era, Vijay Joshi and Ian Little, they have a book on the macro economy of this entire era up to 1991 in which they say that there was also the expectation of about $900 million per year of aid toward a fair number of years on the part of the government of India as a part of the package of devaluation. Those expectations of aid did not actually materialize. That also became a sore point with the government, and said they were completely justified, therefore, in bringing back the export subsidies and the import restrictions.
The export subsidies, export incentives, as they were called, they began very soon after devaluation. In fact, I checked this morning, the Economic Survey of 1966-67, and it says that a new export incentives policy was already being designed starting in mid-1966, which is the timing of the devaluation. According to the survey, it was being done practically—
PANAGARIYA: —concurrently with devaluation. Many of those measures came out by 1967 according to Joshi and Little. Import replenishment, cash subsidies, supply of domestic inputs to exporters, international prices, duty drawbacks, all that basically, they were back by 1967. By 1970, 71 they also say that the import controls had returned with full force and they actually became even more stringent than before devaluation.
That, of course, import compression was automatic. Even if the policy itself doesn’t announce, when you don’t have the foreign exchange because exports are not doing well, automatically import compression begins. Even if the import restrictions themselves may have taken a few years to come in place, it didn’t matter very much because the import licensing policy was in place, and therefore, you could easily accomplish import compression through a slowdown in the issuance of the licenses.
You’d see this very rapid, very sharp decline in the imports. If you start at 1965, ’66, this is just the year prior to devaluation, the import to GDP ratio was 5.1%. In the year 1966, ’67, which is the devaluation year, imports as a proportion of GDP rose by 1.5% to 6.6%. Thereafter, steadily decline.
PANAGARIYA: Every single year in the following three years, imports, not just in absolute terms but as a proportion of the GDP continue to fall. By 1969, ’70, they had reached 4%. Now, given that these imports also include the food imports that were happening, oil imports that were happening, you’d say that pretty much as far as the nonfood, nonoil economy was concerned, we probably had gone into close to autarchy, not quite but close.
RAJAGOPALAN: Very close.
PANAGARIYA: It was quite a serious compression by 1969, ’70.
RAJAGOPALAN: I would say there’s one more thing happening simultaneously, which is the political crisis within the Congress that Mrs. Gandhi is dealing with. She’s trying to establish herself and the opposition to her within the Congress is dubbed “the Syndicate.” This is, of course, K. Kamaraj and Morarji Desai and so on, and they are more liberal-minded relative to her. When I say liberal-minded, I mean in a 1960 Congress way.
They started recognizing the failures of extreme command and control, they saw the foreign exchange crisis, they thought they should move further outward, right? Mrs. Gandhi took this as an opportunity to establish herself as the other side and started turning firmly inward, of course, assisted by P.N. Haksar and the people she surrounded herself with who were very, very socialist.
You see this also in other policies. By the late ’60s, you have bank nationalization, which is the really, really big one. After that, you have all your silk textiles, coal mines and whatever wasn’t included in general insurance in the Nehru regime starts getting nationalized. You had a spate of nationalizations between, say, ’67 and ’75 that has nothing to do directly with the external sector, but this massive uncertainty that is imposed, and also, almost an attack on the private sector.
It’s not surprising to me that given the lack of foreign exchange and exports being depressed, you have massive import compression because now, who is demanding these imports? Forget that we don’t have the currency to actually acquire them. The firms are just completely under attack at this point.
PANAGARIYA: Totally. I think totally. One more important legislation I’ll mention there, quite relevant to industry and therefore trade, and that was the Monopolies and Restrictive Trade Practices Act (MRTP) that was brought in 1969. Actually, one fallout of that act was that this act basically defined what were the MRTP firms. Any firm which had investment, the assets were something like 200 million rupees or something, relatively low-cap were defined as the MRTP firms, that they were too large, they are big business houses. Even if they were operating in different sectors—the definition was in terms of total assets of the industry group taken together.
Any industry group or single firm or what have you, any entity which had assets worth, let’s say, something like, as I said, 200 million rupees worth, got defined as an MRTP firm, and then their access to licensing was limited to a list of core industries. A list was drawn up of core industries, which are all highly capital-intensive industries. In effect, what it meant was that these MRTP firms could apply for licenses only within that core group of industries.
The very fact that these industry groups or these enterprises had a large amount of assets by the standards of the day, meant that they were successful enterprises. Then you say I’m going to restrict you further in terms of what you can do, what you can produce and then you take them into the most labor-intensive sectors.
What that also means is that all capital will basically be absorbed by these enterprises in those sectors, thereby starving the rest of the economy of any capital whatsoever. Workers are working there in large part of the workforce, which is nonagriculture, large part of the nonagricultural workforce basically has no capital. They’re sitting in these tiny little enterprises, cottage industry, household sector.
The small was really very small at the time. Even by definition when Mrs. Gandhi introduced this restriction of small-scale industries, the reservation, it had been practiced as a part of the 1951 IDRA, the Industrial Development and Regulation Act (IDRA) in 1951. It was there, in practice, a small-scale industry, the regulation, but she formalized it as well, I think, around ’67-’68, somewhere there. There was another new development that had taken place before the 1960s were over, that a list of industries was drawn up as a part of IDRA ’51.
PANAGARIYA: Formerly, any large enterprise where large was nothing more than a $1 million in investment, probably even less, was not permitted in those sectors. These are sectors where you have competitive advantage because of the preponderance of labor force, cheap labor. The kinds of sectors where Korea and Taiwan, in parallel, were becoming progressively more and more successful. That’s exactly what was denied.
I think you’re absolutely right, that all these other developments were happening alongside as well, which were basically strangulating the industry. I think somewhere in my “India: The Emerging Giant” book, I refer to this period as saying that there is strangulation of the Indian industry.
Foreign Investment Policy
RAJAGOPALAN: Absolutely. When you talk about MRTP, the focus is largely on domestic firms. I want to actually go in a slightly different direction and talk to you a little bit about foreign firms, in particular the foreign investment policy. This is a policy that started in Nehruvian times, and it was relatively liberal regime under Nehru. Then, of course, post devaluation under Mrs. Gandhi, this also takes an invert turn.
Can you walk us through India’s foreign investment policy, maybe go back to Nehru’s time and describe what this policy was and then bring us back to the devaluation moment and talk about how it impacted foreign firms and so on?
PANAGARIYA: Very interesting history there on foreign investment. As we have discussed already, the Nehru era was relatively more liberal. Nehru really effectively became prime minister in 1946, even though the constitution was adopted in 1950, and elections happened later afterward. Certainly, he was firmly the prime minister of the country much before the constitution was adopted.
The era until about 1957-’58, even on the trade side, had been liberal. In some of my ongoing research on the Nehru period actually, I find that publicly as well as among the political class, there was a lot of support for liberal trade policies. If anything kept them from opening completely, it was always a foreign exchange availability question.
As long as the Sterling balances which India had accumulated during the Second World War—because we were rather successful actually in exporting a lot more than we were importing, and so we had accumulated a lot of foreign exchange which were known as the Sterling balances—these Sterling balances later on became available to us. Using that actually, broadly speaking until about 1956-’57, we maintained a fairly liberal import regime. It was only then when Sterling balances ran out and foreign exchange became very scarce and all, that is where the whole restrictive import regime came into play.
RAJAGOPALAN: With Nehru in 1947, ’48, as you said, he was already prime minister, the provisional parliament and government was in place, but there were some debates in 1948, ’49 about the status of foreign firms because as part of independence, there was also a question of there are all these foreign firms, especially British firms, European firms, can they continue to invest in India? Can they continue to repatriate profits? Will they be taxed in the same way? Will they have additional penalties or no penalties at all?
This is a hot-button issue after 1947. How does Nehru deal with this and how does it inform his foreign investment policy at the beginning of his prime ministership?
PANAGARIYA: Philosophically, by this time, Nehru—I think there are two factors. One, of course, Nehru himself was a bit of a changed man on this set of policies, socialism, so to say. The Nehru of late 1930s, particularly if you go, to the Lucknow—
PANAGARIYA: —session where he was the president, he was a very fiery socialist, bordering communist. If you look at that speech, it’s clearly not the Fabian socialist. This whole notion that somehow Nehru was Fabian socialist always since his days in Cambridge and London as a student, it’s all wrong, actually. Anyway, that’s a separate story.
It was the discussions in the National Planning Committee between 1938 and 1940, which really brought Nehru face-to-face with Indian industrialists, who were appalled with the possibility that the socialism in India could turn into a complete ouster of the private industry. There was a lot of pushback at these meetings for the National Planning Committee and that’s where I think Nehru found that.
Also, a side of Nehru was always very pragmatic, you know, what is feasible? That’s my reading that there’s nothing to be tracked in Nehru writings themselves to see how this transition in his own thinking happened. If you look at the Constituent Assembly debates, etc. Nehru is having to defend a more liberal policy against the attacks from the socialists and the communists. This is where you begin to see that there is a Fabian socialist, Nehru revealing himself.
The view he adopts here is that, look, ultimately our objective is to increase output, production. If production can be increased by the government participating, we should help the government participate all the way. Where private sector can deliver, we should help the private sector. We should let them. As a part of this whole objective that ultimately what we need to do is increase production, he was also very accommodative of the foreign-invested firms.
Also, I should say that around this time, there is a counter factor because there are people likes of Sardar Patel are very much counterforce there. They also kept the socialists a bit in check. If you look at, for example, Industrial Policy Resolution of 1948, that actually is far more liberal. Now, once Patel had disappeared from the scene, and he died in December 1950, a harder-line socialist Nehru did emerge, actually, in the subsequent years. He was also pragmatic so he didn’t want to disturb a private industry. But if you look at 1956 Industrial Policy Resolution, that moves much more toward socialism because it is also preceded by this whole resolution on the socialistic pattern of society and all. Also, the directive principles of policy are moving in the socialist direction.
All that gets reflected in the 1956 Industrial Policy Resolution, which is much more socialist than the ’48 one was. From which, I conclude that there were counterforces which were keeping also, to some degree, Nehru in check on socialism because once those counter forces were gone, a bit more socialist Nehru did emerge in the subsequent years.
This is the political equation as I read it from the various things that I have read. Coming to the actual policy stance, therefore, first of all, Nehru in the Industry Policy Resolution of the Congress 1948, a guarantee was given, actually, that for 10 years, we are not going to nationalize any industries. That applied not to just domestic, but also foreign industries.
A clear assurance was given that there was going to be no nationalization. Nehru also said that they’ll bring the foreign investment policy, but rather than bring the policy, what he did was to, in April 1949, give a foreign investment policy statement. It didn’t necessarily have the legal force, but it ended up basically becoming the framework for the policy that was then adopted pretty much throughout the Nehru era.
In this foreign investment policy statement, this is April 1949, the salient features, I will describe what they were. He accorded national treatment to the existing foreign investments, thereby ending any discrimination against them. Even today, we don’t automatically extend national treatment to foreign investors. All these bilateral investment treaties, etc. are what governed the status of the foreign investors. Often, the national treatment is far from automatic today in the investment policy, but he granted that. He promised policies to enable foreign investment, that we will do everything to provide an enabling environment for the foreign investors.
Also, he permitted the remittances of profits and dividends of foreign companies abroad. That was a big thing, that in spite of foreign exchange issues, foreign exchange scarcity, etc. assurance was given that the foreign funds will be allowed to remit profits as well as dividends as necessary. He provided for controlling foreign interest in companies for a limited period of time. This was relatively, given the state of politics at the time, it was a very liberal foreign investment policy, which was largely maintained.
1949-‘50 budget implemented these promises, and in addition, it provided depreciation allowances and income tax exemptions to a wide range of foreign companies. It abolished capital gains tax on foreign companies. 1950-’51 budget went further; it reduced the business profit tax, personal income tax and super tax as applied to foreign companies and their employees.
1957, the government gave a number of concessions to foreign firms, including reduced wealth tax and tax exemption to foreign personnel. This process continued in 1959, ’61 budgets, the government lowered corporate taxes on income and royalties of foreign firms. India also signed these agreements to avoid double taxation to lower the tax burden of foreign investors with the major source countries such as the United States, Sweden, Denmark, West Germany, Japan.
In 1967, the government established an Indian investment center with offices in the major sources of private foreign capital to disseminate information and advice on profitability of investing in India to foreign investors. A lot of good steps were taken.
There’s a famous book by, I think Michael Kidron, is what I remember, a 1965 book. According to him, Western multinationals were initially lukewarm to India in the early ’50s. In the period following 1957 quite a bit of foreign investment did come into the Indian industry, including in sectors that were regarded as nonessential. What is essential and what is not essential has been a part of policy thinking in India. It still remains.
RAJAGOPALAN: Yes, it still remains.
PANAGARIYA: You still begin to see. There are still some people who think that, oh, there are these nonessential imports, and why are we importing these? Particularly, when it comes to China, you say, these are not essential imports. If they’re coming from China, let’s stop them. Still that baggage continues.
Kidron estimates that between ’57 and ’63, as many as 45% approvals of new capital issues involved foreign investment. So you can see. Remember that there is investment licensing on the side. There are very limited resources available for capital imports. The general sense is that for industries that have been established, raw material, intermediate inputs, components, any parts that may break down a lot, those should get priority, because with limited foreign exchange, those should get priority.
Capital investment often required actually the enterprises to find their sources of foreign exchange. If the enterprise is going to invest in machinery, etc. and which has to be imported, find your own foreign exchange resources. The collaborations with the foreign firms became very important. This is Kidron’s estimate, that almost 45% approvals of new capital issues involve foreign investment. That’s a very large proportion, significant.
One last point, there was also the Hathi Committee. That Hathi Committee said that this was the time during which most foreign drug firms set up their manufacturing subsidiaries in India. There was also an RBI survey of 1969, which the Bhagwati and Desai book mentions, and according to that survey, there were 827 private sector firms with foreign participation of some kind. That’s a fairly large number. 591 had actually equity participation, with 262 having majority foreign holdings.
You can see the liberalism of the time that out of the 591 firms with equity participation, as many as 262, which is pretty close to half of the foreign-invested firms, had majority foreign holdings. These products were available in those days. It’s only after Mrs. Gandhi came in and then they began to be gradually phased out, but they existed. All evidence, on policies and outcomes during the Nehru era, really points to a very liberal regime compared to what was to come after Nehru.
RAJAGOPALAN: A few things here. One, of course, this tells us a lot about Nehru. I agree with you that there’s a certain pragmatism in his socialism. One thing I do admire about Nehru, I’ve been a critic of a lot of the economic policies, but one thing I admire is that the overall goal of economic growth and technological advancement, industrialization, this was front and center.
Now, the economic model of going about it was clearly wrong, but he went with whatever he believed and the orthodoxy believed at the time, but the overall vision of the size of the pie must grow, India must grow each year, there must be new technology coming in and so on, that I think is something which is important to note because not all the socialism we’ve had has been of the same color.
The second, I think this goes back to one of our earlier conversations when we talk about import substitution and protectionism. You were talking about how foreign competition is not just about availability of foreign goods and widgets of some sort, right? It is also about availability of technology, of knowledge. If you have foreign firms setting up in India, one way of thinking about it is, they can bring maybe machinery from abroad, but the other thing they bring in is they function in other countries that are not autarchic or as closed as India.
They know what the global competition is, what the standards are, and they are able to manufacture at those levels or those standards. Even something like, there isn’t enough foreign exchange to replace a machine, if you have foreign collaborations, you may be able to find collaborators who can repair the machine because they have the technological know-how to do that.
Whereas, if you only have Indian firms and you’re used to importing and now you can’t import and the machine breaks down, which we saw lots of examples of that in the late ’70s where if a tiny part broke down, that’s it. A huge chunk of the capital investment of that particular firm was lost waiting for the import license or waiting for the investment license.
There are many, many benefits other than just availability of foreign goods that comes from this liberal regime, which we saw during that ’50s era, roughly speaking. Just a lot of technical expertise coming into the Indian economy, a lot of know-how, building of human capital without people necessarily leaving the country, learning at the workplace and so on.
PANAGARIYA: Totally, this is the time that India is setting up some of these IITs and IIMs, etc.
PANAGARIYA: That also provides a bit of a link. The existence of the foreign firms helps that in terms of the graduates being able to interact with those firms, and also, in that generation, the jobs in these multinationals were very coveted jobs, for good reason. And so it also helped develop the skills of the Indian graduates both on the engineering side as well as on the management side. Undoubtedly, as I said, ultimately, of course, to me, everything is a bit endogenous that the fact that the choice of the model ended up being wrong, unleashed the forces eventually, that gave growth also a bad name.
You see, when the pie really doesn’t grow fast enough and your explicit objective is to grow the pie to combat poverty, if the poverty did not decline, then this alternative view that, oh, growth can’t really deliver; growth has failed.
PANAGARIYA: Growth did not fail. Growth simply did not happen in enough volume. It was not a failure of growth, but the failure of growth to actually happen in the desired volume. That is why the poverty did not fall enough, but that unleashed forces, unfortunately, which was also, to some degree, in line with the socialist philosophy. Ultimately, a very important part of the socialist philosophy is to redistribute and to bring public sector control of the resources. On both counts, I think, the failure of growth to happen, and therefore, the wrong choice of the model—
PANAGARIYA: -—ended up being at the heart of actually what was to come. What happened subsequently under Mrs. Gandhi, to a significant degree, was endogenous to the system. Of course, the leadership matters and the fact that P.N. Haksar was brought in by Mrs. Gandhi did make a big difference, who serves in the prime minister’s office makes all the difference and Haksar was, boy, he was no liberal socialist. He was not a Fabian socialist. He was a hardcore communist, if you would call it. He was much more, and therefore, all the policies that—
RAJAGOPALAN: That came after.
PANAGARIYA: By all accounts, Mrs. Gandhi did rely quite a bit on P.N. Haksar. P.N. Haksar, I think, was the successor actually of L.K. Jha.
RAJAGOPALAN: L.K. Jha, yes. The principal secretary of the prime minister as the locus of control in the Indian economy—
PANAGARIYA: Much more so.
RAJAGOPALAN: —I think that happened under Haksar or at least it got really rigid under Haksar, and to some extent, continues till now. This is another negative—
PANAGARIYA: Very quickly and perhaps already under Haksar, the importance that the cabinet secretary had held, declined. Today the principal secretary in the PMO wields a lot more power than the cabinet secretary does.
RAJAGOPALAN: Cabinet secretary, absolutely.
PANAGARIYA: Because the principal secretary is manning the prime minister’s office, right?
RAJAGOPALAN: Yes. Which is the locus of control.
PANAGARIYA: Whereas the cabinet secretary—
PANAGARIYA: The cabinet secretary, even physically, is located in the Rashtrapati Bhawan. He’s at arm’s length from the prime minister’s office.
RAJAGOPALAN: This is another interesting point here is, I was recently reading Nikhil Menon’s book, and he talks about how planning and democracy went side by side or they were attempting these two seemingly incompatible forces. He talks about how Mahalanobis really creates the planning infrastructure in the early years of the Indian economy and creates plan consciousness and how five-year plans were propagated and so on. He’s a historian. It’s a lovely book.
In a conversation with him, one of the things that he pointed out was how, after the second five-year plan, which is Mahalanobis, his vision, things are now so centralized that a lot of cabinet ministers were quite upset that everything is going through Mahalanobis and the prime minister and not necessarily through the ministry, minister for industry or commerce or the finance ministry, and so on and so forth. There was already the centralization that was taking place in the early ’50s, crystallized by the first and second five-year plan, where the cabinet was becoming less and less important.
Then, as you said, once L.K. Jha comes in and then, of course, P.N. Haksar, even how the files move within the Indian economy and within North and South Block and Rashtrapati Bhavan, that triangular area, and who sits where starts becoming very, very important. You know, who is controlling the final approvals? It’s clearly the principal secretary to the prime minister’s office at this point and has been for a good 40, 50 years now.
PANAGARIYA: Yes. By the way, on the objections within the cabinet, I’m forgetting now the name but one of the finance ministers had resigned actually when—
RAJAGOPALAN: Yes. John Matthai?
PANAGARIYA: Mathai. I think it’s Matthai, yes.
RAJAGOPALAN: I want to come back to the devaluation moment and the failure of devaluation in ’66. Now, how does that impact the foreign investment policy? Because the Nehruvian time is a relatively liberal regime and foreign firms are happy to set up in India, partner in India. They’re also growing, of course, within the limits of India’s foreign exchange situation, but it seems to be going well. Now with the failed devaluation, and the further invert turn domestically and MRTP and so on, what is happening with the foreign investment policy and the impact on foreign firms under Mrs. Gandhi’s regime?
PANAGARIYA: This tightening happens all around alongside the import policy. You also have tightening happening on foreign investment policy. As an example, because of the shortage of foreign exchange, questions get asked: Why are we allowing these remittances of dividends and profits and royalties abroad? You start clamping down. A lot of restrictive measures were introduced on foreign investment and technology imports. In 1968, the Foreign Investment Board was appointed.
Foreign investment proposals anyway had to go through cabinet, but even for the smaller ones, proposals that were $20 million or less, which did not have to go through this kind of scrutiny—basically, decisions used to get made at the bureaucratic level under usual processes, meaning there was no serious restrictions on that. Generally, as I said, they had been looking earlier for foreign collaboration to cover the cost of capital goods imports.
Now, scrutiny became much closer. Even for any investments that were less than $20 million with foreign equity below 40% had to be approved by this newly appointed Foreign Investment Board. Now, this is a new innovation, by the way, which off and on keeps coming back. It existed actually till recently while I was at NITI Aayog, and during that period is when Prime Minister Modi actually finally did away with the Foreign Investment Board.
RAJAGOPALAN: It actually changed color under A.N. Verma because A.N. Verma in Narasimha Rao’s cabinet was using it to attract foreign investment, kind of the opposite of what they were doing in the ’60s. But you’re right, that it has continued as a legacy for a very, very, very long period of time. The scrutiny of who gets invited to the table.
PANAGARIYA: You’re right, yes. That’s one thing. Then also they drew up three lists of products: those in which no foreign collaboration would be permitted, those in which technical collaboration would be permitted but not foreign investment. Royalty payments were not to exceed 5% of total costs, and the terms of collaboration were reduced from 10 to five years, which means that complete indigenization should happen within five years. Now, with that, hardly any foreign investors would actually consider coming in.
The last list included only two types of products, those whose production did not exist and those for which there was only one producer, generally a foreign firm with no competitor. This third list was the last one that I just talked about, those in which foreign investment and technical collaboration, both would be permitted.
There’s a small list of products where both foreign investment and collaboration were permitted, but it’s a short list that included only these two types of products, those whose production did not exist. I mean, if domestic producers are not interested in producing those products, it’s unlikely that foreign producers are going to come in and set up. Even though in principle, it was allowed, the restriction really was such that hardly anyone would dare come in.
Then there was also some concession there that if there was only one producer, which was generally a foreign firm, then again, they were allowed. That’s about it. Either it has to be a product that is not produced or it has to be a product where there is only one producer. You can imagine.
Then beginning in 1972, approval of applications for capacity expansion became subject to a reduction in foreign equity also. If you want to expand your production capacity and you happen to have a foreign-invested partner a partner who is a foreign investor, then you have to reduce the equity. Otherwise, you can’t expand. They’re all around you.
RAJAGOPALAN: I think this was the reason the Bajaj-Vespa marriage broke up. I think this might’ve been one of the reasons because Bajaj wanted to expand capacity and they had a tie-up with Vespa, which was the Italian collaborator. Then eventually that didn’t quite work out. Then Bajaj tried to go in a different direction and market it as Bajaj Chetak and so on.
PANAGARIYA: That may have been later though, I think.
RAJAGOPALAN: A little later?
PANAGARIYA: Yes, that may be a little later because I recall that Vespa was still there till the late ’60s. I’m just trying to recall from my own memory because those are the years I was still in India, but that needs to be checked. It’s possible. I mean, it’s possible, but it needs to be checked.
That was ’72, and then, of course, came the mother of all restrictions, the Foreign Exchange Regulation Act of 1973. This is the infamous FERA, much dreaded and infamous FERA. I mean, this was the act that if you were an Indian national, Indian resident and you were caught even with $5 in your possession, that would be grounds for jail. I mean, you simply were not allowed. It was enforced. It’s a pretty serious act, but it had, obviously, a lot of implications for foreign investment.
I think that really restricted the space. I mean, it was already being restricted given all the measures that I’ve described, but FERA, in particular, went yet further in terms of restricting the space for the foreign investors. It came to require that all nonbank foreign branches and companies incorporated in India that had foreign equity share in excess of 40% to obtain permission from RBI to continue business in India.
Anybody who had more than 40% equity incorporated in India, they were required to go and get the permission of the RBI to continue business. Now, of course, RBI is also part of the government, really. Especially in those days, there is no independence on the RBI.
RAJAGOPALAN: There’s no separation.
PANAGARIYA: Of course, today that sort of thing will never be the mandate of the RBI. Who is RBI to give permission on foreign exchange? It really is a function of the government itself. It’s not RBI. That tells you about the extent to which the RBI was very much a part of the government in those days. RBI would grant this permission only if the foreign branches and companies diluted foreign equity share to 40% or less. In effect, all the enterprises were told that reduce your foreign equity to 40% or less.
With two main exceptions, nonbank branches or companies unwilling to dilute their foreign equity share to 40% had to wind up their business. As a part of that, of course, the two famous examples, IBM and Coca-Cola, they both left India and Coke returned many, many years later.
RAJAGOPALAN: In the ’90s.
PANAGARIYA: After ’91 liberalization, they came back. Of course, there was a whole long period during which we all remember there’s Campa Cola, Thumbs Up, the Indian-made soft drinks that came, although once Coca-Cola came, I think they basically absorbed all those Indian brands.
RAJAGOPALAN: They absorbed all those and Pepsi came just before liberalization, I think. That was the other big move. It’s so strange, you’re right in that if the requirement is that you have to reduce equity to 40%, what they’re really saying to a foreign firm is they need to significantly give up control of the enterprise. Giving up control of the enterprise is not just about production and profits. It’s also about quality and technology and standards, and companies that are unwilling to give up that kind of control or reduce their standards to their Indian partners, naturally they leave.
It’s not surprising that firms like IBM and Coca-Cola left. The market was very large in India, but it had a lot more to do with control and quality than it had to do with, oh, this is 3% more equity or 10% less equity or something like that.
PANAGARIYA: Well, in the case of Coca-Cola, actually, the control was central because they had been keeping their formula secret, and Indian control would have meant that they would have had to reveal the formula. I think that was the reason for Coca-Cola to wind up and leave here.
RAJAGOPALAN: IBM, of course, for, again, quality reasons. It’s such a big loss in a sense, because Indian computing industry, both hardware and software, shifts back 10 years because now important partners have left.
PANAGARIYA: IBM probably also had similar issues, I would imagine, like Coca-Cola, because it would mean giving up what was state-of-the-art technology at the time in computer industry, and so probably that played a role in their departure as well. Absolutely.
RAJAGOPALAN: A number of smaller firms, of course, left. They’re not in the folklore like IBM and Coca-Cola, but a lot of foreign firms wound up either because they were unwilling to live with the loss of control or because they saw it as a foreboding time that was coming that if this is where we are today, then tomorrow something else will be introduced. Then it’s probably best to pack up and leave.
PANAGARIYA: Correct. There were very few enterprises left which could have more than 40% equity. They allowed, with some exceptions, where you could have up to 74%, nobody could have 100%, except possibly bank branches, which were owned. Up to 74%, they allowed foreign equity in a number of types of enterprises, although not that many in any one of these categories existed.
If there was some manufacturer who was producing a product in the core sector—you remember that this core sector was identified around ’72 and ’73, this list of highly capital-intensive industries—if there was a foreign invested enterprise which was producing a product in the core sector, then they could keep up to 74% equity. Then there were enterprises engaged in manufacturing and exporting 60% or more of their output. As long as you are earning foreign exchange at one stage—
RAJAGOPALAN: You could earn foreign exchange.
PANAGARIYA: —then they were allowed. Tea sector, I think you know, these were tea plantations which had been foreign owned. There was fear, obviously, again, that forcing the owners of those tea estates might actually have adverse impact on tea exports. I imagine that was the motivation which allowed the government to allow tea estates to stay in the foreign hands as well. Then there was an exception also granted to those creating skills and infrastructure that were not available indigenously and contributed to exports. This is a bit vaguer, so I imagined that category gave the bureaucrats a little bit of room for manipulation.
Then there were the foreign branches of airlines and shipping companies that were also allowed up to 74%. That was one set of exceptions. There was a second set of exceptions which was introduced later in 1976, and under that exception they allowed a maximum of 51% foreign equity in two types of companies: those exporting 40% of the production. This is a modification of the earlier provision because probably there were not that many enterprises exporting 60%. They reduced that to 40%, but then also said you can have up to 51%, not 74. At least 60% of the output had to be in the core sector, then if you export 10%, then also they were allowed. There’s just some concession.
RAJAGOPALAN: Some tinkering.
PANAGARIYA: Yes, some tinkering.
RAJAGOPALAN: This also meant that these companies became a different category of companies. If you have the Nehru regime where you think about foreign firms will be given the same treatment as domestic firms, now this changes things because MRTP firms are a special category now, FERA companies are a special category.
PANAGARIYA: Yes, absolutely. These companies which took these exceptions and stayed in India came to be known as FERA companies.
RAJAGOPALAN: What was the differential treatment between these companies? Was it good to be a FERA company or was it bad to be a FERA company? Because these things can go both ways depending on what they are producing and what the relationship is.
PANAGARIYA: If you feel that you’re going to be profitable here, then you have no choice—it’s not as though there was a choice between being a FERA company and being something else. Meaning that only other choice was to disinvest and reduce your equity below 40%. Then you can be in the other category and that will reduce some of the restrictions that FERA companies face. Other than that, if you wanted to be a company with 51% or more, up to 51% investment controlling share, you have no choice. You have to be a FERA company. You would be ruled by the—
RAJAGOPALAN: Aside from the fact that there were FERA companies versus non-FERA companies, every individual who wanted to have any foreign exchange was a FERA individual in the sense that it applied to virtually everyone. Sometimes, foreign exchange balances as low as $5 and $10 were regulated. Any company, even a 100% domestically owned company, if they had to go abroad, they needed to go to the RBI and the commerce ministry, request special permissions for foreign exchange and give them a clean plan of what they intended to do with that foreign exchange.
I think Narayana Murthy has an example where he talks about traveling to Germany and they had to go to multiple cities. When they request the permission, they say, we will first go to Berlin, then Frankfurt and then Munich. I’m just making this up. I can’t remember the exact detail. They have these three cities, and then some meeting gets changed, and now they no longer have to go to Frankfurt, they have to go to Paris instead. But when they come back, they have to explain to the RBI why they changed their plan and why they went to Paris instead of Frankfurt, and what foreign exchange balances were spent and how much came back.
In some sense we think, this is a FERA company, this applies to these foreigners or these suits who are coming from Atlanta like Coca-Cola, but actually, FERA just impacted every single person who wished to have anything to do outside the country in terms of foreign exchange. I’m sure you experienced it, you must have some stories of trying to go abroad and have some cash balances as a student, right? What was your experience?
PANAGARIYA: Yes. I think there used to be something called the P-form. I remember I got about $200 from the RBI, and there was some provision that at the airport you could get another $7. I don’t know why there was that provision. I can’t remember, but I remember that there was a provision to get another $7, so that’s all the money I had.
RAJAGOPALAN: $207 and you landed in America.
PANAGARIYA: $207, yes. Yes. That was it. That was it. We were not allowed anything else.
RAJAGOPALAN: Yes. That is extraordinary.
PANAGARIYA: Yes. Yes.
RAJAGOPALAN: It significantly impedes other kinds of human capital development. Just the ability to go abroad and get a law degree or a Ph.D. In a sense, it impacts everything that is happening in India, knowledge building, capital formation, foreign investment. This kind of foreign exchange, draconian law is just crazy.
PANAGARIYA: There is no way I could have come without the fellowship I had from Princeton. It’s just not within the realm of possible. Even if FERA was not there, you needed some domestic currency resources, which also I lacked.
RAJAGOPALAN: Yes, but the FERA makes it complicated, even after you got the fellowship, let’s put it that way.
PANAGARIYA: Yes. It makes the logistics very difficult that you are worried that you are going out with $207 in your pocket. I’ll tell you actually, I remember this, that my fear in the first year was that what if I fail, I got to have at least enough money to be able to pay my airfare back to return to India. Right?
RAJAGOPALAN: That’s true.
PANAGARIYA: That was my worry, because going in, my father paid the airfare, but coming back, I did not want to ask him for the return fare also.
I tell you, I was so relieved. ’74, I came in, after one year I got a job at the World Bank in the summer. I got three months, and the salary was some $900, and so I figured, yes, okay, with three months, you got close to $3,000, you saved about $2,000 there.
RAJAGOPALAN: So you have enough money to catch a flight?
PANAGARIYA: Yes. Yes.
RAJAGOPALAN: Oh, wow. That’s extraordinary. This, of course, continues for a while, this kind of invert turn, but post Emergency, or at least actually not even post Emergency, even with the announcement of the Emergency starting in 1975, some adjustment and tinkering starts happening in the other direction. There are some concessions given, there is some, many call it liberalization, you’ve called it phased liberalization, or at least a step-by-step move in certain sectors to increase capacity or to allow more participation in the market. Can you walk us through that? Because there is a period between ’75 and ’90 where there are some moves in the opposite direction away from this kind of invert turn, before we get to the big moment of liberalization in ’91.
PANAGARIYA: Yes. Okay. There is now, not on foreign investment, by the way, foreign investment may be under Rajiv Gandhi, there is some—those are also relatively piecemeal, but at least, and there are numbers about how many companies actually got the permission from RBI and how many were denied and so forth. Foreign investment largely doesn’t get a serious reprieve in any way till the ’91 reforms. But on the trade side, I think some changes do begin to happen beginning mid-’70s, let’s say, roughly mid-’70s. We had talked about how the import to GDP ratio by 1969-’70 had dropped to—
RAJAGOPALAN: Was 4%.
PANAGARIYA: Yes. Had dropped to 4% in ’69-’70. During this period, export performance remained relatively flat, and big gap between the imports and exports, so exports as a percent of GDP during these years until about until 1968-’69 are about 4%. 1969-’70, they fall further to 3.6%, so not much action at least until ’69-’70, and exports remain low.
Only reason, actually, the imports are maintaining still a bit above, exports are bringing revenue up to 4% of GDP, but imports during this period are more up to, before they dropped to 4%, they’re like 5% in ’68-’69. Prior to that year, they were about close to 6%. That gap was being maintained largely, I think, by a lot of the food imports were happening, and there was PL–480 and so forth. Some borrowing may have been happening, foreign aid may have been coming. Those were the sources of foreign exchange that bridged the gap between the foreign exchange earned from exports and foreign exchange required to import.
RAJAGOPALAN: For imports.
PANAGARIYA: Yes. Early ’70s similar, this pattern remains, that imports in the subsequent years, they do not rise beyond 4.5% until ’74-’75. The imports remain between 4% and 5% during the first half of the ’70s, and exports remain below 4%. It’s above 3%, but it’s below 4%. I think ’73-’74, there is a little bit of break. ’73-’74, this was oil price crisis, if you recall. At the same time, there was also general commodity boom.
Commodity price boom, let’s say. Commodity prices had seen a bit of a boom during ’73-’74. In particular, I think, the sugar, for example, there was also partly this, from India’s point of view, there was sugar, for instance where crop failures had happened both in Cuba and Brazil during that year. That allowed India to actually expand its sugar exports.
Now, domestically, those of us who were in India at this time, we really suffered through because sugar was a very controlled item and you got something like one kilogram per person or something like that. Some very limited amount of sugar actually.
RAJAGOPALAN: Through a ration card. I remember.
PANAGARIYA: Through a ration card, and there’s a black market in sugar and whatnot. Lot of people were using gud [jaggery] to make their tea and all because sugar was so expensive. Anyway, that was part of it. That helped ’70-’71 to ’74-’75. ’74-’75 also, I think commodity prices remained elevated particularly in the ’74-’75 year we got help on things like tea particularly because Kenya and Sri Lanka had crop failures in tea, so that helped India bridge the gap.
That allowed a little bit of expansion, both of exports and of imports during ’70-’71 to ’74- ’75, but the more important catalysts were different. These were a few little things that the market conditions eased up the foreign exchange just a little bit. Not by a big margin, but just a little bit. Politically really, as far as the businesses were concerned, there was always pressure because they had difficulty getting their raw materials, getting their components, intermediate input. There was always this pressure that government needs to do something.
That pressure was there, but something else also had to happen for liberalization to happen and that something had to be where is the foreign exchange going to come from. That was really the crucial issue. Two things happened, which helped. One was the oil crisis also opened the door to migration of the Indians to the Middle East. That began bringing in—
PANAGARIYA: —remittances. There was some bit of migration earlier also before the oil price crisis, but it was small. Having that set of migrants in the Middle East was helpful because when the oil prices rose, and these revenues became available to the oil-exporting countries, they wanted—
RAJAGOPALAN: The remittance has increased.
PANAGARIYA: —to bring in more workers. The fact that we already had a foothold in the Middle East helped that migration could respond and expand pretty quickly.
RAJAGOPALAN: That continues even today. The foothold that was set up in the early ’70s, even now, we have a very substantial number of people seasonally or annually migrating to the Middle East and sending back huge remittances.
PANAGARIYA: Yes, right. No, today India’s remittances are practically about 1% of the—
RAJAGOPALAN: Of course.
PANAGARIYA: Several percent. It’s quite a bit, 2% to 3% of the GDP, so very large. Today, of course. They’re about 6, 7%. Last, actually number $100 billion. We hit $100 billion, actually.
RAJAGOPALAN: In remittances? Wow.
PANAGARIYA: There’s a latest figure that I remember, yes, so it’s fantastic. It’s very large.
RAJAGOPALAN: Arvind, these are relatively what I call circumstantial things that were happening that impacted India’s balance of trade situation. If there is a drought within India and there are two or three bad droughts, it severely impacts. If there are crop failures in other countries, then it boosts India’s exports and brings in a little bit more.
These are what is happening globally and domestically in markets, but was there much movement in policy which moved us toward liberalization, either because of pressure from the business community or others such as liberalizing the licensing regime, like the open general license and so on? Or were mostly what was happening in the mid-’70s just restricted to all these circumstantial things, which may have benefited India a little bit here and there?
PANAGARIYA: Yes, no, I think the very early one is circumstantial. One was these remittances, which helped bring in more foreign exchange. Even by around 1970-’71, your remittances are about $134 million. By ’75-’76, $524 million. Almost fourfold increase, that’s quite substantial. That’s one factor that’s at work. After that, of course, in the second half of the ’70s these remittances were rising by about $300 million every year, such that by ’79-’80, $2.2 billion, that’s a very large amount actually for that time period.
RAJAGOPALAN: That time, yes.
PANAGARIYA: The other thing that happened was that you remember around 1971, the Bretton Woods exchange rate system was collapsing.
PANAGARIYA: After that collapse, actually, some of the European currency depreciated. The German mark, French franc. Now, they appreciated which means relative to those currencies, the dollar and the British pound depreciated. We were pegged to these currencies, rupee was. That allowed rupee to also depreciate against these other European currencies.
RAJAGOPALAN: Yes, without actively depreciating.
PANAGARIYA: Without actively depreciating, and that depreciation also helped exports a bit. I think now this begins to go into the second half of the ’70s that in September 1975, finally, India pegged the rupee now to a basket of currencies.
This was a big important policy change, September 1975. Rather than peg to the British pound or to the U.S. dollar, what we did was that we are going to peg the currency to a basket of currencies. You can always play with the weights on different currencies in the basket, and play with the exchange rate a lot more. It gives you much greater flexibility. This flexibility was used apparently between 1974-’75, and ’78-’79. That’s ’75, ’76, ’77, ’78—4 years.
RAJAGOPALAN: Four years.
PANAGARIYA: In four years’ time, the rupee depreciated about 30% against the British pound. That depreciation was very helpful. They could not devalue in the usual sense after what happened in June 1966.
RAJAGOPALAN: It happened naturally to some extent.
PANAGARIYA: This was surreptitious. Without anybody noticing, there were no announcements to be done at all, but basically, at the technical level, the RBI could basically achieve that depreciation. That was a very smart thing to have done. That depreciation helped the merchandise exports at that time. They grew from $4 billion in ’740-’75 to $6.4 billion in ’77-’78. In today’s context, these are small numbers.
RAJAGOPALAN: No, but it was a big improvement then. India was a tiny economy and so much compression of the external sector that even a little bit of liberalization through depreciation or something else just has this big impact.
PANAGARIYA: Exactly, and $4 billion to $6.4 billion, that’s more than 50% expansion. Again, within those four or five years it continued in the following year, ’79-’80, it went to $7.8 billion. Services exports also stepped in. They went up from $632 million in ’74-’75 to $1.2 billion in ’77-’78, and then to $1.9 billion in ’79-’80. By ’79-’80, your total exports have become, this is $7.8 plus $1.9. It’s about $10.7 billion.
That’s very large compared to where we were, ’74-’75, it’s $6.4 plus $1.2, so it’s $7.6 billion. From $7.6 billion in ’77-’78 we went to $10.7 billion in ’79-’80. Good expansion, and that is what then gives the government confidence to begin liberalizing on the import side. This one single factor, the depreciation, about 30% depreciation became the catalyst to liberalization on the import side that was to follow.
Import Policy Mid-70s Onward
Here on, we can discuss a little bit if you wish on the import side of it. ’75-’76, some small steps get taken, but important. They prove important for the future, not necessarily for ’75-’76 itself, but for the future. One important thing that was done in ’75-’76, was to resurrect the open general licensing list, which basically had been lying dormant at that time. It was a small change. Six items got placed on it. Some free trade zones were also included in it. Meaning that, any enterprise in the free trade zones could import under open general license. Then the six items that they put on the list, could be imported by anybody, regardless of where their location was.
’76-’77 some of the iron and steel items, and some of the machinery requirements, by leather industry, were added to open general licensing as well. Then a much larger expansion took place in ’77-’78. They expanded the OGL, the open general licensing list, to include leather-making machinery, garment-making machinery, a large number of drugs, medicines, chemicals, electronic items, iron and steel items and scientific and technical books.
Now this became an important instrument for the government for liberalization. This had always been used, starting from the Second World War itself, open general licensing had been used, and whenever foreign exchange became available, they would use this instrument.
This had always been in play, but now, for a while it had not been there, but now having been resurrected, they started expanding that. Then in ’75-’76 itself, they’d also introduced a second way to liberalize, and that was the system of automatic license. Now, in a way, if you think about it, you know the word “automatic license” carries a little bit contradiction.
RAJAGOPALAN: It means it’s not licensed.
PANAGARIYA: Either it’s not licensed or it’s not automatic, but that’s how the whole system was. Under automatic license, basically what it did was, that there was a list of selected industries which were given; a list was drawn up of industries. It’s a fairly liberal list. Within those selected industries, the enterprises were given exemption from the domestic nonavailability condition. As you recall, we discussed this when we discussed the import regime, that you had to satisfy the essentiality and domestic nonavailability condition.
Now you no longer had to apply through something like sponsoring agency. The usual track used to be that you put in your application for the imports first to the sponsoring agency, which then gives you the clearances on the essentiality and the domestic nonavailability. Then the application goes to the CCI&E.
RAJAGOPALAN: Chief controller of imports and exports.
PANAGARIYA: Chief controller of imports and exports. Now, under the automatic license, you could apply directly to the CCI&E. That sort of some easing up, there’s a procedural easing up.
RAJAGOPALAN: No, but the procedural easing up helped a lot, because it meant fewer trips made to Delhi, and fewer visits to different ministries to get your file through from one desk to another. It sounds simple, but on a day-to-day basis, it does change a lot for the firm or the businessman.
PANAGARIYA: Yes, yes. Right. Some of the liberalization was also done through the exporters. In the Indian system, it’s always been that restrictions exist, but for exporters we’ll make an exception. They try to also improve the access of the exporters to imported inputs. They expanded the import entitlement. Under import entitlement, an exporter got a certain amount of imports permitted without license. Also, there was the import replenishment license. Under that, once your imported inputs got used up, they were replenished. Meaning that, automatically once you’re used up, you provide the evidence, that you’re used up. Then duty drawback also was offered to the exporters. That also became another instrument.
Now, very interestingly, I discovered actually, through some of the reading, we all think of the liberalization of computers, that it was done by Rajiv Gandhi. That’s the story that we all have heard. There was actually prior step that was taken, much before Rajiv Gandhi, actually, during the Emergency, July 1976. The electronics commission used to exist already then. They announced the policy for the import of computer systems by Indians returning from abroad, or those residing abroad, under the provisions of the import trade control policy of ’76-’77. First liberalization of computer imports—
RAJAGOPALAN: Happened during the Emergency. Wow.
PANAGARIYA: —was done during Emergency. Yes. Basically, individuals were allowed to import computers, provided they came up with necessary foreign exchange, and used the computers for specialized applications, and overseas customers in areas such as engineering design, engineering consultancy and process control.
RAJAGOPALAN: Of course, even that is controlled, what they use the computer for, but sure, there’s some move toward liberalization.
PANAGARIYA: Yes, yes.
RAJAGOPALAN: It is such a strange time that we consider these important moves toward reform.
PANAGARIYA: Yes, yes, yes.
RAJAGOPALAN: After this comes—
PANAGARIYA: Also by the way, we used to have these export controls, remember?
PANAGARIYA: Even on the export side, there were all kinds of restrictions. Some of the liberalization happened on the export side also. ’75-’76, again, about two-thirds of the items that were subject to export licensing were freed up. I think something close to about 300 items had been subject to export licensing.
PANAGARIYA: About two-thirds of those were pretty much freed up. In 1977-’78, some of the remaining items were based on the open general licensing, through some export regulation, though some export regulations remained. One example I found actually of this was the shoe exports. Shoe exports, you see, were at one time actually canalized.
RAJAGOPALAN: You may have to explain what canalizing is for the young listeners and young readers, because this is such a bizarre thing, but there was actually a canal or a government channel through which goods could be brought in and out of the country, which seems very bizarre. So can you first explain canalization, and then how we reduce the number of goods that needed to be canalized over time?
PANAGARIYA: Yes. This is an old history. The agency to canalize, the big one, State Trading Corporation, was created somewhere around second half of the 1950s. It has a very early history. At the time, it was for some very specific items, and what canalization amounts to is, giving monopoly of trade to a state agency, of which State Trading Corporation was only one, although really the biggest one.
Then you had something like MMTC, Minerals and Metals Trading Corporation. There were several others, which were more specialized, but State Trading Corporation was the big one. There were all sorts of reasons for this. Originally one of the key driving forces for this was also because the Eastern European countries, basically, you are dealing with the governments. To conduct trade, the government felt that they also needed a state agency to then negotiate the agreements with the Eastern European countries. Then you needed a state agency, which would then conduct that particular trade with the Eastern European countries.
There were other reasons that if there were too many small little importers of many products, for each of them to go and import the product was a problem. State Trading Corporation will do the importing and then allocate those to the domestic users of those products. Similarly, on the export side, if the exporters were very small, potential exporters were very small, it’s harder for them to do, so they will canalize. Shoes were one of those products. Remember these are small-scale industries, reservation is going on, so there’s no large potential, there is no large exporter here, all small. The State Trading Corporation steps in and says I will export your products.
That’s very Chinese style. China had all these trading companies, foreign trade companies which had the monopoly of trade, in fact. Just as the State Trading Corporation had on certain products, MMTC had certain monopoly on certain products. Like that. Anyway, around this time, there’s a good example of how we made policy.
Around this time ’75-’76, they did actually begin to now allow shoe exports under open general licensing, meaning that individual manufacturers could sell. Then we put a minimum export price. The minimum export price was 75 rupees. This was a story actually in the Times of India of that time period. That story says that at that time, even the Italians that could export their shoes for 75 rupees, only 15% of their shoe exports.
Therefore, about 85% of the Italian shoes were also selling at less than 75 rupees per pair. To expect that these Indian shoes would go at a price of 75 rupees, or more was completely unrealistic, implausible. In a way, you liberalize, but probably nobody could fetch that price. All kinds of anomalies existed in our system at the time.
RAJAGOPALAN: Decanalizing meant that from a system where they could only go through one of these trading corporations or MMTC or something else, they slowly start saying that you can trade on your own. For instance, unlike shoes, if there wasn’t a minimum price, was there an uptick in exports in those areas? Was there an expansion in those goods or it’s hard to find data for that?
PANAGARIYA: You’ll have to look at it. I don’t know. I don’t know the answer. I really don’t know the answer. Here, since we are on to canalization, this area actually was going in the other direction. As I said, this is largely otherwise some bit of liberalization phase, the second half of the ’70s. One area where we are actually also simultaneously going in the opposite direction is canalization.
There is progressively more canalization of imports particularly. As we get to 1980s, I will have some more figures. Even in ’74-’75, they expanded the list. There were 200 items already under canalization. They add in another 10, in ’74-’75. That process continued actually through the second half of the ’70s. It began to unwind in the ’80s. In the ’80s, we began to unwind it.
RAJAGOPALAN: Just as a reminder, though there is an increase in the ’70s, and there’s a slight relaxation in the ’80s when we think of canalization, we’re talking about a list of more than 1,000 goods, more than 1,000 commodities at one point had to be canalized until the ’91 reforms happened and eventually they decanalized in a significant manner. This list is a pretty big one.
PANAGARIYA: No. I don’t know the number of items on the list. One number that I have is from ’74-’75, that number was 210, but I think we’ll come later. If I remember correctly though by ’80-’81, nearly 60% of the imports were coming under canalization. That was a very large proportion. More than half of your imports became canalized, but that will get checked as we proceed further.
Now on the export side also, you had some restrictions introduced. This process is always, all you can say is that on balance, this was a liberalizing phase, but for some particular items, you did introduce more restrictions as well. Things like export taxes on tea and coffee. Any time that the global prices of tea and coffee went up, the government would also raise the export taxes.
Some of this is windfall gain and they should not get windfall gain, but these are the types of things which are very detrimental to the development of the industry, because if the industry sees that anytime we have more profit, you are going to tax it away, then there is no incentive for us to take productivity-enhancing measures. We take productivity-enhancing measures to improve our export performance. Then you are going to come back and hit us with more export tax, so it doesn’t pay.
I think, these policies in the end were detrimental, but that was the thinking that prevailed, that dominated the system. Particularly on the export side, we used to tax quite a bit, the traditional exports of jute, tea, jute products, sometimes even textiles. You would put these export taxes in the belief that we had market power.
Temporarily you do have market power. It is true. The fallout from it is that substitutes come in or the other countries begin to find the exporting more profitable. If you are raising the export price by restricting your exports because you got monopoly power, you don’t see that there are potential exporters sitting there on the fence who become competitive at that higher price.
You don’t get the full advantage of your export restriction because even the price will not rise as much as you thought it would rise, because the other exporters come in and replace you. Also, the importers begin to find substitutes, like when we were putting export taxes on jute, substitution into plastics and other plastic bags and other materials got sped up as a result. One has to be very careful in thinking that you have monopoly power in the export markets. It’s a very temporary thing, even if you have it.
RAJAGOPALAN: Yes. Of course what’s interesting about this post-Emergency period that you’re talking about is Indira Gandhi’s government after the elections doesn’t come back. You have Morarji Desai who is one of the members of the old syndicate who is much more liberal than Indira Gandhi.
The second is that even though the post-Emergency government is a coalition government with very interesting group of people, you have members of the Jana Saṅgh, but you also have Jayaprakash Narayan who are leading them at the helm against Emergency who is an avowed Gandhian socialist. It’s an interesting group of people, but in terms of the technocratic level, which is, what are these lists? Who is deciding what goes in the list and what doesn’t go in the list? What all needs to be rationalized? What prices need to be brought back to par? I think that process starts with the Morarji Desai government, right?
They start moving in a direction away from Mrs. Gandhi. By the time Mrs. Gandhi comes back, in the ’80s, the processes are already underway and the gains from it are enough to give momentum to continue in that direction through the ’80s. Is that a good way to think about this phased liberalization in the late ’70s?
PANAGARIYA: Yes. In fact there is a slightly bigger change as we discussed just now. ’75-’76, some changes begin to happen, the OGL, automatic licensing. That had started, but now with the Morarji Desai government, a more activist policy comes in toward liberalization. You could say that under the earlier one, ’75-’76 to ’77-’78, was a bit more opportunistic. That export revenues became available, and because of the exchange rate, the depreciation exports also expanded. Even at the bureaucratic level the offices got some confidence to liberalize.
RAJAGOPALAN: Then in the ’80s, we get what you have called in your book, “India: The Emerging Giant,” “liberalization by stealth.” Two things are happening in the ’80s. One, of course, there are all these moves, which are being made to reform mainly on the export side, but also the import side. Things like broad banding, which affect domestic licensing regime and so on. Also, a lot of committees have been formed to look into the question of, should we remove sugar subsidies, for instance? What should we do about reforms in the external sector?
In the next episode, can you walk us through the ’80s, the big liberalization by stealth, which is a lot of small things going on simultaneously, and then how that leads up to the big moment in ’91. Of course, preceded by a crazy balance of payments crisis, India is back exactly where it was in ’65-’66, maybe worse in that period. Maybe in the next episode you can take us through that entire journey where a change has started forming.
PANAGARIYA: Right. We’ll start with what is known as the P.C. Alexander Committee which reported in early 1978, the initial Morarji Desai government initiative. That initiative started the process, but then you’re absolutely right that Mrs. Gandhi, when she came in, it continued. There is some case to be made that perhaps Mrs. Gandhi was herself a bit of a changed prime minister and P.N. Haksar was already behind her so to say.
RAJAGOPALAN: There are many reasons, but also once something succeeds, it gets a lot of supporters. They say success has many fathers. If suddenly opening up a little bit is bringing in more foreign exchange, and firms have started doing better, which means businessmen start having better relationship with politicians and giving them little bit more campaign finance money and donations and so on. There is a cycle which can propel that or keep that momentum going.
The technical aspects of that, exactly what is going on in the economy in terms of specific policies, it would be great to hear that from you. It’s outlined in quite a bit of detail in your book, but it would also be great to hear that from you both on the domestic and the foreign side in our episode eight.
PANAGARIYA: Okay, good. Let’s do that.
RAJAGOPALAN: Thank you so much, Arvind. This has been a pleasure, and we will see you soon.
PANAGARIYA: Perfect. See you