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Economic review

India, which embarked on a programme of structural reforms in June 1991 after four decades of planning, is currently attracting significant attention throughout the world. Its large economy and population, vast natural resources and, above all, its highly educated, skilled and scientific labour force mean that India is destined to play a major role in the community of nations.

With a per caput income of about US$310 in 1994, India is one of the world's low-income countries. Unlike those of most East Asian countries, the economy in India was characterized by slow growth during most of the period since the Second World War. It was only during the 1980s that the GDP growth rate accelerated to 5.4 percent and per caput income grew by 3.3 percent per annum. This decade of high growth was followed in 1990 by one of the severest foreign exchange crises in the history of the country. In response, India initiated radical stabilization measures and a structural adjustment programme in June 1991.

Soon after independence, India adopted the path of planned development where the public sector was to play a dominant role in fostering growth at both the central and state levels. The First Five-Year Plan, which was launched in 1950-51, was based on the Harrod-Domar model and primarily concentrated on raising the level of investment in irrigation, power and other infrastructure for accelerating growth. The development strategy was changed radically in 1956 with the initiation of the Nehru-Mahalanobis model of industrial development that emphasized the development of heavy industry under the public sector. Domestic industry was protected from foreign competition through high tariff walls, exchange-rate management, controls and licences. This strategy of import substitution and heavy-industry promotion has been criticized for having created a non-competitive, inefficient, capital-intensive and high-cost industrial structure. It is further argued that this policy discriminated against labour-intensive tradable agriculture and resulted in unwarranted export pessimism because of excessive concern about self-sufficiency. The criticism, however, must be balanced against the fact that during this period India built a large infrastructure not only in heavy and machine goods industries, but also in the areas of power, irrigation, credit, higher education, scientific research and training.

The mid-1960s and early 1970s were characterized by serious economic problems. First, because of wars with neighbours, large resources were diverted towards defence, resulting in a sharp decline in public investment that adversely affected the growth of the economy. Second, the foreign exchange situation forced India to devalue its currency in 1966. Finally, food production failed to keep pace with demand and the country became increasingly dependent on food imports under the United States Government's PL 480. The situation became critical in the mid-1960s with the failure of two consecutive crops in 1964/65 and 1965/66 and the country had to import large quantities of food-grains under PL 480.

In the late 1960s, agricultural growth revived with the adoption of green revolution technology in some regions. Coincidentally, the manufacturing sector which had seen a notable deceleration in growth from 1964-65 to 1975-76, began registering far higher growth from 1977 to 1978.

During the 1980s, the Indian economy witnessed an unprecedented growth rate of 5.4 percent per annum. The 1980s was also a period when limited liberalization measures were initiated and steps were taken to modernize some of the most important industries, such as cement, steel, aluminium and power generation equipment.

The genesis and causes of the 1990 crisis

From 1950 to 1980, while the Indian economy was growing at a relatively slow rate of 3.6 percent, domestic investment exceeded domestic savings by only a small margin. The gap could be bridged through foreign borrowing on a small scale. However, during the period 1979 to 1990, when the growth rate of GDP accelerated to 5.4 percent, the gap between savings and investment widened substantially. The need to finance large capital expenditures and imports of machinery and raw materials, including oil, necessitated heavy borrowing from abroad. The result was a cumulative increase in foreign debt and in repayment liability. Foreign debt increased from US$23.5 billion in 1980 to $63.40 billion in 1991. In 1991, nearly 28 percent of total export revenues went to service the debt. The most important reason for the internal savings rate falling increasingly short of investment requirements was the expanding fiscal deficit of the government which had risen from an average of 6.3 percent of GDP during the Seventh Five-Year Plan to 8.2 percent by 1990-91.

Large fiscal deficits arose for a number of reasons: exorbitant expenditures were incurred by the central government's subsidies of fertilizers, food and exports and by the state governments' of power, transport and irrigation. The inefficient functioning of many of the central and state public sector enterprises further burdened the government budget.

Finally, in addition to the current account deficit, mounting capital account expenditures by the government and public enterprises had to be financed through public borrowing. By 1990, internal debt liabilities had increased to 53 percent of GDP compared with 35 percent in 1980, and interest payments accounted for as much as 24 percent of total government expenditure. In addition, the sources of foreign borrowing underwent some important changes, as soft International Development Association (IDA) and government-to-government loans dried up and high-cost commercial loans from the banks and non-resident Indians had to fill the gap.

As long as the international credibility of India was high, loans were forthcoming and the country could go on living on foreign borrowing. However, the combination of a number of factors, including the sharp rise in import prices of oil and the downgrading of India's credit rating, led to a loss of confidence that resulted in the drying up of short-term credit along with a net outflow of non-resident Indian deposits. Thus, in spite of borrowing from the International Monetary Fund (IMF), the foreign exchange reserves declined.

It was against this background that the new economic policy was introduced. The multilateral agencies such as IMF and the World Bank insisted that the policymakers undertake structural reforms before they agreed to salvage the country from the foreign exchange crisis.

The main components of new economic policy

The aim of the new policy was to bring about a realignment of domestic demand with available resources and to initiate changes in supply and production structures with a view to eliminating the external imbalance. The economy was to be liberalized and gradually integrated with the world economy by the dismantling of tariff walls, the protection of foreign direct investment and upgrading the technology of production in various fields. The broad thrusts of the programmes were financial stability, outward-looking policies and deregulation of domestic markets.

The reforms consisted of two components. The short-term immediate stabilization measures focused on correcting the disequilibrium in the foreign exchange market through demand reduction, reforms in trade policy, a reduction in the fiscal deficit and the dismantling of barriers to the free flow of capital. External competitiveness was to be improved through a large nominal depreciation of the exchange rate.

The medium-term structural adjustment programme introduced reforms in fiscal, exchange rate, trade and industrial policy as well as policies concerning the public sector, the financial sector and the capital market. These reforms included elements such as deregulation of prices and investments, changes in the structure of taxation and public expenditure, moderation in wage increases, privatization of public enterprises and greater integration with the world economy.

The adjustment policies introduced were not specific to the agricultural sector, but concerned the entire economy. Nevertheless, keeping in view the importance and predominance of the agricultural sector in the Indian economy, in terms of both income generation and employment and its intimate relationship with other sectors of the economy through input-output and consumption linkages, the macroeconomic and other changes implied in the stabilization and structural adjustment programme had a significant impact on the sector.

A general review of agricultural development since independence helps to provide the necessary basis for understanding the full implications of structural reform for the agricultural sector of India.

Agricultural policy in India during the planning era

Prior to the liberalization of the Indian economy of June 1991, agricultural policy was governed by a planning framework. The entire gamut of macroeconomic policies, notably trade, fiscal and monetary policies, was designed to serve planning objectives. The plans for the agricultural sector, including its financing and production targets, were all decided through a series of governmental processes at the state and central levels.

The nature and role of planning for the Indian agricultural sector was primarily determined by the sector's specific characteristic of being under the operation of millions of independent producers. Hence, agricultural planning in India consisted in creating a rural infrastructure combined with providing modern inputs and a framework of incentives for farmers that would enable them to increase output through the adoption of modern technology.

Because food availability emerged as a major concern and constraint to the development process, accelerating agricultural and foodgrains growth with a view to providing food security became the central objective of India's agricultural policy. There were several agricultural components in the first and subsequent five-year plans. The first and most important was the implementation of land reforms during the mid-1950s with the objective of eliminating intermediaries and bringing about a greater degree of equality in land distribution.

The second agricultural component was the undertaking of substantial investment in rural infrastructure. A very high priority was accorded to public investment in irrigation and power (large-, medium- and small-scale) in both the central and the state plans. Simultaneously, policies were introduced to provide cheap institutional credit and other subsidies to the farmers to encourage private investment in irrigation. Large subsidies were also given for charges to users of both irrigation and power and fees were kept significantly below the costs of operation. The main thrust of this effort was to create a macroeconomic environment to encourage private investment by farmers and, thus, stimulate production. Promotional policies, including the Special Food Production Programme and agroclimatic regional planning, land and water development programmes, were aimed at accelerating agricultural development.

Large investments were also undertaken for the development of a research system under the aegis of the Indian Council of Agricultural Research and the State Agricultural Universities. Simultaneously, a well-designed extension network was instituted for disseminating new technologies to cultivators. The result was a rapid extension of the land area under high-yielding varieties (HYV).

From 1950 until 1967, the Community Development Programme and a network of extension services were the main instruments in transforming traditional agriculture. These were supplemented by programmes to intensify production in a few well-endowed districts during the early 1960s.

The advent of the green revolution in the mid-1960s marked a turning point in the technological "upgrading" of Indian agriculture. The agricultural research and extension system received special attention during this period since Mexican wheat and International Rice Research Institute (IRRI) rice varieties had to be adapted to Indian conditions and made acceptable to farmers through extension and training.

Initially, new technology was confined to wheat production in the northwestern states of India. In the early 1970s, however, new varieties of rice were successfully introduced and the rice revolution spread not only in Punjab and Haryana but also to many other parts of India including the southern coastal areas. The focus of agricultural policy became the modernization of agriculture through extending seed-fertilizer technology to different parts of the country. Measures were also taken to involve small and marginal farmers in the production process by providing them with new inputs, including seeds, fertilizers aRd credit at subsidized rates.

Administered prices were the third area of policy during the planning era. In the context of pervading food shortages up until the mid-1950s, agricultural price policy had aimed at serving the main planning objective of keeping foodgrain prices low in the interest of food security. With the founding of the Agricultural Price Commission in 1965, price policy also provided incentives to farmers to increase production by establishing remunerative prices and assuring minimum support prices. The objective of the price policy was to reconcile two opposing interests - that of the farmers for fair remuneration and that of the consumers for reasonable prices.

The fourth important component of policy was the establishment of a comprehensive management system for the procurement, storage and public distribution of foodgrains to provide food to consumers at reasonable prices. During periods of scarcity, minimum support and procurement price operations were combined with compulsory procurement, levies on millers, zonal restrictions and other measures to enable the distribution of foodgrains (at subsidized rates) through the public distribution system (PDS). Sufficient food stocks were kept for running the PDS and also to help to stabilize prices through open market operations.

The fifth component was tightly controlled trade and exchange rate policies. In the case of agriculture, except for a few traditional commercial crops, the sector was insulated from world markets through the almost total control of exports and imports. The estimated surplus over domestic consumption requirements determined the quantities to be exported and vice versa for imports. Foodgrains, sugar and edible oils were imported in times of scarcity to prevent domestic prices of essential commodities from rising and to impart a measure of stability to domestic prices in the interest of both producers and consumers. Foreign trade in most agricultural goods was subject to quota or other restrictions such as minimum price requirements.

Finally, financial policy attempted to mobilize resources for public sector expenditure and for public investment. A system was created to extend cooperative and institutional credit to the rural sector, thus facilitating private investment in infrastructure and encouraging the adoption of new technology.

The planning strategy and agriculture

This overall policy package achieved many of the government's objectives. The land reforms were modest but succeeded in making owner-operators the dominant mode of cultivation. However, the legislation regarding land ceilings failed to a large degree. Policies also succeeded in accelerating the growth of agriculture and foodgrains production. As compared to a paltry growth rate of less than 0.25 percent per annum from 1904 to 1944, agricultural output grew by 2.7 percent and foodgrains production by 2.9 percent per annum during the 1949 to 1990 period. The introduction of HYVs during the mid-1960s resulted in a phenomenal increase in the growth rates of wheat and later rice production. Wheat output recorded an annual growth rate of 5.1 percent from 1967 to 1990, while the growth rate in rice production accelerated to 4.1 percent per annum between 1980 and 1990.

In addition, new technologies which were confined to wheat in the irrigated areas of Punjab, Haryana and western Uttar Pradesh during the first phase (1967 to 1975), began spreading to other areas. With a breakthrough in rice, the new technology gradually spread to the irrigated coastal regions of Andhra Pradesh, Tamil Nadu and Karnataka. During the 1980s, new technology spread to the highly populated eastern states of Bihar, Orissa, West Bengal and Assam, resulting in a significant increase in rice production.

Finally, and most important, accelerated growth in foodgrains production resulted in a greater degree of food security for a rapidly rising population and in a reduction of dependence on food imports. By the end of the 1970s, India had become marginally self-sufficient in foodgrains. The steady growth in foodgrains production, over time, increased both physical and economic access to them. The availability of cereals (measured in terms of kilocalories per caput per day) increased by more than 20 percent from 1960 to 1990.

Access to food for the poorer sectors of the population improved as the rapid growth in productivity lowered the real price of wheat and rice. During the 1980s, while the adjusted wholesale prices of all commodities recorded an annual compound growth rate of 6.9 percent per annum, the wholesale prices of wheat and rice rose at an annual rate of only 4.1 percent and 6.5 percent, respectively. The gains from productivity increases were shared by both producers and consumers. Hence, even though the intersectoral barter terms of trade became adverse for wheat and rice growers, their income terms of trade remained favourable because of yield and profitability increases.

Access to food for the poor increased because the proportion of per caput income required to buy food declined over time. While the index of per caput income increased by 545 percent from 1970 to 1990, the price index of food increased by only 280 percent. Finally, access to food for the poor increased because of anti-poverty programmes such as the Integrated Rural

Development Programme, the Rural Landless Employment Guarantee Programme, the National Rural Employment Programme and, later on, the Jawahar Rozgar Yojana. Effective mechanisms were developed for the relief of food scarcities and for resolving the problems of extremely severe droughts through the initiation of special employment programmes.

The planning policies in the context of the structural adjustment programme

While studies recognize India's policy achievements in higher growth and increasing food security to its rising population, the huge fertilizer, irrigation, electricity, credit and consumer food subsidies eventually became unsustainable. At the same time, external trade policies, domestic regulation of agriculture and related policy distortions heavily discriminated against agriculture relative to manufacturing. Moreover, land reform failed to bring about an equitable distribution of land and, as a consequence, very large inequalities continue to exist in the countryside. Finally, the new technologies that were encouraged by the policies and regulations were more appropriate for the richly endowed irrigated regions of India.

Regional inequalities in productivity and income have remained high and in some cases have tended to increase. Agriculturists in general, and small and marginal farmers and landless labourers in particular, remain extremely poor in the less well-endowed regions. The incidence of rural and urban poverty is very high. According to the latest planning commission estimates, in 1987-88, 39 percent of the population in rural areas and 40 percent in urban areas of India were living below the poverty line. As many as 83 million children in India were malnourished in 1991.

Until recently, while many critics focused their attention on these limitations, the general thrust of agricultural policy within the framework of planning had not been seriously questioned. However, after the new economic policy was introduced in 1991, all aspects of planning and associated macroeconomic policy have come under serious discussion:

In India, large subsidies given on agricultural inputs have led to resource misallocation. One study estimates the various subsidies given to the agricultural sector for fertilizers, irrigation and electricity to be in the order of 90.9 billion rupees (Rs) per year during the 1980s. These subsidies placed an unsustainable burden on state and central finances, reducing the government's capacity to undertake large investments. Even then, these subsidies failed to compensate the farmers for the negative impact of lower administered output prices, discrimination against agriculture because of overvalued currency and higher input prices caused by the excessive protection given to industry.

Accordingly, it is argued that many components of economic reforms, such as devaluation of the rupee, drastic reduction of customs duties and reduction of protection to industry, are likely to end discrimination against tradable agriculture. Furthermore, trade liberalization would lead to increased exports from tradable agriculture, which is at a distinct comparative advantage since devaluation and trade reforms.

The impact of macroeconomic reforms on the agricultural sector

India's new economic policy was launched in June 1991. The government began to liberalize the economy by reforming trade, financial, tax and investment policies. Public enterprises were restructured and the budget controlled more closely. Specific policy reforms included floating the rupee, abolishing most industrial licensing, removing import licensing, reducing tariffs and relaxing foreign investment regulations. Although it is too early to assess their full impact, it is important to look at some of the short- and medium-term consequences of these reforms for the agricultural sector.

The short-term stabilization measures included sharp cuts in public spending and fiscal austerity. Consequently, there was a large cut not only in current expenditures but also in public investment. The severe demand restriction resulted in economic growth decelerating from 5.4 percent in 1990-91 to only 0.9 percent in 1991-92, but the economy revived subsequently and the growth rate of GDP rose to 4.3 percent during 1992-93 and 1993-94. It is expected to accelerate to 5.3 percent during 1994-95.

The growth rate in agriculture, which was 3.8 percent in 1990, dropped to -2.3 percent in 1991, but revived to 5.1 percent in 1992,2.9 percent in 1993 and 2.4 percent in 1994. However, the vagaries of monsoons make it very difficult to establish a link between economic reforms and the growth rate in agriculture over a short period of time.

The fiscal adjustments that had the most significant effect on agriculture were the reductions of public investment in irrigation, power and other rural infrastructure, including agricultural research, roads and communications.

The devaluation of the rupee, reductions in tariff barriers and removal of protection to industry (through quotas and licensing) were expected to help end discrimination against agriculture and enable it to obtain more inputs at lower international prices.

The withdrawal of subsidies on fertilizers, electricity and irrigation was an important component in reducing the fiscal deficit. The most important capital input in agriculture is fertilizer. While most of the nitrogenous (N) fertilizers are produced indigenously, most potassium and phosphatic fertilizers are imported. The subsidy to nitrogenous fertilizers was partially withdrawn in 1991. Soon after raising the price of urea by 35 percent, the government reduced it by 5 percent under pressure from the Kulak Lobby. Later, on the recommendation of the Joint Parliamentary Committee on Fertilizer Pricing, the price of urea was reduced by a further 10 percent effective 25 August 1992. The phosphatic (P) and potassic (K) fertilizers were no longer controlled in 1992 and their prices registered a sharp rise as demand increased. To enable indigenous fertilizer producers to compete with importers, the import duty on phosphoric acid was abolished. An adverse consequence of the disproportionate rise in the prices of P and K has been the highly unbalanced use of fertilizers. As against an overall N:P:K ratio of 4:2:1 aggregated for the country, the consumption ratios were 9:3:3 prior to the reforms. In order to restore some balance, the government once again raised the price of urea, by 20 percent, with effect from 10 June 1994. Fertilizer consumption increased to 12.4 million tonnes in 1993-94 and is expected to register a sharp increase to 14.1 million tonnes in 1994-95, mainly as a result of increased demand from the eastern states.

State governments are also giving large subsidies for power and irrigation use. In some cases, these subsidies are so large that states are unable to finance long-term investment in irrigation and power production. This is one important cause of the decline of public investment in agriculture.

A substantial nominal devaluation of the rupee in June, July 1991 made exports of many agricultural commodities more competitive. Thus, exports of rice, wheat, cotton, fruit and vegetables, fish and fish products and meat received a significant boost. Agricultural and agroprocessing industry exports increased from US$3.338 billion in 1991 -92 to $4.1 51 billion in 1993-94.

Despite recommendations for a complete overhaul of the rural credit structure, the abolition of subsidized credit and the closure of regional rural banks, the structure has not been changed in any radical manner since liberalization.

Procurement price adjustments aimed at increasing incentives to producers constitute an important component of the reform package. Prices had to be increased to compensate farmers for increases in the price of inputs such as fertilizers and electricity. Earlier concerns to follow the traditional policy of keeping food prices low as a critically important anti-poverty measure have been swept away by the need for giving greater incentives and increased profitability to producers. However, given the technical and institutional constraints to agricultural production, Indian experts have generally questioned the efficacy of using higher agricultural prices alone to bring about faster agricultural growth. Various studies on short- and long-term price elasticities demonstrate that output responds more readily to infrastructure (especially irrigation) than it does to prices.

In the case of wheat, for example, the procurement, minimum support price was raised from Rs225 in April 1990 to Rs350 per quintal in January 1994 while its price was raised from Rs234 to Rs330 per quintal during the same time. In the case of paddy, the procurement price was raised from Rs205 in 1990/91 to Rs340 per quintal in 1994195. The release price of rice was raised from Rs377 to Rs537 per quintal in April 1994. The price rises of these cereals have created a peculiar situation as the release price for wheat and rice from the public distribution system (PDS) have become even higher than the market price. Consequently, the offtake from public stocks has declined sharply, leading to a large buildup of food stocks to more than 30 million tonnes. As a result of these hikes in administrative prices, Indian rice has become uncompetitive in the international market and wheat exports have also become unfeasible. Moreover, the sharp increases in foodgrain prices and release prices from the "fair price shops" has had a negative impact on food security for the poor in India. Recent reports indicate that the extent of poverty has increased over the last three years.

Liberalization of Indian agriculture and policy issues

Providing food security continues to be the central objective of India's agricultural policy. With a large and growing population of 844 million and an expected acceleration in per caput income over the next decade, the demand for foodgrains is likely to grow at a rapid rate. Policy-makers recognize that accelerating growth in foodgrains production is an essential prerequisite for meeting the rising food demand.

Higher agricultural growth requires both public and private investment in irrigation and other rural infrastructure. However, the rate of investment in agriculture has declined since the early 1980s. An important reason has been that in most states a large proportion of the government budget is required for huge subsidies on power, transport and water and on the inefficient functioning of both power and irrigation systems. In addition, policy-makers are considering decentralizing and privatizing irrigation projects (with explicit subsidies to be provided for socially important schemes), leasing distribution systems to panchayats and forming irrigation cooperatives to establish and collect water charges and to manage and maintain distribution channels.

Private investment in agriculture is likely to increase if public investment grows to allow farmers to adopt yield-raising technology and if farmers have the incentives of remunerative prices.

The reforms and agricultural exports

There is a general agreement among economists and policy-makers that India has export potential in some agricultural products. In addition to traditional commodities, such as tea and coffee, exports of many new commodities, including fish products, rice, fruits and processed food, have shown a rapid increase. Some studies argue that there is major scope for increasing exports of foodgrains such as rice and wheat. In the short term, however, the competitiveness of several agricultural commodities is gradually being eroded because of high inflation attributed to the new economic policy.

The extent to which India should free its trade in foodgrains, oils and sugar, as a consequence of becoming a signatory to GATT, is an issue that has generated a great deal of debate. The main argument in favour suggests that India would stand to gain immensely from complete trade liberalization and that even the interest of food security would be served in a much more efficient and less costly way if, instead of relying on huge food stocks, imports and exports of foodgrains were used as a way of countering domestic supply fluctuations.

The opposite point of view argues that India should not free its trade immediately and that its demand for foodgrains should be met through domestic production instead. This view suggests that, because food production is the predominant means of living for a large percentage of the country's workforce whose fortunes depend on the growth rate of output and productivity in the foodgrains sector, India should be insulated from international price changes. This group argues that free trade is likely to accentuate the variability in domestic market prices in the short term as a result of large fluctuations in the international prices of agricultural commodities. This would expose market prices to great risk and uncertainty. These fluctuations would adversely affect food security for the poor.

The practical approach to trade liberalization suggests that the new liberal climate should make it possible to dispense with many coercive instruments such as compulsory procurement, zonal restrictions and limits on stocks, and to make more effective use of markets at both the national and international levels. Important measures include: reducing the costs of procurement and storage through the better functioning of the Food Corporation of India and the association of private trade with procurement operations; correcting many of the existing deficiencies in the PDS through gradually directing assistance only to the poor in both rural and urban areas, removing its urban bias and extending it to most of the rural areas and strengthening the coverage in poor states such as Bihar and Orissa; introducing a more cost-effective strategy for the management of food stocks, which should take into account likely food demands, the extent of fluctuations in domestic output and prices; allowing the Food Corporation of India to enter the international future markets with a view to reducing buffer stocks and cutting down on costs and subsidies; and developing regional cooperation.

Concluding remarks

In the wake of the macroeconomic reforms, it is possible for the agricultural sector to derive large benefits not only-by catering to increasing domestic demand, but also by making use of the export possibilities brought by increased access to foreign markets. Globalization of Indian agriculture offers both opportunities and challenges to policy-makers. Opportunities exist for deriving large benefits through substantial increase in agricultural exports, especially exports of high-value labour-intensive agricultural products. This can become possible, however, only if the agricultural sector is able to generate larger surpluses through increased public and private investment in rural infrastructure, in research and development, new technology and in marketing. The challenges lie not only in modernizing small-scale agriculture and in making it efficient and competitive, but also in involving the mass of rural people including small and marginal farmers and landless agricultural labourers, in all parts of India, in the development process.


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