INDIA: NEW DIMENSIONS IN ECONOMIC POLICY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP84S00556R000100060004-6
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 17
• Document Creation Date: December 21, 2016
• Document Release Date: October 7, 2008
• Sequence Number: 4
• Publication Date: February 1, 1983
• Content Type: REPORT

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Directorate of Secret
Intelligence
India: New Dimensions
in Economic Policy
State Dept. review completed
Secret
NESA 83-10034
February 1983
Copy 3 3 5
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~~ Intelligence
r -,I
India: New Dimensions
in Economic Policy
This assessment was prepared by
Office of Near East-South Asian Analysis.
Comments and queries are welcome and may be
directed to the Chief, South Asia Division, NESA, on
This assessment was coordinated with the National
Intelligence Council and the Directorate of
Operations
Secret
NESA 83-10034
February 1983
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Secret
in Economic Policy
to economic growth, and provide new opportunities for US business.
Key Judgments Since her return to office in January 1980, Prime Minister Gandhi has
Information available altered the restrictive trend of earlier Indian economic policy. She has
as of 3 December 1982 eased the stranglehold of bureaucratic controls on industry and provided a
was used in this report.
more favorable policy climate for private investment. Gandhi's gradual and
cautious liberalization measures have attracted the attention of Western
policymakers and businessmen and have prompted optimistic speculation
that these changes will eventually modify India's foreign policy, contribute
Gandhi has no comprehensive strategy for economic reform, but a
multitude of minor policy changes have:
? Removed many legal impediments to growth of production and invest-
ment, especially for export industries.
? Simplified import licensing procedures, especially those that impede
exports, and recently permitted limited competition for domestic
manufacturers.
? Encouraged technical cooperation with Western business and increased
slightly India's tolerance of equity investment. 25X1
India's new economic approach was prompted by dissatisfaction with past
economic performance and by interest in the potential benefits of advanced
Western technology. Gandhi's policy changes have not altered the basic
regulatory structure that has long been in place. She regards her liberaliza-
tion effort as an experiment-worth an extended trial but to be abandoned
if production and exports fail to increase. 25X1
Economic liberalization provides new opportunities for Indian industry to
become more efficient. Decontrol efforts alone, however, are not sufficient
to alleviate balance-of-payments problems or ensure faster economic
growth. Overall economic performance has not yet benefited from
Gandhi's policy changes, even though large companies report ambitious
expansion plans and more technical cooperation agreements have been
signed with foreign companies. 25X1
A potential shortage of foreign exchange is the greatest threat to continued
liberalization. Unless developments beyond the control of Gandhi's eco-
nomic policy are favorable, she may have to reimpose some curbs on
industrial imports in order to ensure India's ability to finance purchases of
food, petroleum, and military equipment. 25X1
Secret
NESA 83-10034
February /983
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Economic policy changes are only loosely linked with Gandhi's simulta-
neous efforts to loosen somewhat India's close association with the Soviet
Union. Although liberalization encourages additional trade and technology
ties with Western countries, it will not eliminate Moscow's central place in
New Delhi's foreign policy. Political friction with the United States could
even increase slightly if Gandhi's hopes for technological links and
economic progress are not realized.
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in Economic Policy
Traditional Policies and Problems'
Since independence, Indian policymakers have tried
to promote the often conflicting objectives of growth,
equity, and self-reliance through pervasive govern-
ment intervention in the economy. They supplemented
a full range of macroeconomic policies with an exten-
sive system of direct controls on investment, finance,
prices, and foreign trade. During her earlier term as
Prime Minister (1967-77) Indira Gandhi intensified
restrictions on foreign companies and domestic
25X1 "monopolies."
Under these policies, overall GNP growth has been
slower than in many low-income countries-about 3.6
percent a year since 1950-but India has succeeded in
developing a sophisticated industrial base and improv-
ing rice and wheat production. Fears of famine and
foreign exchange shortages receded in the late 1970s
when India benefited from a series of good harvests
and an inflow of remittances from Indian workers in
the Middle East.
Hopes for sustained economic progress were dashed
soon after Gandhi returned to office in January 1980.
Extremely poor weather in 1979 sent agricultural
production plummeting. Interrelated shortages of
electricity, coal, and rail services crippled industrial
production and exports. India's balance of payments
deteriorated following increases in international pe-
troleum prices and political agitation in the northeast-
ern state of Assam that disrupted domestic oil produc-
tion. Indian officials feared that future development
efforts would have to be curtailed because they
anticipated a reduction in foreign aid commitments,
particularly from the International Development
25X1 Association.
Economic policy changes and the reactions of the private corpo-
rate sector are widely reported in India's extensive business and
financial press, trade association publications, reports of commer-
cial research organizations, and Indian Government publications.
Our judgments in this assessment are based on detailed information
in those open sources, supplemented by reporting from US Embassy
and consular posts in India and analyses prepared by international
Gandhi has relied primarily on traditional policy
approaches to cope with these problems and boost
national output. Her nagging and close supervision
have spurred improved management of the public
power, coal, and rail industries, although bottlenecks
remain. She has continued support for agriculture
through price supports and investment in irrigation.
New Delhi is proceeding with plans for massive
expansion of electricity generating capacity and is
counting on petroleum exploration efforts to increase
India's own crude oil production and reduce import
costs. Gandhi has turned to international financial
institutions for increased support and obtained a $5.7
billion Extended Fund Facility credit from the Inter-
national Monetary Fund (IMF) in 1981.
Supplementing the Old Cures 25X1
While Gandhi is continuing many traditional policy
measures, she has taken a new approach to the private
sector. A multitude of minor changes can be viewed as
a new liberalization policy that loosens government
controls on production and investment and permits
more foreign participation in Indian industry. Gandhi
began by relaxing specific impediments to production
and exports. Very cautiously and gradually, she
opened additional oppportunities for domestic and
foreign business. 25X1
A mixture of confidence and concern about India's
economic prospects prompted the new economic ap-
proach. Gandhi was:
? Impelled to reconsider policy because economic
problems were mounting.
? Able to risk change because of the leeway initially
afforded by comfortable stocks of grain and foreign
exchange and later by support from the IMF.
? Willing to experiment because she and her advisers
were dissatisfied with past performance and be-
lieved that the economy has an unrealized potential
to become strong. 25X1
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Gandhi's liberalization efforts reflect the gradual
dissipation of support for comprehensive government
controls since the 1950s. According to prominent
Indian economic observers, many intellectuals and
bureaucrats now admit that the plethora of govern-
ment regulations has not only slowed growth but also
hindered the achievement of social goals such as
increased employment. Some of Gandhi's principal
advisers share these views and have published studies
that advocate a shift in policy emphasis from control
to development. The probusiness sympathies of
Gandhi's son Sanjay, who was her principal confidant
until his death in June 1980, probably made his
25X1 mother more receptive to these recommendations
Gandhi's new approach is a pragmatic response to
past economic difficulties and not a shift in overall
economic ideology, which continues to favor strong
government intervention in the economy. Although
Gandhi's advisers argue that many government con-
trols have not worked and should be dropped, they do
not favor unfettered operation of market forces, which
they believe would respond only to the interests of the
affluent. In our judgment, Gandhi has never been
deeply committed to any theoretical approach. Rath-
er, the policies she has adopted during her two terms
as Prime Minister suggest that she reacts to the most
glaring political or economic problems. She has
moved to the left in the past when that was expedient.
Now, while she is experimenting with decontrol, her
public statements still contain a vague socialist rheto-
ric. In 1982 she explained to a foreign interviewer that
"our version of socialism is entirely different from
what is practiced in the Soviet Union.... But ... we
must do something tangible for these vast millions of
poor, and we cannot do it if we leave it to big
business."
25X1
The Scope of Liberalization
Domestic Industry. Gandhi's initiatives to ease legal
impediments to the growth of private industry consti-
tute a marked shift from earlier policy restraints.
Since the 1950s the central government has regulated
the type and quantity of goods that may be produced
and determined prices and distribution of several
essential commodities. The Monopolies and Restric-
tive Trade Practices Act, passed during Gandhi's
earlier term of office, imposed additional controls on
investment and production by India's large, diversi-
fied industrial conglomerates.' Gandhi had barely
begun to temper the rigor of her antimonopoly legisla-
tion when she lost the 1977 election. During the
Janata interregnum, policies even more inimical to big
business were often announced but seldom
implemented.
Since Gandhi returned to office, she has removed
some legal restrictions on increases in private-sector
manufacturing and investment. Her industrial policy
statement of mid-1980 "regularized" some capacity
that had been installed in excess of licensed limits and
authorized a few industries to expand slightly without
special permission. She pushed the bureaucracy to
reduce the time required to obtain industrial licenses
and convinced officials that she wanted to spur out-
put. A leading industrialist characterized these early
changes as "probation rather than reprieve" for
business.
India's largest corporations, excluded from the initial
liberalization measures, have benefited from more
recent changes. Export sales are no longer counted
when determining whether a business is large enough
to be subject to antimonopoly restrictions. The indus-
trial policy announced in April 1982 opened new areas
for investment by large or foreign-owned firms and
authorized substantially higher capacity ceilings for
growing companies. Industrialists nonetheless com-
plain that they have gained relatively little, partly
because the new rules are confusing and contain many
qualifications, but also because much production has
not reached licensed limits
New Delhi has curbed its role in setting prices of
essential industrial commodities and specifying distri-
bution to preferred categories of customers. Private
producers of cement, who account for 90 percent of
production, are now permitted to sell one-third of
their output to any customer at any price. A commit-
tee from one private and five public-sector steel
plants-rather than the central government-now
sets prices of steel.
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Domestic Industry: Selected Liberalization Measures
Right of government financial institutions to convert
their loans to private companies into equity limited to
40-percent share of most companies, 51 percent of a
mismanaged company.
"Regularized" capacity installed by some companies in
excess of licensed limits. Permitted manufactures of
some items in 19 industrial sectors to increase their
production capacity by 5 percent a year without special
permission.
September 1980 Prominent industrialists met with Gandhi, acknowledged
a new orientation in bureaucratic procedures in response
to her push for production.
October 1980 Export sales excluded when determining whether a
company is large enough to be subject to especially
stringent limits on growth.
;November 1980 Ceilings on debt and on interest payable on company
debentures relaxed.
March 198/
Maximum share ofequity that may be held by promoter
of a new company raised.
October 1981 "Regularized"capacity installed by pharmaceutical
companies in excess oflicensed limits.
February-March Cement producers permitted to sell part of their produc-
l 982 tion to whomever they want at whatever price they can
obtain.
March-April 1982 Government-administered system for setting prices of
steel and pig iron abolished.
April 1982 Authorized substantially higher capacity ceilings for
companies that exceeded licensed production limits
during any of previous five years. Applies even to large or
foreign-owned companies in an expanded list of "core"
sectors. Definition of "dominance" changed.
Industrialists had feared the convertibility clause
could lead to back-door nationalization, even though
it had never been used for that purpose.
"Automatic"permission to grow was previously
available only to some metal manufacturing indus-
tries. This liberalization did not apply to large
companies or to items reserved for production by
small-scale industry.
Industrial leader characterized changes as "proba-
tion rather than reprieve "for big business.
Change benefited the large companies that were
excluded from the July liberalization.
Change intended to increase the flow of nonhank
funds to the private corporate sector.
Previous restrictions sometimes conflicted with re-
quired minimum share of investment.
This toleration of previously illegal production was
accompanied by restrictions on distribution of prod-
ucts, especially stringent for large or foreign-owned
companies.
Government still regulates price and distribution of
production equivalent to two-thirds of installed
capacity. Change squelched black market in cement.
Prices now set by committee from five public-sector
and one private steel plant under "watchful "eye of
government.
Practical impact of this relatively comprehensive
change limited because many companies had under-
utilized capacity and definition change is unclear.
Liberalization does not apply to 72 industries subject
to special licensing, or to items reserved for small-
scale industry.
The corporate sector has been given greater freedom
to attract funds from outside the banking system.
Companies are now permitted to pay a higher interest
on debentures and on funds deposited with them. The
maximum permissible debt-equity ratio has been re-
laxed, and new tax concessions have been allowed on
25X1 investment
These decontrol measures have created a more favor-
able policy climate for investment. Large companies
had hoped for more freedom, but they report ambi-
tious expansion plans in response to Gandhi's policy
changes and somewhat improved electricity and rail
services. The number of industrial licenses approved
rose sharply in 1980, and the private corporate sector
has obtained more funds from the public and from
government financial institutions. 25X1
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April 1980 Import-export policy: imports of spare parts allowed for
stock and resale. Manufacturers may use REP licenses
(those offered as a reward for exports) to import goods
required for their own production as well as items on a
"shopping list. "
March 1981 Exporters of manufactured metal goods received priority
in distribution of steel and pig iron. Charged internation-
al prices (lower than domestic prices).
Complete tax holidayforfive years offered industries
located in Free Trade Zones.
April /981 Import-export policy: extensive tinkering with lists of
items that may be imported freely and those usually
banned. "Trading houses' that promote rapid export
growth received additional import licenses and foreign
exchange allocations. Last year's liberalization of REP
licenses extended to manufacturers who export through
agents.
August 1981 Exporters allowed to deduct 133 percent of expenditure
on preinvestment surveys and overseas warehouses from
taxable profits.
March 1982 Industries in Free Trade Zones allowed to sell 25 percent
of production in domestic market if they pay import duty
on such sales.
Companies that increase exports by at least 10 percent
allowed tax relief on 10 percent of their export profits (25
percent of profits on overseas construction contracts).
April 1982 Import-export policy: manufacturers who export all their
production allowed to import almost any input they need.
REP licenses may be used to import capital goods even if
a domestic substitute is available. REP licenses may be
traded among exporters. Increases of 10 to 20 percent
over value of past import licenses allowed without special
permission.
Duty-drawback rates increased. Coverage extended to
additional items, including turnkey projects.
August-September Interministerial committee resisted pressure to protect
1982 manufacturers ofsoda ash, PVC, polyester and viscose
fiber from import competition.
September 1982 "Cash compensatory support " extendedfor three years
with reduced benefits for most exports.
Continued modest liberalization begun in 1975 and
significantly extended in 1978, when foreign exchange
reserves were rising. Official text noted importance of
policy stability but cautioned that liberalization is
not an end in itself
Shortages of steel had been curtailing production of
exportable goods.
Most earlier liberalization retained despite new
restrictions on minor items. Effort to balance objec-
tives of protecting domestic industry and assuring
access to imports needed for production, especially in
export-oriented industries.
Exemption previously limited to expenditure on
office maintenance, travel, and advertising.
Major liberalization of procedures for exporters
reduced need to seek bureaucratic approval of im-
ports. Provided limited competition for domestic
manufacturers ofcapital goods. Overall import liber-
alization maintained despite official concern over
poor balance-of-payments position.
90 percent of Indias exports now eligible for this
program, which refunds 6 to 15 percent of the.f.o.b.
value of exports.
Since Mal, 1982 major industrialists who previously
supported import liberalization have complained
about dumping offoreign goods. Businessmen who
use these products prefer to buy cheaper imports.
According to press reports, official nonaction was
prompted by need to contain domestic production
costs and thus accelerate exports.
Program reimburses exporters for some indirect
taxes and market development expenses. Indian
officials deny that these payments, 4 to 18 percent of
fo.b. value of exports, are subsidies.
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25X1
25X1
25X1
Foreign Trade. In a major departure from New
Delhi's traditionally conservative management of for-
eign trade policy, Gandhi has avoided renewing curbs
on imports of industrial equipment and raw materials
even though India's trade deficit has seriously deterio-
rated since 1980. She has even stepped up the import
liberalization begun in the mid-1970s when foreign
exchange reserves were growing.
The import licensing system has been simplified and
new incentives offered for exporters. Fewer bureau-
cratic approvals are required before a license is
granted. Manufacturers with a recurrent need for
imports now receive automatic increases in the value
of their import licenses. Restrictions on the use of
import licenses offered as a reward for exports have
been substantially loosened. The few manufacturers
who export all their production may import almost
anything they need.
New Delhi has even begun to tolerate very limited
import competition for domestic manufacturers. Un-
der revised regulations, successful exporters may
sometimes import a limited amount of capital equip-
ment even if an Indian substitute is available. Since
last May leading industrialists have publicly com-
plained that they are losing sales because of foreign
dumping. An interministerial committee set up to
review import policy has so far, surprisingly, refused
to accommodate them.
Recognition of the need to increase exports pervades
Gandhi's economic strategy. Exporters are the prime
beneficiaries of relaxed controls on industry, imports,
and foreign investment. The government has granted
exporters increased income tax relief and changed the
form of reimbursement for indirect taxes and market
development expenses to minimize foreign criticism.
Gandhi's efforts to alleviate infrastructure bottlenecks
are intended in part to facilitate production of export-
able manufactured goods
Benefits derived from Gandhi's trade policy shifts are
not yet apparent in preliminary trade data. Although
overall export performance has been lackluster, sales
of goods most affected by import controls or export
incentives have held up reasonably well in a depressed
world market. Evidence of improvement in the pro-
duction base for future export growth is mixed.
Exporters have increased their use of import licensing
incentives, but the volume of capital equipment im-
ports grew only modestly in 1980/81 and declined in
Foreign Investment and Technology. Indian policy
now encourages technical cooperation with foreign
business and has become slightly more receptive to
equity investment proposals, reversing the direction
Gandhi followed during her earlier term of office. The
Foreign Exchange Regulation Act (FERA) of 1973
imposed a 40-percent limit on foreign equity in most
companies, although it permitted a higher share in
high technology or export industries.' The succeeding
government implemented this legislation and added
an effort to forgo foreign ownership even in crude oil
exploration. 25X1
In our view, Gandhi is now convinced that advanced
technology can help make Indian industry far more
efficient at home and competitive abroad.
Gandhi and her advisers still prefer to acquire foreign
skills through licensing and technology agreements
rather than equity investment. In support of this
approach, procedures for approving nonequity "col-
laborations" have been simplified, and increased roy-
alty rates are allowed. More important, implementa-
tion of existing regulations has been liberalized. Some
foreign companies have been able to generate substan-
tial equipment sales to India by offering to license
some of their technology 25X1
A somewhat more accommodating approach toward
new equity investment is also evident. Although proj-
ects that contribute advanced technology or promote
exports are still favored, officials now seek opportuni-
ties to highlight the flexibility with which they will
consider suitable proposals. During an interview with
a leading Indian newsmagazine, Gandhi observed that
' This legislation affected about 900 companies. Coca Cola, IBM,
and about 50 others chose to suspend operations in India rather
than comply. Permission to retain more than 40-percent equity has
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 Foreign Investment and Technology: Selected Liberalization Measures
May 1980 Two major multinationals permitted to retain 51-percent
equity in their Indian subsidiaries.
July 1980 Industrial policy statement welcomed foreign investment
in certain cases.
September 1980 Foreign oil companies invited to bid for exploration and
production-sharing contracts.
October 1980 Investment by OPEC countries permitted even if no
technological benefits expected.
November-December During meetings in India, officials noted that foreign
1981 investment is not contrary to self-reliance.
March 1982 Chevron signed oil exploration and production-sharing
contract.
April 1982 Five additional industries opened for foreign investment.
May 1982 Hindustan-Lever permitted to retain 5/-percent foreign
equity.
July 1982 Restrictions on domestic trading by foreign companies
modified.
April, July, August Limits of equity participation by nonresident Indians in
1982 portfolio shares and new issues relaxed.
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Foreign investment allowed in razor blade production
with 24-percent equity (raised to 30 percent in February
1982).
Gandhi actively solicited foreign investment during visit
to United States.
Indicated government willingness to make use of
discretionary exemptions to 40-percent equity limit,
as permitted by existing legislation.
More accommodating emphasis than policy state-
ments of previous government, which discouraged
foreign investment except in certain cases. Legislation
unchanged.
Invitation had been planned in December 1979 but
delayed by change of government. Reversed 1978
decision to forgo foreign equity, which followed
unsuccessful exploration byforeign companies in
1974-78.
First interest in investment as source offinance rather
than of technology or export assistance. This conces-
sion to attract surplus OPECfunds was not consid-
ered a precedent for general liberalization.
Rare example of permission for investment in a
consumer goods industry. Intended in part to provide
competition for domestic industry.
New receptivity to selected foreign investment widely
discussed in the Indian press.
Liberation applied even to large domestic companies.
Decision risked public criticism, since part of produc-
tion consists of consumer goods for the domestic
market.
This change applied to trading in products ofpublic-
sector, small-scale, or unprofitable industries. Un-
usual recognition of economic value of marketing
skills.
August 1982 Foreign oil companies again invited to bidfor exploration
and production-sharing rights.
Japanese company signed investment agreement for
assembly of passenger cars with public-sector firm.
Critics considered project a memorial to Gandhi's
deceased son, who favored it.
Foreign company already active in India plans technical
transfer to public-sector company. Will accept marketing
rights, in India and abroad, to ha lf of output in lieu of
royalty.
November 1982 Nonresidents permitted to remit proceeds from sale of
shares without prior permission of tax authorities.
Proposal, not yet approved by government, evades
limits on expansion of FERA company. Also recog-
nizes value of international marketing skills.
Repatriation of any profit must still await tax
clearance. Part of continuing effort to attract nonresi-
dent investment.
Secret 6
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"as we have grown stronger we are liberalizing ....
Now we're allowing foreign capital in previously
forbidden areas ... because we want to accelerate our
own growth without compromising self-reliance.'
Experience has tempered New Delhi's efforts to re-
strain foreign companies already active in India.
According to press reports of stock exchange activity
and company negotiations with the Indian Govern-
ment, many large companies complied with FERA
legislation by increasing their capital base through the
sale of shares to Indian nationals. The foreign owners
were thus able to retain management control and
expand their activities without having to contribute
additional capital. Since Gandhi's return, several
prominent multinationals have been allowed to retain
51-percent equity, and restrictions on the domestic
trading activities of companies subject to FERA have
been loosened. Press reports indicate that New Delhi
is seriously considering a major policy change to
encourage foreign investors who earlier diluted their
equity to bring it back up to 51 percent-provided
they contribute new funds, invest in approved sectors,
and accept an obligation to export part of their
production.
A marked liberalization for three exceptional types of
foreign investment shows interest in foreign financial
benefits:
? Foreign oil companies have been invited to bid for
exploration and production-sharing rights in several
areas of India, and a contract has been signed with
Chevron.
? Nationals of the OPEC member countries are wel-
come to invest in India even if they are unable to
contribute technical skills.
? Portfolio investment from Indians resident overseas
25X1 is now encouraged.
An impressive increase in the number of collaboration
agreements approved has followed Gandhi's policy
changes, and her welcome to foreign equity, while still
ambivalent, has been sufficient to retain significant
foreign participation in the Indian economy. Major
manufacturing projects with an investment outlay of
more than $1 billion are under way or proposed by
Figure 1
Foreign Technology and
Investment Agreements, 1977-81
Number of Agreements
600
foreign companies already active in India.' In addi-
tion, several multinationals are negotiating major
projects that combine a limited amount of equity
investment with licensing agreements.
Foreign Commercial Borrowing. A more accommo-
dating approach to the use of foreign commercial
loans accompanies the liberalization of trade and
industrial regulations. This reflects a major, albeit
reluctant, change in India's conservative financial
policy, which previously relied predominantly on con-
cessional aid. Before 1980 a few public-sector institu-
tions were allowed to tap international capital mar-
kets for less than $100 million annually, but
commercial loans and European government export
credits have only recently begun to play a major role
in financing Indian imports. Public and private-sector
' Most of the, cost will be financed within India. These projects
constitute less than 2 percent of the total investment plans reported
by an Indian research firm 25X1
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organizations arranged more then $2 billion in non-
concessional loans during the past two years. The
IMF anticipates a sizable step-up this year and
estimates that disbursements could provide more than
$500 million.
Most government borrowing will be used for large
projects, aircraft purchases, and relending to industry,
according to published data on international loans.
New Delhi negotiates syndicated bank loans for major
projects along with foreign government export credits
and concessional aid-a practice that lowers the
average interest rate but limits the choice of supplier.
Direct borrowing by the private sector is permitted for
projects approved by the governmment and accounts
for about 40 percent of total nonconcessional loan
commitments.
Government financial officials have expressed concern
that India's currently low debt service ratio will rise
beyond prudent limits unless borrowing is carefully
managed. Not only does market borrowing entail high
interest rates, but an increased share of World Bank
loans and part of the IMF credit are on commercial
terms. Gandhi has complained to US officials that
India is being punished for its success in becoming
creditworthy and resents US efforts to link a reduc-
tion in multilateral aid with New Delhi's ability to
borrow more commercially.
Limits of Liberalization.
Liberalization measures undertaken so far do not
amount to a comprehensive revision of economic
strategy even though they provide significant new
opportunities for key economic sectors. Most policy
changes have been designed to spur exports, minimize
shortages anticipated by bureaucrats, or shift some
investment costs out of the government budget.
Gandhi has told interviewers that it would not be
desirable to open the economy to market forces. She
remains suspicious of big business-domestic and
foreign-though she is willing to see what it can
accomplish if given more freedom.
Private business is not yet free to invest or produce
whatever it deems profitable. Officials repeatedly
emphasize in public statements that industrial con-
trols must be maintained in order to make best use of
the capital available. The Ministry of Industries
continues to seek increased authority to punish com-
panies that exceed authorized production limits. Po-
tential benefits from policy changes have been de-
layed because of uncertainty over the interpretation of
new regulations. Although some industrialists see a
speedup in official procedures, press reports suggest
that many officials continue to believe their job
security is best served by scrupulous application of
antimonopoly legislation.
The basic regulatory structure governing foreign
trade-lists of items that may be imported freely,
sometimes, or only rarely-remains in place. The
government still restricts most imports when domestic
production increases, and high tariffs provide addi-
tional protection. Imports of most manufactured con-
sumer goods are still prohibited. Gandhi remains
unwilling to permit exports, particularly of agricultur-
al commodities, that might lead to shortages in the
domestic market
Foreign investment policy remains highly restrictive
despite the changes made during the past two and a
half years. Gandhi has told interviewers that she
prefers to steer clear of large multinational firms
whenever possible. New Delhi still discourages pro-
posals intended to take advantage of a protected
domestic market, restricts production by pharmaceu-
tical companies, and only rarely permits investment
that threatens established domestic manufacturers]
New freedom for private corporations does not, in our
view, imply a reduced role for the public sector, nor
elimination of policy discrimination against big busi-
ness.' Predominantly government-owned industries
such as petroleum exploration and refining, electric-
ity, and steel also have major expansion plans, and
they, too, benefit from import liberalization. Some
manufacturing remains reserved for small producers,
and both agriculture and small-scale industry still
benefit from priority in the allocation of bank credit.
The government continues to intervene in the pur-
chase and distribution of foodgrains and sugar.
The public sector accounted for one-fifth of India's GNP in
1980/81 and about 14 percent of net national product in maufac-
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Prospects for Continued Liberalization
We believe Gandhi regards her liberalization program
as an experiment-worth an extended trial but to be
abandoned if output and exports fail to increase. In
our judgment, she is prepared to ignore much criti-
cism but would reinstate some controls if business and
political opposition seems likely to attract widespread
popular support during an economic downturn. We
believe Gandhi will extend her liberalization efforts if
the economy performs well-good weather and
prompt oil discoveries would ease the foreign ex-
change risk her policies entail, and prosperity would
25X1 mute domestic criticism.
Domestic and Foreign Iru7uences. Pressures to main-
tain liberalization will probably be slightly stronger
than those for retrenchment during the next several
months. International lending agencies strongly en-
dorse the relaxation of controls, while the positions of
domestic interest groups are inchoate. As a result, we
believe New Delhi may provide relief for industries
most hurt by imports but will continue most of the
decontrol measures already announced. Gandhi, how-
ever, probably will not risk much further liberaliza-
tion of industrial imports when the annual trade
policy statement is released next April-import costs
are already higher than anticipated because of poor
weather last summer
Business support for liberalization is ambivalent,
judging from extensive comment in the financial press
and company reports. Many larger industrialists who
have benefited from an improved supply of imported
materials and increased investment opportunities
would oppose renewed controls. Other businessmen
depend on a protected domestic market and resist
liberalization. Some manufacturers not only complain
of foreign dumping but also of "unfair" competition
from foreigners who are more efficient because they
produce on a larger scale. Potential exporters argue
that high-cost domestic inputs and unreliable supplies
of power and rail services prevent them from diverting
25X1 production toward foreign markets.
Although economic policy is not yet a popular politi-
cal issue, opposition parties have already begun pre-
paring to exploit potential discontent. During parlia-
mentary debate the leftist parties cooperated with a
Hindu nationalist party in accusing Gandhi of selling
out to multinational companies and financial institu-
tions and abandoning India's traditional self-reliance.
Gandhi's spokesmen are reluctant to jeopardize her
popularity, and so they minimize the welcome for
foreign business when addressing domestic audiences.
25X1
In our view, policy conditions imposed by the Interna-
tional Monetary Fund inhibit Gandhi from backslid-
ing on the liberalization program she began on her
own initiative. The IMF advocates fewer restrictions
on industrial production, further export promotion
efforts, and continued import liberalization. Access to
$3.5 billion as yet undisbursed from an Extended
Fund Facility credit is contingent on satisfactory
performance. IMF leverage will be reduced after mid-
1984 when this loan will be fully drawnF_
Foreign Exchange Constraints. Our assessment is 25X1
that a potential shortage of foreign exchange is the
greatest threat to continued liberalization. We believe
India has only an even chance of avoiding severe
strains on its international payments position by late
1985 or early 1986. Gandhi may modify her policies
before then in order to ease the anticipated problems.
She probably will not encourage domestic industry to
grow by using more imported materials when such
purchases would jeopardize India's ability to pay for
imports of food, petroleum, or military equipment.
Developments beyond the control of Gandhi's policy25X1
will partly determine India's ability to finance contin-
ued economic liberalization, in our view. New Delhi is
counting on increased domestic oil production to
reduce import costs, but no discoveries have been
confirmed since 1977, and production from existing
fields will level off by 1985. India is only intermittent-
ly self-sufficient in foodgrains, and import require-
ments depend largely on the weather. Exports of
several commodities are now inhibited by slack de-
mand in Western countries. Some commercial bank-
ers have become reluctant to increase their exposure
in India, in part because of the fallout from financial
crises in Latin America and Eastern Europe.
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Uncertainty about future foreign aid receipts has
heightened New Delhi's concern about a foreign
exchange shortage. During Gandhi's visit to Washing-
ton last July, she and her advisers observed that it
would be difficult or impossible for India to continue
economic liberalization without access to concessional
loans. Although this argument was intended to elicit
greater US support for Indian borrowing from the
International Development Association and the Asian
Development Bank, in our judgment it also reflects
valid concerns about balance-of-payments prospects
after 1985, when repayments to the International
Monetary Fund must begin.
Implications of Liberalization
Policy Overview. Gandhi's changes reverse the restric-
tive trend of key economic regulations but do not
move very far in the new direction nor set policy
securely on the path toward further decontrol. In our
judgment, Gandhi has no comprehensive strategy for
economic reform. Regulatory change was well under
way before the business press or later, Gandhi herself,
acknowleged a general liberalization. She still uses
the nearly meaningless rhetoric of socialism and self-
reliance while embarking on a pragmatic effort to
lower barriers to industrial growth. Although liberal-
ization provides greater scope for business decisions,
the new freedom is precarious because the basic
regulatory structure remains in place. Gandhi will
probably extend her incremental decontrol efforts if
the benefits to production and exports become appar-
ent, but she could easily reverse them if financial
stringency or political expediency warrant.
Domestic Economy. Gandhi's economic policy
changes are important because they imply a recogni-
tion that bureaucratic controls and protection often
prevent Indian industry from becoming efficient. But
the potential benefits can be realized only if domestic
or foreign demand is adequate and if the supply of
electricity and rail services improves further. Sus-
tained economic growth in India requires satisfactory
weather and success in containing petroleum import
requirements as well as more aggressive decontrol
efforts. Gandhi's liberalization efforts could even con-
tribute to the severity of an economic downturn;
higher current imports and greater commercial bor-
Figure 2
India: Selected Economic Indicators
Note change in scales
Annual Growth Rates
Percent Change
International Reserves
Billion US S
1 II 111INt II IIIl'.1 II I11IAI II IIIIII II Ill
1978 79 80 81 82
Wholesale and Consumer Prices
Index: FY 1978/79=100
160
ISO
140
130
120
Ilo
100
90
1978 79
`' Preliminary data.
h Projection.
CExcluding gold.
588765 2-83
Secret 10
Wholesulc
prices
Consumer
price,
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rowing reduce the foreign exchange reserves that will
be sorely needed if India suffers another poor mon-
soon next year or fails to discover additional petro-
25X1 leum reserves.
Benefits from Gandhi's policy changes are not yet
evident in overall Indian economic performance. GNP
growth slowed last year and will probably stagnate
this year. Industrial gains are moderating, and foreign
exchange reserves continue to decline. Inflation,
which abated late last year, again worries policymak-
ers, according to press reports of their speeches. Poor
weather and labor disruptions account for much of the
deterioration and have obscured the potential benefits
of decontrol. Nevertheless, economic performance
data have given Gandhi little proof that her limited
liberalization efforts have helped raise the country's
output
Foreign Policy. Economic liberalization is only loose-
ly linked with Gandhi's simultaneous efforts to put
greater distance between India and the Soviet Union
and improve her nonaligned image. Both the domestic
and foreign policy trends are prompted-in part-by
the increasing sophistication of the Indian economy,
which makes New Delhi reluctant to purchase inferior
Soviet technology and increases interest in commer-
cial ties with Western countries
Even if trade and technology links with Western
countries increase substantially, Moscow will retain a
central place in India's foreign policy strategy. The
Soviets provide what India believes it must have-
political support against Pakistan, a credible deterrent
to China, and modern weapons on attractive terms. In
addition, we believe Gandhi is not confident of contin-
ued access to Western markets or aid flows and would
not jeopardize her ability to turn to Moscow for
economic support. Conversely, we expect Gandhi to
continue moving toward a more balanced foreign
policy even if she reimposes some controls on imports
or industry
Indian economic policy changes generate additional
commercial ties with the United States but also add to
the risk of political friction. New Delhi will increas-
ingly encounter US export controls as it seeks to
import more technically sophisticated equipment. US
businessmen who tangle with the Indian bureaucracy
for the first time will complain about the extensive
regulations that remain rather than praise decontrol.
More important, the United States would probably be
a scapegoat for an economic downturn-some Indian
officials would attribute part of the trouble to lack of
US financial support for multilateral lending institu-
tions that favored liberalization, while opposition par-
ties would accuse Gandhi of abandoning self-reliance
at the behest of the United States.
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