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Economic
Reforms and the Relevance of Professor B.R.Shenoy
[ June
4, 2007 on the occassion of the Birth Centenary Memorial Lecture
of Prof. B. R. Shenoy,
BY Smt K.J. Udeshi , Chairman.i]
I am truly grateful to the Economics Research
Centre, Mumbai for giving me the privilege to deliver the
Professor B.R.Shenoy Birth Centenary Memorial Lecture. It is
more meaningful to me because, he and I belong to the RBI
family. Prof. Shenoy’s stint in the Reserve Bank of India
(1945-1953) was, according to Professors Mahesh Bhatt and Mukund
Trivedi a very fruitful period of his life in terms of
intellectual and professional accomplishments. While I do recall
meeting Prof. Shenoy’s family, when I was a child, it was only
after I joined the RBI in 1965- long after Shenoy left the RBI -
that I had an appreciation of his monumental contribution to
Indian economic thought. His espousing of causes which were
contrary to the popular fashions from the 1950s to the 1970s
evokes great awe and respect. Despite being out of the pale of
mainstream Indian economic thought, Shenoy made seminal
contributions to the debate of his times. What is even more
significant is that Shenoy’s prophetic advocacy on a number of
issues relating to economic policy are of particular relevance
even today. It is in this context that we have to pay homage to
Professor Shenoy, the sage counselor who was way ahead of his
times.
2. What I propose to do is to refer to select
initiatives in economic reforms of recent years and juxtapose
them with Shenoy’s various policy prescriptions from the early
1950s so that one can admire the perspicacity of his diagnostic
skills and his erudite remedies.
Deficit
Financing and the
Foreign Exchange Crisis
3. The Second Five Year Plan (1956-61)
formulation period was an exciting one for economists. A panel
of economists (April 1955) consisting of the cream of Indian
economists was set up to draw up the Draft Plan Frame for the
Second Plan. The panel was greatly influenced by the dirigiste
Soviet system and most members were enamoured of the high real
growth rates achieved by the USSR & the East European
Countries. There was a distinct tilt towards heavy industry,
which by itself was not necessarily imprudent, but the corollary
was that the Second Five year Plan size of Rs.8800 crore
(against a First Five year Plan of a little over Rs.2000 crore)
had a component of Rs.1000-1200 crore of deficit financing. This
size of deficit financing was a quantum jump. At that time the
definition of deficit financing was the reliance on ad hoc
Treasury Bills and changes in Government cash balances. If one
were to use the present day definition of the “gross fiscal
deficit” the deficit financing for the Second Plan was clearly
staggering. Shenoy, with his vigorous background of monetary
economics, could foresee the dangers in such a large recourse to
the printing press. In prophetic words he argued in his Note of
Dissent on the Memorandum of the Panel of Economists, which is
surely the locus classicus on the subject and requires to be
read in full, but is reproduced here in parts:
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“To force a pace of development in excess
of the capacity of the available real resources must
necessarily involve uncontrolled inflation. In a democratic
community where the masses of the people live close to the
margin of subsistence, uncontrolled inflation may prove to be
explosive and might undermine the existing order of society
…We should be therefore, forewarned of the dangers of an
over ambitious plan… As no plan can be bigger or bolder than
the available resources, the size of the investment programme
should be reviewed periodically to ensure that it keeps within
the limits of savings… The inability of the Plan Frame to
place more than about 75 per cent of the resources required
for the Plan under the usual sources and the reliance of
deficit financing for the rest, is broad evidence that the
size of the plan far exceeds the available savings… Deficit
Financing is essential in an under developed economy to permit
full use of the scarce real resources. By the same token,
deficit financing should stop severely short of the point at
which inflation begins... Inflation tends to be
self-perpetuating… Once inflation begins, it tends to gather
momentum and while it runs its course we are apt to be, more
or less, helpless witnesses. The best protection against
inflation is to prevent it by keeping the investment
programmes within the available real resources.”
4. Shenoy’s Note of Dissent was a sole
voice in the wilderness. Yet, ignoring his views was costly and
the rest is history. What followed was the foreign exchange
crisis of 1957-58 and the response to this was even more
physical controls. The majority view prevailed for the next 35
years and the economy was punctuated by cycles of large deficit
financing, foreign exchange crisis and draconian controls till
it culminated in the foreign exchange crisis of 1991, with
foreign exchange assets of the RBI falling to less than U.S. $1
billion.
5. The Reforms instituted in 1991, inter-alia,
put an end, to the automatic monetization of the budget deficit,
put a greater focus on the gross fiscal deficit and ultimately
culminated in the introduction of the Fiscal Responsibility and
Budget Management Act in 2004. This Act, which puts an end to
RBI financing of primary issues of public debt, enjoins the
Government. to eliminate its revenue deficit and reduce its
fiscal deficit to 3 per cent of GDP by 2009. Similar acts have
been passed by most State Governments. (23 States). So, fiscal
responsibility has now become part of our legislative
commitments.
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6. It has been a long journey from reckless
deficit financing to fiscal responsibility but it is unfortunate
that nowhere is there an acknowledgement to Shenoy’s seminal
work, which, if it had been heeded, would have saved India 35
years of agony of cycles of inflation, foreign exchange crisis
and a virtual collapse of the economy in 1991. One can also
imagine what would India’s economic strength have been today
had the Indian polity accepted Shenoy’s prescriptions 50 years
ago.
Monetary
Policy in a
Liberalised Environment
7. From the mid 1950s, till 1991, the
preoccupation of monetary policy was to moderate the
expansionary impact of a fisc which had no compunctions to
resorting to creation of money. As the dependence of the fisc on
created money declined in the post 1991 period, the strong
expansion of created money emanated from the external sector.
The challenge of monetary policy; today thus is in handling the
expansionary impact of large capital inflows and the consequent
inflation which eventually affects growth. While the RBI has
competently handled the stresses and strains of conducting
monetary policy, how would Shenoy have viewed the new role of
monetary policy? Keen followers of Shenoy would recall his
stance on “zero inflation”. Basic to Shenoy’s framework
would be that inflation would be public enemy No.1 and he would
have, in today’s context, been an inflation targeter. He would
obviously have been a monetary hawk who would have advocated an
active and aggressive monetary policy. In all probability,
Shenoy would have focused on early action to keep inflation
under control and tackled capital flows, forex intervention and
sterilisation as an inevitable corollary of the basic stance of
fighting inflation. In sum, Shenoy’s views would be in sync
with today’s monetary policy.
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8. As we look at the current situation there
is still an advocacy of the stance that a somewhat accommodative
monetary policy would enable us to eke out a higher real rate of
growth and that a higher inflation rate may be a price worth
paying. To those who still see a trade off between growth and
inflation, it would seem that they still need to learn the
lessons taught by Shenoy.
Shenoy’s
Prescriptions on Reforms
9. According to Shenoy the first essential
reform is to put a stop to inflation. In the absence of this
reform, other corrective measures would not produce any
noticeable impact. The prerequisite is, according to him, to
first bring the Government budget into better balance. The other
steps outlined by him were:
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Channeling more funds into the
agricultural sector both under public and private
investment,
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Removing the barriers to internal and
external trade,
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Revising the industrial policy and
abolishing industrial licensing and the system of subsidies,
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Scaling down drastically overall public
sector outlays, even withdrawing the public sector
investments from certain sectors and limiting state
activity.
-
Removing exchange control and adopting a
fully floating rupee,
-
Reducing taxation and balancing the
budget at a vastly lower level of expenditure and
investment,
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Reviewing all economic legislation and
administrative measures with a view to their abandonment or
restructuring them to match the needs of a free economy.
10. If we look at the post 1991 economic
reforms we should surely be hearing the reverberations of
Professor Shenoy’s agenda for reform. Sadly, we appear to
continue to treat Shenoy as a heretic and there is no
acknowledgement to him as the real founding father of the
reforms of the past 15 years.
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Shenoy’s
Critique of the Industrial Policy
11. Shenoy held that an indiscriminate import
substitution policy withdrew resources away from the traditional
and other export industries. Exports remained semi-stagnant
while larger imports were needed to keep the wheels of
production moving and this, according to him, was the link
between indiscriminate import substitution and balance of
payment difficulties. His view was and I quote:
“The attractiveness of the overseas
markets cannot return to norm, unless exporters receive the
full rupee worth of their export earning, so that they may not
find that to cater to the home markets was more remunerative.
Exporters will not receive the full rupee worth of their
export earnings unless the rupee is devalued to the
equilibrium level, or in a background of continuing inflation,
the rupee is floated.”
12. Let me switch to the current scenario. In
an address at a public seminar organized by the Institute of
South Asia Studies in Singapore in November 2006, RBI, Deputy
Governor, Dr. Rakesh Mohan stated:
“Over a period of time through the 1950s,
1960s and 1970s the economy had become over controlled and
rigid; consequently entrepreneurship was heavily constrained.
The import substituting inward looking development strategy
that could have been relevant in the 1950s was no longer
suitable in the modern globalizing world. Hence overall reform
had to be undertaken to lay down a new framework”.
13. Massive deregulation of the industrial
sector, in fact constituted the first major package of reforms
in July 1991. The obsolete system of capacity licensing of
industries was discontinued; the existing legislative
restrictions on the expansion of large companies were removed:
phased manufacturing programmes were terminated; and the
reservation of many basic industries for investment only by the
public sector was removed. At the same time restrictions that
existed on the import of foreign technology were withdrawn and a
new regime welcoming foreign direct investment, hitherto
discouraged, with limits on foreign ownership was introduced.
With these massive reforms introduced in one stroke in 1991, the
stage was set for a policy framework that encouraged new entry
introduced new competition, both domestic and foreign, which
thereby induced the attainment of much greater efficiency in
industry over a period of time.
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14. The Indian corporate sector has gone
through significant technical and financial business process
reengineering on its own and a competitive company can now be
found in almost every industrial sector. It is again apt to
quote Professor Shenoy here:
“In a free society because of the
discipline of a most ruthless consumer, the management under
the duress of survival, has to keep a continual watch over
cost, quality and turnover. This calls for perpetual
flexibility of decisions…It is just not practical to achieve
the requisite decision flexibilities under social ownership
i.e. the ownership of no one in particular - of the means of
production. Experience has shown that the magic of ownership
is among the most powerful forces making for progress.”
Is Professor Shenoy’s stand not vindicated?
External
Sector Reforms,
Exchange Rate Management
and Liberalisation of Exchange Controls
15. Among the first reform moves in 1991 was
devaluation of the exchange rate and a move of the exchange
regime from that of a crawling peg towards a market determined
one, albeit a managed exchange rate. The exchange rate regime
now focuses on management of volatility without a fixed rate
target and the underlying demand and supply conditions are meant
to determine the exchange rate movements in an orderly way.
16. The trade regime too has undergone
massive change with the removal of quantitative restrictions
along with the rationalization of the tariff structure.
17. From the beginning of the reform period
in 1991, the exchange control measures were being gradually
liberalized. Some of the more important measures are as follows:
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Replacement of the earlier draconian FERA
(1973) by the market-friendly FEMA (1999).
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Adoption of convertibility of rupee for
current account transactions with acceptance of Article VIII
of the Articles of Agreement of the IMF in 1993.
-
De facto full capital account
convertibility for non-residents and calibrated
liberalization of transactions undertaken for capital
account purposes in the case of residents.
-
Major delegation of powers by RBI to
Authorised Dealers to release foreign exchange for a variety
of purposes.
-
Residents are now permitted to remit
abroad upto U.S. $ 1,00,000 per financial year and Mutual
Funds are permitted to invest abroad upto U.S.$ 4 billion.
-
Indian corporates are permitted to borrow
invest and acquire assets abroad upto 300 per cent of net
owned funds, which is very liberal.
18. Professor Shenoy’s analysis of the root
cause of the weakness of the Indian rupee, set out in 1968,
reflects his perspicacity in analyzing problems and some of his
views are of direct relevance even to-day. For instance, he
says:
“The essential point is that the strength
of the currency depends on the export position and the latter
provides the basic index of the strength of the currency…
For the export position of a country to be deemed strong, the
expansion of it’s exports must at least keep pace with the
expansion of the national product… When, however, the export
position of a country is strong, though, in the early stages
of development it may import capital, as the economy develops
it is apt to repay more than borrow afresh and eventually
become a capital exporter.”
19. In the context of the 1966 devaluation,
Shenoy felt that the Rupee needed to be devalued to its
equilibrium level and the Rupee should be allowed to float so
that it would remain at the equilibrium level. Recognising the
practical difficulty of arriving at an equilibrium exchange rate
he argued for a floating exchange rate. To him, what was
paramount was non-inflationary fiscal-monetary policies.
20. One wonders what Prof. Shenoy’s view
would have been on the recent large appreciation of the Rupee
with Indian inflation rates well above those of the major
industrial countries and Indian interest rates well above
international interest rates would not Shenoy have felt the
Rupee appreciation as being against fundamentals and against the
interests of the economy?
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The Gold
Problem
21. From as far back as 1939 till 1991 there
had been a ban on the export/import of gold and the policy
approach was to discourage the holding of gold by Indian
citizens. Shenoy had, for many years, argued on the futility of
the Government’s approach on gold. He argued that, despite the
legal restrictions large quantities of gold continued to be
smuggled into the country and that this gold was costing us much
more in terms of foreign exchange than it would if the gold has
been purchased through official channels at the international
price of gold. Despite his persuasive arguments, the Indian
authorities continued to ban the official gold trade. The first
change in official policy on gold came with the 1991 Policy
Reforms wherein non-resident Indians coming to India were
allowed to bring into India 5 Kgs of gold per person subject to
payment of import duty. It was soon found that this was not a
practical solution. In the path-breaking budget of February
1992, the then Finance Minister announced the intention to set
up a Gold Bank by the RBI which would undertake
various types of operations in gold. It is rather unfortunate
that despite the budget announcement the proposal was aborted.
It bears recalling that Shenoy had as far back as 1963, come up
with a detailed proposal to set up a Gold Exchange Bank which
would undertake official purchases and sales of gold. According
to Shenoy’s proposal a 100 per cent government controlled
company could be floated which would be authorized to buy and
sell gold on their own behalf or on behalf of their clients and
it would be permitted to do banking business and be designated
as an Authorised Deader by the RBI. Needless to say the
authorities did not pay heed to Shenoy’s proposal.
22. It was as late as in 1997 that the
authorities significantly liberalized gold imports through
designated banks. Although the 1992 budget proposal to set up a
Gold Bank as a subsidiary of the RBI does not have much merit
now, there is still merit in allowing banks to set up a
dedicated Gold Bank which would not only import/export gold but
also develop various gold derivative instruments. I am referring
to the issue of the Gold Bank in some detail as it once again
illustrates how Shenoy’s thinking was way beyond his own
times.
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Justification
for Increased
Resource Allocation to Agriculture
23. Shenoy’s stand throughout has been that
agriculture stands neglected in our Plans and that only
lip-sympathy is paid. According to a paper brought out recently
by the Consortium of Indian Farmers Associations, the outlay for
agriculture and allied sectors, including irrigation has dropped
from 34 per cent of the total Plan outlay in the First plan
(1951-56) to a mere 10.6 per cent in the 10th Plan.
24. Shenoy argued that the most important
problem of the Indian economy is poverty and unemployment,
Indian national interests would be best served if we give
priority attention to agriculture. It is a sad reflection of our
times that now, almost 50 years later, it is publicly admitted
by the Government and other authorities that agriculture is the
key significant area that has not been subject to comprehensive
reforms leading to deceleration in agriculture growth and that
“this deceleration has clearly had a significant impact on
slower reduction in poverty levels than otherwise would have
been the case.”1
25. “Unlike other economists of his times,
Shenoy’s emphasis on agriculture rested on quite subtle and
distinct type of reasoning. His idea of appropriate pattern of
resource allocation was based on the twin principles of
comparative costs and marginal productivity and was miles away
from the usual simplistic “priority” allocations which
became the fashion of the times.”2
26. In his famous “Note of Dissent”
referred to by me earlier, Shenoy argued strongly against price
support policy for agricultural produce.
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“Price support of agriculture produce in
India is a risky venture and we should be forewarned of the
inherent dangers of it... A policy of price support is, in
essence, a subsidy... The strain of the subsidy will manifest
itself in a shortage of budget resources for the open market
purchase and storage of agriculture produce. This, in due
course would lead to either abandonment of the price support
policy or inflation. In either case damage would result.”
27. Shenoy recommended the abandonment of
procurement of foodgrains by the State. He held that the entry
of the State into the foodgrains market as a buyer, stiffens
prices and that farmers have demonstrated their high sensitivity
to prices and profits.
28. The Consortium of Indian Farmers
Associations questions why most aspects of agriculture such as
prices, exports, processing, storage and transportation remain
under controls. It says:
“The Indian farmer has been made a bonded
labour to provide low-priced food and low-cost raw material…
pushing them towards committing suicides.”
29. In this context, one may recall the
recent banning, in Andhra Pradesh, of lending to farmers by
certain Micro Finance Institutions. This is akin to what
Professor Shenoy has referred to as actions designed to protect
the farmer against usury but result in obstructing the flow of
savings and credit into agriculture and cripple the credit
worthiness of farmers. According to Shenoy, actions against
usury add to the risk and reduce the profitability of the
business of agricultural credit.
30. Having observed the relevance of Shenoy’s
writings on inflation, deficit financing, import policy, the
foreign exchange crisis, the gold problem etc., one can only
hope that in the context of the crisis on the agriculture front,
the concerned authorities would pay heed to Shenoy’s writings
on the abandonment of procurement pricing and removal of all
controls.
31. It is recognised that it is easier to
undertake reforms when the whole country is in the throes of a
crisis as happened in 1991. To undertake sweeping reforms on the
agricultural front, as recommended by Shenoy, when the economy
is on a “roll” and only agriculture is in a crisis may be
difficult, to say the least. Nevertheless, it may help to recall
the role of the Chiapas (Mexican farmers) in the Mexican crisis
that occurred in the 1980s.
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32. In concluding let me recall the words of
internationally renowned economists. Nobel Laureate, Milton
Friedman said:3
“Prof. B.R. Shenoy was a great man who
had the economic understanding to recognise the defects of
current planning in India and what was even rarer, the courage
to state his views openly and without equivocation. Rarely
does such a man bless our society.”
33. Professor Lord Bauer while delivering the
Professor B.R. Shenoy Memorial Lecture in 1993 said:
“Shenoy was a hero and a saint. He was a
hero in the sense in which Thomas Sowell used the term when in
a review article he referred to heroic figures who publicly
resisted fashionable fads and fancies, however, influentially
canvassed and widely accepted. He was a saint in that,
outwardly at any rate, he remained unmoved, even serene, in
the face of neglect, disparagement, even abuse.”
34. In referring to Shenoy’s moral courage
in dissenting from the Second Five Year Plan, Professor Lord
Bauer said:
“… dissent from the received opinion is
by itself of no merit, unless it is intellectually well
founded. Shenoy amply met this requirement. His competence is
not in dispute. The tools of trade of economists acting as
advisers on policy are micro-economics, macro-economics …
and knowledge of institutions and magnitudes. Shenoy qualified
under all these headings.”
35. In their biographical sketch on Shenoy,
Professor Mahesh P. Bhatt, Emeritus Professor School of Social
Sciences, Ahmedabad and Professor Mukund S. Trivedi, former
Professor of Economics, Gujarat College, Ahmedabad refer to him
as -
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“… A social scientist who had an utmost
regard for his commitment to his discipline and made no
compromises in reaching the conclusions, his reasoning led him
to upholding them courageously. For Prof. B.R. Shenoy was
anything but a “Committee” man. He was an economist who
preferred to be right in a minority of one.”
36. Shenoy attained international recognition
but in India, he faced hostility of opposition from every
corner, be it the Government, the bureaucracy or his fellow
economists. It is a tribute to his foresight and courage of
conviction that today his views stand vindicated, in the sense
that the liberalisation policy now adopted bear the ideas which
he ardently espoused. But, as Professor Parth Shah of the Centre
for Civil Society, New Delhi says, “even in these heady days
of liberalization men like Professor Shenoy are at the very
fringe of public memory.”
37. In many ways, Prof. Shenoy was the Indian
Hayek. Like Hayek, Shenoy was hounded out of the corridors where
economic counsel was sought. Yet, like Hayek, Shenoy came out of
his corner fighting for the causes which were dear to him. While
Hayek had the good fortune to be belatedly recognized and
honoured by his detractors, it is poetic justice that Hayek was
awarded the Nobel Prize jointly with Gunnar Myrdal, both of whom
had very divergent views. Unfortunately, Shenoy neither lived to
see the turnaround in policies after 1991 nor did he get any
recognition. If there was any economist of the post independence
period who saw India’s Tomorrow it was Shenoy. There is a need
to recognise the invaluable contributions made by Professor B.R.
Shenoy.
38. The Economics Research Centre has
rendered yeoman service in organising this Memorial Lecture and
bringing Professor Shenoy’s writings into public discourse.
His writings and his courageous profile will not fail to inspire
future generations of Indian economists. As for me, it is a
personal honour and privilege to have delivered the Professor
B.R. Shenoy Birth Centenary Lecture.
References
1. Mohan Rakesh 2006. “Economic Reforms in
India: Where are we and where do we go?” RBI Bulletin December
2006.
2. Prof. Mahesh P. Bhatt and Prof. Mukund S.
Trivedi “A Biographical Sketch.” Planned Progress or Planned
Chaos? East West Books (Madras) Pvt. Ltd.
3. Profiles in Courage - edited by Parth J.
Shah
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