Of intertwined strands of strength…

Sometimes it is not easy for many of us who live in the woods of today?s India to see how the forest has been shaped. It is not incorrect if one were to say that the healthy pace of growth today is on account of domestic consumer demand, lubricated by easily available credit. Nor will it be incorrect if one were to see in the export of goods and services, an agency of growth. Or, for that matter, if one were to ascribe today?s growth to the deepening of the urban phenomenon or the success in aligning agriculture more closely to commercial markets in parts of the country. Such explanations are true in themselves, describe the trees nicely, even a patch of the woods, but do miss out quite a bit.

This is a column. and within the limitations that such a format imposes, I will try and submit what, to my mind, have been some of the critical processes?all successes of reform?which have allowed the present to materialise.

There are to my mind, three elements, born after the process of reform in the early 90s, which have critically shaped the present outcome. First, the reform of Indian capitalism; second, reform of the financial system, particularly of banking; third, the containment of government finance from going over the cliff. There are other powerful elements that predate reforms, in particular the strength of household balance sheets (low on debt, high on savings), improvement in education and gradual societal modernisation?sought to be accelerated in the decades after Independence. But here, we will focus on the first three.

Invasive controls, much of which originated in the emergency rules issued during the two world wars, had hitched a ride in the post-Independence era on the bus of good intentions. To be fair, price and quantitative control, mostly born out of the contingency of the world wars, was quite the norm in that period?not only in the socialist bloc, but in Western Europe and even, to a smaller extent, in North America. The outcome of industrial licensing and state control over the institutions of credit successfully ossified Indian capitalism, amongst, of course, many other outcomes.

So, if you were to go back to 1947 and list the top 20 business houses and then fast-forward to 1991, you would find little that had changed; the Ambanis were the only entrant to this exclusive club and that was about it. Not even the inter se hierarchy of the houses constituting the list would have been altered. Now, move on to 2005, or even 2001, and what have you? Utter devastation, surely, from the point of view of the incumbents, and fascinating creativity from the point of view of those who would expect capitalism to be a system that fosters change and competition. Barring the Tatas, Birlas and a few others, the leading Indian business groups of today comprise comparative newcomers?Infosys, Wipro, Bharti, the bevy of pharmaceutical companies and many others that have become household names.

In the process, Indian business has changed in a very fundamental manner, and that has come with plenty of pain. In the immediate aftermath of the abolishing of industrial licences, there was

no understanding of competition, domestic or international. Little understanding of financial risk and enormous leverage permitted by easy financing from development financial institutions and other state agencies characterised the first years of the post-reform, in-vestment-led boom.

In the second half of the 90s, the decline of import protection coincided with lower prices for steel, chemicals and other commodities, owing to cheap supplies from the former Soviet Union and the new manufacturing colossus, China. Accentuated by the Asian currency crisis. For half a decade since 98, Indian businesses that survived the crisis focused their energies in becoming efficient, paying great attention to strengthening their balance sheets.

One of the key elements of efficient business is how well capital is configured for new investments. The focus thus came to be on brown-field expansion and on acquiring existing assets, which set off a completely unprecedented boom of mergers and acquisitions. Seven years on, the private Indian corporate sector is characterised by low leverage, acute awareness of domestic and international competition and finds itself in a position to make investments in markets abroad?from China to Europe to the Americas and Africa.

The reform of the Indian banking system over the past one-and-a-half decades piloted by the Reserve Bank and government has perhaps been one of the most lasting successes of the reform period.

It is too long and technical a story to relate here. But one must note that what some might have felt in 1991 to have been a virtual basket case, has been progressively brought to a point where the banks are comfortably solvent under standards conforming to international practice. And all that with very little budgetary support from the government. Just as operational systems in banks have undergone a great change for the good, so has it been for the equity markets, where exchanges operate to standards that can compare with the best in the world.

Some might find it over-generous to count as a success that government finances did not go over the brink. The fact, however, is that it is not possible to have a solvent private sector when the government is insolvent. Fortunately, the brakes were applied in time, the economy and tax revenues began to grow and a crisis was certainly averted. The improvement in government finances over the past several years, strengthened by the FRBM legislation, promises a consolidation over the next few years.

To consolidate the growth process, there are other areas which have yet benefited too little from reform and need to be fixed. But that is another story.

The writer is economic advisor to Icra