Indian Economy Overview: In Press


Liberal imports and free capital flows:
A fatal combination

Jayati Ghosh

In terms of economic policy, the performance of the United Front government thus far has been quite miserable. It has blindly followed the path of economic liberalisation determined by the earlier Congress regime, disregarding the widespread unpopularity of such a strategy and the severe hardship it has already caused the working people of the country. This has been especially disappointing given that the United Front government owes its very existence to the clear electoral mandate against such policies which was given last year. Instead of fulfilling this mandate by reversing the regressive economic policies of the past five years, this government so far has actually persisted and even strengthened such tendencies.

This has involved continuing cutbacks on government productive expenditure, policies that systematically erode the viability of the public sector, using administered price hikes as a means of indirectly taxing the common people even while allowing the rich to continue to escape the tax net, reducing the real availability of minimally acceptable public goods and services for the average citizen, and the like. Even for the external sector, the evident lack of any major change in approach by this government has had very negative implications.This government has continued, indeed intensified, the slavish attitude towards foreign investors and the obsession with placating international capital which have characterised official policy since 1991, and has put into place further measures which have dramatically increased the external vulnerability of the economy and effectively put it at the mercy of international speculation.

The latest series of such measures which have very severe negative implications for the external sector relate to the recently-announced liberalisation of certain categories of imports, and new rules allowing more freedom to foreign investment in core mining sectors such as coal. To understand the full ramifications of these policy moves, a little background is necessary. Since the mid-eighties, the government embarked on a series of measures dsigned to reduce import restrictions and liberalise trade. The imports of final consumer goods continued to be banned, but the imports of capital goods and intermediates required for the production of (in particular) luxury consumption items and various durable consumer goods was progressively liberalised. First quota controls and quantitative restrictions were replaced by import tariffs, and subsequently the tariff rates have been continuously lowered.

As a result, the decade since 1985 has witnessed a boom in demand for certain types of consumer goods, such as automobiles, "white goods" such as refrigerators and washing machines, and consumer electronics such as televisions sets and music systems. Most of this production was in the nature of assembly of imported parts, and was very heavily import-intensive both in terms of the components and the machines used in the production process. The growth of CKD ("completely knocked down") production based on imported inputs which essentially involved the domestic contribution being limited to "screwdriver" assembly reduced the role of domestic entrepreneurship and limited the chances of any development of domestic technological capability in these areas. Also, as a result, the overall import-intensity of the new manufacturing has increased substantially. Further, since the imports of the final products were banned even while the import duties on components were progressively lowered, this amounted to very high domestic protection for such luxury goods manufacturing, and directed investment into these suddenly highly profitable areas.

Since 1991, the picture was further complicated by the liberalisation of rules for foreign direct investment into the country. This was part of the Congress regime's desperate attempt to attract any kind of foreign capital, whether productive or speculative, whether short-term or long-term. The result of such greater freedom for multinational capital has been twofold : on the one hand, the sudden increase in portfolio flows into the Indian stock market, for essentially speculative motives of capital gain, which have made the balance of payments dependent upon such flows of "hot" money; on the other hand, the entry of multinational firms primarily into the assembly production of luxury consumer goods, in order to take advantage of the high rates of protection in these sectors. Sometimes this has simply involved the takeover of existing domestic firms with assured market shares by multinationals with established brand names : the takeovers by Coca Cola of Pure Drinks Company and by Gillette of Malhotra Brothers, are the most prominent examples of this tendency. Elsewhere, existing FERA companies have seen the multinational parent firms increase their equity shares upto the newly increased limits while new investments have mainly been confined luxury consumer durables and non-durables such as toiletries and cosmetics. All this has consequently entailed a very substantial outflow of foreign exchange, not only because of the increased imports involved in such production, but also because the limits on profit repatriation by foreign investors have been lifted, and foreign companies are now free to send back all of the profits made in these protected domestic sectors.

This is a most undesirable situation, but it is one which has been created by the policy measures since 1991, not an unpleasant fact of the world which the government is forced to accept. The easy and high profits to be made in these luxury consumption goods sectors have made both foreign and domestic firms more reluctant to engage in more desirable investments with higher social returns, and since the government has been unwilling to undertake the required investments itself, it has resorted to providing expensive guarantees for private profits in critical sectors such as power generation, of which the infamous Enron case is but one example.

In this context, the recent moves to lift import curbs on many consumer goods, most of which are in the luxury goods categories, will only compound the problems inherent in an already problematic environment. 69 items have been shifted from the restricted list to the Special Import Licence (SIL) list and 92 items to the Open General Licence (OGL) category. The OGL list allows for completely free imports on payment of tariff, while the SIL list gives licences for import which can be freely traded, and therefore are transitional. The current premium on SIL licences is around 13 per cent. The items to be liberalised for imports include car air-conditioners, perfumes, creams and lipsticks, small colour television sets, polaroid cameras, escalators, and even aluminium beverage cans (which are being phased out in many industrial countries because of their adverse environmental implications). The relevance of these goods for developmental purposes can easily be gauged.

Freeing imports of these and other goods may lead to an import surge in these items, depending on whether or not the tariffs on them are high enough to prevent such a surge, but they will certainly adversely affect the production of such goods domestically. This is bad news even if the earlier production was by multinational companies who were repatriating all their profits, because it means that those workers employed in such production domestically may lose their jobs.

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Jayati Ghosh Associate Professor Center Economic Studies & Planning,JNU,Delhi


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