The Threat to India's Economic Reforms

ON Dec. 6 a mindless mob of more than 250,000 Hindus attacked and destroyed a 16th-century mosque in Ayodhya, northern India. Ignoring a supreme court directive against any action that might cause harm to the disputed mosque, the crowd of Hindus leveled the Babri masjid (mosque). The action focused the world's attention on one of the thorniest issues in India's effort to remain secular: communal strife between Muslims and Hindus.

The massacre of more than 1,200 Muslims and Hindus in the aftermath of the heinous crime was enough to raise the specter of India's partition in 1947. An estimated half a million people were slaughtered during the partition that led to the creation of Muslim Pakistan. For the first time since independence, sectarian conflict between Hindus and Muslims (constituting 83 percent and 11 percent respectively, of the population) now threatens to undermine the secular nature of the world's largest democracy.

The timing of the present crisis could not have been worse. Only a year and a half ago India had launched its most ambitious liberalization program. With a middle class of about 250 million people, India is a significant market, and the opening of the country to foreigners was greeted with widespread euphoria around the world. Just as the country was beginning to respond to the new economic initiatives, the liberalization package faces possible extinction because of the recent crisis.

For more than 40 years since independence, India has failed repeatedly to capitalize on a multitude of global opportunities. Nearly all governments since 1947 have managed to downplay their inefficiencies, bad policies, and corruption, while keeping the country in virtual isolation from the world by invoking the anti-colonial sentiments associated with the British. The goal of self-sufficiency only led to a web of intricate, inward-looking policies, a heavy reliance on socialism, and the rise of a counte rproductive bureaucratic structure.

The economic malaise reached crisis proportions last year when India nearly defaulted on its foreign debt obligations. Foreign exchange reserves had plummeted to $1 billion - barely enough to finance two weeks of imports - and total foreign debt had amassed to $71 billion. Given the pathetic state of the economy, foreign investment fell earlier in the year, and non-resident Indian (NRI) money flowed out at an alarming rate of $310 million a month between April and June 1991. The downgrading of India's cr edit rating only compounded the problem.

It was a combination of external reactions to the domestic crisis and the outright rejection by the World Bank and the International Monetary Fund of any help prior to economic restructuring that forced India to identify pockets of inefficiencies. Last year, the world witnessed fresh thinking from the otherwise parochial Indian planners. The year carried with it the hope that at last India was making a concerted effort to break free from its economic past. Prime Minister Narashimha Rao, along with Financ e Minister Manmohan Singh, unleashed a spate of deregulation measures and initiatives to enhance India's economic growth. Mr. Rao was elected prime minister following the assassination of Rajiv Gandhi.

In July 1991 the rupee was devalued by 20 percent to stop the outflow of NRI money, give a boost to exports, and convince exporters to repatriate their foreign earnings. The government boldly decided to eliminate $879 million in export subsidies and to practice fiscal austerity. In a surprise move earlier this year, the government made the rupee partially convertible in order to strengthen the market mechanism. Foreign equity participation was increased to 51 percent and foreign investors were allowed ac cess to primary and secondary financial markets.

HE significance of these changes lies not only in the unprecedented emphasis on structural reform, but also in their reflection of a pivotal change in the Indian psyche. Although India is ideologically more open than China, it is, in an economic sense, more closed than China. Centuries of foreign rule have made generations of Indians averse to foreign capital. After all, according to the gospel preached by ethnocentric Indians, the British came in as traders and decided to camp for a long time.

Although Indians have flirted with liberalization measures in the past, this is really the first time that any government has come this far toward restructuring the economy. Many impediments still remain; the infamous bureaucracy exists, and corruption still pervades the system. Yet economic liberalization is slowly but surely taking shape.

And now this religious fervor threatens a monumental collapse of economic initiatives. There have been repeated calls for Rao's resignation because he is not able to safeguard the interests of Muslims in India. A change in government at this time could deliver a hard blow to the reform program and irreparably damage foreign confidence regarding India's commitment to reforms.

The pace of future economic reform is likely to slow. Rao's government so far has avoided many politically sensitive decisions, such as the fate of employees laid off by the closure of unprofitable public sector enterprises and the liberalization of the financial sector.

Having experienced unpleasant results at the hands of Indian governments in the past, many foreign companies have adopted a posture of cautious optimism toward India. They are pleased with the reforms but are wary of potential policy reversals lurking in the background. The incident at Ayodhya provides an opportunity for the government of India to rise to the occasion by avoiding any serious repercussions on the liberalization policy. If it can achieve that, it will have eliminated yet another threat to the unshackling of the economy. If it fails, however, the world will once again shy away from India, and India will reenter its cocoon.

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