Let me start with globalisation. As emphasised above, our trade/GDP ratio went up sharply from 22 per cent of GDP to 33 per cent of GDP over a 10-year period. India has digested the lessons of the 1960s and 1970s, about the enormous distortions and harmful political economy that is induced by protectionism. So we have made much progress in doing unilateral trade liberalisation, and in exploiting the WTO process. We have eliminated quantitative restrictions, and brought down the peak customs rate on manufactured goods from over 150 per cent to a present level of 20 per cent.

What is particularly striking is that this year, with elections impending, we were able to sharply cut tariffs, and this was criticised by some observers as a ‘populist’ thing to do! This highlights the sea change that has taken place in India’s attitude towards trade integration with the world economy. India, which was once described as a ‘hesitant globaliser’, has become a ‘willing globaliser’!

The elimination of QRs, and the drop in the peak rate from 150 per cent to 20 per cent, was obviously costly for many firms and individuals. There are real costs that have to be paid in terms of obsolete business plans, and factors of production had to shift into areas where India has a comparative advantage. In my view, this is a subtle reason behind the upsurge of bad loans in the banking industry in the mid-1990s.

However, the difficult part of our adjustment to eliminating tariffs and QRs now seems to be behind us, and we are well on our way to single digit tariffs. It is striking to observe that while the multilateral discussions about trade reforms are still talking in terms of multi-decade horizons for adjustment, India has been able to move much faster, and unilaterally make progress on trade reforms.

Going from the current account to the capital account, there is now a broad consensus that capital controls are ineffective when there is a large and free current account. There are simply too many opportunities for moving capital across the globe by over invoicing, under invoicing, transfer pricing by multinational corporations, and trade in gold. Hence, India has steadily made progress on freeing up the capital account, particularly in the last five years. For foreign institutional investors, we are 100 per cent convertible. Indian firms can take up to 100 per cent of their net worth out of the country. Domestic citizens can take up to $25,000 out of the country, which is a lot when compared with the per capita income. The opening up of the capital account has enormous implications for the conduct of Indian macro policy. The impossible trinity is now with us, so that a restrictive currency policy comes at the price of monetary price autonomy. Hence, this is a new and exciting phase for Indian macroeconomics.

As an aside, I want to highlight some non-economic factors which have been at the foundation of India’s success in rapid integration into the world economy. These consist of: our strong IT and telecom sectors, our use of English, and our vibrant democracy. Our strengths in IT and telecom have helped us to exploit the Internet, which is an important highway of globalisation today. Our use of English has meant lower transaction costs in interacting with the global economy. Our democracy has helped us avoid the difficulties and hindrances that come into the picture when repressive regimes try to block ideas from flowing in through the Internet. For example, we in India have multiple competing private sector Internet service providers, with high speed lines that reach into the outside world, with no large government effort at censorship or selective blocking of content.

Let me turn to infrastructure. In the early 1990s, infrastructure was high on our minds. The public goods of transportation and communications were clearly a bottleneck to efficiency, and to internal and international trade. In the presence of those constraints, our ability to harness gains from trade was limited, owing to the high transactions costs of engaging in trade. Our inefficiencies in transport and communications ultimately filtered into the exchange rate, where the rupee had to devalue enough to obtain rough parity on the current account.

India chose to go down the path of moving towards competitive markets in infrastructure, with private sector production, under a framework of sound regulation. I believe that this was the right path to go down. But as we all know, this is a difficult path to take. There are truly subtle difficulties in finding the right policy mix, the right ‘rules of the game’ which provide sound incentives to private firms to produce adequate quantities of these goods, while at the same time avoiding monopolistic profit rates. I look at the difficulties in California on electricity, and in the US on broadband telecom, and I sympathise with the problems that they are facing.

For many years, all economists, including myself, used to be somewhat pessimistic about the way things were going on in infrastructure sector in India. From 1991 onwards, the State ceased to invest in infrastructure, but the new policy framework had not fallen into place! So we were stranded between the two stools.

Today, it increasingly looks like the light is at the end of the tunnel on our infrastructure problems.^[9] I believe we have made good progress on telecom, roads, ports, electricity and aviation. The big piece where we have yet to obtain real progress is railways.

In telecom, we have obtained a revolution by having competition between multiple, private telephone companies. We are now at 40 million mobile phones, and are growing at the rate of 2 million mobile phones every month. Little shops offering internet access are now all over the country. Every visiting card that I encounter has an email address on it. We are one of the world’s first countries to shift to a ‘unified licensing’, where the licensing is neutral to telecom technology. I believe we are the only market in the world where the two major technologies for mobile telephony — GSM and CDMA — are locked in grim competitive battle, with customers reaping the rewards of this competition. Total phone subscribers are at 71 million, and what was once thought to be an ambitious target for teledensity that should be achieved by March 2005 was actually achieved in December 2003. Given the existing pace of hectic growth, it looks rather likely that an additional 100 million lines will be added over 2004–05 and 2005–06. This would take teledensity from 7 per cent today to 17 per cent by March 2006.

In roads, we have embarked on an enormous project to build new highways, which will take the sustained mean velocity up from 30 kph to 80 kph. I believe these new roads will generate a new phase of growth in India, by harnessing what I call ‘internal gains from trade’. I believe this is the classical gains-from-trade story, being repeated within the country, when firms 1000 km apart are able to trade for the first time, thanks to the lowered transactions costs. I think the full impact of these roads on investment, and the geographical distribution of production, will play out in the next five years.

We have yet to make the leap to 8-lane expressways, where we will get sustained mean velocities of 160 kph. But we have a big step forward in terms of learning new institutions, revenue sources, and contracting mech­anisms, through which 4-lane highways are now very much in our grasp.

In the area of ports, we have made progress by contracting out the operations of ports to international firms who have specialised expertise on this subject. Remarkably enough, we find that when a public sector terminal competes with an international operator in the same port, the performance of this public sector terminal also improves! The turnaround time at ports dropped by half, from 7.5 days in 1996–97 to 3.5 days in 2001–02. These new ideas in contracting are being steadily applied across the country, giving a revolution in how the ports sector works.

These improvements in ports, roads and telecom sound nice. But are they large enough to make a material difference? Or are they high rates of growth on a very bad base? It is important to focus on the end-result of better infrastructure, which should be more efficient firms. Using the CMIE Prowess database, we observe the 4000 largest manufacturing companies in India. For these firms, working capital as per cent of sales went down dramatically from 13 per cent in 1996 to a level of 3.5 per cent today. This is a striking change, which reflects both the opportunities of being more efficient using the new infrastructure, and the competitive forces which are pushing firms to think more carefully about how they manage inventories.

In the area of electricity, the big change is the Electricity Act, which has setup a path-breaking pro-competitive framework whereby producers and consumers of electricity can interact in an unfettered market. We are already seeing myriad changes in the electricity sector in India as a consequence of this simple fact: that producers and consumers of power are now free to contract with each other across the country. Once again, I see this as a story of going from stifled markets to gains from trade.

A major area of focus in the economic reforms has been the financial sector. Joseph Stiglitz has observed that finance is ‘the brain of the economy’. The financial sector controls the efficiency with which incremental capital formation is converted into incremental GDP.

India has made good progress in building a sound regulatory framework for banking, insurance and the securities markets. Many countries, all over the world, have experienced problems with banking. Obtaining safe and sound banking is genuinely difficult, given the extreme leverage of banks, the opacity of their assets, and the moral hazard induced by a safety net. Difficulties in banking escalate into major macroeconomic problems when the banking system is itself large, when compared with GDP. In India today, bank deposits are just 48 per cent of GDP, and net non-performing assets are just 2.3 per cent of assets. Hence, there is little possibility of difficulties in banking derailing the economy.

In recent years, much detailed work has taken place on strengthening the banking system. Banking has become more competitive through a steady pace of entry by domestic and foreign banks, and has been steadily transformed by the introduction of new technology such as Real-time Gross Settlement System (RTGS). Banking has also benefited, as all creditors have, from the strengthening of creditors’ rights which began in 2001. This continues to be an active area for new work in developing legal structures and institutional mechanisms.

India’s financial system differs from that of many developing countries and it is more in line with the Anglo-Saxon model, with large and liquid public securities markets, and with bank deposits being relatively small when compared with GDP. There has been a particularly remarkable revolution in the stock exchanges in terms of a completely new design replacing traditional notions about how the market should be organised.^[10] India’s NSE and BSE are the 3rd largest and 6th largest exchanges of the world, measured by the number of trades in 2001 and given the present trends, it is likely that in 2004, NSE will surpass NYSE in terms of the number of trades or transactions. India was a pioneer in shifting to T+2 settlement. India is unique by world standards in the extent to which non-transparent transactions have been proscribed: all trades match on the transparent order-matching screen on the equity market.

Equity derivatives trading was launched in India in June 2000, and now has daily turnover of $4 billion. This was one of the most successful launches of equity derivatives trading in the world.^[11] India’s success on the stock exchanges is a poster child of our ability to overcome difficult problems of political economy and entrenched interests, to obtain revolutionary change, and rise to the front ranks of the world. These institutions are precious assets today, and will be key building blocks in the next steps of modernising the financial sector, and improving transparency and competition, in the years to come.

In coming decades, enormous flows of savings are going to be intermediated through the financial sector. It is extremely important that the financial sector should be thoughtful and effective in delivering equity and debt capital into those firms in India which convert it into the highest possible GDP growth. This is particularly important because, as we will argue ahead, there is a good likelihood that the savings rate in India will grow significantly in the coming decade. The financial sector is of crucial importance in converting these vast flows of savings into a maximal impact upon GDP growth.

We know, from the experience of other countries, that this process can go wrong. We need to continue to work on carrying through the reforms in the financial sector. We have many strengths in what has taken place in finance, particularly on the equity market, but a lot remains to be done in banking and the debt market.

A new frontier in financial sector development lies in pension sector reforms. From 1998 to 2003, an intensive effort took place in India to think about alternative strategies in pension reforms, and to design an institutional architecture that would be well suited to solve the unique problems of the Indian setting.^[12] This led to important cabinet decisions in 2003 which are now being implemented.

The basic thrust of these reforms is to build a defined contribution pension system where workers would get a range of investment choices and fund managers. Centralised recordkeeping infrastructure is envisaged, which gives scale economies, keeps down transactions costs, and maximises the contestability of the market for fund management services. This new pension system has been mandatory for all new recruits to the central gov­ernment from 1 January 2004 onwards. It marks the dawn of a new breed of sophisticated institutional investors in the country, who will be sources of investment into debt and equity issued by the projects of the future.

Privatisation has been a major new theme of reforms in recent years. Major successes, where control of a company has been sold off, include VSNL, BALCO, CMC and Maruti. The true significance of privatisation lies not in the proceeds, but in the impact upon productivity. There are 276 public sector companies at the central level. They contributed Rs.2.28 trillion of ‘value added’ in 2001–02. Of these, there are 47 companies with negative value added; i.e., GDP would go up if these firms ceased to exist. Each 1 per cent of increase in value added by these PSUs amounts to Rs.22.8 billion of additional GDP. The international experience suggests that the value added could go up by 20 per cent to 40 per cent after privatisation. Thus privatisation alone could generate a direct impact worth 2 per cent to 4 per cent increase in GDP. In addition, there would be many positive indirect effects of privatisation. Interestingly enough, considerable privatisation efforts are now taking place at the level of state governments also. Of the 919 companies owned by state governments, 33 have been privatised and 69 have been closed down in recent years.

In my discussion about recent themes in reforms, I have highlighted four big areas: globalisation, infrastructure, privatisation, and the financial sector. It is important to reflect on the consequences of success in these four areas: these successes will give improvements in productivity. For a given level of labour and capital, progress in each of these areas will give higher output growth.