Reforms, Gradually and by Stealth

Policy changes can often only be made gradually. Montek Singh Ahluwalia makes this point via two excellent examples in his book, Backstage.

 

The first one was about how cement prices were deregulated. He starts by explaining the problem. Even in the early 1980’s, cement prices were set by the government. The Center even controlled who got how much cement! Such a system led to cement makers feeling that they could make a lot more if only the market could decide prices, private buyers never knowing whether they could get enough cement, all of which then fuelled corruption and black markets.

 

What finally caused a change of heart? AR Antulay, Maharashtra CM, was caught in a scandal where he was siphoning off cement allocated to state projects to be sold to private buyers in return for kickbacks. Much worse (politically speaking) was that he’d used Indira Gandhi’s name in his dealings. She was furious and that opened the window to do something to prevent such things from recurring.

 

Ahluwalia wanted an immediate change to market determined, demand and supply based pricing. Experienced heads told him that big changes could never be done abruptly, however desirable they may be – there will be too much resistance, lobbying and bribing against that big a change. Instead, it was decided to decontrol cement prices gradually. The new policy said cement manufacturers had to surrender a fixed fraction to the government who would allocate it at a fixed price to key projects. The remainder was left to the manufacturer to sell at a price of his choosing to whoever he wanted.

“The surrendered portion could be reduced gradually over time.”

Within 5-6 years, cement prices were completely deregulated.

 

The new policy had an additional benefit – since manufacturers stood to make more if they had a higher “remainder after surrendering”, it incentivized them to increase cement production.

 

The second example was on forex rate. Back then, the exchange rate of the rupee was set by the RBI against a basket of international currencies. Devaluing the rupee was politically problematic, but holding it at some artificial level was costly and harmful to the economy. What could be done?

 

Instead of announcing that the currency exchange rate would be let free, the RBI (with agreement from the relevant ministries) decided to adjust the exchange rate by a small amount periodically and frequently. Nobody notices (or complains) about small changes, but the cumulative effect of many small changes is eventually the same as one big change. The rupee was thus devalued by a whopping 24%, but it was spread over 36 months.

“This was an example of both gradualism and reform by stealth.”