Why those calling for reforms in India may need a reality check

Amid this welter of unsolicited advice, articulated mostly through oped columns, one common suggestion is to use the current global policy flux to carry out long-pending economic reforms. On offer, almost always, is a dog-eared list of policy initiatives.

Well, here is some news for all those brandishing the old reforms placard: keep hoping.

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It is not that these reforms are undesirable, or that the package is inappropriate for India. On the contrary, some of the reforms are absolutely necessary. What seems to be missing are the conditions necessary to get reforms off the ground. The history of economic reforms in India points to the political economy’s critical role; it is futile to think of implementing reforms unmoored from political realities.

In fact, nationalist political realities forced the government in 2017 to reverse years of calibrated opening and re-introduce trade protectionism, through both tariff and non-tariff contrivances. Take a look at how financial-sector reforms are implemented in India.

The first is by incremental steps to minimize shocks to the system. Financial stability is an imprecise metric, but is highly valued and is even part of the Reserve Bank of India’s (RBI) mandate. Here is an example. Data from the February 2025 Financial Sector Assessment Program, conducted by the International Monetary Fund (IMF), shows that public sector institutions held only 55% of total financial sector assets in 2023, down substantially from 63% in 2017. This impressive contraction took place even as the market enlarged. Here’s another data-point: half of the private sector’s credit needs are now met by non-banks.

This greater role for the private sector, including non-banks, has actually materialized over the past decade, silently and without much ballyhoo. It can be argued that private financial institutions managed to surge ahead because state-owned institutions were weighed down with toxic assets. But it is equally true that regulators, while tightening regulations around the non-banking space, also saw a role for them in expanding the financial sector’s breadth and depth.

Regulators and administrators have traditionally favoured incrementalism as the path ahead for reforms; India’s banking sector reforms, based on the Narasimham committee recommendations, were implemented between 1995 and 2005 despite critics demanding a faster pace. The stealthy pace helped minimize dislocation and avoided any crisis. It is RBI’s favoured method even now: sample its sandbox approach.

There is another way in which substantive economic reforms happen: only when there is a crisis, as I explain in my book Slip, Stitch and Stumble.

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For example, former prime minister Rajiv Gandhi came into office in 1984-85 with an extraordinary zeal for reforms; his introduction of broad-banding for industrial licensing (a licence to produce cars also included truck manufacturing, for example, which was not allowed earlier) suddenly added some extra points of growth to a moribund economy. 

He sowed the seeds of an information technology (IT) revolution in India. But, for a variety of reasons, his reformist fervour had a truncated journey. Economic management slipped back to ballooning fiscal deficits and burgeoning foreign debt; by the end of his term, India had a full-blown balance-of-payments crisis.

This created the backdrop for the 1991 burst of reforms by prime minister P.V. Narasimha Rao and finance minister Manmohan Singh. In fact, the Big Bang reforms undertaken then—abolition of industrial licensing, welcoming foreign investment, a two-step devaluation of the rupee, trade reforms—were delivered without much pause. In contrast, financial sector reforms—also a critical part of the package—were stretched out over extended periods.

The reason for this dual approach was political expediency. Changes emanating from the instant brand of reforms did not upset the political equilibrium—foreign competition might discomfit domestic manufacturers but would be welcomed by the citizenry. However, abrupt changes in the financial system could impact not only a large number of depositors, but also create insecurities among public sector bank employees, a key political constituency then.

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In fact, reforms in the financial sector—at least the substantive ones—have mostly been occasioned by some crisis or scam. Capital market reforms gathered pace only after the Harshad Mehta scam surfaced in 1992. Even then, many issues were left unattended and were reformed only when a new scam emerged. Reforms in the non-bank space were undertaken after the collapse of CRB Finance, which left many depositors stranded on the streets and resulted in political embarrassment. 

In contrast, the lack of incentives or political motivation to reform has left many key market areas untouched; for example, an IMF report finds that India’s corporate bond market continues to remain very small, contributing only 16% of gross domestic product.

In the end, the Centre may still want to accomplish land or labour reforms, but can do so only after a close examination of the political implications. Unlike some contentious laws that the Centre managed to push through Parliament using its brute majority, these reforms will need wider stakeholder support.

The author is a senior journalist and author of ‘Slip, Stitch and Stumble: The Untold Story of India’s Financial Sector Reforms’ @rajrishisinghal