India Stumbles in Rush to a Free Market Economy

India's struggle to restructure its economy is faltering, threatening to drag South Asia's largest country deeper into poverty and deprivation, international aid officials, diplomats and Indian business figures say.

Begun a year ago amid widespread international praise and expectations, India's economic reforms promised a commitment to a free market system, a drastic reduction in the intrusion of the state into economic life and a sudden embrace of foreign investment. Unlike India's previous flirtations with economic restructuring, the reforms announced over the last year created significant new liberties for private entrepreneurs, sharply devalued the rupee, and set out to attack the bureaucracy that strangled virtually every private economic initiative.

Now, a year after the new policies were announced by Prime Minister P. V. Narasimha Rao, far less has been accomplished than promised, bureaucratic red tape still hamstrings new investment, both foreign and domestic, and not a single one of India's huge, bankrupt state-controlled industries has been shut. With the economy growing this year at a faint 2.5 percent, barely above the population growth rate, many economists see a need for a rapid acceleration of the reforms.

"It's at a critical point," said one senior Western diplomat. "The next two or three months will tell the story. And I don't know if they have the political will to do what is necessary." Doubts About the Future

Last week, the country's most respected financial journal, The Economic Times, a stalwart supporter of the reforms, cast doubts over the future of India's economy in an editorial that has shaken many policy makers.

"Is India's economic liberalization program coming unstuck?," the paper asked pointedly. "Is it really the case that beneath all the hysteria generated by dramatic announcement of radical change, there was really no substance at all." And does Mr. Rao, the paper asked, "have the stomach for hard decisions and the stamina for dogged pursuit?"

India's economy, a jerry-rigged socialism modeled loosely on that of the former Soviet Union's, relies heavily on state-controlled industries, a measure of central planning and some fixed prices on essential commodities. But India also boasts a strong internal free market in consumer goods and food, an unruly collection of stock markets and an inefficient but private agricultural sector. The result is an economy that is hardly growing and is falling further and further behind the economies of the rest of Asia, particularly that of China.

Last summer, when the country came within a hair of defaulting on its foreign loans, India approached the International Monetary Fund and the World Bank for help, both for short-term financial assistance and help in finding a way of reshaping an economy that was on the verge of collapse. The blizzard of reforms announced in the first six months seemed destined to set the country on a new course.

Some economic analysts remain convinced that the country is headed in the right direction. Surendra Lakshminarayan Rao, the director general of the National Council of Economic Research, a respected think tank here, emphasized the Government's accomplishment's so far.

"If you look back a year ago and you look where we are today," he said, "we've come quite far. There were all kinds of restrictions on industry. All that is gone. There is a tremendous sense of freedom in industry that wasn't there. There's been enormous trade reform. These are indications that the Government is willing to give up considerable business power.

"Having said that, there is still a tremendous amount to do," he added. "As for speed, that is the million dollar question. The central Government point of view is that we have done a great deal, let's go forward slowly."

But other analysts, particularly officials at institutions like the World Bank, are concerned that the pace of reform should not be slowed, but speeded up. They point to the continuing drain of huge, inefficient state-controlled industries, stagnant agricultural growth, a rickety banking system, crippling tariffs on capital equipment imports, and the continuing constraints on foreign investment.

Increasingly Mr. Rao seems consumed by political distractions within his own ruling Congress Party, and with efforts by the opposition Hindu nationalist Bharatiya Janata Party to sow discord between the country's Hindu's and Muslims. In addition, a $1 billion financial scandal that has swept through Bombay's financial community has fueled the opposition's attacks on Mr. Rao's economic policies in Parliament, forcing the Prime Minister to adopt a more defensive approach to his reforms. Pace of Reforms Questioned

Indeed, in a news conference marking his first year in office, Mr. Rao himself offered a rather murky endorsement of the reform process, while suggesting that the process may be moving along too quickly. "I don't think we will want to undo them," the Prime Minister said of the reforms. "Their pace may be slowed down, as somebody pointed out, sometimes deliberately, sometimes because its causes are beyond our control. All that is possible, but the direction will not change. This is what we have decided."

Even as he spoke, however, international economists were expressing concern about the enormous obstacles India still faced before it would realized any significant economic growth. The World Bank, in its annual report on India, said that progress had been made in the past year in liberating elements of the economy from misguided policies and the leaden weight of bureaucracy, but it was far more blunt in detailing the enormous tasks that remain.

The range of issues addressed in the report included the structure of agriculture in the country, from which 70 percent of India's 850 million people still earn their livelihood. "The stagnation in agriculture is the sign of some fundamental problems, but the Government has yet to articulate a comprehensive program for rejuvenating the sector," it said. It also noted the budget-guzzling appetite of the state's insolvent enterprises, and the reduction of subsidies, intended for the poor, but which, in the report's analysis, "accrue mostly to richer farmers."

Fiscal and financial problems remain acute, with only 7 million out of a total population of 850 million paying any form of income tax. Farmers, no matter what their income, pay no income tax and still receive huge subsidies on fertilizer purchases, and get all their electricity free, a grant that accounts for 4 percent of the country's gross domestic product. Criticism From World Bank

The World Bank report was severely critical of India's maze of regulations on private investment, both domestic and foreign, and urged they be gutted. The Bank also called for hastening the closing of bankrupt state-controlled industries. An example cited by the Bank's report is a government fertilizer plant built in Haldia in 1980 that employs 3,000 workers; it has yet to produce a single ton of fertilizer. In India's 45 years of independence, no state industry, no matter how inefficient, how bankrupt, has ever been closed.

So cumbersome still are the bureaucratic hurdles to investment, that Motorola, which intended to invest $1.4 billion in India over the next decade, has thrown up its hands in frustration and has decided to move some of those investments to China. In the first three months of this year, China received $6.5 billion in foreign investment; in contrast, during the same period India has approved only $300 million in foreign investment.

The Bank was particularly harsh in its assessment of the impact of India's economic policies on the poor. Indeed, critics of Mr. Rao's economic reforms insist that only a continued adherence to socialism can address the needs of the poor, who make up more than half the country's population. But, the Bank observed caustically, "Although considerable resources are allocated to the social sectors, they do not adequately reach the poor." In comparison with the rest of Asia, the Bank said, India has done far less well in alleviating poverty.

"In the last 10 months India has overcome a macroeconomic crisis and significantly improved its development policies," the Bank report said. "The process of reform has just started, however, and the challenges ahead are formidable."

It is precisely the question of the pace of reform that is the point of the debate within India's business community. As The Economic Times concluded in its editorial: "The yardstick should not be what things were like two years ago but how they are now in other competing countries. On that score, changes in India have indeed been slow. The time has come to wake up and get on."