During the British rule, India has been a victim of enormous exploitation, where the colonial rulers have misused its natural resources, wealth and manpower. The Indian economy struggled to recover and achieve prosperity to prove the standard of living for the people. On 15th August, 1947 when India achieved Independence, it brought dreams of not just individuals but also economic, social and political freedom. Post-independence, the country had been suffering from widespread poverty and crisis in the industrial and agricultural sectors. The nation had faced casteism, religious violence, naxalism and exogenous shocks such as terrorism, territorial disputes with China in the year 1962 that led to Sino-Indian War, and with Pakistan, which resulted in wars in 1947, 1965, 1971 and 1999. Since India’s Independence, several Reforms have been taken up to make the country self-sufficient, which has actually led to numerous changes in the economy. Various private sector activities were regulated and the government became economic agents – establishing many commercial and industrial enterprises. In this backdrop, enormous pressure on the whole system and dynamic global environment led to the historic Economic Reforms in India.
Economic Reforms refers to a process in which a government prescribes a declining role for the state and expanding role for the private sector in the economy, or it can be seen as a policy shift in an economy from one to another alternative development strategy.
The Economic Reforms of 1991 in India was introduced by Prime Minister P.V. Narsimha Rao and the then Finance Minister Dr. Manmohan Singh in the backdrop of the Balance of Payment crisis and other related factors, which were basically aimed at stabilization and growth of the Indian Economy, and structural adjustments. Let us understand what had led to such a situation in the Indian Economy.
To begin with, we shall talk about Independent India’s first Prime Minister, Pandit Jawaharlal Nehru’s avowed Democratic Socialism ideology, i.e., using democratic methods to bring a large quantity of the country’s productive resources under the public ownership.
In the opinion of Nehruji, this ideology could mitigate the social evils of all third world countries. This ideology believes that the economy and the society must function democratically to meet the needs of the whole country. Democratic Socialism as an ideology is an extension of the liberal propagation of democracy which is altered to suit the requirements of all the countries of the world. The concept of socialism helps to nurture a great sense of collective identity by suppressing the narrow self-interest of individuals.
After independence in 1947, India and its leaders had to make a choice between what kind of country they wanted to be – the Communist Soviet Union or the Capitalist United States. India, during this time, was having high Nationalistic Zeal and ideals such as equality, liberty, unity, etc. was still relatively fresh in the minds of people. Having just come out of the harsh colonial era, defined by ruthless capitalism and leaving most of the country’s population impoverished, India had no intentions to expose its weakened economy and people to the global market forces. On the other hand, the authoritarian communist system of the USSR was unacceptable for a country like India who had just earned its freedom. Hence, India chose a middle path of “Socialist Economy” – where it followed the Soviet Economic Model without adopting its Communist Authoritarianism and established the Democratic Republic. In addition to this, the leaders craved to create a ‘welfare state’.
The Indian economy was divided into Public Sector and the Private sector as shown below:
During the 1950s, the leaders believed that rapid centrally planned industrialization was an answer to the economic challenges, which formed the basis of their Economic Development Strategy and for its implementation, Soviet-style 5 Year Plans were prepared by the Planning Commission of India – consisting of raising capital and creating large industrial state-owned enterprises and institutions. The First Five-Year Plan mainly focused on education, infrastructure and health care. India’s state controlled economic strategy was to close the market to foreign imports, in order to protect the immature and underdeveloped economy and achieve self- sufficiency. However, in order to execute large scale infrastructure in energy project, the Second Five-Year Plan of 1956 focused on importing such capital goods that were unavailable in India – leading to an increase in coal production, hydroelectric power projects and steel plants.
Until the Seventh Five-Year Plan, the country relied heavily upon the Public Sector to be the engine of the country’s development – meaning the private sector had little access to Capital, Skill and Enterprise. Gradually a number of loss-making private units were taken over. Also, the Nationalization of banks was seen during PM Indira Gandhi’s regime (14 private Banks in 1969 and 6 again in the year 1980).
The private sector enterprises were under strict regulation and required licenses to start new companies, new product productions, and expansion of productions, which took a long time to acquire. Moreover, government approval was mandatory for laying off workers or even shut down. This led to widespread red tape corruption in the bureaucracy, for instance, asking to hand over permissions in exchange for bribes. This system of licenses and controls was known as the “Quota Permit – License Raj” -coined by Rajagopalachari to describe the Indian Model of Socialism.
The State-Owned Enterprises (SOE) had a low demand from the consumers and did not prove to be much helpful for the economy as well. Overstaffing and low efficiency, gradually made it a loss-making unit and led to its closure. For example – HMT watches and Modern Foods, etc.
The MONOPOLIS AND RESTRICTIVE TRADE PRACTICES ACT (MRTP) Act, 1969 was enacted with the basic aim of comprehensive control, pattern and quantum of investment to ensure that wealth was not concentrated in the hands of few. However, this act had a poorly resourced commission, was inadequate in dealing with anti-competitive practices, and had cumbersome procedures and scarce resources. Furthermore, no specifications on cartel practices were mentioned.
India, had spent a considerably huge amount for the welfare of the people in the form of subsidies – spending on populist schemes. India has had several types of populism over time. Populism has the potential to hinder growth, fuel inflation and also result in loss of competitiveness and productivity in the long term. PM Indira Gandhi’s Garibi Hatao and launching series of pro-poor programmes, popularised as the 20-point programme, was one such example.
Parallelly India had faced series of wars with China and Pakistan. As a result, there was a rapid increase in defense expenditure and massive import of arms was observed, and money was also spent to recoup losses to human life as well as damage to property. In addition to this, pension to the survivors of martyred soldiers was paid and the cost of rehabilitation of injured soldiers and civilians was borne by the government.
Furthermore, twin droughts in the 1960s was a setback to India’s development and aggravated poverty. It led to massive dependence on the western powers for help. During this period, inflation had accelerated as agricultural production fell by 16%. A massive import of food grains depleted the foreign exchange reserves, and PM Gandhi went in for the Green Revolution, realizing the need for self-sufficiency in food.
Increased pressure on Indian government’s finances due to huge Military spending and the withdrawal of the USA’s aid from India had not left many options with the then Gandhi-led government. A steep devaluation of 57% was observed, where the value of rupee per dollar went from ₹4.76 to ₹7.50 to correct the external payments, which had reached a state of critical disequilibrium. This measure was resorted to with a view to maintain the then existing exports by alignment of external and the internal prices and, thus, giving exports greater competitive strength. During that time, there was a biasness against foreign investments, and the country was dependent on foreign aid. The devaluation measure did not work well as it led to inflation (5.8% in 1961-65 to 6.7% in 1966-70). As a result of this, there was a decline in the export growth and a rising trade deficit became a contributing factor to the Balance of Payment crisis. During the ‘80s, Imports of India showed a much faster increase than that of its exports. The imports increased by 2.3% of GDP, while the exports by 0.3% of GDP. As a result, Trade Deficit increased from an average 1.2% of GDP (1970s) to 3.2% of GDP (1980s).
During the 1970s there was an increase in the fiscal deficit of the government – a situation that describes shortfall in government’s income compared with its spending. Such deficits tend to crowd out private investment, increase inflationary pressure and weaken the balance of payments (BOP), thereafter imposing a burden of debt for the future. The combined deficit (Centre and states) rose from 6% of GDP in the early 1980s to 8-9% up to 1990-91.
Deepening the crisis was the uninterrupted and rapid growth of public debt during the 1980s that had overtaken the country. Most of the Indian economists were of the opinion that a planned public debt is considered desirable in a developing country since, the government borrowing represented part of the domestic saving and capital inflows from abroad absorbed by the government to finance and promote capital formation in the public sector and priority areas of the private sector. Moreover, the economists were also of the opinion that due to a lack of proper vision of the then ruling government, borrowed funds were used for only capital purposes, which otherwise would surely yield adequate direct or indirect returns. The debt had increased from ₹215.77 billion (1970-71) to ₹663.71 billion (1980-81), and to ₹2637.58 billion in 1988-89. The debt of GOI was ₹2282.41 billion at the end of 1988-89 of which internal debt amounted to 51% of GDP that year. The Current Account Deficit (CAD) in the 2nd half of 1980s showed a rising trend and was becoming unsustainable – the issue being the way it was financed. Consequently, India’s external debt rose from ₹194.70 crores in 1980-81 to ₹ 1229.50 crores in 1990-91. Further information about External Debt condition of India are given below:
- During the 1980s, there was a reduction in the flow of concessional assistance to India from the World Bank Group. The disbursements on concessional terms had more than 89% of assistance to India from multilateral sources. In the 1990s, this proportion declined to about 35% – leading to a rise in the average interest cost of eternal borrowing.
- A change in the debt structure from official sources to costlier private sources like External Commercial Borrowing (ECB) and NRI deposits was observed, which was channelled into the government’s deficit financing.
In addition to widening of CAD, the political uncertainty and instability in India from November ’89 to May ’91 was observed due to formation of three coalition governments which has led to delay in tackling the situation of the economic instability, leading to loss of the investor’s confidence and hence, affecting the Indian Economy. The situation was further aggravated by the downgrade of India’s credit rating where India’s long-term foreign debt rating was lowered to the bottom of investment grade. Due to the loss of investor’s confidence, commercial bank financing was difficult to obtain, and outflow began on short-term external debt, as the creditors were unwilling to give out maturing loans.
Apart from internal causes, there were influence of a few international events as well.
- In 1985, when Mikhail Gorbachev became the President of USSR, to kickstart moribund Soviet economy, he instituted the economic and political reforms policies of Glasnost (openness) and Perestroika (re-structuring). He wanted to keep USSR at par with the information and technological revolutions happening in the West. Since, there was a lack of freedom of speech in the Soviet, he wanted to democratize the Soviet System. The escalating economic crisis at the Soviet was another reason why reforms were instituted.
- Glasnost was intended for the liberalization of the political landscape.
- Perestroika or restructuring of economy, was intended to introduce quasi free-market policies instead of the government-run industries.
- These policies were a deviation from the communist policies, and was more closely associated with the market economy. Several communist leaders opposed the policies and encouraged a coup in 1991.
- These policies opened the gates to immense criticism of the entire Soviet rather than sparking a renaissance in Communist thoughts. Soon, the state lost control over the media and the public. A declining economy, rising poverty, unemployment, etc. were reasons behind public disappointment – gradually, making people of Soviet attracted toward Western ideology and their way of life.
- Along with the above factors, depletion of military and economic resources and the Cold War led to the collapse of the Soviet Union.
- India had acquired a socialistic ideology and Five-Year Plan, keeping USSR’s ideology in mind. The disintegration of the USSR showed a lacuna of the socialistic model of economic governance to India and other developing countries. It was basically observed as a victory of Capitalism (disintegration of USSR resulted in a phase of USA’s dominance in world politics) over socialism – “end of ideology” thesis.
Although India has always been a Non-Aligned State, its inclination towards the USSR was due to a close friendly relation between them. Moreover, India and USSR had a healthy trade of economic and military goods. Hence, in Cold War, when USSR was defeated, not only did it weaken the Soviets but also had an impact on India.
- Rupee trade (payment for trade made in rupees) with the Soviets was an important element of India’s total trade till the 1980s. The termination of several rupee payment agreements led to a decline in the new rupee trade credit flow. Due to the disintegration of the USSR, Financial aid from the Soviet Union dried up, which was one of the reasons for the BOP crisis in India.
- A decline in exports to Eastern Europe was observed which constituted for about 22.1% of total exports in 1980 and 19.3% in 1989 – further declining to 17.9% in 1990-91 and to 10.9% in 1991-92.
- The Gulf War began with the invasion of Kuwait by Iraq at the beginning of August 1990 and lasted till February ‘91. There was a reduction in the production of crude oil, and after that, the crude oil prices rapidly rose from $15/ barrel July 1990 to $35/barrel in October 1990. Iraq and Kuwait were the major sources of India’s oil imports, and the war made it necessary to purchase oil from the spot market. Short-term purchases from the spot market had to be followed up by new long-term contracts at higher prices, resulting in an increment in the import oil bill. A loss of reserves was observed due to the sharp rise in the import of oil and petroleum products that subsequently increased trade deficit. In the backdrop of this war, the socio-economic relationship between Indian immigrants and the nations were under immense stress. Increasing visa restrictions, falling wage rates, etc. were responsible for the declining remittances from these immigrants. Remittances improve the well-being of the receiving family members and boost the economies of receiving countries.
All the above factors taken together led to the Balance of Payment crisis in the year 1991 in India. Balance of Payment is a statement that records all the monetary transactions made between residents of a country and the rest of the world during any given period.
During 1991, India faced a severe economic threat, where the government was close to loan default. India’s foreign exchange reserves in June 1991 were such that it could barely cover up its essential imports of some weeks – India gradually heading on defaulting on its external balance of payment obligations.
- In this backdrop, the first step taken by the government was a decision on the exchange rate. The PV Narsimha Rao government decided to devalue the rupee in two stages to ensure the return of capital, increase export competitiveness, and renew international confidence.
- Stage 1 happened in July 1st (realignment or downward adjustment of rupee) where spot selling for dollar was raised to ₹23.04 from ₹21.14 (June 30).
- Stage 2 happened on July 3rd where Dollar was taken to ₹25.95. Hence, there was a rupee devaluation by over 18.5% against the Dollar.
- In February 1991, the Chandrasekhar government, unable to pass the Budget due to downgraded India’s bond ratings by Moody, led to even further deterioration of the ratings. It became impossible for the country to seek short term loans and exacerbated the existing economic crisis. TheWorld Bank and IMF also suspended their assistance, leaving the government with no option except to mortgage the country’s gold to avoid defaulting on payments. It is in this backdrop, a step was taken when an emergency loan was secured by the government of India of $2.2 billion from the International Monetary Fund (IMF) by pledging 67 tons of Gold Reserves as collateral. To raise US$600 million, RBI had to airlift 47 tons of gold to the Bank of England and 20 tons of gold to the Union Bank of Switzerland with the condition that it would be able to repurchase within six months. This immediate measure helped stabilize the economic scenario of the BOP crisis in 1991 temporarily, after which the Chandra Shekhar government collapsed and Economic Reforms of PV Narsimha Rao was brought in immediately.
Economic Reforms of 1991
As explained in the previous section, various reasons were responsible for the economic crisis of 1991 in India. After independence, three-fourth populations were engaged with agriculture with primitive tools and techniques, literacy rate stood at 14%, and average life expectancy was 32 years, indicating that the performance was not much up to the mark. Hence, the main aim of the Indian leaders was the upliftment of their people and the country. The country had experienced an increase in per capita income – especially since the 1980s – as well as a reduction in the poverty and infant mortality rates. Some of the reforms taken up before the historical reform of 1991 have been discussed below:
- Rapid industrialization by implementing centrally prepared five-year plans – involved raising massive amounts of resources and investing them in the creation of large industrial State-owned enterprises (SOEs). The private industry was left to the consumer goods such as clothing, furniture, personal care products – which was labour-intensive and generated mass employment.
- Industries were given significant trade protection from their growth being hampered by competition from efficient foreign producers. The system of industrial licensing was introduced to check the activities of the private firm by the government.
- In the 1960s, chronic food shortages occurred due to drought and followed by the war that led to high poverty and higher inflation. To combat the situation, the government had initiated the Green revolution in the 1960s and the White revolution in the 1970s. Lal Bahadur Shastri promoted the White Revolution – a national campaign to increase the production and supply of milk – by supporting the Amul milk co-operative of Anand, Gujarat and creating the National Dairy Development Board. Upon discussion with Varghese Kurian to replicate a co-operative model for improving farmers’ socio-economic conditions, National Dairy Development Board (NDDB) was established at Anand in 1965. His government also passed the National Agricultural Products Board Act and was responsible for setting up the Food Corporation of India under the Food Corporation’s Act 1964.
- The Indian government was forced to seek monetary aid from the World Bank and IMF in the backdrop of inflation caused due to food shortages in the 1960s. A step towards economic liberalisation was taken by devaluing the rupee to combat inflation and cheapen exports, and the former system of tariffs and export subsidies was abolished.
- Ten-Point Program of 1967 of Indira Gandhi emphasized greater state control of the economy with the understanding that government control assured greater welfare than private control. Hence, a set of policies (Nationalisation of Banks, 1969; MRTP Act, 1969; Nationalisation of Coal Mines, 1971; Nationalisation of General Insurance,1972; FERA,1973, etc.) were formulated to increase regulations of the private sector.
- Due to the sharp rise in international price of oil in the year 1973, inflation rate in India was 20% which was highly unacceptable, and therefore, PM Indira Gandhi asked Dr. Manmohan Singh to draft an anti-inflationary policy – restricting disposable income; inflation was reduced to 5.7% by March 1975.
- The 20-Point Programme announced by Indira Gandhi on July 1975, was claimed to be an attempt to reach out towards the long-cherished ideals to mobilize India’s vast resources for National reconstruction and development.
- During the 1980s, Liberalization steps were undertaken by the government. In 1982, de-regulation of the cement industry took place which, almost overnight, wiped off the black market in cement, production zoomed and actual market prices dropped.
Concurrently, in 1982 and 1983, the government encouraged foreign investments in automobiles and consumer electronics. During this phase, it was recognised that a new, aspirational middle class was emerging with more money to spend and demands for modern consumer goods that could not be ignored. Since the private sector was best positioned to meet the new demands, it had to be given the freedom to expand and respond to these new demands. Tax rates were lowered with a promise of stability. Domestic indirect taxes were modified to allow credit for taxes paid on inputs. The industrial licensing system was not abolished but was made more flexible. It was easier for the manufacturer to diversify without seeking a license every time it wanted to introduce a new product.
Centre for Development of Telematics (C-DOT) was established in August 1984 to develop state-of-the-art telecommunication technology and meet the needs of the Indian telecommunication network. C-DOT revolutionised the communication network in the towns and even villages of India. With the efforts of Rajiv Gandhi, who was hailed as ‘Father of Information and Technology and Telecom Revolution in India’, the PCO revolution took place which even connected the rural area to the outside world. Eventually, in 1986, MTNL (Mahanagar Telephone Nigam Limited) was established, which helped spread the telephone network. With Sam Pitroda as an advisor to the then Prime Minister Rajiv Gandhi, six technology missions related to telecommunications, water, literacy, immunisation, dairy and oilseeds were established.
- Computer hardware and software trade were allowed license benefits which stimulated stunning growth. Texas Instruments were the first to set up their research and development facility in Bangalore – where its issue regarding the allowance to operate a dedicated satellite facility for seamless connectivity to Houston was taken care of by the then government. The subsequent success of the TI venture set the trend for other multinationals to set up similar ventures in India.
- To develop a modern, well-regulated stock market, announcement was made that the capital market should have an independent regulator, which led to the setting up of the Securities and Exchange Board of India in 1987.
In 1991, Dr. Manmohan Singh became the Finance Minister under PV Narsimha Rao Government, while Amar Nath Verma was chosen as his Principal Secretary, and Rakesh Mohan as the Chief Economic Advisor – when the economy was undergoing a severe crisis – Macroeconomic imbalance, fulfilling foreign obligations and other issues such as the poor productivity, rising inflation rate, etc., had to be addressed immediately. On 22nd June, 1991 at 9:50 PM, Prime Minister Rao presented a plan to revive the economy and mentioned that the issues of the economy would be addressed in a decisive manner. He mentioned that the cobwebs of industrialization would be removed by the government and make India internationally competitive. Policy changes during his regime led to the dismantling of the Nehruvian ideologies. Mr Verma helped draft the New Industrial Policy alongside Chief Economic Advisor Rakesh Mohan, and it laid out a plan to foster Indian industry in five points. Eventually, in July 1991, a new Budget (Epochal Budget), also known as the New Economic Policy, was presented by Dr Manmohan Singh.
Economic Liberalisation refers to a country ‘opening up’ to the rest of the world with regard to trade, regulations, taxation and other matters that generally affect business in the country. It is the process or means of the elimination of control of the state over economic activities. It provides greater autonomy to the business enterprises in decision-making and eliminates government interference. Liberalisation, additionally, also means the removal of bureaucratic control on the private sector.
Steps Taken under Liberalization
- Commercial banks were given the freedom to determine interest rates. Previously, the Reserve Bank of India had the onus to decide it.
- The investment limit for small scale industries was raised to Rs. 1 crore.
- Indian industries were given the freedom to import capital goods like machinery and raw materials from foreign countries.
- The industries could diversify their production capacities and reduce production costs. Industries are now free to decide this based on market requirements. Previously, the government used to fix the maximum production capacity of industries.
- Abolition of restrictive trade practices: Previously, companies with assets worth more than Rs.100 crore were classified as MRTP firms (as per Monopolies and Restrictive Trade Practices (MRTP) Act 1969), and were subject to severe restrictions – which was lifted after the reforms.
- Industrial licensing and registration were removed: As per this, the private sector is free to start a new venture of business without obtaining licenses except for the following sectors (which still need licenses):
- Industrial explosives
- Defence equipment
- Hazardous chemicals
The transfer of ownership, property or business from the government to the private sector is termed privatization. The government ceases to be the owner of the entity or business, meaning selling the PSUs (Public Sector Undertakings) to private players. It was meant to remove the political interference in PSUs which was making them models of inefficiencies.
Steps Taken under Privatization
- Selling shares of PSUs to the public and financial institutions. For example, shares of Maruti Udyog Ltd. were sold to private parties.
- Disinvestment in PSUs means selling PSUs to the private sector or strategic sale of minority shares to private partners and selling loss making units to the private sectors. The loss making units were either sold off , or closed after all workers got their legitimate dues and compensation – where, such sale enabled the government to inject competitive and efficient private sector business practices in government enterprises.
- The number of industries that were reserved for the public sector was decreased from 17 to only 3. These are:
- Transport and railway
- Atomic energy
- Mining of atomic minerals
Globalization refers to opening up the economy more towards foreign investment and global trade. According to WHO, globalization can be defined as “increased connections and interdependence of people and countries. It is generally inter-related elements: the opening up of the international borders to the increasingly fast flow of goods, services, finance, people and ideas; and the changes in the institutions and policies at national and international levels that facilitate or promote such flows”.
Steps Taken under Globalization
- Reduction in tariffs: A gradual reduction in customs duties and tariffs on exports and imports to make India attractive to global investment.
- Long term trade policy: Trade policy was enforced for a longer duration. The main features of the trade policy are:
- Liberal policy
- Encouragement of open competition
- Removal of controls on foreign trade
- Before 1991, imports to India were regulated by a positive list of freely importable items. From 1992 onwards, the list was replaced by a limited negative list. Almost all intermediate and capital goods were freed from the list for import restrictions.
- The Indian currency was made partially convertible under liberalised exchange rate management scheme from March 1992 –The importers can get their required quantity of foreign exchange by converting their rupee sources into dollars from the foreign exchange market at market-determined rates. The exporters do not have to surrender their foreign exchange (US dollar or EU Euro) earned abroad to RBI but can sell them in foreign exchange.
The Government said that anyone who deals in current account means international trade of goods and services will be able to convert them to Indian Rupees as follows:
- 40 % of the receipts at Official rate
- 60% of the receipts at Market Rate
This means that only part of the current account receipts was made convertible at market rates, and that is why it was called Partial Convertibility of Rupee on Current Account. The imports of materials other than petroleum, oil products, fertilizers, defence and life-saving drugs and equipment always had to be affected against market-determined rates.
- The equity limit of foreign capital investment was raised from 40% to 100%. The Foreign Exchange Management Act (FEMA) was enacted, replacing the draconian Foreign Exchange Regulation Act (FERA).
In the remarkably short period of time of two years, India was able to come out of its economic crisis. The BOP crisis was over by the end of March1994, thanks to the prudent macroeconomic stabilisation policies such as the devaluation of rupee and other reforms. The foreign exchange reserves rose by $15.7 billion and the FDI and FII both had a massive increment. India’s integration with the global economy increased considerably, where the ratio of exports of goods and services to GDP in India doubled from 1990 to 2000. As the reforms pushed up production of goods and services, inflation rates dropped – resulting in prices falling or remaining constant. However, the focus of the reforms was highly on the formal sector and not much on sectors such as the agriculture or urban informal sectors and hence, forest-dependent communities led to uneven growth and unequal distribution of economic wealth among people. There was also increased disparities between the rich and the poor and the infrastructurally backward and developed states. Organised manufacturing sector which had rigid labour laws, witnessed very little additional employment. As a result, economic reforms, although had accelerated the growth yet failed to generate adequate employment.
The impacts of the NEP of 1991 till date along with the Indian economic conditions post COVID-19 will be discussed in detail in Part II of the article.