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Economic Reforms in India

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Topic Covered: Economic Reforms in India

About Economic Reforms in India

Economic reforms in India refer to the neo-liberal policies introduced by the Narsimha-Rao
government in 1991 when India faced a severe economic crisis due to external debt. This crisis
happened largely due to inefficiency in economic management in the 1980s. The revenues that the
government was generating were not enough to meet the expenses. Hence, it had to make hefty
borrowings from foreign banks to pay the debt. Hence, they were caught up in a debt trap.

• To curb this crisis, India approached the world bank and the international monetary fund (IMF)
for the loan and received $7 million to manage their crisis.

• As a result of which, these international organizations expected India to open its door to trade
with other countries by removing the strict restrictions hitherto present.

• Hence India adopted the LPG (Liberalisation, Privatisation & Globalization) reforms under
the Economic Reforms.

Let us look at each one of them

Liberalization

• Liberalization was brought about with an idea that any regulations or restrictions that were
imposed on free trade must loosen up its grip to allow trade.

• It allowed opening up the economic borders for foreign investments and MNCs.

• Several economic reforms that were imposed under Liberalization include expansion of
production capacity, de-servicing producing areas, abolishing industrial licensing by the
government, and freedom to import goods.

• Economic liberalisation in India refers to the economic liberalization of the country's economic
policies with the goal of making the economy more market and service-oriented and
expanding the role of private and foreign investment.

• Indian economic liberalization was part of a general pattern of economic liberalization and
modernization occurring across the world in the late 20th century.
RBI Gr. B – Economic Reform in India Free RBI Gr. B e-book

• Although unsuccessful attempts at liberalization were made in 1966 and the early 1980s, a
more thorough liberalization was initiated in 1991.

• The reform was prompted by a balance of payments crisis that had led to a severe recession.

Brief about Liberalization of 1991

• The collapse of the Chandra Shekhar government in the midst of the crisis and the
assassination of Rajiv Gandhi led to the election of a new Congress government led by P. V.
Narasimha Rao.

• He selected Amar Nath Verma to be his Principal Secretary and Manmohan Singh to be finance
minister and gave them complete support in doing whatever they thought was necessary to
solve the crisis.

• 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.

• Firstly, it abolished the License Raj by removing licensing restrictions for all industries except
for 18 that "related to security and strategic concerns, social reasons, problems related to
safety and overriding environmental issues."

• To incentivize foreign investment, it laid out a plan to pre-approve all investment up to 51%
foreign equity participation, allowing foreign companies to bring modern technology and
industrial development.

• To further incentivize technological advancement, the old policy of government approval for
foreign technology agreements was scrapped.

• The fourth point proposed to dismantle public monopolies by floating shares of public sector
companies and limiting public sector growth to essential infrastructure, goods and services,
mineral exploration, and defence manufacturing.

• Finally, the concept of an MRTP company, where companies whose assets surpassed a certain
value were placed under government supervision, was scrapped.

Privatization

• Privatization refers to giving more opportunities to the private sector in regulating different
services and reducing the role of the public sector (government-owned enterprises) in them.

• With privatization, FDI (Foreign Direct Investment) was introduced in India giving healthy
competition to the Indian goods and services.
RBI Gr. B – Economic Reform in India Free RBI Gr. B e-book

Privatization in India
• In 1991 India made some major policy changes in their economic ideologies. There were
stagnation and slow growth in the economy.

• To tackle these problems, then Finance Minister Dr Manmohan Singh introduced some major
economic reforms. Now, we call it the liberalization of the Indian Economy and the LPG
reforms.

• Privatization has a very broad meaning in economics.

• Everything ranges from the introduction of private capital to selling government-owned assets
to transitioning to a private economy.

As the definition of privatization is so very diverse let us take a look at the three main features of
privatization.

• Ownership Measures: The ownership of all public enterprises ultimately shifts to private
owners. The denationalization can be complete or partial.

• Organizational Measures: This is where we limit the control of the state in public companies.
Some methods include holding company structuring, leasing. restructuring of the enterprises
etc.

• Operational Measures: Public organizations and companies were running into huge losses.
So, the efficiency of these companies was to be increased.

Conceptualization of Privatization in India

1] Delegation: Here via a contract or franchise or lease or grant etc. the government keeps the
ownership and the responsibility of an enterprise. But the private company will handle the daily
activities and deliver the product or service. The state will remain an active participant in this process.
2] Divestment: The government will sell a majority stake of the enterprise to one or more private
companies. It may keep some ownership but will be a minority stakeholder in the enterprise.
3] Displacement: The first step here will be deregulation. This will allow private players to enter the
market. And slowly and gradually the private company will displace the public enterprise. Here the
private sector will compete with public companies and ultimately outperform them, causing the public
enterprise to be displaced.
4] Disinvestment: Directly selling a portion or whole of a public enterprise to private parties.

Globalization

• In the context of economic reforms, Globalization means the integration of the Indian
economy with the world economy.
RBI Gr. B – Economic Reform in India Free RBI Gr. B e-book

• It means that the economy of India will now also depend on the world economy and vice
versa.

• It encourages FDI and foreign trade with different countries.

Effect of Globalisation in India

• India is one of the countries that succeeded significantly after the initiation and
implementation of globalisation.

• The growth of foreign investment in the field of corporate, retail, and the scientific sector is
enormous in the country.

• It also had a tremendous impact on the social, monetary, cultural, and political areas.

• In recent years, globalisation has increased due to improvements in transportation and

information technology.

• With the improved global synergies, comes the growth of global trade, doctrines, and culture.

Globalisation in the Indian economy

• Indian society is changing drastically after urbanisation and globalisation.

• The economic policies have had a direct influence in forming the basic framework of the
economy.

• Economic policies established and administered by the government also performed an

essential role in planning levels of savings, employment, income, and investments in society.

• Cross country culture is one of the critical impacts of globalisation on Indian society. It has
significantly changed several aspects of the country, including cultural, social, political, and
economic.

• However, economic unification is the main factor that contributes maximum to a country’s
economy into an international economy.

Advantages of Globalisation in India

• Increase in employment: With the opportunity of special economic zones (SEZ), there is an
increase in the number of new jobs available. Including the export processing zones (EPZ)
centre in India is very useful in employing thousands of people. Another additional factor in
India is cheap labour. This feature motivates the big companies in the west to outsource
employees from other regions and cause more employment.

• Increase in compensation: After globalisation, the level of compensation has increased as

compared to the domestic companies due to the skill and knowledge a foreign company
offers. This opportunity also emerged as an alteration of the management structure.
RBI Gr. B – Economic Reform in India Free RBI Gr. B e-book

• High standard of living: With the outbreak of globalisation, the Indian economy, and the
standard of living of an individual has increased. This change is notified with the purchasing
behaviour of a person, especially with those who are associated with foreign companies.
Hence, many cities are undergoing a better standard of living along with business
development.

Why were Economic reforms introduced in India?

Economic reforms were introduced in India because of the following reasons:

1] Poor performance of the public sector

• The public sector was given an important role in development policies during 1951–1990.

• However, the performance of the majority of public enterprises was disappointing.

• They were incurring huge losses because of inefficient management.

• Adverse BoP or imports exceed exports.

• Imports grew at a very high rate without matching the growth of exports.

• The government could not restrict imports even after imposing heavy tariffs and fixing quotas.

• On the other hand, exports were very less due to the low quality and high prices of our goods
as compared to that of foreign goods.

2] Fall in foreign exchange reserves

• Foreign exchange (foreign currencies) reserves, which the government generally maintains to
import petrol and other important items, dropped to levels that were not sufficient for even
a fortnight.

• The government was not able to repay its borrowings from abroad.

• Huge debts on government.

• Government expenditure on various developmental works was more than its revenue from
taxation.

• As a result, the government borrowed money from banks, public and international financial
institutions like the IMF, etc.

3] Inflationary pressure
• There was a consistent rise in the general price level of essential goods in the economy.
RBI Gr. B – Economic Reform in India Free RBI Gr. B e-book

• To control inflation, a new set of policies were required.

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