PEM

MODULE - 3
UNIT 6 - LPG
 NEW ECONOMIC POLICY 1991
Reasons for implementing New Economic policy:
In the early 1990s, India faced a major crisis followed by a foreign exchange deficit,
resulting in its economic downfall. To overcome the crisis, the government came up
with adjustments to the economy by bringing new reforms. The reforms introduced
were called ‘structural reforms’ and launched under the ‘New Economic Policy (NEP)’.

What is New Economic Policy?

The New Economic Policy was introduced in 1991 under the leadership of P. V.
Narasimha Rao. It refers to the economic activities of the government and includes
various policy and structural perform methods like stabilisation measures to control
inflation and correct BoP (Balance of Payment), improving the efficiency of the economy,
and increasing international competitiveness.
The Stabilisation Measures refer to the short-term measures launched by the
government with the aim of:
1. Controlling inflation by keeping the prices of goods under control, and
2. Maintaining a sufficient foreign exchange reserve to correct the weakness of BoP
(Balance of Payment).
Along with Stabilisation measures, the government also
launched Structural Reform Measures (long-term measures) with the aim of:
1. Improving the efficiency of the economy, and
2. Removing rigidity from various segments of the Indian Economy to increase
international competitiveness.

Objectives of the New Economic Policy, 1991

1. The main objective of the NEP was to open the Indian economy into the
Globalisation arena and provide a new direction to the Indian market.
2. The NEP focused on reducing the rate of inflation and building up foreign
exchange reserves to accelerate the economic growth of the country.
3. The NEP aimed at increasing the participation of the private sector in
economic growth by reducing the number of sectors reserved for the
government.
4. The NEP was intended at permitting a global movement of goods and
services, capital, human resources, and technology by reducing trade
restrictions.
5. The NEP aimed at attaining economic stability and an economic market by
eliminating all the unessential trade and tariff restrictions.
Components of the New Economic Policy, 1991
The New Economic Policy has been divided into three broad concepts that
are: Liberalisation, Privatisation, and Globalisation, or the LPG Model. The
LPG Model was introduced to replace the LQP Model, i.e., Licensing, Quotas,
and Permits. The main aim of introducing the reforms was to attain a high
rate of economic growth, reduce the rate of inflation, reduce the fiscal deficit,
and overcome the BoP (Balance of Payment) crisis.

Liberalisation
Liberalisation of an economy is considered a key component of NEP. Before
the New Economic Policy of 1991, the private sector was in control of the
government. Because of this, the domestic industries were not allowed to
take any decisions regarding the industry’s work without the government’s
interference. This resulted in a fall in professionalism and inefficiency of work
within the industry. With the introduction of the liberalisation policy, this
sector gained the freedom of decision-making without any interference
from the government.
The government also decided to abolish the licensing system. Before 1991, a
business needed to get a license from the government to start any
industrial activity. This resulted in a delay in getting a license, as there was a
long queue of people before the window of the government department,
seeking authorisation to get a license. This also resulted in corruption as the
officers started taking bribes to make the process faster. To end this, the
government abolished the licensing system and permitted individuals to start
their industrial activities without any permission (however permission is still
required in industries, such as medicine, defence equipment, etc.).

Under the Liberalisation Policy, the government of India introduced various

economic reforms. These reforms are:

•Industrial Sector Reforms: This reform included policies like Reduction in

Industrial Licensing, Decrease in the Role of the Public Sector, De-reservation
under Small-Scale Industries, and the Monopolies and Restrictive Trade
Practices (MRTP) Act.
•Financial Sector Reforms: This reform included policies like
Change in the Role of RBI, Origin of Private Banks, Increase in
limit of Foreign Investment, and Ease in the Expansion Process.

•Tax Reforms: There are generally two types of taxes, Direct and
Indirect Taxes. This reform included policies like the
Rationalisation of Direct Taxes, Reform in Indirect Taxes, and
Simplification of Process.

•Foreign Exchange Reforms: This reform included policies like the

Devaluation of Rupee and Market Determination of Exchange
Rate.

•Trade and Investment Policy Reforms: This reform included

policies like the Removal of Quantitative Restrictions on Import
and Export, Removal of Export Duties, Restriction in Import
Duties, and Relaxation in Import Licensing System.
Impact of Liberalisation
Positive Impact of Liberalisation in India
Free flow of capital: Liberalisation has enhanced the flow of capital by making it
affordable for the businesses to reach the capital from investors and take a profitable
project.
Diversity for investors: The investors will be benefitted by investing a portion of their
business into a diversifying asset class.
Impact on agriculture: In this area, the cropping designs have experienced a huge
change, but the impact of liberalisation cannot be accurately measured. Government’s
restrictions and interventions can be seen from the production to the distribution of
the crops even today.
Negative Impact of Liberalisation in India
The weakening of the economy: An enormous restoration of the political power and
economic power will lead to weakening the entire Indian economy.
Technological impact: Fast development in technology allows many small scale
industries and other businesses in India to either adjust to changes or shut their
businesses.
Mergers and acquisitions: Here, the small businesses merge with the big companies.
Therefore, the employees of the small companies may need to enhance their skills
and become technologically advanced. This enhancing of skills and the time it might
take, may lead to non-productivity and can be a burden to the company’s capital.
Privatisation
Privatisation refers to the partial or full ownership and operation of public
sector enterprises by the private sector. It implies the withdrawal of
government ownership from the public sector. It can be done in two ways:
1. Outright sale of part of the equity of Public Sector Undertakings (PSUs) to
private entrepreneurs (also known as Disinvestment), or
2. Withdrawal of ownership and management of the public sector companies
from the government to the private sector.

The need for privatisation was felt mainly because of the poor performance of
the Public Sector Undertakings. As a result, the consumers were facing a
major loss, as they did not receive quality products, and other services, such
as poor delivery systems, etc. With the introduction of the privatisation policy,
this factor was eliminated.
•Unlike PSUs, Privatisation promoted the diversification of production.
•Unlike PSUs, the Privatisation of enterprises generated higher profits.
•It also promoted customer superiority.
•Unlike PSUs, Privatisation provides high productivity.
•Unlike PSUs, Privatisation promoted growth and development by working in a
competitive environment.
Objectives of Privatisation
Providing strong momentum for the inflow of FDI
Privatisation aims at providing a strong base for the inflow of FDI.
The increased inflow of FDI improves the financial strength of the economy.
Improving the efficiency of public sector undertakings (PSUs)
The efficiency of PSUs is improved by giving them the autonomy to make
decisions.
Some companies were given special categories of Navratna and Miniratna.
Ways of Privatisation:
Transfer of ownership
Government companies can be converted into private companies in the following
two ways:
•By the withdrawal of the government from the ownership and management of
public sector companies
•By the outright sale of public sector companies.
Disinvestment
•Privatisation of the public sector undertakings by selling off parts of the equity
of PSUs to the private sector is known as disinvestment.
•The purpose of the sale is mainly to improve financial discipline and facilitate
modernisation.
However, there are six methods of privatisation.
•Public sale of shares
•Public auction
•Public tender
•Direct negotiations
•Transfer of control of enterprises that were controlled by the
state or by municipalities
•Lease with a right to purchase
What are the pros of privatisation?
•Improved performance and customer experience
•Politics does not interfere
•Short-term outlook
•Encouragement for shareholders to invest because of returns
•Increased competition
•The government will increase the revenue from the sale
Disadvantages of Privatization
1) Natural Monopoly
Privatization in some sectors where there is low competition may lead to
the monopoly of a single private firm. Having complete monopoly over a
particular sector, the firm gets a free hand to compromise its quality and fix
higher price rates, etc., to churn out large profits. On the other hand, a
government-run agency would have prioritized public interest over profit.
2) Decline in Public Interest
Private companies dealing mainly in public welfare sectors like health,
education, and others are more profit-oriented than welfare-oriented. This
dearly costs the common person in the form of excessive taxes, higher
prices, and a poor state of quality and services.
3) Lack of Regulations
Privatization slips the power of financial and other managerial decisions out
of the government into private hands. This means that the government has
limited or no say in the company’s decisions; neither can the government
impose much regulation over the functioning of the company or its policies.
4) Low Future Investment
Private firms, out of the government’s regulation and control, may
look out for short-term gains, compromising the long-term future
projects. This forces the companies to invest in short-term
beneficial projects rather than long-term ones.

5) Fragmentation of Companies
Privatization might lead to the breaking up of one giant company
into several other rather small enterprises. This fragmentation
ultimately decreases the efficiency and also reduces the
accountability in the management. Companies throw the
responsibility for any losses onto each other and try to escape
responsibility.
Globalisation
Globalisation refers to the integration of the economy of a country with the
economies of other countries. The process of globalisation is associated with
the free flow of trade, capital across borders, increasing openness, growing
economic independence, and deepening economic integration in the world.
The Globalisation of the economy is considered to be a complex phenomenon
as it is a result of a set of various policies that aim at integrating an economy
with the world and transforming it towards greater interdependence.

Objective of Globalisation:
•The main aim of globalisation was to integrate the Indian economy with the
global economy.
•As a result, there will be an unrestricted flow of information, goods and
services, technologies, and even people within countries, which will eventually
enhance the development of the country.
Measures adopted for Globalisation:
1. The government allowed foreign companies to hold 51 percent or more shares
of the Indian companies in the case of collaboration so that they can function
freely and as the owner.
2. This also promoted the transfer of the latest technologies into Indian territory
due to collaboration with MNCs.
3. The reduction of the tariff and non-tariff barriers, adoption of policies to
promote exports, increase in Foreign Investments, increase of foreign currency
in the country (Forex), growth of the IT industry in India, and several other
features came under the globalisation policy.
Advantages of Globalisation in India:
1. 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.

2. 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.

3. 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.
4. Access to New Markets
Globalization gives businesses the opportunity to expand into new markets,
reach international buyers, and increase revenue.
Over time, companies can experience saturation for demand of their
products or services domestically. By expanding globally, they can continue
growing by meeting foreign demand.

5. Spread of Knowledge and Technology

In order to cooperate globally, companies must share similar technology
and a technological structure. E-commerce, for example, allows companies
to sell products worldwide through Amazon.com.
Similarly, a centralized base of knowledge allows companies to quickly
transfer information and develop innovative solutions. For example, in
the healthcare sector that means new medications and medical devices can
go to market faster in different countries.
6. Enhanced Global Cooperation and Tolerance
Globalization enhances cooperation by enabling countries to specialize.
This allows them to leverage their economic strengths and trade those
products for other resources. For example, a country in South America that
specializes in sugar cane can export it to a developed country in exchange
for manufactured goods.
On an interpersonal level, studies have shown that globalization promotes
tolerance, as people are exposed to new cultures and network with others
across the globe.
7. Promotes Economic Growth
Studies have found that globalization enhances economic growth by
distributing resources more efficiently because countries can specialize in
activities with comparative advantages. It also promotes growth indirectly
through complementary reforms in terms of capital and financial
development.
China, the country with the biggest positive change in globalization, saw a
growth rate in 2000 that is 2.33 percentage points higher than in 1975 due
to increased integration.
Disadvantages of Globalization
1. Increased Competition
Although free trade can increase a nation’s wealth, it also increases
competition. Local businesses must compete with multinational
corporations that produce cheaper goods at lower costs, which puts them
at a disadvantage.
At the same time, the increase in choices impacts buying behaviors, as
customers expect high quality products at low prices. That means
companies must continuously adapt to meet demands.
2. Exploitation of Labour and Resources
Wealthy, industrialized nations sometimes enter trade agreements with
developing countries in order to exploit weak labour and environmental
laws. For example, the United States has been known to use foreign
sweatshop labour to produce cheaper goods.
Lack of environmental regulations in some developing countries also
allows developed countries to import resources such as precious metals at
lower prices. This results in both lasting environmental damage and
human rights abuses.
3. Imbalanced Trade
A trade imbalance, also known as a trade deficit, occurs when a country
spends more on imports than it makes on exports. This creates a shortfall in
capital that the country must make up for either by borrowing money from
foreign lenders or permitting foreign investments in its assets.
While lending and investment help promote economic growth, these
strategies can be risky—especially for a developing country. Throughout the
1990s, Thailand, Indonesia, and Malaysia ran large trade deficits and relied
on foreign capital to make up for it. Yet when the Asian financial crisis hit in
1997, foreign investors backed out, leaving these countries in a precarious
financial position.
4. Domestic Job Loss
When industrialized countries outsource labour, it causes a shortage of jobs
domestically. Labourers whose skills are no longer in demand experience
higher unemployment, and struggle to adapt to the changing labour market.
For example, the U.S. trade deficit with China eliminated 3.7 million
jobs between 2001 and 2018, and more than 75% of those losses were in
manufacturing.
Benefits of the LPG Policy
1. Due to the Liberalisation of the economy, the market got opened up to
more foreign investments and import and export of goods.
2. The Liberalisation Policy helped in reducing the dependence on foreign
loans and expand the banking sectors and capital markets.
3. Privatisation Policy helped in opening up the industries, that were
reserved for the public sector, to the private sector.
4. Privatisation Policy helped in reducing the monopolies of the government
by increasing competition.
5. Privatisation of PSUs resulted in the promotion of efficient and improved
quality of goods and services for the consumers.
6. The Globalisation Policy helped in opening the local market to the global
market which helped India in connecting with the global financial markets.
7. It helped in opening up the economy to foreign direct investment and
reducing international trade restrictions.