Liberalization of the Indian Economy, 1991
The Balance of Payment crisis of 1991 had created an unprecedented situation for Indian policymakers. India was on the verge of default on its sovereign debt obligations and had to pledge its gold reserves to the Bank of England as collateral to avail loan from the IMF. This was a moment of reckoning and provided a fertile ground for undertaking reforms which were long overdue.
Background
The reforms of 1991 were not the first attempt to liberalize the economy. Prior attempts in this regard were made in the 1960s and 1980s as well.
A smaller crisis had arisen in 1966 in the aftermath of wars with China (1962) and Pakistan (1965) followed by a drought in 1966 resulting in high inflation and an inflating Government Fiscal Deficit. The crisis forced Indian Government to approach the World Bank and the IMF. As conditions for support, Indian Government devalued the Rupee by 57.5% (from INR 4.76/USD to INR 7.5/USD) and abolished certain export duties. However fearing political backlash over foreign investment, the Government retracted on reforms and instead took a hard turn towards Socialism (like Nationalization of Banks (1969) and passage of MRTP Act (1969) later in the decade).
The recognition that the East Asian Economies (Japan, Taiwan, Singapore having liberal economies) were developing rapidly and the realization that India was lagging behind due to strict Governmental controls over the economy, the Government of India had started taking some baby steps towards liberalization in the 1980s but the approach was not comprehensive and lacked a long term vision. Eventually, the Balance of Payment crisis of 1991 forced Indian policymakers to take some drastic steps.
Overview
The new Indian Government was elected in June 1991 (10th Lok Sabha elections). The Government of India had taken loans from the World Bank and the IMF during the 1991 crisis. But these loans came with conditions to initiate certain economic measures under the Structural Adjustment Programme. The Government immediately took these steps. The reforms were undertaken in various domains.
Fiscal Policy Reforms
One of the major reasons for precipitation of the Balance of Payment crisis was the burgeoning Fiscal Deficit. So the Government initiated measures to lower the deficit. This included both limiting the expenditure and improving the receipts. The Government cut down the budget on subsidies (Fertilizers, sugar etc.). For improving the receipts the Government took several policy measures like disinvestment and tax reforms. The Government aimed to increase tax revenues through more transparent and rational tax structure and better tax compliance.
Monetary Sector Reforms
In addition to fiscal reforms; initiatives were taken to reform the Monetary sector as well.
The Government reduced the reserve requirements. The Statutory Liquidity Ratio was cut down from 38.5% to 25% and the Cash Reserve Ratio was dropped from 25% to 10% over a horizon of 3 years. Both these measures led to increased liquidity in the system
The Government also encouraged the entry of the private sector banks. The branch localization policy was rationalized giving more flexibility to the banks in locating their new branches including the option to relocate the branches.
Industrial Reforms
The Government issued a Statement on Industrial Policy in the Parliament in July 1991. The Statement on Industrial Policy, 1991 began the transition from the strict licencing regime prevalent since 1956 towards a more liberal regime with markedly relaxed licensing requirements.
Under the SIP, 1991, the license requirement was abolished for all sectors except 18 sectors which were of strategic importance.
The Government took steps to promote private sector participation in industrial development. The sectors reserved exclusively for the public sector were reduced from 17 to 8.
Foreign Investment norms were eased and upto 51% foreign equity was automatically approved in certain high priority industries. This step enabled attracting foreign investment and transfer of foreign technology. This policy of liberalizing foreign investment was continued gradually by subsequent Governments and now 100% foreign investment is also allowed in multiple sectors. The Government allowed for automatic approval of technology transfer agreements for high priority sectors.
Foreign Investment Promotion Board was established under the Prime Minister’s Office (PMO) in August 1991 for quick approval of foreign investment.
The Monopolies and Restrictive Trade Practices Act, 1973 was amended to remove the condition of prior approval of the Government for capacity enhancement, establishment of new undertakings etc. The act was repealed later on and was replaced with a more liberal Competition Act in 2002.
Trade Policy Reforms
India’s foreign trade was also opened up. The trade policy regime shifted from positive list to negative list. Earlier free imports were allowed only for a limited number of items under Positive List items. For all other items Government approval was necessary.
From April 1992, only limited items listed in the Negative List required prior Government approval. All other items were freely importable.
Similarly the import tariffs were rationalized, the peak tariff rate was reduced from 300% to 150% in the 1991 General Budget, and was lowered further in the successive budgets.
Exchange Rate Rationalization
The Rupee was devalued by ~20% in July 1991 and it made Indian exports more competitive. It also helped to increase India’s foreign reserves which were heavily depleted during the 1991 Balance of Payment crisis.
Impacts
Some of the policy initiatives had an immediate and tangible impact.
Economic
The growth rate of Indian economy witnessed an upward trend since the economic reforms.
Exhibit: India’s GDP Trend (Source: World Bank)
As is clear from the exhibit above, the GDP has witnessed an upward trend from the mid 1990s and the growth rate trend has been fairly consistent (barring few aberrations like in the year 2007 and 2011 due to the Global Financial Crisis and European Debt Crisis respectively).
The foreign reserves improved from 100 million in May 1991 to USD 15.7 billion in 1994. The foreign reserves have risen to USD 590 billion by February 2021. Today India’s foreign reserves surpass the total external debt of USD 554 billion.
India foreign trade also improved significantly. India’s trade (Imports and Exports) increased from 17% of the GDP in 1990–91 to 30% by 2000–01.
There has been a consistent reduction in the poverty rate. The poverty rate has fallen to ~27% in 2015 from a high of 61% in 1961 and 54% in 2005.
The economy has witnessed a massive increase in foreign investment.
Exhibit: Trend of Foreign Investment in India, 1985–2019 (Source: World Bank)
India’s services sector has grown rapidly since 1991. Many MNCs have set up centers in India providing meaningful livelihood opportunities.
India’s domestic sector has also become more competitive and India today is one of the largest producers of pharmaceuticals, automobile components, electronics and other services.
Political
Political rhetoric aside, the successive Governments have embraced the path of reforms to varying degrees. The Narasimha Rao Government had faced political backlash after the opening up of the economy in 1991. The political acumen of Mr Narasimha Rao ensured that despite running a minority Government, his Government could deftly undertake and implement the reforms. The process of reforms and disinvestment had led to fears of loss of jobs but these fears subsided once the benefits of reforms began to percolate among the citizens.
The reforms were continued by the United Front Government (1996–98) with the 1997 budget often termed as the ‘Dream Budget’. The NDA Government began privatization of various Government owned enterprises in hotels, automobiles, telecom and airports. Tax reforms were undertaken and an attempt to reform Fiscal Policy was made through the passage of FRBM Act in 2003. The PPP model was promoted in the infrastructure sector.
The successive UPA Governments (2004–14) continued the process further and sought greater integration of Indian economy with the World economy (even risking the fall of the Government by signing Indo-US Civil Nuclear Agreement). The UPA II regime also introduced 51% FDI in the retail sector in 2011–12. The NDA Government has reformed the indirect tax regime with the implementation of the GST in 2017.
The gradual opening up of the economy and liberalization of the FDI norms has increased competition within the States to attract the foreign investment directly to their States. In fact, various States now organize regular Investment Summits like the Vibrant Gujarat, Magnetic Maharashtra, Progressive Punjab Summits etc. This is health Competitive Federalism which would prove beneficial to the States’ as well as India’s economy.
Negative Aspects
The growth has been limited to the formal sector of the economy. Agriculture productivity didn’t benefit from reforms.
Social
The benefits of the economic reforms have not accrued uniformly to all the sections of the society. The investments have been in the capital intensive industries rather than labour intensive industries. Thus the improvement in livelihood opportunities has not been commensurate with the increase in capital investment.
The boom in the services sector since 1991 has resulted in job creation but these jobs require a higher level of skill set which can only be acquired through access to higher education. The lack of uniform access to higher education has resulted in disparities in access to livelihoods. According to the IMF, the Gini Coefficient has increased in India from 0.45 in 1990 to 0.51 in 2013. The cause behind this increase is growing disparities in rural and urban areas and within urban areas (privileged, educated and underprivileged). Disparity in access to good education has further widened the rift between the rich and the underprivileged.
The reforms have increased regional disparities as well. States in the West (Gujarat and Maharashtra) and South (Tamil Nadu, Karnataka, Andhra Pradesh) have benefitted more by attracting larger foreign investments while the States in the North (Rajasthan, Uttar Pradesh), East (Bihar, Odisha, Jharkhand) and North East India have lagged behind.
Environmental
The process of urbanization and industrialization has led to deterioration of the environment. Urbanization has led to encroachments on the green spaces and urban river channels which have led to frequent urban floods. The level of pollution in rivers like Ganga and Yamuna have worsened especially in the channel stretches that pass through urban centers like Delhi and Kanpur.
The development projects (like mining, infrastructure) have led to rapid deforestation, encroachment of wild areas and increased man vs wild conflict especially in the Western Ghats.
The air pollution levels have aggravated in big urban centers. Delhi today has the dubious distinction of being the most polluted city in the world. A report released by AirVisual (a Swiss based firm collecting pollution data at global level) listed down 30 most polluted cities in the world of which 21 were from India.
Way Forward
There is no doubt that economic reforms of 1991 have had a major impact on the economic growth in India. India today is one of the fastest growing economies and is poised to quickly recover from the setback caused by the COVID-19 pandemic. Indian economy has come a long way from the 1950s wherein India was dependent on foreign aid for survival to becoming a global supplier of COVID vaccines. The economic reforms of 1991 were the avenue of this transformation.
Nevertheless, India still has to make much progress. While India is poised to become the third largest economy in the world before the end of this decade; in terms of per Capita GDP, India’s ranks lowly ~120–130 at global level. India is still a lower middle income country and requires rapid transformation in order to transition towards the middle income economy and eventually a developed economy.
The reform process that began in 1991 has to be continued further but emphasis must be on making the process more inclusive and sustainable. The Government has to channel its resources in providing equitable access to health and education while leaving the business of business to the business.
Conceptual and Explanatory Notes
Positive List
In International trade, the positive list enumerates the items on which the country has lowered the tariffs or the trade barriers. Items not included in the list have higher tariffs or other restrictions (like quotas). More specifically the Positive List items are covered under Market Access and National Treatment commitments.
Negative List
In International trade, the negative list enumerates the items on which the country will maintain high tariffs or the trade barriers. For items not mentioned in the list there are no trade barriers or other restrictions and the domestic and foreign suppliers/manufacturers face the same conditions.
