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Economic Reforms

Following independence, India adopted a mixed economic system with both public and private sector involvement. Over time, the public sector came to dominate the economy and private sector growth was neglected. This led to economic issues like high deficits, debt, and inflation. By 1991, India was facing a severe economic crisis and turned to the IMF for assistance. As a condition of assistance, India was required to liberalize its economy through reforms like reducing the role of public sector, lifting restrictions on private sector, and removing trade barriers. This New Economic Policy aimed to create a more competitive environment and remove barriers to growth. However, critics argue the reforms negatively impacted agriculture, employment, and public investment.
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0% found this document useful (0 votes)
56 views10 pages

Economic Reforms

Following independence, India adopted a mixed economic system with both public and private sector involvement. Over time, the public sector came to dominate the economy and private sector growth was neglected. This led to economic issues like high deficits, debt, and inflation. By 1991, India was facing a severe economic crisis and turned to the IMF for assistance. As a condition of assistance, India was required to liberalize its economy through reforms like reducing the role of public sector, lifting restrictions on private sector, and removing trade barriers. This New Economic Policy aimed to create a more competitive environment and remove barriers to growth. However, critics argue the reforms negatively impacted agriculture, employment, and public investment.
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Pre-Reform Scenario

Since independence, India has followed a mixed economic system in which the
advantages of both capitalist (market) and socialist (planned) economies are
combined. Under this system, the government and private sector play an
equivalent role in the economy. Although there is some economic freedom in
the use of capital, the government also interferes in economic activities to
promote social welfare. India started its development from stagnation to an
economy that achieved growth in savings and experienced expansion of
agricultural output, which ensured food security. Moreover, there was a
diversification of the industrial sector that helped in producing goods and
services.

The economic situation prior to reform can be summarized as follows:


Following independence, Indian economic policy was primarily influenced by
the exploitative colonial experience and Fabian socialism (aimed to promote
equality of power, wealth, and opportunity).
The Indian leaders (like Jawahar Lal Nehru) found an alternative to extreme
cases of the socialist and capitalist economy, which is the mixed economic
system.
In this, both the public and private sector exists in the economy, with a solid
public sector but also private property and democracy.
This policy focuses on ‘protectionism’ in which domestic industries are
protected, along with import substitution, which includes regulating the import
of foreign goods and promoting products in the domestic market.
Later, there was monitoring of industries, state interference at the micro level in
businesses like financial markets, and the existence of a substantial public sector
in the economy.
In reality, the private sector was neglected, and the public sector controlled the
economy. Significant investments were made in the public sector and minor in
the private sector. It established several rules and regulations that focus on
regulating the economy. It resulted in preventing growth and development.

In 1991, the economic crisis hit India related to external debt. The government
was unable to make payments of the borrowings abroad. The foreign reserves
used to manage imports declined to a level that was not even enough for two
weeks. It further leads to a rise in the prices of essential goods.

Nature of Economic Crisis


From 1980, we can trace the beginning of the economic crisis. At that time,
there was ineffective management of funds.
To implement the policies and administration, the government needs money for
which it gets funds from taxes and public enterprises. In case, Expenditures are
more than Income, the government borrows from banks, its citizens, and
financial institutions.
The government kept on spending its income (on the areas like defense and the
social sector), and there were no returns. Therefore in 1985, India started facing
the BoP problems. It was due to heavy expenditure by the government in
comparison to the low income, which widens the gap between income and
expenditure.
By 1990 end, it was a severe economic crisis. The government was on the verge
of going into default. Later, the central bank refused to give credit.
In 1991, the crisis ultimately met India. The government was unable to make
repayments for the loan abroad.
The foreign exchange reserves dropped to the level that it was insufficient to
last even a fortnight.
The crises further lead to an increase in the prices of essential goods.
The government introduced a new set of policy measures that shifted the focus
of our development initiatives.

Need for Economic Reforms


The economic condition of India in 1991 was pathetic. The government was
unable to generate revenues from the sources like taxation. The income from
public enterprises was also low. However, the government has to spend more on
various issues like unemployment, overpopulation, and poverty, which
increases the need to introduce economic reforms in India.
Economic Reforms are the set of economic policies that aims to accelerate the
pace of growth and development in the economy.

In 1991, the Government of India commenced several economic reforms to get


the economy out of the 90s crisis and improve economic growth. Narasimha
Rao’s Government initiated these reforms to increase confidence in the Indian
economy. It was due to the combined effect of various reasons. The reasons for
the country’s reforms are described below:

1. Poor Performance of the Public Sector:


In the period 1951-1990, the majority of the industries were owned by the
public sector. They were assigned the responsibility of the growth and
development of an economy. Nevertheless, the performance of these enterprises
was very depressing. The employees were neither competitive nor effective
because of job security. This means even if they do not work, they had no fear
of losing their job. The ultimate authority lies with the State. Despite several
disciplinary measures, these enterprises were facing huge losses. It was only the
economic reforms that could help the Indian economy to move in a new
direction. Therefore, the government recognized the need to make these
reforms.

2. A Deficit in Balance of Payment:


It was one of the most significant factors in bringing economic reforms to the
country. The deficit in BoP arises when the foreign payments are more than
foreign receipts. There was an increase in imports besides heavy tariffs and
quotas. However, the exports were low since domestic goods were expensive in
the international market. The only action that would be effective was to get
external help and introduce a new economic policy. This contributed to laying
the foundation of economic reforms in India.

3. Rising Inflation:
There was a persistent rise in the price level of goods and services in the
economy. The rate of inflation was tremendous, poor people were not able to
afford essential foods. Besides, there was a need to inject liquidity into the
economy, which caused a need for economic reforms in India.
4. Massive Debt Burden:
The government expenditure on developmental activities was more than its
revenue from taxation. As a result, the government borrowed from banks, the
public, and financial institutions like IMF.

5. Shortage in Forex Reserves:


The foreign exchange crisis resulted from a sharp decline in foreign exchange.
The government at that time could not finance its imports and repay the interest
that needed to be paid to the international lenders.

6. Inefficient Management:
The roots of the economic crisis can be traced to the inefficient management of
funds. The government was not able to generate sufficient funds from the
revenues such as taxation. On the other hand, government expenditure was
rising, which increased the gap between revenues and expenditures. Moreover,
the government borrowed foreign exchange from international markets and
financial institutions used to purchase consumer goods. It ultimately results in
inefficient management of funds.

7. Restrictions from International Institutions:


India received $7 billion in financial assistance from the World Bank and the
International Monetary Fund (IMF) to tackle its crisis. These organizations
expected India to liberate its economy for availing loans by lifting restrictions
on the private sector, reducing the role of the public sector in various areas, and
removing trade barriers with other nations. India agreed to the conditions and
announced New Economic Policy.

For these reasons, the Government announced New Economic Policy (NEP) on
July 1991. This policy aims to create a competitive environment and remove
barriers to entry and growth of firms. But numerous complaints have been made
by critics related to the New Economic Reforms in the areas like agriculture,
employment, infrastructure development, and budgetary control, which are
discussed below:
Criticism of Economic Reforms
1. Growing Agriculture:
Despite the fact that the GDP growth rate has grown during the reform period,
the country has not witnessed enough job opportunities created as a result of
this expansion.

2. Neglect of Agriculture:
The agriculture sector has been overlooked by the new economic policy in
favour of industry, trade, and services.

(i) Reduction of Public Investment: There has been a decline in public


investment in the agriculture sector involving irrigation, power, market ties,
roads, research, and advancement.

(ii) Liberalisation and Reduction in Import Duties: There have been several
policy changes influencing this sector, which include (a) lowering of import
taxes on agricultural goods (b) Elimination of minimum and fair support prices
(c) removing quantitative constraints on agricultural products. Due to growing
international competition, all of these policies had a negative impact on Indian
farmers.

(iii) Removal of Subsidy: Lifting of fertilizer subsidies increased production


costs, which adversely impacted the small and marginal farmers.

(iv) Shift towards Cash Crops: Agricultural production has switched from food
crops to export crops as a result of export-oriented policy measures.

3. Ineffective Disinvestment Policy:


The government has always set a goal for selling its holding in Public Sector
Enterprises. For example, in 1991-92, the government targeted that
disinvestment will generate ₹2,500 crores. The government has raised ₹3,400
crores more than the target. In 2017-2018, the aim was ₹1,00,000 crore;
however, the actual figure was ₹1,00,057 crore.

But, the government’s disinvestment policy was unsuccessful because:


Public Sector Enterprises were sold to the private sector at a reduced price.
Furthermore, rather than using it for the development of public sector
enterprises and building social infrastructure in the country. The government
used proceeds from disinvestment in compensating shortage of government
revenue.

4. Low Level of Industrial Growth:


The following reasons led to the slowdown in Industrial growth:

(i) Cheaper Imported Goods: There was a great flow of goods and capital from
developed countries like the USA, and as a result, domestic industries were
exposed to imported goods because of globalisation. The demand for domestic
products was replaced by cheaper imports, and domestic producers started to
face import competition.

(ii) Non-Tariff Barriers by Developed Countries: The Government removed all


quota restrictions on exports of textiles and clothing. However, several
developed countries like the USA have not removed their quota restrictions on
the import of textiles from India.

(iii) Lack of Infrastructure Facilities: There was a lack of investment in the


infrastructure facilities, which include power supply. Thus it remained
inadequate.

5. Ineffective Tax Policy:


During the reform period, tax reduction was done to generate larger revenue and
to curb evasion of tax. But, it did not result in an increase in the tax revenue for
the government.
The scope for raising revenue through customs duties was decreased by Tariff
Reduction.
To attract foreign investment tax incentives were provided, which further
reduced the scope of raising tax revenues.

6. Spread of Consumerism:
An unfavourable trend has been driven by the new economic policy by
encouraging the production of luxuries and items of superior consumption.

7. Unbalanced Growth:
Growth has been limited to limited areas of the service sector like
telecommunication, information technology, finance, entertainment, real estate,
trade, and hospitality rather than essential sectors such as agriculture and
industry, which employ millions of people in the country.
Economic reforms simply denote the process in which a government prescribes
less role for the state and expanding role for the private sector.

Major Economic Reforms in India:

Due to the fiscal and balance of payment (BoP) crisis, India launched a process
of Economic Reforms on July 23, 1991, During the Narasimha Rao
government. The economic crisis of 1991 was the simultaneous accumulation of
a large number of events. Though liberal policies were announced by the
government during the 1980s with the slogan of economic reforms it didn’t
materialize much, thus economic reforms were launched with full conviction in
the early 1990s.

Reasons for Major Economic Reforms:


• Collapse of Soviet Union
• The Gulf War
• Political Uncertainty
• Rising Fiscal Deficit
• Grave External Payment Crises (Balance of Payment)
• Gulf Crisis
However, the crisis was converted into an opportunity to bring about
fundamental changes in the approach and conduct of economic policy.

NEW ECONOMIC POLICY


New Economic Policy was based on LPG or Liberalisation, Privatisation and
Globalisation model. This model refers to economic liberalisation or relaxation
in the import tariffs, deregulation of markets or opening the markets for private
and foreign players, and reduction of taxes to expand the economic wings of the
country. The reforms taken under this became part of structural reforms.

STEPS TAKEN UNDER LIBERALISATION

Deregulation / Delicensing of the Industrial Sector:


1. Industrial licensing was abolished for almost all the products. But product
categories — alcohol, cigarettes, hazardous chemicals, industrial explosives,
electronics, aerospace and drugs and pharmaceuticals were regulated.
2. Industries being reserved for the general public sector are defence equipment,
nuclear energy generation and railway transport.
3. Goods produced by small-scale industries have now been deserved.

Financial Sector Reforms:


1. Financial sector includes financial institutions like commercial banks,
investment banks, stock market operations and exchange markets.
2. One of the main aims of monetary sector reforms is to scale back the role of
RBI from the regulator to facilitator of the monetary sector.
3. The reform policies led to the establishment of private sector banks (Indian as
well as foreign. )
4. Foreign investment limit in banks was raised to around 50 per cent.
5. Foreign Institutional Investors (FII) like merchant bankers, mutual funds and
pension funds are now allowed to invest in Indian financial markets.

Tax Reforms:
1. It is concerned with the reforms in the government’s taxation and public
expenditure policies which are collectively known as its fiscal policy.
2. The rate of corporation tax, which was very high earlier, has been gradually
reduced. Efforts have also been made to reform the indirect taxes.
3. In order to encourage better compliance on the part of taxpayers many
procedures have been simplified and the rates also substantially lowered.

Foreign Exchange Reforms (External Sector Reforms):


To resolve the balance of payments crisis, the rupee was devalued (depreciated)
against foreign currencies

Trade and Investment Policy Reforms:


1. Quantitative restrictions on imports and exports were dismantled.
2. Reduction of tariff rates and
3. Removal of licensing procedures for imports
4. Import licensing was abolished except in the case of hazardous and
environmentally sensitive industries.
5. Export duties have been removed to increase the competitive position of
Indian goods in the international markets.
PRIVATIZATION

1. It refers to the transfer of ownership of a property from a government to


private players.
2. Privatisation basically means selling up the shares of public sector
undertakings to private players. It was transferring of ownership or management
to private companies, either partially or entirely.
3. Privatisation was different from disinvestment in the sense that, selling off
part of the equity of PSEs to the public is known as disinvestment. The purpose
of disinvestment, according to the government, was mainly to improve financial
discipline and facilitate modernization.
4. Privatisation resulted in the opening of the public sector to industries that
were previously reserved for the government sector.

GLOBALISATION

1. Globalisation means, generally, the integration of the economy of the country


with the world economy.
2. Outsourcing was one of the important outcomes of the globalisation process.
3. Under outsourcing, a company hires regular service from external sources,
mostly from other countries, which was previously provided internally or from
within the country.

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