How 1991 Economic Reforms Changed India?

How 1991 Economic Reforms Changed India?

This is a guest blog by Aneesh.
Economic reforms were initiated in 1991, with the goal of making the economy more market-oriented and expanding the role of private and foreign investment. After 25 years of this creditable work done it is time to look back to realize what we achieved. In this blog, Aneesh discusses the important issues related to the reforms and understand why the process stagnated and what is the way ahead.

 Economic Crisis

By 1985, India had started having balance of payment problems. By the end of 1990, India was in a serious economic crisis. The government was close to default, the RBI had refused new credit and forex reserves could barely finance three weeks’ worth of imports which led the Indian government to airlift national gold reserves as a pledge to the IMF in exchange for a loan to cover balance of payment debts.

Causes of Crisis

The economic crisis was primarily due to the large and growing fiscal imbalances over the 1980s. In addition to it, currency overvaluation, the current account deficit and investor confidence played significant role in the sharp exchange rate depreciation. India’s oil import bill swelled, exports slumped, credit dried up, and investors took their money out as repercussions of the Gulf War. Large fiscal deficits, over time, had a spill-over effect on the trade deficit culminating in an external payments crisis, leading India into deep economic trouble.

Objectives of Reforms

As per the Ministry of Finance, July 1993, the objectives of the reforms were:
…to bring about rapid and sustained improvement in the quality of the people of India. Central to this goal is the rapid growth in incomes and productive employment… The only durable solution to the curse of poverty is sustained growth of incomes and employment… Such growth requires investment: in farms, in roads, in irrigation, in industry, in power and, above all, in people. And this investment must be productive. Successful and sustained development depends on continuing increases in the productivity of our capital, our land and our labour…”

Major  Actions

Fiscal Reforms: A key element in the stabilization effort was to restore fiscal discipline. The fiscal deficit during 1990-91 was as large as 8.4 percent of GDP. The budget for 1991-92 took a bold step in the direction of correcting fiscal imbalance. It envisaged a reduction in fiscal deficit by nearly two percentage points of GDP from 8.4 percent in 1990-91 to 6.5 percent in 1991-92.
 Capital Markets: Recommendations of the Narasimham Committee were initiated in order to reform capital markets, aimed at removing direct government control and replacing it with a regulatory framework based on transparency and disclosure supervised by an independent regulator. The Securities & Exchange Board of India (SEBI) which was set up in 1988 was given statutory recognition in 1992 on the basis of recommendations of the Committee. SEBI has been mandated to create an environment which would facilitate mobilization of adequate resources through the securities market and its efficient allocation.
Monetary and Financial Sector: Monetary reforms aimed at doing away with interest rate distortions and rationalizing the structure of lending rates. The new policy tried in many ways to make the banking system more efficient. Some of the measures undertaken were:

  • Reserve Requirements: In mid-1991, SLR and CRR were very high. It was proposed to cut down the SLR from 38.5 percent to 25 percent within a time span of three years. Similarly, it was proposed that the CRR be brought down to 10 percent from the earlier 25 percent over a period of four years.
  • Interest Rate Liberalization: Earlier, RBI controlled the rates payable on deposits of different maturities and also the rates which could be charged for bank loans which varied according to the sector of use and also the size of the loan. Interest rates on term deposits were decontrolled in a sequence of steps beginning with longer term deposits, and liberalization was progressively extended to deposits of shorter maturity.
  • Greater competition among public sector, private sector and foreign banks and elimination of administrative constraints.
  • Liberalization of bank branch licensing policy in order to rationalize the existing branch network. Banks were given freedom to relocate branches and open specialized branches.
  • Guidelines for opening new private sector banks.
  • New accounting norms regarding classification of assets and provisions of bad debt were introduced in tune with the Narasimham Committee Report.

Industrial Policy: The government announced a New Industrial Policy on 24 July 1991, in order to consolidate the gains already achieved during the 1980s and to provide greater competitive stimulus to the domestic industry. The New Industrial Policy sought  to promote growth of a more efficient and competitive industrial economy. The central elements of industrial policy reforms were as follows:

  • Industrial licensing was abolished for all projects except in 18 industries. With this, 80 percent of the industry was taken out of the licensing framework.
  • The Monopolies & Restrictive Trade Practices (MRTP) Act was repealed to eliminate the need for prior approval by large companies for capacity expansion or diversification.
  • Areas reserved for the public sector were narrowed down and greater participation by private sector was permitted in core and basic industries. The new policy reduced the number of areas reserved from 17 to 8. These eight are mainly those involving strategic and security concerns.
  • The policy encouraged disinvestment of government holdings of equity share capital of public sector enterprises.
  • The public sector units were provided greater autonomy and professional management that could be helpful for generating reasonable profits, with the help an MOU between the enterprise and the concerned Ministry, through which targets that the enterprise had to achieve were set up.

Rationalization of Exchange Rate Policy: One of the important measures undertaken to improve the balance of payments situation was the devaluation of rupee. In the very first week of July 1991, the rupee was devalued by around 20 percent. The purpose was to bridge the gap between the real and the nominal exchange rates that had emerged on account of rising inflation and thereby to make the exports competitive.
 
Trade Policy Reforms: Under trade policy reforms, the main focus was on greater openness. Hence, the policy package was essentially an outward-oriented one. New initiatives were taken in trade policy to create an environment which would provide a impetus to export while at the same time reducing the degree of regulation and licensing control on foreign trade. The main feature of the new trade policy as it has evolved over the years since 1991 are as follows:

  • Unrestricted imports and exports: Prior to 1991, in India imports were regulated by means of a positive list of freely importable items. From 1992, imports were regulated by a limited negative list. For instance, the trade policy of 1 April 1992, freed imports of almost all intermediate and capital goods. Only 71 items remained restricted.
  • Rationalization of tariff structure: As a first step towards a gradual reduction in the tariffs, the 1991-92 budget had reduced the peak rate of import duty from more than 300 percent to 150 percent. The process of lowering the customs tariffs was carried further in successive budgets.
  • Trading Houses: The 1991 policy allowed export houses and trading houses to import a wide range of items. The Government also permitted the setting up of trading houses with 51 percent foreign equity for the purpose of promoting exports.

Promoting Foreign Investment: The government took several measures to promote foreign investment in India in the post-reform period. Some of the important measures were:

  • In 1991, the government announced a specified list of high technology and high-investment priority industries wherein automatic permission was granted for foreign direct investment (FDI) up to 51 percent foreign equity. The limit was raised to 74 percent and subsequently to 100 percent for many of these industries. Moreover, many new industries have been added to the list over the years.
  • Foreign Investment Promotion Board (FIPB) has been set up to negotiate with international firms and approve direct foreign investment in select areas.
  • Steps were also taken from time to time to promote Foreign Institutional Investment (FII) in India.

Impact of Reforms

Positive

  • Through the reforms, India overcame its worst economic crisis in the remarkably short period of two years.
  • Owing to prudent macroeconomic stabilization policies including devaluation of rupee and other structural reforms, the crisis was over by the end of March 1994 and foreign exchange reserves rose to USD 15.7 billion. Inflows of both FDI and FII into India increased massively.
  • India also increasingly integrated its economy with the global economy. The ratio of total exports of goods and services to GDP in India approximately doubled from 7.3 percent in 1990 to 14 percent in 2000. Within 10 years, the ratio of total goods and services trade to GDP rose from 17.2 percent to 30.6 percent.
  • Reforms led to increased competition in the sectors like banking, leading to more customer choice and increased efficiency. It has also led to increased investment and growth of private sector.
  • It led to a fall in inflation rates as reforms pushed up production of goods and services resulting in either prices falling or remaining constant.
  • Poverty reduced from 36 percent in 1993-94 to 26.1 percent in 1999-00. The poverty ratio in rural areas and in urban areas declined.
  • Expansion in the civil aviation sector was possible due to reforms. In order to promote competition, the government adopted the Open Skies Policy through which private players were allowed into aviation sector in 1991.
  • As a result of the reforms that opened the borders to foreign goods, there was easier access to foreign technology. A good example of this is cell phone technology.
  • India also saw an expansion of the automobile sector, easy availability of motor vehicles, increased competition in the sector and reduction in prices of motor vehicles.
  • Reforms led to the achievement of recognizable increases in international competitiveness in a number of sectors including auto components, telecommunications, software, pharmaceuticals, biotechnology, research and development, and professional services provided by scientists, technologists, doctors, nurses, teachers, management professionals and similar professions.
  • Telecommunications sector has been one of the biggest beneficiaries of economic reforms. Once heavily shackled by regulation and government monopoly, the sector now has several competing service providers. The telecom policy evolved from the National Telecom Policy in 1994 to open up all the sectors to private players.

Negative

  • The reforms were largely in the formal sector of the economy. Agriculture rural population did not see any reforms. This led to uneven growth and unequal distribution of wealth among people.
  • Market-based economic reforms also led to increasing disparities between the rich and the poor and between backward and more developed states.
  • Social sectors like health and education took a backseat under the new reforms. Though very essential, they were not focused upon as a result of which the quality of education and health remains far away from international standards.
  • Economic reforms though having accelerated growth, failed to generate adequate employment.
  • The issue of corruption was not tackled at all.

Prognosis

The process of reforms was far from smooth. The grave economic condition gave the leaders the liberty to initiate reforms. Once the economic condition improved the process of reforms slowed, coming to a standstill under the UPA-II government. The reforms faced serious criticism, particularly from the communists in 1991. The benefits of the reforms were so obvious and far reaching that the critics were shut up. The capitalists won the ideological war in India over the communists.
India has embarked on a process of growth and development once again. It is unfortunate that Indian society awaits a crisis to reform and lack of crisis gets us back to business as usual. It is important to learn from the past reforms that the process should not be allowed to stagnate and continued with vigour. We must ensure inclusive growth by improving agriculture, rural economy, rural infrastructure, labour laws, education and public health. The global environment is favourable with India being one of the most attractive investment destinations; the prices of oil are down and likely to remain so. We are blessed with the demographic dividend. We must not lose the opportunity.

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1 Comment

  1. Thank you very much Mr. Aneesh.!!! I have been trying to understand this topic for very long time. You explained it in crystal clear manner.
    Thank you Sir, for publishing this article on your blog.

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