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India’s 1991 liberalisation leap and lessons for today

Context:

2021 will mark 30 years since the 1991 LPG reforms which were hugely successful, but there is still some progress to be made.

Relevance:

GS-III: Indian Economy (Planning, Mobilisation of resources, Growth and development of Indian Economy)

Dimensions of the Article:

  1. Situations before 1991 Reforms
  2. Reforms of 1991
  3. Why were the reforms needed?
  4. Approaching IMF & IBRD for Loan
  5. What changed and how with the 1991 LPG reforms?

Situations before 1991 Reforms

  • The private sector was not allowed to invest in several sectors thought to be critical for development. The so-called “commanding heights” were reserved for the public sector despite its lacklustre performance.
  • Where the private sector was allowed, it could invest only after getting an industrial licence, and that was especially hard to get for “large” industrial houses.
  • Over 860 items were reserved exclusively for small-scale producers, including many that had very high export potential. Imports were more strictly controlled than in almost any other developing country because it was felt necessary to conserve scarce foreign exchange.
  • Consumer goods simply could not be imported so domestic producers faced no import competition. Producers could import capital goods and intermediates needed for production, but this generally required an import licence which was given only if the government was satisfied that the import was essential and domestic substitutes were not available.
  • Importantly, the import of technology was controlled and Foreign Direct Investment (FDI) was discouraged.

Reforms of 1991

  • In 1991, India met with an economic crisis relating to its external debt — the government was not able to make repayments on its borrowings from abroad; foreign exchange reserves, which we generally maintain to import petroleum and other important items, dropped to levels that were not sufficient for even a fortnight.
  • The crisis was further compounded by the rising prices of essential goods.
  • All these led the government to introduce a new set of policy measures that changed the direction of our developmental strategies.
  • In 1991, in response to a major balance-of-payments crisis, India made a radical shift away from its long-standing policy of inward orientation, and the subsequent reforms have moved the policy regime significantly towards market orientation, deregulation, and liberalization.
  • Indian industry has responded to the increased competition – domestic as well as foreign – with significant restructuring although the constraints arising from poor infrastructure, largely unreformed public sector, slowly reforming banking sector, inflexible labour laws, and other barriers to exit stand in the way of faster adjustment to the new and emerging policy regime which is inspired by market orientation.

Why were the reforms needed?

  • Development policies required that even though the revenues were very low, the government had to overshoot its revenue to meet challenges like unemployment, poverty and population explosion.
  • The continued spending on development programmes of the government did not generate additional revenue back then. Moreover, the government was not able to generate sufficiently from internal sources such as taxation.
  • When the government was spending a large share of its income on areas that do not provide immediate returns such as the social sector and defence, there was a need to utilise the rest of its revenue in a highly efficient manner.
  • The income from public sector undertakings was also not very high to meet the growing expenditure. At times, our foreign exchange, borrowed from other countries and international financial institutions, was spent on meeting consumption needs.
  • Neither was an attempt made to reduce such profligate spending nor sufficient attention was given to boost exports to pay for the growing imports.
  • In the late 1980s, government expenditure began to exceed its revenue by such large margins that meeting the expenditure through borrowings became unsustainable. Prices of many essential goods rose sharply. Imports grew at a very high rate without matching the growth of exports and foreign exchange reserves declined to a level that was not adequate to finance imports for more than two weeks.
  • There was also not sufficient foreign exchange to pay the interest that needed to be paid to international lenders. Also, no country or international funder was willing to lend to India.
  • After the Second World War, almost all the newly independent countries adopted the route of planned development. Though they followed an overall model of the indicative planning, many of them had serious inclination towards imperative planning. As in the case of India, the heavy bias towards imperative planning could only be reformed once the process of economic reforms was started in 1991.

Approaching IMF & IBRD for Loan

  • India approached the International Bank for Reconstruction and Development (IBRD), popularly known as World Bank and the International Monetary Fund (IMF), and received $7 billion as a loan to manage the crisis.
  • For availing the loan, these international agencies expected India to liberalise and open up the economy by removing restrictions on the private sector, reduce the role of the government in many areas and remove trade restrictions between India and other countries.
  • India agreed to the conditionalities of the World Bank and IMF and announced the New Economic Policy (NEP).
  • The NEP consisted of wide-ranging economic reforms towards creating a more competitive environment in the economy and removing the barriers to entry and growth of firms.
  • This set of policies can broadly be classified into two groups: the stabilisation measures and the structural reform measures.
  • Stabilisation measures are short-term measures, intended to correct some of the weaknesses that have developed in the balance of payments and to bring inflation under control. In simple words, this means that there was a need to maintain sufficient foreign exchange reserves and keep the rising prices under control.
  • On the other hand, structural reform policies are long-term measures, aimed at improving the efficiency of the economy and increasing its international competitiveness by removing the rigidities in various segments of the Indian economy. The government initiated a variety of policies which fall under three heads viz., liberalisation, privatisation and globalisation.

What changed and how with the 1991 LPG reforms?

SectorPre-LPGPost-LPG-1991
BankingNationalisation of banks, International economy was not so greatly interconnected Basel norms less stringent.Twin balance sheet syndrome, government required to recapitalise the public sector banks because they cannot do it on their own → Financial burden has increased
Monetary Policy and Fiscal PolicyHigh level of fiscal deficit. RBI’s monetary policy which mandated high level of SLR to finance Government’s borrowing using bank depositors’ money Private sectors investment demand, consumerism has increased therefore RBI is forced to cut down the SLR to increase the loanable funds. Since high level of fiscal deficit was one of the reasons for BOP crisis, now Government has statutory FRBM requirements to control fiscal deficit. RBI has statutory requirement to control inflation – So rampant borrowing from RBI is becoming difficult for government
Private sectorShare of private sector in India’s economic growth and employment generation was limited due to the License Quota Inspector Raj.Drastically increased. Private sector requires ₹20 lakh crores every year for sustaining the current level of Economic Growth and Employment generation Therefore, if the government does not control fiscal deficit → crowding out of the private investment = challenges for India’s growth story.
PSULoss making public sector undertakings were supported by the Government as white elephant.Difficult to sustain the Public Sector Undertakings against the heavy competition of private sector be it Air India or BSNL. Government unable to pay salaries, even no buyers for their privatization
Infrastructure  Population was sparse. Most people didn’t have access to TV, fridge, mobile, internet or social media Their demand for electricity was low.Population has increased. Aspiration of people have increased They want clean water, 24/7 electricity, good quality of roads; Lot of money required for infrastructure finance, Railway alone requires 50 lakh crore between 2016-30, Government can’t spend more than 1.6 lakh crore a year.
Welfare  Right to education, right to food, right to work (MGNREGA) were not yet ‘legal rights’.Now they have become legal rights so the government is required to allocate large amount of funds for them. food subsidy costs ₹ >1.8 lakh crore, MGNREGA ₹ 60k crore Post-LPG era, the level of education and demand for various amenities, and even per capita income has increased, but that has not been a corresponding increase in our tax to GDP (11%, where as countries with similar growth have >20%). This puts further strain on Public Expenditure Management
Public Administration  Small size of Government staff. Their salary levels were also low.Public aspirations have increased, number of welfare schemes increased, Border Security challenges increased → employees have increased 6th pay commission and 7th pay commission → salaries have increased Challenge? ‘Contracting out of the jobs’ to keep revenue deficit minimal. NPS where Employee himself is largely responsible for his pension etc.  

-Source: The Hindu

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