Economic Reforms and Liberalization

Liberalisation and Economic Reforms in India 

India faced a severe economic crisis relating to its external debt in 1991 — the government was not able to make repayments on its borrowings from overseas; foreign exchange reserves dropped to levels that were not enough for even a fortnight. Further, the crisis was compounded by rising prices of essential goods. All these led the government to announce a new set of policy measures. 

Background:

• The ineffective management of the Indian economy can be the origin of the economic crisis in the late 1980s
• Due to high expenses on development programs, the government’s expenditure remained more than its income (revenue)
• The profits from public sector undertakings were also not enough to fulfil the growing expenditure
• At times, India’s foreign exchange, borrowed from other countries and international financial institutions, was spent on meeting consumption needs
• India’s imports were raised at a very high rate without matching the growth of exports
• In the late 1980s, it became unmanageable to meet the expenditure through borrowings as government expenditure began to exceed its revenue by large margins
• To tackle the situation, India approached the World Bank and the International Monetary Fund (IMF) to get $7 billion as a loan to manage the crisis
• For availing the loan, these agencies expected India to liberalize and open its economy by removing restrictions on the private sector, decreasing the role of the government in many sectors and removing trade limitations among India and other countries
• India declared the New Economic Policy (NEP) by agreeing to the conditionalities of the World Bank and the IMF
• This set of policies can broadly be categorised into two groups:

• Stabilisation measures: Intended to correct some of the weaknesses that have developed in the balance of payments and to control inflation, these were the short-term measures
• Structural reform measures: These are the long-term measures aimed at improving the efficiency of the economy and expanding its worldwide seriousness by eliminating the rigidities in different fragments of the Indian economy

The government introduced different strategies that fall under three main heads viz., liberalisation, privatisation, and globalisation

Liberalisation:

Liberalisation was acquainted with shut-down monetary limitations and opening different areas of the economy. Different arrangements under liberalisation were as follows: 

Deregulation of Industrial Sector:

Earlier in India, mechanisms such as industrial licensing, reserving certain industries for the public sector, policies permitting only small-scale industries allowed in certain areas, controls on price fixation, and distribution of certain products were used to regulate the industry. Later, the reforms made the following changes: 

• For all product categories like alcohol, hazardous chemicals, cigarettes, electronics, industrial explosives, aerospace and drugs, and pharmaceuticals, industrial licensing was obliterated
• Only defence equipment, atomic energy generation, and railway transport were left reserved for the public sector
• Many goods manufactured by small-scale industries have now been de-reserved

• The market has been permitted to determine the prices in many industries

Financial Sector Reforms: 

• The financial sector in India, which includes financial institutions such as commercial banks, investment banks, and foreign exchange markets, is regulated by the RBI
• One major purpose of the financial sector reform was to reduce the role of RBI from the controller to facilitator of the monetary area
• It opened up the gates for the establishment of many private sector banks, both originated in Indian and foreign private banks
• Foreign Institutional Investors, such as merchant bankers, mutual funds, and pension funds, were also allowed to invest in Indian financial markets
• Tax Reforms: Tax reforms are concerned with the reforms in the government’s taxation and public expenditure policies, collectively known as fiscal policy Some of the changes made under tax reforms are:

• Taxes on individual income have been continuously reduced as it was felt that high-income tax rates were an important reason for tax evasion. It is a fact that moderate rates of income tax encourage savings and voluntary disclosure of income
• The rate of corporation tax has been gradually reduced as it was very high earlier
• To facilitate the establishment of a common national market for goods and commodities, efforts were made to reform indirect taxes
• In 2016, the Goods and Services Tax (GST) Act was passed to simplify and improve the indirect tax structure in India

Unfamiliar Exchange Reforms: 

• As a prompt measure to handle the Balance of Payments (BOP) emergency, the Rupee was downgraded against unfamiliar monetary forms. Prompting an expansion in unfamiliar trade inflow

• Reforms also set the tone for market-based determination of the value of the Rupee instead of the earlier system of government-determined value 
• Trade and Investment Policy Reforms: It aimed at increasing the efficiency and international competitiveness of the local industry along with the inflow of foreign investment and technology. The following steps were undertaken:

1. Removal quantitative restrictions on imports and exports. 
2. Reduction of tariff rates.
3. Removal of licensing procedures for imports, although not in the case of environmentally sensitive industries.
4. Removal of export duties to increase the global competitiveness of domestic goods.
5. Furthermore, the quantitative restrictions on imports of manufactured goods and agricultural produce were completely eliminated from April 2001.

Conclusion: 

As we have seen, India faced the economic slowdown in 1991 due to balance of payment deficits due to dependence on imports and other external factors. The rupee value devalued during the 1991 crisis. 

The foreign exchange reserves remained only for a fortnight, essential goods prices also got high and inflation increased which gave the government an impetus to open India’s economy.

Borrowing was the only option for the government but, to avail loans from the global institutions, they kept certain conditions such as India to open its economy for private and foreign players, and ease out the licence system.