Economic Reforms in India: Introduction, Need and Examples

In this article we will discuss about:- 1. Introduction to Economic Reforms 2. Need for Economic Reforms 3. Examples.

Introduction to Economic Reforms:

Economic reforms in India refer to the structural adjustments that were initiated in 1991 with the aim of liberalising the economy and to accelerate its rate of economic growth. The Narsimha Rao Government, in 1991, introduced the economic reforms in order to restore internal and external confidence in the Indian economy.

The reforms aimed at bringing in greater participation of the private sector in the growth process of the Indian economy. Policy changes were introduced with respect to industrial licensing, technology up gradation, removal of restrictions on the private sector, foreign investments and foreign trade.

The reforms were aimed at attaining a high rate of economic growth, reducing the rate of inflation, reducing the current account deficit and overcoming the balance of payments crisis. The important features of the economic reforms were Liberalisation, Privatisation and Globalisation, popularly known as LPG.

Need for Economic Reforms:

The economic reforms introduced by the Government of India in 1991 brought in a number of neo-liberal policies aimed at rapid economic growth. The reforms were targeted at various sectors such as the industrial sector, trade, public sector, financial sector, etc.

The need for the introduction of the reforms was because of the following factors:

1. Poor Performance of the Industrial Sector:

Before the introduction of economic reforms, the industrial sector suffered due to bureaucratic controls. The industries had to obtain several licenses and permissions for any undertaking activity such as setting up a new firm, starting a new product line, expansion of existing business, foreign investments and so on. Many public sector enterprises were incurring huge losses due to poor productivity.

The main objectives of the industrial policy introduced in 1991 were:

(i) To unshackle the Indian industrial sector from the cobwebs of unscrupulous bureaucratic controls;

(ii) To introduce liberalisation with the objective of integrating the Indian economy with the world economy;

(iii) To remove restrictions on foreign investments and relieve the entrepreneurs from the restrictions of the MRTP Act; and

(iv) To shed the load of public enterprises those were incurring heavy losses.

2. Adverse Balance of Payments:

India faced a severe economic crisis during the end of 1980s. India was unable to meet its international debt obligations and was pushed to a situation of near bankruptcy. The foreign exchange reserves were insufficient to pay the import bills. The Balance of Payments deficit could not be financed beyond a certain point.

Some of the factors responsible for the crisis were:

(i) Rising level of expenditure over revenue;

(ii) Heavy government borrowing;

(iii) Inefficient utilisation of resources;

(iv) Excessive protection to domestic industries;

(v) Inefficient management of public sector enterprises;

(vi) Lack of technological development and innovation; and

(vii) Lack of investments in research and development.

3. Rise in Fiscal Deficit:

Amidst the political instability and balance of payment crisis, there was a rising fiscal deficit. This was mainly due to the increase in the non- developmental expenditure of the government. The government had to borrow huge sum of money to finance the deficit and to meet the interest obligations on these debts.

The government was in a debt trap. Thus, there was a need to bring in reforms in order to reduce the non-developmental expenditure and to bring about a fiscal discipline.

4. Inflation:

Due to continuous borrowing by the government in order to meet its mounting expenditure, there was a rapid increase in the money supply. The government resorted to deficit financing wherein the RBI financed the borrowings by the Government of India by printing currency notes. This leads to a rise in the money supply. When money supply increased, the demand for goods and services also rose, thereby increasing their prices and causing an inflationary situation.

5. The Gulf War:

The Gulf war during 1990-91 had a significant impact on the supply of oil. As a result, the price of oil shot up, increasing India’s foreign currency outlays. The Gulf crisis also affected the flow of foreign currency into India. The NRI deposits were moving out of India and remittances from Indians employed abroad were also affected during the war.

This further depleted the foreign currency reserves with the RBI. India, thus, had no other option but to look towards IMF for financial assistance.

Amidst the political instability, high inflation, rising fiscal deficit, balance of payment crisis and immense pressure from the international organisations such as IMF and World Bank, India introduced the economic reforms in 1991. With the introduction of economic reforms, many restrictions on the industrial sector were removed.

Reforms were made in the trade, industrial and financial sector. The fiscal reforms aimed at mobilising private investments to boost the infrastructure growth in India. Reforms in the monetary policy aimed at controlling the inflation rate and ensuring smooth flow of resources to the industrial sector. Foreign trade policy removed several trade restrictions. Therefore, India started heading towards becoming a market oriented economy.

Examples of New Economic Reforms:

Economic reforms in India were implemented with the objective of changing the pattern of economic activities in order to liberalise the Indian economy and to accelerate the rate of economic growth. These new economic reforms brought about a structural change in the share of different sectors in the national income.

The new economic reform policies mainly focused on structural reforms in agricultural sector, industrial sector, financial sector and global trade. Such economic reforms were possible with the help of broad and comprehensive policies on liberalisation, privatisation and globalisation.

1. Liberalisation – Meaning and Features:

The new economic policy introduced a number of liberalisation measures to remove the unnecessary controls and regulations on the industrial sector. Liberalisation refers to the removal of restrictions on trade and industry. The main objective of liberalisation was to unshackle the industrial sector from the cobwebs of unnecessary bureaucratic controls.

The main features of liberalisation policy were:

1. Abolition of Industrial Licensing:

The new industrial policy of 1991 abolished the industrial licensing for all the industries except for a selected 18 industries due to security and strategic concerns. These included industries manufacturing hazardous chemicals and industries that could cause environmental pollution.

2. Removal of Restrictions:

All industries, other than those 18, could set up and sell shares without any restrictions, they could expand their business and start a new product line without the need of obtaining any license.

3. Relaxation of MRTP Restrictions:

The MRTP Act aimed at controlling monopoly practices to prevent concentration of economic power. It also aimed at preventing unfair and restrictive trade practices to protect consumer’s interest. Prior to the introduction of reforms, a number of restrictions were imposed on industries with an investment of Rs.100 cores or more under the Monopolies and Restrictive Trade Practices (MRTP) Act.

They had to undergo a pre-entry review for any investment decision. These restrictions were eliminated through the liberalisation policy.

The MRTP Act has now been replaced by the Competition Act, 2002, which came into effect from 2009. The Competition Act checks all anti-competitive practices and prohibits abuse of dominance. In order to protect consumer interest at large, it aims at promoting and sustaining competition in the market.

4. Foreign Investment:

The 1991 reforms reduced a number of procedural bottlenecks for foreign investments. Approval was given for foreign direct investment up to 51 percent of equity in high priority industries. The liberalisation measures enhanced the investment ceiling on small scale industries. Industries were also allowed to raise investments from abroad with simple procedures.

5. Foreign Technology:

Automatic approval was provided to Indian industries with respect to foreign technology agreements, especially in the case of high priority industries. Permissions were not required for hiring foreign technicians and experts and for foreign testing of indigenously developed technologies.

All these measures improved the performance of the industrial sector and domestic industries were compelled to become efficient in order to face the competition from industries abroad.

2. Globalisation – Meaning and Features:

Globalisation may be defined as the integration of the domestic economy with the world economy with the objective of facilitating free movement of goods, services, people, ideas, technology etc. It refers to the opening up of the economy to international competition.

The major features of globalisation measures as undertaken in 1991 were:

1. Reduction of Trade Barriers:

Trade barriers restrict free flow of goods and services between countries. With the introduction of globalisation measures, these restrictions were reduced. Globalisation created an environment for smooth exchange of goods and services between India and other nations.

It provided immense opportunities to Indian industries to expand their markets abroad. It also offered Indian consumers a wide variety of quality goods at competitive prices.

The export-import policy announced for the period 1992-97 removed all restrictions on external trade and enhanced the export capabilities of the Indian industries. All the non-tariff barriers were eliminated and the customs duty that was as high as 250 percent was reduced to about 40 percent.

As a result, the exports rose from 5.8 percent of the GDP in 1990-91 to about 16 percent of the GDP during 2012-13 and the imports increased from 8.8 percent of the GDP to 27 percent of the GDP during the same period.

2. Promotion of Foreign Direct Investment:

With the introduction of globalisation, many Indian industries were opened to foreign direct investment. India became a favorable investment destination for foreign investors due to the low cost of production and availability of cheap labor resources. The efficiency of the banking sector also improved because of the competition from foreign banks.

The government of India further initiated a series of measures to promote foreign technical collaborations in case of high priority industries and for import of foreign technology. Foreign Investment Promotion Board (FIPB) was set up to facilitate foreign direct investments in India. The Foreign Direct Investment increased from USD 97 million in 1990-91 to USD 26,953 million in 2012-13.

3. To Encourage Efficiency:

Globalisation encouraged domestic industries to become more competitive and efficient to face competition at the global level. The domestic industries had to produce quality goods at low cost to compete with the cheaper and superior quality goods of the foreign producers.

4. Diffusion of Technology:

Globalisation provided an opportunity to India to have an access to global technology. It made diffusion of knowledge faster. India could utilise the technologies of developed countries without much investments in research and development.

The globalisation measures introduced in India acted as an engine of growth enabling access to a wide range of opportunities. These measures paved the way for access to latest technologies. It enlarged employment opportunities and increased labor productivity enabling a large proportion of population to rise above the poverty line.

3. Privatisation-Meaning and Features:

Privatisation refers to the introduction of private ownership in public sector enterprises. The privatisation measures introduced during the economic reforms reduced the number of industries reserved exclusively for public sector from 17 to 8. The government holding in public sector enterprises was sold to increase private participation.

Many public-sector units were incurring losses due to inefficiencies in management and lack of innovation and investments in research and development. Privatisation measures enabled the use of modern technology and improved the quality of service and led to efficient utilisation of resources.

Various privatisation measures introduced in India included:

1. Transfer of ownership of public sector units, either fully or partly, to private hands through denationalisation.

2. Transfer of control to the private sector through disinvestment policies.

3. Opening of areas that were exclusively reserved for public sector.

4. Transfer of management to the private sector through franchising, contracting, and leasing.

5. Limiting the scope of the public sector.

The privatisation wave in India, which was a part of the economic reforms of 1991, increased the role of private sector and restricted the public sector to priority areas which included:

1. Physical and social infrastructure

2. Mining and oil exploration

3. Manufacture of products that were of strategic importance and where security concerns were involved like in the case of manufacture of defence equipment, and

4. Investments in technologies that required huge outlay and where private sector investment was inadequate.

Privatisation measures were introduced in India as part of the economic reforms in 1991 for the following reasons:

1. To Reduce the Burden of the Government:

The public sector companies created the base for industrial growth in India. However, a number of public sector companies were incurring continuous losses due to delay in completion of projects and rise in cost of production. Many public sector units were only functioning to protect the interests of the laborers. Privatisation offloaded this burden from the government and reduced the strain on resources.

2. To Promote Efficiency:

Many public sector companies were also struggling due to inefficient management, lack of transparency and corruptive practices. Poor industrial relations and over staffing reduced the productivity, causing losses to these units. Privatisation measures got rid of these problems and enabled the public sector units to achieve optimum productivity.

3. To Enhance Investment Opportunities:

Privatisation helped in reducing the inconsistencies in management and improved the economic status of many public sector units. This brought in good returns and attracted investments.

4. To Facilitate Growth of Infrastructure:

Privatisation of industries led to the growth of industrial sector on modern lines. The private enterprises, to provide competitive products and services, initiated and facilitated improvement of the infrastructure.

5. To Reduce Unnecessary Bureaucratic Interventions:

Privatisation reduced unnecessary government intervention in the management, thereby giving the private enterprises more autonomy in management and operations. This enhanced their efficiency and profitability. Elimination of restrictions effectively reduced corruption and improved productivity.

However, privatisation also had its drawbacks. Some of them are listed below:

1. Loss of Social Welfare:

Private sector is driven by profit motive and is less oriented towards public welfare and social objectives. This brought about distortions in balanced growth of the economy.

2. Corruption:

Private sector sometimes tries to bypass government rules and regulations by corruptive practice which reduces economy’s welfare.

3. Lobbying:

Lobbying issues are also commonly observed in private sector enterprises which can affect labor productivity.

4. Malpractices:

Malpractices in production, supplying low quality goods, manipulation of accounts to evade taxes are common in private enterprises.

5. High Prices:

Private players also charge high prices for their products, since government subsidies are not applicable to these products, which results in reduced consumer welfare.

Thus, privatisation improve or reduce welfare of the people depending on the actions of its stakeholders. Yet, it has played a significant role in India and has helped in getting rid of conventional bureaucratic policies.

Disinvestment:

This is one of the most important strategies adopted by the Government of India as a part of its privatisation measures. Disinvestment is an act by which the government sells its complete or a part of its holding in a public sector unit to the private sector.

The disinvestment policies of the government also enable it to raise huge revenue to finance its fiscal deficit. About Rs. 20,000 cores were raised through disinvestment in public sector units between the period of 1991-92 to 2001-02.

The funds raised through disinvestment are also used:

1. To shut down the industries declared sick by the Board of Industrial and Financial Reconstruction (BIFR) and settle their claims.

2. To restructure and modernise the public sector enterprises.

3. To settle public debt.

The disinvestment policies of the government, by bringing in private participation, improve the efficiency of public sector units by lowering their costs of production. It enables access to modern technology, thus, improving the quality of products and services. Disinvestment can be carried out through public issue of equities to retail investors through Initial Public Offer (IPO).

The Government of India, in its 2017 budget, has set a target of raising Rs. 72,500 core through disinvestment during the financial year 2017-18.