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Economic reforms

Study Material > Economics
  • India followed, the mixed economy framework by combining the advantages of the capitalist economic system with those of the socialist economic system.
  • There are different views of Scholars regarding the economic policy of our country. Some argue that in the process of controlling and regulating the economy, various rules and laws were established which are now hampering the process of growth and development while others states that India's economy which is started from near stagnation in its developmental path have achieved growth in Savings and developed a diversified industrial sector and has experienced sustained expansion of agricultural output which has ensured food security.

Economic crisis  of 1991

  • The situation for economic crisis was started building in 1980s itself.
  • Due to the inefficient management of the Indian economy government expenditure becomes more than its income and meeting expenditure through borrowings became unsustainable.
  • Prices of many essential goods rose sharply. Imports grew at a very high rate without matching growth of exports. The government was not able to make payments on its borrowing from abroad.
  • Foreign Exchange Reserves, which we generally maintain to import petrol and other important items, dropped to a level that was not sufficient for even a fortnight. The crisis was further compound by rising prices of essential goods.

Reason for the economic crisis of 1991

  • Political uncertainity and instability: The period from November 1989 to May 1991 was marked with political uncertainty and instability in India. In fact, within a span of one and half years there were three coalition governments and three Prime Ministers. This led to delay in tackling the ongoing balance of payment crisis, and also led to a loss of investor confidence.
  • Popular politics: Popular politics for vote bank have made the situation worse. Waiving of agriculture loans in 1990s is another important economic feature. Peasants got rid of the debts but waiving of agricultural loan badly damaged the condition of agriculture credit in the country. This waiver was financed by the government and hence increases the Budget deficit.
  • Gulf war: The crisis was immediate by the first Gulf War (1991) which had two pronged negative impact on the Indian Foreign Exchange Reserves.
    1. Oil price rises sharply due to war. The increase in oil prices swept the foreign currency reserves of the country.
    2. Lakhs of Indians in Kuwait lost their jobs as well as Savings and hence private remittances from Indians working in the Gulf region fell down fast.
  • NRIs withdrew the funds and flow of NRI deposits turned negative. The credit rating got negative and India was on the verge of defaulting its International commitments.
  • Increase in Non-oil Imports:The trends in imports and exports show that imports rose much faster than exports during the eighties. Imports increased by 2.3 percent of GDP, while exports increased by only 0.3 percent of GDP. As a consequence, trade deficit increased from an average of 1.2 percent of GDP in the seventies, to 3.2 percent of GDP in eighties.
  • Rise in External Debt:In the second half of the 1980s, the current account deficit was showing a rising trend and was becoming unsustainable. An important issue was the way in which this deficit was being financed. The current account deficit was mainly financed with costly sources of external finance such as external commercial borrowings, NRI deposits, etc.
  • Thus, the balance of payments situation came to the verge of collapse in 1991, mainly because the current account deficits were mainly financed by borrowing from abroad. The economic situation of India was critical; the government was close to default.

Economic Reform

  • 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 loan to manage the crisis. For availing the loan, these international agencies put conditions on India to:
    1. Liberalise and open up the economy by removing restrictions on the private sector.
    2. Reduce the role of the government in many areas.
    3. Remove trade restrictions between India and other countries.
  • India agreed to the conditionalities of World Bank and IMF and announced the New Economic Policy (NEP).

New Economic Policy (NEP)

  • The NEP consisted of wide ranging economic reforms. The thrust of the policies was 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: 
    1. The stabilisation measures and
    2. The structural reform measures
  • Stabilisation measures: These are short term measures, intended to correct Balance of Payment (BoP) crisis and to bring inflation under control.
  • Structural reform: These are long-term measures, aimed at improving the efficiency and competitiveness by removing different barriers of the economy.
  • The reform made by government fall under three heads viz.,
    1. Liberalisation
    2. Privatisation and
    3. Globalisation

Liberalisation

  • Liberalisation means to free economy from the various restrictions and trade barriers introduced by the government which are earlier aimed at regulating the economic activities. Under the head liberalization government has done following reforms:
    1. Deregulation of Industrial Sector
    2. Financial Sector Reforms
    3. Tax Reforms
    4. Foreign Exchange Reforms
    5. Trade and Investment Policy Reforms
  • Deregulation of Industrial Sector: In India, regulatory mechanisms were enforced in various ways. Industrial licensing under which every entrepreneur had to get permission from government officials to: 
    1. Start a firm
    2. Close a firm or
    3. To decide the amount of goods that could be produced
    4. Private sector was not allowed in many industries
    5. Some goods could be produced only in small scale industries and
    6. Controls on price fixation and distribution of selected industrial products.
  • The New Economic Policy introduced in and after 1991 removed many of these restrictions. Industrial licensing was abolished except for following product categories only— alcohol, cigarettes, hazardous chemicals, industrial explosives, electronics, aerospace and drugs and pharmaceuticals.
  • Private players are also allowed for the industries which are earlier reserved for the public sector industries. The only industries which are now reserved for the public sector are defence equipments, atomic energy generation and railway transport.
  • Many goods produced by small scale industries have now been dereserved. In many industries, the market has been allowed to determine the prices.

Financial Sector Reforms

  • Financial sector includes financial institutions such as commercial banks, investment banks, stock exchange operations and foreign exchange market. The financial sector in India is regulated by the Reserve Bank of India (RBI). All the banks and other financial institutions in India are regulated through various norms and regulations of the RBI. The RBI decides the amount of money that the banks can keep with themselves, fixes interest rates, nature of lending to various sectors etc. One of the major contribution of financial sector reforms is that it reduces the role of RBI from regulator to facilitator of financial sector. This means that the financial sector may be allowed to take decisions on many matters without consulting the RBI.
  • The reform policies led to the establishment of private sector banks, Indian as well as foreign. Foreign investment limit in banks was raised to around 50 per cent. Those banks which fulfil certain conditions have been given freedom to set up new branches without the approval of the RBI and rationalise their existing branch networks. 
  • Though banks have been given permission to generate resources from India and abroad, certain managerial aspects have been retained with the RBI to safeguard the interests of the accountholders and the nation.
  • Foreign Institutional Investors (FII) such as merchant bankers, mutual funds and pension funds are now allowed to invest in Indian financial markets.
  • Tax Reforms: Tax reforms are concerned with the reforms in government’s taxation and public expenditure policies which are collectively known as its fiscal policy. There are two types of taxes:
    1. Direct and
    2. Indirect.
  • Direct taxes consist of taxes on incomes of individuals as well as profits of business enterprises. Since 1991, there has been a continuous reduction in the taxes on individual incomes as it was felt that high rates of income tax were an important reason for tax evasion. It is now widely accepted that moderate rates of income tax encourage savings and voluntary disclosure of income. The rate of corporation tax, which was very high earlier, has been gradually reduced.
  • Efforts have also been made to reform the indirect taxes, taxes levied on commodities, in order to facilitate the establishment of a common national market for goods and commodities. Another component of reforms in this area is simplification. 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

  • The first important reform in the external sector was made in the foreign exchange market. In 1991, as an immediate measure to resolve the balance of payments crisis, the rupee was devalued against foreign currencies. This led to an increase in the inflow of foreign exchange. It also set the tone to free the determination of rupee value in the foreign exchange market from government control. Now, more often than not, markets determine exchange rates based on the demand and supply of foreign exchange.

Trade and Investment Policy Reforms

  • Liberalisation of trade and investment regime was initiated to increase :
    1. International competitiveness of industrial production
    2. Foreign investments and
    3. Technology into the economy.
  • Quantitative restrictions on imports by keeping the tariffs very high were abolished which was earlier practiced to protect domestic industries. This brings efficiency and competitiveness in industrial sector.
  • The trade policy reforms aimed at
    1. Dismantling of quantitative restrictions on imports and exports
    2. Reduction of tariff rates and
    3. Removal of licensing procedures for imports.
  • Import licensing was abolished except in case of hazardous and environmentally sensitive industries. Quantitative restrictions on imports of manufactured consumer goods and agricultural products were also fully removed from April 2001. Export duties have been removed to increase the competitive position of Indian goods in the international markets.

Privatisation

  • It is the process of transferring ownershipof a business, enterprise, agency, public service, or public property from the public sector (a government) to the private sector.
  • Government companies are converted into private companies in two ways:
    1. By withdrawal of the government from ownership and management of public sector companies and or
    2. By outright sale of public sector companies.
  • Privatisation of the public sector enterprises by selling off part of the equity of PSEs to the public is known as disinvestment.
  • The purpose of the sale, according to the government, was mainly to improve financial discipline and facilitate modernisation. It was also envisaged that private capital and managerial capabilities could be effectively utilised to improve the performance of the PSUs.
  • The government has also made attempts to improve the efficiency of PSUs by giving them autonomy in taking managerial decisions. For instance, some PSUs have been granted special status as maharatnas, navratnas and miniratnas.

Globalisation

  • Integration of the economy of the country with the world economy is called globalization.
  • It is an outcome of the set of various policies that are aimed at transforming the world towards greater interdependence and integration. It involves creation of networks and activities transcending economic, social and geographical boundaries.
  • Globalisation attempts to establish links in such a way that the happenings in India can be influenced by events happening miles away. It is turning the world into one whole or creating a borderless world.
  • It should be noted here that the Indian idea of globalization is deeply and frequently inclined towards concept of the welfare state which keeps coming in the day to day public policy as an emphatic reference.

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