Indian Economic Reforms in 1991
Continued from “Proclamation of Emergency in 1975”
After the independence in 1947, the Congress government with Jawaharlal Nehru as Prime Minister opted for the concept of the mixed economy which at that point of time was considered as the most suitable option for the sustained growth and development of India. This Nehruvian model of economy served like a soul of the successive Congress governments and there was not much concern or serious thinking on economic reforms till the beginning of the 1990s. During this period, the reigns of the country mostly remained in the hands of three generations of Nehru/Gandhi family for almost four decades (38 years) and other Congress veterans or Ex-Congress leaders who quit Congress aggrieved with the policies of the dynasty. The 1971 slogan of ‘Garibi Hatao’ given by Indira Gandhi too largely remained slogan and failed to adopt any substantive reform for the sustained development.
After the failed experiment of the short-lived National Front Government under VP Singh followed by another minority government under Chandra Shekhar, the fresh mid-term General Elections were held in 1991 for the 10th Lok Sabha. None of the parties could achieve absolute majority but the Congress once again emerged as the single largest party and PV Narasimha Rao was sworn in as Prime Minister on 21st June 1991. He was known as one of the able administrators and a person capable of taking hard decisions. Though he served only for about four years but during his short stint he took major decisions to bring much needed economic reforms. During his days, he tried hard to dismantle the prevailing Licence Raj reversing the socialist policies started by Nehru and followed till date by his successors, largely by his own family members.
With successive wars with China and Pakistan, continued political instability, internal strife and social unrest, the Indian economy was in bad condition in all fronts. The Gulf crisis and collapse of USSR further aggravated the situation. To translate his vision into practice, Narasimha Rao took a bold decision to draft the apolitical Manmohan Singh into his cabinet as the Finance Minister. Earlier, Singh had served in several key assignments in the Government of India, such as the Chief Economic Advisor (1972–76), Reserve Bank governor (1982–85) and Planning Commission head (1985–87). Despite strong opposition, Rao Government carried on several structural reforms liberalising the Indian economy starting from July 1991 onwards.
This new model of economic reforms was commonly based on the principles of liberalization, privatisation and globalisation, popularly known as the LPG Model. The chief objective of this economic reform was to lift the economy of India to the level of the fastest developing economies in the world with all round development and improvement in the living standards of people of India – a major breakthrough event that indeed changed India’s destiny in the following years.
Background of Economic Reforms
Actually, during the second half of the 1980s, Prime Minister Rajiv Gandhi had started a cautious but lacklustre shift towards the market oriented economy. The reason behind this gradual change were many developments in the domestic and international scenario such as low social and economic domestic growth despite four decades of independence, the gradual collapse of socialism in Eastern Europe, global inclination and shift towards the market economy and the fact that changes introduced in China’s economic policies in late 1970s had already started showing positive results. All these changes across the world made out a strong case intellectually, politically and economically for India to change according to global parameters and realities.
The world experience shows that the bold decisions by the politicians are usually made in the compelling circumstances as catalyst to persuade the leadership to go for the change as also to justify it to masses so that the public opinion does not turn against the government. Such a situation indeed developed in India towards the late 1980s. During the last leg of the Rajiv Gandhi government in 1988-89, the balance of payments crisis had started building up which was further aggravated during the largely unstable government of VP Singh in 1990 that culminated in a full-fledged crisis during the short reigns of the Chandra Shekhar government of seven months (November 1990 – June 1991).
Towards the end of 1990, the situation became so alarming that the foreign exchange reserves in the country could barely finance three weeks’ worth of imports and the government came close to defaulting on its financial obligations. The Gulf war had further aggravated the situation and the low exchange reserves compelled a sharp devaluation of the rupee. It was such a precarious situation that the government had to airlift national gold reserves as a pledge to the International Monetary Fund (IMF) in exchange for a loan to cover balance of payment debts. It is not a secret that world financial institutions like IMF and World Bank (WB) press their own agenda of structural reforms while considering the request from the member countries.
The gross fiscal deficit of the government (the Centre and States together) had mounted from 9.0 per cent of GDP in 1980-81 to 12.7 per cent in 1990-91. Of this, the gross fiscal deficit of Centre alone rose from 6.1 per cent of GDP in 1980-81 to 8.4 per cent in 1990-91. The Indian currency, the rupee, was inconvertible and high tariffs and import licensing prevented foreign goods reaching the market. The currency was facing sharp devaluation, the current account deficit was marked and investors’ confidence at the lowest ebb. The foreign exchange reserves of India stood at $1.2 billion in January 1991 showing constant depleting trend, with India on the verge of defaulting on its external balance of payment obligations any time in the ensuing days.
It was in these circumstances that India had to pledge about 67 Metric tons of gold reserves as a collateral security to secure an emergency loan from the IMF. It was in these circumstances that PV Narasimha Rao took over as Prime Minister in June 1991 and roped in Manmohan Singh as Finance Minister. The Rao government undertook several economic reforms in a systematic manner in the ensuing months that are collectively termed as liberalisation in the Indian context. As so far the successive Congress governments had followed a conventional socialist agenda, there was a significant opposition to these reforms particularly by the left parties, intellectuals and within own party alleging that these measures were interference with India's autonomy. But there was no going back and even successive governments have carried on with the liberalisation in the following years.
Needless to say, the success of liberalisation could be fathomed with the very fact that foreign exchange reserves stood at an all-time high of over 426 billion US$ in April 2018 (see contrast: 1.2 billion US$ in January 1991). Similarly, the gross fiscal deficit has come down to about 3.5 per cent of the gross domestic product (GDP) over the years. Also after eighteen years of the onset of the liberalisation, the country brought back about 200 tons of gold from the IMF which works out to nearly three times of what India had to shell out to secure the IMF loan.
Liberalisation, Privatisation and Globalisation (LPG)
The economic reforms broadly encompass three elements namely liberalisation, privatisation and globalisation. Liberalisation in common parlance denotes the slackening of government regulations and the economic liberalisation in India refers to the continuing financial reforms which began since July 1991. Privatisation in practical terms refers to the greater encouragement and participation of the private individuals or companies in the businesses and services sector and inter alia includes the transfer of ownership from the public sector (or government) to the private sector. Globalization basically refers to the process of interaction and integration among the people, companies and governments worldwide employing the available means of transportation and communication technologies. Globalization has grown in the recent years due to advances in transportation and communication technology.
The main issues in liberalisation include doing away with the licensing requirements of the industries, adequate freedom in the scale of business, freedom to determine and fix the prices of goods and services, removing restrictions on the goods and services movement, simplification and reduction in levy of taxes, simplification of import-export procedures for the ease of the trade and business, and simplification of the procedure and processes for the foreign capital investment and technology.
The privatisation broadly includes establishing new enterprises by the private individual(s) or company, transferring the public sector enterprise into the private hands through disinvestment or sale and even transfer of the production/manufacture of goods earlier reserved for a public enterprise to the private hands. The broad features and purpose of the privatisation are increasing the role of the private companies in a given sector of activity, reduction in the size of the government machinery, reduction of the fiscal responsibilities and revenue of the government, introduction of competition and efficiency and speeding up the development of the economy.
Globalisation integrates the economy of a nation with the rest of the world. This facilitates among the countries free flow and exchange of goods and services, free flow of the capital as also the people and relevant information and technology. In addition, the globalization also facilitates a uniform conflict-resolution mechanism among the countries.
Economic Reforms of 1991
Looking back in the retrospective, it would not be exaggeration to say that India achieved political independence in 1947 but had to wait till 1991 for the economic freedom. After the Congress emerged as the largest party in the General Elections in 1991, PV Narsimha Rao was chosen as the Prime Minister which was a paradigm shift in the Congress because he was the first person outside the Nehru-Gandhi family to lead the country. As mentioned the preceding paragraphs, the nation was on the verge of bankruptcy when he assumed the office of the Prime Minister. Closed economy for over four decades, high fiscal deficit in the Centre and States, compulsions of the defence needs, unabated subsidies as a vote bank politics, imbalance of trade and ever growing debt payment liabilities were among the major inhibiting factors that compelled the country to seek and rely more on the external funds through borrowings.
It was not an easy task to seek solutions of the problems by taking measures to open up the economy going against the ideology of the Congress party that traditionally adored Nehruvian Economy and Centralised Planning. Narsimha Rao, however, took a bold initiative to draft Dr. Manmohan Singh, a renowned economist, as finance minister and constituted a committee under him to formulate structural reforms in the best interest of the nation. Within a short time, indications emerged that the measures would indeed have positive results as the economy began to recover in the next 2-3 years. Among the various measures taken, the Licence Raj was significantly curtailed leading to entrepreneurship and competition, a significant part of the public sector was privatized, systematic efforts were made to ease out state control and red-tapism and a favourable environment for the foreign investments was created.
These economic reforms were focused on a comprehensive mix of the Liberalisation, Privatisation and Globalisation (LPG). The reforms introduced by the Rao government in India in July 1991 were a mix the processes involving macroeconomic stabilization and structural adjustment with the short-term and long-term objectives. Stabilization was the need of hour in the short term to restore normalcy of the balance of payments problems besides arresting the inflationary trends while the structural reforms were essential for the long term growth and sustainability of the economic institutions. Accordingly, the newly elected Rao government took determined measures to implement a programme of macroeconomic stabilization through fiscal correction and the structural reforms were initiated in the areas of trade and industry including the public sector.
As reflected in a Discussion Paper of July 1993 vintage, the objectives of the Economic Reforms undertaken by the Finance Ministry were as follows:
“…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."
For the financial sector reforms, a committee was constituted by the then Finance Minister Dr Manmohan Singh under the chairmanship of M. Narasimham, a former RBI governor and the recommendations of the committee were duly considered while promulgating reforms. The major policy initiatives taken by the Government of India to fundamentally address the macroeconomic stabilization and the structural reforms were as follows:
Fiscal Reforms: It was a major factor for addressal in the stabilization effort. As already mentioned earlier, the gross fiscal deficit of the government (including the Centre and States) had mounted from 9.0 per cent of GDP in 1980-81 to 12.7 per cent in 1990-91. This figure for the Centre alone was 8.4 per cent of GDP in 1990-91. The budget for 1991-92 took a bold step in the direction of correcting fiscal imbalance by setting an ambitious target of reduction by about 2%. This was to be achieved mainly through containing the avoidable government revenue expenditure and augmenting government revenues, improving the ratio of the direct taxes to total tax revenues and curbing conspicuous consumption. These efforts achieved moderate success and by 1996-97 the fiscal deficit was pegged around 6% of the GDP.
Some of the important policy initiatives introduced in the budget for the year 1991-92 and continued in the subsequent years for correcting the fiscal indiscipline and imbalance were abolition of the subsidy on sugar, gradual reduction in the fertilizer subsidy, disinvestment of part government equity holdings in select public sector undertakings as also the acceptance and implementation of major recommendations of the Raja Chelliah Committee on Tax Reforms. The Committee recommendations were aimed at making the tax structure stable and transparent for augmenting revenue through better compliance in case of the direct taxes like income and corporation tax as well as indirect taxes like excise and customs duties.
Monetary and Financial Sector Reforms: The new policy was intended to make the banking system more transparent and efficient with the ease of business. The measures undertaken were aimed at doing away with the interest rate distortions and rationalizing the structure of lending rates. Some of the key measures keeping the recommendations of the Narasimham Committee Report 1991 are mentioned below:
Reduction in the statutory liquidity ratio (SLR) and cash reserve ratio (CRR) was to be achieved in line with the recommendations of the Narasimham Committee Report 1991. It was proposed to bring down the SLR from 38.5 per cent to 25 per cent and the CRR from 25 per cent to 10 per cent within a time span of three to four years.
In the past, the RBI controlled the interest rates payable on deposits of different maturities as also the rates charged on the bank loans for the sectoral use according to the size of the loan. In a sequence of steps, the interest rates on time deposits were decontrolled on the long term deposits. The decontrol was progressively extended to deposits of shorter maturity interest rate too.
Steps were taken to eliminate the administrative bottlenecks and augment competition among public sector, private sector and foreign banks. Besides, new accounting norms were also implemented for the classification of the assets and bad debts.
In order to rationalise the bank branches network, the licencing policy was liberalised. Also the banks were given freedom to open specialized branches and relocate branches.
Fresh guidelines for opening new private sector banks were issued.
Capital Market Reforms: The Narasimham Committee recommendations on the reforms of the capital market were accepted and implemented. The objective of such reforms was to remove direct government control and intervention, put a regulatory framework in place and ensure transparency and disclosure under the supervision of the independent regulator. Also the Securities & Exchange Board of India (SEBI) was given statutory recognition in 1992 with a mandate to creating an environment that may attract the mobilization and efficient allocation of adequate resources through the securities market.
Reforming Industrial Policy: The Rao government promulgated a New Industrial Policy in July 1991 with substantive measures to deregulate the industry sector with a long term vision of promoting growth, efficiency and competitiveness. To achieve this, a series of reforms were implemented through the new Industrial Policy. Major highlights of the impetus given to the industry sector were as under:
The Monopolies & Restrictive Trade Practices (MRTP) Act was repealed to eliminate the need for prior approval by large companies for capacity expansion or diversification.
Industrial licensing was abolished in all areas except about one and a-half dozen industries; thus nearly 80 per cent of the industry was relieved of the licensing framework.
The new policy catered for the greater disinvestment of government holdings of equity share capital of the public sector enterprises.
Areas earlier exclusively reserved for the public sector were pruned down and doors were opened for the participation of the private sector in the core and basic industries. The new policy retained only few areas such as railways, atomic energy, space etc from in the public sector domain that involved security and strategic concern.
While encouraging the private sector, the public sector too was granted greater autonomy and professional management with an objective to enhance competitiveness and profits. This was done by signing individual MOUs (Memorandum of Understanding) between the relevant Ministry and enterprise.
Foreign Direct Investment: In the past, the country had a closed economy with a rather faulty socialist agenda. Among other measures, the government also took several steps to attract foreign investment in India for the first time. The government notified a specified list of high technology and high-investment priority industries wherein foreign direct investment (FDI) was permitted up to 51 per cent foreign equity. This limit was progressively increased to 100 per cent for many industries in the following years.
To facilitate the process, the Foreign Investment Promotion Board (FIPB) had been set up to negotiate with international firms and approve FDI up to a specified limit in select areas. Many new industries have been added to this list over the years. Besides, necessary measures were also taken to promote foreign institutional investment (FII) in India.
Trade Policy Reforms: Several trade policy reforms were introduced with a focus on encouraging exports. Due importance was attached to the greater openness and transparency in procedures. Hence, the policy package was essentially an outward-oriented one. New initiatives inter alia included creating favourable environment for trade, needful impetus to export, reduction in the regulatory and licencing requirements of the foreign trade. The more important features of the new trade policy were as under:
Imports in India were regulated through a positive list of freely importable items till 1991. For the ease of trade, this was switched over to a limited negative list of items for import from April 1992. This paved way for free import of all intermediate and capital goods except few items in the restrictive negative list.
The new Trade Policy allowed the export and trading houses to import a wide range of items. With a view to promoting exports, the government granted permission up to 51 per cent foreign equity for the setting of trading houses.
The Chelliah Committee Report had recommended drastic reduction in import duties, say a peak rate of 50 per cent. The government took steps to gradually reduce such tariffs. In the very first federal budget of 1991-92, the government had reduced peak rate of the import duty from over 300 per cent to 150 per cent, and the tariffs were further eased out in the ensuing years.
Exchange Rate Policy Rationalisation: With a view to bridge the gap between the prevailing real and the nominal exchange rates on account of the inflation and other factors, the commensurate devaluation of the Indian Rupee currency was carried out to make exports more competitive and improve the balance of payments position.
These economic reforms were mainly the formal sector centric, and accordingly, a significant boom in threse liberalised areas was noticed in a few years since 1991. Consequently, the largest beneficiaries were the sectors like the telecom and civil aviation. This was a humble yet significant beginning, impact of which was felt in the following years. Even the successive governments, despite their ideological differences, continued with the reforms and more and more sectors were opened. Gradually the reforms were extended to the informal sector including the Micro, Small and Medium Enterprises (MSMEs), agriculture, tribal areas and urban poor class.
Post-1991 On-going Reforms
Following the first phase of reforms carried out by the Rao government, contrary to the apprehensions of many political and economic analysts in the country and abroad, these reforms were not only endorsed by the successive governments irrespective of their socio-political and economic leanings and perceptions but also further liberalisation was adopted and implemented involving other sectors, particularly the infrastructure and power industries.
Structural reforms have largely been carried out in the areas of industry, trade and financial sectors but attempts have also been made to reform agriculture, education, medium and small scale enterprises, cooperatives etc. These reforms broadly comprised of 1) deregulation and granting freedom of participation by the private enterprises for the industrial development, 2) opening of the industries to a greater international competition and liberal imports by reducing import tariff, and the foreign direct investment, and 3) incremental disinvestment of the selected Public Sector Enterprise (PSEs). Apart from these general measures, the sector-specific reforms have also been put in place particularly in the infrastructural industries like roads, power, telecom etc., inter alia setting statutory regulatory authorities.
Consequently, the 'Licence-Permit Raj' has been largely abolished barring the exception of few industries such as the atomic energy and space programme which are still reserved for the public sector due to security and strategic reasons. Most of the items of imports and exports have been deregulated by abolishing licences and tariffs increasingly reduced. Then the Indian rupee has been made convertible for the current account transactions keeping in view the trade policy reforms. The FDI has been one area where the successive governments have taken liberal policy decisions allowing more sectors and greater investment by adopting the investor friendly policies.
FDI has been increasingly liberalised in infrastructure, high-tech, and export oriented industries. All Governments at the Centre and in the States have recognised the critical role of FDI in mobilising funds for financing the accelerated developmental needs of the modern India. So much so that the Central government allowed FDI even in the so far much protected and conservative Defence sector in 2016. As per the policy, foreign investment up to 49 per cent in the Defence sector is permissible through the automatic route, while higher investment is permissible through the government route on case to case basis, where the proposal involves access to the modern and state-of-art technology.
Since the introduction of reforms in 1991, India has come a long way on the path of progress and stabilization. Economic reforms have stayed due to a broad consensus across the political parties that this must be continued for the overall development, growth and prosperity of the country. The Indian rupee is convertible for FDI and portfolio investment. The exchange rates are largely market driven. Interest rates have increasingly come down and experiencing gradual deregulation. Direct taxes rates have been lowered and corporation taxes are nearly compatible with international levels. Fiscal discipline and fiscal prudence is being effectively monitored and controlled. Thus macroeconomic management dovetailed with strategic management of economy has put the country in the bracket of the fastest developing economies in the world in the recent years.
Reforms: China versus India
China and India are fast developing and emerging as the next potential super powers in the world scenario. China has already taken lead and is by all means number two economy and nearly a super power in the world. Indian independence and current socio-political dispensation of China came in quick succession in the years 1947 and 1949, respectively, and economically both the countries started by and large at the same footing. However, China has forged ahead in almost all areas of growth, development and prosperity compared to India in the recent decades. Many people feel fascinated and wonder the reasons behind the faster transformation in China.
The answer lies basically on two counts; the first is its socio-political structure and governance model and the second is grasping opportunity of an early and timely implementation of economic reforms without impediments. Interestingly, the Chinese society has been so evolved over the decades that, unlike India, there is a massive disconnect between politics and economics in China - thanks to its being an extremely totalitarian state. In the Chinese totalarian regime, the politics is almost invisible with the Communist Party and the President of China being in full command. Real politics is played opaquely in the organs of the Communist Party, and not publicly on the streets or in the media as in the case of India. This has its own connotations and implications. For instance, in India if a company wants to establish a power plant, the acquisition of land and statutory clearances itself might take a number of years, say from 2 to six years. In many cases, public and opposition political parties would come in way and even make it impossible citing various reasons. On the other hand, the Chinese political system has no such compulsion; neither any opposition party or group nor public would dare to stall a process initiated or undertaken by the communist government.
After Mao Zedong died in 1976, Deng Xiaoping took over the reigns of power in China in 1978 that continued until his retirement in 1989. Deng led his country to bold initiative of reforms with far-reaching market-economy and opening of the China to the global economy. Under the totalitarian political system, China soon transformed into a market economy open to world markets with vast external surpluses from an erstwhile planned and virtually self-sufficient economy. As a matter of fact, the Chinese Communist Party pursues its economic policies with almost schizophrenic zeal to capture the world market through its state sponsored surpluses in the recent decades. Though China is formally a communist society but, in reality, now its economy is more capitalist than the majority Western countries, including US. Notwithstanding above, the Chinese seldom use the word ‘capitalism’, instead, they prefer ambiguous terms like "socialism with Chinese characteristics" and "the socialist market economy".
The Chinese economic policies and the manner of their implementation are not comparable with the Indian realities. The paradox of their political and economic systems works to their advantage in terms of effective and successful implementation of the economic agenda while the political democracy and economic reforms in India are a mutual drag full of contradictions. For instance, if a major tax initiative (viz. Goods & Services Tax) is taken by the existing government, the principal opposition party, which is credited with the economic reforms of 1991, would simply oppose it hammers and tongs lest the ruling party may take credit for the reform. To find fault and oppose it, they will go to the extent of justifying same tax slab for the capital and luxury goods like imported cars and the items of the ordinary consumer use like sugar and tea.
There is no doubt that India was in serious economic trouble and under the tremendous pressure of the world financial institutions like IMF to introduce open market oriented reforms but that doesn’t in any way dilute or discredit Narsimha Rao and his government’s initiative and resolve to introduce much needed economic reforms in 1991. It is, in fact, particularly praiseworthy because they did it despite opposition within their own party favouring the traditional Nehruvian model and the political risk of the government being in minority whose survival depended on other socialist groups. Ironically, the Indian politics has been such that while the nation acknowledges Narsimha Rao's contribution but the Congress party dominated by a particular family since independence wilfully avoids making a reference to his contriburion in the country’s growth and prosperity even today.
The author would like to share personal experience to vindicate the favourable impact of the reforms undertaken by the Rao government. He had joined the Ministry of Defence in 1994 as a Deputy Secretary handling defence budget among other tasks. Till around mid 1990s, most weapon systems and equipment of capital nature (mostly of Russian origin) were imported under the long term state credit or state guaranteed foreign loans and bulk of the annual capital spending was tied up for the repayment of principal and interest of such credit/loan plus Ordnance Factories’ supplies to the Services, sparing hardly any money for the modernisation programme. Thanks to the economic reforms, the country was able to allocate the much needed money for the defence needs from 1997-98 onwards through annual budgets and all new capital intensive acquisitions were switched over to “cash and carry” mode.
The Indian economy in 1991 was in pretty bad shape. India's GDP (nominal) in 1991 was US$ 278.4 billion and GDP (per capita) was US$ 310 billion while the foreign reserves stood at US$ 1.2 billion in January 1991. Now as per IMF 2017 data, India is the sixth largest economy in the world with a GDP (nominal) of US$ 2.61 trillion and third largest country with GDP (per capita) at US$ 9.45 trillion while the foreign reserves as of April 2018 were all time high at US$ 426 billion. The fiscal deficit, which was in the range of two digits in 1991, has been pegged down to around 3.5 per cent.
The on-going reforms have done away with the Licence Raj, reduced tariffs and interest rates, ended or curtailed many public sector monopolies and allowed automatic approval of FDI in many sectors. The chief beneficiaries have been the infrastructure industries like aviation, rail, road, highways, communication and power sectors bringing all-round development and improvement in the quality of life. The life expectancy has increased, literacy rate improved and food security maximised. Overall thrust of reforms has remained constant but none of the governments has dared to seriously undertake contentious issues like labour reforms and agriculture subsidies. Yet considering the constraints and complexities of the Indian democracy and socio-political system, these are no mean achievements though the country is to go a long way from now.
To be continued...