Economic

Liberalisation

Reforms

and

Economic liberalisation means reducing government intervention in market and

allowing for the unfettered operation of the market forces to determine economic
process. Its about bringing market prices closer to efficiency prices and letting
the household and firms take their economic decisions independently.
But that doesnt mean govt has no role to play. Its just that their role have
been shifted to make sure that market runs perfectly in the presence of any
externality. State has to play the guiding and supportive role. In the earlier stage
of industrialisation, state role is to establish physical infrastructure through govt
investment, developing human resources through education and facilitating
institutional change. In the later stage of industrialisation, state role is functional
and strategic.

Economic Reforms
Although there was a general consensus on the desirability of the reforms
to dismantle the bureaucratic regulatory apparatus evolved over the years, there
has been considerable debate over the content of the reform package, their
sequencing and pace, the implementation and impact. The initial but hesitant
steps of the reform process were taken in 1980s but the real reform process
begin only at 1991 after the BoP crisis.
Some of the major causes of BoP crisis of 1991 were
Collapse of Soviet Union, which was Indias biggest trading partner
Eruption of Gulf war caused the oil prices to go very high and reduced the
remittances being sent by Indian worker from Gulf countries.
Political uncertainty in India led to lowering of Indias rating for short and
long term borrowing by international rating agencies. As a result, not only
India found it difficult to borrow loans in international market but also NRIs
started taking out their money deposited in Indian banks.

The Macroeconomic Crisis

The microeconomic crisis started in 1980s because of excess public spending by
govt causing a budget deficit which later coupled with other external and internal
shocks brought India into a near default situation.
The Indias debt-to-GNP ratio kept on increasing throughout 1980s and
was 60% of GNP towards the end of the decade. This situation was the result of
excess public spending by govt and failure of public sector in generating
investible resources. The budget deficit as a proportion of GDP rose from 6.9 to 9
per cent during the 1980s. The public sector couldnt generate profit and hence
they contributed to macroeconomic efficiency failure.
One other reason was Restrictive Trade and Industrial Licensing
Framework which led to serious loss of efficiency by
Reducing the scale of output

Eliminating effective competition and

Creating Bottlenecks

Rationale for the Reforms

This macroeconomic crisis also provided an opportunity to take long
overdue microeconomic (also known as structural) reforms. This structural
reforms were necessary because we had failed to generate adequate rates of
growth in income and of per capita income.
The reform package outlines by Manmohan Singh in 1991 had three
distinct components.
1. Fiscal stabilization to check the Fiscal Deficit and contain it a
lower level so that public investment in basic social and economic
infrastructure may continue without generating inflationary pressure.
2. Internal liberalisation to increase competitive pressure and let
enterprises make their production and investment decisions based on
market condition which can be referred as freedom of private enterprise.
3. Integration with global economy by removing controls on foreign
trades and exchange rates, lowering of tariffs and attracting Foreign Direct
Investment (FDI).
These public policies can broadly be classified into two categories;
stabilisation policy and structural reform policy. As Rangarajan rightly
points out, stabilisation policies were intended to correct lapses and put the
house in order in short term, the structural reform policies were intended to
accelerate the economic growth in medium term. We will be discussing the
structural reform policy in detail here.

Structural Reforms
Structural reforms were broadly in the areas of industrial licensing and
Regulation, foreign trade and investment and the financial sector.

Industrial Policy Reforms

On 24th July 1991, Indias New Industrial Policy (NIP) was announced. It
dismantled the industrial licensing (or approval) system and abolished the
requirement of obtaining an industrial license from the govt. in all except 18
specified industries. This list of 18 industries was further reduced to six industries
in 1999. Those six industries are viz. drugs and pharmaceuticals, hazardous
chemicals, explosives such as gun powder and detonating fuses, tobacco
products, alcoholic drinks, and electronic, aerospace and defence equipment.
The compulsion for obtaining prior approval for setting units in metros was also
removed. As of now, only two industries are now reserved exclusively for public
sector, these are atomic energy and railway transport. Further, considering a
large requirement of funds for infrastructure, 100% FDI has been allowed in all
infrastructure sectors.

In order to instil health competition among producers, some items are

reserved for the small scale sector and are reviewed from time to time. As of
2014, 20 items are reserved under small scale industry sector. An FDI of 100%
has been allowed under the automatic route in most sectors. NRIs investors are
allowed up to 100% ownership in priority industries.
40% foreign equity investment was abolished and FDI up to 51% was
allowed in almost all industries except those subject to public sector monopoly
and industrial licensing. The concept of automatic approval was introduced
whereby RBI was empowered to approve equity investment up to 51%.
Currently, the system operates on a negative list approach such that
unless the official DFI policy spells out specific restrictions, no restriction applies.
Currently DFI (Direct Foreign Investment) is prohibited only in four sectors:
Retail trading (except single brand retail trading)
Atomic energy
The lottery business
And betting and other forms of gambling.
Recently, the current NDA govt has increases FDI in defence and insurance
from 26% to 49% with full Indian management and control through Foreign
Investment Promotion Board (FIPB) route.
FDI in manufacturing sector today is on automatic route. And
manufacturing units will be allowed to sell its product through retail including Ecommerce platform without any additional approval.
Additionally, a phased programme of disinvestment has been launched in
public ownership and public sector corporations. A Disinvestment Commission
followed by dept. of Disinvestment has been set to recommend the phasing of
the disinvestment process. The outward investment of Indian enterprises has
also been liberalised.
More on NIP can be read from: http://www.gktoday.in/new-industrial-policy-1991/
http://www.economicsdiscussion.net/acts/summary-of-indias-industrialpolicy/6511

Trade Policy Reforms

The import licensing system has been dismantled and all Non-Tariff
Barriers (NTB) has been phased out from all tradable goods except consumer
goods. The tariffs have substantially been done away with. Besides, India has
committed to liberalise its trade regime under WTO agreement.
Tariffs
Tariff has been reduced from a peak rate of 150 per cent in 1990 to a peak
non-agricultural rate of 58 per cent in 2009-10. In the same year, agricultural
tariff stands at 2.5 per cent. The reduction of tariff in non-agricultural product
has played an important role in the convergence of Indias inflation rate to global
inflation rates.
In the recent budget of 2015-16, FM has announced the reduction of
custom duties from 10 per cent to 2.5 per cent for some cases of manufactured
goods

Removal of Quantitative Restrictions (QR)

Import restriction process, which began in 1991, has been completed in a
phased manner.
Indian Custom Single Window Project: 2014-15
In the 2015-16 budget, a single window project has been proposed where
all the required permissions, if any, from all other regulatory agencies would be
obtained online without the traders having to approach these agencies. This
would reduce the interference with govt. agencies and the cost of doing
business.
Also, changes have been made in Custom and Central Excise Act to
expedite the process of disposal of appeals.
Exchange Rate Reforms
The rupee was devalued twice in July 1991 leading to 20% depreciation in
its value. The partial convertibility of Rupee on trade account was announced in
1992-93 budget that was subsequently broadened to full convertibility in August
1994.
With regards to Capital account, India has gradually opened up capital
account. Capital account is virtually free for non-resident corporates with some
restrictions on financial institutions and higher restriction on resident individuals.

Financial Sector Reforms

In January 1993, financial sector reforms were initiated which included
permission to establish private sector bank including foreign joint ventures. Also,
a policy regime was established for functioning of private Non-Banking Finance
Corporations (NBFC) and agencies for rating their credit worthiness.
The main objective of the financial sector was to provide operational
flexibility and functional autonomy to banks and other financial institution so that
they could allocate the resources efficiently. Some of the important initiatives in
the financial sector were:
1. Reduction in statutory pre-emptions so as to release greater funds
for commercial lending
2. Interest rate deregulation to enable price discovery
3. Increased competition by allowing new private sector banks
4. Dilution of govt. holding in public sector banks
5. Strengthening the health of public sector bank by prudential norms
like capital adequacy, income recognition, asset classification, provision
and exposure norms
6. Improving transparency and disclosure norms
Capital Market
The Capital Issues Control Act was repealed and SEBI was established on
th
12 April, 1992 as a watchdog for regulating the function of capital market. Since
then, SEBI has focussed on regulatory reforms and market modernisation.
Modernisation includes online trading and dematerialised trading. Companies

have been allowed to buy back their own share subject to the regulation led
down by SEBI.
Later in 1992, govt announced regulation by Foreign Institutionalized
Investors (FIIs) in the Indian capital market. FIIs can now invest in all securities
traded on the primary and secondary market with full repatriation benefits
without restriction on either volume or lock-in-period.

Fiscal Adjustment and Stabilisation

One of the key aspects of structural adjustment programmes is to restrict
the fiscal deficit of the govt. In the first half of 1980s, fiscal deficit was 6.3 per
cent of GDP which grew up to 8.4 per cent of GDP towards the end of 1980s. In
the post reform period, fiscal deficit has been around 5 per cent of GDP, clearly
suggesting that govt has been successful in managing the fiscal situation quite
well.
The inflation has been stable post reform period and the rate of inflation
has been brought under check. The overall trend in prices has been on decline
since 1992. One more important point to notice here is that of growing
divergence between WPI and CPI. On an average, CPI has always exceeded from
WPI. The reason is weighting schemes of two indices. The CPI has 57.0 per cent
weightage for food compared to 27.5 in WPI. Higher CPI than WPI means an
increase in food prices in 1990s. Also, spurt in prices of housing, medical care
and personal care have also indicated in the rise in CPI.

Economic Progress Post 1991

India, which grew at a rate of 3.5 per cent (also euphemistically called as
Hindu Growth Rate) for forty years before reforms, grew at 5.7 per cent (Real
GDP growth rate) in 1990s and accelerated further to 7.3 per cent in 2000s.
During post reform period, while Services and manufacturing grew at very
fast pace, agriculture fell. The reason was there was no big breakthrough in
technology used in agriculture during this period. Also the momentum of Green
Revolution had died out by 1990s, so agriculture production yield grew very
slowly and eventually stagnating.
During the decade of 2000s, Real GDP growth rate was very high and all
sectors of economy grew at faster pace, with services outperforming all others.
The issue of concern here is relative decline in share of agriculture in total GDP.
While share of manufacturing remained same at 20% throughout the post reform
period, Agriculture share decreased from 28.4 per cent to 15 per cent. Services
took the lost share of agriculture in GDP and its share increased from 51.5 per
cent to 65 per cent of GDP during the same period.
Openness of Indian Economy: The structure of Indian economy also
underwent change during this period in terms of openness. Export and Import of
Goods and services have more than doubled from 23 per cent of GDP in 1990 to
50 per cent of GDP in 2009-11. If capital flows are also included in this
calculation along with trade flows, the rise of openness is much higher. The rise
of openness (measured by Current Receipt and payments + Capital Receipts)
increased from 42% of GDP in 1990s to 107 per cent in the recent period.

The high growth phase of 2004-08 was accompanied by sharp increase in

exports and imports as well as capital inflows. Following the global financial
crisis, the growth rate of trade and capital inflows moderated. Also, the openness
of economy has been accompanied by improvement in Indias external position
as debt to GDP ratio fell from 29 per cent in 1990s to 19 per cent in 2010. The
openness of capital account has resulted in two-way movement in capital with
sharp pickup in Indias outward FDI since the mid-2000s.
Most importantly, average Saving Rate has also increased from 23 per
cent of GDP in 1990s to 31 per cent of GDP in 2000s with peak sacing rate at 33
percent during 2004-08 period of high growth rate. Fiscal consolidation during
this period helped in lifting the saving rate as public sector saving rose
significantly.
This high growth rate was achieved in an environment of price stability as
headline Wholesale Price Index (WPI) dropped to an annual average of 5.5 per
cent in the 2000s compared to 8.1 per cent in 1990s. There was similar drop in
CPI as well.

Impact of Economic Reforms on the Vulnerable Sections

In the total economic policy, there are four elements which can be
identified as being meant specifically for poverty alleviation:
1. Since Agriculture is the mainstay of the majority of the population, growth
in agriculture and therefore resource allocated for agriculture are an
important way to attack the poverty. It is a common knowledge that state
in which agriculture has made spectacular progress poverty levels have
come down.
2. We have evolved over time a reasonably satisfactory food security system.
An important part of this Public Distribution System (PDS). The PDS has
played a notable role in avoiding acute conditions of scarcity and made to
a certain extent the minimum requirements.
3. There is substantial increase in the programmes that are intended to
provide additional employment. The various employment guarantee
scheme as well as the credit-related integrated rural development
programmes are examples.
4. Expenditure of Education and Health also had an important bearing in
reducing poverty levels.\
For more detailed analysis of impact of Economic Reforms on Vulnerable Section,
please refer to Indias Tryst with Destiny by Jagadish Bhagawati and Arvind
Panagariya.

Conclusion
Judging by the externally visible signs, he Indian reform story has been a
remarkable success. After long periods of stagnation in the years following
independence, growth rate shifted into high gear sometime during the 1980s and
in the last decade accelerated sharply, reaching undreamt heights.
Investment as percentage of GDP increased from about 10 per cent in
1950s to 23 per cent in 1980s and close to 36 per cent recently. Similarly, India

today qualifies as Open Economy with import and export accounting to 50 per
cent of GDP and Current receipts and payments plus Capital Receipts accounting
for 107 per cent of GDP. On the Forex front, India has totally transformed itself
from a perennial position to a position of a bundance.
Overall, on growth front, Reforms have delivered beyond expectations
while simultaneously macroeconomic stability has more or less successfully
maintained. But the resulting growth and stability have has a fairly limited
impact on poverty and seem to have aggravated both interpersonal and interregional inequality. The growth has also had an extremely low employment
potential.