Economic liberalisation in India

The economic liberalisation in India refers to the economic liberalization of the country's economic policies with the goal of making the economy more market and service-oriented and expanding the role of private and foreign investment.[1][2] Although unsuccessful attempts at liberalization were made in 1966 and the early 1980s, a more thorough liberalization was initiated in 1991. The reform was prompted by a balance of payments crisis that had led to a severe recession.[3]

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Specific changes included reducing import tariffs, deregulating markets, and reducing taxes, which led to an increase in foreign investment and high economic growth in the 1990s and 2000s. From 1992 to 2005, foreign investment increased 316.9%, and India's gross domestic product (GDP) grew from $266 billion in 1991 to $2.3 trillion in 2018[4][5] According to one study, wages rose on the whole, as well as wages as the labor-to-capital relative share.[3]

Pre-liberalization policies
Further information: Economic history of India and Licence Raj

Indian economic policy after independence was influenced by the colonial experience (which was seen by Indian leaders as exploitative in nature) and by those leaders' exposure to Fabian socialism. Policy tended towards protectionism, with a strong emphasis on import substitution industrialization under state monitoring, state intervention at the micro level in all businesses especially in labour and financial markets, a large public sector, business regulation, and central planning.[6] Five-Year Plans of India resembled central planning in the Soviet Union. Under the Industrial Development Regulation Act of 1951, steel, mining, machine tools, water, telecommunications, insurance, and electrical plants, among other industries, were effectively nationalised.[7] Elaborate licences, regulations and the accompanying red tape, commonly referred to as Licence Raj, were required to set up business in India between 1947 and 1990.[8] The Indian economy of this period is characterised as Dirigism.[9][10]

Before the process of reform began in 1991, the government attempted to close the Indian economy to the outside world. The Indian currency, the rupee, was inconvertible and high tariffs and import licensing prevented foreign goods reaching the market.[11] India also operated a system of central planning for the economy, in which firms required licences to invest and develop. The labyrinthine bureaucracy often led to absurd restrictions—up to 80 agencies had to be satisfied before a firm could be granted a licence to produce and the state would decide what was produced, how much, at what price and what sources of capital were used. The government also prevented firms from laying off workers or closing factories. The central pillar of the policy was import substitution, the belief that India needed to rely on internal markets for development, not international trade—a belief generated by a mixture of socialism and the experience of colonial exploitation. Planning and the state, rather than markets, would determine how much investment was needed in which sectors.

— BBC[12]

Licence Raj established an "irresponsible, self-perpetuating bureaucracy"[13] and corruption flourished under this system.[14] Only four or five licences would be given for steel, electrical power and communications, allowing licence owners to build huge and powerful empires without competition.[12] A huge public sector emerged, allowing state-owned enterprises to record huge losses without being shut down.[12] Controls on business creation also led to poor infrastructure development.[12]

By 1980, this had created widespread economic stagnation. The annual growth rate of the Indian economy had stagnated around 3.5% from the 1950s to 1980s, while per-capita income growth averaged 1.3%.[15] During the same period, Pakistan grew by 5%, Indonesia by 9%, Thailand by 9%, South Korea by 10% and Taiwan by 12%.[16]

Reforms Before 1991

1966 Liberalization Attempt

In 1966, due to rapid inflation caused by an increasing budget deficit accompanying the Sino-Indian War and severe drought, the Indian government was forced to seek monetary aid from the International Monetary Fund (IMF) and World Bank.[17] Pressure from aid donors caused a shift towards economic liberalization, wherein the rupee was devalued to combat inflation and cheapen exports and the former system of tariffs and export subsidies was abolished.[18] However, a second poor harvest and subsequent industrial recession helped fuel political backlash against liberalization, characterized by resentment at foreign involvement in the Indian economy and fear that it might signal a broader shift away from socialist policies.[19] As a result, trade restrictions were reintroduced and the Foreign Investments Board was established in 1968 to scrutinize companies investing in India with more than 40% foreign equity participation.[18]

World Bank loans continued to be taken for agricultural projects since 1972, and these continued as international seed companies that were able to enter Indian markets after the 1991 liberalization.[20]

Economic Reforms During 1980s

As it became evident that the Indian economy was lagging behind its East and Southeast Asian neighbors, the governments of Indira Gandhi and subsequently Rajiv Gandhi began pursuing economic liberalization.[21] The governments loosened restrictions on business creation and import controls while also promoting the growth of the telecommunications and software industries.[22] Reforms under lead to an increase in the average GDP growth rate from 2.9 percent in the 1970s to 5.6 percent, although they failed to fix systemic issues with the Licence Raj.[21] Despite Rajiv Gandhi's dream for more systemic reforms, the Bofors scandal tarnished his government's reputation and impeded his liberalization efforts.[23]

Chandra Shekhar Singh Reforms

The Chandra Shekhar Singh government (1990–91) took several significant steps towards liberalization and laid its foundation.[24]

P. V. Narasimha Rao
Manmohan Singh
Economic liberalisation in India was initiated in 1991 by Prime Minister P. V. Narasimha Rao and his then-Finance Minister Dr. Manmohan Singh.[25]

Liberalization of 1991

Crisis Leading to Reforms
Main article: 1991 Indian economic crisis

By 1991, India still had a fixed exchange rate system, where the rupee was pegged to the value of a basket of currencies of major trading partners. India started having balance of payments problems in 1985, and by the end of 1990, the state of India was in a serious economic crisis. The government was close to default,[26][27] its central bank had refused new credit, and foreign exchange reserves had reduced to the point that India could barely finance two weeks' worth of imports.

Liberalization of 1991

The collapse of the Chandra Shekhar government in the midst of the crisis and the assassination of Rajiv Gandhi led to the election of a new Congress government led by P. V. Narasimha Rao.[28] He selected Amar Nath Verma to be his Principal Secretary and Manmohan Singh to be finance minister and gave them complete support in doing whatever they thought was necessary to solve the crisis.[28] Verma helped draft the New Industrial Policy alongside Chief Economic Advisor Rakesh Mohan, and it laid out a plan to foster Indian industry in five points.[29][30] Firstly, it abolished the License Raj by removing licensing restrictions for all industries except for 18 that "related to security and strategic concerns, social reasons, problems related to safety and overriding environmental issues."[29] To incentivize foreign investment, it laid out a plan to pre-approve all investment up to 51% foreign equity participation, allowing foreign companies to bring modern technology and industrial development.[28][29] To further incentivize technological advancement, the old policy of government approval for foreign technology agreements was scrapped. The fourth point proposed to dismantle public monopolies by floating shares of public sector companies and limiting public sector growth to essential infrastructure, goods and services, mineral exploration, and defense manufacturing.[28][29] Finally the concept of an MRTP company, where companies whose assets surpassed a certain value were placed under government supervision, was scrapped.[28][31]

Meanwhile, Manmohan Singh worked on a new budget that would come to be known as the Epochal Budget.[32] The primary concern was getting the fiscal deficit under control, and he sought to do this by curbing government expenses. Part of this was the disinvestment in public sector companies, but accompanying this was a reduction in subsidies for fertilizer and abolition of subsidies for sugar.[33] He also dealt with the depletion of foreign exchange reserves during the crisis with a 19 per cent devaluation of the rupee with respect to the US dollar, a change which sought to make exports cheaper and accordingly provide the necessary foreign exchange reserves.[34][35] The devaluation made petroleum more expensive to import, so Singh proposed to lower the price of kerosine to benefit the poorer citizens who depended on it while raising petroleum prices for industry and fuel.[36] On 24 July 1991, Manmohan Singh presented the budget alongside his outline for broader reform.[32] During the speech he laid out a new trade policy oriented towards promoting exports and removing import controls.[37] Specifically, he proposed limiting tariff rates to no more than 150 percent while also lowering rates across the board, reducing excise duties, and abolishing export subsidies.[37]

In August 1991, the Reserve Bank of India (RBI) Governor established the Narasimham Committee to recommend changes to the financial system.[38] Recommendations included reducing the statutory liquidity ratio (SLR) and cash reserve ratio (CRR) from 38.5% and 15% respectively to 25% and 10% respectively, allowing market forces to dictate interest rates instead of the government, placing banks under the sole control of the RBI, and reducing the number of public sector banks.[39] The government heeded some of these suggestions, including cutting the SLR and CRR rates, liberalizing interest rates, loosening restrictions on private banks, and allowing banks to open branches free from government mandate.[40][33]

On 12 November 1991, based on an application from the Government of India, World Bank sanctioned a structural adjustment loan/credit that consisted of two components – an IBRD loan of $250 million to be paid over 20 years, and an IDA credit of SDR 183.8 million (equivalent to $250 million) with 35 years maturity, through India's ministry of finance, with the President of India as the borrower. The loan was meant primarily to support the government's program of stabilization and economic reform. This specified deregulation, increased foreign direct investment, liberalization of the trade regime, reforming domestic interest rates, strengthening capital markets (stock exchanges), and initiating public enterprise reform (selling off public enterprises).[41] As part of a bailout deal with the IMF, India was forced to pledge 20 tonnes of gold to Union Bank of Switzerland and 47 tonnes to the Bank of England and Bank of Japan.[42]

The reforms drew heavy scrutiny from opposition leaders. The New Industrial Policy and 1991 Budget was decried by opposition leaders as "command budget from the IMF" and worried that withdrawal of subsidies for fertilizers and hikes in oil prices would harm lower and middle-class citizens.[32] Critics also derided devaluation, fearing it would worsen runaway inflation that would hit the poorest citizens the hardest while doing nothing to fix the trade deficit.[43] In the face of vocal opposition, the support and political will of the prime minister was crucial in order to see through the reforms.[44] Rao was often referred to as Chanakya for his ability to steer tough economic and political legislation through the parliament at a time when he headed a minority government.[45][46]

Impact

Foreign investment in the country (including foreign direct investment, portfolio investment, and investment raised on international capital markets) increased from US$132 million in 1991–92 to $5.3 billion in 1995–96.[47] After the reforms, life expectancy and literacy rates continued to increase at roughly the same rate as before the reforms.[48][49] For the first 10 years after the 1991 reforms, GDP also continued to increase at roughly the same rate as before the reforms.[50][51] Liberalization did not affect all parts of India equally. Urban residents have benefited more than rural residents.[52] An analysis of the effects of liberalization across multiple Indian states found that states with pro-worker labor laws saw slower industry expansion than those with pro-employer labor laws, as industries moved towards states with friendlier business climates.[53]

HSBC GLT, Pune.

By 1997, it became evident that no governing coalition would try to dismantle liberalization, although governments avoided taking on powerful lobbies such as trade unions and farmers on contentious issues such as reforming labour laws and reducing agricultural subsidies.[54] By the turn of the 21st century, India had progressed towards a free-market economy, with a substantial reduction in state control of the economy and increased financial liberalization.[55]

Institutions like the OECD applauded the changes:

Its annual growth in GDP per capita accelerated from just 1¼ per cent in the three decades after Independence to 7½ per cent currently, a rate of growth that will double the average income in a decade.... In service sectors where government regulation has been eased significantly or is less burdensome—such as communications, insurance, asset management and information technology—output has grown rapidly, with exports of information technology-enabled services particularly strong. In those infrastructure sectors which have been opened to competition, such as telecoms and civil aviation, the private sector has proven to be extremely effective and growth has been phenomenal.

— OECD[56]

The fruits of liberalization reached their peak in 2006, when India recorded its highest GDP growth rate of 9.6%.[57] With this, India became the second fastest growing major economy in the world, next only to China.[58] The growth rate has slowed significantly in the first half of 2012.[59] An Organisation for Economic Co-operation and Development (OECD) report states that the average growth rate 7.5% will double the average income in a decade, and more reforms would speed up the pace.[56] The economy then rebounded to 7.3% growth in 2014–15.

Later reforms

The United Front government attempted a progressive budget that encouraged reforms, but the 1997 Asian financial crisis and political instability created economic stagnation.

The Bharatiya Janata Party (BJP)–Atal Bihari Vajpayee administration surprised many by continuing reforms, when it was at the helm of affairs of India for six years, from 1998 to 1999 and from 1999 to 2004.[60] The BJP-led National Democratic Alliance Coalition began privatizing under-performing government-owned business including hotels, VSNL, Maruti Suzuki, and airports. The coalition also began reducing taxes, a fiscal policy aimed at reducing deficits and debts and increased initiatives for public works.

Towards the end of 2011, the Congress-led UPA-2 Coalition Government initiated the introduction of 51% Foreign Direct Investment in retail sector. But due to pressure from fellow coalition parties and the opposition, the decision was rolled back. However, it was approved in December 2012.[61]

The second BJP-led NDA Government also opened up the coal industry through the passing of the Coal Mines (Special Provisions) Bill of 2015. It effectively ended the Indian central government's monopoly over the mining of coal, which existed since nationalization in 1973 through socialist controls. It has opened up the path for private, foreign investments in the sector, since Indian arms of foreign companies are entitled to bid for coal blocks and licences, as well as for commercial mining of coal. This could result in billions of dollars investments by domestic and foreign miners. The move is also beneficial to the state-owned Coal India Limited, which may now get the elbow room to bring in some much needed technology and best practices, while opening up prospects of a better future for millions of mine workers.[62]

In the 2016 budget session of Parliament, the Narendra Modi led BJP Government pushed through the Insolvency and Bankruptcy Code. The Code creates time-bound processes for insolvency resolution of companies and individuals. These processes will be completed within 180 days. If insolvency cannot be resolved, the assets of the borrowers may be sold to repay creditors. This law drastically eases the process of doing business, according to experts and is considered by many to be the second most important reform in India since 1991 next to the proposed GST.[63]

On 1 July 2017, the BJP-led NDA Government under Narendra Modi approved the Act to Uniform Goods and Services Tax (India). It was approved 17 years after the legislation was first proposed under the earlier BJP-led NDA Government under Atal Bihari Vajpayee's administration in 2000.[64] Touted to be India's biggest tax reform in 70 years of independence and the most important overall reform in terms of ease of doing business since 1991. GST replaced a slew of indirect taxes with a unified tax structure and was therefore showcased as dramatically reshaping the country's 2.5 trillion dollar economy.[65]

In the NDA-3 government, Finance Minister Nirmala Sitharaman had on 20 September 2019 announced lowering of the base corporate tax rate to 22 per cent from 30 per cent for companies that do not seek exemptions, and reduced the rate for new manufacturing companies to 15 per cent from 25 per cent. It is believed that this would be very beneficial in attracting investment by MNCs in the Indian economy and thus help in its growth.

This was followed with agricultural and labour reforms in 2020 as an aftermath of the COVID-19 crisis.

See also

References
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