Economic Reforms of 1991 (LPG Reforms)

Economic Reforms of 1991 in India refer to the opening of the country’s economy to the rest of the world with the intention of increasing the role of the private sector and foreign investment.

Economic Reforms of 1991 brought in LGP Reforms in India.

Liberalization entails the removal of governmental limitations on private individual activity.

Privatization refers to the transition of a business, industry, or service from public to private ownership and management.

Globalization is the flow of products, services, capital, and labor across international borders.

Background of Economic Reform in India

• In order to lessen the burdens of the control regime (the licensing Raj), the Rajiv Gandhi administration (1984–1999) undertook a number of reforms in the latter part of the 1980s.
• These included loosening license requirements, lowering import restrictions, implementing export incentives, etc. However, these modifications were minor rather than fundamental, more about easing restrictions and operating them more flexibly than a thorough withdrawal of the control system.
• However, it pushed India’s GDP growth in the 1980s to over 5.5 percent, breaking the previous record of 5 percent growth known as the “Hindu rate of Growth” that had stood for the preceding three decades.
• While the Indian economy appeared to be performing well in the 1980s, there were long-term structural vulnerabilities developing in the system as a result of widespread industrial control through the license raj, Monopolies and Restrictive Trade Practices Act (MRTP) of 1969, nationalization of banks and other industries, self-sufficiency and an inward-looking trade strategy, as well as Import Substitution Industrialization (ISI).
• Due to the fact that imports were nearly two times as high as exports, there was a massive trade deficit in the second half of the 1980s (export earnings were only 55 percent of imports). All of this prompted India to borrow money in the short term more and more by the late 1980s.
• Up until the early 1980s, the government had wisely managed the fiscal (revenue and expenditure) situation, but it started to engage in fiscal profligacy (recklessly wasting money) by taking on large amounts of debt to support various development programs and maintain growth, which caused issues in the late 1980s and early 1990s.
• As a result, the macroeconomic foundations of the economy turned bad (fiscal deficit of 8.4%, current account deficit of 3.14%, high inflation of 17%, huge foreign debt, etc. in 1990–1991); this puts a lot of pressure on the Balance of Payment (BoP) front.

The worrying foreign exchange position was partly caused by the Iraqi invasion of Kuwait in August 1990, which increased oil prices (and the cost of imports) and decreased Indian exports to the Middle East or Gulf region. India’s sovereign rating (international credit rating) was severely lowered, making it very challenging to obtain credit (loan) abroad.

The three primary areas in which economic changes were implemented during the Economic Reforms of 1991 were as follows:

• We removed the complex system of rules, permissions, and licenses.
• In nearly every area of economic activity, we turned around the significant bias in favor of state ownership of the means of production and the expansion of public sector businesses.
• We stopped pursuing an inward-looking trade strategy.

The main goal of the reforms was to quickly and thoroughly integrate the Indian economy with the global economy through trade, investment, and technology flows. To this end, it was necessary to create conditions that would provide Indian entrepreneurs with a business environment that was roughly comparable to that of other developing nations.

Also read: History of Banking in India

Major Reforms Carried Out in 1991

Economic Reforms in India in 1991 carried out several changes. A few important reforms are-

Fiscal Stabilisation

The effectiveness of economic reforms depends on the achievement of fiscal stabilization. In order for the reforms to succeed, the Central Government’s fiscal deficit, which had reached 8.4% in the 1990–1991 fiscal year, needed to be reduced. The below actions were performed in order to decrease the budget deficit.

• Export subsidies were abolished in 1991–1992, and fertilizer subsidies were partially restructured in 1992–1993.
• Budget assistance to loss-making public-sector units in the form of government loans to cover their losses was gradually phased out.
• Some development expenditure, such as spending on social and economic infrastructure, was reformed.

Industrial Policy

Industrial policy has seen the most radical changes as a result of the reform plan. There is no longer a need for the government to grant approval for new investments or for the significant expansion of current capacity as it was previously under industrial licensing (License Raj).

• Nowadays, only a small number of businesses are required to have licenses, mostly due to environmental and pollution concerns. Additionally, the MRTP Act was also eliminated.
• The list of industries that were solely for the public sector to operate was drastically reduced, and many crucial sectors were made available to the private sector, including power generation, hydrocarbons (oil and gas exploration, production, and refining), air transportation, telecommunications, and others.

De-licensing of items reserved for the MSME Sector

Since 1991, the Ministry of Commerce and Industry has been gradually de-licensing the products specified for the MSME sector through a proactive approach.

Foreign Investment

Prior to 1991, India had an extremely restrictive and often regarded hostile foreign investment policy.

The new strategy supported foreign investment considerably more actively in a variety of ways. For foreign equity investments of up to 51 percent in a lengthy list of 34 industries, permission is automatically granted; for investments of more than 51 percent, government approval was required.

Trade and Exchange Rate Policy

With certain required exceptions, all raw materials, other production inputs, and capital products can now be imported without restriction.

Prior to 1991, the RBI-determined an official exchange rate on which the Indian Rupee was converted into foreign currency. The value of the rupee dropped by nearly 24 percent in July 1991. (for alignment of the exchange rate with the market rate).  In 1993, India switched to a market-based exchange rate system (managed float/floating rate).

Tax Reforms

• In June 1991, the highest marginal rate of personal income tax was 56%. This was decreased to 40%.
• For publicly listed enterprises, corporate income tax was lowered from 51.75% to 46%.
• The average amount of customs duty drastically decreased from 200% to only 65%.

Public Sector Reforms

The government started a restricted process of disinvesting its ownership and equity in public sector enterprises instead of going through full privatization, keeping 51% of the equity and management control.

Financial Sector Reforms

• New private banks were allowed to compete in the banking sector, and numerous new banking licenses were granted.
• Trading practices in capital markets are kept under transparent and strict control. In order to oversee the major players in the capital markets and regulate stock exchanges, an independent statutory entity called SEBI was created in 1988.
• The capital market was made available for portfolio investments, and Indian businesses were permitted to access global capital markets by issuing equity or shares overseas through Global Depository Receipts (GDR).

Impact of Economic Reforms of 1991

The economic reforms made in 1991 had a large-scale impact.

On various macroeconomic parameters (short-term)

• Within 2.5 years, inflation dropped from a peak of 17 percent in August 1991 to roughly 8.5 percent.
• Forex reserves increased from $1.2 billion in June 1991 to nearly $15 billion in 1994.
• GDP growth rate increased from 1.1% in 1991–1992 to 4% in 1992–1993
• The fiscal deficit decreased from 8.4%% in 1990–1991 to 5.7% in 1992–1993
• Between 1990–1991 and 1993–1994 exports nearly doubled.

On poverty reduction (long term)

Growth contributes to the reduction of poverty in two ways: first, through the percolation (trickle-down) impact, and second, by enabling the government to raise more funds to support increased social sector spending. So, in order to significantly reduce poverty, two strategies are required:

• allowing rapid economic growth, and
• concentrating on specialized programs to assist the underprivileged and needy

The Indian economy grew at a faster rate of 6.3 percent when we started the reforms in 1991, which enabled the government to raise more resources and pull in a sizable population in the growth process.

However, despite all the reforms, a large portion of Indians remain impoverished. According to estimates from the Tendulkar Committee for 2011–12, there is still 21.9 percent (26.9 cr) of the population living below the poverty line. In addition to being impoverished, they lack the necessities that have been discussed since Independence and before.

On the disparity between rich and poor (long term)

According to data from the National Council of Applied Economic Research, the Gini coefficient in income for rural and urban areas rose from 0.52 in 2004-05 to 0.55 in 2011-12. (the higher the Gini coefficient higher the inequality).

According to data from the National Council of Applied Economic Research, the Gini coefficient in income for rural and urban areas rose from 0.52 in 2004-05 to 0.55 in 2011-12. (the higher the Gini coefficient higher the inequality). The conclusion is that poverty decreased faster but inequality rose throughout the post-reform period.

Conclusion

As a result of our inability to provide enough work opportunities for young people, the post-reform period has been referred to as a period of jobless growth. The creation of numerous high-quality jobs is currently India’s most urgent task since it is the only sustainable way to address chronic poverty; otherwise, the demographic dividend could turn into a nightmare of underemployment and unemployment.

The low rise in rural productivity in India is the other important issue, in contrast to China where rural entrepreneurship was the main economic driver for years.

According to Raghuram Rajan (2014), India simply redistributed resources to rural regions through transfer programs (redistribution) like the guaranteed rural job plan and the minimum support price (MSP) for crops, without the concurrent increase in farm production that increased the demand for goods and services and increased inflation.

However, since 2014, the government has boosted budgeted spending on rural infrastructure.

Article Written By: Priti Raj