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. 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[3][4]
International business analysts[clarification needed] argue that Indian government coalitions should continue liberalization,[5] with the McKinsey Quarterly stating that "removing major obstacles would free India's economy to grow as fast as China's, at 10% a year".[6] However, many debate the extent to which the reforms have been beneficial to the Indian people.[7][8]Income inequality has doubled in India since 1992, with consumption among the poorest remaining static while the wealthiest generate the consumption growth.[9] India's GDP growth rate in 2012–13 was the lowest for a decade, at just 5.1%,[10] at which time more criticism of India's economic reforms surfaced, focused on employment, nutritional values in terms of food intake in calories, leading to charges that there was a worsening current account deficit compared to the period prior to reform.[11]
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.[12]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.[13] Elaborate licences, regulations and the accompanying red tape, commonly referred to as Licence Raj, were required to set up business in India between 1947-90.[14] The Indian economy of this period is characterised as Dirigism.[15][16]
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.[17] 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.
Licence Raj established an "irresponsible, self-perpetuating bureaucracy"[19][page needed] and corruption flourished under this system.[20] 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.[18] A huge public sector emerged, allowing state-owned enterprises to record huge losses without being shut down.[18] Controls on business creation also lead to poor infrastructure development.[18]
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%.[21] During the same period, Pakistan grew by 5%, Indonesia by 9%, Thailand by 9%, South Korea by 10% and Taiwan by 12%.[22]
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.[23] 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.[24] 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. [25] 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. [24]
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.[26]
Economic Reforms During 1980s
As it became evident that the Indian economy was laggi
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.[26]
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. [27] The governments loosened restrictions on business creation and import controls while also promoting the growth of the telecommunications and software industries.[28][page needed] 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. [27] Despite Rajiv Gandhi's dream for more systemic reforms, the Bofors scandal tarnished his government's reputation and impeded his liberalization efforts.[29]
Chandra Shekhar Singh Reforms
The Chandra Shekhar Singh government (1990–91) took several significant steps towards the much needed reforms and laid its foundation.[30]
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, [32][33] its central bank had refused new credit, and foreign exchange reserves had reduced to the point that India could barely finance three 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 lead to the election of a new Congress government lead by P. V. Narasimha Rao.[34] 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.[34] 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.[35][36] 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."[35] 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. [34][35] 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. [34][35] Finally the concept of an MRTP company, where companies whose assets surpassed a certain value were placed under government supervision, was scrapped.[34][37]
Meanwhile, Manmohan Singh worked on a new budget that would come to be known as the Epochal Budget.[38] 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. [39] 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.[40][41] 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. [42] On July 24, 1991, Manmohan Singh presented the budget alongside his outline for broader reform. [38] During the speech he laid out a new trade policy oriented towards promoting exports and removing import controls. [43] Specifically, he proposed limiting tariff rates to no more than 150 percent while also lowering rates across the board, reducing
The collapse of the Chandra Shekhar government in the midst of the crisis and the assassination of Rajiv Gandhi lead to the election of a new Congress government lead by P. V. Narasimha Rao.[34] 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.[34] 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.[35][36] 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."[35] 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. [34][35] 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. [34][35] Finally the concept of an MRTP company, where companies whose assets surpassed a certain value were placed under government supervision, was scrapped.[34][37]
Meanwhile, Manmohan Singh worked on a new budget that would come to be known as the Epochal Budget.[38] 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 se
Meanwhile, Manmohan Singh worked on a new budget that would come to be known as the Epochal Budget.[38] 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. [39] 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.[40][41] 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. [42] On July 24, 1991, Manmohan Singh presented the budget alongside his outline for broader reform. [38] During the speech he laid out a new trade policy oriented towards promoting exports and removing import controls. [43] 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. [43]
In August 1991, the Reserve Bank of India (RBI) Governor established the Narasimham Committee to recommend changes to the financial system. [44] 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.[45] 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.[46][39]
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).[47] 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. [48]
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. [38] 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.[49] In the face of vocal opposition, the support and political will of the prime minister was crucial in order to see through the reforms. [50] 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.[51][52]
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.[53] This has been accompanied by increases in life expectancy, literacy rates, and food security, although urban residents have benefited more than rural residents.[54] However, liberalization did not affect all parts of India equally. 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. [55]
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.[56] By the turn of the 21st century, India had progressed towards a trade unions and farmers on contentious issues such as reforming labour laws and reducing agricultural subsidies.[56] 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.[57]
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 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[59] With this, India became the second fastest growing major economy in the world, next only to China.[60] The growth rate has slowed significantly in the first half of 2012.[61] 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.[58] The economy then rebounded to 7.3% growth in 2014–15.
