Why did India launch a program of economic reforms in 1991

Topic: BusinessComparative Analysis
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Last updated: April 20, 2019

In the literature several minor and major areas are covered by the reform program.

However, according to Jagdish Bhagwati (1993, chapter 2, p.46) “the main elements of India’s policy framework that stifled efficiency and growth until the 1970s and during the 1980s are the following three major groups:1. Extensive bureaucratic controls over production, investment, and trade;2. Inwards-looking trade and foreign investment policies;3. A substantial public sector, going well beyond the conventional confines of public utilises and infrastructure”.The author states that the first two groups affected the private sector’s efficiency negatively and the last group with the inefficient functioning of public sector weakened the public sector’s contribution to economy. And these groups led to low productivity and therefore low economic growth for India.I will elaborate on each of the group in second part of the essay, which will discuss the reasons for economic reforms in India during 1947 – 1991.

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The third part of the essay will discuss the success and failure of the reforms implemented and based on these reasons and implementation of reforms I will give conclusion whether the reforms have created an impact and supported the economic growth.Indian development model and the reasons for economic reforms:In this section I am going to discuss the areas mentioned in the groups described in the introduction, of this essay.Fiscal deficit reduction and industrial and trade policy:In any country balance of payment can arise either because current account is in deficit; a country is importing more than exporting or capital account is in deficit. From my interpretation capital account is in deficit when capital is flowing out of the country than coming into the country. To address this problem of current account deficit trade policies was reformed, and economy adopted more open strategies. Fiscal decadence caused India’s balance of payment crisis in 1991.

Another reason identified for this was due to the international debt servicing. It was observed that the ratio of GDP was as high as 80% and ratio of public debt to GNP increased to nearly 60%. The rising fiscal deficit in 1990s was not financing higher level of public investment and remained more or less constant in this period (Study pack, Economic reforms in India since 1991, p.

330 & Jagdish Bhagwati 1993, chapter 2, p. 67).Besides, both the central and state government took a number of decisions to achieve higher economic growth. Central government reduced subsidies which were known highly distortionary and poorly targeted for example subsidies on food and fertilizers and introduced rational user charges for services such as passenger traffic on railways, the postal system and university education. Central government also economised the overstaffing, which was estimated at 30% and expected to reduce expenditure. As far as the state government is concerned it took steps towards modernising sale tax system and downsizing overstaffing again which was another problem for India’s slow economy and for reforming to be taken place (Study pack, Economic reforms in India since 1991, p.

331).Reforms in industrial and trade policy was described by multiple controls over private investment that limited the areas in high private investors were allowed to operate. Another reason for reforming in this area was a highly ineffective structure which needs to be supported by a highly protective trade policy. The list of Industries which used to cover eighteen industries including iron and steel, heavy plant and machinery, telecommunication and telecom equipment, mineral, oil, mining, air transport services and electrically generation and distribution has been reduced to three industries: defense aircrafts and warships, atomic energy generation and railway transport. Industrial licensing was almost eliminated expect for a few hazardous and environmentally sensitive industries.

Monopolies were abolished to encourage competition. These reforms were again expected to increase growth rate and competition (Study pack, Economic reforms in India since 1991, p. 332).Prior to reform in trade policy high tariffs and restrictions were in place for example imports of manufactured goods were completely banned and certain capital goods were freely importable. Import license was abolished for capital goods. After the reform import license were gradually. This was expected to encourage domestic production of substitutes. reduced.

Besides, a more flexible exchange rate policy was adopted. Combined it was expected that it will solve the current account deficit. As far as the capital account is concerned more attractive policies were put into place to attract foreign direct investment.

This was expected to increase capital inflow, generating more competitive business environment, upgrading technology and expand efficiency skills of production (Study pack, Economic reforms in India since 1991, p. 332).Foreign direct investment was another important part of India’s economy. It was believed that when foreign investment comes in domestic investment it increases aggregate investment in the economy and improves production technology. Therefore the changes in the policy of foreign investment were expected to increase foreign ownership of industries, banks, insurance companies, telecommunications and airlines.

In addition, inflexibility of labour market was a major factor reducing India’s competitiveness in exports and reducing industrial productivity. For example any firm wishing to close down a plant in nay unit employing more than 100 workers can only do so with the permission of the state government and this was rarely granted. Therefore government wanted to reform this policy to raise the level of employment and to have flexibility of labour market (Study pack, Economic reform in India since 1991, p. 333 & 334 & Jagdish Bhagwati 1993, chapter 2, p. 57).Infrastructure development:Growth in economy requires a well functioning infrastructure especially electric power, roads and rail connectivity, telecommunication, air transport and effluent ports.

These were usually provided by public sector monopolies but since the investment needed to improve quality. It could not be activated by public sector. This led to a weak infrastructure system. Therefore changes were made to this policy by opening this sector to private and foreign investment (Study pack, Economic reform in India since 1991, p. 335).Financial sector reform:Reforms in financial sector were mainly in banking system and capital market. Under banking system reforms included measures for liberlisation, measures designed to increase financial soundness and measures for increase competition.

Also India’s’ stock market was accelerated by a stock market scam in 1992 serious weakness of in the regulatory mechanism. Therefore for eliminating approval of reserve bank of India for loans, strengthening banking supervision, for liberlisation and openness, and for dematerialisation of shares and stock market to regulate effectively reform were renewed (Study pack, Economic reforms in India since 1991, p. 336).Another important reform in financial sector was the withdrawal of the special privilege enjoyed by the Unit Trust of India, a dominant mutual fund investment vehicle. As far as he insurance sector reform is concerned, it renewed because government wanted to change it from being a public sector monopoly to private insurance company reducing government role and allowing private insurance companies to enter the market with equity up to 20%. This was expected to stimulate long term savings and depth to capital market (Study pack, Economic reform in India since 1991, p.

336 & 337).Privatisation:India adopted reform policies to achieve high economic growth and another policy they adopted beside trade liberlisation was to encourage privatisation. Indian economy targeted to achieve larger private sector by restructuring the role of government. This reduced government’s intervention and allowed market forces to operate. Initially government adopted a limited approach of selling minority stake in public sector while maintaining the management control.

The main motive was to activate revenue for budget and was expected that private shareholders would increase the commercial orientation of public sector (Study pack, Economic reform in India since 1991, p. 337).Social sector development:The gap of social development among Southeast Asian countries needed to be reduced as India lagged behind for example the literacy rate in India 52% compared with 57% in Indonesia and 79% in Thai 1971. This reform was not only to improve welfare of poor but to increase their income and to create preconditions for rapid economic growth.The problems with the economy faced by India during 1947 to 1991 forced government to reform new policies to achieve higher rates of growth in future (Study pack, Economic reform in India since 1991, p. 338 & 339).

Success and failure of the reform policies:India’s economic performance after reform period has many positive features. The average growth period from 1992 – 1993 to 2001 – 2002 was around 6.0 percent. This put India among the fastest growing developing countries in the 1990s.Fiscal profligacy, which caused balance of payment crisis in India, required an urgent reform which worked. The fiscal deficit of central and state government was successfully reduced from 9.4 percent of GDP in 1990 – 1991 to 7 percent in both 1991 – 1992 and 1993.

Also the balance of payment crises ended by 1993. Not only this, growth rate of 6 perecnet was achieved per year with an average investment rate of around 23 percent after reforms. Also the reform had a medium term fiscal objective of improving public saving but this part of the reform was never put into practice (Study pack, Economic reforms in India since 1991, p. 330).However the reforms in industrial and trade policy took long time as after ten years of the reforms great liberalisation and openness was achieved in this area. Industrial reform policy worked in terms of reducing government role and openness. The differences between states led to an increase in state growth rate as liberlaistaion created a more competitive environment. However the main area where this reform did not work adequately was reserving production of certain items for small scale sector.

Many of these reserved items failed to permit development of production units with modern technology and equipment (Study pack, Economic reform in India since 1991, p.330, 331 & 332).Reforms for foreign direct investment also created a competitive environment for India’s industry compared to the one existed in 1991. Indian companies used advanced technology and improved scale of production, which led to efficiency. Under these reforms they also restructured through mergers and joint ventures, which again led to competitiveness.

Reforms in terms of industrial growth were disappointed. Industrial growth did take place but for first five years but then it slowed down to 4.5 percent in the next five years. India’s share of world export also increased a little bit from 0.5 to 0.6 in 19991 to 1999. The reason for this slow progress was decrease in import duties that made India a high cost produce and therefore less attractive for exportation.

Flexibility of labour market reform also worked and allowed firm to have to seek permission from 100 workers to 1000, which led to decrease in expenditure and economic growth (Study pack, Economic reforms in India since 1991, p. 333 & 334).Under reform for infrastructure where services of electric power, telecommunication etc etc, were decided to open to private sector has been a disappointment.

According to Montek S. Ahluwalia “these were first opened for private investment and private investors were expected to produce electricity for sale to the State Electricity Boards”. Private investors insisted on guaranteed purchase of electricity by state government with additional guarantees from the central government.These attracted criticisms.

The State Electricity Board was financially very weak and electricity tariffs were tool low as well. Because of these difficulties these reforms could not achieved what was targeted and the quality of power remained poor. Railways another important part of the infrastructure reform and important mean of transportation but this was untouched by the reforms. Therefore this sector suffered from “financial constraints and political determined fare structure”.

However the results for telecommunication reforms were much better and caused success in information technology for India (Study pack, Economic reforms in India since 1991, p. 336 & Jagdish Bhagwati 1993, chapter 2, p. 61).Financial sector reforms produced some positive outcomes.

Reforms in this sector were expected to increase efficiency of the public sector banks and it did succeed. Reforms of the withdrawal of special privilege also removed the distortion of capital market. However the benefits of other reforms such as for insurance sector reform are still to come and will become evident over time (Study pack, Economic reforms in India since 1991, p. 337).

Reform in privatisation sector was a prominent component of economic reform but it had very less success. According to Montek S. Ahluwalia “disinvestment receipts were consistently below the budget expectation, average realistaion in first five years was less than 0.

25 percent of GDP compared with an average of 1.7 percent in 17 countries”. Therefore government realised that a great deal of preliminary work is required before privatisation can be successfully implemented (Study pack, Economic reform in India since 1991, p. 338).Finally the development in social sector was worth noting as it continued to improve during the reforms. The literacy rate increased from 52% in1991 to 65% in 2001, and this increase has been high in low literacy states such as Bihar, Madhya Pradesh and Uttar Pradesh (Study pack, Economic reforms in India since 1991, p.

339).Conclusion:Undoubtedly prior to reforms India was at a critical turning point. The reforms were put into place mainly in the microeconomic framework, requiring the structural reforms that would free the economy and improve its functioning. Those reforms that worked did improve the efficiency of the system however some of them such as failure of fiscal front and privatisation needs to be reviewed.

And some were put into to place only recently therefore their benefits for them are still to be felt. After revision once these reforms are put into to place it is possible for India to exceed well beyond 6 percent growth rate per year and achieve the government’s target of 8 percent growth rate per year.

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