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The economic liberalisation in India refers to the economic liberalisation, initiated in 1991, of the country's economic policies, with the goal of making the economy more market-oriented and expanding the role of private and foreign investment. Specific changes include a reduction in import tariffs, deregulation of markets, reduction of taxes, and greater foreign investment. Liberalisation has been credited by its proponents for the high economic growth recorded by the country in the 1990s and 2000s. Its opponents have blamed it for increased poverty, inequality and economic degradation. The overall direction of liberalisation has since remained the same, irrespective of the ruling party, although no party has yet solved a variety of politically difficult issues, such as liberalising labour laws and reducing agricultural subsidies. There exists a lively debate in India as to what made the economic reforms sustainable.
Contents
- Pre liberalisation policies
- Pre 1991 liberalisation attempts
- Prevailing situation during 1980s
- Crisis
- Liberalisation of 1991
- Later reforms
- Challenges to further reforms
- Reforms at the state level
- References
Indian government coalitions have been advised to continue liberalisation. Before 2015 India grew at slower pace than China which has been liberalising its economy since 1978. But in year 2015 India outpaced China in terms of GDP growth rate. The McKinsey Quarterly states that removing main obstacles "would free India's economy to grow as fast as China's, at 10% a year".
There has been significant debate, however, around liberalisation as an inclusive economic growth strategy. Since 1992, income inequality has deepened in India with consumption among the poorest staying stable while the wealthiest generate consumption growth. As India's gross domestic product (GDP) growth rate became lowest in 2012–13 over a decade, growing merely at 5.1%, more criticism of India's economic reforms surfaced, as it apparently failed to address employment growth, nutritional values in terms of food intake in calories, and also exports growth – and thereby leading to a worsening level of current account deficit compared to the prior to the reform period. But then in FY 2013–14 the growth rebounded to 6.9% and then in 2014–15 it rose to 7.3% as a result of the reforms put by the New Government which led to the economy becoming healthy again and the current account deficit coming in control. Growth reached 7.5% in the Jan-Mar quarter of 2015 before slowing to 7.0% in Apr–Jun quarter.
Pre-liberalisation policies
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, industrialisation 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. Five-Year Plans of India resembled central planning in the Soviet Union. Steel, mining, machine tools, water, telecommunications, insurance, and electrical plants, among other industries, were effectively nationalised in the mid-1950s. 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.
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. 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.
Pre-1991 liberalisation attempts
Attempts were made to liberalise the economy in 1966 and 1985. The first attempt was reversed in 1967. Thereafter, a stronger version of socialism was adopted. The second major attempt was in 1985 by prime minister Rajiv Gandhi. The process came to a halt in 1987, though 1967 style reversal did not take place.
In the 80s, the government led by Rajiv Gandhi started light reforms. The government slightly reduced Licence Raj and also promoted the growth of the telecommunications and software industries.
The Chandra Shekhar Singh government (1990–1991) took several significant steps towards the much needed reforms and laid its foundation.
Prevailing situation during 1980s
The fruits of liberalisation reached their peak in 2006, when India recorded its highest GDP growth rate of 9.6%. With this, India became the second fastest growing major economy in the world, next only to China. The growth rate has slowed significantly in the first half of 2012. 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. The economy then rebounded to 7.3% growth in 2014–15.
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 since 1985, and by the end of 1990, the state of India was in a serious economic crisis. The government was close to default, 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. It had to pledge 20 tonnes of gold to Union Bank of Switzerland and 47 tonnes to Bank of England as part of a bailout deal with the International Monetary Fund (IMF). Most of the economic reforms were forced upon India as a part of the IMF bailout.
A Balance of Payments crisis in 1991 pushed the country to near bankruptcy. In return for an IMF bailout, gold was transferred to London as collateral, the rupee devalued and economic reforms were forced upon India. That low point was the catalyst required to transform the economy through badly needed reforms to unshackle the economy. Controls started to be dismantled, tariffs, duties and taxes progressively lowered, state monopolies broken, the economy was opened to trade and investment, private sector enterprise and competition were encouraged and globalisation was slowly embraced. The reforms process continues today and is accepted by all political parties, but the speed is often held hostage by coalition politics and vested interests.
Liberalisation of 1991
In response, Prime Minister Narasimha Rao, along with his finance minister Manmohan Singh, initiated the economic liberalisation of 1991. The reforms did away with the Licence Raj, reduced tariffs and interest rates and ended many public monopolies, allowing automatic approval of foreign direct investment in many sectors. Since then, the overall thrust of liberalisation has remained the same, although no government has tried to take on powerful lobbies such as trade unions and farmers, on contentious issues such as reforming labour laws and reducing agricultural subsidies. 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 liberalisation. This has been accompanied by increases in life expectancy, literacy rates and food security, although urban residents have benefited more than rural residents.
Later reforms
The impact of these reforms may be gauged from the fact that total foreign investment (including foreign direct investment, portfolio investment, and investment raised on international capital markets) in India grew from a minuscule US$132 million in 1991–92 to $5.3 billion in 1995–96.
Annual growth in GDP per capita has accelerated from just 1¼ per cent in the three decades after Independence to 7½ per cent currently, a rate of growth that will double 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.
Election of AB Vajpayee as Prime Minister of India in 1998 and his agenda was a welcome change. His prescription to speed up economic progress included solution of all outstanding problems with the West (Cold War related) and then opening gates for FDI investment. In three years, the West was developing a bit of a fascination to India's brainpower, powered by IT and BPO. By 2004, the West would consider investment in India, should the conditions permit. By the end of Vajpayee's term as prime minister, a framework for the foreign investment had been established. The new incoming government of Dr. Manmohan Singh in 2004 further strengthened the required infrastructure to welcome the FDI.
Today, fascination with India is translating into active consideration of India as a destination for FDI. The A T Kearney study put India second most likely destination for FDI in 2005 behind China. It has displaced US to the third position. This is a great leap forward. India was at the 15th position, only a few years back. To quote the A T Kearney Study, "India's strong performance among manufacturing and telecom & utility firms was driven largely by their desire to make productivity-enhancing investments in IT, business process outsourcing, research and development, and knowledge management activities".
Challenges to further reforms
For 2010, India was ranked 124th among 179 countries in Index of Economic Freedom World Rankings, which is an improvement from the preceding year.
OECD summarised the key reforms that are needed:
In labour markets, employment growth has been concentrated in firms that operate in sectors not covered by India's highly restrictive labour laws. In the formal sector, where these labour laws apply, employment has been falling and firms are becoming more capital intensive despite abundant low-cost labour. Labour market reform is essential to achieve a broader-based development and provide sufficient and higher productivity jobs for the growing labour force. In product markets, inefficient government procedures, particularly in some of the states, acts as a barrier to entrepreneurship and need to be improved. Public companies are generally less productive than private firms and the privatisation programme should be revitalised. A number of barriers to competition in financial markets and some of the infrastructure sectors, which are other constraints on growth, also need to be addressed. The indirect tax system needs to be simplified to create a true national market, while for direct taxes, the taxable base should be broadened and rates lowered. Public expenditure should be re-oriented towards infrastructure investment by reducing subsidies. Furthermore, social policies should be improved to better reach the poor and—given the importance of human capital—the education system also needs to be made more efficient.
Though recently labour law reforms have been enacted at the state level
Reforms at the state level
According to an OECD survey of the Indian economy states that had more liberal regulatory regimes had better economic performance. The survey also concluded that were complementary measures for better delivery of infrastructure, education and basic services implemented, they would boost employment creation and poverty reduction.