Liberalisation, Privatisation And Globalisation: An AppraisalClass 11 Indian Economic Development Notes

Economic Reforms Since 1991

After four decades of planned development, India had built a strong industrial base and achieved self-sufficiency in food grain production. However, a large part of the population still depended on agriculture for their livelihood. In 1991, India faced a severe economic crisis, particularly with its balance of payments, which led the government to introduce a new set of economic policies. These policies are famously known as Liberalisation, Privatisation, and Globalisation (LPG).

Introduction: The Pre-1991 Economy

Since independence, India followed a mixed economy framework, trying to combine the best features of capitalist and socialist systems.

• Arguments against this policy: Some scholars argue that the numerous rules and laws meant to control the economy actually slowed down growth and development.
• Arguments for this policy: Others point out that this approach helped India grow from a stagnant economy to one with a high savings rate, a diverse industrial sector, and food security through sustained agricultural output.

By 1991, a crisis related to external debt became unavoidable. The government was unable to repay its foreign borrowings, and its foreign exchange reserves—needed to import essential goods like petroleum—fell so low they could barely cover two weeks of imports. This, combined with rising prices of essential goods, forced the government to change its economic direction.

Background: The Crisis of 1991

The financial crisis of 1991 was not a sudden event but originated from the inefficient management of the Indian economy during the 1980s.

Causes of the Crisis

• Unsustainable Government Spending: The government's expenditure was consistently higher than its income. To finance this deficit, it borrowed heavily from banks, the public, and international financial institutions.
• Low Revenue Generation: The government's spending on development programs for challenges like unemployment and poverty did not generate enough revenue. Income from sources like taxation and public sector enterprises (PSEs) was also insufficient to meet growing expenses.
• Inefficient Use of Funds: A large portion of government income was spent on areas with no immediate returns, such as the social sector and defence.
• Rising Imports and Stagnant Exports: Imports grew at a very high rate, but exports did not keep pace. This created a large trade deficit. Foreign exchange, often borrowed, was spent on consumption needs rather than productive investments.
• Depleting Foreign Exchange Reserves: By the late 1980s, foreign exchange reserves had dropped to a critical level, insufficient to finance imports for more than two weeks or to pay the interest on international loans.
• Loss of Confidence: With the situation worsening, no country or international lender was willing to lend to India.

The International Response and the New Economic Policy (NEP)

To manage the crisis, India approached the International Bank for Reconstruction and Development (IBRD), also known as the World Bank, and the International Monetary Fund (IMF). It received a loan of $7 billion.

However, this loan came with conditions. The World Bank and IMF expected India to:

• Liberalise and open up the economy.
• Remove restrictions on the private sector.
• Reduce the role of the government in many areas.
• Remove trade restrictions with other countries.

India agreed to these conditions and announced the New Economic Policy (NEP). The NEP aimed to create a more competitive environment and remove barriers to the entry and growth of firms.

The NEP's policies can be divided into two main groups:

1. Stabilisation Measures (Short-term): These were intended to correct weaknesses in the balance of payments and control inflation. The main goals were to maintain sufficient foreign exchange reserves and keep rising prices in check.
2. Structural Reform Measures (Long-term): These were aimed at improving the efficiency of the economy and increasing its international competitiveness by removing rigidities in various sectors.

These reforms were implemented under three main heads: Liberalisation, Privatisation, and Globalisation.

Liberalisation

Liberalisation means putting an end to the rules and laws that restricted economic activity and opening up various sectors of the economy. While some liberalisation measures were introduced in the 1980s, the reforms of 1991 were far more comprehensive.

Deregulation of Industrial Sector

Before 1991, the industrial sector was heavily regulated through:

• Industrial Licensing: An entrepreneur needed government permission to start a firm, close a firm, or decide how much to produce.
• Reservation for Public Sector: Many industries were reserved exclusively for the public sector, meaning the private sector could not enter them.
• Reservation for Small-Scale Industries: Some goods could only be produced by small-scale industries.
• Price Controls: The government controlled the price and distribution of many industrial products.

The 1991 reforms removed many of these restrictions:

• Industrial licensing was abolished for almost all industries, except for a few like alcohol, cigarettes, hazardous chemicals, and industrial explosives.
• The number of industries reserved for the public sector was drastically reduced. Now, only parts of atomic energy generation and some core railway activities are reserved.
• Many goods previously reserved for small-scale industries were dereserved.
• In most industries, the market was allowed to determine prices.

Financial Sector Reforms

The financial sector includes institutions like commercial banks, investment banks, and the stock exchange. It is regulated by the Reserve Bank of India (RBI).

The main aim of financial sector reforms was to reduce the role of the RBI from a regulator to a facilitator. This meant allowing the financial sector to make more decisions on its own.

• Private Banks: The reforms led to the establishment of private sector banks, both Indian and foreign.
• Foreign Investment: The foreign investment limit in banks was raised to around 74 percent.
• Branch Expansion: Banks meeting certain conditions were given the freedom to set up new branches without RBI approval.
• Foreign Institutional Investors (FII): FIIs like merchant bankers and mutual funds were allowed to invest in Indian financial markets.

Tax Reforms

Tax reforms are related to the government's taxation and public expenditure policies, collectively known as its fiscal policy. Taxes are of two types:

• Direct Taxes: Taxes on the income of individuals and profits of businesses.
• Indirect Taxes: Taxes levied on commodities (goods and services).

Key tax reforms since 1991 include:

• Reduction in Direct Taxes: Rates of income tax and corporation tax were gradually reduced. It was believed that high tax rates led to tax evasion, while moderate rates encourage savings and voluntary disclosure of income.
• Reforms in Indirect Taxes: Efforts were made to simplify indirect taxes to create a common national market. This led to the introduction of the Goods and Services Tax (GST) in 2016, aiming to create 'one nation, one tax and one market'.
• Simplification: Tax procedures were simplified to encourage better compliance from taxpayers.

Foreign Exchange Reforms

The first major reform in the external sector was in the foreign exchange market.

• Devaluation of the Rupee: In 1991, as an immediate measure, the rupee was devalued against foreign currencies. Devaluation means deliberately lowering the value of your currency compared to others. This made Indian goods cheaper abroad, leading to an increase in the inflow of foreign exchange.
• Market-Determined Exchange Rate: The government moved away from controlling the rupee's value. Now, the exchange rate is largely determined by the market forces of demand and supply.

Trade and Investment Policy Reforms

These reforms were aimed at increasing the international competitiveness of Indian industries and attracting foreign investment and technology.

• Before 1991, India protected its domestic industries with high tariffs (taxes on imports) and quantitative restrictions (limits on the quantity of imports). This reduced efficiency and competitiveness.

The reforms focused on:

• Dismantling quantitative restrictions on imports and exports.
• Reducing tariff rates.
• Removing licensing procedures for imports.

By April 2001, quantitative restrictions on imports of manufactured consumer goods and agricultural products were fully removed. Export duties were also removed to make Indian goods more competitive internationally.

Privatisation

Privatisation implies shedding the ownership or management of a government-owned enterprise. This can be done in two ways:

1. By the government withdrawing from ownership and management of public sector companies (PSCs).
2. By the outright sale of public sector companies.

A key method of privatisation is disinvestment, which means selling off part of the equity (shares) of Public Sector Enterprises (PSEs) to the public.

The main goals of disinvestment were:

• To improve financial discipline and facilitate modernisation.
• To utilise private capital and managerial skills to improve the performance of PSUs.
• To provide a strong push to the inflow of Foreign Direct Investment (FDI).

Navratnas and Improving PSU Efficiency

To improve the efficiency of PSEs without fully privatising them, the government granted special status to some companies, giving them greater managerial and operational autonomy. These are categorised as:

• Maharatnas: (e.g., Indian Oil Corporation Limited, Steel Authority of India Limited)
• Navratnas: (e.g., Hindustan Aeronautics Limited, Mahanagar Telephone Nigam Limited)
• Miniratnas: (e.g., Bharat Sanchar Nigam Limited, Airport Authority of India)

Globalisation

Globalisation is the integration of a country's economy with the world economy. It is a complex process that aims to create greater interdependence, turning the world into a single, "borderless" whole. It is an outcome of the policies of liberalisation and privatisation.

Outsourcing

One of the most important outcomes of globalisation for India is outsourcing. This is when a company hires regular services from external sources, often in other countries, that were previously done internally.

Services commonly outsourced to India include:

• Voice-based business processes (BPOs or call centres)
• Record keeping and accountancy
• Banking services
• Film editing and music recording
• Clinical advice and teaching

India has become a major outsourcing destination because of:

• Low wage rates.
• Availability of skilled manpower.

World Trade Organisation (WTO)

The WTO was founded in 1995 as the successor to the General Agreement on Trade and Tariff (GATT), which was established in 1948.

The main purposes of the WTO are:

• To establish a rule-based trading system where nations cannot place arbitrary restrictions on trade.
• To promote trade in both goods and services.
• To ensure optimal use of world resources and protect the environment.
• To facilitate international trade by removing tariff and non-tariff barriers and providing greater market access to all member countries.

As a member, India has been active in framing fair global trade rules and has kept its commitments by removing quantitative restrictions and reducing tariffs.

Indian Economy During Reforms: An Assessment

The reform process has now been in place for over three decades, with both positive and negative results.

Positive Outcomes

• GDP Growth: India witnessed rapid GDP growth after 1991. The growth rate increased from 5.6% during 1980-91 to 8.2% during 2007-12. This growth was mainly driven by the service sector.
• Foreign Investment: Foreign investment, including Foreign Direct Investment (FDI) and Foreign Institutional Investment (FII), increased dramatically from about US $100 million in 1990-91 to US$30 billion in 2017-18.
• Foreign Exchange Reserves: Reserves grew from about US $6 billion in 1990-91 to about US$413 billion in 2018-19, making India one of the largest reserve holders in the world.
• Exports: India emerged as a successful exporter of auto parts, pharmaceutical goods, engineering goods, IT software, and textiles.
• Control on Prices: The reforms helped keep rising prices (inflation) under control.

Criticisms and Negative Outcomes

Despite the growth, the reforms have been widely criticised for failing to address some of India's basic problems.

Growth and Employment

• While the GDP growth rate increased, this growth has not generated sufficient employment opportunities.

Reforms in Agriculture

• The agricultural sector has not benefited much from reforms; in fact, its growth rate has been decelerating.
• Fall in Public Investment: Government investment in agricultural infrastructure like irrigation, power, and roads has fallen.
• Increased Costs: The removal of fertiliser subsidies increased the cost of production, hitting small and marginal farmers hard.
• Increased Competition: Reduction in import duties on agricultural products exposed Indian farmers to increased international competition.
• Shift to Cash Crops: An export-oriented policy led to a shift from food grains to cash crops, putting pressure on food grain prices.

Reforms in Industry

• Industrial growth has also slowed down.
• Competition from Imports: Cheaper imports have replaced the demand for domestic goods, forcing local manufacturers to compete.
• Inadequate Infrastructure: Lack of investment has meant that infrastructure, especially power supply, remains inadequate.
• Unequal Market Access: Developing countries like India still face high non-tariff barriers in developed countries' markets. For example, the USA has not removed its quota restrictions on textile imports from India.

Disinvestment

• Critics argue that the assets of PSEs have been undervalued and sold to the private sector, causing a substantial loss to the government.
• The money raised from disinvestment has often been used to cover government revenue shortages rather than for developing PSEs or building social infrastructure.

Reforms and Fiscal Policies

• The reforms have placed limits on public expenditure, especially in social sectors.
• Tax reductions did not lead to a large increase in tax revenue.
• Providing tax incentives to attract foreign investment further reduced the scope for raising tax revenues. This has had a negative impact on developmental and welfare spending.

Conclusion

Globalisation, through liberalisation and privatisation, has produced mixed results.

• The Positive View: Some see it as an opportunity for greater access to global markets, high technology, and for large Indian industries to become global players.
• The Critical View: Others argue it is a strategy by developed countries to expand their markets. They claim it has widened economic disparities, compromised the welfare of poor countries, and concentrated growth in select service sectors like IT and finance, while neglecting vital sectors like agriculture and industry that provide livelihoods for millions. The benefits of growth have largely been limited to high-income groups.