Economic Reforms

The government was not able to generate sufficient revenues from internal sources such as taxation.
The income from public sector undertakings was also not very high. In late 1980s, government
expenditure began to exceed its revenue by such large margins that meeting the expenditure through
borrowings became unsustainable. India was facing huge financial crisis.
India approached the World Bank and International Monetary fund and received $7 billion as loan to
manage crisis. India had to agree on some conditions in order to avail the loan.
So, World bank and IMF announced New Economic Policy in 1991.

A. Economic reforms:-
It is a set of economic policy adopted by government to increase the pace of growth and development.
In 1991, the government of India adopted New Economic policy.
Its components are LIBERALISATION, PRIVATISATION & GLOBALISATION.
B. Need for economic reforms:-
i. Fiscal deficit:-
Fiscal deficit is the difference between government expenditure and government revenue.
Prior to 1991, fiscal deficit was very high because of expenditure in non-development areas and non-plan
expenditure.
The income of public sector was not high to meet the expenditure.
ii. Adverse balance of payments:-
Balance of payment crisis is balance of payment deficit which means imports are greater than exports.
Before 1991, exports were less due to poor quality of domestic goods and imports were more despite of
heavy tariff duty and quotas.
In the wake of these facts, NEP was the only alternative.
iii. Fall in foreign exchange reserves:-
These are the reserves of foreign assets like foreign currencies, foreign securities.
Foreign exchange reserves were reduced because of high imports. There was also not sufficient foreign
exchange to pay the interest to international money lenders.
The situation became so serious that the government had to mortgage country‘s gold reserves with World
Bank.
iv. Inflationary spiral:-
Inflation is consistent rise in general price level.
Before 1991, prices of essential goods have increased.
Because of inflation, economic crisis got worse. Therefore, the need of NEP arises.
v. Poor performance of PSUs:-
Several thousand crore rupees was spent in the growth and development of PSU‘s in India.
But they were not performing well, they incurred huge losses.
Public sector continued to operate even in those areas which could be comfortably shifted to private sector.
C. Elements of New Economic policy:-
I. Liberalization: - Liberalization of the economy means freedom given to producing units from the rules
imposed by the government.
Reforms under liberalization:-
1) Industrial sector reforms: - Government introduced industrial policy in 1991. Various measures were taken
such as:-
i. Abolition of Industrial licensing:-
Earlier industrialists had to get permission from the government to set up their industry.
As per NEP, Industrialist licensing was abolished except industries— alcohol, cigarettes, hazardous
chemicals, industrial explosives, electronics, aerospace and drugs and pharmaceuticals.
ii. Contraction of public sector:-
It was felt that government cannot control everything. So private sector was allowed to participate in growth
object of the country.
The number of industries which were reserved for public sector was reduced from 17 to 3. These were
defence equipment, atomic energy and railway transports.
iii. De-reservation of production areas:-
Prior to 1991, some goods could be produced only in small scale industries.
Now many goods produced by SSI have been dereserved.
Market forces were allowed for allocation of resources.
iv. Expansion of production capacity:-
Earlier there was restriction on the production of goods.
But with economic policy, freedom for licensing was given. It now depends upon producer how to produce
and what to produce.
v. Freedom to import capital goods:-
Liberalization policy gave freedom to import capital goods and technology in order to develop strong
infrastructural base of the country.
2) Financial sector reforms:-
i. Role of RBI:-
Earlier the role of RBI was of regulator. As regulator RBI used to fix interest rate structure.
But with NEP, RBI‘s role was converted from regulator to facilitator. Now RBI has given freedom to
commercial banks to decide upon interest rates.
ii. Establishment of private sector banks:-
Earlier more importance was given to public sector banks.
However, reform policies led to the establishment of private sector banks, Indian as well as foreign, which
increased the size of competition and provided better services to customers.
iii. Foreign investment:-
Foreign institutional investors such as merchant bankers, mutual funds and pension funds are now allowed to
invest in Indian Financial markets.
Foreign investment increased to 50%.
iv. Setting up new branches:-
Full freedom is given to commercial banks to set up new branches all over the country, if they fulfill the
conditions of RBI.
3) Fiscal reforms: - (These are the reforms related to tax structure.)
i. Reduction in Direct taxes:-
With economic reforms, income tax rate has been reduced. This reduction tries to ensure that individuals do
not evade the tax.
ii. Reforms in Indirect taxes:-
Reforms were made in Indirect taxes. Now a days GST has been launched which generates additional tax
revenue, increases tax compliance and reduces tax evasion.
iii. Simplified taxpaying procedure:-
In order to avoid confusion, the taxpaying procedure has been simplified.
4) External sector reforms:-
i. Devaluation of rupee:-
Devaluation refers to reduction in the value of domestic currency. This increases exports and reduces
imports which in turn increase the inflow of foreign exchange.

ii. Foreign trade policy:-

 Tariff on imports was reduced to enhance the domestic trade and achieve economic growth.
Import licensing was abolished.
Export duty has been withdrawn to promote competition.
II. Privatization:-

It refers to transfer of ownership, management and control of government sector enterprises to the private
sector.
It means greater role to the private sector and reduced role of public sector.
It can be done by two ways:-
By withdrawal of the government ownership and management of public sector companies.
By sale of public sector companies.
Privatization of the public sector undertakings by selling part of the equity of PSU‘s to the private sector is
known as disinvestment.
The purpose of privatization is to improve financial discipline and facilitate modernization by encouraging
private sector to invest and participate in economic development with their administrative efficiency.
It was also envisaged that private capital and managerial capabilities could be effectively utilized to improve
the performance of PSU‘s.
Need for privatization:-
The industrial policy resolution stated the importance of public sector for growth and social justice.
Employment was shifted from agriculture to Industries and Nine public sector enterprises known as
NAVRATANS were contributing to GDP.
But other public sector industries were not managed properly and turned into losses.
So, it was decided to sell out public sector shares to private entrepreneurs but keeping Navratans into public
sector.
i. Impact of privatization:-

Positive impact:-
Improves efficiency of management: - Privatization focused on self-interest that is profit maximization,
which increases the efficiency of work. Entrepreneurs work with full commitment and as a result, they achieve
higher production.
Competitiveness: - Privatization focused upon improving the performance by utilizing the capital and
managerial capabilities in an effective way. This encourages competition in domestic and international market
which induces modernization.
Diversification of products: - In order to generate more profit, production process was diversified and
expanded.
Consumer’s sovereignty: - Goods produced by industrialists was according to the choice of consumers,
which resulted in wider choice and better quality of life.
Reduces deficit: - Privatization reduces the financial burden of government by earning sufficient profits and
support government by paying taxes.

Negative impact:-
Neglect social interest:-Private sector functions mainly with the objective of profit maximization, which
ignores the social welfare of people.
High priced goods: - Privatization works according to demand and supply forces. It will increase the price
and it became a major problem of inflation.
Monopolistic control: - If privatization continued to spread like this then soon there will be monopoly control
of private sector which will hamper the objective of growth with social justice.

III. Globalization:-
It is the outcome of policies of liberalization and privatization.
 It refers to free interaction among all the countries of the world in various fields like trade, technology, loans
investment, outsourcing etc.

Policies:-
i. Increase in equity limit of foreign investment:-
The foreign equity limit has been raised from 40% to 51%.
Approvals, sanctions and constraints on foreign investments have been relaxed after economic reforms.
Foreign exchange management act has been enforced.

ii. Partial convertibility:-

Partial convertibility of the currency was allowed by the government.
It refers to purchase and sale of foreign currencies at a price determined by the market. It was allowed for
import and export of goods and services, payment of interest etc.
iii. Long term trade policy:-
A new five-year trade policy was announced to establish the framework of trade with rest of the world.
It removed almost all the restrictions on external trade.
Open competition has been encouraged. All sorts of goods can be traded except for some goods which are
of strategic importance to the nation.
iv. Reduction in Tariffs:-
In conformity with new economic policy, custom duties and tariffs imposed on imports and exports have been
gradually reduced.
The ones, which are still prevailing, have been modified to encourage competitiveness and promote
international trade.
v. Withdrawal of quantitative restrictions:-
Because of policies of WTO the restriction on imports has been abolished.
It ensures that all member countries should be given equal opportunity to trade in international market.
OUTSOURCING: - A company hires regular services from external sources, mostly from
other countries,
which was previously provided internally or from within the country. The low wage rates and
availability of skilled manpower in India have made it a destination for global outsourcing in
the post reform period.

WTO: - Founded in 1995 as the successor of GATT. The objectives of WTO are:-

To enlarge production and trade of services.

To ensure optimum utilization of resources.
To protect the environment.

Advantages of Outsourcing:-
a) Employment: For a developing country like India, employment generation is an important
objective and outsourcing proves to be a boon for creating more employment opportunities.
It leads to generation of
newer and higher paying jobs.
b) Exchange of technical know-how: Outsourcing enables the exchange of ideas and
technical know-how
of sophisticated and advanced technology from developed to developing countries.
c) International worthiness: Outsourcing to India also enhances India‘s international
worthiness
credibility. This increases the inflow of investment to India.
d) Encourages other sectors: Outsourcing not only benefits the service sector but also
affects other related
 sectors like industrial and agricultural sector through various backward and forward
linkages.
e) Contributes to human capital formation: Outsourcing helps in the development and
formation of human capital by training, imparting them with advanced skills, thereby,
increasing their future scope and their suitability for high ranked jobs.
f) Better standard of living and eradication of poverty: By creating more and higher
paying jobs, outsourcing improves the standard and quality of living of the people in the
developing countries. It also helps in reducing poverty.

D. An appraisal of LPG policy:-

MERITS:-
i. Vibrant economy:-
There has been an increase in overall growth rate of the country.
In twelfth plan (2012-17) the GDP rate increased.
In order to achieve such high growth rate, the agriculture sector, industrial sector and service sector has to
be involved.
ii. Stimulant to industrial production:-
LPG policy has shown structural changes and it was a great stimulant to industrial production.
Because of such policies many industries

iii. Check on fiscal deficit:-

Fiscal deficit, which adversely affected the Indian economy prior to 1991, now started recovering after the
economic reforms.
It reduced from 8.5% in 1991 to nearly 4% in 2015-2016.
iv. A check on inflation:-
Prior to 1991, general price level was rising. Gulf crisis hit the Indian economy adversely and there was
continuous increase in the price level.
Due to LPG policies, inflation is brought under control. The annual rate of inflation reduced from nearly 16.7%
to 5.7%.
v. Consumer’s sovereignty:-
Now, consumers have ample of goods to make choice because of diverse global markets.
Products are as per the taste and preference of consumers.
Overall consumption expenditure has risen which implies increase in status of people.

Rise in foreign exchange reserves:-

Due to rise in exports, the amount of forex reserves has also increased which contributes in the growth rate
of country.

DEMERITS:-

i. Neglect of agriculture:-
Reforms have not been able to benefit agriculture. It is because public investment in agriculture sector like
irrigation, power, roads etc. has been reduced in the reform period.
There was more focus on production of cash crops instead of food crops.
ii. Urban concentration of economic growth:-
The entire industries were set up in the urban areas which will increase gap between rural and urban area.
The industries are set up in urban areas because the infrastructural facilities are available there.
iii. Economic colonialism:-
MNC‘s are being set up in the country, therefore it affects the domestic industries.
Domestic industries are unable to compete with foreign companies.
iv. Spread of consumerism:-
Because of competition and setup of Multinational companies consumers are adopting themselves into
western culture.
v. Lopsided growth process:-
Growth process was incomplete as it did not focus upon all sectors of the economy.
Industrialization is being given more importance and farming sector is being neglected.
Production of cash crops has increased supply in foreign markets whereas domestic supply has been
reduced.

Demonetization:- New initiative was taken by the Government of India on 8 November 2016 to tackle the
problem of corruption, black money, terrorism and circulation of fake currency in the economy. Old currency
notes of 500 and 1000 were no longer legal tenders. New currency notes in the denomination of 500 and 2000
were launched.
Positive impact:-
Improved tax compliance as large number of people was brought in the tax ambit.
It is a demonstration of state‘s decision to put a curb on black money.
Tax compliance will improve and corruption will decrease.

GST: - This law came into effect from 1 July 2017.

Aim:-
To generate additional revenue for the government
To reduce tax evasion.
To create ‗one nation, one tax and one market‘.

Features:-
It is a destination-based consumption tax with facility of Input Tax Credit in the supply chain.
There are 5 standard rates applied i.e.0%, 5%, 12%, 18% and 28%.
It has amalgamated a large number of central and state taxes and cesses.

Effect of Reform on Industrial sector

Decreasing demand of industrial products:- (i) Cheaper imports have replaced the demand for domestic
goods. Domestic manufacturers are facing competition from imports. (ii) The infrastructural facilities, including
power supply, have remained inadequate due to lack of investment.
Non-access to developed country‘s markets:- A developing country like India does not have access to
developed country‘s markets due to high non-tariff barriers.

Effect of reform on Agriculture sector

Fall in public investment in Agriculture:- In the reform period the investment by government reduced
especially in area of irrigation, power roads etc.
Removal of fertilizer subsidy:- Removal of subsidy on fertilizers has adverse effect on small and marginal
farmers because their cost of production has increased.
Increased International competition:- Indian farmers had to face increased international competition because
of reduction of import duties on food grains, removal of minimum support price etc.
Export oriented policy:- Prices of food grains increased because of attraction of agricultural products toward
exports and because of this, production of cash crops increased.

******************************