Failures of Planning and India’s 1991 LPG Economic Reforms
Failures of Pre-1991 Economic Planning
Increase in Poverty
- The number of people who fail to get the basic necessities of life was increasing.
- The policies adopted by the government till 1990 were very rigid and were unable to generate sufficient employment opportunities and income.
High Rate of Inflation
- Despite some progress shown by policies undertaken by the government till 1991, it was observed that the government could not control the persistent rise in prices.
- The price level increased from nearly 6% in 1956 to 16.7% in 1990.
Unemployment Crisis
- Though the initiatives taken by the government did generate more employment opportunities, unemployment did not subside.
- The major cause of this problem was the higher growth rate of population.
- The number of unemployed increased from 54 lakh to 85 lakh persons in 1990.
Deficient Infrastructure
- Development of infrastructure continued to be inadequate. Actual growth of infrastructure was not as per targeted growth.
- Shortage of power has been a serious constraint in the overall process of growth and development.
Introduction to Economic Reforms
Economic reform is a set of economic policies adopted by the government to increase the pace of growth and development.
In 1991, the Government of India adopted the New Economic Policy (NEP).
Its components are LIBERALIZATION, PRIVATIZATION & GLOBALIZATION.
Need for the 1991 Economic Reforms
Fiscal Deficit
- Fiscal deficit is the difference between government expenditure and government revenue.
- Prior to 1991, the fiscal deficit was very high because of expenditure in non-development areas and non-plan expenditure.
- The income of the public sector was not high enough to meet the expenditure.
Adverse Balance of Payments (BOP)
- Balance of Payment crisis is a BOP deficit, which means imports are greater than exports.
- Before 1991, exports were less due to the poor quality of domestic goods, and imports were more despite heavy tariff duties and quotas.
- In the wake of these facts, the NEP was the only alternative.
Fall in Foreign Exchange Reserves
- These are the reserves of foreign assets like foreign currencies and foreign securities.
- Foreign exchange reserves were reduced because of high imports. There was also insufficient foreign exchange to pay interest to international money lenders.
- The situation became so serious that the government had to mortgage the country’s gold reserves with the World Bank.
Inflationary Spiral
- Inflation is the consistent rise in the general price level.
- Before 1991, prices of essential goods had increased.
- Because of inflation, the economic crisis worsened. Therefore, the need for the NEP arose.
Poor Performance of Public Sector Undertakings (PSUs)
- Several thousand crore rupees were spent on the growth and development of PSUs in India.
- But they were not performing well; they incurred huge losses.
- The public sector continued to operate even in those areas which could be comfortably shifted to the private sector.
Elements of the New Economic Policy (NEP)
I. Liberalization
Liberalization of the economy means freedom given to producing units from the rules imposed by the government.
Reforms under Liberalization
Industrial Sector Reforms
The government introduced the Industrial Policy in 1991. Various measures were taken, such as:
- Abolition of Industrial Licensing: Earlier, industrialists had to get permission from the government to set up their industry. As per NEP, industrial licensing was abolished except for industries like alcohol, cigarettes, hazardous chemicals, industrial explosives, electronics, aerospace, and drugs and pharmaceuticals.
- Contraction of Public Sector: It was felt that the government could not control everything. So, the private sector was allowed to participate in the country’s growth objectives. The number of industries reserved for the public sector was reduced from 17 to 3. These were defence equipment, atomic energy, and railway transports.
- De-reservation of Production Areas: Prior to 1991, some goods could be produced only in small-scale industries (SSI). Now, many goods produced by SSI have been dereserved. Market forces were allowed for the allocation of resources.
- Expansion of Production Capacity: Earlier, there was a restriction on the production of goods. But with the economic policy, freedom from licensing was given. It now depends upon the producer how to produce and what to produce.
- Freedom to Import Capital Goods: The liberalization policy gave freedom to import capital goods and technology in order to develop a strong infrastructural base for the country.
Financial Sector Reforms
- Role of RBI: Earlier, the role of the RBI was that of a regulator, fixing the interest rate structure. But with the NEP, the RBI’s role was converted from regulator to facilitator. Now, the RBI has given freedom to commercial banks to decide upon interest rates.
- 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, both Indian and foreign, which increased competition and provided better services to customers.
- Foreign Investment: Foreign Institutional Investors (FIIs) such as merchant bankers, mutual funds, and pension funds are now allowed to invest in Indian financial markets. Foreign investment increased to 50%.
- Setting up New Branches: Full freedom is given to commercial banks to set up new branches all over the country, provided they fulfill the conditions of the RBI.
Fiscal Reforms (Tax Structure)
- Reduction in Direct Taxes: With economic reforms, the income tax rate has been reduced. This reduction tries to ensure that individuals do not evade tax.
- Reforms in Indirect Taxes: Reforms were made in indirect taxes. Nowadays, GST has been launched, which generates additional tax revenue, increases tax compliance, and reduces tax evasion.
External Sector Reforms
- Devaluation of Rupee: Devaluation refers to a reduction in the value of domestic currency. This increases exports and reduces imports, which in turn increases the inflow of foreign exchange.
- Foreign Trade Policy: Tariff on imports was reduced to enhance domestic trade and achieve economic growth. Import licensing was abolished. Export duty has been withdrawn to promote competition.
II. Privatization
Privatization refers to the transfer of ownership, management, and control of government sector enterprises to the private sector. It means a greater role for the private sector and a reduced role for the public sector.
It can be done in 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 PSUs to the private sector is known as disinvestment.
The purpose of privatization is to improve financial discipline and facilitate modernization by encouraging the 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 PSUs.
Need for Privatization
The Industrial Policy Resolution stated the importance of the public sector for growth and social justice. Employment was shifted from agriculture to industries, and nine public sector enterprises known as Navratans were contributing significantly 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, while keeping the Navratans in the public sector.
Impact of Privatization
Positive Impact
- Improves Efficiency of Management: Privatization focuses on self-interest (profit maximization), which increases the efficiency of work. Entrepreneurs work with full commitment, and as a result, they achieve higher production.
- Competitiveness: Privatization focuses upon improving performance by utilizing capital and managerial capabilities in an effective way. This encourages competition in domestic and international markets, which induces modernization.
- Diversification of Products: In order to generate more profit, the production process was diversified and expanded.
- Consumer’s Sovereignty: Goods produced by industrialists were according to the choice of consumers, which resulted in wider choice and a better quality of life.
Negative Impact
- Neglect of Social Interest: The 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. This can increase prices and become a major problem leading to inflation.
- Monopolistic Control: If privatization continues to spread, there will soon be monopolistic control by the private sector, which will hamper the objective of growth with social justice.
III. Globalization
Globalization is the outcome of the 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.
Globalization Policies
- 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. The Foreign Exchange Management Act (FEMA) has been enforced.
- Partial Convertibility: Partial convertibility of the currency was allowed by the government. It refers to the purchase and sale of foreign currencies at a price determined by the market. It was allowed for the import and export of goods and services, payment of interest, etc.
- Long-Term Trade Policy: A new five-year trade policy was announced to establish the framework of trade with the rest of the world. It removed almost all 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.
- Reduction in Tariffs: In conformity with the 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.
Outsourcing and International Trade
Outsourcing
Outsourcing is when a company hires regular services from external sources, mostly from other countries, which were 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.
Advantages of Outsourcing (India)
- 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 the generation of newer and higher-paying jobs.
- 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.
- International Worthiness: Outsourcing to India also enhances India’s international worthiness and credibility. This increases the inflow of investment to India.
- Encourages Other Sectors: Outsourcing not only benefits the service sector but also affects other related sectors like the industrial and agricultural sectors through various backward and forward linkages.
- Contributes to Human Capital Formation: Outsourcing helps in the development and formation of human capital by training and imparting advanced skills, thereby increasing their future scope and their suitability for high-ranked jobs.
World Trade Organization (WTO)
The WTO was founded in 1995 as the successor of GATT (General Agreement on Tariffs and Trade). The objectives of the WTO are:
- To enlarge production and trade of services.
- To ensure optimum utilization of resources.
- To protect the environment.
Appraisal of the LPG Policy
Merits of LPG
- Vibrant Economy: There has been an increase in the overall growth rate of the country. In the Twelfth Plan (2012-2017), the GDP rate increased. In order to achieve such a high growth rate, the agriculture sector, industrial sector, and service sector have been involved.
- Stimulant to Industrial Production: The LPG policy has shown structural changes and was a great stimulant to industrial production. Because of such policies, many industries came up and gained global recognition.
- Check on Fiscal Deficit: Fiscal deficit, which adversely affected the Indian economy prior to 1991, started recovering after the economic reforms. It reduced from 8.5% in 1991 to nearly 4% in 2015–2016.
- A Check on Inflation: Prior to 1991, the general price level was rising. The Gulf Crisis hit the Indian economy adversely, leading to a continuous increase in the price level. Due to LPG policies, inflation was brought under control. The annual rate of inflation reduced from nearly 16.7% to 5.7%.
- Consumer’s Sovereignty: Now, consumers have ample goods to choose from because of diverse global markets. Products are available as per the taste and preference of consumers. Overall consumption expenditure has risen, which implies an increase in the status of people.
Demerits of LPG
- Neglect of Agriculture: Reforms have not been able to benefit agriculture significantly. This is because public investment in the agriculture sector (like irrigation, power, roads, etc.) has been reduced during the reform period. There was more focus on the production of cash crops instead of food crops.
- Urban Concentration of Economic Growth: Industries were primarily set up in urban areas, which increased the gap between rural and urban areas.
- Economic Colonialism: Multinational Corporations (MNCs) being set up in the country affect domestic industries. Domestic industries are often unable to compete with foreign companies.
Recent Economic Initiatives in India
Demonetization (November 8, 2016)
This new initiative was taken by the Government of India on November 8, 2016, to tackle the problems of corruption, black money, terrorism, and the 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 of Demonetization
- Improved tax compliance as a large number of people were brought into the tax ambit.
- It is a demonstration of the state’s decision to curb black money.
- Tax compliance will improve and corruption will decrease.
Goods and Services Tax (GST) (July 1, 2017)
This law came into effect from July 1, 2017.
Aims of GST
- To generate additional revenue for the government.
- To reduce tax evasion.
- To create “one nation, one tax and one market.”