Economic reforms in 1991 – Explained, pointwise

Introduction

Three decades after India embarked upon the path of economic liberalisation it is time to analyze the impact of economic reforms in 1991. Reforms of 1991 did change the course of economic policymaking in India. The broad contours of the evolving reforms have remained the same.  But their trajectory and direction have been largely influenced by the political leadership and their understanding of how the economy needs to be managed.

Condition of Indian economy prior to economic reforms in 1991

The control system has restricted entrepreneurship. For instance,

The private sector was not allowed to invest in a number of sectors thought to be critical for development. This approach was continued despite the public sector’s lackluster performance. In sectors where the private sector was allowed, it could invest only after getting an industrial license, and that was especially hard to get for “large” industrial houses. Over 860 items were reserved exclusively for small-scale producers, including many that had very high export potential.

Imports were more strictly controlled than in almost any other developing country because it was felt necessary to conserve scarce foreign exchange. Consumer goods simply could not be imported so domestic producers faced no import competition. Producers could import capital goods and intermediates needed for production, but this generally required an import license.

India’s foreign exchange reserves had fallen to just about $1 billion in the first week of July, barely enough to meet three weeks’ imports. To complicate matters, non-resident Indians had begun withdrawing their deposits, making the foreign exchange reserves situation even more precarious. Finally, the import of technology was controlled and Foreign Direct Investment (FDI) was discouraged.

Major changes brought by Economic reforms in 1991

• The government abolished export subsidies like the system of providing cash compensatory support to exporters; removed supplementary licenses, which used to help exporters with import facilities;
• The government also divested the state trading corporations of their monopoly over the import of a host of goods (also described as decanalisation).
• By March 1993, the government introduced a unified exchange rate, linked to the markets. Exporters could convert their entire dollar earnings at the market-linked exchange rate.
• Industrial licensing was abolished for all sectors except 18 specified groups. The asset limit for companies governed by the Monopolies and Restrictive Trade Practices Act was abolished in one stroke.
• Automatic approval for foreign investment up to 51 percent equity was allowed in 34 industries. Private companies were freed from the requirement of obtaining the government’s permission for entering into technology agreements with foreign enterprises.
• Most importantly, a policy on gradual disinvestment of government equity in public sector units was announced.
• Based on the recommendations of the committee headed by M Narasimham, paved the way for new private-sector banks and the phased out of development financial institutions.

The evolution of the Indian economy since economic reforms in 1991

• The reforms were aimed at unleashing the energies of the private sector to accelerate economic growth. It is done in a manner that ensured an adequate flow of benefits to the poor. The reforms certainly succeeded in this objective.
• India followed a gradualist approach, but the results are dramatic.
  • The GDP growth averaged 7% in the 25 years from 1992 to 2017, compared with an average of 5% in the preceding ten years and 4% in the preceding 20 years.
  • As growth accelerated, poverty declined. Between 2004-05 and 2011-12, the last year for which official data on poverty are available, about 140 million people were pulled above the poverty line.
  • India progressively lowered import tariffs from an estimated 57.5% in 1992 to 8.9% in 2008, but this trend has been reversed over the past few years.
  • India for the first time between 2004-2014 witnessed a fall in employment in agriculture. 
• Direct tax rates were rationalized with a three-slab structure during the economic reforms, with the peak rate being 30 percent in 1997. That structure remains intact even today, though attempts have been made to rationalize it further.
• Industrial policy has broadly followed the course outlined during the economic reforms. Now it is moving towards more delicensing, easier foreign investment norms, increased role for the private sector, and more disinvestment of government equity in public sector units.
• But some reforms, begun in 1991, have yet to be completed. For instance,
  • Health, education and environmental concerns have not been adequately built into our development strategy.
  • Some pending factor market reforms, in areas such as labour and land, remain so far.

Challenges in the Indian economy at present

• Indian industry has legitimate complaints about poor infrastructure, poor logistics and time-consuming trade procedures, which reduce its competitiveness.
• The government’s economic agenda of building a self-reliant India (Aatmanirbhar Bharat) has meant not only a rise in import tariffs for some goods but also the return of a discretionary incentive system to encourage investment in different sectors of the economy. For instance,
  • The proposed policy for the e-commerce entities has provisions that threaten to reintroduce an inspector raj, banished some years ago from most businesses.
• The COVID-19 pandemic has of course triggered a collapse in employment. A recent study by Santosh Mehrotra and Jajati K. Parida finds that the substantial slowdown in GDP growth after 2016-17 led to employment actually falling from 474 million in 2011-12 to 469 million in 2018-19.

Suggestions to improve the Indian Economy

• Fixing import duty: The NITI Aayog under its first Vice-Chairman, Arvind Panagariya, had recommended that India should move to an average duty rate of about 7%, gradually narrowing the range of variation across products and eliminating duty reversals.
  • As far as unfair competition from China is concerned, the solution lies in a faster method of imposing anti-dumping duties on China, not raising import duties across the board.
• Joining international platforms:
  • India’s policy of “Look East” to “Act East” remains a positive signal for the Indian economy. But opting out of RCEP (Regional Comprehensive Economic Partnership) will hamper India’s progress.
    • India’s fear that the Indian industry would not be able to compete against China is not acceptable. As, the reduction in tariffs required under RCEP was to be accomplished over several years, giving ample time for India to improve competitiveness.
    • Indian industry has legitimate complaints about things that make India uncompetitive that need to be addressed directly instead of opting out of RCEP.
    • Geopolitics is forcing major countries to reduce dependence on China. Further, India can reasonably expect to become a major player in non-China-dominated supply chains.
  • Major developed countries, such as the U.S., Europe, and the U.K., seem to be moving away from multilateral negotiations. Instead, they started working on agreements with important groups bilaterally.  However, such FTAs will include provisions on contentious issues such as intellectual property rights and bilateral investment protection. India must be willing to accept that.
• Experience shows that India needs to get back to 7% to 8% growth if we want to make progress on poverty reduction and provide enough jobs for our growing labour force.
• Controlling the pandemic: The priority now must be to get the vaccination coverage expanded as soon as possible. This will create conditions conducive to a return to normalcy.