Why India Changed Its Economic Policy in 1991?



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What is an Economic Policy?

An economic policy refers to the actions taken or laws implemented by the government that are intended to influence the economy of a country.

Economic policy before liberalization

India had followed the mixed economy since independence by combining the advantages of market economic system (capitalist economy) and the planned economic system (socialist economy). 

The public sector had a leading role in the development of the economy. Its dominance led to the establishment of various laws that hampered the development and growth of the economy. 

The government had introduced the Industrial Licensing system that meant that an industry could manufacture, expand or diversify its products only after getting a written permission from the government that was known as an industrial license. It was easier to obtain it if the industrial unit was to be established in an economically backward region. This policy was adopted to promote regional equity. 

Later in 1950s, Import substitution policy, also known as Inward-Looking policy was introduced. It refers to substitution of imports by domestic products. It was done by imposing heavy duty on imported goods, known as Tariffs, and by fixing the maximum limit of a commodity that can be imported by a domestic producer. 

Why did India change its Economic Policy in 1991?

The economic condition in Indian in 1991 was miserable due to various reasons:

1. Deficit in Balance of Payments:

Deficit in BOP refers to a situation where foreign payments for imports exceed foreign receipts from exports. Even after imposing quantitative restrictions, there was a sharp rise in imports and a slow increase in exports of India. 

2. Inflationary pressures:

The general price level rose consistently due to increase in money supply and shortage of essential commodities.

3. Fall in foreign exchange:

The foreign exchange reserves were at the lowest level in 1991 that led to a foreign exchange crisis in India. It was not adequate to finance imports for more than a fortnight or to pay interest to international lenders.


4. Inefficient Management
:

Sufficient revenue could not be generated by the government from internal sources like taxation, running of PSU’s, etc. the government expenditure began to exceed revenue by large margins.

5. Huge burden of debts:

Since the government expenditure was much higher than the revenue generated, the government had to take loans from banks, public and international financial institutions.

New Economic Policy, 1991

Former Prime Minister, Manmohan Singh on July 24, 1991, introduced the New Economic Policy (NEP). He is also known as the father of the NEP. The structure of this new policy is based on Liberalisation, Privatisation and Globalisation.

Liberalisation

Liberalisation means removal of entry and growth restrictions on the private sector. It aims at making the economy more competitive by deregulation and reduction of government controls over private sector. Its main purpose is to create incentives for increasing efficiency of operations in the economy that would unlock the economic potential of the country. 

What are the economic reforms under Liberalization?

1. Industrial Sector Reforms

  • De-reservation under SSI’s: 

Unlike the former economic policy that reserved various items that could only be produced by SSI’s, many such goods had now been unreserved.

  • Decrease in role of public sector: 

The number of industries that had earlier been reserved for the public sector had now reduced from 17 to 3- defense equipment, atomic energy generations and railway transport. 

  • Reduction in industrial licensing: 

Licenses were now only required for industries related to strategic and security considerations.

  • Monopolies and Restrictive Trade Policies (MRTP) Act: 

Larger companies now did not have to seek prior approval for establishment of new undertakings, amalgamations, etc.


2. Financial Sector Reforms

Role of RBI was reduced from regulator to facilitator of financial sector.
Indian as well as foreign private banks such as ICICI bank, HSBC bank, etc. were established. Limit of foreign investment in bank was raised to 51%.
Banks were allowed to set up new branches after RBI’s approval.

3. Tax Reforms

In order to reduce tax evasion, corporate and income taxes were reduced.
Considerable reforms have been made in indirect taxes.
The taxation process has been made easier in order to encourage better compliance on the part of taxpayers. 

4. Foreign Exchange Reforms

To overcome BOP crisis, the government devalued Indian rupee.
Market forces determined the vale of rupee in terms of foreign currency.

5. Trade and Investment Policy Reforms

Quantitative restrictions on imports and exports were removed. Export duties were removed. Import duties were reduced. Import licensing system was also relaxed.

Privatization

Privatization refers to transfer of ownership, management and control of public sector enterprises to entrepreneurs in private sector. It can be done in 2 ways:
Transfer of ownership from government to the private sector.
Disinvestment that refers to privatizing a part of a PSU by selling off its part to the public. 
Its purpose was to facilitate modernization and improve the performance of the PSUs.

Globalization

Globalization means integrating the national economy with world economy through removal of barriers on international trade and capital movements. 

What were the changes made by globalization?

Automatic permission was made available for the following:

  • FDI up to 51% of foreign equity. 
  • High priority industry up to a sum of Rs. 1 crore in respect of foreign technology agreements.
  • Indian rupee was devalued by nearly 20%.
  • Union Budget 1922-23 made Indian rupee partially convertible and then fully convertible in Union Budget 1933-34.
  • New 5 year export-import policy (1922-27) was announced and it removed restrictions and controls on external trade.
  • Customs duty was reduced from 250% to 10% in 20017-07 budget.

What are the benefits of NEP 1991?

  • Growth in GDP: India’s GDP was as low as 1.1% 1990-91 in comparison to 7.5% in 2016-17.
  • There has been a decrease in the rate of unemployment from 5.45% in 1991 to 2.55% in 2019.
  • Per capita income has increased due to an increase in employment.
  • Exports have increased and India is at a better position in the worldwide trade.

What are the drawbacks of NEP 1991?

  • Per capita income of the farmers has gone down due to a decrease in contribution of agriculture in GDP from 29.02% to 18%.
  • Local and small firms are facing intense competition due to lack of financial resources, technology and resources against MNCs.
  • Pollution in the country has increased due to emissions from industrial plants.
  • There has been a substantial increase in income inequalities. The rich have become richer and the poor have become poorer. 
Written by -  Hunnar Kaushal

Edited by - Chhavi Gupta

Why India Changed Its Economic Policy in 1991? Why India Changed Its Economic Policy in 1991? Reviewed by Chhavi Gupta on June 30, 2020 Rating: 5

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