LPG reforms in India for 30 years

“When learning is purposeful, creativity blossoms. When creativity blossoms, thinking emanates. When thinking emanates, knowledge is fully lit. When knowledge is lit, economy flourishes.” – A.P.J. Abdul Kalam.

“There is a need for financial reform along ethical lines that would produce in its turn an economic reform to benefit everyone. This would nevertheless require a courageous change of attitude on the part of political leaders.” – Pope Francis
“Without the concern for social welfare, economic growth is inhumanly proportional to economic disparity.” – Abhijit Naskar, in Martyr Meets World: To Solve The Hard Problem of Inhumanity

“Our vision is not just of economic growth, but also of a growth which would improve the life of the common man”. – Manmohan Singh
“Reform is not an event, it is an process. We will continue to push forward the cause of reform.”- Manmohan Singh

#2 Through Definition/ Explanation

Economic reform includes policies directed at achieving improvements in economic efficiency, either by eliminating or reducing distortions in individual sectors of the economy or by reforming economy-wide policies such as tax policy and competition policy with an emphasis on economic efficiency, rather than other goals such as equity or employment growth. Economic reforms in India refer to the structural adjustments that were initiated in 1991 with the aim of liberalising the economy and to accelerate its rate of economic growth.

The reforms were aimed at attaining a high rate of economic growth, reducing the rate of inflation, reducing the current account deficit and overcoming the balance of payments crisis also with respect to industrial licensing, technology up gradation, removal of restrictions on the private sector, foreign investments and foreign trade.

Three decades ago India embarked on a new economic journey when Manmohan Singh, then Finance Minister, placed the reform Bill and echoed Victor Hugo, “No power on earth can stop an idea whose time has come,” in Parliament. Since then, the crisis-hit economy has come a long way and marked its firm presence in the global platform.

Body Content

India has completed 30 years of its economic reform. Due to these reforms, India has strengthened its position economically and made great progress. But it is imperative to know what were the necessary conditions due to which India had to adopt economic reform. Like David Cameron once said “Economy is the beginning and end of anything, if you don’t have a strong economy, you can’t make any concrete reforms.”

Before the introduction of economic reforms, the industrial sector suffered due to bureaucratic controls. Industries had to obtain many licenses and permissions- ‘License Raj’ for any undertaking activity such as setting up a new firm, starting a new product line, expansion of existing business, foreign investment etc. Many public sector enterprises were incurring huge losses due to poor productivity.

The fiscal deficit was widening. This was mainly due to an increase in non-developmental expenditure of the government. The government had to borrow huge amounts of money to meet the deficit and to meet the interest obligations on these loans. Government was trapped in a ‘debt trap’. Thus, there was a need to bring in reforms to reduce non-developmental expenditure and bring about fiscal discipline.

Continuous borrowing by the government to meet its increasing expenditure led to a rapid increase in the money supply. The government resorted to deficit financing in which the RBI borrowed money by the Government of India by printing currency notes. This increased the money supply. When the money supply increased, the demand for goods and services also increased, raising their prices and creating inflationary conditions. By the early 1990s, India was battling double-digit inflation, a gross fiscal deficit was above 7.5 percent of GDP, internal debt was close to 54 percent of GDP and foreign exchange reserves stood at a fortnight’s worth of import bills.

The Gulf War had a significant impact on the supply of oil during 1990-91. As a result, the price of oil increased, increasing India’s foreign exchange outlay. The Gulf crisis also affected the inflow of foreign exchange into India. NRI deposits were moving out of India and remittances from Indians working abroad were also affected during the war.

The political situation in India was also quite volatile in the early years after 1990. The National Front government fell in November 1990. The Chandrashekhar government was very short-lived. The Congress also ensured that Finance Minister Yashwant Sinha could not present the full budget for 1991-92 at the end of February. This was a major political blow to the Chandrasekhar government’s ability to handle the economy.

Neither the government could outline its policy action to stem the economic fallout, nor could it use the package to seek more funding from multilateral financial institutions such as the International Monetary Fund (IMF) and the World Bank. India’s foreign exchange reserves were depleting and Non-Resident Indians (NRIs) were withdrawing their deposits. This put more pressure on the country’s balance of payments and the ability of the government to finance itself was under pressure.

In the midst of political instability, high inflation, rising fiscal deficit, payments crisis and immense pressure from international organizations such as the IMF and the World Bank, India initiated economic reforms in 1991. With the introduction of economic reforms, many restrictions on the industrial sector were removed.

Liberalisation started with a dose of devaluation and was followed by slew of policies which together were famously termed as LPG (Liberalisation, Privatisation and Globalisation) reforms. As is always the case, the change was not welcomed by all. There was political resistance from within and outside the ruling party since many were not sanguine about its success.

How does an economy comprising 891 million people take a U-turn?

For every change that Prime Minister P.V. Narasimha Rao introduced in 1991, there was a putrefying ecosystem of decaying politics, rent-seeking inspectors, entrenched businesses, all bound together by a ‘system’ of vested interests and articulated by the Bombay Club that had to be dismantled. On the one side was the rise of a new politics of growth, driven by new entrepreneurs.

In the middle lay an ocean of opportunities. Every clause in the Statement on Industrial Policy 1991 had thousands, if not hundreds of thousands, of people benefiting from and immersed in the inertia of the past business as usual. Several of these had money power – not just a handful of industrialists but the bureaucracy, the politicians, the ‘system.’

The Good, the bad and the Ugly

Although it is not entirely true to say that economic reforms were only a necessary condition and not a satisfactory condition, many such positive changes were seen, due to which these reforms appeared to be sufficient for that time. The reforms had an impact on the socio-economic fabric of India. From about 45% of the population below the national poverty line in 1994, the rate has dropped to 21.9% in 2011. Literacy rate, Gross Enrolment Ratio and life expectancy have also improved.

Post-reform growth rates have been less volatile as compared to pre- reform years, due to an increase in the share of services in the precarious agriculture sector. The coefficient of variation in the annual growth rate of GDP decreased from 80 percent during 1961-1990 to 30 percent in 1991-2020. Inflation and government deficit also turned into acceptable figures.

Thanks to prudent macroeconomic stabilization policies including devaluation of the rupee and other structural reforms, the BoP crisis ended by the end of March 1994 and foreign exchange reserves increased to US$ 15.7 billion. There has been a huge increase in the inflow of both FDI and FII into India. Through reforms, India overcame its worst economic crisis in a remarkably short span of two years.

India also rapidly integrated its economy with the global economy. The proportion of total exports of goods and services to GDP in India almost doubled from 7.3% in 1990 to 14% in 2000. The reforms led to increased competition in sectors such as banking, leading to greater customer choice and increased efficiency. This has also led to increased investment and growth of private companies in these sectors. Thirty years down the line, from a GDP of $512.92 billion in 1991, India had grown to a $2.70-trillion (in constant 2010 US$) by 2020. Besides, the average annual growth rates in GDP, post the 1990s, have been around 6.25 per cent against 4.18 per cent for the three decades prior to the reforms.

1991 Economic reforms improved the economic condition of the country and removed many problems but there was a scope for improvement on a large scale. Somewhere it got missed, that’s why economic reform did not prove to be sufficient condition. World Bank estimates show that the Gini index, a measure of income inequality, has deteriorated marginally from 31.7 in 1993 to 35.7 in 2011.

Reforms were mainly in the ‘formal sector’ of the economy with agriculture, the urban informal sector, forest dependent communities and other vulnerable sections not seeing any major improvement. This led to unequal development and unequal distribution of economic freedom among the people. Economic liberalization (subject to stricter labour laws) in the organized manufacturing sector has led to growth with little additional employment. Another attack is that with the creation of heavily mechanized industries in urban areas, the rural population started migrating to towns and cities on a large scale, making the problem of unemployment more acute and complicated.

Arvind Panagariya in one of his papers has assessed the LPG reforms. He believes, that the accomplishments of the past decade are dwarfed only by what remains to be done. To begin with, the fiscal deficit is in a dire state. The combined deficit at the center and states exceeds 10 percent of GDP. Given an already high debt- to-GDP ratio of nearly 60 percent, this deficit is unsustainable; it is also crowding out private investment. From the viewpoint of long-run growth, the “old economy” must be further unshackled. A key deficiency of India’s growth process has been the failure of the conventional industry to pull workers out of agriculture into gainful employment. Today, in contrast to virtually all successful developing economies, approximately 60 percent of India’s workforce still remains in agriculture – directly or indirectly

The revival of conventional industry requires reforms in key areas. First, a large number of highly labour- intensive products remain reserved for small-scale producers. As a result, the labour-intensive industry has been scuttled in India and, with trade liberalization, will find it almost impossible to survive. This reservation must end with small-scale producers given assistance through alternative measures rather than a total ban on large-scale entry. Privatization of public sector enterprises needs to be speeded up.

With almost two thirds of the industrial output of the organized sector in these enterprises, it will be difficult to stimulate industrial growth in the short to medium run without faster privatization. Finally, trade liberalization must proceed apace with all tariffs brought down to 15 percent or less. Again, this is necessary to reallocate production toward labour-intensive products in which India has ‘comparative advantage’. It will also be salutary for poverty reduction.

Infrastructure is another important area of reforms. Roads, railways, and ports all need expansion as well as improvement in the quality of service. The government has recently taken steps in this direction, particularly in the area of roads, but the pace remains slow. The most important area of reforms is perhaps India’s power sector. Virtually no sector of the economy—industry, agriculture, or services—can achieve successful transformation without adequate supply of power.

The power sector has been a government monopoly at the state level and suffers from proverbial inefficiency including large-scale thefts of electricity in almost every state. Reforms involving privatization of power generation and distribution have been undertaken in several states recently but no spectacular successes have emerged as yet. This is the area with highest payoffs for imaginative reforms.

Fertilizer and food subsidies pose yet another challenge. As much as 0.7 percent of GDP goes into fertilizer subsidies. Contrary to popular impression, much of this subsidy goes to support the inefficient domestic fertilizer industry rather than farmers. In the last five years, the prices for fertilizer paid by farmers have been close to the world price. Guaranteed rates of return to fertilizer manufacturers have allowed firms with costs two to three times the price in the world market to stay in business. Between food and fertilizer subsidies, there is scope for generating savings worth more than 1 percent of GDP.

Economic reforms of the last decade have virtually bypassed agriculture. Besides fertilizers among others, farmers need adequate supply of water and electricity. Currently, these are provided free of charge but their supply is highly unreliable. Farmers must also be able to reap the full market price for their product rather than be subject to a procurement price below the market price. Further, export restrictions must be phased out.

Financial sector reforms, particularly the reform of banking, remain a distant goal. While foreign banks are now allowed freely to open branches in India, they have not yet moved in aggressively. Banking sector privatization will take time but large efficiency gains could be achieved if labour laws are reformed to restore the hire and fire policy. Layoffs in banks have been very difficult, and voluntary retirement schemes extremely costly.

Finally, the reform of bureaucracy is essential. The problem of a bloated bureaucracy and the need for downsizing it is well recognized. But with policy making becoming an increasingly sophisticated and specialized activity, it is necessary to open the top bureaucracy to outside specialists.

Market-based economic reforms also often lead to growing inequalities between rich and poor, and between structurally backward and more developed states. Social sectors such as health and education have been neglected. These areas, although very important, were not focused and the result can be seen in the disappointingly low levels of education and health indicators today. A major reason for the rising inequality is the heterogeneity of the Indian population, leading to varying adjustment capacity. The inequalities also can stem from structural changes induced by the reforms.

The debate between big bang reforms of enabling the mechanism of 1991 and the gradualism that followed over the next thirty years continues in 2021. Both have worked. While the Statement on Industrial Policy 1991 reframed the foundations of economic policy; ended the dominance of the State in allowing businesses to be set up, grow or diversify; the reforms that have followed since then have been a mix of both.

The gradual cut in direct income tax rates across governments or the sequential setting up of regulators (capital markets under ex PM P.V. Narasimha Rao, insurance and pensions under Ex PM Atal Bihari Vajpayee, real estate under PM Narendra Modi) has been gradualist in approach, mixed in outcomes. That of the goods and services tax or the farm laws is a mix of both gradualist arguments over decades and its executive conclusion by law.

On the other side of the velocity spectrum lies Manmohan Singh’s Mahatma Gandhi National Rural Employment Guarantee Scheme that offered social security to millions by its enactment and Narendra Modi’s Jan Dhan Yojana that overnight gave 300 million unbanked citizens bank accounts. It is difficult to decide which is the more efficient route.

Economists may seek a ‘big bang’ but politics needs the balm of democratic conversations through gradualism. On the other hand, gradualist policies can be discussed until death, while the 21st-century India needs agile policy decisions. At this moment, agility seems like a distant dream, but given the ongoing pandemic and the economic crisis emanating from it, India’s politics may well deliver a new growth orbit.

Conclusion

Therefore, we can say that there were many such necessary conditions behind adopting economic reforms, on which we had to adopt economic reforms to improve, although it did not prove to be completely sufficient but it helped a lot in development and currently, we have to face those shortcomings. We need to consider the shortcomings of our policy and adopt our economic reforms according to the current situation. Converting a crisis into an opportunity is riskier than it sounds.

In the current scenario, India needs to act quickly to avoid an imminent crisis, so we have to change economic policy: create confidence, foster investment, cut the public deficit, restructure taxation and reform the labour laws so we can live in happy and a developed country. Like Tyler Cowen once said “Economics is everywhere, and understanding economics can help you make better decisions and lead a happier life”.