Economic liberalisation in India refers to a series of policy changes that opened the country's economy to the world and made it more market-oriented and consumption-driven. The goal was to expand the role of private and foreign investment, seen as a means of achieving economic growth and development. Although some attempts at liberalisation occurred in 1966 and the early 1980s, a more comprehensive reform came in 1991.
The 1991 reforms followed a balance-of-payments crisis in which foreign exchange reserves fell to about three weeks of imports. The crisis followed a decade of large fiscal deficits and rising external debt, and was triggered by the oil-price spike and loss of Gulf remittances caused by the Gulf War of 1990–91, and by the collapse of trade with the Soviet Union. India borrowed from the International Monetary Fund (IMF) and the World Bank, whose loans carried policy conditions; how far those conditions, rather than the government's own programme, drove the reforms is disputed. At his now famous budget speech that instituted the reforms, Manmohan Singh said on 24 July 1991: "Let the whole world hear it loud and clear. India is now wide awake."
Growth has been faster since the reforms than in earlier decades, and poverty has fallen sharply, although economists debate how much of that fall was due to reforms. Critics point to rising income inequality, slow growth in formal employment, agrarian distress, and environment damage following the reforms.
Pre-liberalisation policies Indian economic policy after independence was shaped by the colonial experience, which was exploitative and began as a takeover by a British trading company, and by leaders' ideas, particularly Prime Minister Nehru's exposure to Fabian socialism. Under the Congress Party governments of Nehru and his successors, policy tended towards protectionism, with a strong emphasis on import substitution industrialisation under state monitoring, state intervention at the micro level in all businesses, especially in labour and financial markets, a large public sector, business regulation, and central planning. The annual growth rate of the Indian economy averaged around 4% from the 1950s to 1980s, while per-capita income growth averaged 1.3%.
During the brief rule of the Janata party in late 1970s, the government, seeking to promote economic self-reliance and indigenous industries, required multinational corporations to partner with Indian corporations. The policy proved controversial, reduced foreign investment, and led to the high-profile exit of corporations such as Coca-Cola and IBM from India. They re-entered the Indian market following the reforms.
Reforms before 1991
1966 liberalisation attempt In 1966, due to rapid inflation caused by accompanying the Sino-Indian War and severe drought, the Indian government was forced to seek monetary aid from the International Monetary Fund (IMF) and World Bank. Pressure from the Bretton Woods institutions caused a shift towards economic liberalisation, wherein the rupee was devalued to combat inflation (even though devaluation results in increased import costs) and cheapen exports and the former system of tariffs and export subsidies was abolished.Mukherji, R. (2000). India's Aborted Liberalization-1966. Pacific Affairs, 73(3), 377–379. doi:10.2307/2672025 However, a second poor harvest and subsequent industrial recession helped fuel political backlash against liberalisation, characterised by resentment at foreign involvement in the Indian economy and fear that it might signal a broader shift away from socialist policies. As a result, trade restrictions were reintroduced and the Foreign Investments Board was established in 1968 to scrutinise companies investing in India with more than 40% foreign equity participation.
World Bank loans continued to be taken for agricultural projects since 1972, and these continued as international seed companies that were able to enter Indian markets after the 1991 liberalisation.
Economic reforms during the 1980s
As it became evident that the Indian economy was lagging behind its East and Southeast Asian neighbours, the governments of Indira Gandhi and subsequently Rajiv Gandhi began pursuing economic liberalisation. The New Computer Policy of 1984 was instrumental, as it eased import restrictions on technology, encouraged private investments, and provided incentives for software exports. This policy led to rapid growth in India's hardware and software sectors. Organizations like NASSCOM (established in 1988) supported the industry by fostering development, standardizing practices, and promoting Indian IT firms globally. India also established Software Technology Parks (STPs) to provide infrastructure, tax benefits, and faster data communications, enabling companies to export software services globally. The governments loosened restrictions on business creation and import controls while also promoting the growth of the automobile, digitalization, telecommunications and software industries.History of Computing in India: 1955–2010, Rajaraman, V. Reforms under lead to an increase in the average GDP growth rate from 2.9 percent in the 1970s to 5.6 per cent, although they failed to fix systemic issues with the Licence Raj. Despite Rajiv Gandhi's dream for more systemic reforms, the Bofors scandal tarnished his government's reputation and impeded his liberalisation efforts.
Growth during the 1980s was higher than in the preceding decades but fragile. It not only culminated in a crisis in June 1991 but also exhibited significantly higher variance than growth in the 1990s. Central to the high growth rate in the 1980s was the high growth of 7.6 percent during 1988–1991.
The fragile but faster growth during the 1980s took place in the context of significant reforms throughout the decade but especially starting in 1985. The liberalization pushed industrial growth to a hefty 9.2 percent during the crucial high growth period of 1988–1991.
Liberalisation of 1991
Crisis leading to reforms
With the liberalisation of trade in high-value goods like automobiles, electronics, fridges, washing machines, air conditioners, etc., in the 1980s, Indian imports shot up as significant components were imported. With a floating exchange rate, this could've been alleviated somewhat and adjustments would have been more gradual, but India's fixed exchange rates at the time placed the entire burden on the state to maintain parity by depleting its foreign exchange reserves. Higher income earners, benefiting from import liberalisation, could now purchase foreign goods at low prices due to the fixed exchange rate, with the state absorbing the pressure on the exchange rate.
The First Gulf War in 1991, after the Iraqi invasion of Kuwait, resulted in a huge blow to the Indian economy from a spike in oil prices and a drop in remittances from Indian expats in the Gulf region.
With high growth in the automobile sector in the 1980s, the demand for oil grew significantly and thus added to the demand for foreign exchange. Additionally, India was going through large-scale socio-political turmoil due to the government's reservations for backward classes and communal violence. All of these factors contributed to a balance of payments issue and provided stronger justification for broader liberalisation measures, which had already begun in the 1980s. Communists and socialists, who were the main political opposition to economic liberalisation, had also lost moral courage with the dissolution of the Soviet Union, the rise of East and South-East Asian tigers, and even China's opening up of its economy.
With trade and investment restrictions reduced in 1980s, there were policies and initiatives to increase exports particularly electronics and IT software. However, they picked speed and scale in 1990s due to long gestation period, WTO evolution and overall global trade growth.
By 1991, India still had a fixed exchange rate system, where the rupee was pegged to the value of a basket of currencies of major trading partners. Although a fixed exchange rate system helped India to achieve currency stability, it also necessitated that the Indian Government utilize its foreign exchange reserves in the event of currency pressures in order to avoid a breach of the currency peg especially since speculators are attempting to profit of off breaking the peg. The government was close to default on its external debtIndia's Pathway through Financial Crisis . Arunabha Ghosh. Global Economic Governance Programme. Retrieved 2 March 2007.What Caused the 1991 Currency Crisis in India? , IMF Staff Papers, Valerie Cerra and Sweta Chaman Saxena. and foreign exchange reserves had reduced to the point that India could barely finance two weeks' worth of imports.
Liberalisation of 1991
The collapse of the Chandra Shekhar government in the midst of the crisis and the assassination of Rajiv Gandhi led to the election of a new Congress government led by P. V. Narasimha Rao. He selected Amar Nath Verma to be his Principal Secretary and Manmohan Singh to be finance minister and gave them complete support in doing whatever they thought was necessary to solve the crisis. Verma helped draft the New Industrial Policy alongside Chief Economic Advisor Rakesh Mohan, and it laid out a plan to foster Indian industry in five points.Verma, A. N. (1991). Statement on Industrial Policy (India, Ministry of Industry). New Delhi: Government of India.
Firstly, it abolished the License Raj by removing licensing restrictions for all industries except for 18 that "related to security and strategic concerns, social reasons, problems related to safety and overriding environmental issues." To incentivise foreign investment, it laid out a plan to pre-approve all investment up to 51% foreign equity participation, allowing foreign companies to bring modern technology and industrial development. To further incentivise technological advancement, the old policy of government approval for foreign technology agreements was scrapped. The fourth point proposed to dismantle public monopolies by floating shares of public sector companies and limiting public sector growth to essential infrastructure, goods and services, mineral exploration, and defense manufacturing. Finally the concept of an MRTP company, where companies whose assets surpassed a certain value were placed under government supervision, was scrapped.
Meanwhile, Manmohan Singh worked on a new budget that would come to be known as the Epochal Budget. The primary concern was getting the fiscal deficit under control, and he sought to do this by curbing government expenses. Part of this was the disinvestment in public sector companies, but accompanying this was a reduction in subsidies for fertilizer and abolition of subsidies for sugar. He also dealt with the depletion of foreign exchange reserves during the crisis with a 19 per cent devaluation of the rupee with respect to the US dollar, a change which sought to make exports cheaper and accordingly provide the necessary foreign exchange reserves. The devaluation made petroleum more expensive to import, so Singh proposed to lower the price of kerosene to benefit the poorer citizens who depended on it while raising petroleum prices for industry and fuel.Singh, M. (24 July 1991). Budget 1991–1992 [PDF]. New Delhi: Government of India Ministry of Finance. pp. 11. Manmohan Singh presented the budget alongside his outline for broader reform. During the speech he laid out a new trade policy oriented towards promoting exports and removing import controls.Singh, M. (24 July 1991). Budget 1991–1992 [PDF]. New Delhi: Government of India Ministry of Finance. Specifically, he proposed limiting tariff rates to no more than 150 percent while also lowering rates across the board, reducing excise duties, and abolishing export subsidies.