General Studies IIIEconomy

LPG reforms in India (Liberalization, Privatization, Globalization)


LPG reforms:

The economic liberalization in India refers to the economic liberalization of the country’s economic policies with the goal of making the economy more market and service-oriented and expanding the role of private and foreign investment. Indian economic liberalization was part of a general pattern of economic liberalization and modernization occurring across the world in the late 20th century. Although unsuccessful attempts at liberalization were made in 1966 and the early 1980s, a more thorough liberalization was initiated in 1991. The LPG reforms prompted by a balance of payments crisis that had led to a severe recession.

Specific changes included reducing import tariffs, deregulating markets, and reducing taxes, which led to an increase in foreign investment and high economic growth in the 1990s and 2000s. From 1992 to 2005, foreign investment increased 316.9%, and India’s gross domestic product (GDP) grew from $266 billion in 1991 to $2.3 trillion in 2018 According to one study, wages rose on the whole, as well as wages as the labor-to-capital relative share.

Pre-liberalization policies

Indian economic policy after independence was influenced by the colonial experience (which was exploitative in nature) and by those leaders’ exposure to Fabian socialism. Policy tended towards protectionism, with a strong emphasis on import substitution industrialization 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. Five-Year Plans of India resembled central planning in the Soviet Union. Under the Industrial Development Regulation Act of 1951, steel, mining, machine tools, water, telecommunications, insurance, and electrical plants, among other industries, were effectively nationalised. Elaborate licences, regulations and the accompanying red tape, commonly referred to as Licence Raj, were required to set up business in India between 1947 and 1990. The Indian economy of this period is characterised as Dirigism.

Licence Raj established an “irresponsible, self-perpetuating bureaucracy”and corruption flourished under this system.Only four or five licences would be given for steel, electrical power and communications, allowing licence owners to build huge and powerful empires without competition. A huge public sector emerged, allowing state-owned enterprises to record huge losses without being shut down. Controls on business creation also led to poor infrastructure development.

By 1980, this had created widespread economic stagnation. The annual growth rate of the Indian economy had stagnated around 3.5% from the 1950s to 1980s, while per-capita income growth averaged 1.3%. During the same period, Pakistan grew by 5%, Indonesia by 9%, Thailand by 9%, South Korea by 10% and Taiwan by 12%.

Reforms Before 1991


1966 Liberalization Attempt

In 1966, due to rapid inflation caused by an increasing budget deficit 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 aid donors caused a shift towards economic liberalization, wherein the rupee was devalued to combat inflation and cheapen exports and the former system of tariffs and export subsidies was abolished. However, a second poor harvest and subsequent industrial recession helped fuel political backlash against liberalization, characterized 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 scrutinize 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 liberalization.

Economic Reforms During 1980s

As it became evident that the Indian economy was lagging behind its East and Southeast Asian neighbors, the governments of Indira Gandhi and subsequently Rajiv Gandhi began pursuing economic liberalization. The governments loosened restrictions on business creation and import controls while also promoting the growth of the telecommunications and software industries. Reforms under lead to an increase in the average GDP growth rate from 2.9 percent in the 1970s to 5.6 percent, 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 liberalization efforts.

Factors that led to LPG reforms of 1991

  • Rise in Prices: The inflation rate increased from around 6% to 16% and the country’s economic position became worse.
  • Rise in Fiscal Deficit: Government’s fiscal deficit increased due to increase in non-development expenditure. Due to the rise in fiscal deficit, there was a rise in public debt and interest to be paid. In 1991, interest liability became 36.4% of total government expenditure.
  • Adverse Balance of Payments: In 1980-81, current account deficit was Rs. 2214 crore and rose to Rs. 17,367 crores in 1990- 91. To cover this deficit, government took a large amount of foreign loans, which further increased the interest payments.
  • Dismal Performance of PSUs: PSUs were not performing well due to number of reasons, including political interference and unprofessionalism in operations.
  • Fall in Foreign Exchange Reserves: India’s foreign exchange reserve fell to its record lowest in 1990-91 and it was insufficient to pay for an import bill even for 2 weeks.

International events associated with Indian reforms:

  • The Soviet Union was collapsing at the time, proving that more socialism could not be the solution for India’s ills.
  • Deng Xiaoping had revolutionized China with market-friendly reforms.
  • The 1990-91 Iraq war led to the stoppage of flow of foreign currency from Gulf countries.
  • To tide over the Balance of Payment (BoP) issues, India borrowed huge amounts from the International Monetary Fund (IMF).
  • The Asian financial crisis of 1997-99 laid India low.
  • The dot-com collapse and global recession of 2001, and the huge global uncertainty created in the run-up to the invasion of Iraq in 2003.
  • The global boom of 2003-08 was spearheaded by China.

LPG Reforms in India: LPG meaning

  • Liberalization– Liberalization is a broad term that refers to the practice of making laws, systems, or opinions less severe, usually in the sense of eliminating certain government regulations or restrictions.
  • Privatization– It refers to the transfer of ownership of property or business from a government to a privately owned entity.
  • Globalization– It refers to the expansion of economic activities, transcending political boundaries of nation states.

Features of LPG Policy 1991

  • Abolition of Industrial licensing/ Permit Raj
  • Public sector role diluted
  • Beginning of privatisation
  • Free entry to foreign investment and technology
  • Industrial location policy liberalized
  • Abolition of phased manufacturing programmes for new projects
  • Removal of mandatory convertibility clause
  • Reduction in import tariffs
  • Deregulation of markets
  • Reduction of taxes

LPG Reforms in India:  Positive outcomes

  • Increase in India’s GDP growth rate: During 1990-91, India’s GDP growth rate was only 1.1% but after LPG reforms of 1991, GDP growth rate increased year by year and in 2015-16 it was estimated to be 7.5% by the IMF.
  • Foreign investment destination: Since 1991, India has firmly established itself as a lucrative foreign investment destination and FDI equity inflows in India in 2019-20 (till August) stood at US$ 19.33 billion.
  • Decrease in unemployment rate: In 1991, the unemployment rate was high. However, LPG reforms of 1991 led to arrival of new foreign companies and more jobs got generated thus leading to decrease in unemployment rate.
  • Per Capita income increased due to an increase in employment.
  • Exports have increased and stood at USD 26.38 billion as of October, 2019

LPG Reforms in India: Challenging outcomes

  • Decrease in agriculture GVA: In 1991, agriculture provided employment to 72% of the population and contributed 29.02 percent of the GDP. Now, the share of agriculture in the GDP has gone down drastically to 18%. This has resulted in decrease in per capita income of the farmers and increase in the rural indebtedness.
  • MNC vs local business: Due to opening up of the Indian economy to foreign competition, more MNCs started competing with local businesses. This led to highly unequal business competition.
  • Globalization has also contributed to the destruction of the environment through pollution by emissions from manufacturing plants and clearing of vegetation cover.
  • Widening income gaps: LPG reforms of 1991 have led to widening income gaps within the country. The higher growth rate was achieved at the cost of declining incomes of majority of people, thus leading to increase in inequality.

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