Economic liberalisation in India

The economic liberalisation in India** refers to ongoing economic reforms in India that started on 24 July 1991. After Independence in 1947, India adhered to socialist policies. In the 1980s, Prime Minister Rajiv Gandhi initiated some reforms. In 1991, after India faced a balance of payments crisis, it had to sell 67 tons of gold to Union Bank of Switzerland and Bank of England as part of a bailout deal with the International Monetary Fund (IMF). In addition, IMF required India to undertake a series of structural economic reforms . As a result of this requirement, the government of P. V. Narasimha Rao and his finance minister Manmohan Singh (the present Prime Minister of India) started breakthrough reforms, although they did not implement many of the reforms IMF wanted. The new neo-liberal policies included opening for international trade and investment, deregulation, initiation of privatization, tax reforms, and inflation-controlling measures. The overall direction of liberalisation has since remained the same, irrespective of the ruling party, although no party has yet tried to take on powerful lobbies such as the trade unions and farmers, or contentious issues such as reforming labour laws and reducing agricultural subsidies. The main objective of the government was to transform the economic system from socialism to capitalism so as to achieve high economic growth and industrialize the nation for the well-being of Indian citizens. Today India is mainly characterized as a market economy.

As of 2009, about 300 million people—equivalent to the entire population of the United States—have escaped extreme poverty. The fruits of liberalisation reached their peak in 2007, when India recorded its highest GDP growth rate of 9%. With this, India became the second fastest growing major economy in the world, next only to China. An Organisation for Economic Co-operation and Development (OECD) report states that the average growth rate 7.5% will double the average income in a decade, and more reforms would speed up the pace.

Indian government coalitions have been advised to continue liberalisation. India grows at slower pace than China, which has been liberalising its economy since 1978. McKinsey states that removing main obstacles "would free India’s economy to grow as fast as China’s, at 10 percent a year".

For 2010, India was ranked 124th among 179 countries in Index of Economic Freedom World Rankings, which is an improvement from the preceding year.

Pre-liberalisation policies

Further information: Economic history of India and Licence Raj

Indian economic policy after independence was influenced by the colonial experience (which was seen by Indian leaders as 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. Steel, mining, machine tools, water, telecommunications, insurance, and electrical plants, among other industries, were effectively nationalized in the mid-1950s. 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.

Before the process of reform began in 1991, the government attempted to close the Indian economy to the outside world. The Indian currency, the rupee, was inconvertible and high tariffs and import licensing prevented foreign goods reaching the market. India also operated a system of central planning for the economy, in which firms required licenses to invest and develop. The labyrinthine bureaucracy often led to absurd restrictions—up to 80 agencies had to be satisfied before a firm could be granted a licence to produce and the state would decide what was produced, how much, at what price and what sources of capital were used. The government also prevented firms from laying off workers or closing factories. The central pillar of the policy was import substitution, the belief that India needed to rely on internal markets for development, not international trade—a belief generated by a mixture of socialism and the experience of colonial exploitation. Planning and the state, rather than markets, would determine how much investment was needed in which sectors.

— BBC

In the 80s, the government led by Rajiv Gandhi started light reforms. The government slightly reduced Licence Raj and also promoted the growth of the telecommunications and software industries.

The Vishwanath Pratap Singh (1989–1990) and Chandra Shekhar Singh government (1990–1991) did not add any significant reforms.

Impact

• The low annual growth rate of the economy of India before 1980, which stagnated around 3.5% from 1950s to 1980s, while per capita income averaged 1.3%. At the same time, Pakistan grew by 5%, Indonesia by 9%, Thailand by 9%, South Korea by 10% and in Taiwan by 12%.
• Only four or five licences would be given for steel, electrical power and communications. License owners built up huge powerful empires.
• A huge public sector emerged. State-owned enterprises made large losses.
• Infrastructure investment was poor because of the public sector monopoly.
• Licence Raj established the "irresponsible, self-perpetuating bureaucracy that still exists throughout much of the country" and corruption flourished under this system.

Narasimha Rao government (1991–1996)

Present Prime Minister Manmohan Singh was then Finance Minister in Cabinet of Prime Minister P V Narasimha Rao

Crisis

Main article: 1991 India economic crisis

The assassination of prime minister Indira Gandhi in 1984, and later of her son Rajiv Gandhi in 1991, crushed international investor confidence on the economy that was eventually pushed to the brink by the early 1990s.

As of 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. India started having balance of payments problems since 1985, and by the end of 1990, it was in a serious economic crisis. The government was close to default, its central bank had refused new credit and foreign exchange reserves had reduced to the point that India could barely finance three weeks’ worth of imports.

A Balance of Payments crisis in 1991 pushed the country to near bankruptcy. In return for an IMF bailout, gold was transferred to London as collateral, the rupee devalued and economic reforms were forced upon India. That low point was the catalyst required to transform the economy through badly needed reforms to unshackle the economy. Controls started to be dismantled, tariffs, duties and taxes progressively lowered, state monopolies broken, the economy was opened to trade and investment, private sector enterprise and competition were encouraged and globalisation was slowly embraced. The reforms process continues today and is accepted by all political parties, but the speed is often held hostage by coalition politics and vested interests.

— India Report, Astaire Research

Sustainability of Economic Liberalization

Go to : Economic_liberalization

Later reforms

• The Bharatiya Janata Party (BJP)-Atal Bihari Vajpayee administration surprised many by continuing reforms, when it was at the helm of affairs of India for five years.
• The BJP-led National Democratic Alliance Coalition began privatizing under-performing government owned business including hotels, VSNL, Maruti Suzuki, Airports and began reduction of taxes, a sound fiscal policy aimed at reducing deficits and debts and increased initiatives for public works.
• The United Front government attempted a progressive budget that encouraged reforms, but the 1997 Asian financial crisis and political instability created economic stagnation.
• Economic and technology-related sanctions have repeatedly not proved to be very effective in compelling nations to change their sovereign decisions made in enlightened self-interest. India faced severe sanctions after Pokhran-I (five nuclear tests on 11 and 13 May 1998 at the Pokhran range in Rajasthan Desert), and sanctions that were more comprehensive were imposed following Pokhran-II. There were dire predictions of the collapse of the economy, double-digit inflation etc.
• After five years, most of the sanctions have been lifted and the Indian economy is continuing to grow at an acceptably satisfactory rate. The growth rate for 2003–04 was 6.0%. Though India’s Gross National Income is only $477.4 billion by conventional calculations, it translates into $2,913 billion purchasing power parity (PPP), according to the latest world development indicators. In PPP terms, it is the world's fourth largest economy, behind only the US, China and Japan.

Impact of reforms

The HSBC Global Technology Center in Pune develops software for the entire HSBC group.

The impact of these reforms may be gauged from the fact that total foreign investment (including foreign direct investment, portfolio investment, and investment raised on international capital markets) in India grew from a minuscule US$132 million in 1991–92 to $5.3 billion in 1995–96.

Cities like NOIDA, Gurgaon, Gaziabad, Bangalore, Hyderabad, Pune, Chennai, Jaipur, Indore and Ahmedabad have risen in prominence and economic importance, become centres of rising industries and destination for foreign investment and firms.

Annual growth in GDP per capita has accelerated from just 1¼ per cent in the three decades after Independence to 7½ per cent currently, a rate of growth that will double average income in a decade. [...] In service sectors where government regulation has been eased significantly or is less burdensome—such as communications, insurance, asset management and information technology—output has grown rapidly, with exports of information technology enabled services particularly strong. In those infrastructure sectors which have been opened to competition, such as telecoms and civil aviation, the private sector has proven to be extremely effective and growth has been phenomenal.

— OECD

Election of AB Vajpayee as Prime Minister of India in 1998 and his agenda was a welcome change. His prescription to speed up economic progress included solution of all outstanding problems with the West (Cold War related) and then opening gates for FDI investment. In three years, the West was developing a bit of a fascination to India’s brainpower, powered by IT and BPO. By 2004, the West would consider investment in India, should the conditions permit. By the end of Vajpayee’s term as Prime Minister, a framework for the foreign investment had been established. The new incoming government of Professor Manmohan Singh in 2004 is further strengthening the required infrastructure to welcome the FDI.

Today, fascination with India is translating into active consideration of India as a destination for FDI. The A T Kearney study is putting India second most likely destination for FDI in 2005 behind China. It has displaced US to the third position. This is a great leap forward. India was at the 15th position, only a few years back. To quote the A T Kearney Study “India's strong performance among manufacturing and telecom & utility firms was driven largely by their desire to make productivity-enhancing investments in IT, business process outsourcing, research and development, and knowledge management activities”.

Still, India has not made into the grade where manufacturing investment will be targeted to it. That status belongs to China. But, progressively positive noises are being heard in the world financial circles to consider India at par with China. A few of the remaining antiquated labor laws in India need to be repealed and neglected infrastructure are upgraded to put an investor at ease. The irony is that all plans to redress the labor laws or upgrading of the infrastructure are shot down by left leaning politicians at the federal level. Only recently a proposal to use a part of India’s huge foreign reserves to rebuild infrastructure was shot down by these politicians. To the contrary, they have nothing-worthwhile alternative to offer.

Ongoing economic challenges

Main article: Economy of India

• Problems in the agricultural sector.
• Highly restrictive and complex labour laws.
• Inadequate infrastructure, which is often government monopoly.
• Failing education.
• Inefficient public sector.
• Inflation in basic consumable goods.
• Corruption
• High fiscal deficit

OECD summarized the key reforms that are needed:

In labour markets, employment growth has been concentrated in firms that operate in sectors not covered by India’s highly restrictive labour laws. In the formal sector, where these labour laws apply, employment has been falling and firms are becoming more capital intensive despite abundant low-cost labour. Labour market reform is essential to achieve a broader-based development and provide sufficient and higher productivity jobs for the growing labour force. In product markets, inefficient government procedures, particularly in some of the states, acts as a barrier to entrepreneurship and need to be improved. Public companies are generally less productive than private firms and the privatisation programme should be revitalised. A number of barriers to competition in financial markets and some of the infrastructure sectors, which are other constraints on growth, also need to be addressed. The indirect tax system needs to be simplified to create a true national market, while for direct taxes, the taxable base should be broadened and rates lowered. Public expenditure should be re-oriented towards infrastructure investment by reducing subsidies. Furthermore, social policies should be improved to better reach the poor and—given the importance of human capital—the education system also needs to be made more efficient.

— OECD

Reforms at the state level

See also: Economic disparities in India

The Economic Survey of India 2007 by OECD concluded:

At the state level, economic performance is much better in states with a relatively liberal regulatory environment than in the relatively more restrictive states".

The analysis of this report suggests that the differences in economic performance across states are associated with the extent to which states have introduced market-oriented reforms. Thus, further reforms on these lines, complemented with measures to improve infrastructure, education and basic services, would increase the potential for growth outside of agriculture and thus boost better-paid employment, which is a key to sharing the fruits of growth and lowering poverty.

See also

• Economy of India
• Globalisation in India
• License Raj
• Hindu rate of growth

External links

• For a short educational video of the "economic history of India".
• Nick Gillespie (2009). "What Slumdog Millionaire can teach Americans about economic stimulus". Reason.
• Gurcharan Das (2006). "The India Model". The Foreign Affairs.
• Aditya Gupta (2006). "How wrong has the Indian Left been about economic reforms?" (PDF). Centre for Civil Society.
• "The India Report" (PDF). Astaire Research <<doesn't work>>. 2007.

'Bold text