Economic Reforms Since 1991

Learning Outcomes:

1. Understand the roots of India’s 1991 economic crisis.
2. Identify key economic reforms initiated post-1991.
3. Analyze the impact of these reforms on various sectors like fiscal policy, trade, and labor markets.
4. Recognize the political and social challenges to reforms.
5. Compare India’s reform trajectory with other developing nations.

The Indian economy’s long-standing constraints, combined with immediate crises, culminated in a major fiscal and balance of payments crisis in 1991. This led to the implementation of comprehensive economic reforms and structural adjustments initiated by the Narasimha Rao-led minority government, with economist Manmohan Singh at the helm as the finance minister. These reforms were considered revolutionary given India’s inward-looking economic policies prior to 1991.

Early Calls for Reform

By the 1960s, experts like Manmohan Singh and Jagdish Bhagwati advocated for economic openness and a reduction in controls. Despite their efforts, the following decades witnessed a hesitant approach towards reforms:

1. A mid-1960s attempt at reform failed due to external and internal factors.
2. The 1970s saw ‘reform by stealth’ through currency depreciation, though outright devaluation was politically infeasible.
3. In the 1980s, Indira Gandhi and Rajiv Gandhi introduced partial deregulation, but significant areas like fiscal balance and public sector reform were largely untouched.
4. Political instability, such as the Bofors scandal and crises in Punjab, further stalled reform momentum.

Important Note:
India’s political crises, ranging from Bofors allegations to the destruction of the Babri Masjid, made it difficult to sustain reforms, as governments were cautious about introducing unpopular measures.

The 1991 Crisis and Comprehensive Reforms

The 1991 crisis became the tipping point for comprehensive reforms. Several factors enabled this shift:

1. Fiscal Correction: Immediate action was taken to stabilize the fiscal deficit.
2. Exchange Rate Adjustment: The rupee underwent a significant devaluation of around 20%.
3. Liberalization of Trade: Import controls were eased, facilitating greater access to global markets.
4. Industrial Licensing: The restrictive MRTP Act was abolished, reducing barriers to large-scale industrial investments.
5. Public Sector Reforms: Gradual privatization and capital market reforms were introduced, with a focus on opening up to multinational corporations.
6. Foreign Direct Investment (FDI): Restrictions were lifted to encourage foreign investment, particularly in the form of FDI.

These reforms freed the economy from internal controls and aligned it with the global market, fostering economic globalization.

Initial Impact of Reforms

The initial years of reform saw significant improvements across multiple fronts:

1. The GDP growth rate, which was 0.8% in 1991–92, quickly recovered to 5.3% in 1992–93 and 6.2% in 1993–94.
2. India’s gross domestic savings increased, averaging over 23% between 1991 and 1997.
3. Industrial production rebounded from negative growth in manufacturing to 12.8% growth by 1995–96.
4. Agricultural growth, too, maintained a steady pace, with a growth rate of over 3% by 1996–97.

Table: Comparative Economic Indicators Pre- and Post-Reforms

The reforms proved successful in stabilizing the economy and maintaining growth despite challenges like the Ayodhya crisis.

Fiscal and External Sector Reforms

The government’s reforms also extended to fiscal policies and the external sector:

1. The fiscal deficit was reduced from 8.3% of GDP in 1990–91 to an average of 6% between 1992 and 1997.
2. Exports rebounded, growing by an average of nearly 20% between 1993 and 1996, leading to improved self-reliance. Export earnings covered nearly 90% of import payments by the mid-1990s, compared to 60% in the 1980s.
3. The current account deficit fell to 1.6% of GDP by 1995–96, down from an unsustainable 3.2% in 1990–91.
4. Foreign exchange reserves grew significantly, from a mere two weeks of imports in July 1991 to cover seven months of imports by 1999.

However, while external debt improved, with the debt-to-GDP ratio falling from 41% in 1991–92 to 28.7% in 1995–96, India’s debt service ratio remained higher than that of China and other East Asian countries.

Stock Market and Investment Reforms

Reforms also transformed capital markets and investment flows:

1. The market capitalization on Indian stock exchanges rose sharply, from 5% of GDP in 1980 to 60% of GDP by 1993.
2. Repealing the Capital Issues Control Act of 1947 allowed greater freedom for companies to raise funds, both domestically and internationally.
3. Foreign Direct Investment (FDI) grew rapidly, from $129 million in 1991–92 to $2.1 billion in 1995–96.

Despite the sharp increase in foreign investment, India lagged behind countries like China, which absorbed over $30 billion annually in FDI.

Table: FDI Growth Comparison (India vs. China)

Poverty and Social Impact of Reforms

The charge that reforms were anti-poor was central to critiques, particularly from the left. However, economic growth typically correlates with poverty reduction:

1. Poverty rates in India fell from 51.3% in 1977–78 to 38.9% in 1987–88, and continued to decline post-reforms.
2. Comparative countries like China and Indonesia managed to drastically reduce poverty with higher growth rates, from 59.5% and 64.3% in 1975, respectively, to much lower levels by the mid-1990s.

The initial stabilization phase of India’s reforms had relatively minimal impact on the poor. The government managed to maintain its Social Services and Rural Development (SSRD) expenditure, minimizing the potential harm of fiscal tightening.

Important Note:
Critics argued that the rise in rural poverty in 1992–93 was more due to drought and food shortages than the stabilization programme itself, highlighting the limited negative impact of reforms on poverty.

Ongoing Challenges and Political Instability

Despite the initial success, reform momentum slowed by the mid-1990s:

1. Continued political instability and the lack of a clear parliamentary majority led to populist policies and reluctance to take difficult fiscal decisions.
2. The public savings-investment gap remained high, with the fiscal deficit continuing to be a challenge.
3. Subsidies on food grains, fertilizers, and oil remained a substantial burden, constraining public investment in crucial sectors like agriculture and infrastructure.

Table: Key Subsidy Burden (Rs Billion)

Declining Growth and External Factors

From 1997, India’s economic growth began to decelerate:

1. GDP growth fell to 5% in 1997–98, down from 7.8% in 1996–97.
2. Exports growth slowed, turning negative in 1998–99, while industrial growth halved from its 1995–96 peak.
3. The East Asian crisis further exacerbated the slowdown, causing a fall in foreign capital inflows, including FDI and portfolio investments.

In addition to external factors, internal weaknesses such as poor infrastructure, rigid labor laws, and continued trade restrictions hindered the export potential.

Fiscal Deficit and Structural Issues

The fiscal deficit continued to be a major issue:

1. The primary deficit, which had been reduced to 0.6% of GDP in 1996–97

, doubled to 1.3% in 1997–98, further straining public finances.

2. The selective implementation of the Fifth Pay Commission’s recommendations by the United Front government in 1997 led to a sharp increase in government expenditure without compensatory savings.

Important Note:
The Economic Survey of 1998-99 suggested reconsidering constitutional limits on the fiscal deficit, highlighting the growing concern over India’s fiscal slippage.

Conclusion of the Reforms

Despite challenges, the broad political consensus around reforms was a major achievement. Even traditionally opposing factions like the Communists and BJP continued to support the reform process, though with divergent approaches.

Multiple-Choice Question

What was the primary reason for India’s 1991 economic crisis?

1. A global recession.
2. A fiscal and balance of payments crisis.
3. Political instability due to the Bofors scandal.
4. Collapse of the Socialist bloc.

Answer: 2. A fiscal and balance of payments crisis.