Liberalization in India – 1991

Slide 2 [Introduction]

Liberalization means removal of entry and growth restrictions on the private sector.

It involves deregulation and reduction of government controls and greater autonomy of private
investment, to make economy more competitive. Under this process business is given free hand and is
allowed to run on commercial lines.
Liberalization can be termed as the precondition for economic growth in India. It is a broad term that
usually refers to fewer government regulations and restrictions, mainly on economic activities.

Thus, liberalization is basically a change in the economic philosophy of a state.

Slide 3 [Background]

Since Independence, India followed the mixed economic system. But in reality, the public sector
dominated the control and private sector was ignored. There was huge investment in public sector and
very low investment in private sector.

The economic condition of India was very miserable in 1991. It was due to cumulative effect of number
of reasons: -

 Poor performance of public sector

 Deficit in Balance of Payments
 Inflationary Pressures
 Fall in Foreign Exchange Reserves
 Huge burden of Debts

Slide 4 [The Year: 1991]

The then Government of India, in 1991, started the economic reforms in order to rebuild internal and
external faith in the Indian economy. Liberalization is the core essence of the reforms.

The purpose of liberalization was to unlock the economic potential of the country by encouraging
private sector and multinational corporations to invest and expand, it was also to introduce much more
competition into the economy which will in exchange help domestic companies to grow.

“Within a generation, the countries of East Asia have transformed themselves. China, Indonesia, Korea,
Thailand and Malaysia today have living standards much above ours… What they have achieved, we
must strive for.” ~Discussion Paper on Economic Reforms (Ministry of Finance) in July 1993

Slide 5 [Industrial Sector Reforms]

The New Industrial Policy established in 1991 sought substantially to deregulate Industry so as to
promote growth of a more efficient and competitive industrial economy.

Industrial licensing was abolished for all projects except in 18 industries. With this, 80% of the industry
was taken out of the licensing framework. The Monopolies & Restrictive Trade Practices Act was
repealed to eliminate the need for prior approval by large companies for capacity expansion or
diversification. Areas reserved for the public sector were narrowed down and greater participation by
private sector was permitted in core and basic industries from 17 to 8. These remaining eight are mainly
those involving strategic and security concerns.

Slide 6 [Financial Sector Reforms]

The new policy tried in many ways to make the banking system more efficient.

Reduction in statutory liquidity ratio and the cash reserve ratio in line with the recommendations of the
Narasimham Committee Report, 1991. Interest rates on time deposits were decontrolled by RBI in a
sequence of steps beginning with longer term deposits, and liberalization was progressively extended to
deposits of shorter maturity. Liberalization of bank branch licensing policy was made possible in order to
rationalize the existing branch network. Banks were given freedom to relocate branches and open
specialized branches. New accounting norms regarding classification of assets and provisions of bad
debt were also introduced.

Slide 7 [Foreign Exchange and Trade Reforms]

The main focus here was on greater openness. Hence, the policy package was essentially an outward-
oriented one.

From 1992, imports were regulated by a limited negative list. Only 71 items remained restricted. As a
first step towards a gradual reduction in the tariffs, the 1991-92 budget had reduced the peak rate of
import duty from more than 300 % to 150 %. The process of lowering the customs tariffs was carried
further in successive budgets. The new policy allowed export houses and trading houses to import a
wide range of items. The Government also permitted the setting up of trading houses with 51 % foreign
equity for the purpose of promoting exports. Export houses and trading houses were provided the
benefit of self-certification under the advance license system, which permits duty free imports for
exports

To overcome Balance of Payments crisis, the rupee was devalued against foreign currencies. The
government allowed rupee value to be freed from its control.

Slide 8 [Aftermath]
Through reform, India overcame its worst economic crisis in the remarkably short period of two years.
Thanks to prudent macroeconomic stabilization policies including devaluation of rupee and other
structural reforms, the BoP crisis was over by the end of March 1994 and foreign exchange reserves rose
to USD 15.7 billion.

India also increasingly integrated its economy with the global economy. The ratio of total exports of
goods and services to GDP in India approximately doubled from 1990 to 2000. Within 10 years, the ratio
of total goods and services trade to GDP rose twofold. Reforms led to increased competition in the
sectors like banking, leading to more customer choice and increased efficiency. It has also led to
increased investment and growth of private players in these sectors.

There was a fall in inflation rates as reforms pushed up production of goods and services resulting in
either prices falling or remaining constant. There was a significant Improvement in GDP growth. The
poverty ratio in rural areas and in urban areas declined.

Slide 9 [Faults]

The reforms were largely in the formal sector of the economy, the agriculture, urban informal sector and
forest dependent communities did not see any reforms. This led to uneven growth and unequal
distribution of economic freedom among people.

Economic liberalization in the organized manufacturing sector has led to growth with very little
additional employment.

It has also been blamed for increasing disparities between the rich and the poor and between
infrastructurally backward and more developed states.

Social sectors like health and education have been neglected. These areas, though very important, were
not focused upon and the result can be seen in the dismally low levels of education and health
indicators today.

“Economic reforms have accelerated growth but failed to generate adequate employment.”

References:

https://en.wikipedia.org/wiki/Liberalization

http://indiabefore91.in/1991-economic-reforms

http://indiabefore91.in/impact-reforms

Important Terms:
Statuary Liquidity Ratio: The reserve requirement that commercial banks are required to maintain in the
form of cash, gold reserves, PSU, bonds with themselves.

Cash Reserve Ratio: The reserve requirement is a central bank regulation that sets the minimum amount
of reserves that must be held by a commercial bank with the central bank.

Negative list: Negative list means the list of goods/services which are exempt from a facility/policy. 

Equity: The ownership of assets that may have debts or other liabilities attached to them.

Devaluation: The official lowering of the value of a country's currency within a fixed exchange-rate
system.