Economic Reforms

In 1991, the Indian economy was tottering. There was a massive shortage of funds, the government-owned sectors were malfunctioning, and the bureaucracy was bleeding the economy.

Together with the concepts of the ‘License Raj’ and various manners of Red Tape, there was fear that the Indian nation would go bankrupt. It was the ideal time for the economic reform in India.


Decision for an Economic Reform

It was at that crucial juncture that the then-Prime Minister, P.V. Narasimha Rao, took command of the affair and executed a series of crafted and synchronised moves which would later be crucial for the country. 

  • These moves were made with the knowledge and idea of the entire cabinet, especially the young and dynamic Finance Minister - Dr Manmohan Singh. He came armed with the concept of LPG in economics.

  • This process of involving globalization, bringing more confidence in the Indian economy, lifting and removing some of the archaic laws and keeping the nation afloat is now known as liberalisation. The entire manoeuvre is collectively termed as economic reforms in India.


What was the Need for Economic Reforms?

There were several pressing needs for these reforms. In fact, leading economists at that time urged the governments that came before to be even more proactive and take these steps earlier. 

But it was only in 1991 that things reached such a tipping point that something had to be done. 

The economic reforms in India since 1991 are exercises of both politics and business.  Economic reforms in any country mainly involves the introduction of the private sector in what often tend to be tightly controlled and regulated economies. 

The then-Finance Minister realised the importance of structural reforms and proceeded on special plans. 

Private companies provide the momentum needed by the governments of those countries to bring about better competition. And competition brings around a revolution in the economy. It is the basic meaning of reform. 

In India’s case, there were 5 precipitating reasons why such reforms were needed immediately. These are the following:

  1. The Industrial Sector’s Poor Performance : Prior to the 1990s, the industries were mostly Government owned. The employees did not feel the need to be either competitive or effective because their jobs were secure. The State had the ultimate authority. Thus, the industries were in the red. 

There was room for several disciplinary actions but the vision remained stagnant. The new economic reforms helped kick-start the economy in a fresh direction.

  1. Adverse Balance of Payments : This was the single-biggest factor which was at play. India’s BOP was unsustainable, and the little foreign exchange that the country’s resources had was not enough. India would soon be unable to purchase oil because of this factor. Besides, the BOP between the Centre and the states had risen to an unprecedented 11%. 

At this juncture, the only step that would work was to seek external help, introduce the LPG formula and bring about a New Economic Policy or NEP. All three were done. It has proven to be the foundation of financial reforms in India.

  1. Rise in Fiscal Deficit : India’s current account was bleeding. The Centre did not have any funds on its hands. The deficit was caused due to both external and internal factors. Suffice to say that the deficit had been a constant since the First Planning Commission’s tenure which started in 1950. 

By 1991, the rates were unsustainable. Inflation was also rising and had to be curbed. Ultimately, the Government had to implement the NEP in view of the Indian economic reforms. 

  1. Galloping Inflation : The rate of inflation at the time was immense. Poor and marginalised people of the society did not have enough access to food. At a massive 13.88%, this inflation rate could not be borne any more. Liquidity had to be poured into the economy and had to be done very quickly. 

  2. The First Gulf War : This is regarded as the second most-important factor which necessitated the NEP. In 1991, Iraq, under the dictator Saddam Hussein, invaded Kuwait despite international warnings and an Armada of American warships asking Hussein not to.

When this happened, the crude oil price skyrocketed. India was already tottering and this was the straw that broke the camel’s back. Oil was necessary, but India could not procure it from any source due to the 4 factors mentioned above. 

This led to the First Gulf War. Kuwait’s oil fields would not be serviceable for several months. The decision for the new NEP was thus taken immediately.

All recent economic reforms in India follow the pattern that started in 1991. 


Were the Reforms Necessary?

Apart from the familiar LPG (Liberalisation, Privatisation and Globalisation) formula, there was a series of brave and profitable decisions which were taken on a war footing. A loan of $7 billion was taken from the IMF and the World Bank in anticipation of the New Economic Policy. 

The NEP and the LPG reforms which were propounded by Dr. Singh and his team of experts laid out the following reasons for its existence.

  1. To decrease the exchange rate of the Indian Rupee vis-a-vis the American Dollar. This exchange rate is highly disruptive if it gets above the psychologically sensitive 75 mark. In 1991, the rate was very high and steps had to be taken.

  2. To help the introduction of private players in some of the most closely-guarded economic corridors. Until 1991, there were very few sectors in which the private players could compete against the government-held establishments. 

This had led to the creation of the infamous ‘License Raj’ which is a derogatory term for the corrupt and inefficient bureaucracy. Once private players poured in, the real might of the Indian market was put on full display. This is another reason why the then PM has been hailed as the master of economic reforms in India.

  1. To help the economy avail the contents of the private purse, the NEP was essential. Besides, the loans from the IMF and the World Bank were directly tied to the NEP’s implementation.

  2. Another reason for the rollout of the NEP was to end the monopoly of certain government enterprises in specific sectors like defence manufacture and food processing. These sectors had virtually had no private competition to speak of before 1991. 

Post that, the scenario changed. Economic reforms led to a sudden glut of major private players. The government-owned companies had to tidy up their act.

  1. A pressing reason for the reforms as to ensure that the Indian Banking Sector did not collapse. There were no private banks, and all the people’s savings and earnings were put in PSU banks. This was a recipe for disaster. 

While the RBI had done a commendable job, there was a false notion that all the PSU banks were ‘too big to fail.’ Dr Singh noted that this was not the case and the spirit of private banking, as we know it now, was ushered in.

  1. The world business community had to know that there would be no more slow-motion economic progress. Decision making was left to talented and high-powered committees which were run mostly by technocrats like Sam Pitroda, who later became one of the driving figures of the Indian Telecom Revolution. 

Pitroda had been handpicked by the PM and his FM. Technocracy was encouraged, and this has led to such innovative programs like ‘Make in India’ and ‘Start-Up India.’ All these are legacies of economic reforms in India.

  1. To introduce more Foreign Direct Investment or FDI, a new fiscal policy had to be put in place. This was done in 1991 and 3 special economic terms were added to the Indian lexicon- Deregulation, Privatisation and Exit Policy. Simply put, this gave an extra impetus to many foreign companies to invest in India’s economy. 

They had the liberty to take a good look of the existing laws and then take decisions which would suit them the best. Previously, the FDI norms had been rather vague. The picture sharpened after liberalisation and privatisation were adopted.

  1. Finally, perhaps an over-riding aspect which jolted the Government into action was the rationale that most of the other major South Asian countries were going past India in their growth stories. India’s per-capita GDP was still inadequate. The banking sector was lackadaisical in giving loans. Poverty was still a looming presence. If the country had to enter the new century, something drastic had to be done. This was the New Economic Policy.

Thanks to the bold decisions of the policymakers of 1991 and later, India is on its way to becoming a $5 trillion economy. To know more about economic reforms, and find all the related details about India’s economy, visit Vedantu’s website today.

FAQ (Frequently Asked Questions)

1. What were the 5 Main Reasons for Economic Reforms?

The 5 Most Important Reasons are:

  • High inflation

  • The war in Kuwait

  • Widening fiscal deficit

  • Adverse Balance of Payments

  • A stumbling government sector

2. Name Two Industries Where the NEP has Shown Benefits

Among the many such fields, the travel/tourism industry and the software/IT revolution are excellent examples. India’s travel industry accounts for 8% of all employment opportunities, clearly a successful sector.