Indian Economy: Liberalization, Privatisation, and Globalization (LPG) reforms

Introduction

India initially embraced a mixed economy post-independence, integrating aspects of capitalism and socialism. In 1991, an economic crisis, marked by external debt challenges and declining foreign reserves, prompted a pivotal shift. The government initiated Liberalization, Privatisation, and Globalization (LPG) reforms, redirecting India towards a new developmental trajectory.

Overview of Indian Economy Prior 1991

• Production Across Countries
  • Pre-20th century, production was mostly national, with global trade centered on raw materials, food, and finished goods, i.e colonial areas like India primarily exported raw materials and imported finished products.
• Situation Prior to the LPG Era
  • Government funds were generated through taxation, public sector enterprises, and borrowing when expenditures exceed income.
• Economic Disparities and Fiscal Management
  • Despite low revenues, increased government spending on unemployment, poverty, and population issues, with developmental programs failing to generate sufficient revenue, 
  • It was compounded by inadequate internal generation and reliance on non-immediate return areas, leading to a deficit as public sector undertakings’ income fell short of escalating expenditures.
• Foreign Exchange and International Borrowing
  • Late 1980s: Widening gap between government revenue and expenditure, unsustainable borrowing, uncontrolled consumption-led use of foreign exchange, soaring essential goods prices, and a precarious depletion of foreign exchange reserves due to imbalanced imports and exports.
• Crisis Management and International Assistance
  • Deepening crisis: Plummeting foreign exchange reserves prompt India to seek a $7 billion loan from the World Bank and IMF, contingent on economic liberalization, reduced government intervention, and trade restriction abolishment.

New Economic Policy (NEP) Introduction

• Complying with the international agencies’ conditions, India announced the New Economic Policy (NEP).
• The NEP encompassed two primary strategies:
  • Stabilisation Measures: Short-term measures to rectify balance of payments discrepancies and control inflation by maintaining adequate foreign exchange reserves
  • Structural Reform Measures: Long-term measures to augment the economy’s efficiency and international competitiveness by eliminating rigidities in various segments of the Indian economy. 
• The core themes of the reforms were 
  • Liberalization: It is the direction of reforms. 
  • Privatisation: It is path to the reforms.
  • Globalisation: It is the ultimate aim of reforms.

Liberalization

• Liberalization in 1991: Launched to remove governmental restrictions, granting businesses freedom in import-export decisions.
• Comprehensive Impact: Policies extended to industrial, financial, taxation, foreign exchange, trade, and investment sectors.
• Deregulation of the Industrial Sector
  • Pre-1991 Regulatory Mechanisms: Stringent regulations included industrial licensing, limited private sector involvement, small-scale industries reservations, and controls on price and distribution.
  • Post-1991 Reforms: Industrial licensing was abolished for most categories (exceptions for alcohol, hazardous chemicals).
  • De-reservation of goods previously restricted to small-scale industries.
  • Introduction of market-determined prices in most industries.
• Financial Sector Reforms
  • Pre-1991 Financial Sector Regulation: Under stringent regulation by the Reserve Bank of India (RBI), covering commercial banks, investment banks, stock exchanges, and the foreign exchange market.
  • Post-1991 Reforms:
    • Transitioned RBI’s role from regulator to facilitator, allowing the financial sector autonomy in decision-making.
    • Facilitated establishment of private sector banks (Indian and foreign) with increased foreign investment limits (around 74%).
    • Banks meeting certain conditions could establish branches and rationalize networks without RBI approval, while retaining some managerial aspects with RBI for stakeholder safeguarding.
• Foreign Institutional Investors (FIIs) like merchant bankers, mutual funds, and pension funds permitted to invest in Indian financial markets.

Tax Reforms

• Tax Reforms Post-1991: Focused on modifying government taxation and public expenditure policies as part of fiscal policy.
  • Reduction in Income and Corporation Taxes:
  • Witnessed a continuous reduction in individual income taxes and corporation tax rates post-1991.
  • Aimed At: promoting savings, voluntary income disclosure, and compliance.
• Indirect Tax Reforms:
  • Efforts made to reform indirect taxes on commodities.
  • The goal was to establish a common national market for goods and commodities.
• Goods and Services Tax (GST) Act 2016:
  • In 2016, efforts culminated in the establishment of a unified indirect tax system through the Goods and Services Tax Act 2016.
  • Effective from July 2017, aimed at simplifying tax procedures and reducing evasion.
• Foreign Exchange Reforms
  • 1991 Balance of Payments Crisis Response: Immediate devaluation of the rupee to address the crisis, boosting foreign exchange inflow.
• Exchange Rate Reforms:
  • Initiated market-determined exchange rates post-1991.
  • Based on foreign exchange demand and supply, reducing government control over the rupee’s value.
• Trade and Investment Policy Reforms
  • Aimed at enhancing international competitiveness and attracting foreign investments and technology infusion.
• Dismantling Pre-Reform Policies: Abolished high tariffs and tight control over imports that hindered manufacturing sector growth and efficiency.
• Reform Measures (Effective from April 2001):
  • Abolished import licensing (excluding hazardous and environmentally sensitive industries).
  • Removed quantitative restrictions on imports and exports.
  • Reduced tariff rates.
• Objectives:
• • Boost competitive stance of Indian goods in international markets.
  • Foster efficiency and modern technology adoption in local industries.

Privatisation

• Meaning: Privatisation denotes the transition from government ownership or management to private sector control of enterprises. 
• This transition manifests in two primary ways: 
  • By the government relinquishing ownership and management of public sector companies.
  • By the outright sale of such companies.
• Disinvestment is the strategic process through which the government reduces its ownership stake in public sector enterprises by selling shares to either strategic or financial buyers. 
  • This can be achieved through the sale of shares on stock exchanges or by directly selling shares to interested buyers. 
• Approaches to Disinvestment:
  • Minority Disinvestment: The government maintains a majority stake in the company, typically greater than 51%, ensuring that it retains management control.
  • Majority Divestment: Control of the company is transferred to the acquiring entity, but the government retains some stake, allowing for continued involvement.
• Complete Privatisation: The entire 100% control of the company is transferred to the buyer, resulting in complete privatization.
• Disinvestment Process in India: In India, the Department of Investment and Public Asset Management (DIPAM), under the Ministry of Finance, oversees the disinvestment process. 
• National Investment Fund (NIF): To channelize the proceeds from the disinvestment of Central Public Sector Enterprises, the government established the National Investment Fund (NIF) in 2005.
• Benefits of Privatisation
  • Facilitating Foreign Direct Investment (FDI): Privatisation was envisaged as a catalyst for increasing the inflow of Foreign Direct Investment (FDI), thereby contributing to economic growth and modernisation.
  • Enhancing PSU Efficiency through Managerial Autonomy: The government aimed to boost the efficiency of PSUs by granting them managerial autonomy. 
    • This autonomy was manifested through the conferment of special statuses like Maharatnas, Navratnas, and Miniratnas on certain PSUs, empowering them with greater managerial discretion.

Globalization

• Globalization is broadly perceived as the integration of a nation’s economy with the global economy, fostering greater interdependence and integration. 
• It is the ultimate aim of LPG reforms.

Indian Economy During Reforms: An Assessment

• As the reform process in India completes three decades, an assessment of the Indian economy reveals a mixed scenario. 
• Growth is primarily gauged by the Gross Domestic Product (GDP).
• GDP Growth and Sectoral Performance
• Post-1991: India saw a substantial rise in GDP growth, from 5.6% during 1980-91 to 8.2% during 2007-12, mainly driven by the service sector. Refer to table 13.1
• However, the agriculture sector saw a decline in growth, while the industrial sector showed fluctuations.
• Despite a setback in growth rates across sectors during 2012-15, the service sector continued to thrive, notably with a 9.8% growth rate in 2014-15.
• Foreign Investments and Reserves
  • The reform era ushered in a significant increase in foreign direct investment (FDI) and foreign exchange reserves, with FDI and foreign institutional investment (FII) rising from about US $100 million in 1990-91 to US $30 billion in 2017-18.
  • Foreign exchange reserves surged from about US $6 billion in 1990-91 to about US $413 billion in 2018-19 (In October 2021 and , making India one of the largest foreign exchange reserve holders globally.
• Export Dynamics
  • India emerged as a successful exporter of auto parts, pharmaceutical goods, engineering goods, IT software, and textiles post-1991.

Conclusion

• India’s shift from a mixed economy to embracing globalization post-1991 has brought both opportunities and challenges. 
• Key reforms aimed at attracting foreign investment and integrating India with the global economy yielded mixed outcomes. 
• While urban consumers and certain sectors like IT benefited, the agrarian sector and small producers faced hurdles. The chapter underlines the need for a balanced approach to ensure ‘fair globalization’, safeguarding the interests of the less privileged while fostering inclusive growth.