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Before 1991 Economic Reform

Since independence, India followed the mixed economy framework by combining the advantages of the capitalist economic system with those of the socialist economic system.

Some scholars argue that, over the years, this policy resulted in the establishment of a variety of rules and laws, which were aimed at controlling and regulating the economy, ended up instead in hampering the process of growth and development.

Others state that India, which started its developmental path from near stagnation, has since been able to achieve growth in savings, developed a diversified industrial sector which produces a variety of goods and has experienced sustained expansion of agricultural output which has ensured food security.

In 1991, India met with an economic crisis relating to its external debt —

  the government was not able to make repayments on its borrowings from abroad;

  foreign exchange reserves, which we generally maintain to import petrol and other important items, dropped to levels that were not sufficient for even a fortnight;

  The crisis was further compounded by rising prices of essential goods.

All these led the government to introduce a new set of policy measures which changed the direction of our developmental strategies.

BACKGROUND (Reasons for economic crisis and need for new set of policy measures)

The origin of the financial crisis can be traced from the inefficient management of the Indian economy in the 1980s. Government’s expenditure was more than its income.

What happens when expenditure is more than income?

  Government borrows to finance the deficit from banks and also from people within the country and from international financial institutions.

  Government had to overshoot its revenue to meet problems like unemployment, poverty and population explosion (revenues were very low; no chance of generating immediate returns)No generation of additional revenue even via taxation.

  Income from public sector undertakingswas not very high to meet the growing expenditure.

  Government borrowed foreign exchange  Spent on meeting consumption needs. Government neither made any attempt to reduce such profligate spending nor sufficient attention was given to boost exports to pay for the growing imports.

 

In the late 1980s,

  Government expenditure began to exceed its revenue by such large margins that meeting the expenditure through borrowings became unsustainable.

  There was sharp rise in the prices of many essential goods.

  Imports grew at a very high rate without matching growth of exports.

  Foreign exchange reserves declined to a level that was not adequate to finance imports for more

than two weeks.

  No sufficient foreign exchange to pay the interest that needs to be paid to international lenders.

India took a step…

India approached the International Bank for Reconstruction and Development (IBRD)—World Bank and the International Monetary Fund (IMF) and received $7 billion as loan to manage the crisis.

How to avail the loan?

International agencies expected India to liberalize and open up the economy by

  Removing restrictions on the private sector

  Reducing the role of the government in many areas

  Removing trade restrictions

 

What did India do?

India agreed to the conditionality’s of World Bank and IMF—announced the New Economic Policy (NEP) – which consisted of wide ranging economic reforms, such as:

  Creating a more competitive environment in the economy by removing the barriers to entry and growth of firms;

  Introduced liberalization with a view to integrate the Indian economy with the world economy;

  to remove restrictions on direct foreign investment as also to free the domestic entrepreneur from the restrictions of Monopolies and Restrictive Trade Practices (MRTP) Act;

  to unshackle the Indian industrial economy from the cobwebs of unnecessary bureaucratic controls;

  to shed the load of public sector enterprises which have shown a very low rate of return or which were incurring losses over the years.

The government initiated a variety of policies which fall under three heads: viz., liberalisation, privatisation and globalisation.

 

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