Economic reforms (New economic policy) 1991

Economic policy adopted by the government of India since 1991 is known as NEP.

Need for Economic reforms

To overcome economic crisis, the NEP was required. Following are certain reasons which aroused
the need for making economic reforms in the country.
1. Rise in fiscal deficit: Fiscal deficit refers to a situation when the government expenditure exceeds
government revenue .This is due to increase in non-development expenditure and non-plan
expenditure therefore economic reforms was needed to increase government revenue to meet the
challenges like unemployment, poverty and population explosion.
2. Adverse Balance of payment: It is a situation when outflow is greater than inflow of foreign
exchange. This is due to the fact that imports were more due to heavy tariffs and quotas while
exports were less due to poor quality of domestic goods.
3. Rise in price/Inflation: Inflation refers to a continuous rise in price or it is a consistent rise in
general price level. Inflation is caused due to deficit financing which is the printing of new
currencies which leads to an increase in money supply and if aggregate supply cannot increase at the
same rate as aggregate demand, price are bound to rise.
4. Fall in foreign exchange reserves: Foreign exchange reserves are the reserves of foreign assets like
foreign currencies, foreign securities etc. The FER fell to a lowest level. India was not in a position
to pay import bills even for 15 days. It was also unable to pay interest to other countries for debts and
also no country or international funder was willing to lend to India.
5. Poor performance of Public Sector undertakings: PSU’s are those enterprises which are wholly
owned by government. In 1951 there were 5 enterprises in public sector in India but in 1991 the
number rose to 232.government had invested crores of rupees in these enterprise yet overall
performance was disappointing due to political interference, high level of corruption and inefficient
management.
6. Inefficient management: The origin of financial crisis can be traced from the inefficient
management of the Indian economy. Government expenditure constantly exceeds its revenue. Due to
inefficient management the rules and laws which aimed at controlling and regulating the economy
ended up in hampering the process of growth and development hence this led to the need for
economic reforms.

New Economic Policy

India approached the International Bank for Reconstruction and Development (IBRD) popularly
known as World Bank and International Monetary Fund (IMF) and received 7 million dollar as loan to
manage the crisis. For availing the loan, these international agencies expected India to liberalise and open up
the economy by removing restrictions on the private sector, reduce the role of the government in many areas
and remove trade restrictions between India and other countries. India agreed to the conditions of the World
Bank and IMF.
In order to overcome the economic crisis and to accelerate the pace of economic growth, India
announced the New Economic Policy in July 1991.The government initiated a variety of policies also known
as the elements of New Economic Policy that is Liberalisation, Privatisation and Globalisation.

I. Liberalisation
It is any process whereby a state lifts restrictions on some private individual activities. Liberalisation
occurs when something which used to be banned is no longer banned or when government regulations are
relaxed.
The following reforms were initiated under Liberalisation-
1. Industrial Sector Reforms: According to NEP, Industrial licensing was abolished for almost all
products except for some industries which are of strategic importance for a nation like alcohol,
cigarettes, hazardous chemicals, industrial explosives, aerospace, drugs and pharmaceuticals. It was
also felt that government cannot control everything so the number of industries reserved for the

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 public sector has been reduced from 17 to 3 which include only defence equipment, atomic energy
generation and railway transport.
2. Financial Sector Reforms: Prior to 1991, private sector banks were not encouraged as public sector
was given more importance in government policies. But the NEP led to the establishment of a private
sector banks which increase the size of completion and provided better services to the consumers.
Also, prior to 1991, foreign investment in Indian financial markets was restricted but with the reform
policies foreign countries or foreign institutional investors (FII) are allowed to invest in Indian
financial markets.
3. Fiscal or Tax Reforms: Prior to 1991 there was a continuous increase in the rate of direct taxes
which was responsible for tax evasion. It is widely accepted that moderate rates of income tax
encourage savings and voluntary disclosure of income. The rate of corporate tax has also been
gradually reduced. Also recently, the parliament passed a law GST Act 2016 to simplify and
introduce a unified Indirect tax system in India. This law came into effect from July 2017. This is
expected to generate additional revenue for the government, reduce tax evasion and create one
nation, one tax and one market.
4. Foreign Exchange Reforms: Prior to 1991, India faced an adverse balance of payment where
outflow of foreign exchange is greater than the inflow of foreign exchange. However, the NEP
brought about devaluation of rupee which means that there is reduction in the value of domestic
currency in relation to foreign currency by the government. This encourages export and discourages
imports which therefore led to the increase in the inflow of foreign exchange. Also, earlier the
determination of Foreign Exchange Rate (FER) was controlled by the government but now the
government allowed market forces to determine FER.
5. Trade and Investment Policy Reforms: Prior to 1991, India followed a policy of quantitative
restrictions on import and export by keeping the tariffs very high. But now, Liberalisation aimed at
removing restrictions on all items of imports expect in case of hazardous and environmentally
sensitive industries. The peak tariff rates have been brought down from 355% to 50% to enhance the
domestic trade i.e. to promote the efficiency of the local industries and the adoption of modern
technologies.

II. Privatisation
Privatisation refers to the transfer of ownership, management and control of government sector
enterprises to the private sector. Privatisation of the public sector undertakings (PSU’s) or public sector
enterprises (PSE’s) or the selling off part of the equity of the public sector to the private sector is known as
Disinvestment. It is done to improve efficiency and to increase competitiveness of the private sector. The
purpose of privatisation is to improve financial discipline and facilitate modernisation by encouraging
private sector to invest and participate in economic development with their administrative efficiency.

Positive impact or advantages of Privatisation: Privatisation increases the Foreign Direct Investment
(FDI) because of expanded domestic market. It targeted that private capital and managerial capabilities
could be effectively utilised to improve the performance. This would further encourage competitiveness in
domestic as well as international markets. Also, privatisation aims to satisfy the unlimited wants of the
consumers in order to create a market for production. This will result in diversification and expansion of
production and also promotes consumer’s sovereignty. Privatisation also supports managerial efficiency as
entrepreneurs will be free to make quick decision without the interference of the government.

Negative impact or disadvantages of Privatisation: Private sector functions mainly with the objective of
profit maximisation which may be done at the cost of social welfare of people and may even cause
consequent unemployment. Thus, socialistic pattern of society may just be a dream reality as social interest
is not the primary objective of the private sector.
Privatisation also functions on the basis of market mechanism. When price rises, the demand by those
who cannot pay this price will fall. If it continues, this may become a major problem of inflation. If inflation
is not controlled, it may affect the majority adversely. Privatisation if remains uncontrolled may turn into
monopoly, where private owners may have monopoly control over the market. This situation may also be
characterised by concentration of power in few hands.
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 III. Globalisation
Globalisation is the outcome of the policies of Liberalisation and Privatisation. Globalisation aims at
turning the world into one whole or creating a borderless world. It is complex phenomenon. Globalisation
refers to free interaction among all the countries of the world in various fields like trade, technology, loans,
investment, outsourcing, etc.
- Outsourcing means obtaining goods and services by contract from an outside source. With the
growth of information technology (IT), outsourcing has acquired an international dimension and it
has intensified in recent times. The main service which are being outsourced from India by
developed countries are: Voice Based business processes (known as BPO or call centers), banking
services, railway inquiry, record keeping, accountancy, music recording, etc.

Positive Impact of Globalisation

Points in favour of Globalisation are:
1. Globalisation has been able to establish links in such a way that the happenings (advancement) in
India can be influenced by events happening miles away (rest of the world).
2. It has been able to turn the world into one whole or creating a borderless world as it provides easy
access to global markets.
3. It should be seen as an opportunity in terms of greater access to global markets and increased
possibility of large industries of developing countries to become important players in the
international arena.

Negative Impact of Globalisation

Points against globalisation are:
1. Globalisation is the strategy of the developed countries to expand their markets in other countries.
2. It has widened the economic disparities among nations and people.
3. It has also compromised the welfare and identity of the people belonging to poor countries.

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