Context: Thirty years ago, the liberalization regime launched in 1991 completed its 30 years in 2021. 

  • A severe balance of payments problem triggered an acute economic crisis that year. 
  • Three decades later, the pandemic-induced lockdown brought the wheels of economic activity to a grinding halt, triggering a sharp economic contraction in the first half of the fiscal year. 

The main features of the control system before the 1991 reforms 

  • The private sector was not allowed to invest in a number of sectors thought to be critical for development. 
  • The “commanding heights” were reserved for the public sector despite its lacklustre performance. 
    • It was India's first Prime Minister Jawaharlal Nehru, inspired by the then Soviet Union-pioneered model of state sponsored growth, who mooted the idea of placing the government—and within it the state-owned and state-run PSUs—as the commanding heights of the Indian economy.
  • License raj: Where the private sector was allowed, it could invest only after getting an industrial licence, and that was especially hard to get for “large” industrial houses. 
    • Over 860 items were reserved exclusively for small-scale producers, including many that had very high export potential. 
  • Imports were more strictly controlled than in almost any other developing country because it was felt necessary to conserve scarce foreign exchange. 
  • Consumer goods could not be imported so domestic producers faced no import competition. 
  • Producers could import capital goods and intermediates needed for production, but this generally required an import licence. 
    • This was given only if the government was satisfied that the import was essential and domestic substitutes were not available.
  • Finally, the import of technology was controlled and Foreign Direct Investment (FDI) was discouraged.

Salient features of 1991 reforms: 

  • LPG reforms: India's New Economic Policy was announced on July 24, 1991 known as the LPG or Liberalisation, Privatisation and Globalisation model. 
    • Liberalization- It refers to the process of making policies less constraining of economic activity and also reduction of tariff or removal of non-tariff barriers.
    • Except for 18 controlled industries, licenses were abolished across the board
    • Industrialists were free to enter any sector and expand capacities without govt.’s approvals. 
    • Foreign ownership, hitherto restricted to 40%, was taken above the critical threshold of 51%. 
    • The monopolies law was abolished. 
    • The state was allowed to sell public sector.

Significance of 1991 reforms

India’s post-1990 economic strategy entailed three important breaks with the past. 

  • One was to dismantle the vast network of controls and permits that dominated the economic system. 
  • The second was to redefine the role of the state as a facilitator of economic transactions and as a neutral regulator rather than the primary provider of goods and services. 
  • The third was to move away from a regime of import substitution and to integrate fully with the global trading system.
  • Liberalization was adopted as the guiding principle of governance and all governments since 1991, including the current one, have broadly stuck to that path.

Key outcomes of 1991 reforms

  • The GDP growth averaged 7% in the 25 years from 1992 to 2017, compared with an average of 5% in the preceding ten years and 4% in the preceding 20! 
  • And as growth accelerated, poverty declined. Between 2004-05 and 2011-12, the last year for which official data on poverty are available, about 140 million people were pulled above the poverty line. 
  • Increase in employment: There was a fall in employment in agriculture, which is a desirable structural shift of labour out of agriculture. 
    • But it was accompanied by sufficient growth in total employment in non-agriculture sectors, so that the labour displaced from agriculture was absorbed in non-agriculture. 

Criticism of 1991 reforms:

  • India is still at the lower end of the middle-income group of countries and many more reforms are needed to get to the top of the group.
  • The 1991 reforms package faced heavy criticism as being dictated by the International Monetary Fund (IMF) and World Bank. 
  • Some of the reforms were criticized as a sellout to capitalists.
  • Employment in manufacturing did not increase: This was because we were not able to replicate the East Asian experience of rapid growth in the export of labour-intensive manufactures. 
  • Most of the increase in employment was not regular contractual employment but informal non-contractual employment. It is possible that rigid labour laws were at least partly responsible.

1991 crisis Vs 2021 crisis

  • 1991 crisis: Reducing the fiscal deficit was essential in 1991 because the crisis was caused by excess domestic demand sucking in imports and widening the current account deficit (CAD).
    • A loss of confidence triggered an outflow of funds and financing CAD forced a sharp drawdown in reserves. 
    • Reducing the fiscal deficit was an obvious way of containing demand.
    • The 1991 strategy had two components — reducing the fiscal deficit and implementing structural reforms. Both are relevant today, but with differences.
  • 2021 crisis: The crisis today is not caused by excess demand
    • It has been triggered by a collapse in production following the disruption caused by the pandemic, which, in turn, has caused a fall in demand. 
    • Investment, a key source of aggregate demand, has also slowed because of unutilised capacity and uncertainty about growth.
    • Job crisis: The substantial slowdown in GDP growth after 2016-17 led to employment actually falling from 474 million in 2011-12 to 469 million in 2018-19. 
    • Employment in agriculture continued to decline, but non-agricultural employment grew much more slowly. 
    • The COVID-19 pandemic has of course triggered a collapse in employment. 
    • Decline in investment: There is a decline in the gross fixed capital formation (GFCF) rate, which has fallen from 29% of GDP in 2018-19 to 24.2% in 2020-21. 

Way forward:

Past experience shows that we need to get back to 7% to 8% growth if we want to make progress on poverty reduction and provide enough jobs for our growing labour force.

  • The priority now must be to get the vaccination coverage expanded as soon as possible. This will create conditions conducive to a return to normalcy. 
  • Growth should become the top priority now, for the finance ministry and for the entire government.
    • While it is desirable that the fiscal deficit be brought down, the scope for it is limited in 2021-22. It could still be around 7% of GDP. 
    • Going forward, a new map for fiscal consolidation must be drawn up.
  • ‘Maruti Model Of Disinvestment’: The govt should be giving up 26% in each public sector undertaking, including banks, to strategic partners, followed by a hugely profitable ‘exit from control’.
    • The Government of India was the majority shareholder in Maruti Udyog Ltd., but Suzuki exercised control even though Suzuki owned only 26% in the unlisted company.
  • The government will need to step up public investments to boost growth. In a developing economy, growth is sustained only by investment. 
    • A proper climate for investment must be created: Changes in corporate tax rates announced some months ago will help once growth starts picking up.
    • The policy framework must be supportive of fresh investments so that entrepreneurs are encouraged to take risks. 
    • Non-economic factors such as a peaceful environment and social cohesion are also relevant. The government must begin to act on all these fronts.
  • Duty rates: The NITI Aayog had recommended that we should move to an average duty rate of about 7%, gradually narrowing the range of variation across products and eliminating duty reversals. This is the right approach.
  • Another important lesson from 1991 is that we need to move away from a “long list of reforms” approach towards a more strategic approach, focussing on the most critical reforms needed immediately.
    • The 1991 reforms succeeded because they were structured around a core package of mutually supportive reforms.
  • Bank reforms: Vesting the government’s equity in PSBs into a holding corporation run by a board of independent professionals, which then appoints the top management, would be a serious reform. It was recommended by the PJ Nayak committee in 2015. 
  • GST reforms: GST is a major reform and it was expected to generate greater tax buoyancy. It has not done so. 
    • Its rate structure and exclusions need to be reviewed. 
    • An important lesson from 1991 is that tax reforms are best evolved by an expert group outside government. 
    • Such a group should be set up and asked to review the experience so far, and make proposals for reform which could be discussed in the GST Council. This cannot be left to the revenue department.

The 1991 reforms helped the economy stave off a crisis and then bloom. It is time to outline a credible new reform agenda that will not just bring GDP back to pre-crisis levels, but also ensure growth rates higher than it had when it entered the pandemic.