India's Economic Reforms

Why Did Economic Reforms become necessary in India? What were the results of economic reforms? India’s economy, which had been one of the largest in the world till about three hundred years ago, had steadily deteriorated during the period of British Rule which lasted till 1947. The agricultural sector suffered the most which resulted in famines and extreme poverty. The yield per acre was low and there was a persistent threat of drought and flood. There was no efficient irrigation facility. The food production was stagnant or was falling.

There was no industry to manufacture goods and only the textile industry faced the industry manufactured goods from Britain. GDP growth was almost zero. In 1947, after independence Prime Minister Jawaharlal Nehru, highly impressed with the Soviet Model of economic development, added elements of this model into the Mixed Economy model which was to be introduced in India. This included centralised planning. The Socialist Model advocated government intervention to guide the economy, including state ownership of key industries.

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The objective of this strategy was to achieve high and balanced economic development while introducing programs and measures to help the poor. The belief was that industrialisation was the key to economic development. As there were few entrepreneurs capable of bringing in large scale industrialisation and hence introducing a market economy would not be feasible, it was decided that the government would take the initiative to in this regard. Hence it was believed that the Soviet model would be the ideal one to adopt in this regard.

Nehru was also influenced by Socialist thinkers like P C Mahalanobis. Hence this model is also known as Nehruvian – Mahalanobis model. It was this model that India followed for several years up to the 1970s. Economic growth till the 1980s was very low if not negligible. During the period from 1950 to 1970s it is believed that there was a near stagnation of economic growth as a result of the Nehruvian economic model. But a closer look reveals that there was increase in GDP growth over each decade though quite low. There was not mush improvement in the agricultural sector till the late 1960s.

The Soviet model carried the criticism that industrial development is at the cost of agriculture. The agricultural sector’s performance during this period indicated that there may be some truth in this statement. If the green revolution had not taken place, India would have faced a grave crisis in the 1970s. In India, between 1950 and 1990, the proportion GDP contributed by agriculture declined significantly but not the population depending on it. The formation of Planning Commission in 1950 and the five year plans, gave greater importance to agricultural growth and the agricultural sector gained in prominence.

In the 1960s, improved agricultural practices, better seeds and use of fertilizer, soil and water conservation, land development, land consolidation, agricultural credit and marketing and price incentive resulted in improved agricultural productivity and it is the reason why India enjoys relative food security today. Till then growth in the agricultural sector was negligible. There were internal contradictions. India had needed rapid industrialisation along with supporting the poor. Rapid industrialisation required a shift of resources from the agricultural sector to the industrial sector. 0 percent of the population were depended on agriculture and lived in the countryside hence supporting them required directing of resources to the rural economy. It also required government support for smaller labour-intensive farms at the expense of larger capital-intensive industries. Small scale units attracted government support and here the goal was to increase employment since they employed more workers per unit of output and capital. This resulted in discouraging economies of scale and encouraging high cost production. Hence India ended up having inefficient small scale industries and monopolistic large scale industries.

India had one of the most protected economies in Asia and fortified it with policies such as import substitution, high tariff rates, import duties etc. The private sector produced most consumer goods but was controlled directly by several government regulations and financial institutions that provided major financing for large private-sector projects. Government emphasized self-sufficiency rather than foreign trade and imposed strict controls on imports and exports. In the 1950s, there was steady economic growth, but growth in the 1960s and 1970s were less encouraging.

Hence people were forced to pay larger prices for consumer goods. There was a slowdown in the 1970s particularly due to the deceleration of the agricultural growth followed by a recovery in the 1980s. This pick-up was benefitted from the initiation of limited economic reforms introduced in the 1980s aimed at increasing the domestic competitiveness. There was high rate of industrial growth as result of the new policies which encouraged industry growth rate hence was higher and about 5. 5%. But when compared to China which introduced economic reforms as early as in 1978, India’s growth rate was low.

India’s private industry started depending on short term loan from foreign agencies for their long term projects. They were encouraged by the new policies of the government. These loans had a maturity period averaging about 5 years. India’s foreign exchange reserves were not very high. Since 1985 there was Balance Of Payment (BOP) problems and by the end of 1990, India was in a serious economic crisis. In the year 1991, towards the middle of the year, India’s exchange rate was subjected to a severe adjustment. This event began with a slide in the value of the rupee leading up to the middle of the year 1991.

The authorities at the Reserve Bank of India slowed the decline in value by expending foreign exchange reserves. With reserves nearly depleted, however, the exchange rate was devalued sharply on July 1 and July 3 against major foreign currencies. There was a huge demand on India’s foreign exchange reserves due to the maturity of international loans. Also precipitated by the gulf war India’s oil import bill swelled, the exports went down, credit dried up and investors pulled out their money. Over time, fiscal deficits had a spill over effect on trade deficit resulting in an external payments crisis.

Add to this the collapse of the Soviet Union and the new Russian state under Boris Yeltsin started demanding repayment of all the loans. Since the fiscal deficit was met by borrowings, internal debt of the government accumulated rapidly reaching 53% of GDP at the end of 1990-91. Foreign exchange reserves had dried up. By the end of 1990, India was facing a grave economic crisis. The government had to secure an emergency loan of $2. 2 billion from the IMF by pledging 67 tons of India’s gold reserves as collateral. This helped tide over the crisis and also provided the stimulus for India’s economic reforms.

Introduction of economic reforms and its impact In 1991, the new administration led by Narasimha Rao came to power . Dr. Manmohan Singh was appointed as finance minister. Dr. Singh (who is now the prime minister) unveiled a comprehensive program of economic reforms, which includes: * Recognizing the importance of the private sector as a leading engine of growth. * Greater reliance on market forces and competition as the primary means of increasing efficiency. * Opening the economy to international trade, foreign investment, and foreign technology. Economic reforms meant many things.

It meant the lowering most tariff and non-tariff barriers to promote the trade of goods and services; it meant liberalizing many legal procedures related to investment, corporate taxation, trade, commercial banking, stock market activity and most importantly the recruitment and layoff of labour; it meant the disinvestment of public assets like public sector units; it meant paying special attention to the balancing of the budget or at least making some serious efforts at reducing the government budget deficit; it meant the gradual entry of foreign capital into the Indian economy (both as FDI as well as portfolio investment); it meant a gradual retreat of the government from the provision of social services like health and education and also meant the simultaneous encouragement of private capital to enter into these areas and many more similar changes. Growth (%) With economic reforms being introduced, economic growth accelerated. The economic reforms have put emphasis on the open market economic policies.

The reform process has had some very beneficial effects on the Indian economy, including higher growth rates, lower inflation, and significant increases in foreign investment. Industrial growth was very high during the period 1992-97 in the enthusiasm of reforms. However, there was a significant slowdown during 1997-2002. As tariffs were reduced, import controls were lifted, and domestic competitive threats emerged at the same time, the initial protective effects of the devaluation of 1991 wore off and the Indian corporate sector, particularly in manufacturing, found itself in difficulty. The Indian corporate sector was therefore in the throes of significant technical restructuring, business process restructuring and financial restructuring, all at the same time.

Though this process resulted in an industrial slowdown then, it has contributed to the industrial competitiveness that is now observed. There is a revival of manufacturing. Trade liberalisation and tariff reforms have provided increased access to Indian companies to the best inputs available globally at almost world prices. On the other hand, the gradual opening has enabled Indian companies to adjust adequately to be able to compete in world markets and with imports in the domestic economy. Indian Industry very soon adapted to the changes restructuring itself to meet the new challenges. Technology transfer and exposure from foreign nations improved the competiveness of the Indian industry.

Foreign investments have come in various sectors and there has been a good growth in the standard of living, per capital income and Gross Domestic Product. The manufacturing sector is growing at a heartening rate. But it is the services sector which has shown the greatest growth and it grew in such a way that it now contributes more that 50% of India’s GDP. Software services along with the export of products is growing at a massive pace and thereby witnessed an unprecedented rise of 35. 5 percent and reached an amount of $ 18 billion in the period 2006-07. The Information Technology Enabled Services (ITES) and Business Process Outsourcing (BPO) sectors grew by 33. 5 percent and earned a revenue of $8. 4 billion. The service sector has also been focusing in various investments of late.

As more liberalisation is being expected in the India economy, sectors like banking are on its way to loom large and occupy a more significant position in India’s economy. Along with the high rates of growth, employment opportunities have also increased. India is now a preferred destination for Foreign Direct Investments (FDI). India is now strong in telecommunication, Information Technology and other significant areas such as automobiles, auto components, chemicals, apparels, pharmaceuticals, and jewellery. Savings and investment rates have also dramatically increased. Imports and exports have increased considerably. India’s foreign exchange reserves now stand at about $295 billion.

The growth rate now stands at about 8% and is stated to reach 10% and above in the next few years. Indian economy is now the eleventh largest in the world by nominal GDP and fourth largest by Purchasing Power Parity (PPP). Top 10 economies as of 2001| GDP PPP (International Billion dollars)| | 2001| 1980| | GDP| Rank| GDP| Rank| USA| 9792| 1| 2957| 1| China | 5111| 2| 421| 9| Japan| 3193| 3| 1085| 2| India | 2930| 4| 529| 5| Germany | 2057| 5| 803| 3| Italy | 1430| 6| 544| 4| UK | 1420| 7| 498| 7| France | 1420| 8| 518| 6| Brazil | 1269| 9| 467| 8| Canada| 843| 10| 274| 11| Select Indicators of India’s progress| | | | | | |

Year| Per Capita Income (at 1993-94 prices in Rs)| Poverty (%)| Literacy (%)| Life Expectancy (Years)| Power Capacity (MW)| 1951| 3,687| 45| 18| 32| 1,362| 1961| 4,429| 45| 28| 41| 4,653| 1971| 5,002| 52| 34| 46| 14,709| 1981| 5,352| 43| 44| 50| 30,214| 1991| 7,321| 35| 52| 59| 64,000| 2001| 10,308| 26| 65| 65| 1,02,000| 2005| 12,414| 20| 68| 67| 1,18,419| The poverty rate has consistently declined. But this decline has not been accompanied by an improvement in the measures of social well-being. Inequality has increased during the post-reform period. There is a general feeling that the rich is getting richer while the poor are getting poorer.

The rich-poor gap is growing and immediate steps have to be taken to address this problem. The situation of 80% of the nation’s wealth being in the hands of 20% of the population should be rectified and more equitable distribution ensured. Inclusive growth is the key to sustainable economic development. The post-reform period has not seen much efforts directed in this regard. Hence more efforts have to be made to ensure inclusive growth. Inflation has reached record levels during the post reform period, especially food inflation which is going up to alarming levels. While the service sector showed high growth, agriculture has witnessed stagnation in growth.

In recent years the agricultural sector is showing declining levels of growth which needs to be taken seriously. Productivity is coming down. Irrigation and other facilities have not improved and there is still a dependence on the monsoons. Even the economy’s performance is still dependent on the monsoons which should throw light on the importance of the agricultural sector. Improved agricultural performance is not only important for sustaining economic growth but also for maintaining low and stable inflation levels. Volatile agricultural production and lower food stocks internationally are beginning to raise growing concerns about rising food prices influencing overall inflation both globally and in India.

In the medium term, therefore, efforts would have to be directed towards not only improving the crop yields but also putting in place a market driven incentive system for agricultural crops for a practical solution to address the demand-supply mismatches and tackle food inflation. Sustained improvement in crop yields requires an enhanced focus on the revitalisation of agricultural research, developmental extension. Food security is an essential factor for the sustained development of an emerging economy like India. Hence the government should take the necessary steps in this regard to revive the agricultural sector which is now contributing about 18% of India’s GDP.

The government must take all necessary steps to ensure that the impressive growth that we are now witnessing since the introduction of economic reforms is reaching down to all sections of the society including the poor. As of now growth has not led to equality. This problem should be addressed as soon as possible. Since many of the unfavourable factors both internal and external have now either gone or significant reduced, India should try to improve its efficiency in utilising its resources to realise its full potential in order to make a significant impact on poverty reduction, realise inclusive growth thereby ensuring sustained economic development.