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ECONOMIC REFORMS: LPG POLICY | Indian Economic Development | Class 12


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.


  • The origin of the financial crisis can be traced from the inefficient management of the Indian economy in the 1980s.

  • We know that for implementing various policies and its general administration, the government generates funds from various sources such as taxation, running of public sector enterprises etc.

  • When expenditure is more than income, the government borrows to finance the deficit from banks and also from people within the country and from international financial institutions.

  • When we import goods like petroleum, we pay in dollars which we earn from our exports.

  • Development policies required that even though the revenues were very low, the government had to overshoot its revenue to meet challenges like unemployment, poverty and population explosion.

  • The continued spending on development programmes of the government did not generate additional revenue. Moreover, the government was not able to generate sufficiently from internal sources such as taxation.

  • When the government was spending a large share of its income on areas which do not provide immediate returns such as the social sector and defense, there was a need to utilize the rest of its revenue in a highly efficient manner.

  • The income from public sector undertakings was also not very high to meet the growing expenditure. At times, our foreign exchange, borrowed from other countries and international financial institutions, was spent on meeting consumption needs.

  • Neither was an attempt made 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.

  • Prices of many essential goods rose sharply. 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. There was also not sufficient foreign exchange to pay the interest that needs to be paid to international lenders.

  • Also no country or international funder was willing to lend to India.

  • India approached the International Bank for Reconstruction andDevelopment(IBRD), popularly known as World Bank and theInternational Monetary Fund(IMF), and received $7 billion as loan to manage the crisis.

  • For availing the loan, these international agencies expected India to liberalize 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 World Bank and IMF and announced the New Economic Policy(NEP).

The New Economic Policy

The NEP consisted of wide ranging economic reforms. The thrust of the policies was towards creating a more competitive environment in the economy and removing the barriers to entry and growth of firms.

This set of policies can broadly be classified into two groups:

  • Stabilization measures : Stabilization measures are short-term measures, intended to correct some of the weaknesses that have developed in thebalance of payments and to bring inflation under control.

In simple words, this means that there was a need to maintain sufficient foreign exchange reserves and keep the rising prices under control.

  • Structural Reforms: Structural reform policies are long-term measures, aimed at improving the efficiency of the economy and increasing its international competitiveness by removing the rigidities in various segments of the Indian economy. The government initiated a variety of policies which fall under three heads viz., liberalization, privatization and globalization.


As pointed out in the beginning, rules and laws which were aimed at regulating the economic activities became major hindrances in growth and development. Liberalization was introduced to put an end to these restrictions and open up various sectors of the economy.

Though a few liberalisation measures were introduced in 1980s in areas of industrial licensing, export-import policy, technology upgradation, fiscal policy and foreign investment, reform policies initiated in 1991 were more comprehensive.

A. Deregulation of Industrial Sector:

In India, regulatory mechanisms were enforced in various ways:

  1. Industrial licensing under which every entrepreneur had to get permission from government officials to start a firm, close a firm or to decide the amount of goods that could be produced

  2. Private sector was not allowed in many industries

  3. Some goods could be produced only in small scale industries and

  4. Controls on price fixation and distribution of selected industrial products.

The reform policies introduced in and after 1991 removed many of these restrictions. Industrial licensing was abolished for almost all but product categories alcohol, cigarettes, hazardous chemicals, industrial explosives, electronics, aerospace and drugs and pharmaceuticals.

The only industries which are now reserved for the public sector are defence equipments, atomic energy generation and railway transport. Many goods produced by small scale industries have now been de-reserved. In many industries, the market has been allowed to determine the prices.

B. Financial Sector Reforms:

Financial sector includes financial institutions such as commercial banks, investment banks, stock exchange operations and foreign exchange market. The financial sector in India is regulated by the Reserve Bank of India (RBI).

The RBI decides the amount of money that the banks can keep with themselves, fixes interest rates, nature of lending to various sectors etc.

  • One of the major aims of financial sector reforms is to reduce the role of RBI from regulator to facilitator of financial sector. This means that the financial sector may be allowed to take decisions on many matters without consulting the RBI.

  • The reform policies led to the establishment of private sector banks, Indian as well as foreign.

  • Foreign investment limit in banks was raised to around 50 %.

  • Those banks which fulfil certain conditions have been given freedom to set up new branches without the approval of the RBI and rationalise their existing branch networks.

  • Though banks have been given permission to generate resources from India and abroad, certain managerial aspects have been retained with the RBI to safeguard the interests of the account-holders and the nation.

  • Foreign Institutional Investors(FII) such as merchant bankers, mutual funds and pension funds are now allowed to invest in Indian financial markets.

C. Tax Reforms:

  • Tax reforms are concerned with the reforms in governments taxation and public expenditure policies which are collectively known as its fiscal policy.

  • There are two types of taxes: direct and indirect.

  • Direct taxes consist of taxes on incomes of individuals as well as profits of business enterprises.

  • Since 1991, there has been a continuous reduction in the taxes on individual incomes as it was felt that high rates of income tax were an important reason for tax evasion.

  • It is now widely accepted that moderate rates of income tax encourage savings and voluntary disclosure of income. The rate of corporation tax, which was very high earlier, has been gradually reduced.

  • Efforts have also been made to reform the indirect taxes, taxes levied on commodities, in order to facilitate the establishment of a common national market for goods and commodities (GST recently)

  • Another component of reforms in this area is simplification. In order to encourage better compliance on the part of taxpayers many procedures have been simplified and the rates also substantially lowered.

  • Recently Indian Parliament Passed a law Goods and Services Tax Act 2016 to simplify and introduce a unified indirect tax system in India.

D. Foreign Exchange Reforms:

  • The first important reform in the external sector was made in the foreign exchange market. In 1991, as an immediate measure to resolve the balance of payments crisis, the rupee was devalued against foreign currencies.

  • This led to an increase in the inflow of foreign exchange.

  • It also set the tone to free the determination of rupee value in the foreign exchange market from government control.

  • Now, more often than not, markets determine exchange rates based on the demand and supply of foreign exchange.

E. Trade and Investment Policy Reforms:

Liberalization of trade and investment regime was initiated to increase international competitiveness of industrial production and also foreign investments and technology into the economy.

The aim was also to promote the efficiency of the local industries and the adoption of modern technologies.

In order to protect domestic industries, India was following a regime of quantitative restrictions on imports. This was encouraged through tight control over imports and by keeping the tariffs very high.

These policies reduced efficiency and competitiveness which led to slow growth of the manufacturing sector.

The trade policy reforms aimed at:

  1. Dismantling of quantitative restrictions on imports and exports

  2. Reduction of tariff rates and

  3. Removal of licensing procedures for imports.

  • Import licensing was abolished except in case of hazardous and environmentally sensitive industries.

  • Quantitative restrictions on imports of manufactured consumer goods and agricultural products were also fully removed from April 2001.

  • Export duties have been removed to increase the competitive position of Indian goods in the international markets.


It implies shedding of the ownership or management of a government owned enterprise.

Government companies are converted into private companies in two ways:

  1. by withdrawal of the government from ownership and management of public sector companies and or

  2. by outright sale of public sector companies.

Privatisation of the public sector enterprises by selling off part of the equity of PSEs to the public is known as disinvestment.

The purpose of the sale, according to the government, was mainly to improve financial discipline and facilitate modernisation.

It was also envisaged that private capital and managerial capabilities could be effectively utilised to improve the performance of the PSUs. The government envisaged that privatisation could provide strong push to the inflow of FDI.

The government has also made attempts to improve the efficiency of PSUs by giving them autonomy in taking managerial decisions.


Although globalisation is generally understood to mean integration of the economy of the country with the world economy, it is a complex phenomenon.

It is an outcome of the set of various policies that are aimed at transforming the world towards greater interdependence and integration. It involves creation of networks and activities transcending economic, social and geographical boundaries.

Globalisation attempts to establish links in such a way that the happenings in India can be influenced by events happening miles away. It is turning the world into one whole or creating a borderless world.


Outsourcing is one of the important outcomes of the globalisation process. In outsourcing, a company hires regular service from external sources, mostly from other countries, which was previously provided internally or from within the country (like legal advice, computer service, advertisement, security each provided by respective departments of the company).

As a form of economic activity, outsourcing has intensified, in recent times, because of the growth of fast modes of communication, particularly the growth of Information Technology (IT).

Many of the services such as voice-based business processes (popularly known as BPO or call centres), record keeping, accountancy, banking services, music recording, film editing, book transcription, clinical advice or even teaching are being outsourced by companies in developed countries to India.

With the help of modern telecommunication links including the Internet, the text, voice and visual data in respect of these services is digitised and transmitted in real time over continents and national boundaries.

Most multinational corporations, and even small companies, are outsourcing their services to India where they can be availed at a cheaper cost with reasonable degree of skill and accuracy.

The low wage rates and availability of skilled manpower in India have made it a destination for global outsourcing in the post-reform period.

World Trade Organisation (WTO)

The WTO was founded in 1995 as the successor organisation to the General

What is "Agreement on Trade and Tariff (GATT)"?

GATT was established in 1948 with 23 countries as the global trade organisation to administer all multilateral trade agreements by providing equal opportunities to all countries in the international market for trading purposes.

WTO is expected to establish a rule-based trading regime in which nations cannot place arbitrary restrictions on trade.

In addition, its purpose is also to enlarge production and trade of services, to ensure optimum utilisation of world resources and to protect the environment.

The WTO agreements cover trade in goods as well as services to facilitate international trade (bilateral and multilateral) through removal of tariff as well as nontariff barriers and providing greater market access to all member countries.

As an important member of WTO, India has been in the forefront of framing fair global rules, regulations and safeguards and advocating the interests of the developing world.

India has kept its commitments towards liberalization of trade, made in the WTO, by removing quantitative restrictions on imports and reducing tariff rates.

Indian Economy During Reforms: An Assessment

In economics, growth of an economy is measured by the Gross Domestic Product.

The growth of GDP increased from 5.6 % during 1980-91 to 8.2 % during 2007-1012. During the reform period, the growth of agriculture has declined. While the industrial sectors reported fluctuation, the growth of service sector has gone up. This indicates that the growth is mainly driven by the growth in the service sector.

The Twelfth Plan (2012-2017) envisaged the GDP growth rate at 9 or 9.5 %. In order to achieve such a high growth rate, the agriculture, industrial and service sectors have to grow at the rates of 4 to 4.2, 9.6 to 10.9 and 10 percentage points, respectively.

  • However, some scholars raise apprehensions over the projection of such high rates of growth as unsustainable.

  • The opening up of the economy has led to rapid increase in foreign direct investment and foreign exchange reserves. The foreign investment, which includes foreign direct investment(FDI) and foreign institutional investment(FII), has increased from about US

$100 million in 1990-91 to US $ 73.5 billion in 2014-15.

  • There has been an increase in the foreign exchange reserves from about US$ 6 billion in 1990-91 to about US $420 billion in 2019. India is one of the largest foreign exchange reserve holders in the world.

  • India is seen as a successful exporter of auto parts, engineering goods, IT software and textiles in the reform period. Rising prices have also been kept under control.

  • On the other hand, the reform process has been widely criticised for not being able to address some of the basic problems facing our economy especially in the areas of employment, agriculture, industry, infrastructure development and fiscal management.

  • Though the GDP growth rate has increased in the reform period, scholars point out that the reform-led growth has not generated sufficient employment opportunities in the country.

Reforms in Agriculture

  • Reforms have not been able to benefit agriculture, where the growth rate has been decelerating.

  • Public investment in agriculture sector especially in infrastructure, which includes irrigation, power, roads, market linkages and research and extension (which played a crucial role in the Green Revolution), has fallen in the reform period.

  • Further, the removal of fertiliser subsidy has led to increase in the cost of production, which has severely affected the small and marginal farmers.

  • This sector has been experiencing a number of policy changes such as reduction in import duties on agricultural products, removal of minimum support price and lifting of quantitative restrictions on agricultural products; these have adversely affected Indian farmers as they now have to face increased international competition.

Moreover, because of export- oriented policy strategies in agriculture, there has been a shift from production for the domestic market towards production for the export market focusing on cash crops in lieu of production of food grains. This puts pressure on prices of food grains.

Reforms in Industry

Industrial growth has also recorded a slowdown. This is because of decreasing demand of industrial products due to various reasons such as cheaper imports, inadequate investment in infrastructure etc.

In a globalised world, developing countries are compelled to open up their economies to greater flow of goods and capital from developed countries and rendering their industries vulnerable to imported goods.

Cheaper imports have, thus, replaced the demand for domestic goods. Domestic manufacturers are facing competition from imports.

The infrastructure facilities, including power supply, have remained inadequate due to lack of investment. Globalisation is, thus, often seen as creating conditions for the free movement of goods and services from foreign countries that adversely affect the local industries and employment opportunities in developing countries.

Moreover, a developing country like India still does not have the access to developed countries; markets because of high non-tariff barriers.

For example, although all quota restrictions on exports of textiles and clothing have been removed in India, U.S.A. has not removed their quota restriction on import of textiles from India and China.


  • Every year, the government fixes a target for disinvestment of PSEs. For instance, in 1991-92, it was targeted to mobilise Rs 2500 crore through disinvestment.

  • The government was able to mobilise Rs 3040 crore more than the target. In 2014-15, the target was about Rs 56,000 crore whereas the achievement was about Rs 34,500 crore. - It is set at 1,05,000 crore in 2019-2020.

  • Critics point out that the assets of PSEs have been undervalued and sold to the private sector. This means that there has been a substantial loss to the government.

Moreover, the proceeds from disinvestment were used to offset the shortage of government revenues rather than using it for the development of PSEs and building social infrastructure in the country.

  • Reforms and Fiscal Policies: Economic reforms have placed limits on the growth of public expenditure especially in social sectors.

  • The tax reductions in the reform period, aimed at yielding larger revenue and to curb tax evasion, have not resulted in increase in tax revenue for the government.

  • Also, the reform policies involving tariff reduction have curtailed the scope for raising revenue through customs duties. In order to attract foreign investment, tax incentives were provided to foreign investors which further reduced the scope for raising tax revenues.

  • This has a negative impact on developmental and welfare expenditures.


The process of globalisation through liberalization and privatisation policies has produced positive as well as negative results both for India and other countries.

Some scholars argue that globalization should be seen as an opportunity in terms of greater access to global markets, high technology and increased possibility of large industries of developing countries to become important players in the international arena.


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