Chapter Notes - Liberalization, Privatisation and Globalisation

Table of Contents
1. Introduction
2. Background
3. What is Liberalisation?
4. Privatisation
5. What is Globalisation?
6. Indian Economy During Reforms: An Assessment
7. Conclusion
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Introduction

• After independence, India adopted a mixed economy that combined elements of capitalism and socialism.
• During the early decades some regulations helped achieve goals such as industrial development, household savings and food security, but over time a heavy regulatory framework came to be seen by many as a constraint on efficiency and growth.
• By 1991, India faced a severe balance of payments crisis. Foreign exchange reserves had fallen to levels sufficient for only a few weeks of imports, external debt servicing became difficult, and inflationary pressures rose.
• To manage the crisis, the government introduced a set of policy changes that altered India's broad economic strategy.
• This chapter explains the background to the 1991 crisis, the policy response known as the New Economic Policy (NEP), and the three broad strands of reform usually cited as liberalisation, privatisation and globalisation (the LPG reforms), together with their impacts and critiques.

Background

• The financial crisis in India can be traced back to the mismanagement of the economy in the 1980s.
• The government relied on tax revenues and profits from public sector enterprises to meet development and administrative expenses; when revenues fell short it borrowed from banks, domestic savers and multilateral lenders.
• Essential imports, especially petroleum, had to be paid for in foreign currency earned from exports. A widening gap between imports and exports reduced external reserves.
• High expenditure on social services, subsidies and defence, often without immediate returns, strained the budget and increased dependence on debt.
• In the late 1980s foreign exchange reserves fell to critically low levels, leaving the country vulnerable to external shocks and making it difficult to meet interest and principal payments on external debt.
• India negotiated assistance from the International Bank for Reconstruction and Development (World Bank) and the International Monetary Fund (IMF), receiving a loan package of roughly $7 billion along with policy conditionalities.
• In return, India accepted the need for structural change: reducing excessive state control, opening the economy to competition, and correcting macroeconomic imbalances. These measures were announced as part of the New Economic Policy (NEP) and included stabilisation measures (to fix balance of payments and inflation) and structural reforms (to raise efficiency and competitiveness).
• The structural reforms are commonly grouped under liberalisation, privatisation and globalisation.

What is Liberalisation?

Liberalisation refers to removal or relaxation of government controls and restrictions so that markets and private actors can operate with greater freedom. It aims to improve economic efficiency by reducing bureaucratic interference, encouraging competition, and allowing market forces to allocate resources.

Some liberalising steps were taken in the 1980s but the comprehensive set of reforms introduced in 1991 represented a major shift in policy.

Deregulation of the Industrial Sector

Before 1991, industry in India was tightly regulated through licensing, restrictions on private participation and controls on production and prices. The 1991 reforms sought to remove needless controls and allow industry to respond to market signals.

Key regulatory mechanisms that existed before reforms:

1. Industrial licensing: Investors required government permission to start, expand, or close many kinds of industrial activity.
2. Sector restrictions: Private participation was barred or heavily restricted in several industries.
3. Small-scale reservations: Production of certain goods was reserved for small-scale industries.
4. Price and distribution controls: The government fixed prices or regulated distribution of selected industrial products.

Removal of restrictions:

• Abolition of industrial licensing: Licence requirements were removed for most products; a short list of exceptions remained (for example, alcohol, cigarettes, hazardous chemicals, industrial explosives, certain electronics, aerospace and defence related products and some areas of pharmaceuticals).
• Public sector reservations: Only a few activities-such as atomic energy and certain railway functions-remained reserved for the public sector.
• Deregulation of small-scale reservations: Many items that were earlier reserved for small-scale units were de-reserved so that larger firms could produce them.
• Market-determined pricing: Price controls were relaxed so that market forces could determine prices in most industries.

Financial Sector Reforms

The financial sector reforms aimed to increase efficiency, competition and autonomy within banking and capital markets and to reposition the Reserve Bank of India (RBI) more as a regulator and facilitator rather than a direct controller of credit allocation.

• Objectives: Enhance the autonomy and competitiveness of financial institutions and reduce direct control over interest rates and credit allocation.
• New banks: Private sector banks-both Indian and foreign-were allowed to operate, increasing competition.
• Foreign investment in banks: Liberalisation raised the permissible foreign equity in banks subject to conditions (policy frameworks have evolved over time).
• Branch expansion: Banks meeting prudential norms were given greater freedom to open new branches and rationalise networks without seeking RBI permission for every change.
• Foreign Institutional Investors (FIIs): Merchant bankers, mutual funds and pension funds from abroad were permitted to invest in Indian securities, deepening capital markets.

Tax Reforms

• Tax reform refers to changes in taxation and public expenditure policies-the government's fiscal policy-to make revenue systems efficient and growth-friendly.
• Taxes are of two broad types: direct (imposed on income and profits) and indirect (imposed on goods and services).
• Direct tax reforms: Since 1991 there has been a gradual reduction and simplification of income-tax rates and measures to broaden the tax base, aimed at curbing tax evasion and encouraging voluntary compliance.
• Corporate tax: Corporate tax rates have also been reduced over time to make Indian industry more competitive.
• Indirect tax reforms: Reforms sought to create a common national market for goods by rationalising and simplifying indirect taxes.
• Goods and Services Tax (GST): Introduced in 2016 after a constitutional amendment, GST replaced many indirect taxes with a unified tax on the supply of goods and services, aiming to reduce tax cascading, increase compliance and create a single domestic market.
• Administrative reforms: Simplification of tax procedures and lowering of rates were intended to improve compliance and increase net revenue collection.

Foreign Exchange Reforms

• During 1991 the external sector reforms included changes in the management of foreign exchange and exchange rate policy.
• Devaluation and exchange-rate flexibility: The rupee was devalued to restore competitiveness and the economy moved from a fixed to a more market-determined exchange-rate regime. Exchange rates are now largely determined by supply and demand for foreign exchange in the market.
• Objective: Encourage exports, attract foreign capital and reduce external imbalances by allowing market forces to play a greater role in the determination of the rupee's value.

Trade and Investment Policy Reforms

• Trade and investment reforms aimed to improve international competitiveness by reducing protection, encouraging exports and attracting foreign technology and capital.
• Earlier policies used quantitative restrictions (such as import quotas) and high tariffs to protect domestic industry; this limited competition and efficiency.
• Policy reforms removed many quantitative restrictions and significantly reduced tariff rates, while also simplifying import licensing procedures.
• Import licensing was abolished for most goods except those that were hazardous or environmentally sensitive; by April 2001 quantitative restrictions on imports of manufactured consumer goods and many agricultural products had been removed and export duties reduced or removed to encourage exports.

Privatisation

• Privatisation is the transfer of ownership, management or control of public sector enterprises to private parties.
• Government companies can be changed into private entities by:
  1. Withdrawal of government ownership and management;
  2. Outright sale of public sector companies.
• Disinvestment is the sale of part of the equity of public sector enterprises to private investors or the public; it is a tool of privatisation but does not always amount to full transfer of ownership.
• Objectives of privatisation and disinvestment include improving financial discipline, raising capital for modernisation, introducing private managerial skills and increasing efficiency.
• Privatisation is also expected to attract Foreign Direct Investment (FDI) and technology through private participation.
• To improve PSU performance the government granted greater autonomy to many public sector undertakings and designated stronger units as maharatnas, navratnas and miniratnas, giving them more freedom in investment and managerial decisions.

What is Globalisation?

• Globalisation is the process by which a country's economy becomes increasingly integrated with the global economy. It involves cross-border flows of goods, services, capital, technology and ideas, and greater interdependence among nations.

Outsourcing

• Outsourcing is the practice of contracting out tasks or services to external firms, often located in other countries, rather than performing them in-house.
• Key services outsourced include legal work, IT support, customer service (call centres), record keeping, accounting, and specialised back-office functions.
• Advances in communication technology-especially the Internet and faster telecommunication-have enabled real-time transmission of data and made outsourcing viable across long distances.
• India emerged as a major destination for outsourcing because of its combination of skilled manpower, relatively lower wage costs, and strong capabilities in information technology and related services.
• Outsourcing connects firms globally but also raises questions about job displacement, skill development and the quality of employment produced.

World Trade Organization (WTO)

• The World Trade Organization (WTO) was established in 1995 as the institutional successor to the General Agreement on Tariffs and Trade (GATT), which began in 1948 with 23 countries to administer multilateral trade rules.
• The WTO seeks to build a rule-based global trading system that reduces arbitrary trade restrictions and promotes non-discriminatory treatment among members.
• Its agreements cover trade in goods and services and include measures to reduce tariffs and non-tariff barriers, improve market access and provide dispute settlement.
• The WTO also addresses trade-related aspects of intellectual property and aims to ensure efficient use of world resources and environmental protection while expanding trade.
• India is an active member of the WTO and has implemented many commitments including removal of quantitative restrictions on imports and reductions in tariff rates.

Criticisms of WTO and Global Rules

• Limited benefits: Some critics argue that much world trade is concentrated among developed countries, so the gains for developing nations may be limited without special safeguards.
• Agricultural subsidies: Developed countries often provide large agricultural subsidies that distort world prices while pressuring developing countries to liberalise their markets.
• Asymmetric market access: Developing countries sometimes find it difficult to access developed-country markets due to non-tariff barriers, regulatory standards and subsidies in rich countries, despite being asked to open their own markets.

Indian Economy During Reforms: An Assessment

The reform process launched in 1991 spans more than three decades. The following assessment summarises broad outcomes and remaining challenges.

GDP Growth

• Average GDP growth accelerated after 1991. For example, growth increased from about 5.6% in 1980-91 to higher rates in the 2000s, with peak periods showing rapid expansion (growth around 8.2% for 2007-12 in some estimates).
• Growth since reforms has been largely driven by the service sector, while agriculture growth slowed and industry showed variable performance.
• Growth rates have also fluctuated over time, with a slowdown in several periods (for example after 2012) and recoveries in others.

Foreign Investment and Exchange Reserves

• Reforms opened the economy to greater foreign investment. Net foreign direct investment (FDI) flows rose substantially compared to pre-1991 levels.
• Foreign exchange reserves rose dramatically from around $6 billion in 1990-91 to over $400 billion by the late 2010s (around $413 billion in 2018-19), strengthening external stability.
• Foreign investment (including FDI and portfolio flows) increased from measured values in the early 1990s to several tens of billions of dollars in later decades (for instance, rising from about $100 million or so in 1990-91 to about $30 billion in later years for net inflows in some years).

Exports and Challenges

• India became a strong exporter of auto parts, pharmaceuticals, engineering goods, IT services and software, and textiles.
• Inflation was kept under relatively better control in many years compared to pre-reform periods, though inflation remains an ongoing policy concern.
• Challenges persist in creating enough quality employment, improving agricultural productivity, boosting manufacturing, expanding infrastructure and maintaining sound fiscal management.

Growth and Employment

• Although GDP growth increased, the growth was not always employment-intensive; many sectors that expanded (notably some service industries) created fewer jobs per unit of output than traditional manufacturing and agriculture.
• Generating sufficient productive employment for a large and growing workforce remains a core challenge.

Reforms in Agriculture

• Agricultural growth decelerated in some periods after liberalisation.
• Public investment in agricultural infrastructure-such as irrigation, rural roads and storage-has not kept pace with requirements in many regions.
• Partial removal or rationalisation of fertiliser subsidies and changes in minimum support price policies affected production costs and incomes of small and marginal farmers.
• Lower import duties and removal of quantitative restrictions exposed farmers to greater international competition, sometimes lowering domestic prices for certain crops and creating vulnerability for producers.
• A shift towards export-oriented production in some segments altered cropping patterns and had implications for domestic foodgrain prices and food security measures.

Reforms in Industry

• Industrial growth has been uneven. Some of the slowdown reflected weaker domestic demand, competition from cheaper imports and inadequate infrastructure (for example unreliable power supply and transport bottlenecks).
• Increased global competition meant domestic manufacturers faced pressure from imports of cheaper goods.
• Insufficient investment in infrastructure and logistics reduced competitiveness in some manufacturing segments.
• Non-tariff barriers in some developed markets continued to restrict Indian exporters' access, even as India removed many of its own quota restrictions and trade barriers.

Disinvestment

• The government sets annual targets for disinvestment (sale of equity in public sector enterprises). For example, in 1991-92 the target was to mobilise Rs 2500 crore, and the government mobilised about ₹ 3,040 crore.
• In 2017-18 the annual disinvestment target was about ₹ 1,00,000 crore and the actual receipts were slightly above the target (about ₹ 1,00,057 crore).
• Critics argue that some public assets were undervalued and sold cheaply to private buyers, causing potential long-term revenue loss and public concern over loss of strategic assets.
• Proceeds from disinvestment have often been used to meet revenue shortfalls rather than being systematically reinvested in modernising public enterprises or strengthening social infrastructure, raising questions about the best use of such proceeds.

Reforms and Fiscal Policies

• Economic reforms constrained the growth of public spending in some areas; fiscal consolidation became a policy priority to restore macro stability.
• Some tax cuts aimed at improving incentives and broadening the tax base did not immediately result in higher revenues in all periods; improving tax administration and compliance remains important.
• Reductions in tariff rates lowered customs revenue potential and the government also offers tax incentives to attract foreign investment, which can reduce net revenue unless offset by higher growth.
• Lower public revenue growth poses challenges for financing developmental and welfare programmes unless matched by improved efficiency of public expenditure or alternative revenue sources.

Conclusion

• Globalisation, supported by liberalisation and privatisation, has produced both benefits and costs for India.
• Positive outcomes include faster average growth, deeper integration with world trade, large increases in foreign exchange reserves and stronger inflows of foreign investment and technology in many sectors.
• Concerns include inadequate job creation relative to the labour force, uneven gains across sectors and regions, pressures on small farmers and domestic industry from international competition, and questions about social equity and the fiscal use of disinvestment proceeds.
• Policy debates therefore focus on complementing liberalisation with stronger social and infrastructure investments, targeted support for agriculture and small industry, skills development, and prudent fiscal and regulatory measures so that growth is more inclusive and sustainable.