INTRODUCTION

The economic reforms initiated in 1991

ECONOMIC REFORMS

Popularly, economic reforms denote the process in which a government prescribes declining role for state and expanding role for the private sector in an economy. attribute the differences in the performance of economies to the differences in the 'strategies' they follow. The different strategies of development evolved through a long period of trial and error by different countries under the influence of different sets of ideologies.

Planning Model

Till the rise of the Soviet Union, the prevalent development strategy in the Euro-American countries was the capitalist system of economy, which promoted the principles of laissez-faire and dominant role for private capital in the economy. Once the Soviet Union went for the planning model (including the East European countries and finally China in 1949) most of the developing countries after their independence were influenced by socialism and the governments there took a central role in planned development. As these economies were dominated by foreign colonisers, they worried that opening themselves to foreign investment would lead to a new form of domination, the domination by large multinationals. That is why most of these countries went for 'protectionist' economic policy with import substitution as one method, side by side. But by the 1970s, the world was having convincing proofs that the socialist as well as the planned economies were inclined to follow their kind of development strategy-because either they had very slow and lower growth rates or were stagnating. The experiences of these economies gave rise to a new ideology which is popular as the 'Washington Consensus'.

Washington Consensus

The Washington Consensus is a set of 10 economic policy prescriptions considered to constitute the "standard" reform package promoted for crisis-wracked developing countries by Washington, D.C.–based institutions such as the International Monetary Fund (IMF), World Bank, and the US Treasury Department.

The prescriptions encompassed policies in such areas as macroeconomic stabilization, economic opening with respect to both trade and investment, and the expansion of market forces within the domestic economy.

Subsequent to Williamson's use of the terminology, and despite his emphatic opposition, the phrase Washington Consensus has come to be used fairly widely in a second, broader sense, to refer to a more general orientation towards a strongly market-based approach (sometimes described as market fundamentalism or neoliberalism). In emphasizing the magnitude of the difference between the two alternative definitions, Williamson himself has argued (see § Origins of policy agenda and § Broad sense below) that his ten original, narrowly defined prescriptions have largely acquired the status of "motherhood and apple pie" (i.e., are broadly taken for granted), whereas the subsequent broader definition, representing a form of neoliberal manifesto, "never enjoyed a consensus [in Washington] or anywhere much else" and can reasonably be said to be dead.

Discussion of the Washington Consensus has long been contentious. Partly this reflects a lack of agreement over what is meant by the term, in face of the contrast between the broader and narrower definitions. But there are also substantive differences involved over the merits and consequences of the various policy prescriptions involved. Some critics take issue, for example, with the original Consensus's emphasis on the opening of developing countries to global markets, and/or with what they see as an excessive focus on strengthening the influence of domestic market forces, arguably at the expense of key functions of the state. For other commentators the issue is more what is missing, including such areas as institution-building and targeted efforts to improve opportunities for the weakest in society. Despite these areas of controversy, a number of developmental institutions and economists (such as Joseph Stiglitz) would by now accept the more general proposition that strategies best work if they are specifically designed to the certain circumstances of the individual countries.

Mixed Economic System

In the real world today a pure free market economy and pure command economy or a centrally planned economic system are not found.

Almost all economies have now become mixed economic system in which government plays an important role in allocation of resources and distribution of income.

Thus mixed economy or mixed economic system refers to an economic system in which both free market and Government have significant roles in the working of the economy. In a mixed economy elements of both free market system and control or regulation by the Government are present. The proportion of free market working and Government regulation varies from country to country.

Many economies of the present-day world are examples of mixed economy. Mixed economy functions through private enterprise as well as Government. The Government interferes with or regulates the private enterprise in various ways. It has now been realised that the free and unfet­tered functioning of the private enterprise gives rise to many evils.

As a result of free working of the private enterprise, there are violent fluctuations in economic activities; sometimes the condi­tions of depression and unemployment are created and sometimes the conditions of boom and inflation emerge. Thus a free-market economy suffers from what are called business cycles, with all their consequent evils. Besides, as a result of free functioning of the private enterprise and price mechanism, extreme inequalities of income and wealth are produced.

The following of ‘Laissez Faire’ policy by the Government, weaker sections of the society are not protected. On the other hand, the command economic system in which resource allocation and income distribution is decided through centralized planning collapsed due to various deficiencies and failures. Therefore, in both Russia and China free-market economic system along with some govern­ment control has been adopted.

In has also been realised that in a developing country like India, desired rate of economic growth cannot be achieved under free private enterprise. Therefore, in order to avoid the evils of the free private enterprise and free functioning of the market mechanism and to achieve the desired rate of economic growth the Government takes an active part in the functioning of the economic system in most economies of the world.

Today all the capitalist economies have become mixed form of economies, because in all of them economic role of the Government has greatly increased.’ Laissez Faire’ policy advocated by Adam Smith and other classical economists has now been given up because of its several shortcomings and evils.

Therefore, the economies of the United States of America and Britain have also become mixed systems. Paul Samuelson and A.H. Hansen, eminent American economists, have called the economies of America, Britain and France as ‘Mixed Capitalist System’ or’ Mixed Enterprise System’, because in them the Government now interferes in the economic activities and takes active part in the functioning of the economic system and regulates and controls the private enterprise by various methods.

Mixed Capitalist System

It is worth noting that mixed economies can be classified into two forms. One form of mixed economy is that in which means of production are in the ownership of private sector and the Government regulates and controls the activities of private enterprise through direct controls (such as price control, licensing system, control over imports, etc.) as well as through monetary and fiscal policies. In such a type of economy, the government does not take over the means of produc­tion, and if it does, it does so relatively on a small scale.

That is why such a type of ‘mixed system’ has been called Mixed Capitalist System because such an economic system is basically capital­ist and the Government regulates and controls the economic activities through various types of controls and various measures of monetary and fiscal policies so that the various evils of the free working of the private enterprise and the price mechanism are avoided and the economic system is directed towards the desired goals.

In such a type of ‘mixed economy,’ Government itself does not undertake the work of production on a large scale. Government’s production work is merely confined to the production of equipment’s and materials for the army and the working of the public utility services. Such a type of mixed economic system is also called controlled capitalism.

Indian Economy as a Mixed Economic System

The second form of a mixed economy is that in which the Government not only regulates and controls the private enterprise through various types of direct controls and appropriate monetary and fiscal policies, it also directly participates in the production of various goods and services.

In such a type of mixed economy, various basic industries and infrastructure industries are generally in the ownership of the public sector and it is the government which organizes and runs them. The remaining industries are in the ownership of private enterprise and it is the private enterprise which is assigned the task of production in them. But it is worth remembering that the government regulates and controls the private enterprise in such industries also through direct control and appropriate monetary and fiscal measures.

The economies of the United States of America and Britain have also become mixed economies. But the nature of mixed economy of India is quite different from them, because in the mixed economy of India the public sector takes more active, more important and more extensive part in the working and growth of the economy.. Whereas the mixed economies of the USA and England are biased towards capitalism, the mixed economy of India is biased towards socialism

Functioning of a Mixed Economy

A mixed economy functions through both price mechanism and planning by the Government. So far as the industries in the public sector are concerned the price, output and investment decisions are taken by the government or the authorities appointed by the government according to the strategy and policy frame of the development plans.

But the private sector of the mixed economy is governed and regulated by the price and market mechanism and therefore in regard to the industries in the private sectors, the decisions regarding price, output and investment are taken by the private entrepreneurs or the industrialists with a view to making profits and these decisions are mainly based on price mecha­nism. The private sector in the mixed economy is, however, influenced, regulated and controlled by the government through monetary and fiscal measures as well as through direct or physical controls.

Prior to 1991 in India, there was a ‘licensing system’ according to which to start and establish factories in certain industries, the government’s permission or license was neces­sary. However, under the economic reforms initiated since 1991 in India, licensing and permit system has been done away with and private sector has been given a lot of freedom for deciding about production and expansion in their enterprises.

Even foreign investment by multinational companies has been allowed to make investment in India and repatriate the profits to their home countries. However the government also regulates and controls the investment and production in the private sector through appropriate monetary and fiscal measures. By providing concessions in taxation, and by making available cheap credit facilities, the government provides incentives to private entrepreneurs for investment in the desired lines of production decided in development plans.

Role of Government in a Mixed Economic System

As noted above, in the mixed economic system the Government plays a significant role in allocation of scarce resources and distribution of income. However, despite the important role of Government, the people and private enterprises are free to make economic transactions.

They voluntarily decide whether or not to transact, have the right to buy and sell what they want. Workers are free to accept or refuse any work they do not want to do, free to move to different places for employment of their choice. The right to own property and freedom of contract are maintained by the Government.

The Government makes laws which provide right to ownership of property and freedom of contract and courts are set up by it to enforce these laws. Besides, the Government maintains law and order to protect life and liberty of the people and to enforce property rights of the people. It also makes arrangements for defence of the country against foreign aggression.

Besides the above basic functions, Government intervenes in the economy to correct what are called market failures. These are the situations in which free market does not work efficiently. For example, natural resources such as forests, mines, common pastures tend to be overexploited resulting in their destruction under free market conditions.

Further, some goods, called public goods such as defense, law and order are not produced at all by private enterprises which are driven by profit motive. This is because once produced the people who do not even pay for them cannot be prevented from using them.

Moreover, private enterprises while producing goods often impose costs that are called detrimental externalities on others by their economic activities. For example, the production of goods in factories pollutes air and water surrounding them. This environment pollution causes a lot of harm to the people but the private enterprises do not have to pay for the harms they do to others.

Nor do they take into account these externalities in their cost calculations while making their investment decisions. As a result, there is overproduction of such goods whose production pollutes environment and impose costs on others and this causes misallocation of resources. The Government can prevent them by imposing taxes on private enterprises which pollute environment.

Above all, the Government in modern mixed economic systems takes fiscal and monetary policies to stabilize the economy against fluctuations in national income, employment and prices. Recession causes huge unemployment which deprives people of their livelihood. On the other hand, when there is inflation, cost of living of the people rises and as result there is a lot of human suffering. Inflation is a tax that hurts the poor people most. Following J.M. Keynes the Govern­ment adopts discretionary fiscal and monetary policies to lift the economy out of recession.

For example, recently in 2007-09 when due to global financial crisis originated in the US due to bursting of sub-prime housing loan bubble which caused global recession and meltdown, the Governments in the US, Britain, Japan, France and India too increased public expenditure and cut taxes to revive their economies.

In the US and other free market economies the Government even helped private banks with funds to bail them out of the turmoil. In India the Government borrowed heavily in 2008-09 and 2009-10 to increase its expenditure and also to cut taxes to prevent slowdown of the Indian economy due to the impact of global financial crisis. Similarly, when there is inflation the Central Bank of a country adopts tight monetary policy and the Government adopts contractionary fiscal policy to control rise in prices.

Last but not the least, it is a vital function of the modern Government to promote economic growth. Economic growth requires capital accumulation, progress in technology and investment in social sectors such as education and health. Besides, in developing countries like India the Government has to adopt measures to eradicate poverty that prevails on a large scale in these countries. For example, the Indian Government has started Mahatma Gandhi National Rural Employment Guarantee Scheme (MNREGS) under which it provides guaranteed employment to the poor households. Further, to help the poor.

The Government in India has also begun Public Distribution System under which it provides subsidized food grains to the poor households. Just as there are market failures, there are Government failures too. Mixed economy represents a middle path between a purely free-market economy and purely command economy.

Economic liberalisation

The economic liberalisation in India refers to the economic liberalisation, initiated in 1991, of the country's economic policies, with the goal of making the economy more market and service-oriented and expanding the role of private and foreign investment.
Specific changes include a reduction in import tariffs, deregulation of markets, reduction of taxes, and greater foreign investment.
Liberalisation has been credited by its proponents for the high economic growth recorded by the country in the 1990s and 2000s.

Indian government coalitions have been advised to continue liberalisation. Before 2015 India grew at slower pace than China which has been liberalising its economy since 1978. But in year 2015 India outpaced China in terms of GDP growth rate.The McKinsey Quarterly states that removing main obstacles "would free India's economy to grow as fast as China's, at 10% a year".
There has been significant debate, however, around liberalisation as an inclusive economic growth strategy. Since 1992, income inequality has deepened in India with consumption among the poorest staying stable while the wealthiest generate consumption growth. As India's gross domestic product (GDP) growth rate became lowest in 2012–13 over a decade, growing merely at 5.1%,more criticism of India's economic reforms surfaced, as it apparently failed to address employment growth, nutritional values in terms of food intake in calories, and also exports growth – and thereby leading to a worsening level of current account deficit compared to the prior to the reform period. But then in FY 2013–14 the growth rebounded to 6.9% and then in 2014–15 it rose to 7.3% as a result of the reforms put by the New Government which led to the economy becoming healthy again and the current account deficit coming in control. Growth reached 7.5% in the Jan–Mar quarter of 2015 before slowing to 7.0% in Apr–Jun quarter.

Pre-liberalisation policies

Indian economic policy after independence was influenced by the colonial experience (which was seen by Indian leaders as exploitative in nature) and by those leaders' exposure to Fabian socialism. Policy tended towards protectionism, with a strong emphasis on import substitution, industrialisation under state monitoring, state intervention at the micro level in all businesses especially in labour and financial markets, a large public sector, business regulation, and central planning.Five-Year Plans of India resembled central planning in the Soviet Union. Steel, mining, machine tools, water, telecommunications, insurance, and electrical plants, among other industries, were effectively nationalised in the mid-1950s. Elaborate licences, regulations and the accompanying red tape, commonly referred to as Licence Raj, were required to set up business in India between 1947 and 1990.

Obligatory Reforms

By 1991, India still had a fixed exchange rate system, where the rupee was pegged to the value of a basket of currencies of major trading partners. India started having balance of payments problems since 1985, and by the end of 1990, the state of India was in a serious economic crisis. The government was close to default, its central bank had refused new credit and foreign exchange reserves had reduced to the point that India could barely finance three weeks’ worth of imports. It had to pledge 20 tonnes of gold to Union Bank of Switzerland and 47 tonnes to Bank of England as part of a bailout deal with the International Monetary Fund (IMF). Most of the economic reforms were forced upon India as a part of the IMF bailout.

The IMF conditions put forth for India were as under:
(i) Devaluation of the rupee by 22 per cent (which was effected in two phases and the Indian rupee fell down from Rs. 21 to Rs. 27 per US dollar).
(ii) Drastic reduction in the peak import tariff from the prevailing level of 130 per cent to 30 per cent (India completed it by 2000-01 itself and now it is voluntarily cut to the level of 15 per cent).
(iii) Excise duties (i.e., CENVAT now) to be hiked by 20 per cent to neutralise the revenue short falls due to the custom cut (a major tax reform programme was launched to streamline, simplify and modernise the Indian tax structure which is still going on).
(iv) All government expenditure to be cut down by 10 per cent, annually (i.e., cutting the cost of running the government and denotes, interests; pays, pension and PF; subsidies. A pressure on the government to consolidate the fiscal deficit and go for fiscal prudence).

Though India was able to pay back its IMF dues in time, the structural reform of the economy was launched to fulfil the above-given conditions of the IMF. The ultimate goal of the IMF was to help India bring about equilibirium in its BoP situation in the short-term and go for macroeconomic and structural adjustments so that in future the economy faces no such crisis

Reform Measures

The economic reform programme, that India launched, consisted of two categories of measures:
1> Macroeconomic Stabilisation Measures
2> Structural Reform Measures

Macroeconomic Stabilization

Stabilisation involves returning to low and stable inflation and a
sustainable fiscal and current account position

Structural Adjustments

“…policy responses to external shocks, carried out with the objective of regaining the pre-shock growth path of the
national economy”

TYPICAL REFORM PROCESS OF AN ECONOMY

Macro-economic stabilisation
Domestic deregulation of investment production and prices
Liberalisation of foreign trade
Privatisation of the public sector
Financial Sector Reforms and tax reforms

REFORM PRIORITIES

1> Stabilize the economy
2> Fiscal deficit contraction
3> To place the economy on a higher growth path through enhanced levels of investment, and improvements in productivity, efficiency and competitiveness.

Therefore, a small IMF loan was drawn from reserve tranche and without conditionalities, fresh borrowings were made from Bank of England and Japan in exchange for physical delivery of gold. But even after this, India’s foreign exchange reserve was enough for only 2 weeks’ of import.

STABILIZATION through NEW ECONOMIC POLICY (NEP)

1> Deflation of the economy, reducing the rate of growth and curbing the ‘excessive’ demands
2> Devaluation* of the rupee, alongwith the initial period of import compression.
In July 1991 there was a devaluation of 22 per cent combined with an abolition of export subsidies and the introduction of an import entitlement scheme for exporters

However, stabilization was seen as a temporary strategy; it was mostly implemented so as to gain back the international investor’s confidence, increase access to foreign exchange and permit a higher rate of growth.

STRUCTURAL ADJUSTMENT

1> To do away with all kinds of fiscal deficits
2> It involved not just opening up of the private sector but also bureaucratization, over manning, and soft budget constraints typical of state enterprise
3> Imports were liberalized not only to gain access to capital goods, intermediaries and raw materials needed to restructure and become internationally competitive but also to expose it to the cutting edge of international competition.
4> Domestic deregulation: To market forces to allow their disciplining economic activity
5> To ensure that private initiative would more than adequately replace the state as the locomotive of growth, tax policies were rationalized and the tax regime rendered “less burdensome”.
6> Tax reforms were mainly liberalized so as to avoid any kind of disincentive to not save or invest.
7> Government’s self imposed constraints to reduce the alarming fiscal deficit: Reduced expenditures on subsidies and administration, rather focused only on interest payments.

Liberalisation, Privatisation and Globalisation - LPG

During the tenure of Narasimha Rao Government (1991), India met with an economic crisis relating to its external debt. The government was unable to make repayments on its borrowings from abroad; foreign exchange reserves were not sucient to repay the debts. The prices of essential goods were rising and the imports were growing at a very high rate. As a result, the government initiated a new set of policy measures to reform the conditions of an economy and several economic reform programme were also introduced in this respect to promote privatisation, liberalisation and globalisation.

By introducing concept of liberalisation, privatisation and globalisation, government have revived the condition of Indian Economy.

Liberalisation

Libralisation was introduced with an aim to put an end to those restrictions which became major hindrances in growth and development of various sectors. It is generally dened as the lossening of government regulations in a country to allow for private sector companies to operate business transactions with fewer ristrictions. In relation to developing countries, this term refers to opening of economic border for multinationals and foreign investment.

Objectives of Liberalisation

The main objectives of liberalisation policy are
(i) To increase competition among domestic industries.
(ii) To increase foreign capital formation and technology.
(iii) To decrease the debt burden of the country.
(iv) To encourage export and import of goods and services.

Industrial Sector

(i) Abolition of Industrial Licensing Government abolished the licensing requirement of all industries, except for the five industries, which are
• Liquor
• Cigarettes
• Defence equipment
• Industrial explosives
• Dangerous chemicals, chugs and pharmaceuticals.
(ii) Contraction of Public Sector The number of industries reserved for the public sector was reduced from 17 to 8.
Presendy, only three industries are ’ reserved for public sector. They are
• Railways
• Atomic energy
• Defence
(iii) De-reservation of Production Areas The production areas which were earlier reserved for SSI were de-reserved.
(iv) Expansion of Production Capacity The producer’s were allowed to expand their production capacity according to market demand. The need for licensing was abolished.
(v) Freedom to Import Capital Goods The business and production units were given freedom to import capital goods to upgrade their technology.

Financial Sector Reforms

Financial sector includes financial institutions such as commercial banks, investment banks, stock exchange operations and foreign exchange market.
The following reforms were initiated in this sector
(i) Reducing Various Ratio Statutory Liquidity Ratio (SLR) was lowered from 38.5% to 25%. Cash Reserve Ratio (CRR) was lowered from 15% to 4.1%.
(ii) Competition from New Private Sector Banks The banking sector was opened for the private sector. This led to an increase in competition and expansion of services for consumers.
(iii) Change in the Role of RBI RBI’s role underwent a change from a ‘regulator’ to a ‘facilitator’.
(iv) De-regulation of Interest Rates Except for savings accounts, banks were able to decide their own interest rates

Tax Reforms/Fiscal Reforms

Tax reforms are concerned with the reforms in government’s taxation and public expenditure policies which are collectively known as its scal policy. Moderate and Simplied Tax Structure Prior to 1991, the tax rates in the country were quite high, which led to tax evasion. The scal reforms simplied the tax structure and lowered the rates of taxation. This reduced tax-evasion and increased government’s revenues.

Foreign Exchange Reforms/External Sector Reforms

External sector reforms include reforms relating to foreign exchange and foreign trade. The following reforms were initiated in this sector
(i) Devaluation of Rupee Devaluation implies a fall in the value of rupee against some foreign currency. In 1991, the rupee was devalued to increase our country’s exports and to discourage imports.
(ii) Other Measures
• Import quotas were abolished.
• Policy of import licensing was almost scrapped.
• Import duty was reduced.
• Export duty was completely withdrawn.