The economic system works on a delicate balance of numerous aspects that must function optimally for a strong economy; however, time after time, it has been observed that decisions by leaders of a country imbalance the economy causing inflation and can even collapse of the economy. The Indian economy was also close to collapse in 1991; however, many economic reforms helped the country avoid the economic crisis.
Before Economic Reform 1991
As India attained independence in 1947, the entire population of the country was looking forward to a developed economy, and the leaders were set out with the goal of converting India into a self-sustaining. Although the goal was noble as it should be, the approach to this goal was what led the Indian economy to plummet before 1991. A complex regime to conserve the foreign exchange was introduced, along with an approach to expand public investment. Although private businesses were allowed to operate, the introduction of strict policies made it difficult. Moreover, key sectors were controlled by the state. Unsurprisingly, excessive intervention from the government resulted in fluctuating market prices, wages, and interest rates, while also causing galloping inflation. At the beginning of 1991, the Indian economy was on the brink of collapse. To save the economy, drastic measures were taken, which came to be known as the Economic Reforms of 1991.
The Goal of the Economic Reform
Undoubtedly, saving the economy of India from the collapse was the primary objective of these reforms; however, the ministry of finance has aimed to achieve other goals as well. The secondary target for the economic reforms of 1991 was to increase the rate of income and employment in the entire country. Increasing the standard of living was another major concern for the government, as nearly half of the population was living under the poverty line. To put that into perspective, presently, the poverty rate in India is 22.5 percent; however, in 1987, it was over 50 percent.
Key Steps in the Economic Reform 1991
As mentioned previously, the key sectors were ruled by the state, and to sustain productivity in those sectors, significant capital was required, which was simply not there, resulting in a fiscal deficit of 8.4 percent of GDP in 1990. Therefore, balancing the fiscal discipline through stabilization efforts was important, and a new budget was introduced for 1991-92 that aimed at reducing the fiscal deficit by 2 percent, from 8.4 percent to 6.5 percent of GDP. Drastic steps were taken by the government, such as reducing the subsidy on fertilizers, removing sugar subsidy, removing the investment from certain public sectors, and lastly, accepting the Tax Reforms Committee. All of these combined led to a stable fiscal balance.
Financial Sector Reforms
Before the Economic Reform 1991, the Indian banking system was also struggling with distorted interest rates. One of the key sectors controlled by the government at the time was the banking system, the Reserve Bank of India (RBI) controlled the rates of deposits of maturities, loans, and the size of loans. The state began with decontrolling the deposits of maturities and allowed the deposit of shorter deposits. Liberalization of the banking sector had a profound effect on the economy of India, it increased competition among public, private, and foreign banks. The Economic Reform 1991 was crucial for private banks, as this was the time that allowed private banks to relocate and open specialized branches. Statutory liquidity ratio (SLR) and cash reserve ratio (CRR) were also reduced, these were brought from 38.5 and 25 percent to 25 percent and 10 percent, respectively.
Capital Market Reforms
Once again, to remove the control of the government in the capital market, these reforms were introduced. It was decided that a regulatory framework must replace the government to allow regulators to report objectively. Additionally, the Narasimham Committee set up the Securities & Exchange Board of India (SEBI) in 1988, which aimed at the security of the market, along with the efficient allocation of funds.
Industrial Policy Reforms
Industries contribute tremendously not only to the economy of a nation but also to the increase the standard of living by providing products based on the demand. Unsurprisingly, industries were heavily regulated by the state before 1991. Deregulation of industries occurred that promoted the competition. Additionally, industrial licensing was removed, along with the monopoly act that restricted large companies from expanding. Lastly, areas dedicated to the public sector were shrunk to make room for the private industries.
Trade Policy Reforms
Part of the reason why India was doing poorly before 1991 was its strict policies for international trade for goods and services. Tariff rates were set at 300 percent. Unsurprisingly, slashing import duties was the first step to enable businesses to conduct more trades, and the tariff rates in 1991 were reduced to 150 percent. These kept on decreasing with the annual budget. Restrictions on items were also removed. Previously, items that were banned for import were in triple digits, which were reduced to 71 following the Economic Reform 1991.
Encouraging Foreign Investment
Foreign Direct Investment (FDI) is a method that boosts the productivity of businesses tremendously, in turn contributing to the economy. To encourage FDI, the equity limitation was raised from 51 percent to 75 percent, then 100 percent, especially for technology and high-investment priority industries.
Devaluation of the currency
Traditionally, the countries that face inflation try to combat it by printing more money in hopes of people purchasing more so that the economy could stabilize; however, this approach never works. Thankfully, India decided to devalue its currency by 20 percent in two successions, and this proved effective.