Background to LPG Reforms
• When expenditure is more than income, government borrows to finance deficit from banks, people within country, and international financial institutions.
• Development policies required that even though revenues were very low, government had to overshoot its revenue to meet challenges like unemployment, poverty, & population explosion. continued spending on development programmes of government did not generate additional revenue.
• economic condition of India in year 1991 was very miserable. It was due to cumulative effect of a number of reasons.
• government was not able to generate sufficient revenue from internal sources such as taxation.
• income from public sector undertakings was not very high to meet growing expenditure.
• At times, our foreign exchange, borrowed from other countries and international financial institutions, was spent on meeting consumption needs.
• In late 1980s, government expenditure began to exceed its revenue by such large margins that meeting 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 insufficient foreign exchange to pay interest that needed to be paid to international lenders.
• India went to International Bank for Reconstruction and Development [IBRD], which is also known as World Bank and International Monetary Fund [IMF], and asked for a loan of $7 billion to help deal with crisis.
• In order to get a loan, these international organisations wanted India to liberalise and open up its economy by removing restrictions on private sector, reducing government’s role in many areas, and removing trade barriers between India and other countries.
• India agreed to conditionalities of World Bank and IMF and announced New Economic Policy [NEP].
• This set of policies can broadly be classified into two groups: stabilisation measures and structural reform measures.
• Stabilisation measures are short-term measures intended to correct some of weaknesses that have developed in balance of payments and to bring inflation under control. In other words, this means that there was a need to maintain sufficient foreign exchange reserves and keep rising prices under control.
• On other hand, structural reform policies are longterm measures, aimed at improving efficiency of economy and increasing its international competitiveness by removing rigidities in various segments of Indian economy.
• New Economic Policy was announced in July 1991. It consisted of wide range of economic reforms. main aim of policy was to create a more competitive environment in economy and remove barriers to entry growth of firms.
• government initiated a variety of policies which fall under three heads viz., Liberalisation, privatisation, and globalization.
Liberalization Deregulation of Industrial Sector
• Liberalisation means removal of entry and growth restrictions on private sector.
• reform policies were introduced in July 1991 and removed many restrictions.
• Industrial licensing was abolished for all firms except for some industries like alcohol, cigarettes, hazardous chemicals, industrial explosives, electronics, aerospace, drugs & pharmaceuticals.
• only industries which are now reserved for public sector are a part of atomic energy generation and some core activities in railway transport.
• Many goods produced by small-scale industries have now been de-reserved. In most industries, market has been allowed to determine prices.
Tax Reforms
• Tax reforms are concerned with reforms in government’s taxation and public expenditure policies, which are collectively called 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.
• Indirect taxes refer to those taxes which affect income and property of people through their consumption expenditure. Indirect taxes are usually imposed on goods and services.
• Since 1991, there has been a continuous reduction in taxes on individual incomes as it was felt that high rates of income tax were an important reason for tax evasion. This is now widely accepted that moderate rates of income tax encourage savings and voluntary disclosure of income.
• rate of corporation tax, which was very high earlier, has been gradually reduced.
• Efforts have been made to reform indirect taxes, which are taxes levied on commodities, to facilitate establishment of a common national market for goods and commodities.
• In order to encourage better compliance on part of taxpayers, many procedures have been simplified.
• In 2016, Indian Parliament passed a law, Goods & Services Tax Act 2016, to simplify and introduce a unified indirect tax system in India. This law came into effect from July 2017. It is expected to generate additional revenue for government, reduce tax evasion and create ‘one nation, one tax & one market’.
Financial Sector Reforms
• financial sector includes financial institutions, such as commercial banks, investment banks, stock exchange operations, and foreign exchange market.
• financial sector in India is regulated by Reserve Bank of India [RBI]. RBI decides amount of money that banks can keep with themselves, fixes interest rates, nature of lending to various sectors.
• One of major aims of financial sector reforms is to reduce role of RBI from regulator to facilitator of financial sector. This means that financial sector may be allowed to take decisions on many matters without consulting RBI.
• reform policies led to establishment of private sector banks, Indian as well as foreign.
• foreign investment limit in banks was raised to around 74%. Those banks which fulfil certain conditions have been given freedom to set up new branches without approval of RBI and to rationalise their existing branch networks.
• Foreign Institutional Investors [FII], such as merchant bankers, mutual funds, and pension funds, are now allowed to invest in Indian financial markets.
Foreign Exchange Reforms
• In 1991, as an immediate measure to resolve balance of payments crisis, rupee was devalued against foreign currencies.
• Devaluation refers to a reduction in value of domestic currency by government.
• This led to an increase in inflow of foreign exchange. It set tone for free determination of rupee value in foreign exchange market from government control.
• Now, more often than ever markets determine exchange rates based on demand and supply of foreign exchange.
Trade and Investment Policy Reforms
• Before 1991, a lot of restrictions were imposed on imports to protect domestic industries. However, this protection reduced efficiency and competitiveness of domestic industries and led to their slow growth. So, reform in trade and investment policy were initiated.
• Liberalisation of trade and investment regime was initiated to increase international competitiveness of industrial production and to attract foreign investments and technology into economy. aim was to promote efficiency of local industries and adoption of modern technologies.
• trade policy reforms are aimed at [i] dismantling quantitative restrictions on imports and exports [ii] reduction of tariff rates and [iii] 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 fully removed from April 2001.
• Export duties have been removed to increase competitive position of Indian goods in international markets.
Privatization
• It implies transfer of ownership, management and control of public sector enterprises to enterprises in private sector.
• Government companies are converted into private companies in two ways: [i] by withdrawal of government from ownership and management of public sector companies and [ii] by outright sale of public sector companies.
• Privatisation of public sector enterprises by selling off part of equity of PSEs to public is called disinvestment.
• purpose of sale, according to government, was mainly to improve financial discipline and facilitate modernisation. It was envisaged that private capital and managerial capabilities could be effectively utilised to improve performance of PSUs.
• government envisaged that privatisation could provide a strong impetus to inflow of FDI.
• government has made attempts to improve efficiency of PSUs by giving them autonomy in taking managerial decisions.
Globalization
• This is an outcome of set of various policies that are aimed at transforming world towards greater interdependence and integration. It involves creation of networks and activities transcending economic, social & geographical boundaries.
• Globalization attempts to establish links in such a way that happenings in India can be influenced by events happening miles away. This is turning world into one whole or creating a borderless world.
• Outsourcing is one of important outcomes of globalization process.
• In outsourcing, a company hires regular service from external sources, mostly from other countries, which was previously provided internally or from within country [like legal advice, computer service, advertisement, and security — each provided by respective departments of company].
• Outsourcing has intensified in recent times, because of growth of fast modes of communication, particularly growth of Information Technology [IT].
• Companies in developed countries send jobs to India like voice-based business processes [called BPO or call centres], record keeping, accounting, banking services, music recording, film editing, book transcription, clinical advice, and even teaching.
• Most big companies and even some small ones are sending their work to India, where it can be done for less money and with a good level of skill and accuracy.
• low wage rates and availability of skilled manpower in India have made it a destination for global outsourcing in post-reform period.
World Trade Organization [WTO]
• WTO was founded in 1995 as successor organisation to General Agreement on Tariffs and Trade [GATT].
• GATT was established in 1948 with 23 countries as global trade organisation to administer all multilateral trade agreements by providing equal opportunities to all countries in international market for trading purposes.
• WTO is expected to establish a rule-based trading regime in which nations cannot place arbitrary restrictions on trade. Its purpose is to enlarge production and trade of services, ensure optimum utilisation of world resources and protect environment.
• WTO agreements cover trade in goods as well as services to facilitate international trade [bilateral and multilateral] through removal of tariffs as well as non-tariff barriers and providing greater market access to all member countries.
• As an important member of WTO, India has been at forefront of framing fair global rules, regulations and safeguards and advocating interests of developing world.