What are the impact of liberalization and SAPs in India?

India launched massive economic reforms in July 1991 to overcome the economic crisis which has set in the economy because of shortage of foreign exchange (forex) reserves.

The forex reserves since the beginning of 1990 was in bad shape mainly because of rising import bill, fall in exports and meagre inflows of FDI. Severe strain on forex reserves was placed by the high levels of imported raw material component in India’s exports.

Especially the import of oil and petroleum products amounts to about 20 per cent of total import bill; The US-Iraq Gulf War of 1990-91 which led to sharp increase in international oil prices affected India directly and forex reserves began to decline from USS 1.1 billion in August 1990 to US$896 million in January 1991.

The Gulf War also affected India’s exports to Iraq, Kuwait, and other West Asian countries following United Nations trade embargo on Iraq and tense situation in the Arabian Sea. Besides, the remittances of the Indian labour working in Kuwait ceased to flow in as they were evacuated and shifted back to India following the War.

The impact of all these factors was multiple on the Indian economy and it disrupted industrial production, accelerated inflation to peak level of 16.7 per cent in August 1991 and sharp decline in real GDP growth rate to 2.5 percent.

Amidst all this economic chaos, there was political instability at the national level and a caretaker Central government was in the office. The elections were declared and the new government assumed office in June 1991.

Immediately, the new government took series of corrective measures to rejuvenate economy. The short-term measures were aimed at crisis management such as devaluation of the Indian currency to boost up exports. The long-term measures were of structural reforms, aimed at improving efficiency and productivity.

To correct imbalance in the BOPs, the government borrowed huge loans from the IMF. The devaluation of the Indian currency helped to curb nonessential imports. These measures helped to overcome the problem of forex reserves crisis (on BOPs) as exports began to pick up.

Along with these measures, the government launched large-scale economic reforms in July 1991 as per the guidelines provided by the IMF and the World Bank. Then in July 1991 as per the guidelines provided by the IMF and the World Bank. The process of these reforms is still continuing.

The principal thrust of ‘First Generation Reforms’ of 1990s was opening the economy to foreign producers and investors. The reforms were initiated in the following four areas:

(i) Fiscal Correction

To meet the increasing need of the expenditure the government often borrowed heavily from abroad (mostly from IMF) and this over-borrowing led the situation to debt-trap. The mounting pressure of external debt and limited mobilisation of domestic income created serious trouble in the management of the economy.

To come out of the situation and reduce the expenditure, a suggestion was put forward to abolish various subsidies, including export subsidy. Another suggestion was to increase fertilizer prices, keep non-plan expenditures (including defence expenditure) in check. The government applied these measures and brought macro-economic situation under control.

(ii) Trade Policy Reforms

The thrust of the trade policy reforms was to provide stimulus to exports. The pursuit of import-substitution policy’ since independence adversely affected exports. Under the new trade policy it was decided to pursue ‘pro-active export policy’ by reducing the degree of regulation and licensing control.

The first task was to improve price competitiveness of exports by devaluing the currency (i.e. rupee). For encouraging the competition in the domestic market tariff barriers to imports were reduced. The high tariff level of 150 per cent in 1991 was brought down to 35 per cent in 2001 and to 20 per cent in the ‘ Budget of 2003-4. Quantitative restrictions on imports were also phased out. Trade liberalisation opened the gates for large-scale foreign products in the indigenous market.

(iii) Industrial Policy Reforms

The revamping of industrial sector was another important item on reform agenda. The dismal performance of industrial and manufacturing sector (both in private and public sector) was a matter of serious concern.

The slowdown of public and private sectors had badly affected employment opportunities. To enhance private and foreign participation, the government decided to deregulate industry. For doing so the industrial licensing was abolished for all projects except in industries where strategic or environmental concerns are paramount.

Now about 80 per cent of industry has been taken out of the licensing framework. Besides, areas reserved for the public sector have been narrowed down, and greater participation by private sector is permitted in core and basic industries.

With the opening up of the industrial sector, the foreign investment is flowing in the economy. The joint ventures and collaborations (between the Indian and foreign industry) are rising.

Even defence (production) industry is opened up to private domestic and foreign investors and up to 26 per cent foreign investment is permitted (subject to licensing). And for the Indian private sector (participation), the defence industry is opened up to 100 per cent, subject to licensing.

(iv) Public Sector Reforms

One of the principal thrusts of the reform process is to re-structure public sector enterprises. Over the years, the public sector units incurred huge losses. To run them involved huge investment with no hope for adequate returns. Under the reform process a sizeable number of public units have been either partially privatized or fully sold out.

The process of disinvestment has been continuing and the government is offering equity to private and foreign investors. Rather the disinvestment of public sector is on top priority under the agenda of Second Generation Reforms’ which have been launched in 2001.

Currently the government is showing great interest in opening the economy further by liberalisation of equity limits for private domestic and foreign investors, for example, petroleum refining(under public sector) should be opened up 100 percent; civil aviation 49 percent, pipeline (oil and gas) 100 percent, real estate (complexes) 100 per cent, etc.

So far, the economy has shown the mixed result of the process of liberalisation and SAPs. Initially, after launching the process in July 1991 the exports rose rapidly. This rise was mainly because of currency devaluation. Similarly, between 1991 and 1996 the GDP growth rate was impressive. The FDI inflows and the forex reserves improved to a comfortable level.

However, the process lost momentum because of two reasons: first, the political instability between mid 1996 and October 1999 at the central government level created uncertainty about the continuity of the process. Secondly, the Asian Financial Crisis of July 1997 affected India’s exports adversely and the value of rupee (visa-vis US dollar) deteriorated to new low, affecting the sentiments of the foreign investors. Since October 1999 the political instability as well as the Asian financial crisis has ended.

The government in the subsequent period has been showing commitment to widening the scope of reform process. The result of this determination is quite evident as the FDI inflow has increased to about US$3 billion per annum. Exports have also picked up again.