New Economic Policy 1991
In 1991, India Implemented a New Economic Policy for Rapid Development. After gaining independence, India recognized the need for accelerated economic growth to achieve self-sufficiency. This called for a strategic approach to economic development, leading to large-scale industrialization, technological advancement, socio-economic policies, and comprehensive planning and development programs. P. V. Narasimha Rao played a pivotal role in initiating the New Economic Policy in 1991.
Hence, the importance of the public sector was deemed essential. India, in its pursuit of economic growth, adopted a mixed economy approach that combined liberal trade policies with a strong public sector and a commitment to socialist values. Concurrently, it initiated comprehensive economic planning efforts aimed at revitalizing the nation’s economy.
Economic Planning: Mixed Outcomes
In short, we can say that the five decades of economic planning in India have been marked by a blend of both accomplishments and setbacks. While substantial progress has been made in various sectors, concerns lingered over the development of the public sector. Furthermore, excessive regulations weighed down the private sector.
The foreign exchange reserves to fund imports were in a precarious state. Withdrawals from non-resident Indian accounts were ongoing, and access to new credit facilities was limited. Inflation was spiralling out of control, and industrial growth was slowing down significantly.
The first blow came to the U.S.S.R. as the enthusiasm for socialism gradually shifted in favour of a free-market economy. Various factors like a significant decline in exchange rates, a balance of payment deficit, rapidly rising inflation, an ongoing increase in deficit financing, and widespread political instability, compelled everyone to embrace a policy of new economic reforms aimed at revitalization.
To liberate the economy from the grip of crises and propel it towards rapid development, the Indian government instituted substantial changes in its policies concerning trade, foreign investment, industry, exchange rates, fiscal matters, and more. When all these components are considered together, they constitute an Economic Policy that marks a departure from the previous one.
Since July 1991, when the rupee depreciated, the Indian government has introduced a series of ‘New Economic Reforms.’ While these reforms pertain to various sectors of the economy, they all aim to promote economic prosperity.
Meaning of New Economic Policy 1991
According to C. Rangarajan, “The New Economic Policy includes diverse policy measures and changes introduced from the year 1991”.
All these measures share a common goal: to enhance the efficiency of a system burdened by excessive controls, reduce competition within the private sector, and consolidate fragmented capacity.
The new economic policy aimed to foster a competitive environment within the economy, with the goal of enhancing overall efficiency and productivity. To realize this objective, the policy introduced essential reforms in trade, industrial policy, monetary policy, and fiscal policy.
Features of New Economic Policy 1991
The main features of the New Economic Policy (NIP) are as follows:
1) Abolition of Industrial Licensing
To liberalize the Indian economy, a significant step taken under NIP was the abolition of industrial licensing, with certain exceptions for industries related to environmental issues, safety, security, and strategic concerns.
According to the amendments made in February 1999, only six industries require compulsory licensing. These industries include alcohol, cigarettes, hazardous chemicals, drugs and pharmaceuticals, industrial explosives, and electronic, aerospace, and defence equipment.
2) Diminishing Role of the Public Sector
In contrast to the Industrial Policy of 1956, the New Industrial Policy aimed to reduce the public sector’s role in fostering economic growth and development. In 1991, the number of reserved industries was reduced from seventeen to eight, and currently, only two industries remain under public sector reservation. Additionally, the arms and ammunition industry was transferred to the private sector.
The government initiated a divestment scheme within the public sector to alleviate its burden. Under this scheme, financial institutions, mutual funds, employees, and the general public were offered shares in public organizations. Simultaneously, the private sector’s involvement in promising economic sectors was encouraged.
3) Incentives and Concessions for Foreign Investment and Technology
The New Industrial Policy identified 34 high-priority industries that demanded substantial investment and advanced technology. Foreign direct investment ranging from 50% to 100% was automatically approved, depending on the nature of the activity. Currently, 100% foreign equity is permitted in sectors such as road construction and maintenance, highways, ports, bridges, and electricity production and distribution. These investment decisions aimed to enhance India’s development and economic strength.
4) Drastic Amendments to the MRTP Act
The New Industrial Policy brought about significant amendments to the Monopolies and Restrictive Trade Practices (MRTP) Act, aiming to streamline the operations of MRTP companies. These companies held considerable market share and assets. Prior to these amendments, MRTP Act-regulated companies faced asset size restrictions. The revisions in the MRTP Act removed such limitations, allowing these companies to operate with greater freedom. For instance, in many industries, the maximum foreign equity cap was raised to 51%. In certain sectors like tool manufacturing, life-saving medicines, and Export-Oriented Units (EOUs), 100% foreign equity was permitted. The amended act also emphasized the prevention and control of restrictive and unfair trade practices.
5) Removal of Compulsory Convertibility Clause
In India, industrial investments primarily came from banks and financial institutions in the form of loans. These institutions operated under a compulsory convertibility clause for their lending activities. Under this clause, institutions had the option to convert a portion of their loans into equity of the borrowing firm with management approval. However, this provision was rarely exercised as it could potentially lead to financial institutions taking control of private companies. Therefore, the New Industrial Policy eliminated the compulsory convertibility clause.
Implications of New Economic Policy 1991 in India
The major implications of the new economic policy of 1991 are as follows:
1) Growth of New Economy Companies
The introduction of the new industrial policy in 1991 prompted the growth of new economy companies. A prime example is Infosys, which experienced significant expansion in size and structure thanks to these industrial policy changes.
2) Economy Bailed Out
The new industrial policy served as a lifeline for the Indian economy during a period of economic crisis and decline.
3) New Entrepreneurs
The New Industrial Policy (NIP) paved the way for economic recovery and the emergence of favourable market conditions, creating opportunities for budding entrepreneurs like Sunil Mittal of Bharti Enterprises.
4) FDI and New Technologies
The 1991 industrial policy had a distinct focus on leveraging foreign technology and investment to drive India’s economic development. These changes were driven by the intention to attract Foreign Direct Investment (FDI) and tap into new technologies from the global arena.
5) Greater Competitive Strength
The 1991 New Industrial Policy (NIP) introduced several policies and regulations that enhanced the efficiency of Indian organizations and fostered their competitive growth. It also promoted and supported entrepreneurship, making the Indian economy resilient in the face of competition from multinational corporations.
6) Healthy Competition
The MRTP Act hindered the growth of Indian enterprises for an extended period. Although its intended purpose was to curb monopolies and restrictive trade practices, it fell short of expectations. In 1991, the New Industrial Policy (NIP) introduced amendments to the MRTP Act aimed at fostering a healthier competitive environment. Furthermore, a new law, known as the Competition Law, was enacted to encourage competition among companies while penalizing those who hindered healthy competition.
7) Sustained Economic Growth
New Economic Policy 1991 played a pivotal role in fostering enhanced productivity, increased employment opportunities, and sustained economic growth. These positive outcomes were achieved through a combination of NIP initiatives and key reforms, including fiscal policy and monetary policy.
Limitations of the New Economic Policy 1991
Some limitations of the New Economic Policy 1991, are as follows:
1) New Economic Policy 1991 marked the end of the Industrial Policy Resolution of 1956, often referred to as the nation’s economic constitution.
2) Native Indian industries faced the threat of destruction due to the unrestricted entry of multinational companies.
3) Several frauds and scams could occur due to the absence of an adequate legal framework.
4) Multinationals, equipped with advanced technology, could dominate the Indian market and promote extensive consumption, particularly in the consumer durables segment. If these MNCs operate independently, they should prioritize indigenous research and development.
5) The presence of inconsistent and irrelevant policies and restrictions within the New Economic Policy of 1991 may result in uneven economic development and exacerbate social and economic inequalities. These issues could ultimately threaten social harmony and cause irreparable long-term damage.
6) It was also observed that multinational corporations (MNCs) could leverage small-scale producers or manufacturers for their products, reaping substantial profits by selling them in the Indian markets. Many MNCs saw India primarily as a hub for intermediary trading to boost their profits rather than as an export and production base.
Phases of Economic Reforms
(i) First Phase (1985-90)
The process of privatization was initiated during the government of Mr Morarji Desai, further progressed during Mrs. Indira Gandhi’s tenure, and gained momentum under the leadership of Shri Rajiv Gandhi.
Under the leadership of Shri Rajiv Gandhi, new trends were introduced in the government’s Economic Policy. These trends emphasized the adoption of modern techniques, enhancing productivity, and fully harnessing our potential as key components of a national campaign.
The new economic policy placed a greater emphasis on the role of the private sector. Shri Rajiv Gandhi explicitly stated that the public sector has expanded into areas where it shouldn’t have. We intend to strengthen the public sector to handle what the private sector cannot. However, our goal is to foster greater growth in the private sector, which will contribute to the economy’s more dynamic progress.
To promote the private sector, numerous policy changes were implemented, addressing matters such as the export-import policy, technological advancement, fiscal policy, industrial licenses, the elimination of controls and restrictions, foreign share capital, and streamlining fiscal and administrative regulations for a simplified regulatory system.
All these changes were designed to create a favourable environment for the private sector, with the goal of stimulating substantial investment, modernizing the economy, and fostering rapid growth.
KN Raj’s Vision and Policy Impact
KN Raj aptly encapsulated the objective of economic policy during this period. While there is a consensus that a notable aspect of these policy changes was the tightening of monetary policy through interest rate hikes. The exchange rate was adjusted by 22 per cent, and significant liberalization and simplification of trade policy were introduced.
The primary emphasis was on enhancing the efficiency and effectiveness of international competition and industrial production. This approach aimed to encourage greater utilization of foreign technology and investment, ultimately leading to improved performance in the public sector, as well as facilitating its reform, modernization, and the enhancement of the financial sector’s capabilities to meet the economy’s needs more efficiently.
Likewise, the New Economic Policy of 1991 aimed to eliminate unnecessary restrictions on licensing and the Monopolies and Restrictive Trade Practices (MRTP) Act. The focus shifted towards not granting industrial licenses to companies unless they aligned their production with regulated standards.
India initiated several measures in the following manner
Cement was completely deregulated, and several private companies were granted additional licensed capacities.
i) The percentage of sugar available for free sale in the open market was increased.
ii) The asset limit for large business houses was raised from Rs 20 crore to Rs 100 crore.
3. Asset Limit
The asset threshold for large business houses was raised from Rs 20 crore to Rs 100 crore.
The scheme of broadening licenses was introduced to expand the production of two-wheelers and later extended to cover 25 other industries, including four-wheelers.
Ninety-four drugs were deregulated, and the MRTP Act was amended to exclude 27 industries from its purview.
The New Textile Policy of 1985 eliminated the distinctions between power loom, mill, and handloom, as well as the distinctions between synthetic and natural fibres for licensing purposes.
The electrical materials industry was exempted from the MRTP Act, and the entry of FERA businesses into this sector was liberalized.
8. Foreign Trade
In 1985, the export and import policy was introduced with the aim of streamlining imports, bolstering export production capabilities, and promoting technological advancement.
9. In 1985, the long-term fiscal policy was unveiled to ensure the effective execution of the Seventh Plan.
(ii) Second Phase (After 1990)
The initial phase of economic reforms failed to yield the expected outcomes. The deficit in the trade balance saw a modest increase, resulting in an average deficit of Rs 5,935 crore during the Sixth Plan, which then escalated to Rs 10,841 crore in the Seventh Plan.
Receipts in the invisible accounts significantly declined, leading to a severe balance of payments crisis. In response, the Indian government sought assistance from the World Bank and IMF, securing a loan of Rs. 87 billion to address the issue.
The IMF agreed to extend a loan facility, but it emphasized the need for India to steer its economy in the right direction. Dr. Manmohan assured the IMF Director of the Indian government’s commitment to establish specific macroeconomic objectives and implement policy measures aimed at stabilizing the economy’s structure.
In 1991, under the leadership of Narasimha Rao’s government, a series of crucial steps were taken to steer the economy in the right direction. These measures encompassed tightening the monetary policy by aligning the rupee’s exchange rate to 22 per cent, increasing interest rates, curbing the fiscal deficit, liberalizing foreign trade policies, and implementing other policy reforms aimed at fostering economic growth. These actions aimed to inject a fresh sense of dynamism into the economic process.
The Finance Minister at the time, Manmohan Singh, emphasized the importance of enhancing work efficiency and promoting international competitiveness in industrial production. This approach aimed to leverage foreign technology and investment to enhance the performance of the public sector. Additionally, there was a focus on streamlining, reforming, and modernizing the financial sector to better cater to the needs of the economy.
Policy Measures of the Second Phase
The following represents the primary macroeconomic objectives of economic reforms in India (second phase):
(a) The goal was to attain an economic growth rate ranging from 3 per cent to 3.5 per cent in 1991-92 and 4 per cent in 1992-93.
(b) The objective was to lower the inflation rate to 9 per cent in 1991-92 and further to 6 per cent in 1992-93.
(c) The aim was to boost foreign exchange reserves to $2.2 billion in 1991-92 as a means to address the challenging balance of payments situation.
(d) The objective was to decrease the current account deficit to 2.5 per cent of the total domestic product in the 1990-91 budget and further reduce it to 2 per cent by 1992-93.
Arguments in favour of New Economic Reforms
In 1991, the Indian government initiated a series of new economic reforms in the country.
The arguments in favour of these reforms were as follows:
(i) These new economic reforms aim to attain a target growth rate of 8 per cent, in line with the growth rates seen in other Asian countries such as Malaysia, Hong Kong, Singapore, South Korea, and more.
(ii) The new economic reforms will promote increased competition in the industrial sector.
(iii) Ensuring equal distribution of income and wealth will contribute to reducing poverty levels.
(iv) The new economic reforms are designed to enhance the efficiency and profitability of public sector enterprises.
(v) This will facilitate increased investment in critical sectors.
(vi) This will boost the development of small-scale industries in the country’s less developed regions.
(vii) This will be advantageous in attracting foreign direct investment to the country.
(viii) The new economic reforms aim to rectify the growing imbalance in the balance of payment. Additionally, they are advantageous for boosting exports and discouraging imports, ultimately leading to an increase in foreign exchange reserves.
(x) This policy can be employed to address the coordination issues within the economy.
(xi) The New Economic Policy includes several measures to control the fiscal deficit in the budget.
Arguments against New Economic Reforms
Although the new economic reforms have numerous merits, there have also been some arguments presented against them, which are outlined below:
(i) The new economic reforms have overlooked the agricultural sector.
(ii) The new economic reforms allowed the Indian economy to integrate with global institutions like the IMF and subsequently engage with the World Bank.
(iii) The new economic reforms have heightened reliance on foreign technology while falling short in the development of domestic technologies.
(iv) The new economic reforms have elevated reliance on foreign aid and investment, potentially leading to a significant increase in external debt.
(v) This policy may lead to the liberalization of the country, potentially resulting in the sale of Indian businesses’ shares to foreign investors.
Some more arguments are listed below:
(vi) The new economic reforms are expected to exacerbate the issue of unemployment due to potential layoffs in large industries. Furthermore, the new economic policy does not create significant employment opportunities within the country.
(vii) The new economic reforms place a stronger emphasis on the privatization of public enterprises.
(viii) The new economic reforms foster a detrimental trend of consumerism.
As a result, there is an encouragement to produce goods for the elite class and luxury items.
(ix) There’s a concern that the new economic policy may not effectively curb the increasing prices and could struggle to manage financial assistance, reduce the fiscal deficit, and prevent other economic challenges.
What is meant by new economic policy?
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