Economic Environment in India

The economic environment of a country is the set of macro-level factors that shape how wealth is produced and distributed. For a business, these factors are not abstract — they determine whether the market is growing, whether the government is friendly or hostile, and whether capital and labour are easy to obtain. In India, this environment has changed dramatically since Independence, and the textbook traces that entire journey.

What the Economic Environment Includes

The economic environment in India consists of several broad categories of factors:

• (a) Stage of economic development — whether the country is agrarian, industrialising, or a services-led economy.
• (b) Economic structure — India operates as a mixed economy, where both the public sector and the private sector have recognised roles.
• (c) Government economic policies — these include industrial policy, monetary policy (handled by the RBI, controlling money supply and interest rates), and fiscal policy (government taxation and spending).
• (d) Economic planning — Five-Year Plans, annual Union Budgets, and other planning documents.
• (e) Economic indices — national income, distribution of income, rate and growth of GNP, per capita income, disposable personal income, rate of savings and investments, value of exports and imports, and balance of payments.
• (f) Infrastructural factors — financial institutions, banks, modes of transportation, and communication facilities.

The State of the Indian Economy at Independence

At the time of Independence in 1947, the Indian economy was in a poor state:

• (a) It was mainly agricultural and rural in character.
• (b) About 70% of the working population was employed in agriculture.
• (c) About 85% of the population lived in villages.
• (d) Production used irrational, low-productivity technology.
• (e) Communicable diseases were widespread, mortality rates were high, and there was no good public health system.

The Post-Independence Development Strategy

To solve these problems, the government took several steps:

• The State controlled certain industries.
• Central planning was introduced.
• The importance of the private sector was reduced.

The main objectives of India’s development plans were:

1. Initiate rapid economic growth to raise the standard of living, reduce unemployment, and reduce poverty.
2. Become self-reliant and set up a strong industrial base with emphasis on heavy and basic industries.
3. Reduce inequalities of income and wealth.
4. Adopt a socialist pattern of development — based on equality and preventing exploitation of man by man. In line with this planning, the public sector was given the lead role in infrastructure industries, while the private sector was broadly given the responsibility of developing consumer goods industries. At the same time, the government imposed several restrictions, regulations, and controls on the working of private sector enterprises.

Mixed Results and the 1991 Crisis

India’s experience with economic planning delivered mixed results. By 1991, the economy faced a serious crisis. The textbook lists the major elements of this crisis:

• Fiscal crisis: The fiscal deficit reached 6.6% of GDP in 1990-91.
• Heavy internal debt: Rose to about 50% of GDP, with interest payments draining about 39% of total revenue collections of the central government.
• Low GNP growth: Fell to 1.4% from a peak of 10.5% in 1988-89.
• Negative agricultural and industrial growth: Overall agricultural production, foodgrain production, and industrial production showed negative growth rates of –2.8%, –5.3%, and –0.1% respectively.
• Soaring inflation: Both wholesale and consumer price indices showed inflation at 13-14%.
• Shrinkage of foreign trade: Imports fell by 19.4% and exports by 1.5% (in dollar terms).
• Depreciation of the rupee: Fell by 26.7% against the US dollar.
• Critical foreign exchange reserves: Reserves were barely adequate to meet import requirements of a few weeks. Non-Resident Indians (NRIs) were withdrawing deposits at an alarmingly high rate.
• Loss of international confidence: India’s creditworthiness rating fell from AAA to BB+ (put on credit watch).
• Near default: The country was on the verge of defaulting on international financial obligations.

The New Industrial Policy of 1991: Liberalisation, Privatisation, Globalisation (LPG)

As a part of economic reforms, the Government of India announced a New Industrial Policy in July 1991. Its broad features were:

• (a) The number of industries under compulsory licensing was reduced to six.
• (b) Many industries earlier reserved for the public sector were dereserved. The role of the public sector was limited to only four industries of strategic importance.
• (c) Disinvestment was carried out in many public sector enterprises.
• (d) Policy towards foreign capital was liberalised. The share of foreign equity participation was increased, and in many activities 100% Foreign Direct Investment (FDI) was permitted.
• (e) Automatic permission was granted for technology agreements with foreign companies.
• (f) The Foreign Investment Promotion Board (FIPB) was set up to promote and channelise foreign investment in India.
• Obstacles in the way of growth and expansion of large industrial houses were removed.
• The small-scale sector was assured all help and accorded due recognition.

In essence, this policy sought to do three things:

• Liberalisation: Liberate industry from the shackles of the licensing system (the licence-permit-quota raj).
• Privatisation: Drastically reduce the role of the public sector.
• Globalisation: Encourage foreign private participation in India’s industrial development.

Liberalisation in Detail

Liberalisation of the Indian industry took place with respect to:

1. Abolishing licensing requirements in most industries (except a short list).
2. Freedom in deciding the scale of business activities — no restrictions on expansion or contraction.
3. Removal of restrictions on the movement of goods and services.
4. Freedom in fixing the prices of goods and services.
5. Reduction in tax rates and lifting of unnecessary controls over the economy.
6. Simplifying procedures for imports and exports.
7. Making it easier to attract foreign capital and technology to India.

Privatisation in Detail

The new reforms aimed to give a greater role to the private sector and a reduced role to the public sector. This was a reversal of the earlier development strategy. To achieve this, the government:

• Redefined the role of the public sector in the New Industrial Policy of 1991.
• Adopted the policy of planned disinvestment of the public sector.
• Decided to refer loss-making and sick enterprises to the Board of Industrial and Financial Reconstruction (BIFR).

Globalisation in Detail

Globalisation means the integration of the various economies of the world, leading towards the emergence of a cohesive global economy.

Till 1991, India had followed a policy of strictly regulating imports through:

• Licensing of imports.
• Tariff restrictions.
• Quantitative restrictions.

The new reforms aimed at trade liberalisation — import liberalisation, export promotion through rationalisation of the tariff structure, and reforms with respect to foreign exchange — so that the country would not remain isolated.

A truly globalised economy implies a boundaryless world where there is:

1. Free flow of goods and services across nations.
2. Free flow of capital across nations.
3. Free flow of information and technology.
4. Free movement of people across borders.
5. A common acceptable mechanism for the settlement of disputes.
6. A global governance perspective.

Early Crisis Management Measures (1991)

The textbook lists the early steps taken to manage the crisis:

• Fiscal correction: Aimed at reducing the fiscal deficit by about 7,700 crore rupees in 1991-92.
• New Industrial Policy: Announced in July 1991 to deregulate industry.
• Abolition of industrial licensing: For all projects except 18 industries of high strategic/environmental importance. About 80% of industries were delicensed.
• Amendment of the MRTP Act: Eliminated the need for prior government approval for large companies for capacity expansion, diversification, and mergers.
• Opening of public sector areas: Nine areas in basic and core industries earlier reserved for the public sector were opened to the private sector.
• Foreign equity limit raised: From 40% to 51% in a wide range of priority industries.
• FIPB established: To negotiate proposals from large international firms and expedite clearances.
• Rupee devaluation: By 18% during July 1-3, 1991, supported by a standby credit of 2.3 billion dollars from the IMF.
• World Bank and IMF loans: A 500 million dollar Structural Adjustment Loan from the World Bank and loans totalling SDR 1.3 billion from the IMF.
• India Development Bond Scheme and Immunity Scheme: To repatriate funds held abroad; over 2 billion dollars were mobilised during 1991-92.
• Gold brought back: From the Bank of England and the Bank of Japan.
• Import control and credit squeeze continued.
• Eximscrips: Administered licensing of imports replaced by freely tradeable import entitlements linked to export earnings.
• Liberalised Exchange Rate Management System (LERMS): A dual exchange rate system was established, with one rate effectively floated in the market.
• Import licensing eliminated: In most capital goods, raw materials, intermediates, and components. The Advance Licensing System was considerably simplified.

Demonetisation (2016)

On November 8, 2016, the Government of India demonetised the two largest denomination notes — Rs 500 and Rs 1,000 — with immediate effect, ceasing to be legal tender except for a few specified purposes (like paying utility bills). This led to 86% of the money in circulation becoming invalid. People had to deposit the invalid currency in banks, with restrictions placed on cash withdrawals. …