Background to India's 1991 Economic Reforms

For roughly four decades after independence, India followed a development strategy in which the government played a very large, direct role in economic decision-making. A private firm that wanted to start a new industrial unit, expand its existing capacity, change its product mix, or import machinery generally needed prior government approval in the form of an industrial licence or permit, and the import of many goods was restricted through a system of quotas. Because approvals, permits, and quotas touched almost every significant business decision, this system came to be widely known as the "Licence-Permit-Quota Raj". A wide range of industries — including several considered to occupy the "commanding heights" of the economy, such as core infrastructure, heavy industry, and key utilities — were reserved wholly or mainly for the public sector, and foreign investment and foreign trade were both kept under tight government control, with strict limits on the extent to which a foreign company could hold equity in an Indian business.

This approach had genuine achievements to its credit in the decades after independence — it helped build a domestic industrial base, a public-sector-led infrastructure, and a measure of self-reliance in several sectors. Over time, however, the heavy layer of licensing, permits, and quotas also created real problems: decision-making was slow and bureaucratic, competition was limited so firms had little pressure to improve efficiency or quality, many public sector enterprises ran at a loss or well below their potential, and the economy as a whole grew at a comparatively modest pace for many years.

These underlying weaknesses came to a head by 1990-91. India's foreign exchange reserves fell to a critically low level — reportedly barely sufficient to cover only a few weeks of essential imports — at the same time as the country's fiscal deficit and external borrowing had grown large over the preceding years. A sharp rise in global oil prices around the Gulf crisis of 1990 added further pressure on the country's import bill and its already-strained foreign exchange position. This combination is generally described as a Balance of Payments (BoP) crisis — a situation in which a country is unable to comfortably meet its external payment obligations (for imports, debt servicing, and other foreign-currency needs) out of its available foreign exchange reserves and current earnings.

Facing this crisis, the Government of India approached international financial institutions, including the International Monetary Fund, for emergency support, and in July 1991 announced a New Economic Policy that marked a decisive shift in approach. Rather than continuing with the earlier model of extensive government control over private economic activity, the new policy began dismantling large parts of the licence-permit-quota system, reduced restrictions on private investment, opened the doors wider to foreign investment and trade, and began reassessing the role of the public sector in the economy. This one policy announcement is the origin point of the three reform threads studied in this chapter — Liberalization, Privatization, and Globalization, together referred to by the short form "LPG" — which, although discussed separately for the sake of study, were introduced together as parts of a single, coherent reform package rather than as three independent decisions. It is worth noting that the 1991 reforms and the balance-of-payments crisis that triggered them are a well-documented, shared part of India's economic history, taught across commerce and economics curricula in Indian schools generally — they are not the syllabus content of any one board alone.