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Economic Reforms: Need and Criticism of Economic Reforms

Last Updated : 06 Apr, 2023
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Pre-Reform Scenario

Since independence, India has followed a mixed economic system in which the advantages of both capitalist (market) and socialist (planned) economies are combined. Under this system, the government and private sector play an equivalent role in the economy. Although there is some economic freedom in the use of capital, the government also interferes in economic activities to promote social welfare. India started its development from stagnation to an economy that achieved growth in savings and experienced expansion of agricultural output, which ensured food security. Moreover, there was a diversification of the industrial sector that helped in producing goods and services. 

The economic situation prior to reform can be summarized as follows:

  1. Following independence, Indian economic policy was primarily influenced by the exploitative colonial experience and Fabian socialism (aimed to promote equality of power, wealth, and opportunity).
  2. The Indian leaders (like Jawahar Lal Nehru) found an alternative to extreme cases of the socialist and capitalist economy, which is the mixed economic system.
  3. In this, both the public and private sector exists in the economy, with a solid public sector but also private property and democracy.
  4. This policy focuses on ‘protectionism’ in which domestic industries are protected, along with import substitution, which includes regulating the import of foreign goods and promoting products in the domestic market.
  5. Later, there was monitoring of industries, state interference at the micro level in businesses like financial markets, and the existence of a substantial public sector in the economy.

In reality, the private sector was neglected, and the public sector controlled the economy. Significant investments were made in the public sector and minor in the private sector. It established several rules and regulations that focus on regulating the economy. It resulted in preventing growth and development. 

In 1991, the economic crisis hit India related to external debt. The government was unable to make payments of the borrowings abroad. The foreign reserves used to manage imports declined to a level that was not even enough for two weeks. It further leads to a rise in the prices of essential goods. 

Nature of Economic Crisis

  • From 1980, we can trace the beginning of the economic crisis. At that time, there was ineffective management of funds. 
  • To implement the policies and administration, the government needs money for which it gets funds from taxes and public enterprises. In case, Expenditures are more than Income, the government borrows from banks, its citizens, and financial institutions. 
  • The government kept on spending its income (on the areas like defense and the social sector), and there were no returns. Therefore in 1985, India started facing the BoP problems. It was due to heavy expenditure by the government in comparison to the low income, which widens the gap between income and expenditure.
  • By 1990 end, it was a severe economic crisis. The government was on the verge of going into default. Later, the central bank refused to give credit.
  • In 1991, the crisis ultimately met India. The government was unable to make repayments for the loan abroad.
  • The foreign exchange reserves dropped to the level that it was insufficient to last even a fortnight. 
  • The crises further lead to an increase in the prices of essential goods.

The government introduced a new set of policy measures that shifted the focus of our development initiatives.

Need for Economic Reforms 

The economic condition of India in 1991 was pathetic. The government was unable to generate revenues from the sources like taxation. The income from public enterprises was also low. However, the government has to spend more on various issues like unemployment, overpopulation, and poverty, which increases the need to introduce economic reforms in India.

Economic Reforms are the set of economic policies that aims to accelerate the pace of growth and development in the economy.  

In 1991, the Government of India commenced several economic reforms to get the economy out of the 90s crisis and improve economic growth. Narasimha Rao’s Government initiated these reforms to increase confidence in the Indian economy.  It was due to the combined effect of various reasons. The reasons for the country’s reforms are described below:


1. Poor Performance of the Public Sector:

In the period 1951-1990, the majority of the industries were owned by the public sector. They were assigned the responsibility of the growth and development of an economy. Nevertheless, the performance of these enterprises was very depressing. The employees were neither competitive nor effective because of job security. This means even if they do not work, they had no fear of losing their job. The ultimate authority lies with the State. Despite several disciplinary measures, these enterprises were facing huge losses. It was only the economic reforms that could help the Indian economy to move in a new direction. Therefore, the government recognized the need to make these reforms.

2.  A Deficit in Balance of Payment:

It was one of the most significant factors in bringing economic reforms to the country. The deficit in BoP arises when the foreign payments are more than foreign receipts. There was an increase in imports besides heavy tariffs and quotas. However, the exports were low since domestic goods were expensive in the international market. The only action that would be effective was to get external help and introduce a new economic policy. This contributed to laying the foundation of economic reforms in India.

3. Rising Inflation:

There was a persistent rise in the price level of goods and services in the economy. The rate of inflation was tremendous, poor people were not able to afford essential foods. Besides, there was a need to inject liquidity into the economy, which caused a need for economic reforms in India.

4. Massive Debt Burden:

The government expenditure on developmental activities was more than its revenue from taxation. As a result, the government borrowed from banks, the public, and financial institutions like IMF.

5. Shortage in Forex Reserves:

The foreign exchange crisis resulted from a sharp decline in foreign exchange. The government at that time could not finance its imports and repay the interest that needed to be paid to the international lenders.

6. Inefficient Management:

The roots of the economic crisis can be traced to the inefficient management of funds. The government was not able to generate sufficient funds from the revenues such as taxation. On the other hand, government expenditure was rising, which increased the gap between revenues and expenditures. Moreover, the government borrowed foreign exchange from international markets and financial institutions used to purchase consumer goods. It ultimately results in inefficient management of funds.

7. Restrictions from International Institutions: 

India received $7 billion in financial assistance from the World Bank and the International Monetary Fund (IMF) to tackle its crisis. These organizations expected India to liberate its economy for availing loans by lifting restrictions on the private sector, reducing the role of the public sector in various areas, and removing trade barriers with other nations. India agreed to the conditions and announced New Economic Policy. 

For these reasons, the Government announced New Economic Policy (NEP) on July 1991. This policy aims to create a competitive environment and remove barriers to entry and growth of firms. But numerous complaints have been made by critics related to the New Economic Reforms in the areas like agriculture, employment, infrastructure development, and budgetary control, which are discussed below:

Criticism of Economic Reforms

1. Growing Agriculture:

Despite the fact that the GDP growth rate has grown during the reform period, the country has not witnessed enough job opportunities created as a result of this expansion. 

2. Neglect of Agriculture:

The agriculture sector has been overlooked by the new economic policy in favour of industry, trade, and services.

(i) Reduction of Public Investment: There has been a decline in public investment in the agriculture sector involving irrigation, power, market ties, roads, research, and advancement.

(ii) Liberalisation and Reduction in Import Duties: There have been several policy changes influencing this sector, which include (a) lowering of import taxes on agricultural goods (b) Elimination of minimum and fair support prices (c) removing quantitative constraints on agricultural products. Due to growing international competition, all of these policies had a negative impact on Indian farmers.

(iii) Removal of Subsidy: Lifting of fertilizer subsidies increased production costs, which adversely impacted the small and marginal farmers.

(iv) Shift towards Cash Crops: Agricultural production has switched from food crops to export crops as a result of export-oriented policy measures.

3. Ineffective Disinvestment Policy:

The government has always set a goal for selling its holding in Public Sector Enterprises. For example, in 1991-92, the government targeted that disinvestment will generate ₹2,500 crores. The government has raised ₹3,400 crores more than the target. In 2017-2018, the aim was ₹1,00,000 crore; however, the actual figure was ₹1,00,057 crore.

But, the government’s disinvestment policy was unsuccessful because:

  • Public Sector Enterprises were sold to the private sector at a reduced price.
  • Furthermore, rather than using it for the development of public sector enterprises and building social infrastructure in the country. The government used proceeds from disinvestment in compensating shortage of government revenue.

4. Low Level of Industrial Growth:   

The following reasons led to the slowdown in Industrial growth:

(i) Cheaper Imported Goods: There was a great flow of goods and capital from developed countries like the USA, and as a result, domestic industries were exposed to imported goods because of globalisation. The demand for domestic products was replaced by cheaper imports, and domestic producers started to face import competition.

(ii) Non-Tariff Barriers by Developed Countries: The Government removed all quota restrictions on exports of textiles and clothing. However, several developed countries like the USA have not removed their quota restrictions on the import of textiles from India.

(iii) Lack of Infrastructure Facilities: There was a lack of investment in the infrastructure facilities, which include power supply. Thus it remained inadequate.

5. Ineffective Tax Policy:

During the reform period, tax reduction was done to generate larger revenue and to curb evasion of tax. But, it did not result in an increase in the tax revenue for the government.

  • The scope for raising revenue through customs duties was decreased by Tariff Reduction.
  • To attract foreign investment tax incentives were provided, which further reduced the scope of raising tax revenues.

6. Spread of Consumerism:

An unfavourable trend has been driven by the new economic policy by encouraging the production of luxuries and items of superior consumption.

7. Unbalanced Growth:

Growth has been limited to limited areas of the service sector like telecommunication, information technology, finance, entertainment, real estate, trade, and hospitality rather than essential sectors such as agriculture and industry, which employ millions of people in the country.

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