Three decades ago, in July 1991, India embarked on a path of liberalising trade and industry. The liberalisation became necessary after the country’s economy came to a grinding halt and faced a crisis following years of strict controls and restrictions that characterised central planning.
The economy was brought down on its knees before the reforms could be ushered in.
How India reached this point
Just after independence, India turned to a centrally planned economy in the 1950s under the country’s first prime minister, Jawaharlal Nehru. The move changed the fundamental character of the Indian economy.
Nehru adopted the Soviet model for industry in which the government was supposed to precisely decide quantities and prices of most industrial products in the country.
Markets, where prices guide producers on what to produce and how much to produce, was stripped of their role, which was now played by a bunch of bureaucrats and economists sitting in the Planning Commission.
They decided how much of steel, copper, cars and scooters should be consumed by the Indian population, and who would produce these, and the price they would sell them at, and the quantity of raw material that could be imported. They sat with input-output tables and gave out licenses to industry to produce and to traders to import essential items.
Barely any new product was produced and no new technology was adopted. Indian bureaucrats would go to conferences abroad with their suits smelling of kerosene as dry-cleaning equipment was not allowed to be imported.
India’s industry became uncompetitive using outdated technology, producing the same old models and was unable to sell its products overseas. The rupee’s exchange rate was administered and hugely overvalued, further leading to poor exports.
The government tried raising tax rates to increase revenue, but when that did not help, it borrowed by forcing banks to lend nearly half of bank deposits. When sources of borrowing dried up, the government simply had the Reserve Bank of India print more money.
Inflation spiralled and price rise added to the misery, especially with very large sections of the population already below the poverty line.
Shortages led to rationing, and rationing led to queues and black markets. Not only did consumers have to wait for years for a new car, a scooter or a phone, they had to queue up for hours to buy sugar, wheat, rice and kerosene.
Balance of payments crisis
The collapse of the planned economy became imminent as the system became more and more inefficient. India was not able to pay for its needs of oil imports.
The oil price hikes in the 1970s and the Kuwait war in 1991 pushed up the price of oil and threw India into a balance of payment crisis and the country was no longer able to pay for its imports.
Trade credit to India stopped being rolled over and suddenly in mid-1991 the country found itself on its knees.
The P.V. Narasimha Rao-led Congress government went to the International Monetary Fund (IMF) with a begging bowl and found itself accepting IMF conditions that led it to de-license industry and imports. The fiscal deficit was brought under control, the rupee was made market determined beginning with a large devaluation.
These changes had been demanded by many in the country for a long time by economists like Jagdish Bhagwati, expert committees set up by the government itself, and by political parties such as the Swatantra Party and Jana Sangh, which opposed the Soviet-style central planning model imposed by Nehru and reinforced by Indira Gandhi.
International organisations like the IMF, the World Bank and academic economists had also commented on how India was trapped in poverty and low-growth, and pushed for these changes — especially after the collapse of the Soviet Union.
A crisis that was necessary
As many observers often say, India needed a crisis before it could bring in reforms. There was no building a political consensus before the reforms were unleashed.
Then finance minister Manmohan Singh’s speech in Parliament shocked even those in the Congress. Few had any inkling of what was to come as the discussions with the IMF had been held in secrecy. The opposition from the Left and the trade unions had been ignored as transport in India would have completely shut down within days if the IMF loan was not taken and imports were not resumed.
The reforms were a necessity, brought upon the country to undo the mistakes of decades of restrictions, red-tape and an inward-looking approach.
With the benefit of hindsight, India was lucky to face the crisis. Before the reforms, industrial production and international trade were prohibited unless a licence was obtained.
A stroke of pen changed this. New technology and innovations from around the world — Japan, Korea, the US, the UK, Europe, etc — came along with foreign companies and investment.
Indian exports grew rapidly after that. The country got out of its low-growth trap and was able to pull millions out of poverty and give children food, nutrition and education.
Thirty years later, we know it was the right thing to do. But was it enough? We’ll look at that next week.
la Patnaik is an economist and a professor at National Institute of Public Finance and Policy.