PRE REFORMS SCENARION & NEW ECONOMIC POLICY

The origin of the financial crisis can be traced from the inefficient management of the
Indian economy in the 1980s. The government generates funds from various sources
such as taxation, running of public sector enterprises etc. When expenditure is more
than income, the government borrows to finance the deficit from banks and also from
people within the country and from international financial institutions. When we import
goods like petroleum, we pay in dollars which we earn from our exports. Development
policies required that even though the revenues were very low, the government had to
overshoot its revenue to meet challenges like unemployment, poverty and population
explosion. The income from public sector undertakings was also not very high to meet
the growing expenditure. At times, our foreign exchange, borrowed from other
countries and international financial institutions, was spent on meeting consumption
needs. Neither was an attempt made to reduce such profligate spending nor sufficient
attention was given to boost exports to pay for the growing imports.
In the late 1980s, government expenditure began to exceed its revenue by such large
margins that meeting the expenditure through borrowings became unsustainable.
Prices of many essential goods rose sharply. Imports grew at a very high rate without
matching growth of exports. There was also not sufficient foreign exchange to pay the
interest that needs to be paid to international lenders. Also no country or international
funder was willing to lend to India.
India approached the International Bank for Reconstruction and Development (IBRD),
popularly known as World Bank and the International Monetary Fund (IMF), and
received $7 billion as loan to manage the crisis. For availing the loan, these international
agencies expected India to liberalise and open up the economy by removing restrictions
on the private sector, reduce the role of the government in many areas and remove
trade restrictions between India and other countries.
India agreed to the conditionalities of World Bank and IMF and announced the New
Economic Policy (NEP). The NEP consisted of wide ranging economic reforms. The thrust
of the policies was towards creating a more competitive environment in the economy
and removing the barriers to entry and growth of firms. This set of policies can broadly
be classified into two groups: the stabilisation measures and the structural reform
measures. Stabilisation measures are short-term measures, intended to correct some of
the weaknesses that have developed in the balance of payments and to bring inflation
under control. In simple words, this means that there was a need to maintain sufficient
foreign exchange reserves and keep the rising prices under control. On the other hand,
structural reform policies are long-term measures, aimed at improving the efficiency of
the economy and increasing its international competitiveness by removing the rigidities
in various segments of the Indian economy. The government initiated a variety of
policies which fall under three heads viz., liberalisation, privatisation and globalisation.
The following measures were taken to liberalize and globalize the economy:

1. Devaluation: To solve the balance of payment problem Indian currency were

devaluated by 18 to 19%.

2. Disinvestment: To make the LPG model smooth many of the public sectors were sold
to the private sector.
3. Allowing Foreign Direct Investment (FDI): FDI was allowed in a wide range of sectors
such as Insurance (26%), defense industries (26%) etc.
4. NRI Scheme: The facilities which were available to foreign investors were also given to
NRI's.

The New Economic Policy (NEP-1991) introduced changes in the areas of trade policies,
monetary & financial policies, fiscal & budgetary policies, and pricing & institutional
reforms. The salient features of NEP-1991 are (i) liberalization (internal and external), (ii)
extending privatization, (iii) redirecting scarce Public Sector Resources to Areas where
the private sector is unlikely to enter, (iv) globalization of economy, and (v) market
friendly state.

The main OBJECTIVES behind the launching of the New Economic policy (NEP) in 1991
are stated as follows:
1. The main objective was to plunge Indian Economy in to the arena of
‘Globalization and to give it a new thrust on market orientation.
2. The NEP intended to bring down the rate of inflation

3. It intended to move towards higher economic growth rate and to build sufficient
foreign exchange reserves.

4. It wanted to achieve economic stabilization and to convert the economy into a
market economy by removing all kinds of un-necessary restrictions.

5. It wanted to permit the international flow of goods, services, capital, human
resources and technology, without many restrictions.
6. It wanted to increase the participation of private players in the all sectors of the
economy. That is why the reserved numbers of sectors for government were reduced. 

FEATURES OF NEP (Q.P)

1. Liberalisation:
The new economic policy has made provision for liberalizing the economy against
unnecessary controls and regulations. Here the liberalisation simply indicates liberating
the trade and industry from unwanted restrictions. In order to liberalise the economy
and to bring transparency in the policy, the New Industrial Policy, 1991 has abolished
the system of industrial licensing for all industrial undertaking, except for a short list of
18 industries related to security and strategic concern, social reasons, hazardous
chemicals and overriding environmental concerns and items of elitist consumption.

The New Industrial Policy has liberalized the industries in

the following manner:
(i) All other industries, excepting 18 industries, are delicensed and allowed to set up and
sell shares without any restriction;

(ii) Industries are allowed to expand their capacity freely as per the needs of the market;

(iii) Producers are allowed to produce any commodity or diversify their output as per the
demand in the market;

(iv) MRTP companies (having investment beyond Rs. 100 crore) are now no longer
required to go for pre-entry of investment decisions and they are now allowed to expand
their size;

(v) In 1996-97, the policy of industrial reforms has enhanced the investment ceilings in plant
and machinery for small scale industries.

(vi) Industries have been set free to buy foreign exchange from open market and also to
make necessary imports. The aforesaid measures have liberalised the industries to take
prompt decisions so as to raise their efficiency in production and to face open
competition in the market.

2. Privatisation:
Another important feature of New Economic Policy is the promotion of the policy of
privatisation. Here the word privatisation means introduction of private ownership in
publicly owned and managed enterprises and also signifies introduction of private
control and management in public sector enterprises. Under the policy of economic
reforms private sector has been allowed to play a major role in respect of economic
activities.

The privatisation programme of the economic reforms

includes:
(i) Reducing the number of industries reserved for the public sector from 17 to 8;

(ii) Raising the share of private sector to total investment to 55 per cent at the end of
Eighth Plan;

(iii) Selling the government equity holdings of public sector enterprises among the
workers and public for greater participation of private individuals;

(iv) Institutional credit support, to private sector enterprises from the national financial
institutions. Thus this privatisation move is expected to raise the efficiency and
productivity of the private sector.

3. Globalisation of the Economy:

By the term globalisation we mean opening up of the economy for world market by
attaining international competitiveness. Thus the globalisation of the economy simply
indicates interaction of the country relating to production, trading and financial
transactions with the developed industrialised countries of the world.

Globalisation of the Indian economy has made the

following changes:
(i) The New Economic Policy (1991) has prepared a specified list of high technology and
high investment priority industries in which automatic permission will be available for
foreign direct investment up to 51 per cent of foreign equity.

(ii) In respect of foreign technology agreements, automatic permission is provided in

high priority industry up to a sum of Rs. 1 crore. No permission is now required for
hiring foreign technicians or for testing indigenously developed technology abroad.
(iii) In order to make international adjustment of Indian currency, rupee was devalued
in July 1991 by nearly 20 per cent which also stimulated exports, discouraged imports
and raised the influx of foreign capital.

(iv) A new five year export-import policy, 1992-97 was announced by the Government. The
main objectives of the new policy are to establish the framework of globalisation of India’s
foreign trade, to promote productivity, modernisation and competitiveness of Indian industry
and thereby to enhance its export capabilities and also to simplify and streamline the procedures
governing exports and imports

(vii) In order to increase the flow of foreign investment and technology the Government
has taken several measures like:

(a) Granting foreign technical collaborations of high priority industries,

(b) Freedom to import foreign technology by private entrepreneurs and also to test
indigenous technology abroad,

(c) Establishing Foreign Investment Promotion Board (FIPB) for finalizing foreign
investment and collaboration proposals and

(d) Offering concessions to FERA/FEMA companies.

4. New Public Sector Policy:

Another important feature of new economic policy is its change in public sector policy.
The new policy has shifted its emphasis from public to private sector.

The Industrial Policy has undertaken the following four

major policy decisions in respect of public sector:
(i) Reduction in the list of industries reserved for the public sector from 17 to 8 and
introducing selective competition in the reserved areas.

(ii) Disinvestment of shares in PSEs to raise resources and encourage wider

participation of general public and workers in the ownership of PSEs.

(iii) Policy for sick PSEs be designed at par with that of the private sector. Sick PSEs
which are unlikely to turn around will be referred to BIFR for formulation of revival
schemes.
(iv) Improving performance through the performance contract or Memorandum of
Understanding (MOU) system by which Managements are to be granted greater
autonomy and held accountable for results.

5. Modernisation:
The New Economic Policy has been providing high priority to the introduction of
modern techniques in production system. The policy facilitates the growth of sunrise
industries, i.e. electronics and computers. In order to introduce better and improved
technology, the government is permitting all foreign collaboration proposals related to
the import of high technology. Steps have also been taken for the modernisation of the
age-old steel, textile, jute, sugar, leather industries having rich potential. This is
important for attaining self reliance and also for cost reduction and the production of
high quality goods required for both internal consumption and exports. Steps have also
been taken for the revival and modernisation of sick industrial units established both
under public and private sectors.

6. Financial Reforms:
Government has undertaken various measures for the reform of the financial sector.

These include:
(i) Reduction in liquidity ratio,

(ii) Abolition of direct credit programmes,

(iii) Free determination of interest rates,

(iv) Necessary improvement in the banking accounting system,

(v) Making provision for Non-performing assets (NPAs),

(vi) Establishing speedy recovery of loans by special tribunals,

(vii) Reconstitution of banking system for the establishment of a few banks of

international standard, national banks, local banks, rural banks, private sector banks
etc.,

(viii) Liberal treatment to foreign banks;

(ix) Abolition of branch licensing system,

(x) Giving more freedom to banks and ending dual control of RBI and Finance Ministry,

7. Fiscal Reforms:
Another important feature of New Economic Policy is to introduce fiscal policy reforms.
The Government initiated various fiscal measures in order to reduce the fiscal deficit
from 8.4 per cent of GDP in 1990-91 to 5.0 per cent in 1996-97 and then to 4.4 per cent
in 1999- 2000.

In order to achieve the target the Government has introduced various controls over
public expenditure and took initiative to raise its both tax and non-tax revenue. The
other measures include imposition of fiscal discipline by both Central and State
Governments, reduction of subsidies, rationalisation of excise and custom duties rate
structure, constituting Expenditure Reforms Commission in 1999-2000 budget,