Implementation of New Economic Policy to Indian economy in 1991

Several major economic and political changes occurred during the 1970s and 1980s, which affected the developing countries and paved the way for the implementation of IMF-sponsored Structural Adjustment Policies (New Economic Policy) in India in 1991. This was due to a combination of factors such as stagnant agriculture, low levels of industrial growth and diversification, inadequate capital formation, adverse terms of trade in international markets, limits to domestic resource mobilization due to a fairly narrow tax-base, loss making public sector enterprises, over regulated and controlled economy, poor industrial productivity, huge amount of fiscal deficit, huge amount of public debt, poor rating of Indian economy by international agencies, foreign exchange crisis etc.

New Economic Policy of 1991 includes globalization, liberalization and privatization (Disinvestment)

  1. Globalization means flow capital (finance in the form of foreign direct investment (FDI) and foreign portfolio investment (FPI), technology, human resource, goods and service among countries. FDI is investment in real assets like automobile, consumer goods production, service sectors like insurance, telecommunication, air transport etc.
  2. Liberalisation means freeing the economic activities and business from unnecessary bureaucratic and other controls imposed by the governments.
  3. Privatisation or Disinvestment: Selling the government owned public sector enterprises to private industrialists and opening the government operating sectors for private investment.

The New Economic Policy includes reduction in government expenditure, opening of the economy to trade and foreign investment, adjustment of the exchange rate from fixed exchange rate system to flexible exchange rate system, deregulation in most markets and the removal of restrictions on entry, on exit, on capacity and on pricing.

Immediate consequences of economic liberalization that are to focus on are (a) an increase in internal and external competition and (b) structural change induced by changes in relative prices in the economy.

The Major areas of  New Economic Policy 1991 are

  1. Fiscal policy reforms
  2. Monetary policy reform
  3. Pricing policy reform
  4. External policy reform
  5. Industrial policy reform
  6. Foreign investment policy reform
  7. Trade policy reform
  8. Public sector policy reform

The principal reforms initiated in the year 1991 included; reduction in import tariffs on most goods other than consumer goods, removal of quantitative restrictions and liberal terms of entry for foreign investors. India’s simple average tariff rate was reduced from 128% in 1991 to about 32.3% in 2001-02. Quotas and non-tariff barriers were also reduced.. To restore Macro economic stability, the reforms package of structural adjustment policies are aimed at freeing markets by dismantling controls on production, prices and trade and reducing intervention in the economy. The need to control the fiscal deficit led to policies to curb public expenditure and these cuts were mainly on social sector expenditure and on production and consumption subsidies, which directly affected the living standards of the economically vulnerable sections of the population. Privatisation, Liberalisation and export-promotion were the main features of the economic reforms recommended by the international institutions for the problems facing by the developing countries .At the same time, the role of the state in advanced industrial economies was not shrinking as expected, but growing despite the ideological bias in favour of a “rolled back” state. The share of national income spends by government, which averaged 30% in the rich industrial countries in 1960 increased to 42.5% by 1980 and 45% by 1990.The experiences of countries, which have undergone these reforms, have in most cases not led to the expected outcome but have infact worsened the state of their economies. In India, the New Economic Policy (NEP) is a set of policy (ies) and administrative procedures introduced in July 1991 to bring about changes in the economic direction of the country.

Industrial Policy Resolution 1991 (IPR-1991)

The regulatory policy framework which acted as a barrier to entry and growth by the entrepreneur was sought to be basically changed by the Industrial Policy announced in July 1991.The measures introduced in this area along with other economic reforms were as under: Industrial licensing has been abolished for all projects except for a list of 15 industries related to security, strategic or environmental concerns and certain items of luxury consumption that have a high proportion of imported inputs. The exemption from licensing also applies to the expansion of existing units.

  • Industrial licensing was abolished for all projects except for a list of 15 industries related to security, strategic or environmental concerns and certain items of luxury consumption that had a high proportion of imported inputs.
  • The Monopolies and Restrictive Trade Practices (MRTP) Act applied in a manner which eliminated the need to seek prior government approval for expansion of present undertakings and establishment of new undertakings by large companies.
  • The set of activities henceforth reserved for the public sector was much narrower than before, and there would be no ban on the remaining reserved areas being opened up to the private sector.

Foreign Investment Policy

The Industrial Policy 1991 also provided increased opportunities for foreign investment with a view to take advantage of technology transfer, marketing expertise and introduction of modern managerial techniques. It was also intended to promote a much – needed shift in the composition of external private capital flows. The following measures were announced in this regard:

  • Automatic approval would be given for direct foreign investment upto 51 per cent foreign equity ownership in a wide range of industries. Earlier, all foreign investment was generally limited to 40 per cent.
  • To provide access to international markets, major foreign equity holdings upto 51 per cent equity would be allowed for trading companies primarily engaged in export activities.
  • Automatic permission would be given for foreign technology agreements for royalty payments upto 5 per cent of domestic sales or 8 per cent of export sales or for lumpsum payments of Rs.10 million. Automatic approval for all other royalty payments will also be given if the projects can generate internally the foreign exchange required.
  • Abolished MRTP Act and FERA and instead of FERA, FEMA Act was passed in the Parliament.
  • The threshold (Minimum) asset limit for companies under MRTP Act was raised from Rs.20 crores to Rs.100 Crores.

Public Sector Policy

The Government was of the view that public sector had not generated internal surpluses on a large scale. On account of its inadequate exposure to competition; the public sector was subject to a high cost structure. To provide a solution to the problems of the public sector, Government decided to adopt a new approach, the key elements of which were:

  • The existing portfolio of public sector investment would be reviewed with a greater sense of realism to avoid areas where social considerations were not paramount or where the private sector would be more efficient.
  • Enterprises in areas where continued public sector involvement was judged appropriate would be provided a much greater degree of managerial autonomy.
  • Budgetary support to public  enterprises would be progressively reduced
  • To provide further market discipline for public enterprises, competition from the private sector would be encouraged and part of the equity in selected enterprises would be disinvested; and
  • Chronically sick public enterprises would not be allowed to incur heavy losses.

As a follow up of this policy, several measures were taken:

  • The number of industries reserved for the public sector was reduced from 17 to 8. Even in these areas, private sector participation was allowed selectively. Joint ventures with foreign companies would be encouraged.
  • Public enterprises that were chronically sick and unlikely to be turned around would be referred to the Board for Industrial and Financial Reconstruction (BIFR) for rehabilitation or restructuring.
  • The existing system of monitoring public enterprises through Memorandum of Understanding (MOU) was strengthened with primary emphasis on profitability and rate of return.
  • Initiated the disinvestment of public sector enterprises.