Knowledge nugget of the day: Manmohan Singh’s contribution to India economy — LPG Reforms

Key Takeaways:

1. When Manmohan Singh became Finance Minister in 1991, India was on the verge of economic collapse, with foreign exchange reserves sufficient to cover only a few weeks of essential imports. Faced with one of the most serious economic challenges in independent India, Singh decided to introduce economic reforms in 1991, focused on liberalisation, privatisation, and opening up India’s economy, aligning with market-driven principles.

2. Singh’s reforms in 1991 sought to liberalise and end the ‘Licence Raj’ through industrial policy reforms. These helped India navigate a critical balance-of-payments crisis when the country had foreign exchange reserves sufficient for just two weeks of imports as against the normal safe level of three months of import cover at that time.

3. The new Industrial Policy Resolution abolished most trade licences, and provided freedom to enterprises, opening up the country to foreign direct investment, thereby, substantially deregulating the industrial sector.

The objective of the Economic Reform: Liberalisation, Privatisation, and Globalisation

📍Liberalisation: The reform ended the excessive regulatory framework known as the ‘license-permit raj’ system. The new industrial policy abolished industrial licensing for all projects barring a select few strategic industries, allowed the government to disinvest its shareholding in the public sector, and amended the Monopolies and Restrictive Trade Practices (MRTP) Act to allow for the setting up, expansion, and merger of businesses without prior approval. These measures were followed up with liberalisation of the banking sector and capital markets.

In line with the recommendations of the Narasimham Committee Report of 1991, the government proposed to cut down the SLR (statutory liquidity ratio) from 38.5 percent to 25 percent over a three-year period, and cash reserve ratio from 25 per cent to 10 percent over a period of four years. Bank branch licensing policy and setting of interest rates by lenders were also liberalised. These measures ensured that the financial sector had the capacity to fund the economic expansion being initiated by liberal industrial and trade policy.

Dr Manmohan Singh in conversation with the World Bank President Lewis T Preston in 1992. (Express Archives)

📍Privatisation: It led to the transfer of businesses from the control of the state to the private sector. The new policy reduced the number of areas reserved only for public sector companies from 17 to 8. These structural reforms led to new enterprises coming into the picture both in the industrial and services sectors, growth gaining momentum, and a large number of Indians exiting poverty.  With these policy reforms, nearly 80 percent of the industry was taken out of the industrial licensing framework and the Monopolies & Restrictive Trade Practices (MRTP) Act was repealed to eliminate the need for prior approval for capacity expansion by companies.

📍Globalisation: The main objective of globalisation was to integrate the Indian economy with the world economy by reducing trade barriers, and facilitating the free flow of capital, technology, and labour. The 1991 reform reduced the trade import duties, automatic permission was allowed to be given for foreign technology agreements in high-priority industries, and disallowed the permission for hiring of foreign technicians and foreign testing of indigenously developed technologies. The Indian government allowed direct foreign investment of up to 51 per cent foreign equity and removed bottlenecks to facilitate foreign technology agreements in high-priority industries.

As finance minister in 1991, I ended my budget speech by quoting Victor Hugo, ‘No power on Earth can stop an idea whose time has come’. Thirty years later, as a nation, we must remember Robert Frost’s poem, ‘But I have promises to keep and miles to go before I sleep’.

— Singh said on the 25th anniversary of the LPG Reforms.

BEYOND THE NUGGET: Economic Crisis of 1990

1. A sharp jump in oil prices in August 1990 led to an acute economic crisis, turning the balance of payment situation unmanageable, depleting foreign exchange reserves along with massive capital outflows, and pushing India closer to a possibility of default.

2. These peculiar circumstances led to the government mounting the economic defence by devaluing the rupee on July 1, 1991, and the RBI transferring over 46 tonnes of gold from its reserves to the Bank of England for borrowing forex to manage immediate liquidity problems resulting from the Balance of Payment problem.

3. It was for the first time that there was the prospect of default on external commitments as the foreign currency reserves had fallen to a mere $1 billion by mid-1991.

4. This crisis compelled the government to create a new framework in which the fundamental principle would be that competition is key to improving efficiency.

(Source: Manmohan Singh, the original liberaliser, From the verge of collapse: How Manmohan Singh introduced 1991 economic reforms If we had maintained the momentum of 1991, we could have achieved much more)

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