Liberalisation

Topic: The 1991 Crisis and LPG Reforms: An Appraisal · NCERT: Class 10, Ch 4 "Globalisation and the Indian Economy"; Class 11, Ch 3 "Liberalisation, Privatisation and Globalisation: An Appraisal"

Meaning

Liberalisation means removing the barriers or restrictions set by the government, so that sectors of the economy open up to private firms, competition and market forces. In 1991 India did this in five areas: industrial delicensing, the financial sector, taxes, foreign exchange, and trade and investment.

It is the first "L" of the LPG reforms. It started India's shift from the licence-permit system towards a market economy, while India stays a mixed economy.

Explanation

Where liberalisation fits in the 1991 package

• New Economic Policy (NEP), 1991: the reform package India began in 1991. Class 11 NCERT splits it into two groups of measures.
• Stabilisation measures are short-term steps. They fix the Balance of Payments (BoP, the record of all money flowing between India and the world) and control inflation. Examples are devaluation, fiscal correction and tight money. This is IMF-style demand management.

• Structural reform measures are long-term steps. They raise efficiency and international competitiveness by removing rigidities (fixed rules and controls that stop firms and markets from adjusting). This is World Bank-style supply-side reform.

• Liberalisation is a structural reform, not a stabilisation measure.

• Why it was needed:
• Under the licence-permit system, the government decided what firms could produce, how much, and at what price.
• Firms had no pressure to compete, so industry became inefficient and uncompetitive.
• Liberalisation lets markets and prices decide more of what, how and for whom to produce.

The five areas of liberalisation (Class 11)

1. Industrial sector (deregulation) - Most industrial licensing was ended. - Fewer industries were reserved for the public sector. - Price controls and capacity controls were relaxed.

2. Financial sector - The RBI's role changed from controller to facilitator. - The Narasimham Committee (November 1991) recommended a phased cut in SLR and CRR, along with norms on accounting, income recognition and capital adequacy [3].

   • CRR (Cash Reserve Ratio): the share of deposits a bank must keep as cash with the RBI.
   • SLR (Statutory Liquidity Ratio): the share of deposits a bank must keep in safe assets such as government securities.
   • Why a lower CRR and SLR matters:
   • Banks lock away less money
   • → they have more money to lend to businesses
   • → credit starts to follow market demand, not government orders.

3. Tax reforms - Income tax and corporate tax rates were made lower and simpler. - The tax base was widened. - Customs duties (taxes on imports) were reduced.

4. Foreign exchange - The rupee's value moved step by step from being fixed by the government to being set by the market. - Rupees could now be freely changed into foreign currency for everyday payments such as trade and travel.

5. Trade and investment - Import licensing was phased out. - Tariffs (taxes on imports) were cut. - FDI caps (limits on foreign ownership in Indian firms) were raised. - Quantitative restrictions (QRs), which are physical limits on the quantity of imports rather than a tax on them, were removed.

Order and speed of liberalisation

• First focus: industrial deregulation and trade liberalisation. Licences needed for investment and for imports were cut sharply [2].
• Later focus: tax reform, tariff cuts and financial-sector reform [2].
• Stabilise first, then liberalise. When reserves are near zero, an economy cannot absorb deep reform. So devaluation, fiscal cuts and IMF money came first (1991-92), and deeper trade and financial liberalisation followed over the decade [2].
• Gradualism: India opened up in small, planned steps. It did not use a "big bang".
• Russia in the 1990s freed prices overnight and carried out mass privatisation. The result was an output collapse and asset grabbing, where a few insiders took state firms cheaply.

In India

• Starting point: in June 1991, India's gross official reserves covered only a few weeks' worth of imports, and inflation was in double digits and rising [2]. The crisis created the pressure to liberalise.
• External-sector liberalisation, step by step:
• 1 and 3 July 1991: the rupee was devalued in two stages, by about 18% in US dollar terms [3]. This was a stabilisation step that came before liberalisation.
• March 1992: the Liberalised Exchange Rate Management System (LERMS) began. It was a dual exchange rate: part official rate, part market rate. It acted as a bridge to a market-set rate [3][4].
• 1 March 1993: LERMS was replaced by a unified, market-determined exchange rate, based on the demand for and supply of foreign exchange [4].

• August 1994: the rupee became convertible on the current account, and India accepted Article VIII of the IMF's Articles of Agreement [3][4].

• Banking liberalisation:

• The Narasimham Committee (November 1991) recommended phased cuts in SLR and CRR [3].

• In April 1992, norms for income recognition, asset classification, provisioning and capital adequacy were introduced, with compliance deadlines in 1994 and 1996 [3].

• Trade liberalisation and the WTO:

• India kept QRs on balance-of-payments grounds, which GATT allows as an exception [6].
• The US took India to the WTO in dispute DS90 over QRs on 2,714 tariff lines [5].
• The EXIM Policy of 31 March 2000 removed QRs on 714 items, which left 715 items [6].

• QRs on the remaining 715 items were removed with effect from 1 April 2001 [5].

• What is still not liberalised: full capital-account convertibility has not been adopted. The capital account covers buying foreign assets, and such purchases are still controlled.

Don't confuse with

• Privatisation: this shifts the ownership or management of public sector enterprises to private hands, for example through disinvestment. Liberalisation only removes rules and controls. It does not change who owns a firm.
• Globalisation: this links India's economy with the world through trade, investment, technology and people. Liberalisation is the domestic policy tool that makes this link possible.
• Stabilisation measures: devaluation, fiscal correction and tight money are short-term, IMF-style fixes for the BoP and inflation. Liberalisation is a long-term, World Bank-style structural reform.
• Current-account convertibility vs capital-account convertibility: the rupee became freely convertible for trade, travel and education payments in August 1994 [3]. Convertibility for buying assets (the capital account) has not been fully allowed.

Prelims Hooks

• Class 10 NCERT defines liberalisation as "removing barriers or restrictions set by the government". It is a structural reform, not a stabilisation measure.
• Class 11 lists five areas: industrial deregulation, financial sector, tax reforms, foreign exchange, and trade and investment.
• Narasimham Committee (1991) = financial-sector reform, including a phased cut in SLR and CRR [3].
• LERMS (March 1992) was a dual exchange rate. The unified market-determined rate came from 1 March 1993 [4]. Current-account convertibility and IMF Article VIII came in August 1994 [3].
• QRs fully removed from 1 April 2001 (the last 715 items), after WTO dispute DS90 brought by the US [5]. Trap: the complainant was the US, not the EU.
• The first reforms targeted industrial deregulation and trade liberalisation. Tax, tariff and financial reforms came later [2].

Mains Points

• Gradualism as a strength and a weakness: India liberalised in steps (1991 → 1992 → 1993 → 1994 → 2001) and so avoided the output collapse Russia suffered under shock therapy. The cost was slow reform, and the push for reform faded once the crisis passed. Full capital-account convertibility is still pending.
• First-generation vs second-generation liberalisation: the Centre largely finished liberalising product markets, trade, finance and the exchange rate, often by executive order. The binding limits today are in factor markets (markets for inputs to production: land, labour and power). Here the states must act, and political consensus is needed. This links to cooperative federalism (GS-II) and competitiveness (GS-III).
• "Externally imposed" or "home-grown"? India's liberalisation matched much of the Washington Consensus, the policy package pushed by the IMF, World Bank and US Treasury, and it came alongside IMF and World Bank loans [2]. Critics therefore call it externally driven. Supporters reply that India chose its own pace and sequence.

Related concepts

• Stabilisation measures
• Structural reform measures

Read more

• Stabilisation and structural reform: the architecture of LPG