Economic liberalisation in India

Based on Wikipedia: Economic liberalisation in India

In the summer of 1991, India was so broke that it had to load sixty-seven tonnes of gold onto planes and ship it to banks in London, Zurich, and Tokyo just to secure emergency loans. The country's foreign exchange reserves had dwindled to the point where they could cover less than three weeks of imports. For a nation of nearly 900 million people, this was the economic equivalent of having your credit cards maxed out, your checking account overdrawn, and the rent due tomorrow.

This crisis didn't just threaten India's economy. It threatened India's sovereignty. And the response to it would transform the country from a socialist-leaning, inward-looking nation into one of the fastest-growing major economies in the world.

The Seeds of Crisis

To understand how India found itself in such desperate straits, you need to go back to independence in 1947. The leaders who built modern India, particularly Prime Minister Jawaharlal Nehru, had watched the British East India Company colonize their country under the guise of trade. They weren't about to let that happen again.

Nehru and his successors embraced what economists call import substitution industrialization. The idea was straightforward: instead of buying goods from abroad, India would make everything itself. The government would control the commanding heights of the economy. Foreign companies would be kept at arm's length. Domestic industry would be protected behind high tariff walls.

This approach had a name that captured its bureaucratic essence: the Licence Raj. If you wanted to start a business, expand production, import machinery, or do almost anything commercial, you needed a license from the government. Getting these licenses required navigating byzantine procedures, endless paperwork, and often, unofficial payments to the right officials. The system was designed to give the state control over every aspect of economic life.

There was logic to this approach. Many newly independent nations in the mid-twentieth century adopted similar policies, reasoning that infant industries needed protection from established foreign competitors. And India did build a substantial industrial base during these decades, including steel mills, power plants, and manufacturing facilities.

But the results were underwhelming. From the 1950s through the 1980s, India's economy grew at an average of just four percent per year. Per capita income growth was even more anemic at around 1.3 percent annually. Economists began calling this the Hindu rate of growth, a somewhat unfair term that blamed religion for what were really policy failures.

Meanwhile, India's neighbors were leaving it behind. South Korea, Taiwan, Singapore, and Hong Kong, the so-called Asian Tigers, were growing at breakneck speed by embracing export-oriented manufacturing and foreign investment. Even China, a communist country, had begun opening its economy in the late 1970s under Deng Xiaoping.

The Coca-Cola Test

Nothing illustrated India's attitude toward foreign business quite like the Coca-Cola saga.

In the late 1970s, the Janata Party government, seeking to promote economic self-reliance, passed regulations requiring multinational corporations to partner with Indian companies. Coca-Cola and IBM, rather than share their proprietary secrets with local partners, simply left the country.

For nationalist politicians, this was a victory. India had stood up to corporate America. For consumers, it meant no more Coke. For the economy, it meant one less source of foreign investment and expertise.

The irony would become apparent in the 1990s when Coca-Cola returned after liberalization. The company's superior marketing and distribution networks quickly overwhelmed domestic competitors like Pure Drinks Group and Parle Bisleri, which had filled the gap during Coca-Cola's absence. Several Indian bottling plants closed. Parle eventually sold much of its cola business to Coca-Cola itself. The protectionist interlude had merely delayed, not prevented, foreign competition while depriving Indian companies of decades of experience competing against world-class rivals.

Early Reform Attempts

India's first serious flirtation with liberalization came in 1966, under pressure from a familiar source: the International Monetary Fund and World Bank, collectively known as the Bretton Woods institutions after the New Hampshire resort where they were conceived in 1944.

India was struggling with rapid inflation following a war with China in 1962 and severe droughts. The government needed foreign loans. The price for those loans was economic reform. India devalued the rupee, hoping to make exports cheaper and reduce the trade deficit. Tariffs and export subsidies were scaled back.

Then came the backlash. A second poor harvest and industrial recession gave ammunition to critics who resented foreign meddling in India's economy. There were fears that liberalization was the first step toward abandoning socialist principles. By 1968, trade restrictions were back in place, and a new Foreign Investments Board was established to scrutinize any company with more than forty percent foreign ownership.

The lesson seemed clear: economic reform in India would face fierce political opposition.

The 1980s Awakening

Change came gradually during the 1980s under Prime Ministers Indira Gandhi and her son Rajiv Gandhi. Both began loosening the Licence Raj's grip, though neither dismantled it entirely.

The most significant reform was the New Computer Policy of 1984, which did something almost revolutionary for India at the time: it eased restrictions on importing technology. Private investment in computing was encouraged. Software exports received government support. This policy planted the seeds for India's future information technology boom.

In 1988, the National Association of Software and Service Companies, known by its abbreviation NASSCOM, was established to support the nascent industry. Software Technology Parks were created to provide infrastructure and tax benefits to companies producing software for export. These parks offered something crucial for a software business: reliable data communications, which were hard to come by in India at the time.

The reforms worked, at least partially. Economic growth during the 1980s averaged 5.6 percent, significantly better than the previous decades. Industrial output grew even faster. From 1988 to 1991, the economy expanded at an impressive 7.6 percent annually.

But this growth was fragile, built on a shaky foundation.

The Architecture of Crisis

Here's where it gets technical, but understanding the mechanics matters.

India maintained a fixed exchange rate, meaning the government set the rupee's value relative to a basket of foreign currencies rather than letting markets determine it. Fixed exchange rates can provide stability for businesses and prevent currency speculation. But they also require the government to actively defend the exchange rate using its foreign currency reserves.

Think of it like maintaining a dam. As long as the water pressure on one side roughly equals the resistance of the dam, everything is fine. But if pressure builds, like if more people want to exchange rupees for dollars than the other way around, the government must open the floodgates on its reserves to maintain the balance.

During the 1980s, India liberalized imports of consumer goods like automobiles, electronics, refrigerators, and air conditioners. Wealthier Indians, eager for products unavailable domestically, began buying foreign goods. With the fixed exchange rate, they got these imports at artificially low prices because the government was essentially subsidizing the rupee's value.

Meanwhile, India's booming automobile industry needed oil, lots of it, and India didn't produce enough domestically. Every barrel of imported crude drew down the foreign exchange reserves.

The dam was weakening.

When Everything Went Wrong at Once

In August 1990, Iraq invaded Kuwait. The First Gulf War that followed sent oil prices skyrocketing. India, dependent on imported petroleum, suddenly faced a much larger import bill.

That same crisis cut off another source of foreign currency: remittances from the millions of Indians working in Gulf states. Many had to flee the war zone, returning home without the ability to send money back from abroad.

Then the Soviet Union collapsed. This wasn't just an ideological blow to India's socialist-leaning establishment. The USSR had been a major trading partner, and the disruption of established commercial relationships created additional economic strain. It also meant that the socialist model India had partially followed for decades was now thoroughly discredited on the world stage.

India was also going through domestic turmoil. The government's decision to implement reservations, a form of affirmative action for historically disadvantaged castes, sparked widespread protests. Communal violence between Hindus and Muslims added to the instability.

Foreign investors and creditors, watching this chaos, began pulling their money out of India. The dam was breaking.

The Gold Airlift

By early 1991, India's foreign exchange reserves covered less than two weeks of imports. The country was on the brink of defaulting on its international debt obligations.

The government of Prime Minister Chandra Shekhar, already weakened politically, had to take drastic action. India pledged twenty tonnes of gold to Union Bank of Switzerland and another forty-seven tonnes to the Bank of England and Bank of Japan. The gold was physically airlifted out of the country, a humiliating spectacle for a proud nation.

This bought time, but it didn't solve the underlying problem. And then the political situation grew even more chaotic.

The Chandra Shekhar government collapsed. During the ensuing election campaign, former Prime Minister Rajiv Gandhi was assassinated by a suicide bomber. Out of this tragedy emerged a new government led by P. V. Narasimha Rao, an experienced but uncharismatic politician who had been considering retirement.

Rao made a decision that would change India's trajectory: he appointed Manmohan Singh as Finance Minister.

The Quiet Revolutionary

Manmohan Singh was an unlikely revolutionary. A soft-spoken economist who had earned his doctorate from Oxford, he had spent his career in various government positions and international organizations. He was not a politician; he had never won an elected office. He wore a distinctive light blue turban and spoke so quietly that people sometimes strained to hear him.

But Singh understood economics, and he understood that India's crisis required not just emergency measures but fundamental reforms. Prime Minister Rao gave him complete authority to do whatever he thought necessary.

Working with Principal Secretary Amar Nath Verma and Chief Economic Advisor Rakesh Mohan, Singh developed a comprehensive reform plan. The centerpiece was the New Industrial Policy, announced in July 1991, which attacked the Licence Raj from multiple directions.

First, licensing requirements were abolished for all but eighteen industries deemed essential for security, safety, or environmental reasons. Suddenly, entrepreneurs could start businesses without begging the government for permission.

Second, foreign investment was welcomed rather than feared. Companies could now invest up to fifty-one percent foreign equity without prior government approval. The old requirement that foreign companies share their technology through partnership agreements was scrapped.

Third, public sector monopolies were broken up. The government would sell shares in state-owned companies and limit new public sector investment to truly essential areas like defense and infrastructure.

Fourth, the concept of Monopolies and Restrictive Trade Practices companies was abolished. Previously, any company whose assets exceeded a certain threshold was placed under special government supervision, effectively punishing success. No more.

The Epochal Budget

Singh's budget, presented on July 24, 1991, addressed the immediate crisis while laying groundwork for long-term transformation. He called it a crisis budget, but history would call it the Epochal Budget.

To control the fiscal deficit, Singh cut government spending. Subsidies for fertilizer were reduced. Sugar subsidies were eliminated entirely. State-owned companies would be partially privatized.

The rupee was devalued by nineteen percent against the dollar, making Indian exports cheaper and imports more expensive. This was painful medicine. It meant that imported goods, including the petroleum that powered Indian industry, would cost more. But it also meant that India's foreign exchange reserves would stretch further and that exporters could compete more effectively in global markets.

Singh knew the oil price increase would hurt ordinary Indians who depended on kerosene for cooking and lighting. So he created a two-tier system: kerosene prices for household use would actually decrease, while industrial petroleum prices would rise. The poor would be protected while businesses absorbed the higher costs.

Trade policy was reoriented entirely. The old system of high tariffs, some exceeding three hundred percent, would be brought down to a maximum of one hundred fifty percent. Export subsidies were abolished, replaced by a more level playing field. Import controls were loosened.

When Singh presented this budget to Parliament, he concluded with words that echoed around the world: "Let the whole world hear it loud and clear. India is now wide awake."

The Strings Attached

It would be naive to present these reforms as purely India's choice. The International Monetary Fund and World Bank were not offering advice. They were setting conditions.

In November 1991, the World Bank approved a structural adjustment loan of five hundred million dollars. The loan document specified exactly what India was expected to do: deregulate industry, increase foreign direct investment, liberalize trade, reform interest rates, strengthen stock markets, and sell off public enterprises.

This conditionality was controversial then and remains so now. Critics argued that India was surrendering economic sovereignty to institutions dominated by wealthy Western nations. The reforms were not purely voluntary but imposed under duress by creditors who held India's financial survival in their hands.

Opposition politicians in India attacked the budget as a command budget from the IMF. They warned that ending subsidies and raising fuel prices would devastate the poor. They predicted that devaluation would cause runaway inflation. They questioned whether the trade deficit would improve at all or whether India would simply import more expensive goods while its exports remained uncompetitive.

Prime Minister Rao's political support was crucial during this period. Without his backing, Singh's reforms might have died in parliamentary opposition. Rao absorbed enormous political criticism to give his finance minister the space to work.

Reforming the Banks

India's financial system also needed restructuring. Banks were heavily regulated, required to hold large portions of their deposits in government securities and cash reserves rather than lending to businesses. Interest rates were set by government diktat rather than market forces.

In August 1991, the Reserve Bank of India, the country's central bank, established the Narasimham Committee to recommend changes. The committee proposed dramatic reforms: reduce the statutory liquidity ratio from thirty-eight and a half percent to twenty-five percent, cut the cash reserve ratio from fifteen percent to ten percent, let markets set interest rates, give the central bank sole authority over banking regulation, and reduce the number of public sector banks.

The government implemented many of these recommendations over the following years. Private banks were allowed to compete more freely. Branch opening, previously controlled by government mandate, was liberalized. The banking sector began its long transformation from a sleepy government-dominated system to a more competitive industry.

What Changed

The reforms inaugurated a period of economic transformation that continues to this day. India's economy has grown at an average of around six to seven percent annually since 1991, roughly double the pre-reform rate. The services sector, particularly information technology and business process outsourcing, emerged as major drivers of growth and employment.

Foreign investment, once viewed with suspicion, became a source of capital, technology, and expertise. Multinational companies established operations in India, creating jobs and training workers. Indian companies, no longer protected from competition, became more efficient and innovative. Some, like the Tata Group and Infosys, became global players themselves.

The software industry that had been nurtured in the 1980s exploded after liberalization. Companies in Bangalore, Hyderabad, and other cities began providing services to clients around the world. By the early 2000s, India had become synonymous with information technology outsourcing, a remarkable achievement for a country that had once struggled to provide reliable telephone service.

The Critics' Concerns

Not everyone celebrated these changes.

Environmental concerns mounted as industrial expansion accelerated and regulations were relaxed to attract investment. Factories proliferated without adequate pollution controls. Natural resources were exploited more intensively.

The benefits of growth were not equally distributed. While a new middle class emerged, enjoying consumer goods and opportunities that their parents could never have imagined, hundreds of millions of Indians remained in poverty. Some argued that liberalization had actually widened inequality, creating islands of prosperity in a sea of deprivation.

Traditional industries and small businesses often struggled to compete against larger, better-capitalized rivals, both foreign and domestic. Artisans and farmers found their livelihoods threatened by cheap imports and changing market conditions.

The agricultural sector, which still employed the majority of Indians, did not benefit from liberalization to the same degree as industry and services. Farmer distress, including tragically high rates of suicide among indebted cultivators, remained a persistent problem.

The Debate Continues

More than three decades after Manmohan Singh's epochal budget, the debate over India's economic liberalization continues.

Supporters point to undeniable achievements: hundreds of millions lifted out of extreme poverty, a thriving technology sector, companies that compete globally, and an economy that has become the world's fifth largest. They argue that without the 1991 reforms, India would have remained trapped in the low-growth equilibrium of earlier decades.

Critics counter that the growth has been insufficiently inclusive, that environmental damage has been severe, and that India remains far behind where it should be given its human capital and potential. They note that while China also liberalized its economy, it maintained more state direction and achieved faster poverty reduction.

What seems clear is that India in 1991 had few good options. The status quo was unsustainable. The country was essentially bankrupt. Some form of reform was necessary, though its exact shape was subject to debate and continues to be refined.

The gold airlift to foreign banks marked a low point in India's post-independence history. But it also marked a turning point. India was indeed, as Singh declared, wide awake. Whether it has made the most of its waking hours remains a question for future historians to answer.