India Economic and Financial Policy in the 1990’s

By | December 16, 2021

As far as economic policy changes are concerned, the 1990s were far more significant for India than the previous four decades. These transformations are best appreciated when viewed in relation to the behavior of the Indian economy and related economic policy in the period preceding the last decade. For about 35 years after 1947, Indian economic policy remained practically unchanging with respect to its three basic characteristics: industrialization as a primary objective, the protection of the economy through tariff barriers, a strongly interventionist role of the state. Of these only the last aspect requires some additional consideration.

In the 1950s, the Indian state had launched an industrialization program that was to be implemented thanks to a massive increase in public spending, reserving certain areas of industrial activity deemed ‘crucial’ to the government and limiting the expansion of private industrial capacity through a policy of licenses. The logic of the latter measure was the need to avoid wasting resources. To this was added the management of international trade through restrictions on exports and imports. The goods that were allowed to be imported (mostly equipment and accessories) were subject to tariffs, and the quantity that could be imported depended on the license granted. All this generated an industrial structure which, although not totally monopolistic, was certainly oligopolistic. This policy was carried on roughly unchanged until the 1980s, with the exception of a brief interval in the mid-1960s. Subsequently, hit by the shortage of two consecutive harvests and a currency crisis, India was forced to turn to multilateral agencies. However, after a substantial devaluation of the exchange rate and a brief interlude of trade liberalization, economic policy essentially reverted to its previous regime. This period also saw a slowdown in public investments, due to the progressive worsening of public finances, manifested by the emergence in India of what is called revenue deficit ; which, from a technical point of view, is a public current account deficit rather than capital account deficit, but which, from a substantial point of view, means public debt aimed at financing consumer spending.

In the 1980s, a three-tier reform program began in India. In chronological order, industrial policy reforms, exchange rate policy reforms and an expansive macroeconomic policy were envisaged. The industrial policy reforms provided for facilitations in the granting of licenses for industrial investments, while the reforms concerning relations with foreign countries involved changes in the exchange rate policy towards a system of managed fluctuation. However, the most conspicuous change of the 1980s occurred in the sphere of macroeconomic management. Public spending on consumption, and in particular on subsidies, recorded growth which, in the absence of an increase in revenues, contributed to the deterioration of public finances. Furthermore, contrary to usual practice, the government resorted to international loans to finance spending. The Gulf War of 1991 hit the Indian economy in two ways: on the one hand, with an increase in the international price of oil, and on the other, with a reduction in remittances from Indian immigrants residing in the region. This caused a payments crisis and, with the economy close to being unable to honor external commitments, the government turned to the International Monetary Fund, which granted it a standby loan in exchange for sweeping reforms.

The changes in economic policy promoted starting from 1991, among the most radical of the period after 1947, have included macroeconomic stabilization and structural reforms. Macroeconomic stabilization aimed to correct the external imbalance; longer-term structural reforms were to contribute to an improvement in the current account, while a reduction in the fiscal deficit should have both brought the trade deficit under control and reduced the rate of inflation. Following a series of changes, the current trading regime has two characteristics: a reduction in quantitative controls on imports (now limited to consumer goods) and a substantial general reduction in tariffs. The maximum tariff rate, equal to 110 % in 1992 – 93, had dropped to 40 % in 1995 – 96. The exchange rate is virtually fluctuating for all current account transactions. Taking into account the control system in force in India for over four decades, this can only be considered a radical change. Other structural reforms concerned industrial policy, completely abolishing the licensing system and significantly easing the constraints on foreign investment. For India defense and foreign policy, please check

As regards the effects of the new economic trend, the positive impact of the reforms on the country’s financial position vis-à-vis foreign countries should first of all be noted. A few years after the reforms began, both India’s external debt (percentage of GDP) and its debt service ratio fell; as a result, the balance of payments situation is considered sustainable in the medium term. Since the reforms had been necessitated primarily by the critical position of the balance of payments, it can be said that they have been crowned with some success. This also denotes a certain resilience of the Indian economy, which has been able to cope with the growing competitiveness resulting from the opening towards foreign countries.

The assessment of economic growth is, however, less positive: although the economy has experienced a recovery after an initial slowdown, an inevitable result of the demand shock caused by the stabilization, it has not returned to the levels it had reached in the late 1980s. This is largely due to the disappointing response of private investment despite some measures to stimulate supply, such as lowering the tax rate on personal and business income. Furthermore, although the data on poverty must be viewed with caution, there are reasons to believe that poverty has not been affected by the reforms, and this is certainly a factor to bear in mind when making a final judgment on Indian economic policy.

India economic policy