LPG Reforms and Effects in India

LPG Reforms and Effects in India

• The Liberalization, Privatization and Globalization (LPG) reforms were introduced in India in the early 1990s to deal with economic and financial crisis. India approached the International Bank for Reconstruction and Development (IBRD), popularly known as World Bank and the International Monetary Fund (IMF), and received $7 billion as loan to manage the crisis.  

Causes of the Balance-of-Payment Crisis

• High Fiscal Deficit: The fiscal deficit in 1990 and 1991 was approximately 8.4% of GDP
• Impact of Crude Oil Prices and Gulf War: The invasion of Kuwait by Iraq in 1990 and 1991 caused a surge in oil prices, 
• High Inflation: Rapid increase in the money supply led to a rise in inflation from 6.7% to 16.7
• Rising Internal Debt: As a consequence of the high fiscal deficit, the government's internal debt soared. It surged from 35% of GDP in 1985-86 to 53% of GDP in 1990-91
• Depleted Forex Reserves: By June 1991, India had less than $1 billion in forex reserves, just enough to cover three weeks of imports, posing a significant challenge for conducting international business and worsening the balance of payment crisis. 
• Capital Flight: Investors swiftly withdrew their investments from India as they perceived the worsening economic conditions. This exacerbated the crisis, leading to a negative cycle of economic decline.

Introduction of the New Economic Policy, 1991 

• In response to the crisis, the Indian government announced the New Economic Policy in 1991, which served as a foundation for economic reforms known as the LPG reforms (Liberalization, Privatization, Globalization). 
• The LPG model included various reforms in different sectors:

• Industrial Policy Liberalization: Reductions in import tariffs, elimination of the license-permit raj (restrictive industrial licensing), and other measures to promote industrial growth and competitiveness.
• Privatization Initiatives: Deregulation of markets, reforms in the banking sector, and other measures to encourage private participation and improve efficiency.
• Globalization Measures: Changes in exchange rates, liberalization of trade and foreign direct investment policies, and removal of mandatory convertibility to stimulate international trade and investment.

Goals of Liberalization 

The objectives of liberalization in the Indian economy were to:

• Encourage Private Businesses, Facilitate Global Integration, Address Balance-of-Payments Issues, Enhance Private Sector Participation, Attract Foreign Direct Investment, Promote Competition

Policies of Liberalization:

The liberalization policies that contributed to the expansion of the Indian economy included:

• Financial Sector Reforms: Deregulation of the banking sector, introduction of market-based interest rates, and liberalization of capital markets.
• Industrial Sector Reforms: Reduction of industrial licensing requirements, simplification of regulations, and encouragement of private sector participation.
• External Sector Reforms: Liberalization of trade policies, reduction of import tariffs, and relaxation of restrictions on foreign exchange transactions.
• Foreign Exchange Reforms: Introduction of market-determined exchange rates, easing restrictions on capital movements, and simplification of foreign exchange regulations.
• Trade and Investment Policy Reforms: Opening up of key sectors to foreign investment, streamlining investment procedures, and encouraging export-oriented industries.

Impact of Liberalization on the Indian Economy

• Increased Economic Growth: From 1991 to 2020, the country's GDP grew at an average rate of 6.7%, compared to an average rate of 3.5% in the preceding three decades.
• Higher Foreign Investment: FDI inflows increased from $97 million in 1990-91 to $81.72 billion in 2020-21, according to the Ministry of Commerce and Industry.
• Improvement in Industrial Productivity: The Indian manufacturing sector's productivity increased by 6.8% annually between 1991 and 2006, as per a study by the Reserve Bank of India.
• Expansion of the Services Sector: The services sector's contribution increased from 37.2% in 1990-91 to 54.3% in 2020-21, according to the Ministry of Statistics and Programme Implementation.
• Increase in per capita income: The average monthly per capita expenditure of Indian households increased significantly from Rs. 206 in 1987-88 to Rs. 2,446 in 2017-18, based on a study by the National Sample Survey Office.
• Agriculture: Availability of modern Agro- technologies, Rise in production and productivity, Growth of Agro-exports (USD 43.37 billion in 2023).

Negative Impacts of Liberalization

• Widening Income Inequality: The top 1% of the population held 22% of the country's wealth in 1991, which rose to 42.5% in 2018, while the bottom 50% saw a decline in their share of wealth from 14% to 12.5%.
• Jobless Growth: India had job growth of 3% per annum in the 1970s and when the economy grew at 3-3.5 % however over the last three decades despite growth over 5-8% the job growth is only close to 1% per annum.
• Environmental Degradation: The industrialization and economic growth resulting from the reforms contributed to increased pollution levels in India. The country ranked 177th out of 180 countries in terms of air quality in 2020, according to the Environmental Performance Index.
• Dependence on Foreign Investment: The FDI inflows increased from $97 million in 1990-91 to $81.72 billion in 2020-21
• Agriculture: The status of Indian agricultural sector indicates that globalization did not yield the desired results in India.