Introduction and Background

  1. Since independence, India followed the mixed economy framework by combining the advantages of the market economic system with those of the planned economic system.
  2. Over the years, this policy resulted in the establishment of a variety of rules and laws which were aimed at controlling and regulating the economy.
  3. Instead, it ended up in hampering the process of growth and development.
  4. In 1991, India met with an economic crisis relating to its external debt, the government was not able to make repayments on its borrowings from abroad.
  5. Foreign exchange reserves, which we generally maintain to import petrol and other important items, dropped to levels that were not sufficient for even a fortnight.
  6. All these led the government to introduce a new set of policy measures which changed the direction of our developmental strategies.

Advent of crisis

  1. The origin of the financial crisis can be traced from the inefficient management of the Indian economy in the 1980s.
  2. The government generates funds from various sources such as taxation, running of public sector enterprises etc.
  3. When expenditure is more than income, the government borrows to finance the deficit from banks and also from people within the country and from international financial institutions.
  4. When we import goods like petroleum, we pay in dollars which we earn from our exports.
  5. Even though the revenues were very low, the government had to overshoot its revenue to meet problems like unemployment, poverty and population explosion.
  6. The government was not able to generate sufficiently from internal sources such as taxation.
  7. The government was spending a large share of its income on areas which do not provide immediate returns such as the social sector and defence.
  8. The income from public sector undertakings was also not very high to meet the growing expenditure.
  9. Our foreign exchange, borrowed from other countries and international financial institutions, was spent on meeting consumption needs.
  10. Neither was an attempt made to reduce such profligate spending nor sufficient attention was given to boost exports to pay for the growing imports.
  11. In the late 1980s, government expenditure began to exceed its revenue by such large margins that it became unsustainable.

Declination of foreign exchange reserve & assistance from the financial institution

  1. Prices of many essential goods rose sharply. Imports grew at a very high rate without matching the growth in exports.
  2. Foreign exchange reserves declined to a level that was not adequate to finance imports for more than two weeks.
  3. There was also not sufficient foreign exchange to pay the interest that needs to be paid to international lenders.
  4. India approached the International Bank for Reconstruction and Development (IBRD) popularly known as the World Bank and the International Monetary Fund (IMF) it received $7 billion as the loan to manage the crisis.

Condition led by financial institution and beginning of NEP

  1. These international agencies expected India to liberalise and open up the economy by removing restrictions on the private sector.
  2. Reduce the role of the government in many areas and remove trade restrictions.
  3. India agreed to the conditionality of the World Bank and IMF and announced the New Economic Policy (NEP). The NEP consisted of wide-ranging economic reforms.
  4. The thrust of the policies was towards creating a more competitive environment in the economy and removing the barriers to entry and growth of firms.

Measures were taken under NEP

It can broadly be classified into two groups:

  • The stabilisation measures
  • The structural reform measures
  1. Stabilisation measures are short-term measures, intended to correct some of the weaknesses that have developed in the balance of payments and to bring inflation under control.
  2. This means that there was a need to maintain sufficient foreign exchange reserves and keep the rising prices under control.
  3. Structural reform policies are long-term measures, aimed at improving the efficiency of the economy and increasing its international competitiveness by removing the rigidities in various segments of the Indian economy.
  4. The government initiated a variety of policies which fall under three heads viz., liberalisation, privatisation and globalisation.
  5. The first two are policy strategies and the last one is the outcome of these strategies.


  1. Liberalisation was introduced to put an end to these restrictions and open up various sectors of the economy.
  2. A few liberalisation measures were introduced in the 1980s in areas of industrial licensing, export-import policy, technology upgradation, fiscal policy and foreign investment; reform policies initiated in 1991 were more comprehensive.
  3. Some important areas such as the industrial sector, financial sector, tax reforms, foreign exchange markets and trade and investment sectors which received greater attention in and after 1991.

Deregulation of the Industrial Sector

In India, regulatory mechanism regulatory mechanisms were enforced in various ways

  1. Industrial licensing under which every entrepreneur had to get permission from government officials to start a firm, close a firm or to decide the number of goods that could be produced
  2. The private sector was not allowed in many industries
  • Some goods could be produced only in small-scale industries
  1. Controls on price fixation and distribution of selected industrial products.
  2. The reform policies introduced in and after 1991 removed many of these restrictions.
  3. The only industries which are now reserved for the public sector are defence equipment, atomic energy generation and railway transport.
  4. Many goods produced by small-scale industries have now been dereserved, in many industries; the market has been allowed to determine the prices.

Financial Sector Reforms

  1. The financial sector in India is controlled by the Reserve Bank of India (RBI).
  2. The RBI decides the amount of money that the banks can keep with themselves, fixes interest rates, nature of lending to various sectors etc.
  3. One of the major aims of financial sector reforms is to reduce the role of RBI from the regulator to facilitator of the financial sector.
  4. The reform policies led to the establishment of private sector banks, Indian as well as foreign.
  5. Foreign investment limit in banks was raised to around 50 per cent.
  6. Those banks which fulfil certain conditions have been given freedom to set up new branches without the approval of the RBI and rationalise their existing branch networks.
  7. Certain aspects have been retained with the RBI to safeguard the interests of the account-holders and the nation.
  8. Foreign Institutional Investors (FII) such as merchant bankers, mutual funds and pension funds are now allowed to invest in Indian financial markets.

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