1. Chapter 2
Review of Economic Policies and Growth
Performance
2.1 Introduction
The Indian government has been following the path of planned economic
development since Independence. During the long period of more than six decades
since the adoption of the First Five-Year Plan in 1951, the government has
implemented various policies and programmes in order to (1) achieve high eco-
nomic growth with equality, (2) improve the living conditions of people and reduce
the incidence of unemployment and poverty and (3) achieve balanced regional
development. Naturally, during the regime of planned economic development,
economic policies and strategies of the government were influenced by these
objectives. However, the economy has experienced, among other things, wide
fluctuations in the growth rate of gross domestic product (GDP) and its various
components, high incidence of unemployment and poverty, large interregional
disparities in development, etc. The post-Independence period has witnessed
major policy changes at several time points, and the economy has reached the
present state of development after passing through various phases.
This chapter briefly reviews the economic policies adopted by the government at
different time points, with special reference to the large-scale economic reform
programmes since 1991, and evaluates the growth performance of the economy during
different phases. There exists a huge literature reviewing the large-scale economic
reforms and their impacts on various aspects of the economy (see, e.g. Acharya et al.
2006; Ahuja et al. 2006; Bhattacharya and Kar 2007; Panagariya 2005). Drawing on
the existing literature, we make a review of the policies adopted by the Indian
government since 1950. For convenience of analysis, the period since 1950 is divided
into three subperiods: (1) 1950–1980, (2) 1980–1991 and (3) 1991 onwards.
M. Ghosh, Liberalization, Growth and Regional Disparities in India,
India Studies in Business and Economics, DOI 10.1007/978-81-322-0981-2_2,
# Springer India 2013
9

2. 2.2 Policies and Performance During 1950–1980
During 1950–1967, efforts were made to step up investment, accelerate growth
and achieve social justice. The First Five-Year Plan (1951–1956) accorded high
priority to agriculture, irrigation and infrastructure. The Second Five-Year Plan
(1956–1961) shifted the strategy to industrialisation through development of heavy
industry led by public sector investment. This was influenced by the thought that
underdevelopment is due to the lack of industrialisation. This view was also
supported by a number of empirical studies reporting a high degree of correlation
between the level of industrialisation and growth rate in an economy. The approach
to development during this period had three components: (1) import substitution
and inward-looking policies for giving protection and opportunity to Indian
industries to become competitive in the world market, (2) focus on the public sector
and (3) centrality of the planning process.
During the period from 1950–1951 to the mid-1960s (the pre-green revolution
period), the agricultural sector witnessed various policies concerning agrarian
reforms, institutional changes and development of major irrigation projects.
Intermediary landlordism was abolished, tenants were given security of farming
and ownership of land, land ceilings were imposed to eliminate large landholdings,
cooperative credit institutions were strengthened and land consolidation programmes
were implemented to reduce fragmentation of land holdings. Expansion of area
was the main source of agricultural growth during the pre-green revolution period.
Though industry and services grew at the rate of 6.3 and 4.8%, respectively,
during 1951–1966, GDP and per capita GDP grew at the rate of 3.4 and 1.4% only.
This was due to poor performance of the agricultural sector, registering a low
growth rate of 1.8% caused by unprecedented droughts in two consecutive years
1965–1966 and 1966–1967.
The strategy of ‘development through planning and controls’ adopted during the
1950s and 1960s continued during the 1970s. The planners and policymakers
understood the need for using a wide variety of instruments and controls to promote
industrial development in a desired direction. The period (1967–1980) witnessed a
marked strengthening of the import-substitution strategy and a clear preference for
government controls over a widening area of economic activity. These include
nationalisation of banks and insurance in 1969–1970, Foreign Exchange Regulation
Act (FERA) to control external payments, reservations for small industries, Monop-
oly and Restrictive Trade Practices (MRTP) Act and tighter industrial licensing.
The major policies adopted during the control regime (1970s) include industrial
licensing policy, import control policy, foreign exchange control, foreign exchange
rate control, capital market control, price control and controls of the banking sector.
In the early 1960s, the country faced a severe food shortage crisis for which a
large quantity of wheat had to be imported. This provoked the policymakers to
search for a breakthrough in agricultural production and reduce the dependence on
foreign countries for food grains. This prompted the government to introduce the
high yielding varieties (HYVs) of wheat and rice in the mid-1960s in the areas with
assured irrigation. This marked the beginning of the second phase in agricultural
10 2 Review of Economic Policies and Growth Performance

3. policy during which agrarian reforms were given secondary importance and the
policies concerning research, extension, input supply, agricultural credit, market-
ing, price support and dissemination of the HYV technology were given the prime
importance. The green revolution technology was remarkably successful in raising
food grains production and attaining self-sufficiency in food grains like wheat and
rice. Increase in productivity rather than expansion in area became the main source
of growth in production during the green revolution period.
Two important institutions—Food Corporation of India (FCI) and Agricultural
Prices Commission (APC)—were formed in this period. The APC was subse-
quently renamed as the Commission for Agricultural Costs and Prices (CACP).
These institutions were established to ensure remunerative prices to farmers,
maintain reasonable price for consumers, procure food grains and maintain buffer
stocks to run the public distribution system (PDS) and to avoid the adverse impact
of seasonal fluctuations in output on price stability.
Though aggregate investment in the economy continued to rise during most of
the period (1967–1980), there was no significant acceleration in the GDP or in per
capita GDP growth rate from the rate achieved during 1951–1966. It was thought
that productivity growth had lost momentum under the development strategy full of
controls. Low rates of industrial growth, the economy experienced in the late 1960s,
continued through the 1970s. Industrial growth rate declined from 6.3% during
1951–1966 to 4.1% during 1967–1980. However, due to introduction of the HYV
technology, the performance of the agricultural sector improved from the previous
period as agricultural output grew at the rate of 3.3% during 1967–1980.
The slow growth in the industrial sector raised doubts about the efficacy of the
system of extensive controls on industry, finance and foreign trade and payments.
The second oil price shock of 1979–1980 and the subsequent recourse to the
International Monetary Fund (IMF) strengthened the doubts at the end of the period
1967–1980. It was felt that there was a need to move towards a market-led
economy, which would ensure higher growth rates. The planners and policymakers
were convinced by this idea, and the moves towards market-led economy gained
momentum during the 1980s.
2.3 Policies and Performance During 1980–1991
The policies adopted during this period for the sectors other than agriculture include
the following. The policies concerning the industrial sector were mainly
probusiness in nature:
1. A new Industrial Policy Statement was framed in 1980 that liberalised licensing
for large-scale industries, regularised the installation of excess capacity and
allowed automatic expansion of capacity to some of them.
2. The growing irrelevance of the MRTP Act was recognised, and a number of
industries were exempted from this Act.
2.3 Policies and Performance During 1980–1991 11

4. 3. A number of industries were delicensed from the FERA in 1986. The threshold
limit for FERA was also raised.
4. Reforms were adopted in the external sector. In 1985, a trade policy was
announced to provide more flexibility to the exporters and importers.
5. Two important policy changes were made in the fiscal sector: (a) adoption of
expansionary fiscal policy involving high level of government expenditures and
(b) the method of financing these expenditures shifted from a tax-financed to a
debt-financed programme.
While there was a clear change in economic policy towards delicensing and
deregulation in the industrial sector, there was no major change in agricultural
policy. The decade of 1980s did not see any major policy initiative for agriculture.
However, agricultural growth and the resultant increase in real farm incomes led to
the emergence of interest groups and lobbies, which started influencing the farm
policy in the country. Subsidies and support to the agricultural sector increased
considerably during this period. However, public sector spending in agriculture for
infrastructure development in real term and total public investment in agriculture
started declining after 1980–1981, although private investment was rising. The
rural economy started witnessing a process of diversification, leading to growth in
non-food grain output like milk, fishery, poultry, vegetables, fruits, etc. This
accelerated the growth in GDP originating from agriculture during the 1980s.
The economy performed far better during 1980–1991 than in the previous
period. The performance of the agricultural sector, with a growth rate of 3.5%
during this period, was better than in the previous period (3.3%). Industry achieved
a remarkably higher growth rate of 7.1% during this period, presumably due to the
probusiness policies. The services sector also performed very well during this
period, as it recorded a growth rate of 6.8%, which is significantly higher than in
the previous period. The improved performance of agriculture, industry and
services yielded an impressive growth rate of GDP (5.6%) and per capita GDP
(3.4%) during the 1980s, a significant decade for the Indian economy, as it
successfully broke free of the ‘Hindu rate of growth’.
2.4 Economic Reforms Since 1991
Some of the policies followed during the 1980s had given rise to a number of
problems that created a critical situation in the economy in the early 1990s:
1. The shift from the tax-financed expenditure to the debt-financed expenditure
programme had led to steady increase in both the domestic and external
debt–GDP ratios. By the end of the 1980s, these ratios had reached such high
levels that there was a genuine worry to India falling into a debt trap.
2. Fiscal deficits–GDP ratio mounted to as high as 8.14% and spilled over to the
external sector, requiring growing recourse to external borrowing on commercial
terms.
12 2 Review of Economic Policies and Growth Performance

5. 3. Low export–GDP ratio, rising trade and current account deficit and deteriorating
external debt profile and external shocks, viz. the 1990 Gulf War, leading to a
hike in oil prices and the import bill, and slowing down in remittances from the
Gulf countries put pressure on the balance of payments situation. The situation
was such that foreign exchange reserves came down to a level that was less than
the cost of 2 weeks worth of imports.
4. Inflation rate during the 1980s was 8.58% on average with the highest at
10.94% and the lowest at 6.82%.
To break out of this critical macroeconomic and balance of payments situation,
India took a substantial amount of loan from the IMF in 1991, devalued the rupee by
22% against the dollar and adopted comprehensive economic reforms involving
structural adjustment and liberalisation programmes. The severe economic crisis in
the early 1990s provoked the Indian government to make fundamental changes in
the content and approach to economic policy. The economic reform programmes
involving radical changes in trade and industrial policies aiming at improving the
efficiency of the economy and increasing its international competitiveness were
thought to be essential to ensure long-term viability in the balance of payments
(BOP) and to restore the condition for rapid growth in the economy.
The major thrusts of the reforms involved measures to address the macroeco-
nomic and balance of payments crisis through (1) fiscal consolidation and tax
reforms, (2) removal of controls on industrial investment and imports, (3) reduction
of tariffs, (4) creation of a favourable environment for attracting foreign invest-
ment, (5) prudent management of exchange rate allowing the market to play a major
role in its determination and making the rupee convertible for current account
transactions and (6) opening the energy and telecommunication sectors for both
domestic and foreign private investment.
These pro-market policies are classified into (1) fiscal policy reforms involving
tax reforms, expenditure management, restructuring of the public sector and fiscal
and monetary coordination; (2) financial sector reforms including the banking
sector and capital market; (3) industrial policy and abolition of the license system;
(4) foreign investment policy reforms; (5) reforms in the external sector covering
foreign trade and exchange rate policies; and (6) agricultural sector reforms
concerning the internal and external trade in agricultural commodities. The major
economic reforms undertaken for different sectors of the economy are listed below.
2.4.1 Fiscal Sector
1. Measures for reduction in fiscal deficit.
2. Reforms in major taxes: significant reduction in direct and indirect tax rates to
maintain them at international levels and introduction of a number of schemes
including the famous ‘one by six’ criteria to expand the tax base and increase tax
revenues.
2.4 Economic Reforms Since 1991 13

6. 2.4.2 Public Sector
1. Disinvestment of public enterprises.
2. Greater autonomy and accountability for public enterprises.
2.4.3 Industrial Sector
1. Virtual abolition of industrial licensing: The licensing requirements for domestic
production and imports have been largely abolished.
2. Abolition of separate permission needed by MRTP houses.
3. Sharp reduction of industries reserved for the public sector.
4. Freer access to foreign technology.
2.4.4 Financial Sector
1. Autonomy of the Reserve Bank of India (RBI); the practice of automatic
monetisation of the fiscal deficit through the issue of short-term treasury bills
to the RBI discontinued; the volume of RBI credit to the government is to be
determined by the bank; the government now falls back on its market
borrowings to balance its budget.
2. Reduction of reserve requirements for banks, notably the cash reserve ratio
(CRR) and the statutory liquidity ratio (SLR).
3. Gradual freeing up of interest rates; interest rate to be determined by the market
forces and no attempt to be made to deliberately keep them at a low level.
4. Setting up and legislative empowerment of the Securities and Exchange Board
of India (SEBI) and establishment of National Stock Exchange (NSE) in order to
(a) provide more transparency to the transaction, (b) ensure that the agents in the
stock market do not indulge in unfair practices, (c) allow mutual funds to enter
the market so that small investors could enter the market without going through
brokers and middlemen and (d) allow foreign institutional investors to enter
these markets.
5. Abolition of government control over capital issues.
2.4.5 External Sector
1. Devaluation and transition to a market-determined exchange rate.
2. The foreign exchange rate regime shifted from the practice of pegging to a
basket of currencies to a managed float in 1993, the RBI started regulating the
market by the purchase and sale of foreign exchange and the government also
moved to convertibility for transactions in the current account.
14 2 Review of Economic Policies and Growth Performance

7. 3. Phased reduction of import licensing: The government started lifting quantitative
restriction (QRs) on imports from the mid-1980s and substituting them
with tariffs; QRs were largely abolished and tariff rates were brought down
significantly during the 1990s.
4. Phased reduction of peak custom duties.
5. Policies to encourage direct and portfolio foreign investment.
6. Monitoring and controls over external borrowing, especially short term.
7. Build-up of foreign exchange reserves.
8. Amendment of the Foreign Exchange Regulation Act (FERA) to reduce
restrictions on firms.
2.4.6 Agricultural Sector
The comprehensive economic reforms have focused mainly on industrial, financial
and trade policies. The agricultural sector, which still contributes about 15% of the
GDP and provides livelihood to about 52% of the population, has witnessed modest
changes in policies. The process of reforms in agriculture actually began from
1994–1995 when India became a part of the multilateral trading system under the
World Trade Organization (WTO). The policy reforms in agriculture may be
classified into two categories: (1) the policy reforms liberalising the external
trade in agricultural commodities, advancing thereby the openness and integration
of the agricultural sector to the world economy, and (2) the measures to reform
internal (domestic) trade and agricultural policies.
Efforts have been made to change external trade policies in line with the
provisions laid under the WTO. Tariff rates (TRs) and nontariff barriers (NTBs)
have been reduced for several commodities, and provisions have been made to
revise them keeping in view of the movements of world commodity prices, increase
in imports and concerns for food security and self-sufficiency. Measures for pro-
motion of export of agricultural commodities have been initiated through removal
of restrictions on licensing, minimum export price, etc. Besides, the reduction of
protection to industry and the consequent depreciation in the exchange rate are
likely to help agricultural exports by changing the relative prices in favour of
agriculture.
There have been a number of policy reforms liberalising the restrictions on
internal trade in agricultural commodities. Some of these include (a) removal of
restraints on interstate movement of food grains, (b) restructuring of the public
distribution system, (c) relaxation of restrictions under the Essential Commodities
Act, (d) introduction of forward trading in most agricultural commodities and (e)
removal of some marketing restriction of crop produce. For details of the internal
and external trade policies and agricultural sector reforms, see Athukorala (2005)
and Bathla (2006).
While agriculture has benefited from the changes in external and internal trade
and other farm policies, it has suffered from the decline in public investment in
2.4 Economic Reforms Since 1991 15

8. areas of critical importance for agricultural growth, such as irrigation and drainage,
soil conservation and water management systems and rural infrastructure. The
decline in public investment in agriculture actually began much before the reforms,
and this was sharper in the 1980s than in the 1990s (Gulati and Bathla 2001).
Although this decline was more than offset by a rise in private investment in
agriculture, which accelerated after the reforms, there is nothing denying that public
investment in agricultural infrastructure has to be increased for achieving higher
productivity, and agriculture needs much more focused attention in order to revive
the stagnating agricultural economy (Mohan 2006).
The economy recorded a mixed performance during the post-reform period.
During 1991–2001, the growth performance of the agricultural sector was relatively
poor with an average growth rate of 2.7%, much lower than the rate in the previous
period. Industrial sector recorded an average growth rate of 5.7%, down from the
growth rate of 7.1% in the previous period. The performance of the services sector
during this period was better than in the previous period, as the growth rate
registered an increase from 6.8 to 7.6%. The performance of the economy was
more or less stable, as the growth rate of GDP (5.6%) and per capita GDP (3.5%)
during 1991–2001 remained almost same as in the previous period. The economy
witnessed an improvement in the growth performance during 2001/2002–2008/
2009, as GDP grew at the rate of 7.6%, net domestic product (NDP) at the rate of
7.5% and per capita NDP at the rate of 5.9%. Agriculture, industry and services
grew at the rate of 2.8, 7.1 and 9.6%, respectively.
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