Economic reforms since 1991

The first principle

An economy grows when its labour and capital move to the uses where they produce the most, and that movement needs prices, competition and the freedom to enter and exit. Before 1991 India decided through licences, quotas and public ownership who could produce what, where and how much, so capital stayed where the state had put it. The reforms of 1991 replaced that rationing with markets in most of industry and trade, and every debate about their effects turns on how far markets reached and who they left behind.

The core

What the old system was

• The licence raj. The Industries (Development and Regulation) Act, 1951 required a licence to set up, expand or relocate a factory, the Monopolies and Restrictive Trade Practices (MRTP) Act, 1969 capped the growth of large houses, and the Foreign Exchange Regulation Act (FERA), 1973 limited foreign equity, usually to 40 per cent. Imports needed licences and faced very high duties, and hundreds of products were reserved for small units.
• Why it slowed growth. With entry blocked, firms competed for licences rather than customers, so efficiency and quality lagged. Growth averaged about 3.5 per cent a year from the 1950s to the 1970s, which Raj Krishna called the "Hindu rate of growth", and it rose to about 5.5 per cent in the 1980s only with partial delicensing and heavy public borrowing.

The crisis of 1991

• The build up. The Central government's fiscal deficit was close to 8 per cent of gross domestic product (GDP) in 1990-91, and the current account deficit, near 3 per cent of GDP, was financed by short term loans and deposits of non resident Indians.
• The trigger. The Gulf War of 1990-91 raised oil prices and cut remittances, ratings agencies downgraded India and the deposits began to leave. By mid 1991 reserves covered about two weeks of imports, and the government pledged about 47 tonnes of gold with the Bank of England and the Bank of Japan to raise emergency loans.

The response: stabilisation and structural reform

• Stabilisation dealt with the immediate crisis: the rupee was devalued by about 18 to 19 per cent in two steps on 1 and 3 July 1991, the fiscal deficit was cut and the International Monetary Fund (IMF) lent under a standby arrangement. It worked on demand and the balance of payments in the short run.
• Structural reform changed how the economy works in the long run, under three heads usually called liberalisation, privatisation and globalisation (LPG).
• Liberalisation. The New Industrial Policy of 24 July 1991 abolished industrial licensing for all but 18 industries (now five, such as defence equipment and hazardous chemicals), removed the MRTP asset limit and cut the list reserved for the public sector from 17 industries to eight.
• Privatisation. Minority stakes in public enterprises were sold from 1991-92, and strategic sales with transfer of control followed from 1999, as the public sector note explains.
• Globalisation. Import licensing was dismantled, the peak customs duty was cut in stages from 150 per cent in 1991-92 to 10 per cent on most non agricultural goods by 2007-08, foreign direct investment up to 51 per cent was approved automatically in priority industries, and the rupee became convertible on the current account in August 1994.
• Finance and tax. The Narasimham Committee (1991) set the path for banking reform and the Chelliah Committee (1991) for a simpler tax system with lower rates and a wider base.

Dimensions

• Growth. Average growth rose to about 6 to 7 per cent a year in the three decades after 1991, with a peak of over 8 per cent in the boom years from 2003-04 to 2007-08. Higher growth compounds: the worked example shows why a gain of three points a year matters more than any single policy.
• Industry. Delicensing and import competition forced firms to modernise, so sectors such as automobiles, telecommunications and pharmaceuticals grew into world scale industries, while firms that had lived on protection shut down or were bought.
• Services. Software and business services, which needed little licensing and drew on English speaking engineers, grew fastest of all, so India's structural change ran from farms to services, largely skipping the factory stage.
• External. Exports and imports of goods and services together rose from about 15 per cent of GDP in 1990 to over 50 per cent at their peak in the early 2010s (World Bank), and India moved from a reserve crisis to large reserves.
• Fiscal and federal. Lower tariffs cut customs revenue, so taxes had to come from a wider domestic base, a shift completed by the Goods and Services Tax (GST) in 2017. States began to compete for investment, which widened the gap between States that attracted it and those that did not.
• Social. Faster growth cut poverty, but the gains were uneven between skilled and unskilled workers, cities and villages, and coastal and inland States.

In practice

Effects on poverty and inequality

• Poverty fell, and faster after 2004-05. By the Tendulkar method, the share of people below the poverty line fell from 45.3 per cent in 1993-94 to 37.2 per cent in 2004-05 and 21.9 per cent in 2011-12 (Planning Commission, 2013), so the fall per year tripled in the later period. The World Bank estimates extreme poverty at 5.3 per cent in 2022-23, at its international line of 3 dollars a day, against 27.1 per cent in 2011-12 (World Bank, 2025).
• Inequality rose at the top. The World Inequality Lab estimates that the top 1 per cent received 22.6 per cent of national income in 2022-23, the highest share since its series began in 1922 (Bharti, Chancel, Piketty and Somanchi, 2024). Inequality of consumption measured by household surveys looks far milder, and the World Bank finds that it fell between 2011-12 and 2022-23, partly because surveys miss the richest households, so the two measures should not be confused.

Effects on jobs

• Jobs lagged output. Agriculture still employed 43.0 per cent of workers in 2025, manufacturing only 12.1 per cent, and 56.2 per cent of workers were self employed (Periodic Labour Force Survey, PLFS, 2025). Growth led by capital intensive industry and skilled services created fewer jobs than the movement out of farming needed, which is the "jobless growth" critique.
• Rigid labour law. Firms stayed small or used contract labour to avoid laws that required permission to lay off workers in large units, so labour intensive manufacturing did not take off as it did in East Asia.

Second generation reforms

• What the term means. The first generation removed controls by executive decision. The second generation, from about 1999, needed new laws and new regulators in factor markets and in States, which is slower and politically harder.
• The main laws. The Fiscal Responsibility and Budget Management (FRBM) Act, 2003 set fiscal rules; the Electricity Act, 2003 opened generation and trading; the Competition Act, 2002 replaced the MRTP Act; the Insolvency and Bankruptcy Code (IBC), 2016 made exit time bound; the amendment of the Reserve Bank of India Act in 2016 created inflation targeting with a Monetary Policy Committee; and GST in 2017 made one national market.
• Labour and land. The four labour codes on wages, industrial relations, social security and occupational safety, which merged 29 Central labour laws, came into force on 21 November 2025. Land remains the least reformed factor market and sits mostly with the States.

Issues and way forward

• Premature deindustrialisation. Manufacturing's share of output and jobs stayed flat while services grew, because India's labour intensive industries were too small and too protected to compete with China. Factor market reform, cheaper logistics and stable trade policy, rather than higher tariffs, are the remedies most economists propose.
• Inequality and regional divergence. Returns to capital and skills rose faster than wages, and investment went to States with ports, power and skilled workers. Public spending on education and health, and on infrastructure in lagging States, is the standard answer, together with better data on top incomes.
• Agriculture left out. The 1991 reforms barely touched farming, where controls on markets, land leasing and exports continued, so farm incomes fell behind; the agriculture notes carry this.
• Reforms by stealth. Many reforms were made without building a public case, so they were reversed or stalled when they hurt organised groups, as the repeal of the farm laws in 2021 showed. Consultation with States and a clear account of who gains and who loses make reform last.
• Federal implementation. Labour, land, power distribution and urban regulation are largely State subjects, so the next round depends on competition and cooperation among States, through bodies such as the GST Council.

Common confusions

• Stabilisation and structural adjustment. Stabilisation is short run management of demand, deficits and the exchange rate, while structural adjustment changes the rules of production, trade and ownership over many years; 1991 did both together.
• Liberalisation and privatisation. Liberalisation removes controls on what private firms may do, while privatisation transfers ownership from the state; India liberalised far more than it privatised.
• Disinvestment and privatisation. Disinvestment is any sale of government shares, often a minority stake that leaves control with the state, while privatisation passes control to a private buyer.
• Current and capital account convertibility. India made the rupee freely convertible for trade, travel and income payments in 1994, but capital account transactions are still allowed only within limits.
• Poverty and inequality. Poverty counts people below a line, while inequality measures how income or consumption is spread, so poverty can fall while inequality rises, as it did after 1991.

For the exam

• Keyword bank: licence raj, balance of payments crisis, stabilisation and structural adjustment, New Industrial Policy 1991, delicensing, current account convertibility, liberalisation privatisation globalisation, second generation reforms, jobless growth, premature deindustrialisation, top 1 per cent income share, Insolvency and Bankruptcy Code, labour codes, cooperative federalism.
• Previous year questions: Practise the previous year questions on this topic →
• Use in an answer:
  • Introduction with data: In mid 1991 India's reserves covered about two weeks of imports; three decades later the poverty ratio had fallen from 45.3 per cent in 1993-94 to 21.9 per cent in 2011-12 by the Tendulkar method.
  • Introduction with a source: The Statement on Industrial Policy of July 1991 abolished licensing for all but 18 industries and opened the door to foreign investment, ending four decades of the licence raj.
  • Conclusion: The reforms of 1991 freed industry and trade, but the factor markets for land and labour and the farm sector were reformed late, so growth created fewer good jobs than India needed.
  • Conclusion: The next round of reform is federal and legal rather than executive, and it will last only if States share in its design and its gains.