ECONOMIC REFORMS IN INDIA:
EXPERIENCES AND EMERGING DIMENSIONS
Dr. R. SHASHI KUMAR
M.A., M.Phil., Ph.D.
DEPARTMENT OF ECONOMICS
E-mail : firstname.lastname@example.org
Mobile : 098444 17452
Residence Phone: 0816-22 00 878
Globalization is evolving fast. The traditional areas of strength are shifting. The
consumerist areas of the West are becoming less strong as the economic balance shifts.
The producing areas of the East are becoming less strong as wider factors come into
importance. Globalization is spreading—and with significant consequences.
In just over a decade, India has grown into one of the world’s leading economies.
Out of an economic crisis that saw the country’s gross domestic product (GDP) growth
reduced to just 1.1 percent in 1991, India now enjoys a current growth rate of 8 percent
annually, making it second only to China as the world’s fastest-growing economy.
Today, the country, which had long been one of the richest nations on earth prior to the
1800s, is once again becoming a global economic powerhouse—the world’s fourth-
largest economy after the United States, China, and Japan (as measured by GDP at
purchasing power parity in 2008).
What is particularly impressive about India’s recent growth is the distinctive way
in which it has been achieved. Typically, poorer countries grow through low technology,
labor-intensive processes that accelerate with the strong export of manufactured goods,
which has been the primary driver for growth in China. By contrast, a large proportion of
India’s growth comes from high technology processes requiring skilled labor, in which
exports of services have played a key role. This growth pattern has resulted in services
becoming the largest component of the Indian economy—contributing 51 percent of
GDP—making India’s situation unique in the developing world.
How did India achieve such atypical, yet dramatic success with a service-driven
economy? In simple terms, it had enough of the right ingredients to make it the right
environment at the right time to do so. Those ingredients—changes that eased its
regulatory environment, an available supply of skilled workers who, very importantly,
spoke fluent English, and the minimum physical infrastructure—have helped India
become an outsourcing destination of choice for many global technology services
companies since the mid-1990s.
A more important question, however, is whether India will continue to have
enough of the right ingredients to continue its growth and further build an innovative
services sector that is integrated into global services supply chains. Its recent successes
notwithstanding, India faces some significant internal and external pressures that could
derail growth if not managed effectively. Its physical infrastructure, for example, is
strained to capacity at the same time that other countries—most notably, China—are
investing to create attractive environments that could enable them to leapfrog India as the
leading service economy in the developing world.
This paper briefly examines some of the challenges for India to address in order to
ensure its continued growth as a leading service economy. Further, simplifying its
regulatory environment to make it easier to initiate and conduct business in India in a
way that is similar to other global environments
2. ECONOMIC REFORMS OF INDIA
The New Economic Policy can be divided into two parts: the stabilisation
programmes and the structural adjustment and reform programmes. While the former
part basically aims at reducing macroeconomic imbalances (such as fiscal and current
account deficits) by restraining aggregate demand, the latter essentially aims at increasing
growth, by eliminating supply bottlenecks that hinder competitiveness, efficiency and
dynamism to the economic system.
Indian Economic Policy was influenced by a Fabian-socialistic approach with
emphasis on protectionism, import substitution, industrialization, state intervention in
labor and financial markets, and central planning. The government had strict restrictive
economic policies over the private sector participation, foreign trade and foreign direct
investment. The first breakthrough came with Jawaharlal Nehru and statistician Prasanta
Chandra Mahalanobis, who emphasized on more flexible economic policies involving
both public and private sectors based on direct and indirect state intervention. However,
the economic policy changed after 1980 with the removal of restrictions on capacity
expansion for incumbents, price controls and reduction in corporate taxes. The
revolutionary change came with the economic liberalization of 1991, undertaken by the
then prime minister of India, P. V. Narasimha Rao and the finance minister Manmohan
Singh. Considering the balance-of-payments crisis, they formulated a new set of
economic policy in India, ending many public monopolies and allowing automatic
approval of foreign direct investment in many sectors of the Indian economy.
The New Economic Policy at present comprise of:
Civil Aviation Policy
Foreign Direct Investment Policy
Broad Band Policy 2004
National Electricity Policy
New Telecom Policy 1999
Foreign Trade Policy
National Mineral policy
Monetary and Credit Policy
Non-Resident Indians (NRIS) Policy
Current Export-Import Policy
Current Monetary And Credit Policy
Indian Direct Investment In Joint Ventures And Wholly Owned
Policies And Procedures For External Commercial Borrowings
Overseas Venture Capital Investment In India
Baggage Rules for Indian residents or foreigners residing in India.
At present, the New Economic Policy has made India as one of the most
prosperous economy of the developing world. Indian economy is one of the most
preferred destinations for the foreign direct investments especially in the real-estate
sector, in which from March 2005 onwards, FDI is allowed 100 percent, as per the India
3. INDIA AND THE WORLD ECONOMY
India’s economy has been one of the stars of global economics in recent years,
growing 9.2 percent in 2007 and 9.6 percent in 2006. Growth had been supported by
markets reforms, huge inflows of FDI, rising foreign exchange reserves, both an IT and
real estate boom, and a flourishing capital market. From a long-term perspective, the
prospect of China becoming the world’s largest economy, and India the third largest,
within the next 10-15 years, represents a return to the order which has prevailed
throughout most of human history. According to some reports, China and India accounted
for around half of global GDP (see figure 1). For much of this period China and India
were intact polities, had the world’s largest populations and were technological leaders.
Major Economies’s Share of Global GDP, 0-2008
1000 1500 1600 1700 1820 1870 1913 1950 1973 1991 2000 2008
Sources: OECD Development Centre, 2001: IMF, World economic Outlook Database,
This shows the annual growth rate of India’s GDP compared to that of other
developing countries or regions from 1961 to 2001. While in the fifties, Indian economic
growth had reached almost 4 percent a year, this growth rate stagnated around 3.5 percent
a year in the sixties and seventies; it accelerated to 5 percent in the eighties and to 6
percent in the nineties. Indian economic performance has regularly improved compared
to world average. In the sixties, it was significantly below world level, but in the
seventies, it kept pace with world average as the latter slowed down. In the eighties and
nineties Indian economic growth stood well above world average. However Indian
performance fell short of what was achieved by China.
4. GDP AND PERCAPITA INCOME GROWTH RATE
India has grown by leaps and bounds in recent years and is emerging as a major
world economic power. After lumbering along at a pace of about 4–5 percent GDP
growth a year in the 1980s and the 1990s, the economy has surged in this decade, posting
an average annual growth of 8.5 percent since 2005 (see figure 2). The challenge now is
to maintain this growth momentum and provide benefits as well as economic
opportunities to a broad swath of the population. India’s financial system—comprising its
banks, equity markets, bond markets, and myriad other financial institutions—is a crucial
determinant of the country’s future growth trajectory. The financial system’s ability to
channel domestic savings and foreign capital into productive investment and to provide
financial services—such as payments, savings, insurance, and pensions—to a vast
majority of households will influence economic as well as social stability. While India’s
financial institutions and regulatory structures have been developing gradually, the time
has come to make a more concerted push toward the next generation of financial reforms.
A growing and increasingly complex market-oriented economy, and its greater
integration with global trade and finance, will require deeper, more efficient, and well-
regulated financial markets. Until recently, India has seen strong growth coupled with
moderate inflation during the current decade, although now prices are climbing rapidly
GDP and CPI, A Comparative Analysis
1985-89 1990-94 1995-99 2000-04 2005-08
Sources: IMF, 2008
India always held great promise. Soon after independence, in 1947, its foreign
reserves were among the worlds largest, at US $2.1 billion in 1950. It accounted for 2.4
percent of global trade. It was one of the prosperous countries in terms of growth in GDP
and overall economic activity; certainly ahead of China. The following figure shows the
growth of per capita income of India from 1950 to 2008.
4.1. Per capita Income
India – Per Capita Income
(GNP at factor cost, Constant prices, Indian rupees per year)*
0 0 0 0 0 2 4 6 8 0 2 4 6 8
5 6 7 8 9 9 9 9 9 0 0 0 0 0
9 9 9 9 9 9 9 9 9 0 0 0 0 0
1 1 1 1 1 1 1 1 1 2 2 2 2 2
At 1993-94 rupees
Source: Reuters, EcoWn
Despite several problems facing the Indian economy many economists point to
potential strengths of the Indian economy which could enable it to continue to benefit
from high levels of economic growth in the future.
5. AGRICULTURE, INDUSTRY AND SERVICE SECTORS
In the India of old, there was no conventional business cycle. A good year was
one with a good monsoon and a downturn was generally about a bad monsoon. These
developments played out over a short horizon of one or two years. Output fluctuations
significantly reflected a succession of uncorrelated monsoon shocks—it was not a
conventional business cycle.
A major change in the behaviour of the Indian macro economy, then, consists of
the rapidly dropping importance of agriculture. As Figure 1 shows, the share of
agriculture in GDP has dropped quite sharply from 27 percent in 1996-97 to 17.5 percent
in 2006-07. In addition, the vulnerability of agriculture to the monsoon is declining
through the spread of irrigation. The linkages between agriculture and the economy are
weakening. Putting these factors together, the domination of monsoon shocks in
influencing the macro economy has been substantially attenuated.
Traditionally agriculture has remained the backbone of India’s economic growth.
The weather related crisis such as drought, flood and cyclone has affected the agriculture
production and ultimately the growth in overall economic activities. In 60s, the
contribution of agriculture to GDP was around 50-55 percent. Over the period, the share
of agriculture to GDP has declined drastically to around 20 percent. The share of industry
has improved marginally. The share of services sector to GDP has increased significantly.
However, it must be noted that agriculture still employs almost 60 percent of the
population. Besides, social problems such as poverty, inequality are widespread in rural
areas. The benefits of ‘Green revolution’ have been limited to certain areas and there is
an urgent need to innovate and implement the new techniques of farming in both existing
and new areas (refer figure 4).
Agriculture, Industry and Services Sector
1960 1966 1972 1978 1984 1990 1991 1994 1996 1998 2000 2004 2008
Agriculture Industry Services
Source: RBI Bulletins.
6. INDIA’S EXTERNAL TRADE
Export growth in India has been much faster than GDP growth over the past few
decades. Several factors appear to have contributed to this phenomenon including
foreign direct investment (FDI). However, despite increasing inflows of FDI especially in
recent years there has not been any attempt to assess its contribution to India's export
performance of the channels through which FDI influences growth. Using annual data for
1970-98 we investigate the determinants of export performance in India in a simultaneous
equation framework. Results suggest that demand for Indian exports increases when its
export prices fall in relation to world prices. Furthermore, the real appreciation of the
rupee adversely affects India's exports. Export supply is positively related to the domestic
relative price of exports and higher domestic demand reduces export supply. Foreign
investment appears to have statistically no significant impact on export performance
although the coefficient of FDI has a positive sign. The following figure 5 highlights
India’s balance of trade.
India’s Balance of Trade
1984 1994 2003 2004 2008
Total Exports Total Imports
Source: CMIE Bulletins.
6.1. Trade Orientation of the Indian Economy
Since the major economic reforms were initiated in mid 1991, the trade
orientation of the Indian economy has increased significantly. Thus trade (Export plus
import) to GDP ratio increased from 14.6 percent in 1990-91 to 23.5 percent in 2003-04.
The share of export as well as import in GDP has shown similar movements indicating
that the supply capability as well as absorption capacity have improved simultaneously
over the years (refer table 1).
Trade Orientation of the Indian Economy
1990-91 5.8 8.8
1999-2000 8.4 12.4
2000-01 9.8 13.0
2001-02 9.4 12.0
2004-05 10.3 12.8
2007-08 10.4 13.2
Source: Reserve Bank of India, Annual Report 2007-08.
The New Economic Policy of 1991 included standard structural adjustment
measures including the devaluation of the rupee, increase in interest rates, reduction in
public investment and expenditure, reduction in public sector food and fertilizer
subsidies, increase in imports and foreign investment in capital-intensive and high-tech
activities, and abolition of the cash compensatory support for exports. Slowly but steadily
India’s share in global merchandise trade has improved from meager 0.5 percent (in early
1990s) to 1 percent (2007). The share of merchandise trade to GDP has increased
substantially to almost 35 percent. In early 1990s, India had foreign reserves for hardly 3
months. The outward looking policy has accentuated the foreign reserves to US$ 170
billion in 2006 from US$ 5 billion in 1993. The huge pool of foreign reserves would help
to manage not only rising imports but also external debt (figure 6).
1 4 6 8 0 2 4 6 8
9 9 9 9 0 0 0 0 0
9 9 9 9 0 0 0 0 0
1 1 1 1 2 2 2 2 2
Import cover of foreign reserves (LHS) Foreign Reserves (RHS)
Source: RBI Bulletins.
The Indian foreign exchange market has witnessed far reaching changes since the
early 1990s following the phased transition from a pegged exchange rate regime to a
market determined exchange rate regime in 1993 and the subsequent adoption of current
account convertibility in 1994 and substantial liberalisation of capital account
transactions. Market participants have also been provided with greater flexibility to
undertake foreign exchange operations and manage their risks. This has been facilitated
through simplification of procedures and availability of several new instruments.
7. INFRASTRUCTURE AND INVESTMENT
The development of infrastructure is critical to keep the Indian economy on new
growth trajectory. This is one area where there is a need for private sector and foreign
investment to come in. Because of the long gestation period, and many social
implications, the infrastructure sector competes unfavorably with manufacturing and
many other sectors. For this, specific policies in this area are needed to make
infrastructure attractive. Clearly, there is a wide gap between the potential demand for
infrastructure for high growth and the available supply. This is the challenge placed
before the economy, i.e. before the public and private sector and foreign investors. This
can also be seen as an opportunity for a widening market and enhanced production. The
following figure 7 shows different prospects of investment avenues in Infrastructure.
Also, the figure 8 shows the investment destiny of India.
Investment Avenues in Infrastructure, 2008
Source: Indian Economic Surveys.
FDI and Portfolio Investment
1991-92 1992-93 1995-96 1999-00 2001-02 2005-06 2007-08
Foreign Direct Investment Portfolio
Source: Economic Survey, India
8. POVERTY AND INEQUALITY
Although poverty has continued to fall with economic reform, it is evident that
growth in and of itself will not eliminate poverty. Over a quarter of the country continues
to live in poverty. The widening of regional and interstate disparities during the 1990s,
despite overall economic liberalization, highlights the importance of strengthening slow
growing states. In China, there are relatively few poor, rural areas, but in India, these are
the heartland. Wealth is generally more concentrated in urban rather than rural areas
where the majority of the people are living (refer figure 9 for more details).
India Poverty Rate
1960 1965 1970 1980 1991 1995 2000 2005 2008
Total Rural Urban
Source: The World Bank Reports.
The Indian economy has been on an upward growth path. In the fiscal year just
ended in March 2007, growth of GDP in real terms was 9.4 percent. The average growth
rate over the last two years was 9.2 per cent and over the last four years 8.6 percent. In
the Tenth Five Year Plan period from 2002-03 too 2006-07, real GDP grew at 7.6 percent
per annum. While being lower than the target growth rate of 8 percent per annum,
(mainly because of the poor growth rate in the first year of the Plan), this growth was
higher than in any earlier Five Year Plan. The following is the important success story of
9.1. Growth Rate
The growth rates of 8.5 percent to 9.5 percent per annum observed in the most
recent years have to be seen against the background of a slow and stagnant growth rate of
3½ percent per annum over the three decades from 1950 to 1980 and a significantly
improved growth performance of 5.8 percent per annum during the two decades from
1980 to 2000. With population growth of close to 2 percent per annum, the period from
1950 to 1980 saw per capita income increase at the rate of 1.5 percent per annum. By
contrast, the most recent years have seen per capita income increasing at 7.5 to 8 percent
per annum as population growth has declined to 1.5 percent.
9.2. Poverty declines but challenge remains
The percentage of population in poverty (officially defined as consuming below a
certain level) declined from around 50 percent in 1980 to 28 percent in 2004-05. An
alternative estimate using slightly different sampling methodology suggests that poverty
declined from 26 percent in 1999-00 to 22 percent in 2004-05. Even at 28 percent, close
to 300 million people remain below the poverty line. In any case, the estimate is based on
a narrow definition of poverty rather than a multidimensional definition which
incorporates social development indicators of health and education. India’s record on
social development has been poor. To sum up, while India’s economic performance is
showing strong improvement, the challenge of alleviating poverty remains large.
9.3. Private sector is the driving force
The acceleration in growth in the past five years or so is largely driven by the
private sector. We are not only reaching the South-East Asian levels of saving (32.4
percent) and investment (33.8 percent) rates but the private sector has played a major role
in generating these savings and investment. The rate of private investment in 2005-06
was 26.4 percent, up from 15 percent in 1996-97. Over the same period, the rate of public
investment increased marginally from 7 percent to 7.4 percent.
9.4. Reforms were steered forward within a robust democratic regime
A very important feature of India’s economic reforms is that they were steered
forward by four different democratically elected governments at the Centre and numerous
other governments at the state level which represented different political parties or their
combinations. The policy changes were debated in a noisy atmosphere of an open and
vibrant media and pursued with active involvement of the civil society. China still has to
face this music. In India, a robust democratic regime has ensured that slowly and surely
the mindset has moved away from controls towards competition – domestic as well as
The inadequacy and poor quality of infrastructure has been known for some time
to be a major challenge for sustaining growth rates of 7 to 8 percent for the Indian
economy. The acceleration in the growth rate to 8.5 to 9.5 per cent in recent years has
heightened these concerns, but the progress on infrastructure reforms as well as outcomes
has been mixed. The new paradigm for infrastructure development is that of public
private partnership based on model concession agreements emphasizing accountability
and transparency. While there has been a sea change in telecommunications and
significant reforms have been undertaken in the area of airports, ports and civil aviation,
and more recently in roads and railways, there is a real problem with electric power.
This sector has not shared in the resurgence of growth in India. After 1996-97,
growth was an annual average of 1 percent up to 2000-01 and 2.5 percent from 2001-02
to 2006-07. Problems in Indian agriculture are either related to stagnant productivity
levels requiring heavy doses of research and improved practices of water management
and cultivation, etc., or those that are directly the result of government policy design, e.g.,
spiraling input subsidies for agriculture which have eaten into government’s capacity for
public investment, inefficient marketing systems, and a highly inefficient public
distribution system at subsidized prices for consumers. In times of agricultural shortages
in recent months policies have also resorted to knee-jerk reactions such as export bans (as
in the case of pulses) and a ban on future trading (as in the case of wheat).
9.7. Human Capital
Increasingly, skill shortages are emerging as a major challenge to sustaining the
high growth rates of the manufacturing and services sectors. We often hear of the
demographic dividend in that 50 percent of India’s population today is of working age.
Also, unlike what is the case in major economies such as China, Brazil, USA and Japan,
this proportion is projected to continue to increase until 2035. It is also true that India
today has the youngest labour force in the world. This has implications for increases not
only in the labour force but also in the saving rate and in the pace of urbanization.
However, this young labour force has to be equipped with a skill set which is in demand
as the high growth rate continues and accelerates. The challenge is to provide high
quality education as well as adequate opportunities for productive employment.
9.8. India’s Destiny
The following figure 10 shows India’s provision of becoming one of the competitive
economies of the world. By 2020, if India accelerates all its resources, it would become
one of the greatest economic powers of the world.
2006 2007 2008
India China G-7 Countries Newly Industrialized Asia World
Source: World Development Reports
10. PROBLEMS OF INDIAN ECONOMY
One reason why importing, exporting, and transporting goods is as slow and
difficult in India is the lack of sufficient networks over which to move them. Despite the
fact highways are used to transport 80 percent of goods in the country, they comprise
only 2 percent of the country’s roads. The technological revolution that has occurred in
global shipping, which has resulted in containerized shipping and consolidation among
shippers, in turn resulting in port consolidation, has passed by India. The country cannot
handle the large capacity vessels that account for one-quarter of global container
capacity, and its inefficient ports are a key factor in its extended imports and exports.
But while India continues to have enough talented workers to meet most of the
needs of its services sector, these workers represent just a small portion of the population.
Most Indians lack the skills to participate in a service economy, and continue to be
employed in low-skilled, rural occupations. Three-quarters of the population leave school
before finishing the eighth grade, and almost 40 percent of the population is illiterate.
Most adult Indians—almost two-thirds during the 1990s—are not employed, primarily
because very few adult females are in the workforce. Just imagine the contributions to the
Indian economy that could be made if an additional 10 percent of the population—some
110 million people—became literate, or if more women joined the workforce. The
following are the major problems of Indian economy.
1. Inflation: Fuelled by rising wages, property prices and food prices inflation in
India is an increasing problem. Inflation is currently between 12 to 15 percent. A record
98 percent of Indian firms report operating close to full capacity with economic growth of
9.2 percent per annum inflationary pressures is likely to increase, especially with supply
side constraints such as infrastructure.
2. Poor educational standards: Although India has benefited from a high percent of
English speakers. (Important for call centre industry) there are still high levels of
illiteracy amongst the population. It is worse in rural areas and amongst women. Over 50
percent of Indian women are illiterates.
3. Poor Infrastructure: Many Indians lack basic amenities lack access to running
water. Indian public services are creaking under the strain of bureaucracy and
inefficiency. Over 40 percent of Indian fruit rots before it reach the market; this is one
example of the supply constraints and inefficiency’s facing the Indian economy.
4. Balance of Payments deterioration: Although India has built up large amounts of
foreign currency reserves the current account deficit has deteriorate in recent months.
This deterioration is a result of the overheating of the economy. Aggregate Supply cannot
meet Aggregate demand so consumers are sucking in imports. Excluding workers
remittances India’s current account deficit is approaching 5 percent of GDP.
5. High levels of debt: Buoyed by a property boom the amount of lending in India
has grown by 30 percent in the past year. However there are concerns about the risk of
such loans. If they are dependent on rising property prices it could be problematic.
Furthermore if inflation increases further it may force the RBI to increase interest rates. If
interest rates raise substantially it will leave those indebted facing rising interest
payments and potentially reducing consumer spending in the future.
6. Inequality has risen rather than decreased: It is hoped that economic growth
would help drag the Indian poor above the poverty line. However so far economic growth
has been highly uneven benefiting the skilled and wealthy disproportionately. Many of
India’s rural poor are yet to receive any tangible benefit from the India’s economic
growth. More than 78 million homes do not have electricity. 33 percent (268 million) of
the population live on less than $1 per day. Furthermore with the spread of television in
Indian villages the poor are increasingly aware of the disparity between rich and poor.
7. Large Budget Deficit: India has one of the largest budget deficits in the
developing world. Excluding subsidies it amounts to nearly 8 percent of GDP. Although
it is fallen a little in the past year. It still allows little scope for increasing investment in
public services like health and education.
11. SUGESTIONS FOR BETTER PERFORMANCE
The following are the important steps that India has to take for its continuous
competitiveness in the world economic situation.
Increase taxes on services and implement a tax on e-commerce;
Modernize tax administration through better utilizing technology;
Use technology to better enforce property and agricultural income taxes;
Institute mechanisms like greater public transparency to increase
Design strategies to increase venture capital;
Further reduce import duties and restrictions;
Reduce costly procedures for exporting finished or intermediate goods;
Attract foreign investment to meet demand for infrastructure projects;
Further reduce reservations for small businesses; and
Formalize special economic zones (SEZs), where normal investment and
trade restrictions do not apply, to help leverage further reform.
Implement major public works projects, taking advantage of public-
private partnerships where possible;
Deregulate wage practices.
Labor reforms should be coupled with the creation of a stronger social
safety net to support affected employees.
Undoubtedly, India will develop further innovations as it continues to address the
regulatory, infrastructure, and other challenges it faces today. How well it does so,
however, will depend on how committed it is to building a modern business environment.
While some of India’s recent success occurred by design—its easing of various business
regulations—much more was due to fortunate happenstance: the availability of a large
English-speaking workforce (a benefit of the country’s colonial past) and the
development of global technology infrastructures (which allowed companies to
seamlessly move operations offshore to India). Further expanding its market economy
will require much more proactive measures. China, for example, is already investing
significantly more to create a more globally competitive business environment. While
India’s democratic government may make it harder to quickly enact changes and weather
any short-term hardships related to those changes, it must nevertheless be as diligent as
China in implementing a systematic, planned approach to building its economy if India is
to sustain its current success.