1991: When India Gained Economic Freedom

India became free from the British in 1947, but Indians gained economic freedom only in 1991.

India Before 1991: A Socialist State

In the 1980s, Indian parents would order a Bajaj scooter when their children were born so that it would arrive by the time they became adults. The wait time for telephone lines was 5-10 years; having a phone was a status symbol. The outdated Hindustan Ambassador car, a knockoff of the 1950s British Oxford Morris, took 8-10 years to arrive. Second hand Ambassador cars cost more than new ones because second hand cars arrived more quickly.

India was a socialist state: the government controlled means of production. Soviet-style 5-year plans dictated which firms could produce what goods, how much could be produced, and what quantity of goods and services could be imported. 

Consumers had limited choices. Indians could only buy government-manufactured HMT wristwatches, and it was considered a luxury to own a watch. Buying a watch, getting a gas connection, and securing a refrigerator all involved 6-12 month waiting periods. Only black-and-white TVs were available until the mid-1980s, with Doordarshan as the sole channel. 

Entrepreneurs were stifled. Industrial licensing (the “license-permit raj”) required companies to obtain government permission for starting a business, expanding production, and changing product lines. Entrepreneurs often waited years for approvals. Import tariffs exceeding 300% made accessing raw materials and technology difficult. Narayana Murthy, founder of Infosys, made fifty trips to Delhi and had to wait 3 years to import a computer. 

Students traveling abroad were allowed to take only $200–500 in foreign exchange per year, regardless of the actual expenses needed for tuition, accommodation, or living abroad. Students had to apply to the Reserve Bank of India for foreign exchange approval, often waiting months to pay for their living expenses.

Economic growth was low for decades: per capita income grew at 1.3% annually for four decades. In 1991, 45% of the country lived below the poverty line. 50% of Indian children were undernourished in the late 1980s. India had only 5 million telephone lines for a population of 850 million. Only 44% of villages in India had electricity.

India in 1991: Balance of Payments Crisis

India faced one of its worst economic crises in 1991. It had enough foreign exchange reserves to pay for just two weeks of imports. A safe level was considered at least six times that amount. By mid-1991, India was in need of another loan that the IMF was unwilling to make. India was about to default on its external debt obligations, which would lead to capital flight, inflation, and potentially years of unemployment. 

70% of India’s total crude oil consumption was driven by imports. The Gulf War of 1990-91 resulted in a spike in oil prices, resulting in inflation rising to 17% by August 1991. Loss making public sector enterprises worsened India’s fiscal deficit. Protectionist policies made Indian exporters uncompetitive in the global market. India was forced to pledge 67 tons of gold to secure a $2.2 billion loan from the IMF.

India needed to undertake the most radical and controversial set of economic reforms since its independence. It needed to address the three pillars of the license raj: state control of entire sectors, limits on private business, and isolation from world markets.

Challenges for Narasimha Rao

Narasimha Rao was sworn in as Prime Minister on June 21, 1991, at the peak of the economic crisis. His government faced serious challenges to implement reforms. 

First, Rao’s government was a minority in Parliament. The two previous governments were also minority governments and fell due to loss of coalition support. Unlike other global leaders who implemented radical reforms, Rao had far less power. China’s Deng Xiaoping, Singapore’s Lee Kuan Yew, and South Korea’s Park Chung-hee all had more centralized control to implement reforms with fewer checks and balances. 

Second, established business houses (‘Bombay club’) had benefited from the existing license raj. Reforms would increase domestic and external competition for these business houses.

Third, Congress was the party of socialists. Liberalizing the economy meant abandoning the ideals of Nehru and Indira Gandhi. Socialism was the dominant intellectual influence in media and universities.

Market based reforms do not benefit any particular constituency; in fact, it hurts specific constituencies like the Bombay club and the Congress’s socialist wing. Most of its benefits aren’t seen in the short-term. The group that benefits most from the reforms are Indians who aren’t born yet.

Past Attempts at Economic Reforms: Rajiv Gandhi’s Failure

India faced economic crises in 1965-67, 1973-75, and 1979-81. None of those crises led to comprehensive economic reforms. The ideas for economic reforms were present earlier, but leaders lacked the political ability to maneuver through an entrenched bureacracy. 

In 1970, economists Jagdish Bhagwati and Padma Desai criticized the license raj, including state control of sectors, rules that prevented businesses from growing, and isolation from global economic trade. 

By the 1980s, India had a critical mass of officials who could implement economic reforms if politicians could manage the political challenges of reforms. 

Rajiv Gandhi, India’s Prime Minister from 1984 to 1989, had the will and idea of reforms, but not the political ability. He made small changes such as the ability for the private sector to participate in areas typically reserved for the public sector. For example, Tata’s Titan brand could now make wristwatches, a category reserved for government owned Hindustan Machine Tools (HMT). 

However, Rajiv’s biggest opposition to economic reforms came from within the Congress party. When he announced his economic vision in December 1985, the Congress Working Committee was so bitterly opposed to reforms that he abandoned the idea altogether. Even though Rajiv had the largest political mandate in India’s history (he won 36% more seats than Modi in 2019), he still could not get economic reforms past the socialists within Congress and the vested business interests in Mumbai.

Rao’s First Decision: Appointing Manmohan Singh as Finance Minister

Rao was previously ignorant about economics, once telling Jairam Ramesh: “I don’t understand economics… Pranab and you have to explain.” But this changed when he read an eight-page document prepared by senior bureaucrats on June 20, 1991. It spoke about the severity of the current account crisis and the need for reform, including dismantling trade barriers and removing licenses, permits, and anti-monopoly laws that shackled domestic entrepreneurs. Rao needed to choose a finance minister that was reform oriented, incorruptible, and acceptable to the west. The most important early decision Rao made was to choose Manmohan Singh as his finance minister.

Manmohan Singh wasn’t the preferred choice of the Congress Party, Pranab Mukherjee was. Pranab had been finance minister from 1982 to 1984 and sided with Rao during the tussle for prime ministership. His reigns as finance minister from 1982-84 and 2009-12 were characterized by crony capitalism and a centralization of the economy. Reforms would not have taken place if Pranab was finance minister in 1991.

Manmohan, on the other hand, believed that the knowledge available to civil servants for central planning was not superior to the knowledge available to everyday entrepreneurs on the ground. He also held every important office relating to economic affairs in India. He was Chief Economic Advisor to the finance ministry, Governor of RBI, and Deputy Chairman of the Planning Commission. This meant that when he wanted work done across these departments, he could pick up the phone and call people he personally worked with, rather than needing to work his way through the bureaucracy.

Devaluation of the Rupee

The rupee was historically artificially inflated against the dollar, which discouraged foreign investors and depressed exports. Since an expensive rupee made it harder for Indian exporters, the previous governments introduced a Cash Compensatory Scheme for exporters—an example of a subsidy (artificially inflated rupee) that gave rise to another subsidy (cash subsidies for exporters). One distortion led to another distortion, as was the norm in pre-1991 India.

There was strong opposition in India to devaluing the rupee. Opposition parties viewed an artificially inflated rupee as a symbol of national pride and a devalued rupee as submitting to the West. Singh, backed by Rao, conducted two rounds of devaluation by 18% on July 1 and July 3, 1991. A more competitive exchange rate eased concerns of foreign investors and exporters. Singh also removed the Cash Compensatory Scheme for exporters. This proved to the IMF that India, this time, was serious about reforms.

Rao’s Political Tactics

Rajiv Gandhi and others attempted economic reforms previously, but lacked the political ability to pass controversial reforms while staying in power. Rao’s primary challenge was: how do you implement radical reforms without having the power of the Gandhis?

Rao played up the crisis. “Desperate maladies call for drastic remedies”, he said in a speech in July 1991. He shifted the blame on others. “The Reserve Bank changed the exchange rate of the rupee”, he said. He cited the interests of the poor, arguing that the additional foreign exchange produced would be used to import everyday items for common people: kerosene, diesel, fertilizers, edible oil, and steel. 

Most importantly, he linked the reforms to Rajiv Gandhi’s legacy. He said, “what we have done is a continuation of policies initiated by Rajiv Gandhi”. This was not true, but it was critical to link reforms to Rajiv and Nehru’s legacy to placate the Congress party. The most radical policy changes are brought not by showing that they are radical but by pretending that they change nothing. There was no strong political constituency for market reforms. Rao had to overcome entrenched socialist bureaucracies and large corrupt businesses that benefited from the legacy system.

End of the License Raj

Rao’s government executed with a sense of urgency that India hadn’t seen before. Within his first month, he presented industrial policy reforms that were the most revolutionary economic reforms in the history of independent India. It ended manufacturing limits for the private sector, allowed foreign investment upto 51%, and increased the exempt threshold under anti-monopoly laws.

Rao initially received strong opposition from Arjun Singh and other Congress members since it deviated from socialist policies. But he worked to add a long preamble to the policy to link the new ideas to the fundamental ideas of the Congress and Nehru. Rao told the Congress Working Committee that the new policies were a continuation of Nehru’s 1956 policy resolution; they only reversed Indira Gandhi’s sharp leftward tilt. He said they continued to believe in the commanding heights of the public sector. This was a lie, but it was needed to convince the old guard in the Congress Party.

Rao was able to take a policy that was controversial, make small changes, link it to a Nehruvian past, and drag his party behind the most significant economic reform in the history of independent India. All in his first month in office.

  • Elimination of industrial licensing
    • Industrial licensing was abolished for all industries except for 18 sectors, which included those of strategic or environmental concern (e.g., defense, hazardous chemicals, explosives, tobacco, alcohol).
    • This list of reserved industries was later reduced to 6 sectors by 1993.
  • Reduction in public sector dominance
    • The number of industries reserved exclusively for the public sector was reduced from 17 to 8, covering arms and ammunition, atomic energy, railways, mining of specific minerals (e.g., coal, lignite), minerals for atomic energy, defense aircrafts, industrial explosives, and hazardous chemicals
  • Abolition of Asset Limits under the Monopolies and Restrictive Trade Practices (MRTP) Act
    • Companies were no longer required to seek government approval for expansion, mergers, or new ventures if their asset size exceeded ₹100 crores.
  • Simplification of industrial location policy
    • Elaborate licenses were previously required for setting up industries. These requirements were abolished for most locations except urban areas with populations of over 1 million.

Rao didn’t present industrial reforms even though he was the industry minister. Instead, he asked the minister of state for industry to present it. The minister of state started with, “sir, I beg to lay on the table a statement on Industrial Policy.” This innocuous declaration masked the profoundly radical policy he had just announced. Its most famous sentence was that industrial licensing will henceforth be abolished for all industries, except those specified, irrespective of levels of investment. It limited public sector monopolies to only eight sectors and eased anti-monopoly restrictions that prevented companies from growing. It raised the permitted level of foreign investment from 40% to 51% in thirty four industries. This was the single most radical economic document in independent India’s history, and it was announced without fanfare. The biggest changes are quiet.

Historic Budget of 1991

Within his first month in office, Rao and Singh presented a groundbreaking budget. It overhauled import-export policy, connecting India to the world. It slashed subsidies, making foreign investment easier. 

Since the budget was a sensitive document that businessmen would pay money to know in advance, its preparation was highly secretive. In the weeks leading up to the July 24 budget announcement, everyone working on the budget lived locked down in a basement in North Block. They had to eat and sleep there and didn’t have access to phones.

Rao was unimpressed with the first draft of Manmohan’s budget, which seemed too weak and watered down. After reading it, he said to Manmohan, “if this is what I wanted, why would I have selected you?” Rao wanted an aggressive budget.

Manmohan delivered. A sweeping set of reforms were announced in the historic 1991 budget.

  • Trade policy reforms
    • Reduction in import duties from an abnormally high 85-90% to 50-60%.
    • De-licensing of imports for capital goods, raw materials, and components. Many items, especially in the electronics and machinery sectors, were moved from the restricted list to the Open General License (OGL) list.
    • Import duty was reduced from 300% to 150%. They were further reduced to 50% in 1996.
  • Foreign direct investment
    • FDI was allowed in a range of sectors with automatic approval for investments up to 51% equity in certain industries.
    • Key sectors included electronics, food processing, textiles, and infrastructure.
    • Technology collaborations with foreign firms were encouraged to modernize Indian industries.
  • Disinvestment of public sector units
    • Introduction of a policy to disinvest shares of select PSUs to raise resources and reduce fiscal deficits.
    • Encouragement of greater autonomy for profit-making PSUs to enhance efficiency.
  • Fiscal reforms
    • Reduction in fiscal deficit from 8.4% of GDP to 5.9% of GDP through expenditure cuts and revenue enhancements.
    • Reduction in subsidies for fertilizers and petroleum.
  • Support from IMF
    • Adjustments to meet conditions set by the International Monetary Fund (IMF), as India had just secured a $2.2 billion loan.

The way the budget was presented was Machiavellian. Instead of announcing the controversial industrial policy reforms along with the budget, Rao ensured that industrial reforms were announced in the morning while the budget was announced in the evening. This was before 24 hour news cycles and the internet. By announcing industrial reforms in the morning, the next day’s newspapers would focus on the evening budget, rather than the more politically sensitive overhaul of industrial policy.

Were the reforms driven solely by the economic crisis and the IMF?

A common misrepresentation of the reforms were that they were driven solely by the IMF. This narrative was partly driven by Narasimha Rao himself, who wanted to create the illusion that he was forced to undertake significant economic reform because of the economic crisis. But this was not true.

Rao continued significant reform well beyond the resolution of India’s balance of payments crisis. Rao implemented significant industrial delicensing, opening up the banking sector to private companies like ICICI and HDFC Bank, setting up the Securities and Exchange Board of India as a regulator, increasing foreign direct investment limits, opening the telecommunication industry to private companies, and opening the power generation sector to the private sector.

What was the impact of the reforms?

The reforms of 1991 and subsequent economic reforms between 1992 and 1996 changed India forever.

400 million people were lifted out of poverty after 1991, making these reforms one of the greatest humanitarian accomplishments of the 20th century. Per capita growth increased from 1.3% pre-1991 to around 5% post 1991. Almost all rural areas have access to electricity versus just 44% in 1991. In 1991, tele-density was 0.6%, i.e. that there were about 0.6 telephone connections per 100 individuals. As of 2024, tele-density is 86%.

Most importantly, the Indian entrepreneur is unshackled from the license raj. The government no longer controls means of production. Individuals are free to decide what they want to create, how much to produce, and whether they want to change this over time. Indian consumers are free to decide what goods and services they can buy. It was only after 1991 that India attained economic freedom.

This post is inspired by the excellent book Half – Lion: How P.V Narasimha Rao Transformed India. Here are a few resources I recommend on the 1991-96 reforms: