LPG Reforms 1991 — Study Notes

Overview

The economic reforms of 1991 mark a watershed moment in Indian economic history. Faced with a severe balance of payments crisis, foreign exchange reserves down to barely two weeks of imports, and inflation spiralling out of control, India was compelled to fundamentally restructure its economic policy. The New Economic Policy announced by Prime Minister P.V. Narasimha Rao and Finance Minister Dr. Manmohan Singh on July 24, 1991, dismantled decades of state control and ushered in the era of Liberalisation, Privatisation, and Globalisation (LPG).

For UPSSSC PET, this topic is crucial because it bridges pre-reform socialist planning and modern India's market-driven economy. Questions often test understanding of what changed (licensing abolished, tariffs reduced), why it changed (BOP crisis, inefficiency of old system), and the key architects (Manmohan Singh). Candidates must know the reforms' three pillars—liberalisation (freeing domestic business), privatisation (reducing public sector dominance), and globalisation (opening to world trade)—and their immediate impact.

This topic typically yields 2–3 direct questions on reforms' causes, components, or outcomes. Familiarity with the 1991 budget speech highlights, IMF conditionalities, and subsequent policy changes (e.g., MRTP amendment, FERA replaced by FEMA) will help tackle both factual and analytical questions confidently.

Key Concepts

• **Balance of Payments Crisis (1991)**: By June 1991, India's forex reserves fell to $1 billion (enough for 2 weeks of imports), external debt exceeded $70 billion, inflation touched 17%, and fiscal deficit crossed 8% of GDP. The crisis forced India to pledge 47 tonnes of gold to the Bank of England and IMF for emergency loans.

• **Liberalisation**: Removal of industrial licensing under the License Raj (except for security/environmental sectors), reduction of entry barriers, deregulation of interest rates and prices, and dismantling of the Monopolies and Restrictive Trade Practices Act (MRTP) restrictions on large companies. Private sector was allowed to enter previously reserved areas.

• **Privatisation**: Reduction of public sector monopoly through disinvestment (selling government equity in PSUs), closure of chronically loss-making units, and opening sectors like telecom, aviation, and power to private investment. Public sector's role shifted from dominance to strategic presence in select areas.

• **Globalisation**: Integration with world economy by reducing import tariffs (from average 200% to below 50% in phases), abolishing import licensing, allowing Foreign Direct Investment (FDI) up to 51% automatic approval in many sectors, and making rupee convertible on current account (LERMS introduced, later full convertibility in 1994).

• **Manmohan Singh's Budget Speech**: The July 1991 budget speech is famous for quoting Victor Hugo—"No power on earth can stop an idea whose time has come"—symbolising inevitability of reforms. The budget announced rupee devaluation (18-19%), introduced dual exchange rate system, cut subsidies, and raised administered prices.

• **Structural Adjustment Programme (SAP)**: IMF-World Bank conditionalities for loans included fiscal consolidation (reducing deficits), trade liberalisation, public sector reform, and financial sector deregulation. These conditionalities shaped India's reform path for the 1990s.

Formulas / Key Facts

• **Year of Reforms**: 1991 (July 24, 1991 budget)
• **Prime Minister**: P.V. Narasimha Rao
• **Finance Minister**: Dr. Manmohan Singh
• **Forex Reserves (June 1991)**: $1 billion (barely 2 weeks of imports)
• **External Debt (1991)**: Over $70 billion
• **Inflation Rate (1991)**: Approximately 17%
• **Fiscal Deficit (1991)**: Over 8% of GDP
• **Gold Pledge**: 47 tonnes pledged to Bank of England for emergency loan
• **Industrial Delicensing**: Reduced licensed industries from all to only 6 sectors (defence, atomic energy, railway transport, hazardous chemicals, tobacco, alcohol)
• **Tariff Reduction**: Average import tariffs reduced from ~200% (1991) to ~50% by mid-1990s
• **FDI Limit**: Automatic approval for FDI up to 51% in priority sectors
• **MRTP Amendments**: Asset limit restrictions on large companies removed; competition focus introduced
• **FERA → FEMA**: Foreign Exchange Regulation Act (FERA, 1973) replaced by Foreign Exchange Management Act (FEMA, 1999), shifting from control to management
• **Current Account Convertibility**: Achieved in 1994 (rupee convertible for trade transactions)
• **Narasimha Rao Government**: Congress minority government (1991-1996) supported externally

Worked Examples

**Example 1: Why did India adopt LPG reforms in 1991?**

**Step 1**: Identify immediate trigger—Balance of Payments crisis. Forex reserves fell to critical $1 billion in June 1991, threatening India's ability to pay for essential imports like oil and food.

**Step 2**: Note structural problems—Decades of License Raj created inefficiencies; public sector monopolies were loss-making; high tariffs made Indian goods uncompetitive globally; fiscal deficit ballooned due to subsidies and PSU losses.

**Step 3**: External pressure—IMF and World Bank offered emergency loans conditional on structural reforms (Structural Adjustment Programme).

**Answer**: India adopted LPG reforms due to acute BOP crisis (forex down to 2 weeks' imports), chronic inefficiencies from License Raj, mounting fiscal deficit, and IMF conditionalities for bailout loans.

---

**Example 2: What is liberalisation? Give two concrete measures taken in 1991.**

**Step 1**: Define—Liberalisation means reducing government controls and allowing market forces greater role in economic decision-making.

**Step 2**: Measure 1—Abolition of industrial licensing for most industries (delicensed all except 6 strategic/hazardous sectors).

**Step 3**: Measure 2—Removal of MRTP Act restrictions on expansion of large firms, ending asset ceiling limits.

**Answer**: Liberalisation reduced state control over business. Two measures: (i) Industrial delicensing—ended License Raj for most sectors; (ii) MRTP amendment—removed asset limits on large companies, promoting expansion.

---

**Example 3: Differentiate privatisation and globalisation in the context of 1991 reforms.**

**Privatisation (internal focus)**: Reduced government's role in production; started disinvestment of PSU equity; opened sectors like telecom/aviation to private players; aimed to improve efficiency by reducing public sector monopoly.

**Globalisation (external focus)**: Opened Indian economy to world trade and investment; slashed import tariffs and quotas; allowed FDI inflows; made rupee convertible on current account; integrated India with global markets.

**Key Difference**: Privatisation reduced state ownership within India; globalisation opened India to foreign competition and capital.

Common Mistakes

• **Confusing reforms with complete privatisation**: Students often think 1991 meant selling off all PSUs immediately. Wrong → 1991 began gradual disinvestment; strategic PSUs (defence, atomic energy) remained public. Complete privatisation was never the goal; reducing inefficiency and fiscal burden was.

• **Assuming liberalisation = no regulation**: Some believe liberalisation meant zero government control. Wrong → Liberalisation removed unnecessary controls (License Raj), but regulation for competition (Competition Act 2002), consumer protection, and environmental safety continued. It's about smarter regulation, not absence of regulation.

• **Ignoring the crisis context**: Answering "why 1991 reforms?" without mentioning BOP crisis, gold pledge, or IMF conditionalities misses the compulsion behind reforms. Correct approach → Always start with the crisis trigger before listing structural reasons.

• **Mixing up FERA and FEMA**: Students confuse the two acts or think both existed in 1991. Wrong → FERA (1973) was control-oriented pre-reform law; it was replaced by management-oriented FEMA in 1999 post-reform. In 1991, FERA was still in force.

• **Overstating immediate results**: Claiming 1991 reforms instantly solved all problems is incorrect. Fix → Reforms set direction; positive effects like higher growth (6-7%), increased FDI, poverty reduction came gradually over the 1990s-2000s. The process was gradual and ongoing.

Quick Reference

• **1991 LPG = Liberalisation + Privatisation + Globalisation** in response to BOP crisis.
• **Key trigger**: Forex reserves down to $1 billion (June 1991); gold pledged for IMF loans.
• **Manmohan Singh**: Finance Minister who delivered landmark July 1991 budget; "idea whose time has come."
• **Industrial licensing**: Abolished for all except 6 strategic sectors (defence, atomic, railway, hazardous, tobacco, alcohol).
• **FDI & globalisation**: Automatic FDI approval up to 51%; tariffs cut from 200% to ~50%; rupee made current account convertible (1994).
• **Reforms = shift from state-controlled economy to market-driven economy**, not overnight but starting point for modern Indian growth story.