LPG Reforms of 1991: The Economic Crisis and the New Economic Policy

The 1991 Economic Crisis in India: Causes and Course

Fiscal Deficits and External Debt in the 1980s

The 1991 economic crisis had its origin in the way the economy was managed through the 1980s. Government spending ran ahead of revenue year after year, and the gap was met by borrowing at home and from abroad. Taxes and the profits of public sector undertakings did not grow fast enough to pay for the expenditure, and at times money borrowed from abroad was spent on consumption rather than on investment that could repay it. Imports grew much faster than exports, and little was done to raise exports to pay for them.

The figures in the Union Budget of July 1991 show the scale of the imbalance:

• Fiscal deficit: The Centre's fiscal deficit was more than 8 per cent of GDP in 1990‑91, against 6 per cent at the beginning of the 1980s and 4 per cent in the mid-1970s.
• Internal debt: The Centre's internal public debt had reached about 55 per cent of GDP, and interest payments alone took almost 20 per cent of its total expenditure.
• External debt: External debt, including deposits of non-resident Indians, stood at 23 per cent of GDP at the end of 1990‑91, and debt service took about 21 per cent of current account receipts.
• Current account: The current account deficit, about 2 per cent of GDP for several years, rose above 2.5 per cent of GDP in 1990‑91.

India's external debt rose from $20.6 billion in 1980‑81 to $64.4 billion in 1989‑90. When the government spends more than it earns and the country also imports more than it exports, the two gaps feed each other; economists call this the twin deficit problem.

The Gulf War, Political Instability and the Loss of Confidence

Three shocks in 1990‑91 turned this weakness into a crisis. The Gulf War raised the price of oil, so India spent its reserves faster on petroleum imports, while the remittances sent home by Indians working in the Gulf region fell. The Soviet Union, India's largest trading partner until 1991, was in turmoil, and India's exports collapsed. At home, a period of unstable governments shook the confidence of lenders. In February 1991 the government of Chandra Shekhar could not pass the budget after Moody's downgraded India's bond ratings.

Capital inflows through commercial borrowing and non-resident deposits fell sharply. India drew on the IMF in July 1990 and again in January 1991, yet the reserves kept falling. Prices also rose sharply. In 1990‑91 the wholesale price index rose by 12.1 per cent and the consumer price index by 13.6 per cent, and the rise was concentrated in essential goods, which hurt the poor most.

Reserves Below a Fortnight of Imports

The foreign exchange reserves, which a country keeps to pay for petroleum and other essential imports, kept falling through 1990‑91. By July 1991 they stood at about ₹2,500 crore, roughly $1 billion at the exchange rate of the time, enough to finance imports for only a fortnight. There was not enough foreign exchange even to pay the interest due to international lenders, and no country or international lender was willing to lend to India.

The Rescue of 1991: Gold, IMF Loans and a New Government

Pledging India's Gold Reserves

The best-remembered step of the rescue was the use of India's gold to raise money abroad. The Reserve Bank of India airlifted 47 tonnes of gold to the Bank of England and 20 tonnes to the Union Bank of Switzerland, raising about $600 million to keep payments going. The pledge became the lasting symbol of the crisis. In 2024 the Reserve Bank brought 100 tonnes of gold back to India from the United Kingdom, the first move of gold on that scale since 1991.

IMF and World Bank Loans and Their Conditions

India then approached the International Bank for Reconstruction and Development, popularly known as the World Bank, and the IMF, and received about $7 billion in loans to manage the crisis. The lenders expected India in return to open up the economy, remove restrictions on the private sector, reduce the role of the government in many areas and remove trade restrictions with other countries. India accepted these conditions and announced the New Economic Policy.

The World Bank's structural adjustment loan, proposed in its report of 12 November 1991 and approved in December 1991, had two parts. The first was a loan of $250 million from the International Bank for Reconstruction and Development; the second was a credit of about $250 million (183.8 million Special Drawing Rights) from the International Development Association. The loan ran alongside an IMF stand-by arrangement approved on 31 October 1991 and was the Bank Group's first policy-based loan to India.

How far the reforms were shaped by these conditions, and how far by the government's own choice, is still disputed. Many experts had argued for such changes since the mid-1980s, but opposition leaders described the 1991 budget as a "command budget from the IMF".

The Narasimha Rao Government and Manmohan Singh

The reforms were carried out by a new government. Rajiv Gandhi was assassinated in May 1991 during the election campaign, the Congress emerged as the single largest party, and the party chose P. V. Narasimha Rao as Prime Minister. Rao took office on 21 June 1991 at the head of a minority government and appointed Manmohan Singh, a former Governor of the Reserve Bank, as Finance Minister.

Rao gave his Finance Minister complete support, and his political will was crucial in the face of opposition to the devaluation and to higher fertiliser and oil prices. His skill in steering difficult legislation through Parliament without a majority earned him the name Chanakya. The changes had begun under Rajiv Gandhi in the 1980s, but they first became clearly visible in 1991 and changed the direction the economy had followed since independence.

The New Economic Policy of 1991: Stabilisation and Structural Reform

Stabilisation Measures and Structural Reform Measures Compared

The New Economic Policy of 1991 had two groups of measures with different time horizons. Stabilisation measures are short-term measures meant to correct the weaknesses in the balance of payments and to bring inflation under control; in plain terms, they rebuild the foreign exchange reserves and hold prices down. Structural reform measures are long-term measures that raise the efficiency of the economy and its international competitiveness by removing rigidities in industry, trade, finance and the public sector.

The two had to come in that order. Stabilisation bought time with the gold, the loans and a cut in the fiscal deficit; structural reform used that time to dismantle the controls. The international lenders called the second track a structural adjustment programme, which is why the two components of the New Economic Policy are often named stabilisation and structural adjustment.

The July 1991 Devaluation of the Rupee

The first step of reform was taken in the foreign exchange market. The Reserve Bank devalued the rupee by about 18 per cent against foreign currencies, in two steps on 1 July and 3 July 1991, so that the market's reaction to the first step could be tested. Devaluation is a deliberate cut in the official value of a currency; it makes exports cheaper abroad and imports dearer at home, and in 1991 it raised the inflow of foreign exchange.

The budget of 24 July described the two exchange rate adjustments as the beginning of a move from a regime of quantitative restrictions on trade to a mechanism based on prices. The devaluation also began to free the value of the rupee from government control. Today the exchange rate is, more often than not, set by the demand and supply of foreign exchange in the market.

The New Industrial Policy of 1991

Abolition of Industrial Licensing

The Statement on Industrial Policy, issued on 24 July 1991, struck at the heart of the licence raj. Before 1991, an entrepreneur needed the government's permission to start a firm, to close it or to decide how much to produce; many industries were closed to the private sector, some goods could be made only by small-scale units, and the prices and distribution of selected products were controlled. The new policy abolished industrial licensing for all but 18 industries, those linked to security, strategic concerns, safety, social reasons and the environment.

Licensing was cut further in the following years. Today it applies only to a few product categories, namely alcohol, cigarettes, hazardous chemicals, industrial explosives, electronics, aerospace, and drugs and pharmaceuticals. Many goods once reserved for small-scale industries have been dereserved, and in most industries the market now decides prices.

Public Sector Reservation, the MRTP Act and Foreign Investment

The same policy narrowed the role of the public sector. Industries reserved for the state were cut, and the public sector was to concentrate on areas that were strategic, needed high technology or formed essential infrastructure. Today only a part of atomic energy generation and some core activities in railway transport remain reserved for the public sector.

The policy also removed the asset limits of the Monopolies and Restrictive Trade Practices (MRTP) Act, 1969, under which large firms needed government approval to expand. A firm no longer needed permission simply because it was big; the law was later replaced by the Competition Act, 2002, which deals with anti-competitive conduct rather than size.

Foreign investment was welcomed in a way it had never been before:

• Prompt approval: Foreign direct investment up to 51 per cent equity in specified high-priority industries was to be approved promptly, if the equity inflows paid for imported capital goods and the outflow of dividends was balanced by export earnings.
• Export trading: Trading companies engaged mainly in exports could also have foreign equity up to 51 per cent.
• Special board: A special board was to be constituted to negotiate with large international firms for investment that would bring high technology and access to world markets.
• Technology: The old rule requiring government approval for agreements on foreign technology was scrapped.

The Union Budget of 1991‑92 and Trade Policy Reform

Fiscal Correction in the Budget of 24 July 1991

Manmohan Singh presented the Union Budget for 1991‑92 on 24 July 1991, the same day the industrial policy was announced. He told Parliament that the new government had inherited an economy "in deep crisis" and that the centre-piece of its strategy would be a credible fiscal adjustment. Without the new measures, the fiscal deficit of 1991‑92 could have exceeded ₹52,000 crore; the budget estimated it at ₹39,732 crore before additional resources were raised. He also promised to keep the burden of adjustment on the poor as light as possible, calling it "adjustment with a human face".

The budget cut subsidies and raised new resources:

• Fertiliser subsidy: The subsidy was reduced; fertiliser prices rose for the first time since July 1981, and low-analysis fertilisers such as calcium ammonium nitrate were freed from price and movement controls.
• Export subsidies: Export subsidies were abolished from 3 July 1991, since exporters were compensated through the new exchange rate and the enlarged Replenishment Licensing System; only ₹1,224 crore had to be provided for them in 1991‑92, against an earlier estimate of ₹4,200 crore.
• Disinvestment: Up to 20 per cent of government equity in selected public sector undertakings was to be sold to mutual funds and investment institutions in the public sector, which was expected to yield ₹2,500 crore in the year.

The speech ended with a line from Victor Hugo, that "no power on earth can stop an idea whose time has come", and with the declaration that "India is now wide awake".

Trade Policy Reform: From Quantitative Restrictions to Tariffs

Before 1991 India protected its industries through quantitative restrictions, limits on the quantity of goods that could be imported, together with very high tariffs. These policies reduced efficiency and competitiveness and slowed the growth of manufacturing. The trade reforms that began in 1991 aimed at dismantling quantitative restrictions on imports and exports, reducing tariff rates and removing licensing procedures for imports.

The changes came in steps. The budget of 1991‑92 proposed a ceiling of 150 per cent on tariff rates and lower rates across the board. Import licensing was abolished except for hazardous and environmentally sensitive industries, and export duties were removed to make Indian goods more competitive abroad. Quantitative restrictions on imports of manufactured consumer goods and agricultural products were removed fully only from April 2001.

Banking, Capital Market and Tax Reforms After 1991

The Narasimham Committee on the Financial System

Banking had been under firm state control since the nationalisation of the 14 largest commercial banks with effect from midnight on 19 July 1969; six more banks were nationalised in 1980. Branches spread to rural areas and credit was directed to priority sectors, but by the late 1980s rigidities and weaknesses had made serious inroads into the banking system. The budget of 1991 promised a high-level committee to examine the whole financial system, so that banks could meet capital adequacy and prudential norms and become more profitable.

The Committee on the Financial System, chaired by M. Narasimham, a former Governor of the Reserve Bank, was appointed on 14 August 1991. It submitted its report in November 1991, and the report was tabled in Parliament on 17 December 1991. Its main recommendations were these:

• Reserve ratios: The statutory liquidity ratio (SLR) should fall from 38.5 per cent to 25 per cent and the cash reserve ratio (CRR) from 15 per cent to 10 per cent, freeing bank funds for lending.
• Directed credit: Priority sector lending, which the committee saw as a main cause of bad loans and low profits, should be phased out.
• Interest rates: Market forces rather than the government should set interest rates.
• Supervision: Banks should be placed under the sole control of the Reserve Bank, and the number of public sector banks should be reduced.

The government cut the SLR and CRR, freed interest rates and allowed private banks, Indian and foreign, to enter. Foreign investment in banks was later allowed up to about 74 per cent, and foreign institutional investors such as mutual funds and pension funds were allowed into Indian financial markets. The aim was to change the Reserve Bank's role from regulator to facilitator of the financial sector. A second Narasimham Committee, on banking sector reforms, was set up in December 1997 and reported in April 1998.

SEBI, Tax Reform and the Chelliah Committee

The capital market got its own regulator. The Securities and Exchange Board of India (SEBI), set up on 12 April 1988 as an executive body, received statutory powers on 30 January 1992 through the SEBI Act, 1992. It took over the regulation of share issues from the Controller of Capital Issues and the government, so that an independent body would administer the law.

Tax reform followed a committee chaired by the economist Raja Chelliah, who headed the Tax Reforms Committee from 1991 to 1993. Since 1991 personal income tax rates have been reduced steadily, because very high rates were an important reason for tax evasion, and the rate of corporation tax has also been lowered gradually. Procedures were simplified to encourage compliance. The reform of indirect taxes took much longer. The Constitution was amended in 2016 to empower the Union and State governments to make laws imposing the Goods and Services Tax (GST), which came into force on 1 July 2017 with the aim of "one nation, one tax and one market".

Privatisation, Disinvestment and Globalisation After 1991

Disinvestment and the Maharatna, Navratna and Miniratna Companies

Privatisation means shedding the ownership or management of a government enterprise, either by the government's withdrawal from ownership and management or by the outright sale of the enterprise. The sale of part of the equity of public sector enterprises to the public is called disinvestment. Its stated purpose was to improve financial discipline, to bring in private capital and managerial skill, and to modernise the enterprises.

Disinvestment began with the budget of 1991‑92, whose target of ₹2,500 crore was exceeded. A committee headed by C. Rangarajan, which reported in 1993, recommended that disinvestment of up to 49 per cent be allowed in companies reserved for the public sector and up to 100 per cent in others. The government also gave its profitable enterprises more autonomy by naming them maharatnas, navratnas and miniratnas; Indian Oil Corporation and Steel Authority of India are maharatnas.

Globalisation, the WTO and the Move from FERA to FEMA

Globalisation is the integration of a country's economy with the world economy. It was not a separate policy in 1991 but the outcome of liberalisation and privatisation together. Its most visible result in India was outsourcing, in which firms in developed countries hire services such as call centres, record keeping, accountancy, film editing and clinical advice from India, drawn by low wage rates and the availability of skilled workers.

Two institutional changes fixed India's place in the open world economy:

• World Trade Organization: The WTO was founded in 1995 as the successor to the General Agreement on Tariffs and Trade (GATT), set up in 1948 with 23 countries. As an important member of the WTO, India has kept its commitments to remove quantitative restrictions on imports and reduce tariff rates.
• FERA to FEMA: The Foreign Exchange Regulation Act (FERA), 1973, treated every dealing in foreign exchange as prohibited unless specifically permitted, and even minor offences under it could lead to imprisonment. The Foreign Exchange Management Act (FEMA), 1999, passed on 29 December 1999, came into force on 1 June 2000. It aims at facilitating external trade and payments and makes foreign exchange offences civil rather than criminal.

Economic Reforms Since 1991: Outcomes and Criticism

Growth, Foreign Investment and Reserves After 1991

The economy grew faster after 1991. Average annual GDP growth rose from 5.6 per cent in 1980‑91 to 6.4 per cent in 1992‑2001, 7.8 per cent in 2002‑07 and 8.2 per cent in 2007‑12, and was 5.6 per cent in the single year 2012‑13. Services led this growth, while agricultural growth slowed and industrial growth fluctuated.

The external position changed beyond recognition:

• Foreign investment: Foreign direct investment and foreign institutional investment together rose from about $100 million in 1990‑91 to $23 billion in 2022‑23.
• Reserves: Foreign exchange reserves rose from about $6 billion in 1990‑91 to about $646 billion in 2023‑24, and stood at about $729 billion on 21 August 2026. India is now one of the largest holders of foreign exchange reserves in the world.
• Exports: India's share of world merchandise exports rose from 0.6 per cent in 1991 to 1.7 per cent in 2018, and India became a successful exporter of auto parts, pharmaceutical goods, engineering goods, IT software and textiles.

Extreme poverty also fell significantly in the three decades after 1991, though economists disagree on how much of the faster growth came from the reforms of 1991 and how much from the partial reforms of the 1980s.

Criticism: Agriculture, Industry, Employment and Public Finance

The reforms have been widely criticised for leaving some basic problems unsolved:

• Employment: GDP growth rose, but it did not create enough jobs.
• Agriculture: Public investment in agricultural infrastructure, including irrigation, power, roads, market links and research and extension, fell after 1991. The partial removal of the fertiliser subsidy raised costs for small and marginal farmers, and lower import duties and the removal of quantitative restrictions exposed farmers to international competition. A shift towards export crops in place of food grains put pressure on food prices.
• Industry: Critics hold that industry suffered because cheaper imports replaced the demand for domestic goods, and because investment in infrastructure, including power, remained inadequate. Developed countries kept non-tariff barriers against Indian goods.
• Disinvestment: Critics argue that the assets of public enterprises were undervalued when sold, and that the proceeds were used to cover revenue shortfalls rather than to develop the enterprises or social infrastructure.
• Public finance: Limits on public expenditure fell hardest on the social sectors. Tax cuts did not raise revenue as hoped, tariff cuts reduced customs revenue and tax incentives to foreign investors narrowed the tax base further.

A sharper critique holds that the crisis of the early 1990s itself grew out of deep inequalities in Indian society, and that the externally advised reform package widened them. On this view, the incomes and consumption of high-income groups rose most, and growth was concentrated in a few services such as telecommunication, information technology, finance, real estate and trade, rather than in agriculture and industry, which provide livelihoods to millions.

Governance After Liberalisation: Regulators and Administrative Reform

An open economy needs a different kind of state, one that sets rules and settles disputes rather than one that grants permissions. The governmental system responded first by building regulators. SEBI received statutory powers in 1992, IRDAI has regulated insurance since 1999, and the Competition Act, 2002, replaced the MRTP Act. Insurance was opened to private companies in 2000 with a 26 per cent limit on foreign investment, which was raised to 49 per cent and then, in May 2021, to 74 per cent; in December 2025 Parliament passed a law allowing up to 100 per cent.

The reform of the administration itself moved far more slowly. The Planning Commission was replaced by the NITI Aayog only on 1 January 2015, and the government decided in 2022 to wind up the Tariff Commission, a remnant of the licence and permit era. In the 2020s the government removed more than 42,000 compliances and decriminalised more than 3,700 legal provisions to improve the ease of doing business. The gaps the critics identify, in public investment in agriculture, in employment and in the social sectors, show where the response is still incomplete.

Significance of 1991 in Post-Independence History

Continuity with the 1980s and the Politics of Reform

The reforms of 1991 had a prehistory. A few liberalising steps were taken in the 1980s in industrial licensing, export-import policy, technology upgradation, fiscal policy and foreign investment. Growth had already risen from about 3.6 per cent a year between 1951 and 1974, the slow pace known as the "Hindu rate of growth", to 5.6 per cent a year in 1980‑91. What made 1991 different was its scope. The policies of 1991 were far more comprehensive, and they reached industry, trade, finance and taxation together.

The politics of 1991 explain how the turn was made. A minority government, formed after an election marked by an assassination, took decisions that earlier governments had postponed. The reforms were widely criticised by movements and organisations, yet the governments that followed continued to promote liberalisation and closer links with the world economy. This is why 1991 stands as the turning point of economic policy in contemporary India.

Sources

• NCERT: Class 11 Indian Economic Development, Chapter 3
• NCERT: Class 12 Politics in India since Independence, Chapter 8
• Ministry of Finance: Budget 1991‑92, Speech of Shri Manmohan Singh, Minister of Finance, 24 July 1991
• Ministry of Finance: Economic Survey 2019‑20, Volume 1, Chapter 5, Creating Jobs and Growth by Specializing to Exports in Network Products
• World Bank: India, Structural Adjustment Loan/Credit, President's Report of 12 November 1991
• World Bank: India, Structural Adjustment Loan/Credit, Project Completion Report (Report No. 14582)
• Press Information Bureau: The Sabka Bima Sabki Raksha (Amendment of Insurance Laws) Bill, 2025 passed by Parliament
• UPSC: Civil Services Examination question papers
• Wikipedia: 1991 Indian economic crisis
• Wikipedia: Economic liberalisation in India
• Wikipedia: Licence Raj
• Wikipedia: Narasimham Committee
• Wikipedia: Securities and Exchange Board of India
• Wikipedia: Raja Chelliah
• Wikipedia: Disinvestment in India
• Wikipedia: Foreign Exchange Management Act
• Wikipedia: Competition Act, 2002
• Wikipedia: Insurance in India
• Wikipedia: Nationalisation of banks in India
• Wikipedia: Foreign-exchange reserves of India
• Wikipedia: P. V. Narasimha Rao
• Wikipedia: Manmohan Singh