1991 Balance of Payments Crisis

By early 1991, India was on the brink of default. Multiple factors converged:

  • Foreign exchange reserves down to ~$1.2 billion (two weeks of imports);
  • Gulf War (August 1990) — oil prices spiked; remittances from Indians in Gulf collapsed;
  • Soviet Union collapse — India's largest trading partner under rupee-trade arrangement gone;
  • Fiscal deficit — 8.4% of GDP;
  • Inflation — ~17%;
  • Current account deficit — 3.5% of GDP;
  • External debt — ~$70 billion;
  • India had to pledge 47 tonnes of gold to the Bank of England as collateral for an emergency loan (May-July 1991);
  • Sovereign credit rating downgraded; investors fleeing.

PM Chandra Shekhar's caretaker government fell. PM Narasimha Rao took office 21 June 1991 and appointed Manmohan Singh as Finance Minister.

New Economic Policy — 24 July 1991

Manmohan Singh's first Budget speech on 24 July 1991 announced the New Economic Policy (NEP) — a comprehensive shift from the planning era's controlled regime to a liberalised market regime.

The NEP had two parts:

  1. Stabilisation measures — short-term, IMF-backed, to address BoP crisis;
  2. Structural reforms — long-term, to dismantle the License Raj and integrate India globally.

The structural reforms are organised under three pillars: Liberalisation, Privatisation, Globalisation — collectively the LPG reforms.

24 Jul 1991
Manmohan Singh Budget
$1.2 B
Forex reserves at low
47 tonnes
Gold pledged
~3.5% → 7%+
Avg growth shift post-LPG

Stabilisation measures

  • Rupee devalued in two steps (1 July and 3 July 1991) — by ~18-19% cumulatively;
  • IMF emergency loan — ~$2.2 billion under SBA (Stand-By Arrangement);
  • World Bank Structural Adjustment Loan;
  • Fiscal consolidation — fiscal deficit targets;
  • Reduction in subsidies;
  • Inflation control through monetary tightening.

Liberalisation — dismantling the License Raj

Liberalisation means reducing government control over economic decisions and increasing the role of markets and private enterprise.

Key liberalisation measures:

  • Industrial licensing abolished for most industries (only 18 retained, later reduced to 5);
  • MRTP Act dismantled;
  • Public sector reservation reduced — from 17 industries (IPR 1956) to 8, then 3, now 2 (atomic energy, railways);
  • Small Scale Industry (SSI) reservation reduced;
  • Tariff reductions — average from ~85% to ~12% over 30 years;
  • Quantitative Restrictions removed from most imports by 2001;
  • Foreign Investment Promotion Board (FIPB) for fast-track approval;
  • Rupee convertibility on current account (1994);
  • Banking deregulation — new private banks allowed;
  • Capital markets liberalised — FII investment allowed;
  • Insurance opened to private (IRDA Act 1999).

Industrial Policy 1991

Announced 24 July 1991 (same day as Budget). Key features:

  • Industrial licensing abolished for all industries except 18 (later 5);
  • Public sector reservation reduced;
  • MRTP Act amended to remove asset thresholds;
  • Foreign equity up to 51% in 35 high-priority industries under automatic route;
  • Foreign technology agreements automatic in high-priority industries;
  • BIFR (Board for Industrial & Financial Reconstruction) for sick units;
  • Disinvestment of public sector announced.

Trade reforms

  • Tariff reductions — peak rates cut from 350% (1990) to 150% (1991), to 50% (2000), to ~12% (2020s);
  • QRs removed from intermediate and capital goods (1991-95);
  • QRs removed from consumer goods by 2001 (WTO dispute panel ruling);
  • EXIM Policy — multi-year (1992-97, etc.);
  • Export Processing Zones → Special Economic Zones (SEZs, 2005);
  • WTO entry 1995 — committed to schedule of bound tariffs.

Financial sector reforms — Narasimham Committee

The M. Narasimham Committee on Financial System (1991, Narasimham-I) and 1998 (Narasimham-II) shaped India's financial sector reforms.

Key recommendations and reforms

  • Reduction in SLR and CRR — SLR cut from 38.5% to 25%; CRR from 15% to 4.5%;
  • Interest rate deregulation — rates set by market;
  • New private banks allowed — HDFC, ICICI, Axis, Yes, IndusInd, Kotak;
  • NPA management — prudential norms, capital adequacy (CRAR 9%+);
  • SEBI statutory status (1992) — capital markets regulator;
  • Demat (NSDL 1996) — paperless trading;
  • FII investment allowed (1992);
  • Insurance opened to private (IRDA Act 1999);
  • Pension reforms — NPS introduced 2004 (Old Pension Scheme phased out for new govt employees).

Privatisation

Privatisation means transferring ownership and management from public to private sector. India adopted a gradual approach:

  • Disinvestment — partial sale of equity in PSEs; began with Hindustan Lever, BHEL stakes 1991-92;
  • Department of Disinvestment (later DIPAM) established 1999;
  • Strategic sale — full transfer of management — Modern Foods, BALCO, VSNL, Hindustan Zinc, IPCL (1999-2003);
  • Air India / Indian Airlines — strategic sale to Tata Sons (2022);
  • BPCL, CONCOR, Shipping Corporation — strategic sale pipeline;
  • LIC IPO May 2022 — partial listing;
  • National Monetisation Pipeline 2021 — ₹6 lakh crore over 4 years.

Globalisation

Globalisation means integrating Indian economy with the world economy — for goods, services, capital, technology, and labour movement.

Key measures:

  • FDI — 100% in most sectors; automatic route in many;
  • FERA replaced by FEMA 1999 — Foreign Exchange Management Act;
  • Rupee convertibility on current account (1994); partial on capital account;
  • WTO membership 1995 — GATT (goods), GATS (services), TRIPS (IP);
  • Free Trade Agreements — Sri Lanka, ASEAN, Korea, Japan, UAE, Australia;
  • Outsourcing destination — IT services boom from 1995 onwards;
  • Indian MNCs emerge — TCS, Infosys, Tata, Wipro, Bharti.

WTO and India

WTO was established on 1 January 1995, replacing GATT 1947. India was a founding member. Key agreements:

  • GATT (Goods) — tariff and non-tariff barrier reductions;
  • GATS (Services) — services trade liberalisation;
  • TRIPS (Intellectual Property) — minimum standards for patents, copyrights, trademarks; India had to extend patent protection to pharma (Patent Amendment Act 2005);
  • Dispute Settlement Body — adjudication mechanism.

India has been a key voice in WTO debates — agricultural subsidies, food security buffer stocks, TRIPS flexibility (especially for generic medicines and traditional knowledge).

Appraisal — what LPG achieved and where it fell short

Achievements

  • GDP growth — from ~3.5% to ~7-8% (best in independent India's history);
  • Per capita income — from ~$300 (1991) to ~$2,600 (2024);
  • Forex reserves — from $1.2 bn (1991) to ~$650 bn (2024);
  • Poverty headcount — from ~50% (1973-74) to ~10% (Tendulkar; ~5% per latest NITI Aayog MPI);
  • India became 5th largest economy;
  • Services boom — IT, financial services, telecommunications;
  • FDI inflows — from ~$100 mn (1991) to ~$80 bn (2024);
  • Indian MNCs emerged — TCS, Infosys, Tata, Bharti, Mahindra;
  • Middle class expansion — from ~30 mn to ~300 mn;
  • UPI & digital economy — India became a digital payments leader.

Shortcomings

  • Inequality rose — Gini coefficient up; top-1% wealth share ~40%;
  • Agricultural distress — farmer suicides peak; recurring crises;
  • Jobless growth — output grew faster than employment;
  • Industrial sector employment stagnated despite output growth;
  • Manufacturing share stuck at ~14-17% of GDP (target was 25%);
  • Unorganised sector dominance continues — ~90% of workforce;
  • Healthcare and education spending below need;
  • Environmental costs — pollution, climate, water;
  • Crony capitalism concerns;
  • Regional disparities widened — Southern + Western states pulled ahead.

NCERT exercise solutions — selected answers

Q1. Why were reforms introduced in India?

Reforms were introduced in 1991 because: (1) BALANCE OF PAYMENTS CRISIS — Forex reserves down to $1.2 billion (only 2 weeks of imports); risk of default on external debt; (2) GULF WAR (Aug 1990) — oil prices spiked; Gulf remittances collapsed; (3) SOVIET UNION COLLAPSE — India's largest trading partner under rupee-trade gone; (4) FISCAL DEFICIT — 8.4% of GDP; government borrowing unsustainable; (5) INFLATION — 17%; eroding purchasing power; (6) STAGNANT GROWTH — Hindu Rate of 3.5%; couldn't lift poverty fast; (7) UNCOMPETITIVE INDUSTRY — License Raj created inefficiency; consumers got poor quality at high prices; (8) LIMITED EXPORTS — couldn't earn enough forex; (9) NEED for FOREIGN CAPITAL and TECHNOLOGY; (10) WORLD WAS CHANGING — China (1978), East Asian tigers showed alternative model; (11) IMF/WORLD BANK CONDITIONALITIES — emergency loan came with reform conditions. India's choice was: continue License Raj and face economic collapse; or reform and integrate with world economy. Manmohan Singh and Narasimha Rao chose reform.

Q2. How many countries are members of the WTO?

The WTO has 164 MEMBER COUNTRIES (as of 2024). WTO was established on 1 JANUARY 1995 by the Marrakesh Agreement, replacing the General Agreement on Tariffs and Trade (GATT) 1947. India is a FOUNDING MEMBER of WTO (and was a contracting party to GATT 1948). HQ in Geneva, Switzerland. WTO's MAIN FUNCTIONS: (1) Administer trade agreements (GATT, GATS, TRIPS); (2) Resolve trade disputes via Dispute Settlement Body; (3) Monitor national trade policies; (4) Provide technical assistance to developing countries; (5) Promote multilateral trade negotiations (e.g., Doha Round, started 2001; largely stalled). KEY AGREEMENTS: (1) GATT — Goods; (2) GATS — Services; (3) TRIPS — Intellectual property rights; (4) AGREEMENT ON AGRICULTURE; (5) ANTI-DUMPING; (6) DISPUTE SETTLEMENT UNDERSTANDING. India has been active in WTO debates on agricultural subsidies, generic medicines (TRIPS flexibility), services trade. Most recent: 13th Ministerial Conference (MC13), Abu Dhabi February-March 2024.

Q3. Why did RBI have to change its role from controller to facilitator of the financial sector?

Before 1991, RBI was a CONTROLLER of the financial sector — fixing interest rates, allocating credit, deciding who could be a bank, exchange controls under FERA. After 1991 reforms, RBI's role changed to FACILITATOR — enabling market-based financial system. REASONS: (1) MARKET-BASED ECONOMY needs MARKET-DETERMINED interest rates; controllers create distortions; (2) FOREIGN INVESTMENT requires CONVERTIBILITY and PREDICTABLE rules; (3) PRIVATE BANKS need REGULATORY rather than directive role from RBI; (4) FINANCIAL INNOVATION (derivatives, securitisation) needs flexible regulator; (5) NARASIMHAM COMMITTEE 1991 + 1998 recommended this transition; (6) GLOBALISATION required REGULATION-WITH-AUTONOMY framework; (7) FEMA 1999 (Foreign Exchange MANAGEMENT) replaced FERA 1973 (Foreign Exchange REGULATION) — language shift signals role change. RBI's NEW ROLE: (1) MONETARY POLICY through inflation targeting (2016); (2) PRUDENTIAL REGULATION of banks; (3) PAYMENT SYSTEMS oversight (UPI, RTGS, NEFT); (4) Foreign exchange management; (5) Banker to government; (6) LENDER OF LAST RESORT. RBI is now a SOPHISTICATED CENTRAL BANK comparable to Fed, ECB, BoJ.

Q4. How is RBI controlling the commercial banks?

RBI controls commercial banks through: (1) LICENSING — RBI grants licenses to open banks; (2) CASH RESERVE RATIO (CRR) — banks must keep this % of deposits with RBI as cash (currently ~4.5%); (3) STATUTORY LIQUIDITY RATIO (SLR) — banks must hold this % of deposits in government securities/gold (currently ~18%); (4) REPO RATE — rate at which RBI lends to banks; sets short-term interest rate; (5) REVERSE REPO — rate RBI borrows from banks; (6) OPEN MARKET OPERATIONS — buying/selling g-securities; (7) PRIORITY SECTOR LENDING — banks must lend 40% to priority sectors (agriculture 18%, MSME, education, housing, weaker sections); (8) CAPITAL ADEQUACY — banks must maintain CRAR 9%+; (9) NPA NORMS — restructuring/provisioning of bad loans; (10) MORAL SUASION — RBI advice on lending policies, deposit rates; (11) SUPERVISION via on-site/off-site inspection; (12) RESOLUTION FRAMEWORK — IBC 2016, Banks Boards Bureau; (13) FOREX MANAGEMENT — under FEMA 1999. POST-2016: INFLATION TARGETING framework — 4% ±2% — main monetary policy anchor; 6-member Monetary Policy Committee. RBI's tools have expanded with the financial system's complexity.

Q5. What are the major factors responsible for the high growth of the service sector?

Major factors for service sector growth: (1) LIBERALISATION post-1991 — IT, telecom, banking, insurance, retail liberalised; (2) GLOBAL OUTSOURCING — India became destination for IT services (Y2K bug 1999 catalyst; English-speaking, cheap labour); (3) IT REVOLUTION — Bangalore, Hyderabad, Chennai, Pune, NCR emerged as IT hubs; TCS, Infosys, Wipro became global leaders; ~$200 billion IT exports today; (4) TELECOM REVOLUTION — Mobile penetration 100%+; UPI; Digital India; Reliance Jio (2016) sparked mobile internet revolution; (5) RISING URBAN MIDDLE CLASS — Demanded financial services, healthcare, education, entertainment, hospitality; (6) FDI in services — 100% in most sub-sectors; (7) URBANISATION — Service jobs concentrated in cities; (8) RETAIL boom — E-commerce (Amazon, Flipkart, Meesho); modern retail; quick commerce; (9) BANKING expansion — PMJDY, RuPay, UPI; financial inclusion; (10) HEALTHCARE — Hospitals, pharma, medical tourism; (11) EDUCATION — Private schools, coaching, ed-tech; (12) TOURISM — Increasing share of GDP; (13) GIG ECONOMY — Uber, Zomato, Swiggy, Urban Company. RESULT: services share of GDP from ~40% (1991) to ~56% (2024); employment share ~30%. Services exports — ~$340 billion (2024).

Q6. Examine the effects of import substitution.

IMPORT SUBSTITUTION INDUSTRIALISATION (ISI) was Indian strategy 1950-1990: REPLACE imports with DOMESTIC PRODUCTION. POSITIVE effects: (1) Built INDIGENOUS INDUSTRIAL BASE — steel, fertilisers, capital goods; (2) Provided EMPLOYMENT in protected industries; (3) Preserved FOREIGN EXCHANGE; (4) Built SCIENTIFIC and ENGINEERING capacity (IITs, CSIR labs); (5) Made INDIA SELF-RELIANT in food, basic industries by 1980s. NEGATIVE effects: (1) INEFFICIENCY — Protected industries had no incentive to innovate; (2) HIGH COSTS — Cement, steel, autos cost much more in India than international prices; (3) POOR QUALITY — Consumers got Ambassador-Premier era cars, Bajaj scooters with year-long waiting lists; (4) LIMITED EXPORTS — Uncompetitive industries couldn't export; (5) CHRONIC TRADE DEFICITS; (6) BALANCE OF PAYMENTS recurring crises; (7) MISALLOCATION of resources — Protected industries vs labour-intensive ones; (8) RENT-SEEKING — Licence Raj created corruption; (9) MISSED GLOBAL TECHNOLOGY waves — semiconductors, software (until 1990s); (10) Slow productivity growth — Total factor productivity growth ~1% per year. POST-1991, India shifted to EXPORT-PROMOTION model — but ISI legacy continues in some sectors. CURRENT POLICY (Atmanirbhar Bharat, PLI 2020-25) is a CALIBRATED RETURN to ISI for SELECT SECTORS — semiconductors, batteries, defence.

Q7. Why are tariffs imposed?

Tariffs (import duties) are imposed for: (1) PROTECT INFANT INDUSTRIES — Young domestic industries can't compete with established foreign firms; tariffs give them time to develop; (2) RAISE GOVERNMENT REVENUE — Tariffs are a tax; especially important before income tax developed; (3) BALANCE OF PAYMENTS — Reduce imports when forex reserves low; (4) PROTECT EMPLOYMENT — Domestic jobs in import-competing industries; (5) NATIONAL SECURITY — Strategic sectors (defence, energy, food); (6) RETALIATION — Against unfair foreign trade practices; (7) ENVIRONMENTAL/HEALTH STANDARDS — Carbon border tax, sanitary rules; (8) CULTURAL — Protect domestic film, music, publishing. PROBLEMS WITH TARIFFS: (1) REDUCE CONSUMER WELFARE — Higher prices for consumers; (2) PROTECT INEFFICIENT INDUSTRIES — No incentive to improve; (3) REDUCE CHOICE; (4) INVITE RETALIATION; (5) DISTORT TRADE PATTERNS. WTO rules: Bound tariffs (committed maximum); MFN (Most Favoured Nation) principle. INDIA's POSITION: (1) Pre-1991: average tariff ~85%; (2) Post-1991: gradual reduction; (3) Current (2024): average ~12%; selectively higher in agriculture, automobiles; (4) Strategic sectors (electronics, semiconductors) — RECENT INCREASE in tariffs to support PLI policy; (5) FTAs reduce tariffs with specific partners. Tariffs remain a POLICY TOOL but used strategically, not generally.

UPSC PYQ tagging

UPSC angle

1991 LPG reforms are foundational for GS-3 economic development. Strong answers cite the BoP crisis (47 tonnes gold, $1.2 bn reserves), Narasimha Rao + Manmohan Singh, Industrial Policy 1991, Narasimham Committee, WTO entry 1995, and the long-arc appraisal. Also relevant for GS-2 (international institutions — WTO, IMF).

  • 2017 GS-3: "Examine the impact of liberalization on companies owned by Indians. Are they competing with the MNCs satisfactorily?"
  • 2019 GS-3: "Define potential GDP and explain its determinants. What are the factors that have been inhibiting India from realizing its potential GDP?"
  • 2020 GS-3: "Examine the role of Special Economic Zones (SEZs) in India's foreign trade."
  • 2024 GS-3: "Discuss India's stance at the WTO Ministerial Conferences. What are the key issues affecting India's negotiating position?"
  • Likely 2026: "Trace the arc of India's economic reforms from 1991 to Atmanirbhar Bharat 2020. Has India found a coherent economic strategy?"
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