Economics

Second Generation Reforms: Economic Reforms in India

Second Generation Reforms

As we all know, India introduced economic reforms of Liberalization Globalization, and Privatization (LPG reforms) in 1991, which was mainly aimed to liberalize the Indian Economy and fuel economic growth, which was more or less stagnant before the reforms, all thanks to the socialistic policies. And these reforms were mostly influenced by the Washington Consensus and driven by the Balance of Payment (BoP) crisis. This is because India needed urgent funds to cope up with the crisis, which India got from the International Monetary Fund (IMF), however, these funds were given on a condition. And these conditions ultimately led to the LPG reforms and further fueled the Second Generation Reforms.

 

Second Generation Reforms
Image by- Times of India

So, after the LPG reforms, the Government carried out various other economic reforms in the country, namely the first, second, and third-generation economic reforms in India. And, broadly speaking, these three generations of economic reforms were mainly aimed to liberalize the economy and promote private sector participation in the economy.

The reforms driven by Washington Consensus were indeed beneficial for India, but was it reforming or ruinous for other developing nations? Click here to find out. 

Second Generation Reforms

In order to better understand the second-generation reforms in India, let’s first have a brief understanding of the policies undertaken in the first-generation economic reforms.

First Generation Reforms
Second Generation Reforms
Image by- ORF

As stated earlier, India undertook the economic reforms of Liberalization, Privatization, and Globalization. And these reforms, initiated in 1991 and lasted till 2000, were considered the First Generation Economic Reforms. So, the policies of the first generation reforms can be summarized as-

Public Sector Reforms

As a part of privatization reforms, the Government undertook various measures to reduce or completely sell its shareholdings (disinvestment and corporatization) in the Public Sector Undertakings (PSUs). However, in the initial period, the Government undertook token disinvestment policy, as the Government took great caution in disinvesting. Under the token disinvestment policy, which is also called ‘minority stake sale’, the process of disinvestment was gradual and the government made the policy to sell the shares of PSUs a maximum of up to 49 percent. Hence, Government ultimately retained the ownership of the companies.

The main aim of the policy of privatization was to make the public sector companies more efficient in their functioning and operations, and ultimately more profitable. However, the government wasn’t able to achieve this, mainly because the government sold only a 5-10% stake in the PSUs, hence, there were no structural changes in the functioning of the companies as it was still mostly controlled by the Government. So, the initial disinvestment policy just brought some additional funds to the government, which was mainly used to reduce the financial burden on the government i.e. mitigating fiscal deficit.

Promoting the Private Sector
Second Generation Reforms
Image by- ORF

One of the most important measures taken by the Government in this regard was to mitigate the Licence Raj and introduce delicencing of the industries. Other major steps taken towards privatization included more liberalized policy decisions such as the policy of dereservation, simplifying the environmental laws for setting up industries, abolition of the conversion of loans into shares, etc. Another major policy decision was to abolish the MRTP (Monopolies and Restrictive Trade Practices), under which the firms with assets of and above 25 crores were considered as ‘monopolies’ and called MRTP companies. And this 25 crore limit was called the upper limit. Under the act, these ‘monopolistic’ companies were obliged to take permission from the Government of India for further business expansion. The main aim of this policy was to prevent monopolies, but this policy gradually became obsolete and harmed the businesses.

External Sector Reforms

There were other major reforms that fulfilled the aim of Liberalization, Privatization, and Globalization and played a major role in enhancing India’s economy. For promoting globalization, the Government introduced various measures such as switching to the floating exchange rate, granting permission to foreign investments, introducing the Foreign Exchange Management Act, abolishing quantitative restrictions on imports, and further reforms in the capital account.

Apart from them, Government also initiated tax reforms for simplifying and modernizing the taxing system. Financial sector reforms were taken in the fields of banking, insurance, capital markets, and mutual funds.

Second Generation Reforms
Second Generation Reforms
Image by- Times of India

The first-generation reforms were aimed to make the Indian economy a market-driven economy rather than a centrally planned and command-type economy. These reforms were indeed successful, but however, didn’t achieve the desired results. This was mainly because of the flaws mentioned earlier in the article, such as extensive caution in the process of disinvestment, etc. So, the Second Generation Reforms were introduced in the country in 2000-2001.

The main features of the Second Generation Reforms were-

Deregulation and Liberalization
Second Generation Refroms
Image by- tutorialspoint

Under this, the Government abolished the policy of Administered Price Mechanism (APM), and ultimately deregulated and liberalized the prices which were earlier regulated and fixed by the Government under the Administered Price Mechanism. This step, taken by the Government was considered the ‘backbone’ for the success of the economic reform process of India.

The main products whose prices were regulated by the Government included petroleum, sugar, drugs, fertilizers, etc. And most of these goods were produced by the private sector. However, the main aim of the private sector, ‘making profit’, was not fulfilled due to this policy of regulating the prices. The prices of the goods, instead of being determined by the forces of demand and supply, were determined by the contemporary policies of the government, which extensively hindered the profitability of these private companies. So, as the profits of these private companies diminished, so did their growth prospects.

So, in order to enhance the profitability of the companies and incentivize their growth, the Government took the step to provide more autonomy to the companies to determine the prices of their products and liberalize the pricing. Most of the products have now been phased out of the Administered Price Mechanism. However, there are still some products whose prices are determined under the influence of APM, they are-

  • Petroleum segment- LPG and Kerosene Oil
  • Fertilizers segment- Urea

Keeping these products under the APM was a necessity, as if their pricing was completely liberalized, the public would have faced huge inconvenience and hardships due to the fluctuations in their prices caused by the disruption in the demand-supply mechanism. Let’s take LPG and Kerosene for example. We all know that their prices are mostly driven by the international oil prices, which could be manipulated by OPEC (Organization of Petroleum Exporting Countries) and big speculation in the market, or it could be affected by some crisis, such as the COVID. So, the fluctuations in their prices would have a direct impact on the public, as if the international oil prices increase substantially, so would the price of Kerosene and LPG, causing great hardship for the people. So, in order to mitigate these effects, Government intervenes and regulates the prices of LPG and Kerosene through various steps. For example, the Government issued Oil Bonds to various Oil Marketing Companies (OMCs) from 2005-2010, to compensate them for the losses they faced to protect the consumers from rising crude oil prices.

Image by- Toonpool

Apart from these reforms, the Government opened the petroleum sector for private investment and cut down or reduced the subsidies on various goods. Moreover, many of the drugs have also been phased out of the APM. These reforms have yielded good results, but however, further steps towards this are required to achieve the desired results. One of the major steps to achieve this would be to further cut down subsidies on various goods.

Reforms in the Legal Sector

The legal sector reforms were initiated during the first generation reforms. These were mainly aimed to mitigate and remove the Licence Raj and strict regulatory laws which adversely affected the growth and expansion of businesses. However, the steps taken in the first-generation reforms were not enough and newer reforms were needed. So, among the legal reforms taken during the second generation reforms include-

  • reforms in the Indian Penal Code (IPC)
  • reforms in Code of Criminal Procedure (CrPC)
  • Abolishment of outdated and contradictory laws
  • reforms in Labor Laws and Company Law
  • Introduction of suitable legal provisions for newer areas such as Cyber Law
Reforms in the Public Sector

The reforms in Public Sector Undertakings include strategic disinvestment. In contrast to the ‘minority stake sale’ or ‘token disinvestment’, the Government undertook the policy of strategic disinvestment in the Second-Generation Reforms. Under the process of strategic disinvestment, government sells the majority stake in the PSE (Public Sector Enterprise) and transfers the ownership and management control of the concerned enterprise. This was mainly done to bring structural changes in the functioning of the enterprises, as the ownership and management control was transferred to the private entity, they had the power to make all the major decisions regarding the company.

Types of Disinvestment
Image by- Vajiram IAS

Other major reforms in the public sector included free leverage to the capital market, greenfield ventures, international tie-ups, and giving greater functional autonomy.

Critical Sector Reforms

The main focus in the critical sector reforms was the infrastructure reforms, the main components in the infrastructure sector included roads, telecom sector, and power. And under this, the State Governments played an important role in these economic reforms, with the Central Government playing a supportive role. So, it was the State Governments that initiated new measures for these reforms.

Another major focus was on agriculture. Numerous agriculture reforms were initiated such as research and development in agriculture. Until the second-generation reforms, it was the government that facilitated the R&D in the agriculture sector, but however, active participation of the private sector was needed. So, the second-generation reforms paved the way for active participation of the private sector in this field. Other major reforms included the promotion of corporate and contract farming and irrigation.

Tax Devolution to the States

As we all know that the ‘coalition-era ‘ started in the 1990s, which brought about more respect for the state governments and further enhanced their powers and autonomy. And these changes in the political arena were accompanied by changes in the economic arena too with the advent of the second-generation reforms.

The Centre now made policies that were inclined towards the interest of the States. The Planning Commission and Financial Commission now took greater fiscal care of the state. Central Government made the policy to provide greater fiscal leverage to the states, and also initiated the tax reforms, which were, again, in favor of the states.

Reforms in the Social Sector
Image by- Postgraduate Search

Along with the infrastructure and agriculture, the Government also took measures for reforming the social sector in India, mainly healthcare and education. For this, the Government enhanced the budgetary allocation for this sector and introduced many newer development programs.

Fiscal Consolidation

Fiscal Consolidation was a major component of the first-generation reforms. But in the second-generation reforms, the government provided a constitutional commitment for fiscal consolidation by passing the Fiscal Responsibility and Budget Management Act (FRBM Act) in 2003.  And this step of the Central Government was followed by the States, as the states also passed the Fiscal Responsibility Acts (FRAs).

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