Why reforms: the 1991 crisis
- For years the government spent more than its income and borrowed a lot; spending did not create enough income to repay.
- Imports grew faster than exports; oil prices rose in the Gulf War (1990–91).
- By 1991 forex reserves could pay for only about two weeks of imports, and prices of essentials were rising fast.
India took loans from the World Bank and IMF and agreed to open up the economy. This package is called the New Economic Policy (NEP). It had stabilisation measures (short term: fix BoP and inflation) and structural reform measures (long term: make the economy efficient).
Liberalisation
Liberalisation means removing rules that held back the economy.
- Industrial sector: licensing ended for almost all industries except a few (like alcohol, tobacco, defence items, hazardous chemicals). Only a few industries stayed reserved for the public sector. Prices were more freely set by the market.
- Financial sector: the RBI changed from a regulator to a facilitator; private banks (Indian and foreign) came in; foreign institutional investors could invest.
- Tax reforms: lower income and corporate tax rates; simpler indirect taxes, which later led to GST.
- Foreign exchange: the rupee was devalued in 1991; later its value was set mainly by the market.
- Trade and investment: import licences removed (except harmful goods), tariffs cut, quotas ended by 2001, export duties removed.
Privatisation
Privatisation means giving ownership or management of public firms to private hands. It is done by selling assets, or by disinvestment: the government sells part of its shares in a public sector enterprise (PSU) to the public.
Aims: raise efficiency, bring in private capital and skills, and raise money for the budget. Some strong PSUs got more freedom to act as Maharatnas, Navratnas and Miniratnas.
Globalisation, WTO and outsourcing
Globalisation means linking the country's economy with the world economy.
- Outsourcing: firms hire outside services, often from other countries. India became a hub for call centres, IT, accounting, medical transcription and research because of skilled, lower-cost workers and cheap communication.
- World Trade Organisation (WTO): set up in 1995 (after GATT, 1948) to create rule-based trade, cut tariffs and open services trade. India is a founder member and has pushed for fair rules for developing countries.
Appraisal of LPG
Gains
- Faster GDP growth, led by services.
- Big rise in forex reserves and foreign investment.
- More choice and better quality goods for buyers; IT, auto and telecom boomed.
Problems
- Agriculture: less public investment in irrigation, power and research; cheaper imports and reduced subsidies hurt farmers; shift to export cash crops.
- Industry: cheap imports and poor infrastructure hurt local firms; small units struggled; 'jobless growth' in many areas.
- Disinvestment: sometimes assets were undervalued, and money was used to fill budget gaps rather than build assets.
- Fiscal policy: tax cuts to attract investors limited revenue.
Demonetisation (2016)
On 8 November 2016 the government announced that old ₹500 and ₹1000 notes would stop being legal tender. They made up about 86% of the cash in use by value. People had to deposit or exchange them in banks; new ₹500 and ₹2000 notes were issued.
Aims
- Fight black money (hidden, untaxed income) and fake notes.
- Stop cash-funded crime and terror financing.
- Push digital payments and a 'less-cash' economy; widen the tax net.
Effects
- More people used UPI, cards and wallets; bank deposits and tax filers rose.
- Cash shortage hurt small traders, farmers and daily-wage workers for some months; growth slowed briefly.
- RBI data showed almost all old notes (over 99%) came back to banks, so little black cash was destroyed directly.
Goods and Services Tax (GST)
GST began on 1 July 2017. It is one indirect tax on the supply of goods and services, replacing many older taxes like central excise, service tax, VAT, entry tax and octroi. Slogan: One Nation, One Tax.
- CGST + SGST: on sales within a state, the tax is split equally between the Centre and the state.
- IGST: on sales from one state to another, collected by the Centre and shared.
- GST Council: the Union Finance Minister and state finance ministers decide rates together.
- Rates: at first 5%, 12%, 18% and 28%. From September 2025 most goods moved to two main rates, 5% and 18%, with a special high rate of 40% on a few luxury and harmful goods.
Benefits and problems
- Removed 'tax on tax' (cascading) through input tax credit; one national market; check-post queues ended; more businesses in the formal system.
- Early on, frequent rule changes and online filing were hard for small traders; petrol and alcohol stay outside GST.
Try it at home
Look at a restaurant or shop bill. Find the CGST and SGST lines. Are they equal? Add them and work out the GST rate.
Key formulas and definitions
- LPG = Liberalisation + Privatisation + Globalisation (New Economic Policy, 1991)
- Disinvestment = sale of part of government's shares in a PSU
- GST within a state: GST = CGST + SGST, with CGST = SGST = GST ÷ 2
- Bill = Price + Price × GST rate ÷ 100
- Inter-state sale: IGST = full GST rate
Worked examples
1. Give two causes of the 1991 crisis.
(1) Years of high government borrowing and deficits. (2) Imports far above exports and a jump in oil prices, so forex reserves fell to about two weeks of imports.
2. How did liberalisation change the financial sector?
The RBI moved from controlling to guiding; private and foreign banks were allowed; foreign institutional investors could invest in Indian markets.
3. A shirt costs ₹1,000 and GST is 5%. Find CGST, SGST and the bill.
GST = ₹50. CGST = ₹25, SGST = ₹25. Bill = ₹1,050.
4. A phone costs ₹12,000 with 18% GST, sold within Maharashtra. Find CGST, SGST and the bill.
GST = 12,000 × 18% = ₹2,160. CGST = SGST = ₹1,080. Bill = ₹14,160.
5. The same phone is sold from Maharashtra to a buyer in Gujarat. What tax applies and how much?
IGST at 18% = ₹2,160, collected by the Centre and later shared.
6. Why did demonetisation not destroy much black money directly?
Over 99% of the cancelled notes came back to banks. Much black wealth is held as gold, property or foreign assets, not cash.
Common mistakes
- Thinking privatisation only means selling whole companies. Disinvestment of part of the shares is also privatisation.
- Saying GST replaced all taxes. It replaced many indirect taxes; income tax is a direct tax and remains.
- Writing that CGST and SGST are added twice to the rate. An 18% GST means 9% CGST + 9% SGST, not 36%.
- Confusing demonetisation (2016) with devaluation (1991). One cancelled notes; the other lowered the rupee's official value.