Political Economy of India

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The development of India's economy was based on socialist-inspired policies after independence. It included state-ownership of various sectors, regulation and red tape which was known as 'Licence Raj' and protection from the world markets. The Political Economy of India has rapidly changed with the liberalization of the economy in the 1990s. It has now moved towards a market-based system and is the world's second fastest growing major economy after China. India recorded the highest GDP growth rate of 9% in 2007.

The growth rate has reached 7.5% in the late 2000s. The country is the world's twelth-largest economy by (PPP) purchasing power parity adjusted exchange rates. It is ranked 118th by PPP and 128th on per capital basis in the world. The most important priorities for India according to the World Bank are public sector reform, agricultural, removal of labor regulations, infrastructure, rural development and reforms in backward states.

The liberalization of India's economy was initiated by Prime Minister Rajiv Gandhi in the 1980's. In 1991, the International Monetary Fund (IMF) bailed out India through a $1.8 billion loan when it faced a crisis on defaulting on its loans. During this time, Prime Minister P. V. Narasimha Rao and his finance minister Manmohan Singh initiated new reforms.

The new reforms led to easier international trade and investment, privatization, deregulation, inflation-controlling measures and tax reforms. Liberalization has been the same irrespective of which party headed the government. But no party has yet thought of reforming labor laws and reducing agricultural subsidies which may anger powerful lobbies like trade unions and farmers.

Pre liberalization

From independence, economic policies included import substitution, protectionism, industrialization, business regulation, intervention of the state in labor and financial markets. There were Five-Year Plans similar to the central planning in the Soviet Union. In the mid-1950s, industries such as telecommunications, machine tools, steel, insurance, electrical plants were nationalized. Between 1947 and 1990, licenses, regulations which were accompanied with red tapism were required for setting up businesses. This was referred to as the Licence Raj.

The impact of these was that from 1950s to 1980s the economy of India stagnated around 3.5% and there was low annual growth rate. Industries like communications, steel and power were given only four or five licences. Therefore license owners made a huge business. There was a large public sector and losses were incurred by state-owned enterprises. Because of public sector monopoly there was poor infrastructure investment. With the License Raj system, there was wide spread corruption.

Rajiv Gandhi government (1984-1989)

Prime Minister Rajiv Gandhi initiated lighter reforms by reducing the License Raj and promoting the growth of software and telecommunications industries.

Narasimha Rao government (1991-1996)

With the assassination of Prime Minister Indira Gandhi in 1984 and her son Rajiv Gandhi in 1991, confidence for international investment in the economy was crushed. Since 1985, there was a balance of payments problem and by late 1990s the country faced a serious economic crisis.

The Narasimha Rao government started the liberalization process by abolishing the Licence Raj system which ended various monopolies, reforming capital markets, inviting foreign investment, reforming the trade regime and capital markets. Its goal was to reduce the fiscal deficit, privatize the public sector, and increase infrastructure investment. To open up foreign trade, there were trade reforms and foreign direct investment regulation.

There was reduction in industrial licensing and only 18 industries needed licensing. There was rationalized of industrial regulation. The Controller of Capital Issues was abolished in 1992 which regulated the number and prices of shares a company can issue. The Security Laws (Amendment) and SEBI Act of 1992 were introduced. The National Stock Exchange was started as a computer-based trading system from 1994 and by 1996 it became the largest exchange in the country. Tariffs were reduced, the rupee was made convertible, foreign direct investment was encouraged in priority sectors, India's equity markets were opened up in 1992 for foreign institutional investors. Inefficient loss-inducing government corporations were also privatized.

The political economy of India also included other later reforms such as forming Special Economic Zones, initiating the Golden Quadrilateral project for constructing a network of highways, enacting the Right to Information Act (2005), Right to Education Bill (2008) and Indo-US civilian nuclear agreement (2008). The impact of all these reforms is reflected in the amount of foreign investment which grew to $5.3 billion in 1995-96 from $132 million in 1991-92.