Economic reforms were introduced in the year 1991 in India to combat economic crisis. Economic Crisis of 1991 was a culminated outcome of the policy failure in the preceding years. It was in that year the Indian government was experiencing huge fiscal deficits, large balance of payment deficits, high inflation level and an acute fall in the foreign exchange reserves. Because of the combined effect of all these factors, economic reforms became inevitable and were the only way to move Indian economy out of this crisis.
The following are the factors that necessitated the need for the economic reforms.
1. Huge Fiscal Deficit: Throughout 1980s, fiscal deficit was getting worse due to huge non-development expenditures. Subsequently, a major portion of this deficit was financed by borrowings (both from external and domestic source).
The increased borrowings resulted in increased public debt and mounting interest payment obligations. The domestic borrowings by government increased from 35% to 49.8% of GDP during 1980-81 to 1990-91. Moreover, the interest payments obligations accounted for 39.1% of total fiscal deficit. Consequently, India lost its financial worthiness in the international market and, fell in a debt trap. Thus, economic reforms were needed urgently.
2. Weak BOP Situation: BOP represents the excess of total amount of exports over total amount of imports. Due to lack of competitiveness of Indian products, India was not able to earn enough foreign exchange through exports to finance our imports. The current account deficit rose from 1.35% to 3.69% of GDP during 1980-81 to 1990-91. In order to finance this huge current account deficit, Indian government borrowed a huge amount from the international market. Consequently, the external debt increased from 12% to 23% of GDP during the same period. On the other hand, Indian exports were not potent enough to earn sufficient foreign exchange to repay these external debt obligations. This BOP crisis compelled the need for the economic reforms.
3. High level of Inflation: The high fiscal deficits forced the central government to monetize the fiscal deficits by borrowings from RBI. RBI printed new money that pushed up the inflation level, thereby, making the domestic goods more expensive. The rate of inflation rose from 6.7% p.a. to 10.3% p.a. during 1980s to 1990-91. In order to lower the inflation rate, government in 1991 had to opt for the economic reforms.
4. Sick PSUs: Public Sector Undertakings were assigned the prime role of industrialisation and removal of inequality of income and poverty. However, the subsequent years witnessed the failure of PSUs to perform these roles efficiently and effectively. The sick PSUs added an extra financial burden on the government's budget.
Thus, because of all the above reasons existing concomitantly, the economic reforms became inevitable.