📇 Looking Back at India's Licence Raj

This Republic Day let’s take a look at the Licence Raj policy and how it shaped India's economic growth.

Watching Shark Tank India has made us realise that more and more Indians want to revolutionise the world with their startup ideas.

This urge to create something new and something big has given India 42 unicorns (a company valued at $1 billion) in just the last year! This is all a gift of time and evolving economic policies.

Because in pre-1991 India, it was almost impossible to even have a flourishing business.

All thanks to the government's Licence Raj policy.

The Policies that Shaped India

When we gained independence in 1947, the brightest minds of India came together to write a new future for the country.

And many of these thinkers were inspired by the communist policies that the Soviet Bloc was following. They thought that a government-controlled economy would allow India to grow at a faster rate, something which was needed as British rule had left us extremely poor. Who else even had so many resources to strengthen the infrastructure?

However, some others advocated for capitalism, saying that was the only way for India to grow and expand.

So, ultimately a compromise was struck and "economic socialism" was born.

Under economic socialism, private sector companies in India would exist but it was the public sector that would be the star.

In fact, Jawaharlal Nehru, our first Prime Minister even said, "The public sector must grow not only absolutely but also relatively to the private sector."

So, the private sector became the step-child.

Now to keep this step-child in check and make sure it does not steal the thunder of the public sector, new rules were introduced.

These rules allowed the government to basically boss around the private sector. Private sector companies would have to take licences for literally everything, from starting a business to expanding it.

And getting these licences was not easy. Sometimes companies would have to run around to approximately 80 different offices! 

And even after you got your licence you couldn't conduct your business in peace. The government would fix the price of your products.

This system also made competition very tough. For instance, if your competitor got a licence to expand and you didn't, it would be a devastating blow to your business. And you couldn't even fire any employees or close your factories at your discretion.

Not just that, the government could at any moment decide to take over the reins of your business. That's what happened to many private sector banks and even Air India. They were nationalised. This entire headache was named 'Licence Raj' by C. Rajagopalachari, who thought this system was just as bad as the British Raj.

So, the private sector couldn't really grow to the heights it could achieve. And meanwhile, the public sector became complacent under the government's rule. Their anti-competitive stance made them lazy and unorganized, which is why many of them to date are making huge losses.

The Impact of These Policies

All of this obviously negatively impacted the Indian economy. While other Asian economies were flourishing (Indonesia grew by 6%, Thailand 7%, Taiwan 8% and South Korea 9%), India only grew by 4% in this period.

Plus, the government's focus on industrialisation (which it thought was the fastest way India could become a global power) and the declining private sector meant that there were not enough consumer goods being produced in the country.

So, we had to heavily rely on imports. Meanwhile, since the rupee was overvalued our exports accounted for only 5% of the GDP (since the value of the rupee was high, taking goods from us would cost other countries more). This increased India's fiscal deficit ( the difference between the government's earnings and its expenditure). 

This imbalance between imports and exports also meant that our foreign exchange reserves were low.

Somehow despite all these troubles, India was managing.

But then several global crises such as the Gulf War, the fall of the Soviet bloc and two wars with Pakistan, made our situation much worse.

We only had three weeks worth of foreign exchange reserves left. This and the already high price of the value led to widespread inflation in India. 

The average rate of inflation in India in 1990-91 was around 10%, whereas the GDP growth rate declined to 5.5%. India’s fiscal deficit grew from 5.71% to 8.4% of GDP in 1990-91.

This was termed as the Balance of Payments crisis, which ended the licence raj policies and the tight control of the government over the private sector (Here's our in-depth piece about this crisis).

Wondering how?

You see, to get out of this economic crisis, India had to borrow money. It took a loan of $2.2 billion by pledging 67 tonnes of Gold as collateral to the International Monetary Fund (IMF).

But the IMF doesn't just loan out money to any and every country. It had a few conditions, namely that India would have to open up its economy and accept liberalisation and globalisation.

And so on, April 27, 1991, a historic budget was announced that changed the course of India's economy. We embraced liberalisation.

While many have seen this move as a game-changer for India, it has its own set of drawbacks. You see, it is liberalisation, which led to the spread of capitalism in India, that caused massive wealth inequality. The income share of the top 10% in India was 35% in 1991 and now it is 57.1%. 

But it also helped our economy grow and brought us out of the rut.

However, what's interesting now is that India is going in a completely different direction than the one we started out with. It is concentrating on converting the public sector enterprises into private sector companies to improve their performance. 

And what the licence raj policy has taught us is that complete focus on just one sector could be harmful in the long run.

What do you think this new direction means for India?

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