A Short History of Indian Economy

13 min readJul 8, 2021

Song of the Golden Bird

“At a time when the West of Europe, the birth place of modern industrial system, was inhabited by uncivilised tribes, India was famous for the wealth of her rulers and for high artistic skill of her craftsmen. And even at a much later period, when the merchant adventurers from the west made their first appearance in India, the industrial development of this country was at any rate, not inferior to that of the more advanced European nations.”

Industrial Commission (1918)

Prior to the arrival of the British and other imperial powers on Indian soil, agriculture had dominated the economy. Yet, some industries, producing certain special products, enjoyed worldwide reputation.

During those days, the muslin of Dacca, silk sarees of Benaras, shawls and carpets of Kashmir and Amritsar, the calicos of Bengal, dhoti and dopattas of Ahmedabad, silk and bordered cloth of Nagpur and Murshidabad etc. were very famous and received much recognition in international markets.

India had also developed high level of metallurgy and the cast-iron pillar standing near Delhi testifies to it.

19th century author and economic reformer M.G. Ranade, recorded that Indian industries “not only supplied all local wants but also enabled India to export its finished products to foreign countries.” Indian export items consisted mostly of manufactured items like cotton and silk fabrics, calicos, silk and woollen cloth and artistic wares made of glass and metal. The other major export items included cinnamon, pepper, opium, indigo etc.

For 17 centuries before the arrival of British, India produced 33% of the global GDP declared the Chief Economic Adviser K V Subramanian in a recent interview, citing British economist Angus Maddison’s research on GDP contribution by major economies from 1 AD to 2008. United States, which is the most powerful country today, in comparison, he said, is dominant only about half a century

The US$45 Trillion Loot*

Its decline started with the British East India Company taking control of Bengal in 1765. By the time the joint stock company left in 1947, having metamorphosized into the expanded Raj covering the entire sub-continent from 1857 onwards, Utsa Patnaik, the renowned economist and Columbia University professor, estimates the British Crown had siphoned over US$45 trillion out of India

Every year from 1900 onwards, 26–36 per cent of the Central government’s budget was sent to Britain towards fees to rule India(sic) as millions died of malnutrition and several other diseases.

Britain exported food grains from India and imposed high taxes on imports, which spread famine and reduced purchasing power of its people. Per capita annual consumption of food, which was 200 kg in 1900, went down to 137kg during World War II in 1946.

Angus Maddison, once again, reported, as a result, India’s share of world GDP shrank from 22.6% in 1700 — almost equal to Europe’s share of 23.3% — to 3.8% in 1952.

India was a net exporter of textiles and other manufactured goods before the East India Company monopolized trade. Once it obtained the right to tax it started using these tax receipts to purchase goods for export — forcing the Indian peasants and artisans to accept whatever prices were offered to them — often just taking them for free.

Under the British Raj starting 1858, colonisers added a special new twist to the tax-and-buy system. As the East India Company’s monopoly broke down, Indian producers were allowed to export their goods directly to other countries. But Britain made sure that the payments for those goods nonetheless ended up in London.

How did this work? Basically, anyone who wanted to buy goods from India would do so using special Council Bills — a unique paper currency issued only by the British Crown. And the only way to get those bills was to buy them from London with gold or silver. So traders would pay London in gold to get the bills, and then use the bills to pay Indian producers. When Indians cashed the bills in at the local colonial office, they were “paid” in rupees out of tax revenues — money that had just been collected from them. So, once again, they were not in fact paid at all; they were defrauded, revealed Patnaik in her research.

Meanwhile, London ended up with all of the gold and silver that should have gone directly to the Indians in exchange for their exports.

This corrupt system meant that even while India was running an impressive trade surplus with the rest of the world — a surplus that lasted for three decades in the early 20th century — it showed up as a deficit in the national accounts because the real income from India’s exports was appropriated in its entirety by Britain.

Difficult Freedom

India’s prospect at independence, therefore, were not bright. The country was hopelessly poor as a result of its systematic and willful deindustrialization by Britain.

British infrastructure was built not to improve Indian society or even help British traders profit, it was started in the 1850s only after a series of economic crises made the British worry about rebellion and diminishing taxes. Railways came up as a solution to the problem of transporting troops quickly across India to suppress dissent.

The British occupation of India serves three lessons;

1. India was wealthy but powerless, weak and divided and therefore became victim of colonialism, loot and plundering. Its wealth taken away by the British to enrich themselves, while Indians suffered extreme poverty, famine and death.

2. Power does not come from wealth — which India had in plenty. It comes from military force and its ability to inflict violence.

3. Markets are important. Trade and Commerce must be conducted to the advantage to the country, if required by force. The 300million consumers presented a huge commercial opportunity for Britain, for instance. In 1910 about 20% of goods made in British factories worth 137 million pounds were exported to India, even as Indian manufacturing was destroyed for failure to export to Europe.

But there is another lesson though. At the height of its rule, the British officials and troops numbered less than 20,000. How could they possibly control 300million Indians? By keeping the Indian princes, traders and local elites divided — while sharing the fruits of plundering with them — by co-opting them as partners in their fraudulent ruling enterprise.

Fighters for India’s independence were acutely aware of this fact. While many eventually turned against the British, their desire to maintain their status quo remained. This was revealed when efforts made by Sardar Patel and others to get them to join the Dominion of India at the time of Independence in 1947, were fiercely resisted.

At this stage the role of Indian merchants during British colonialism must be explained.

It is a widely accepted that the installation of the British rule itself was brought about with an act of bribery, when Robert Clive successfully bribed Mir Jafar, the commander-in-chief of the Nawab’s army that led to the defeat of Siraj-ud-Daulah at Plassey in 1757; and the capture of Calcutta

The man who guaranteed the bribe was the Jagat Seth of Murshidabad. He, along with Omichund, another wealthy Hindu merchant, conspired to bring down the Nawab. Omichund was eventually double crossed by the British and could not obtain the agreed bribe.

Cautious Optimism

Jawaharlal Nehru was suspicious of the Indian business class, that had colluded effectively with the British and enriched themselves in the process. The state was to occupy an important role in the re-industrialization of India — he insisted. Gandhi’s ideas of self-sufficiency through the development of village and cottage industries were considered archaic, impracticable and peripheral to the Indian dream.

The Industrial Policy Resolution of 1948, therefore, proposed a mixed economy. Earlier, the Bombay Plan (A Brief Memorandum Outlining a Plan of Economic Development for India), crafted by eight influential businessmen including J.R.D Tata and G.D. Birla envisaging a substantial public sector with state interventions and regulations in order to protect indigenous industries was rejected by Nehru.

It is another matter that the idea of incorporating the best elements of both capitalism and communism/socialism did not quite happen, and in practice, the country got a mix of the worst of both systems, and ended up as a “mixed-up” economy — a 2004 report revealed.

“Public sector corporations served as the personal fiefdoms of politicians and bureaucrats in power — the state thus became the “private” property of the privileged few. At the same time, private corporate groups prospered thanks to a generous infusion of funds from government-controlled banks and financial institutions. Thus, the losses of the public sector became translated into the profits of the private sector. Successive Congress governments (before the P. V. Narasimha Rao regime) set up an excessively bureaucratic economic system that stifled entrepreneurship and private initiative, on the one hand, and failed to provide primary education and basic health-care to the majority of Indians, on the other”

The economic history of Independent India can be summarised in four distinct phases.

First Phase — Tryst with Soviet Style Industrialisation: 1947 to 1984

Nehru was impressed with the economic achievements of Stalinist USSR and yet was too much of a democrat to force such economic policies on a country just out of the crisis of Independence. He let Finance Minister Shanmukham Chetty, a delegate to the Bretton Woods and Gandhi’s protégé, present the first budget in November 1947 but made him leave; to be replaced by an economics professor John Mathai in 1949.

A Planning Commission was duly setup in 1950 to oversee five-year plans modelled after the USSR. The first five-year plan, launched in 1951, focused on agriculture and irrigation to boost farm output to save precious foreign exchange spent on food grain imports. It was a success. The economy grew at an annualised 3.6%, beating the target of 2.1%.

B.R Shenoy, a libertarian economist, follower of Fredrick Hayek, meanwhile warned that deficit financing of Nehru’s “heavy industrialisation” was a recipe for trouble. India faced an external payments crisis, expectedly, soon after in 1957.

The second five-year plan (1956–61) laid the foundation for economic modernisation to better serve India’s long-term growth imperatives. Launched in 1956, it was based on the Mahalanobis model that advocated rapid industrialisation with a focus on heavy industries and capital goods.

Industrial Policy Resolution 1956 (considered as the economic constitution of India) paved the way for the development of the public sector and ushered in the licence Raj.

The 1956 resolution categorised industries into three groups. Industries of basic and strategic importance were to be exclusively in the public sector. The second group comprised industries that were to be incrementally state-owned. The third, comprising mostly consumer industries, was left for the private sector. The private sector was kept on a tight leash through a system of licences.

Power and steel were identified as key priorities. Several hydro-electric projects and factories came up as did the Indian Institutes of Technology — set up to support the engineering manpower required for rapid industrialisation.

Focus on industrialisation caused a large reallocation of funds away from the farm sector which resulted, inevitably, in food shortages and inflation. Nehru passed away in 1964 and Shastri became the Prime Minister who partly restored agriculture as a focus area and introduced the first economic reform by giving larger role to private enterprises. The seeds of Green Revolution were sown. It was to make India independent and self-sufficient in production of food grains and elimination of constant threats of famine.

Shastri passed away in 1966. His other efforts eventually produced the co-operative movement and the White revolution. All in a short rule of 2 years.

The economic situation however worsened following war with China in 1966 and with Pakistan in 1971. Indira Gandhi was now the Prime Minister taking on after Shastri’s death. Her popularity allowed her, in 1969, to deal with the crisis by nationalising the banking sector — which she thought was partly responsible for lack of financing to the poor. Several financial scams, on the other hand, appeared to have been supported by the banks.

Crony Capitalism

Bank nationalisation help boost farm credit and lending to priority sectors. Financial savings jumped as banks were made to open branches in rural areas. Politically-influenced lending however led to crony capitalism — that remains to the day. Her decision to devalue the rupee in 1966 by 57% — ostensibly to counter balance-of-payment crisis (and boosting export) instead resulted in inflation and further crisis.

To increase her power and deal with economic (and related political) disturbances, Indira Gandhi imposed emergency and restored confidence in the system but she was defeated in 1977 elections clearing the way for a rag tag government of opposition parties under the umbrella of Janata Party to take her place.

Political Experiment Gone Astray

Janta Party Prime Minister, Morarji Desai carried out the first demonetisation of Indian currency by cancelling the status of ₹1,000, ₹5,000 and ₹10,000 banknotes in a crackdown on illicit wealth.

Strikes led by trade union demands and coupled with the legal requirement to reduce foreign shareholding to 40% forced multinational companies out of the country — most notably IBM and Coca Cola quit. The government fell in 1980 under its own weight of unsustainable coalition politics.

Phase 2 — License Raj.

In her second term beginning 1980, Indira Gandhi came with a reformist mind and unleashed a series of measures that her son Rajiv Gandhi, who became the Prime Minister, carried on when she was suddenly killed in 1984 by her own bodyguard.

The 1985–86 budget lowered direct taxes for companies and raised exemption limits for income tax. Rajiv is widely credited for ushering in the information technology and telecom revolutions in the country.

A critical feature of the Indian economy has always been its high fiscal deficit — an outcome of the government spending more than its income. Much of the government spending is on servicing interest cost of borrowings; defence; pensions; subsidising food, fertiliser and fuel consumption; and schemes directed at housing, poverty, health and cleanliness. A large portion of the government’s capital remains locked up in its own companies and holdings, which it is unable to sell. The Indian economy, thus, continues to suffer from good capital chasing bad, and a lack of political will to implement bold reforms.

Phase 3 — End of Socialist Dream

The year 1991 marks a tectonic shift in the economic policies of India. Narasimha Rao who took over as Prime Minister after Rajiv Gandhi’s untimely death along with Manmohan Singh as finance minister launched a series of economic reforms, including the dismantling of the licence Raj.

The rupee was devalued for the first time by 57% on 6 June 1966 to shore up exports. The move was triggered by the 1965 Indo-Pak war, when the US withdrew aid to India. The next devaluation, however, proved to be far more eventful: On 1 July 1991, the Reserve Bank of India lowered the value of the currency by 9%, and then by 11% just two days later.

This was when the economy was facing its worst crisis, and the country’s foreign exchange reserves could pay for only three weeks of imports.

With the death of Rajiv Gandhi and leadership of the Congress party unclear, two short lived governments gave way to the installation of BJP led coalition in 1998 under Atal Bihari Vajpayee that lasted for a complete term — a first by a non-Congress led alliance.

BJP carried on deepening the 1991 reforms and opening the economy further until 2004, when Congress made a surprising comeback. Rajiv Gandhi’s widow Sonia who led the campaign for Congress, installed Manmohan Singh as Prime Minister while influencing economic and social policies as the head of a National Advisory Council of which she made herself the Chairperson.

Social welfare and redistributive economics

FDI started to accelerate and increased foreign ownership(in some cases up to 100%) in several areas of economy including infrastructure, single brand stores, insurance industry, special economic zones, ports and airports etc. bore fruit with high GDP growth.

One key achievement of the Congress government was the introduction of the National Rural Employment Guarantee Scheme in February 2006. Starting with 200 most backward districts, the program was later expanded to cover all rural districts.

The scheme aimed to enhance livelihood security by providing at least 100 days of guaranteed wage employment in a fiscal year to every rural household whose adult members volunteer to do unskilled manual work. The 10 years when Singh was prime minister were also a time of high growth and expansion of the economy as loan rates softened. The stock markets boomed.

The 10 years of Congress led coalition rule, however, saw some major scandals emerge. In particular, corruption in the Commonwealth Games organisation and the award of 4G Licenses and spectrum as well as the opaque distribution of coal blocks were singled out by the government Auditor.

The last days of the government were rocked by a massive people movement called India Against Corruption. It had a major impact on the image of the government and paved the way for a massive victory of BJP — the key political party leading the opposition alliance under the nationalist Prime Minister Narendra Modi.

Modi led the BJP campaign from the front with a promise to bring back India’s wealth hidden abroad in offshore accounts, investigating all corruption cases, reforming the civil service and judiciary and generally providing a clean and transparent government.

Phase 4 — Cleaning the House

On 8 November 2016 Prime Minister Modi in a televised address to the nation announced the cancellation of ₹500 and ₹1,000 banknotes, amounting to 85% of the currency in circulation by value “to break the grip of corruption and black money”

He abolished the Planning Commission and replaced it with an Advisory Body called NITI Ayog (NITI stood for National Institute for Transforming India, doing away with the last vestige of command and control economy.

To rid the banks of bad loans and clean up their balance sheets,

Modi government introduced the Insolvency and Bankruptcy Code, 2016 (IBC) which made it possible for lenders to oust errant promoters from a company and hand it over to financially sound owners. This was a major reform to allow companies restructure and start afresh.

The other key reform of the Modi government is the introduction of the Goods and Services Tax — a single, uniform tax applicable across India, allowing for the movement and easy sale of goods.

Known for his penchant for use of technology in government, Modi strengthened the use of innovative schemes such as Aadhaar (a unique identification system originally introduced by the Congress) and mobile phones to not only to improve access to finance and banking services for the public but also to enable Direct Benefits Transfer thereby reducing corruption and pilfering in the distribution of social welfare.

Ease of doing business, friendly FDI policy and access to foreign capital has helped the financing of startups and businesses in the tech sector. This has resulted in several home-grown unicorns. Credit Suisse reported in April 21 that there are about 100 unicorns in India with a combined market value of $240 billion, in sectors from e-commerce and fintech to education, logistics and food-delivery

The success of startups has created a new ecosystem of angel and venture funding, and incubators and accelerators — as well as new patterns of consumption in society

Starting in 1984, the Indian economy has shown consistent rise in GDP breaking away from the proverbial Hindu rate of growth. It now ranks as the third largest economy after US and China adjusted for purchasing power parity.

A Short History of Indian Economy

Written by Baljinder Sharma

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