Navigating Revenue Challenges in Post-Liberalisation India

When India launched its landmark economic reforms in July 1991, the country was in serious fiscal distress – foreign exchange reserves had fallen to dangerously low levels, inflation was spiralling, and the fiscal deficit had ballooned to over 8 percent of GDP. The reforms that followed, guided by Prime Minister P.V. Narasimha Rao and Finance Minister Dr. Manmohan Singh, fundamentally restructured how India earned and managed its public revenue. But the transition was far from smooth. Disinvestment from public sector units, sweeping tax reforms, and dramatic tariff reductions all promised to fix the government’s finances – yet each came with its own set of complications. Understanding these revenue challenges reveals just how complex and contested the post-liberalisation fiscal landscape really was.

The fiscal crisis that forced India’s hand
Disinvestment: selling public assets to plug the revenue gap
How disinvestment began
The gap between targets and reality
Tax reforms: the Chelliah Committee and its aftermath
Direct tax improvements
The problem of tax incentives
The customs revenue problem: when lower tariffs meant lower income
Revenue loss from tariff cuts
The declining tax-GDP ratio: a persistent concern
Why revenue enhancement proved so difficult
Searching for balance: the broader fiscal picture

The fiscal crisis that forced India’s hand

India’s revenue troubles in 1991 were not sudden – they had been building for years. Fiscal imbalances had assumed serious proportions since the mid-1980s, with expenditure consistently outpacing revenue growth. The gross fiscal deficit of the central and state governments combined reached 10 percent of GDP in 1990-91, and inflation peaked at nearly 17 percent in August 1991. The government was spending far more than it was earning, and a significant portion of borrowed funds was being used just to meet everyday running costs – a deeply unsustainable pattern.

India’s foreign exchange reserves fell to levels covering less than three weeks of imports, forcing the country to approach the International Monetary Fund (IMF) and the World Bank for emergency support. That support came with strict conditions: structural reforms, fiscal discipline, and a move toward a liberalised, market-oriented economy. The government had little choice but to comply. What followed was a comprehensive effort to reform the revenue side of public finance – through disinvestment, tax restructuring, and trade liberalisation – each with significant and sometimes unintended consequences.

Disinvestment: selling public assets to plug the revenue gap

One of the most significant revenue strategies adopted after 1991 was disinvestment – the partial or full sale of government stakes in Public Sector Undertakings (PSUs). For decades, PSUs had been central to India’s development strategy, but many had become financially inefficient. Public enterprises were used as tools for political and bureaucratic manipulation, resulting in low capacity utilisation, reduced productivity, and failure to innovate. Disinvestment was meant to reduce the fiscal burden, generate non-tax revenue, and bring greater efficiency through private participation.

How disinvestment began

The process started modestly. In 1991-92, 31 selected PSUs were disinvested, raising ₹3,038 crore. The approach in this initial phase was cautious – rather than selling off entire enterprises, the government sold small minority stakes, averaging around 8.87 percent, to financial institutions and the public. A committee headed by C. Rangarajan was set up to develop guidelines, recommending disinvestment of up to 49 percent in public sector companies and 100 percent in non-strategic ones. This was a politically sensitive step, facing stiff resistance from labour unions and sections of the political establishment who feared job losses and the loss of state control over strategic assets.

The gap between targets and reality

Despite the intent, disinvestment consistently fell short of its revenue potential. Against an aggregate target of ₹54,300 crore to be raised from PSU disinvestment between 1991-92 and 2000-01, the government managed to raise just ₹20,078 crore – less than half the target – and met its annual disinvestment target in only three out of ten years. In 1993-94, disinvestment proceeds were nil against a target of ₹3,500 crore. The reasons were many: valuation disputes, lack of investor interest, legal challenges, and political hesitation. The credibility of the disinvestment process suffered from the impression that it was mainly a short-term budgetary measure to cover fiscal deficits, rather than a structural reform. Since control over most PSUs remained unchanged, performance improvements were also limited.

It was only between 1999 and 2004, under the NDA government led by Prime Minister Atal Bihari Vajpayee, that more decisive strategic sales took place – including the divestiture of BALCO, Hindustan Zinc, IPCL, and VSNL. But even this phase was marked by controversy, and the momentum stalled in subsequent years.

Tax reforms: the Chelliah Committee and its aftermath

Alongside disinvestment, the government undertook a comprehensive overhaul of the tax system. The fiscal crisis of 1991 provided the first big opportunity for a serious rethink of tax policy, and a committee was set up under the chairmanship of Raja Chelliah to draw a roadmap for tax reforms. The Chelliah Committee’s recommendations were far-reaching: rationalise direct tax rates, reduce exemptions, broaden the tax base, simplify customs duties, and improve compliance. The idea was to make the tax system more efficient, transparent, and revenue-productive over time.

Direct tax improvements

On the direct tax side, some progress was visible. The share of direct taxes in total tax revenue, which was less than 14 percent in 1990-91, improved over the decade as income tax administration was strengthened, the taxpayer net was expanded through registration drives, and filing requirements were updated. Income tax revenue as a proportion of GDP improved steadily, reflecting administrative improvements and an expansion in the taxpayer base. However, the gains were partially undermined by the continuation of numerous exemptions and incentives for savings, regional development, infrastructure, and exports – all of which thinned out the overall income tax base and kept effective tax rates lower than the stated rates.

The problem of tax incentives

A persistent issue was the proliferation of tax incentives. Sunset tax exemption clauses were extended and new incentives crept in, despite the scaling back of central tax incentives in the newly emerging economy. These exemptions covered a wide range of activities – from capital investment and research to exports and charitable organisations. While many were economically justifiable individually, their cumulative effect was a narrowing of the tax base. The effective corporate tax rate was skewed among companies, benefiting large entities and resulting in inequity within the corporate sector. The reforms intended to be revenue-neutral, but in practice, rate reductions without equivalent base expansion simply reduced collections.

The customs revenue problem: when lower tariffs meant lower income

Perhaps the most direct and visible revenue challenge came from trade liberalisation. Before 1991, India’s trade regime was extraordinarily protectionist. In 1990-91, the highest tariff rate stood at 355 percent, with a simple average of all tariff rates at 113 percent. Tariffs were not just a trade policy tool – they were a major source of government revenue. Tariff revenue as a proportion of imports had risen from 20 percent in 1980-81 to 44 percent in 1989-90, making customs duties a fiscal pillar of the pre-reform state.

Post-1991, this changed dramatically. As a first step, the 1991-92 budget reduced the peak rate of import duty from over 300 percent to 150 percent, and the process of lowering customs tariffs continued in successive budgets. The Chelliah Committee had recommended a peak rate of just 50 percent. Over time, India’s trade policy reform delivered a major reduction in average tariffs – with average applied tariffs in 2015-16 being roughly one-tenth of what they were in 1990-91. This was a remarkable transformation, but it came at a real fiscal cost in the short and medium term.

Revenue loss from tariff cuts

As customs duties fell, so did the government’s customs collections. Declines in customs and excise revenues were not compensated by the increase in income tax revenues, leaving a gap in total tax collections. Loss of revenue was explicitly a major concern during reform deliberations, and was cited as a reason for not reducing import duties more than what was being announced at each stage. In some instances, tariffs were deliberately kept higher than they might otherwise have been, to protect both revenue and domestic industries – a tension that ran through the entire liberalisation process.

The declining tax-GDP ratio: a persistent concern

The combined effect of all these developments – reduced customs collections, insufficient expansion of the direct tax base, and shortfalls in disinvestment proceeds – showed up starkly in India’s overall tax-to-GDP ratio. The tax-GDP ratio, which was over 16 percent in 1990-91, declined sharply to less than 14 percent in 1993-94, and despite some recovery thereafter, remained below 15 percent – a matter of serious fiscal concern. This decline was not incidental – it was the direct result of cutting tax rates without a commensurate expansion in the tax base.

The combined central and state tax-to-GDP ratio fell during the decade, and the implications for the consolidated fiscal deficit and public debt were significant. Meanwhile, the entire improvement in the central government’s fiscal situation up to 1996-97 came primarily from a reduction in the expenditure-to-GDP ratio – from 17.3 percent in 1990-91 to 13.9 percent in 1996-97 – with most of the cut falling on capital expenditure. In other words, the government was not actually raising more revenue; it was simply spending less – and doing so by cutting investment rather than consumption, which had its own long-term costs for infrastructure and growth.

Why revenue enhancement proved so difficult

The difficulty India faced in boosting revenues post-liberalisation reflected a structural tension at the heart of the reform programme. Tax reductions and tariff reduction policies aimed at enlarging revenue and attracting foreign investment did not significantly increase the government’s tax revenue, adversely affecting developmental and welfare expenditures. Lower rates were supposed to encourage compliance and investment, thereby expanding the base and eventually recovering lost revenue – a supply-side logic. But this took time, and in the interim, revenue shortfalls were real and immediate.

The low buoyancy of revenue – meaning the weak response of tax collections to GDP growth – was a disturbing pattern across multiple taxes during the 1990s. Even as the economy grew, tax revenues did not keep pace, partly because growth was concentrated in sectors and entities that benefited from exemptions or that fell outside the existing tax net. Informal-sector activity, a large agricultural sector, and the sheer complexity of administering a newly reformed tax system all limited the government’s ability to translate economic growth into fiscal gains.

Searching for balance: the broader fiscal picture

India’s post-liberalisation revenue story is ultimately one of difficult trade-offs. Disinvestment provided some non-tax revenue but fell far short of targets and did not resolve the deeper question of PSU reform. Tax reforms modernised the structure but introduced new exemptions that narrowed the base. Trade liberalisation opened the economy but reduced customs collections significantly. And the declining tax-GDP ratio meant the government was squeezed on both ends – unable to raise enough revenue while simultaneously facing pressure to maintain social spending.

Improvement in the tax ratio through deepening reform of the indirect tax regime and stronger tax enforcement remained a key recommendation for fiscal consolidation through this period. India’s eventual introduction of the Goods and Services Tax (GST) decades later can be seen as a partial answer to many of these challenges – an attempt to create a unified, broader-based indirect tax system that could reduce evasion and improve collections. But through the 1990s and into the 2000s, navigating revenue in a liberalising economy remained one of the central and largely unresolved challenges of India’s structural adjustment.

What do you think? If reducing tariffs and tax rates was supposed to grow the economy and ultimately increase government revenues, why did India’s tax-to-GDP ratio fall so sharply in the early 1990s instead? And given the persistent shortfall in disinvestment targets, should the government have pursued a more aggressive privatisation strategy from the outset, or was the cautious, gradualist approach the right call for a politically complex democracy like India?

References

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Table of Contents

The fiscal crisis that forced India’s hand 🔗

Disinvestment: selling public assets to plug the revenue gap 🔗

How disinvestment began 🔗

The gap between targets and reality 🔗

Tax reforms: the Chelliah Committee and its aftermath 🔗

Direct tax improvements 🔗

The problem of tax incentives 🔗

The customs revenue problem: when lower tariffs meant lower income 🔗

Revenue loss from tariff cuts 🔗

The declining tax-GDP ratio: a persistent concern 🔗

Why revenue enhancement proved so difficult 🔗

Searching for balance: the broader fiscal picture 🔗