Economic History of India: Colonial Economy, Planning and NITI Aayog for RBI Grade B ESI

Last updated: 2026-11-11 · MockMentor

The Indian Economy unit of the RBI Grade B Phase 2 Economic and Social Issues (ESI) syllabus begins with how the economy came to be what it is. The colonial period explains why India started independent life poor, rural and barely industrialised. The planning era explains the large public sector, the licence system and the focus on heavy industry. The 1991 crisis explains the turn towards markets. Almost every question on reforms, industrial policy, agriculture or the role of the state needs this history as its base.

In one line: India moved from a colonial economy drained of its surplus, through four decades of state-led planning, to a market-oriented economy after 1991, and replaced the Planning Commission with NITI Aayog in 2015.

Basic concepts

• Drain of wealth: the transfer of a part of India's output to Britain without any matching return, through salaries, pensions, profits and "home charges" paid from Indian revenue.
• Deindustrialisation: the decline of India's traditional handicraft and textile industries during colonial rule, without the rise of modern industry to replace them.
• Commercialisation of agriculture: the shift from growing food for local use to growing cash crops such as cotton, indigo and jute for export.
• Economic planning: deciding the use of a country's resources through a central plan with set targets and priorities, instead of leaving it fully to markets.
• Mixed economy: an economy where the public and private sectors work side by side, with the state planning and regulating key areas.
• Licence Raj: the system of industrial licences, permits and controls under which private firms needed government approval to set up, expand or change production.
• LPG reforms: Liberalisation, Privatisation and Globalisation, the three directions of the reforms launched in 1991.

Why in News?

1. The new national accounts with base year 2022-23, released on 27 February 2026, put India's real GDP growth at 7.7% for 2025-26, making it the fastest-growing large economy.
2. NITI Aayog is working on the "Viksit Bharat @2047" vision, the goal of making India a developed country by the 100th year of Independence.
3. In 2026, India marked 35 years of the economic reforms of July 1991.

The Indian economy under colonial rule

India before British rule

In the 17th and early 18th centuries, India was one of the largest economies in the world. Its cotton and silk textiles, spices, indigo and metal goods were traded across Asia, Africa and Europe. Most people worked in agriculture in self-sufficient villages, but towns such as Dhaka, Murshidabad, Surat and Masulipatnam were centres of skilled handicraft production. The economy was not modern, but it was productive and well connected to world trade.

How colonial rule changed the economy

1. Deindustrialisation. British policy turned India into a supplier of raw materials and a market for British factory goods. Cheap machine-made cloth from Lancashire, entering India with almost no duty, while Indian textiles faced high duties in Britain, ruined India's weavers. The loss of courtly patronage after the fall of Indian rulers hit craft industries further. Millions of artisans were pushed back into farming.

2. The drain of wealth. Dadabhai Naoroji, in "Poverty and Un-British Rule in India", and R.C. Dutt, in "The Economic History of India", argued that a large share of India's surplus was sent to Britain every year as home charges, salaries and pensions of British officials, interest on public debt and profits of British firms. This drain reduced the resources available for investment in India.

3. Land revenue systems. The Permanent Settlement (Zamindari) of 1793 in Bengal, the Ryotwari system in Madras and Bombay, and the Mahalwari system in north-west India all fixed high revenue demands. Zamindars and moneylenders gained, peasants fell into debt, and little was invested in improving land.

4. Commercialisation of agriculture. Farmers were pushed to grow cash crops for export. Food production lagged behind, and when harvests failed, there was little to fall back on.

5. Famines. Repeated famines killed millions of people, including the Great Famine of 1876-78 and the Bengal Famine of 1943, in which about 30 lakh people died. Amartya Sen later showed that the Bengal Famine was caused less by a fall in food output than by a collapse in poor people's ability to buy food.

6. Infrastructure for export. Railways (from 1853), ports, the telegraph and the postal system were built mainly to carry raw materials to ports and British goods inland, and to help administration. They did help market integration, but their design served colonial trade first.

7. Limited modern industry. Some industries grew, especially cotton mills in Bombay and Ahmedabad and jute mills in Bengal from the mid-19th century. The Tata Iron and Steel Company was set up in 1907. But there was almost no capital goods industry.

The economy at Independence

This was the starting point from which independent India set out to plan its development.

Planning before Independence

The idea that the state should direct economic development had support across the political spectrum before 1947.

Planning after Independence

Why India chose planning

India's leaders saw planning as the fastest way to overcome colonial backwardness. The Soviet Union's rapid industrialisation under Five Year Plans made a strong impression. Markets alone, it was argued, would not build steel plants, dams and power stations, and would not reduce poverty or regional inequality. At the same time, India kept a democratic political system and a private sector, which made Indian planning indicative in many areas rather than fully command-based.

The Planning Commission

The Planning Commission was set up on 15 March 1950 by a resolution of the Union Cabinet, not by the Constitution or a law. The Prime Minister was its chairperson. The National Development Council (NDC), set up in 1952 with the Prime Minister, Chief Ministers and members of the Planning Commission, approved the Plans.

Its main functions were to assess the country's resources, draw up Five Year Plans, set priorities, allocate resources among sectors and states, and review progress. It also gave plan grants to states, which gave it great influence over state spending.

Objectives of planning

1. Growth: raising national income and per capita income.
2. Modernisation: adopting new technology and changing the structure of the economy.
3. Self-reliance: reducing dependence on imports, especially of food and capital goods.
4. Equity: reducing poverty and inequality of income, wealth and region.
5. Employment: creating jobs for a growing labour force.

The Five Year Plans

The Mahalanobis model

P.C. Mahalanobis, who designed the Second Plan, divided the economy into a sector producing capital goods (machines that make machines) and a sector producing consumer goods. He argued that investing heavily in capital goods first would raise the economy's capacity to grow in the long run, even if it meant less consumption in the short run. Consumer goods were to be produced by small and cottage industries, which would also provide jobs. The model laid the base of India's steel, heavy engineering and power industries, but it neglected agriculture and exports.

What planning achieved

• An industrial base in steel, power, heavy machinery, chemicals and fertilisers, and a large public sector.
• Food self-sufficiency after the Green Revolution, which ended dependence on food imports under the US PL-480 programme.
• A network of universities, research institutes, the Indian Institutes of Technology (IITs) and the Indian Institutes of Management (IIMs).
• Expansion of banking to rural areas after bank nationalisation in 1969 and 1980.
• Large gains in life expectancy and literacy compared with 1947.

Where planning fell short

• Growth averaged about 3.5% a year from 1950 to 1980, which economist Raj Krishna called the "Hindu rate of growth". With population growing about 2% a year, per capita income rose slowly.
• The licence system, controls on capacity, the reservation of products for small industry and the restrictions of the Monopolies and Restrictive Trade Practices (MRTP) Act held back competition, scale and efficiency.
• Many public sector units made losses and depended on budget support.
• Inward-looking trade policy, with high tariffs and import controls, kept India out of the export boom that transformed East Asia.
• Poverty and unemployment remained high; land reforms were weak in most states.

The 1991 crisis and the economic reforms

What caused the crisis

By 1990-91, India faced a severe balance of payments crisis. The fiscal deficit of the Centre had reached about 8% of GDP, and the combined deficit of the Centre and states was close to 10%. The Gulf War of 1990 raised oil prices and stopped remittances from Indian workers in Kuwait. Political instability and a downgrade of India's credit rating made foreign lenders and non-resident Indians pull money out. By June 1991, foreign exchange reserves had fallen to about US$1 billion, enough to pay for only two to three weeks of imports. Inflation was above 13%.

The government pledged gold with the Bank of England and the Bank of Japan to raise emergency loans, and sought help from the International Monetary Fund (IMF) and the World Bank. In return, it agreed to a programme of stabilisation and structural reform.

Stabilisation and structural reform

The three directions: LPG

1. Liberalisation: removing controls on the domestic economy. Industrial licensing was abolished for all but a few industries. The MRTP limits on the size of firms were dropped. Interest rates were gradually freed. Many items were removed from the list reserved for small industry.
2. Privatisation: reducing the role of the state as owner. The number of industries reserved for the public sector was cut, and the government began selling part of its shareholding in public enterprises (disinvestment).
3. Globalisation: integrating with the world economy. Import licences and tariffs were cut sharply, the rupee moved to a market-determined exchange rate in 1993 and became convertible on the current account in 1994, and Foreign Direct Investment (FDI) up to 51% was allowed automatically in many industries. India joined the World Trade Organization (WTO) as a founding member in 1995.

Our chapter on economic reforms since 1991 covers what the reforms did, how they have continued and the debates around them.

From the Planning Commission to NITI Aayog

Why the Planning Commission was replaced

After 1991, the market, and not the plan, became the main driver of investment. The Planning Commission's top-down, "one size fits all" approach and its control over funds to states sat uneasily with this. States wanted more freedom and more untied money. On 1 January 2015, the Union Cabinet replaced it with the National Institution for Transforming India, NITI Aayog.

Structure of NITI Aayog

Planning Commission and NITI Aayog compared

Functions of NITI Aayog

• Develop a shared vision of national development priorities with the states.
• Promote cooperative federalism through regular work with states, and competitive federalism through indices that rank them, such as the SDG India Index, the Export Preparedness Index and the School Education Quality Index.
• Prepare long-term policy frameworks and monitor their progress.
• Run the Aspirational Districts and Aspirational Blocks programmes for the most backward areas.
• Host the Atal Innovation Mission to build innovation and entrepreneurship.
• Evaluate government programmes through its Development Monitoring and Evaluation Office.

Critics argue that without financial powers, NITI Aayog's influence depends on political will, and that it has become more of a think tank for the Centre than a forum where states shape policy. Supporters reply that a market economy needs ideas, coordination and evaluation from a planning body, and that control over money is better left to the Finance Ministry.

The Indian economy today

Before and after 2008

From 2003 to 2008, India grew at nearly 9% a year, its fastest run up to then, driven by high investment, a global boom and strong services exports. The global financial crisis of 2008 slowed growth sharply. The government's large fiscal stimulus and RBI's rate cuts helped a quick recovery, but led to high inflation and a wide current account deficit by 2013, when India was named among the "Fragile Five" economies during the "taper tantrum".

The years after 2014 brought major structural changes: the Insolvency and Bankruptcy Code (2016), demonetisation (2016), the Goods and Services Tax (2017), inflation targeting by RBI (2016), and the clean-up of bank balance sheets. The COVID-19 pandemic caused a contraction of 5.8% in 2020-21 under the old series, followed by a strong recovery. Under the new 2022-23 series, growth was 7.2% in 2023-24, 7.1% in 2024-25 and 7.7% in 2025-26.

Main features of the Indian economy

• A large, young population: the most populous country in the world, with a median age under 30.
• Services-led growth: services produce more than half of GVA, while agriculture produces under a fifth but employs over two-fifths of workers.
• A mixed economy with a large public sector in banking, energy and infrastructure, and a dynamic private sector.
• High saving and investment rates of about a third of GDP.
• Informality: most workers are in the informal sector, without written contracts or social security.
• A strong digital public infrastructure: Aadhaar, the Unified Payments Interface (UPI) and Jan Dhan accounts.
• Regional disparity: large gaps in income and social indicators between southern and western states and those in the north and east.

Main concerns

• Slow creation of good jobs, especially in manufacturing.
• Low female labour force participation.
• Low productivity in agriculture and a large number of small farms.
• Inequality of income and wealth.
• Weak learning outcomes in schools and a skills gap.
• High public debt of the Centre and states together.
• Dependence on imported crude oil, electronics and critical minerals.
• Exposure to climate change.

Way forward

• Use the demographic dividend by investing in skills, health and jobs for young people.
• Make manufacturing a much larger employer through labour-intensive industries and export competitiveness.
• Strengthen cooperative federalism, since states now drive much of the investment climate and service delivery.
• Raise agricultural productivity and move workers into higher-paying non-farm jobs.
• Keep fiscal and external balances in check so that growth is not interrupted by crises like 1991 or 2013.

Possible exam and interview questions

1. Explain how British colonial policy led to the deindustrialisation of India and the drain of wealth. (420 words)
2. Critically evaluate the achievements and failures of planning in India from 1951 to 1991. (620 words)
3. What were the causes of the 1991 economic crisis, and how did the government respond?
4. Compare the Planning Commission and NITI Aayog. Has NITI Aayog strengthened cooperative federalism?
5. Interview: Was the Mahalanobis strategy of heavy industrialisation the right choice for India in the 1950s?

Related reading: national income and per capita income, economic reforms since 1991, and our RBI Grade B previous year question analysis.

More in ESI

• National Income
• Human Development
• Poverty
• Employment
• Sustainable Development

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