25 YEARS OF INDIAN ECONOMIC REFORMS
The economic policy that India followed after independence was built on five pillars—comprehensive planning, heavy industry strategy, priority to the public sector, import substitution and government intervention. This policy was the product of those times. The Great Depression of the 1930s, the ascendency of the Soviet Union and the decolonisation following the world war II created a political and economic environment that favoured such a policy. Leaders like Jawaharlal Nehru were impressed by the initial success of the socialist experiment in the Soviet Union. Thus, the Soviet model five-year plans and the public sector-led industrialisation drive became strong pillars of India’s economic policy.
This policy did prod use some beneficial impact on the Indian economy. It gave India a well-diversified industrial system; the Green Revolution made India self-sufficient in food and the government’s focus on centres of excellence like the IITs and IIMs gave India a strong base in excellent human resources. But this policy, which was government-led, also created a ‘Permit License Quota raj, which stifled initiative and enterprise and fostered corruption. Well-meaning government intervention led to over-regulation of industry and suppression of private enterprise. The success of the Asian Tigers—Hong Kong, Singapore, South Korea and Taiwan—which followed a different economic model led to reconsideration in economic policy in developing economies. The collapse of the Soviet Union in the late eighties and the change of direction in China following the ascendency of Deng Xiao Peng created an environment of change in economic policy. The Balance of Payments crisis of 1991 forced the change in economic policy and the initiation of economic reforms in India.
The Crisis of 1991
In 1991 India faced its worst economic crisis of the post-independent era. Deteriorating macro-economic conditions culminated in a full-blown Balance of Payments crisis in 1991. India’s foreign exchange reserves fell to USD 1 billion—just sufficient for two weeks of import requirements. Fiscal deficit at 8% of GDP and current account deficit at 4% of GDP crossed all limits of macro-economic prudence. Credit rating agencies like Standard & Poor’s and Moody downgraded India’s credit rating to speculative grade, triggering a flight of capital from the country.
India came close to defaulting on its international commitments. The government had to sell some gold and the RBI was forced to pledge part of its gold reserves with the Bank of England to raise the much-needed foreign exchange. Finally, the government approached the IMF, which granted two loans of USD 1.03 billion and USD 789 billion under two different schemes.
Initiation of Reforms Under Narasimha Rao and Manmohan Singh
In June 1991, a new government under the leadership of P. V. Narasimha Rao assumed office. Rao chose a technocrat with proven academic and administrative credentials, Manmohan Singh, as his finance minister.
Manmohan Singh initiated far-reaching economic reforms, whose consequences on the economy in the years that followed were truly profound. Manmohan Singh began by devaluing the rupee by 9% and 11% respectively on July 1 and July 3. This was followed by trade liberalisation that helped improve India’s credit rating. On July 24, Manmohan Singh presented his epoch-making budget which initiated the process of dismantling the License Raj, which had stifled the enterprise and initiative of Indians for long. From 1991 onwards, reforms became a continuous process encompassing all sectors and segments of the economy.
Salient features of the reforms
- Delicensing the number of industries that required licenses was reduced.
- The number of industries reserved for the public sector was reduced to six. All others were opened to the private sector.
- Automatic approval for foreign investment up to 51%.
- Removal of MRTP restrictions on investment.
- Public sector units were given more autonomy.
- Disinvestment of a part of government securities in many PSUs initiated
Capital Market Reforms
- Abolition of Controller of Capital Issues (CCI) and free pricing of IPOs.
- Securities and Exchange Board of India (SEBI) empowered.
- Mutual funds opened to the private! Foreign sector.
- Indian companies allowed raising capital abroad through GDR/ADR issues.
- Foreign portfolio investment (FPI) by Foreign Institutional Investors (FILs) allowed.
- Investment norms for NRIs and Overseas.
- National Stock Exchange (NSE) set up.
- Online trading and dematerialisation of securities initiated.
- Rolling settlement and derivatives trading (options and futures) allowed.
- Trade was liberalized and quantitative restrictions on imports were removed.
- Since 1992 imports are regulated through a negative list, which has been progressively reduced.
- Export Processing Zones (EPZ) scheme and 100% EOU schemes introduced to provide for duty free enclaves.
- Rupee made convertible on the trade account and later on the current account.
- Foreign Exchange Regulation Act (FERA) was replaced by the Foreign Exchange Management Act (FEMA).
- Telecom services opened to the private sector.
- Foreign equity participation allowed in telecom joint ventures.
- Telecom Regulatory Authority of India (TRAI) set up.
- Private airlines allowed.
- National Highway Act amended to levy fee on national highways.
- Road sector declared an industry to facilitate borrowing on easy terms.
- Private investment in road projects liberalised.
- A National Highway Project merging the Golden Quadrilateral connecting Delhi Mumbai, Chennai and Kolkata with the East-West (Sichar to Saurashtra) and North-South (Kashmir to Kanyakumari) corridors launched.
Financial Sector Reforms
- Narasimham Committee recommendations on banking sector implemented.
- New generation banks allowed in the private sector.
- Bank branch licensing liberalised.
- SLR and CRR reduced.
- Interest rates deregulated.
- Nationalised banks allowed access to capital markets for debt and equity.
- Prudential norms for capital adequacy, income recognition, asset classification and provisioning for bad debts introduced.
- Malhotra committee recommendations on insurance reforms implemented.
- Insurance Regulatory Development Authority (IRDA) Act passed in 1999 facilitating foreign direct investment of 29% in life and general insurance. FDI in insurance later enhanced to 49%.
- Direct and indirect taxes rationalised.
- Maximum marginal rate of income tax (56% in 1990) and corporate tax (51.75% in 1990) reduced in successive budgets to touch 30% by the turn of the century.
- Peak customs duty (300%) in 1990 reduced in successive budgets. Presently, excluding a small list consisting of liquor, used cars etc. the peak customs duty stands at 10 percent.
- Value Added Tax (VAT) in lieu of sales tax introduced at the state level.
- Service tax introduced on services.
Reform is a process. Successive governments, which came to power since 1991, have taken the reforms forward. Some of the recent reforms include the following:
- 51% FDI in multi-brand retail allowed subject to certain conditions.
- 100% FDI in single brand retail allowed.
- Transparency introduced in coal and spectrum allocation through auction.
- FDI in insurance raised to 49% in 2015.
- Coal Mines Bill passed allowing private investment in coal mining.
- Black money Act 2015 passed.
- Bankruptcy bill passed.
- Small banks and payment banks allowed by the RBI.
On June 20, 2016 the government announced major liberalisation of FDI, making India one of the most liberal and attractive FDI destinations in the world. The reforms in brief:
- Defence: 100 per cent FDI permitted through government approval route, in cases resulting in access to modern technology. FDI limit for defence sector applicable to manufacturing of small arms.
- Pharmaceuticals: 74 per cent FDI under automatic route in brown field pharmaceuticals.
- Aviation: 100 per cent FDI under automatic route in brown field airport projects. Also, FDI in scheduled air transport service/do mestic scheduled passenger airline and regional air transport service raised to 100%. But, restriction on investment by foreign airlines to continue.
- Food trading: 100 per cent FDI under government approval route for trading, including through e-commerce, for food products manufactured or produced in India
- Media: Cable, DTH, teleports can all have 100% FDI.
- Private security agency: FDI up to 49% under automatic route and up to 74% on government approval route.
- Single brand retail: Local sourcing norms relaxed up to three years for all single brand entities. Another five years. Relaxation for trading of products having ‘state-of-the-art’ and ‘cutting-edge’ technology will be allowed.
- Animal husbandry: FDI In Animal Husbandry (including breeding of dogs), Pisciculture, Aquaculture and Apiculture IS allowed up to 100% under Automatic Route under controlled conditions. In 2015–16, India emerged as the largest recipient of FDI among emerging markets with an FDI inflow of USD 55.56 billion. With the new liberal policy, this trend is likely to accelerate.