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Process Of Economic Liberalization In India

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Published: Thu, 20 Apr 2017

Though economic liberalization in India started in the late 1970s, economic reforms began in earnest only in July 1991. A balance of payments crisis at the time opened the way for an International Monetary Fund (IMF) program that caused the adoption of a major reform package. Though the foreign-exchange reserve recovered quickly and ended effectively the temporary influence of the IMF and World Bank, reforms continued in a stop-go fashion. India’s reforms have been incremental. Prior to the introduction of the reforms, the heavy industry was a state monopoly.

Other industries were either subject to limited industrial licensing or reserved for the small-scale sector. The reforms of the last 10 years have gone a long way toward freeing up the domestic economy from state control. State monopoly has been abolished in virtually all sectors, which have been opened to the private sector. The License Raj is a entity of the past.

The small-scale industry reservation still exists but even here progress has been made. Apparel, with its large export potential, was recently opened to all investors. In the area of international trade, in 1991, import licensing was spread throughout with goods divided into banned, restricted, limited permissible, and subject to open general licensing (OGL). The OGL category gave the maximum liberty but it covered only 30 percent of imports. Moreover, certain conditions had still to be fulfilled before the permission to import was granted under the OGL system.

Imports were also subject to excessively high tariffs. The top rate was 400 percent. As much as 60 percent of tariff lines were subject to rates ranging from 110 to 150 percent and only 4 percent of the tariff rates were below 60 percent. The exchange rate was highly over-valued. Strict exchange controls applied not only to capital account but also current account transactions. Foreign investment was subject to strict restrictions. Companies were not allowed more than 40 percent foreign equity unless they were in the high-tech sector or were export-oriented. As a result, foreign investment amounted to a worthless $100-200 million per annum.

Today, import licensing has been completely abolished. This includes textiles and clothing, which remain protected in developed countries through the multi-fiber arrangement. The highest tariff rate has come down to 45 percent (including the tariff surcharge and the so-called Special Additional Duty) with the average tariff rate reducing to less than 25 percent.

Progress has also been made in many areas that were previously not in the limit of reforms. Insurance has been opened to private investors, both domestic and foreign. Diesel oil and gas prices have undergone some increases. At least symbolic reductions have also been made in fertilizer and food subsidies. The value added tax has undergone substantial rationalization.

These reforms have paid handsomely. Second, labor laws must be reformed so as to restore the employer’s right to layoff workers upon adequate compensation to them.

Infrastructure is another important area of reforms. Roads, railways, and ports all need expansion as well as improvement in the quality of service. The government has recently taken steps in this direction, particularly in the area of roads, but the pace remains slow.

The most important area of reforms is perhaps India’s power sector. Virtually no sector of the economy industry, agriculture, orservices-can achieve successful transformation without adequate supply of power. The power sector has been a government monopoly at the state level and suffers from proverbial inefficiency including large-scale thefts of electricity in almost every state.

Reforms involving privatization of power generation and distribution have been undertaken in several states recently but no spectacular successes have emerged as yet. This is the area with highest payoffs for imaginative reforms.

While foreign banks are now allowed freely open branches in India, they have not yet moved in aggressively.Finally, the reform of bureaucracy is essential. The problem of a bloated bureaucracy and the need for downsizing it is well recognized.

REASONS BEHIND ECONOMIC REFORMS

Before the process of reform began in 1991, the government attempted to close the Indian economy to the outside world. The Indian currency, the rupee, was inconvertible and high tariffs and import licensing prevented foreign goods reaching the market. India also operated a system of central planning for the economy, in which firms required licenses to invest and develop.

The labyrinthine bureaucracy often led to absurd restrictions-up to 80 agencies had to be satisfied before a firm could be granted a licence to produce and the state would decide what was produced, how much, at what price and what sources of capital were used. The government also prevented firms from laying off workers or closing factories.

The central pillar of the policy was import substitution, the belief that India needed to rely on internal markets for development, not international trade-a belief generated by a mixture of socialism and the experience of colonial exploitation. Planning and the state, rather than markets, would determine how much investment was needed in which sectors.

NARASIMHA RAO GOVERNMENT (1991-1996)

Crisis

The assassination of prime minister Indira Gandhi in 1984, and later of her son Rajiv Gandhi in 1991, crushed international investor confidence on the economy that was eventually pushed to the brink by the early 1990s.

As of 1991, India still had a fixed exchange rate system, where the rupee was pegged to the value of a basket of currencies of major trading partners. India started having balance of payments problems since 1985, and by the end of 1990, it was in a serious economic crisis.

The government was close to default, its central bank had refused new credit and foreign exchange reserves had reduced to the point that India could barely finance three weeks’ worth of imports.

A Balance of Payments crisis in 1991 pushed the country to near bankruptcy. In return for an IMF bailout, gold was transferred to London as collateral, the Rupee devalued and economic reforms were forced upon India. That low point was the catalyst required to transform the economy through badly needed reforms to unshackle the economy.

Controls started to be dismantled, tariffs, duties and taxes progressively lowered, state monopolies broken, the economy was opened to trade and investment, private sector enterprise and competition were encouraged and globalisation was slowly embraced.

The reforms process continues today and is accepted by all political parties, but the speed is often held hostage by coalition politics and vested interests.

Reforms

The Government of India headed by Narasimha Rao decided to usher in several reforms that are collectively termed as liberalisation in the Indian media. Narasimha Rao appointed Manmohan Singh as a special economical advisor to implement liberalisation.

The reforms progressed furthest in the areas of opening up to foreign investment, reforming capital markets, deregulating domestic business, and reforming the trade regime. Liberalisation has done away with the Licence Raj (investment, industrial and import licensing) and ended many public monopolies, allowing automatic approval of foreign direct investment in many sectors..

Rao’s government’s goals were reducing the fiscal deficit, privatization of the public sector, and increasing investment in infrastructure. Trade reforms and changes in the regulation of foreign direct investment were introduced to open India to foreign trade while stabilizing external loans.

Rao’s finance minister, Manmohan Singh, an acclaimed economist, played a central role in implementing these reforms. New research suggests that the scope and pattern of these reforms in India’s foreign investment and external trade sectors followed the Chinese experience with external economic reforms.

In the industrial sector, industrial licensing was cut, leaving only 18 industries subject to licensing. Industrial regulation was rationalized.Abolishing in 1992 the Controller of Capital Issues which decided the prices and number of shares that firms could issue.

Introducing the SEBI Act of 1992 and the Security Laws (Amendment) which gave SEBI the legal authority to register and regulate all security market intermediaries. Starting in 1994 of the National Stock Exchange as a computer-based trading system which served as an instrument to leverage reforms of India’s other stock exchanges. The NSE emerged as India’s largest exchange by 1996.Reducing tariffs from an average of 85 percent to 25 percent, and rolling back quantitative controls. (The rupee was made convertible on trade account.)

Encouraging foreign direct investment by increasing the maximum limit on share of foreign capital in joint ventures from 40 to 51 percent with 100 percent foreign equity permitted in priority sectors.

Streamlining procedures for FDI approvals, and in at least 35 industries, automatically approving projects within the limits for foreign participation.Opening up in 1992 of India’s equity markets to investment by foreign institutional investors and permitting Indian firms to raise capital on international markets by issuing Global Depository Receipts (GDRs).Marginal tax rates were reduced.


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