Syllabus: Effects of liberalization on the economy, changes in industrial policy and their effects on industrial growth.
PAST YEAR QUESTIONS
UPSC 2017 “Industrial growth rate has lagged behind in the overall growth of Gross-Domestic-Product (GDP) in the post-reform period” Give reasons. How far the recent changes in Industrial Policy are capable of increasing the industrial growth rate?
UPSC 2013: Examine the impact of liberalization on companies owned by Indians. Are they competing with the MNCs satisfactorily? Discuss.
The liberalisation was aimed at ending the licence-permit raj by decreasing the government intervention in the business, thereby pushing economic growth through reforms. The policy opened up the country to global economy. It discouraged public sector monopoly and paved the way for competition in the market.
Indian Economy Before 1991
- Nehru chose the instrument of a mixed economy for the social transformation of the country because he was convinced that capitalist path was not suitable to India and totalitarian kind of communism was against the ethos of the country.
- He tried to cut out a middle path for development which combines the virtues of individual freedom and liberty with that of equality, while avoiding the evils of both capitalism and socialism. It was his bold experiment to combine the social justice of socialism with democracy’s freedom.
Economic Situation after Nehru (1965 to 1991)
- Two successive monsoon failures in 1965 and 1966 added to a burden on agriculture which was showing signs of stagnation. Rate of inflation rose to 12% from 1965 to 1968 and food prices rose to 20%.
- The two wars of 1962 (China) and 1965 (Pakistan) led to massive increase in defence expenditure which resulted in governments consolidated fiscal deficit of 7.3% of GDP in 1966-67.
- The Rajiv Gandhi government (1984 – 89) introduced certain reforms in the second half of the 1980s like relaxation in the grant of licenses, reduction in import restrictions, introduction of export incentives which led India to a higher growth of over 5.5% of GDP in the 1980s and broke the 3.5% growth record of the previous three decades called the “Hindu rate of Growth”
Industrial Policies (pre-1991) are as follows
- The industrial sector was highly regulated, bureaucratic controls and subject to strict licensing system by the government with the need for a licence for any industrial activity, besides the need for compulsory registration before commencing the business.
- The policy of 1956 brought the role of public sector sharply by reserving as many as eighteen areas exclusively for the public sector. In certain areas, private sector was allowed but subject to the requirement of licence and registration. However, public sector could also be set up in these areas if deemed necessary by the Government.
- Thus, most critical and important areas of oil, power, heavy equipment’s, telecom, etc., were exclusively in the domain of public sector.
- Bigger private companies were highly regulated through the monopolies and restrictive trade practices (MRTP) act and known as MRTP companies and similarly foreign companies were regulated through the Foreign Exchange Regulation Act (FERA) and known as FERA companies.
- It was believed by the government that as a company grows in size it can resort to monopolistic and exploitative tendencies. As a result, even after a licence and commencing of business, the private sector had to seek approval from the government for capacity expansion, diversification and other such business decisions.
- The earlier policies with a view to give public sector commanding heights and control over key industries/services also paved the way for nationalization or take over from private sector. Thus, coal mining, banking, insurance, textile mills (sick industries were taken over to protect employment) earlier in the private sector, were nationalized.
- The pre-1991 policies had price regulation for industrial goods with prices of steel, cement and other basic goods controlled by the government.
- Each and every policy had stressed on the mixed economy character of the economy which is co-existence of the public and private sector but in reality, it was heavily tilted towards the public sector.
To summarize, the pre-1991 policies were highly regulated and regimented oriented, near dominance of the public sector and a very limited space with bureaucratic control over private sector companies.
Objectives of the Reform
- Fiscal Stabilisation: Fiscal stabilisation is an essential precondition for the success of economic reforms. A reduction in the Central Government’s fiscal deficit was therefore critical for the reforms to take off which had reached to 8.4% in 1990-91. The following steps were taken to reduce the fiscal deficit.
Abolition of export subsidies in 1991-92 and the partial restructuring of fertilizer subsidy in 1992-93
Budget support to loss-making public-sector units in the form of government loans to cover their losses was progressively phased out
Certain development expenditure was restructured including expenditure on social and economic infrastructure
- De-licensing of items reserved for MSME Sector: Since 1991, the ministry of Commerce and Industry was progressively de-licensing the items reserved for MSME sector through a forward-looking policy. Over the years since 1991, the list of items reserved for manufacturing by MSME sector was reduced from over 800 to nil by April 2015. The items which were reserved consisted of pickles & chutneys, mustard oil (except solvent extracted), groundnut oil wooden fixtures, exercise books and registers, wax candles, laundry soap, glass bangles, steel almirah, rolling shutters, steel chairs and tables, padlocks, stainless steel and aluminium utensils etc.
- Foreign Investment: Before 1991, India’s policy towards foreign investment was very selective and was widely perceived as being unfriendly. The percentage of ownership allowed to foreign investors was generally restricted to 40% except in certain high technology areas and foreign investment was generally discouraged in consumer goods sector unless supported by strong export commitments. The new policy was much more actively supportive of foreign investment in a wide range of activities. Permission is automatically granted for foreign equity investment up to 51% in a large list of 34 industries and for more than 51% Govt. approval was required.
- Trade and Exchange Rate Policy: The complex import control regime earlier applicable to imports of raw materials, other inputs, capital goods were virtually dismantled. Now all raw materials, other inputs required for production and capital goods can be freely imported except for a relatively small negative list. Import of certain consumer goods were allowed against special import licenses which were given to certain categories of exporters as incentives. The exclusion of consumer goods from trade liberalisation was a restrictive element in trade policy which the government promised will be gradually liberalized, but for all other sectors, quantitative restrictions on imports were largely eliminated. The removal of quantitative restrictions on imports was accompanied by a gradual lowering of customs duties.
- Tax Reforms:
- The maximum marginal rate of personal income tax was 56% in June 1991. This was reduced to 40%
- Corporate income tax was reduced from 51.75% to 46% for public listed companies
- Customs duty was considerably reduced from an average of around 200% to 65%
- Public Sector Reforms: Reform of the public sector is a critical element in structural adjustment programmes all over the world and was also included on India’s reform agenda. Instead of outright privatization, the government initiated a limited process of disinvestment of government ownership/ equity in public sector companies with government retaining 51% of the equity and management control.
- Financial Sector Reforms:
- Banking Sector was opened up to private competition from new private banks and several new banking licenses were granted.
- Transparency and supervision in trading practices in capital markets. SEBI (established in 1988 but given statutory powers in April 1992) was established as an independent statutory authority for regulating stock exchanges and supervising the major players in the capital markets.
- Capital market was opened for portfolio investments and Indian companies were allowed to access international capital markets by issuing equity/ shares abroad through Global Depository Receipts (GDR).
- The requirement of government permission of companies issuing capital as well as system of government control over the pricing of new equity by private companies was abolished with the repeal of the Capital Issues Control Act in May 1992.
Impact of liberalisation
Short Term Impact
- Inflation reduced from a peak of 17% in August 1991 to about 8.5% within 2.5 years
- Forex reserves increased from $1.2 billion in June 1991 to over $15 billion in 1994
- GDP growth increased from 1.1% in 1991-92 to 4% in 1992-93
- Fiscal deficit reduced from 8.4% in 1990-91 to 5.7% in 1992-93
- Exports more than doubled from 1990-91 to 1993-94
Positive Impact in long run-
- GDP: Once admonished for its “Hindu rate of growth– post-reforms, India remained the second fastest growing economy in the world, behind China until 2015. Especially, between 2005 and 2008, the economy clocked the 9% mark annually.
- FDI: Before 1991, foreign investment was negligible. The first year of reform saw a total foreign investment of only $74 million. However, investments have steadily risen since then, except for occasional blips between 1997 and 2000 and 2008 and 2012 – owing to the global economic slowdown. As of 31 March 2016, the country has received total FDI of $371 billion.
- Free flow of capital: Liberalisation has improved flow of capital into the country which makes it inexpensive for the companies to access capital from investors. Lower cost of capital enables to undertake lucrative projects which they may not have been possible with a higher cost of capital pre-liberalisation, leading to higher growth rates.
- Foreign Reserves: It was India’s dismal state of forex reserves that forced the government to bring in economic reforms. Now, forex reserves are at a record high. In 1991, it stood at just $5.8 billion. As of 24 June, the country’s forex reserves are at $608 billion.
- Stock Market Performance: Generally, when a country relaxes its laws, taxes, the stock market values also rise. Stock Markets are platforms on which Corporate Securities can be traded in real time.
- Political Risks Reduced: Liberalisation policies in the country lessens political risks to investors. The government can attract more foreign investment through liberalisation of economic policies. These are the areas that support and foster a readiness to do business in the country such as a strong legal foundation to settle disputes, fair and enforceable laws.
- Diversification for Investors: In a liberalised economy, Investors gets benefit by being able to invest a portion of their portfolio into a diversifying asset class.
- Impact on Agriculture: In the area of agriculture, the cropping patterns has undergone a huge modification, but the impact of liberalisation cannot be properly measured. It is observed that there are still all-pervasive government controls and interventions starting from production to distribution for the produce.
Negative Impact in long run-
- Destabilization of the economy: tremendous redistribution of economic power and political power leads to Destabilizing effects on the entire Indian economy.
- Impact of FDI in Banking sector: Foreign direct investment allowed in the banking and insurance sectors resulted in decline of government’s stake in banks and insurance firms.
- Threat from Multinationals: Prior to 1991 MNC’s did not play much role in the Indian economy. In the pre-reform period, there was domination of public enterprises in the economy. On account of liberalisation, competition has increased for the Indian firms. Multinationals are quite big and operate in several countries which has turned out a threat to local Indian Firms.
- Technological Impact: Rapid increase in technology forces many enterprises and small-scale industries in India to either adapt to changes or close their businesses.