ECONOMIC REFORMS IN INDIA

ECONOMIC REFORMS IN INDIA

Section B_Group 2 Ravi barun (68) Arib khan (69) Arjun arya(71) Kaushik patel(94) Anurag mathur(99)

Jerin john(128)

Pre 1990 scenario in India..

Till 90s India was a more of a Socialist economy. i.e. -Dominant role of government
-Import substitution

-Huge investments in public sector and in capital goods.

Permit Raj
-High tariffs and quantitative restrictions

Heavy dependence on agriculture income-72% employment Indias GDP rose from 3.5 to 5% in 80s. The volume of exports grow after decades of independence.

 Manufacturing growth in public sector was around 7-8% after years of degrading performance.

Late 80s and early 90s scenario:

The central govt. fiscal deficits increased from 6% of GDP to above 9% in a time period of 1980s-90.

Nationalization of industries and financial institutions

50% of industrial assets was owned by government Subsidized 90000 sick units Nationalized 100% of banks

Export policy
Decline of export growth from 6.5%(1950)-3.6%(1970) Cash Assistance scheme Registered exporters policy

Reasons that led to 1991 crisis..

In 1991 India experienced a classic external payments crisis high fiscal deficit,
external borrowing to finance it, rising debt service commitments and resulting inflation, inadequate adjustments in the exchange rate and a deteriorating current account The economic crisis was primarily due to the large and growing fiscal imbalances over the 1980s. During mid eighties, India started having balance of payments

problems. Precipitated by the Gulf War, Indias oil import bill swelled, exports
slumped, credit dried up and investors took their money out. Large fiscal deficits, over time, had a spill over effect on the trade deficit cumulating in an external payments crisis. By the end of 1990, India was in serious economic trouble.

Continued
Petroleum import costs in 19901991 increased by half to US$5.7 billion. The other shock was the slow economic growth in Indias export markets. and in the U.S. Indias largest export destination fell from 3.9 percent in 1988 to 1 percent in 1991. Conditions in another major export market the Soviet Union had also worsened due to the oil shock. World growth had also declined from 4.5 percent in 1988 to 2.25 percent in 1991.Consequently, Indias export growth was only 4 percent in 1990-91.

 The gross fiscal deficit of the government (center and states) rose from 9.0 percent of GDP in 1980-81 to 10.4 percent in 1985-86 and to 12.7 percent in 1990-91. For the center the gross fiscal deficit rose from 6.1 percent of GDP in 1980-81 to 8.3 percent in 1985-86 and to around 12% in 1990-91. Since these deficits had to be met by borrowings, the internal debt of the government accumulated rapidly, rising from 35 percent of GDP at the end of 1980-81 to 53 percent of GDP at the end of 1990-91. The foreign exchange reserves had dried up to the point that India could barely finance three weeks worth of imports. INFLATION REACHED 12.1% during the crisis.

FOREIGN EXCHANGE RESERVES (INCL. GOLD AND SDRS) (US $BN.)

1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98

5.83 9.22 9.83 19.25 25.19 21.69 26.42 29.37

Source: M S.Ahluwalia 2000; RBI Annual Reports

INTERNAL & EXTERNAL REASONS THAT BRED FOR CRISIS

IMMEDIATE RESPONSE..

The Immediate response was to secure an emergency loan of $2.2 billion from the International Monetary Fund by pledging 67 tons of India's gold reserves as collateral. The Reserve Bank of India had to lift 47 tons of gold to the Bank of England and 20 tons of gold to the Union Bank of Switzerland to raise $600 million. National sentiments were outraged and there was public outcry The Chandra Shekher government had collapsed

P.V. Narasimha Rao took over as Prime Minister in June, the crisis forcing him to rope in Manmohan Singh as Finance Minister, who unshackled what was then called the 'caged tiger'.

The Rao government ushered in several reforms that are collectively termed as
liberalization in the Indian media. Although, most of these reforms came because IMF required those reforms as a condition for loaning money to India in order to overcome the crisis.

Main Features Of Economic Reforms

PRIVATISATION

LIBERALISATION

GLOBALISATION

ECONOMIC REFORMS

New Economic Policy 1991

New Economic Policy (1991)

Industrial Sector Reforms

Public Sector Policy Industrial Licensing Policy MRTP Act

External Trade Reforms

Foreign Investment Foreign Technology Agreements

Public Sector Policy.

Existence of large number of chronically sick public enterprises incurring heavy losses, operating in a competitive market and serving little or no public purpose Measures:

Portfolio of public sector investments reviewed with a view to focus the public sector on strategic, high tech and essential infrastructure

Public Enterprises which are chronically sick and which are unlikely to be turned around referred to the Board for Industrial and Financial Reconstruction (BIFR) for revival/rehabilitation schemes

Contd..

Part of the governments shareholdings in the public sector would be

offered to mutual funds, financial institutions, the general public and workers to raise resources and encourage wider public participation

Instilling professionalism in board of public sector companies

Greater thrust on performance improvement and greater autonomy to

management

Industrial Licensing Policy.

Role of the government changed from that of only exercising control to one of providing help and guidance by making essential procedures fully transparent and by eliminating delays Industrial licensing to be abolished for all projects except for a short list of industries related to securities and strategic concerns. In projects where imported capital goods are required, automatic clearance will be given in cases where foreign exchange availability is ensured through foreign equity. Location other than cities of more than 1 million population, there will be no requirement of obtaining industrial approvals from the central Government except for industries subject to compulsory licensing.

List of Industries..

MRTP ACT
Monopolies and Restrictive Trade Practices Act, 1969 was amended. The
important objectives were: Prevention of concentration of economic power in the hands of few which will be detrimental to the common interest; and Regulation of monopolistic, restrictive and unfair trade practices. Hence, the MRTP Act now concerned only with the prohibition of monopolistic, restrictive and unfair trade practices followed by the industrial undertakings and the trading communities.

Major Economic reforms /solutions to crisis.

Indias economic policy-making can be illuminated by examining five key sets of decisions: Devaluation IMF programme A new exchange rate regime and changes in the RBIs role Carefully managed opening up to foreign investment Financial sector reform

Devaluation.
It refers to decline in value of a currency with respect to other currencies,
which is most of the times brought by central bank. Value of money is decreased Encourages exports and discourages imports Trade deficit decreases . Employment increases, demand for domestic goods and services increases. All above leads to foreign reserve currency. So that later the trade can be done easily.

IMF approached.
As India was going through so many reforms during the 1991 period it needed a huge amount of money.

And India largely got what it wanted. In a November 1991 stand-by agreement the IMF promised to provide $2.2 billion over a period of twenty months.

FOREIGN INVESTMENT.
Aimed at encouraging foreign trading companies to assist Indian exporters

in export activities:
Approval was given for direct foreign investment upto 51% foreign equity in high priority industries Import of the components, raw materials and intermediate goods, and payment of know how fees and royalties would be governed by the general policy applicable to other domestic units, the payment of dividends would be monitored through the Reserve Bank of India Majority foreign equity holding upto 51% equity would be allowed for trading companies primarily engaged in export activities

Foreign Technology Agreements.

In order to inject the desired level of technological dynamism in Indian industry Automatic permission will be given for foreign technology agreements in high priority industries up to a lump

sum payment of Rs. 1 crore, 5% royalty for domestic sales or 8% for

exports, subject to an overall limit of 8% of sales over a 10 year period from date of agreement or 7 years from commencement of

production. .
No permission will be necessary for hiring of foreign technicians, foreign testing of indigenously developed technologies.

Financial Sector Reform.

Interest rates on term loans and on the bulk of debt instruments in capital markets have been decontrolled and deposit interest rates have been increased. Full statutory powers will be given to the Securities and Exchange Board of India (SEBI) to regulate, promote, and monitor Stock Exchanges in India

correspondingly the functions of the Controller of Capital Issues are being

redefined. The private sector is now allowed to establish Mutual Funds. RBI supervision over commercial banks and other financial institutions.

Tax reforms.
Since 1991 several efforts have been made through the annual budget process to achieve tax reforms. These have focused on: Expanding the tax base by including services (not previously taxed); Reducing rates of direct taxes for individuals and corporations;

Abolishing most export subsidies,

Lowering import duties Rationalizing sales tax and reducing the cascading effect of central indirect taxes by introducing a Modified Value Added Tax and a soon-to-be implemented nationwide Value Added Tax. Providing for tax incentives for infrastructure and export-oriented sectors, including setting up Special (Export) Economic Zones;

Reducing fiscal deficits..

Faced with the necessity of reducing the fiscal deficit in the crisis year of 1991-92, Finance Minister Singh attempted to reduce fertilizer and food subsidies in 1991-92 and to some extent in 1992-93. Simultaneously, he (and

several subsequent finance ministers) resorted to the softer options of

reducing public investment expenditure and reducing public expenditure on social welfare services from 1991 to 1995. These measures did help reduce the fiscal deficit of the central government to 4.8 percent of GDP at the end of 199293. However, further cuts in fertilizer and food subsidies were opposed in Parliament and proved suicidal for the ruling Congress Party, which lost power in state elections in 1993-94.

Evaluation of New Economic Policy - 1991

Positive Aspects:

Fulfilled a long-felt demand of the corporate sector for declaring in very

clear terms that licensing was abolished for all industries except 18
industries which included coal, petroleum, sugar, motor cars, cigarettes, hazardous, chemicals, pharmaceuticals and some luxury items

Business houses intending to float new companies or undertake substantial expansion were not required to seek clearance from the MRTP Commission

Bottlenecks created by the bureaucracy were struck down by this

singular decision of the Government

Overall relief in the dismantling of industrial licensing and regime of controls

Evaluation of New Economic Policy - 1991

Negative Aspects:

Policy regarding Foreign Capital:

Assertions by critics assert that the welcome foreign capital may lead us to selling of our sovereignty to multinationals.

Prudence demanded that utmost care to be taken to invite foreign capital in high priority industries only.

Monitoring of payment of dividends by RBI

Second Generation Reforms

Objectives of second generation reforms..

Increase in the rate of economic growth.

Control over fiscal deficit Promoting FDI

Decline in deficit of BOP

Reduction in poverty

Second Generation Reforms .

The 2nd generation reforms focus on 4 areas in particular: The financial system paying greater attention to the soundness of banking systems and encouraging greater transparency and the

liberalization of capital accounts. Good governance-By improving public resource management and transparency of the economic and regulatory environment for private sector

activity
Composition of fiscal adjustment- Reducing unproductive expenditures such as military spending and focusing spending on social sectors Deeper structural reform- including civil service reform, labour market reform, trade and regulatory reform, and agrarian reform.

Reforms.
Defense production was opened up for Indian private sector with unto 26
per cent foreign equity. Reduction in the minimum Government ownership in nationalized banks

from 51 to 33 per cent

FDI limit was raised to 49 per cent in banking sector 100 per cent foreign investment on domestic route has been allowed in

pharmaceutical sector , airport ,mass rapid transport systems and

townships

Contd..
100 per cent FDI allowed in hotel and tourism industry.

In the telecom sector FDI up to 74 per cent has been permitted to Internet service providers.

Reforms contd.
Custom duty was significantly reduced Corporate tax was brought down to 30% State level sales tax to VAT Introduction of Fiscal Responsibility and Budget Management Act 2004 Extension of service tax to 51 services

CAUSES OF PRESENT ECONOMIC SLOWDOWN AND NEED FOR REFORMS

1. RISING INFLATION
Inflation adversely impacts the poor more than the rich or the middle classes
and results in further widening of gap between rich and poor. When inflation is driven by high food prices , the consequences are magnified since the economically weaker section spend more than half of their incomes on food.

2. INEFFECTIVE MONETORY POLICIES

To keep check on inflation, government started tightening liquidity by increasing interest rates which has contributed to a slowdown of investments in industry and capital formation.

3. WEAKENING RUPEE
The depreciation in the value of the Indian Rupees results in the jumping of trade deficit by 56 per cent between 2010-11 and 2011-12. More than half of the Indias import bill is accounted for two itemscrude oil and gold- are inelastic and Indias export market in the West have shrunk drastically due to Great Recession

4. REDUCTION IN FIIs AND FDIs

FII and FDI are also reduced as investors are taking larger amount

to their home countries even as some domestic industrialists prefer

to invest outside India rather than at home.

5. RAMPANT CORRUPTION

Who doesnt know about

a. 2G scam b. Coalgate c. CWG scam d. Adarsh Housing Society scam e. Karnataka illegal mining scam f. ISRO's S-band scam

Instead of ensuring transparency in the manner in which natural resources are valued and allocated, government policies have been opaque, resulting in a plethora of allegations of corruption and nepotism.

6. POLITICAL PARALYSIS
No support from its coalition partners and

opposition in major initiatives taken up by ruling party resulting in parliamentary dysfunctional.

PRESENT REFORMS.
1. FDI in Multi-Brand Retail Up to 51% FDI in multibrand retail trading has been permitted A foreign investor would be required to invest a minimum of USD 100 million, with at least 50% invested in backend infrastructure within three years of its initial investment. At least 30% of products must be sourced from local small industries Retail outlets may only be set up in city with a population exceeding 1 million.

2.

FDI in Civil Aviation

Foreign airlines will be permitted to invest up to 49% of the paidup capital of Indian Companies

3.

FDI in Broadcasting
FDI in broadcasting carriage sector hiked from 49% to 74%

4.

FDI in Power Trading Exchanges

Foreign investment up to 49% (with an FDI limit of 26% and FII investment limit of 23% of the paidup capital) has been permitted in power trading exchanges

5.

Divestment of PSUs
The government approved the sale of its minority stakes in four PSUs, namely, Hindustan Copper, Oil India, MMTC and National Aluminium

Company Limited, with a view to raise up to INR 15,000 crores

6. New tax cuts for business and introduction of a more transparent , non-

retrospective tax regime for investors & various schemes for Investors in the

equity market and boost the domestic investment (RGES)

7. 8. Hike in diesel fuel prices by 14% Curtailing the subsidy on natural gas cylinders

2011-2012: 6.5 2010-2011:9.5

Fiscal Deficit (% of GDP)

Centre 1990-91 1996-97 2002-03 2003-04 2004-05
(Revised)

States 3.3 2.7 4.7 4.4 3.8 3.7

Consolidated 9.4 6.4 10.1 8.4 8.3 7.7

6.6 4.1 5.9 4.8 4.5 4.3

2005-06

2009-10: 7.4% 2010-11: 6.5%

Source: Rao (2005), Table A4, RBI (2005a), Table 11

2012: 295235.2 US$ Mn 2011: 2 US$ Mn

WHAT CAN BE THE FUTURE REFORMS?

SPV(Special Purpose Vehicle) for PPP projects Push infrastructure PSUs to spend their cash surplus Clear private sector dues by PSUs and ministries Set up Coordination Committee among related ministries Use SEB bailout to clean up power sector Map Land Using GIS and zone it

Speed up road construction

Ecommerce

RECAP

From : Finance minister (1991)

To : Prime minister(2004- in office)

Two decades have passed but India still stands on the same growth rate facing similar problems and no solutions with same man holding power for around a decade who changed the scenario in 2 years..