Foreign Trade Regime : Analytical Phases and

Changes over Time ( Period 1950-1991)

J. Bhagwati and A. Krueger defined a set of analytical phases in which exchange control
regime can be found. However 2 important things must be kept in mind -

1. It is not necessary that a country must pass through all the phases.

2. A country need not pass through the phases in the chronological sequence as
given by Bhagwati and Krueger.

The Phases were:

Phase I: Characteristics of this Phase -

• Quantitative Restrictions ( QRs) are imposed on international transactions to

control balance of payments (BoP)deficit and later on intensified.

• During this period reliance upon QRs to contain BoP deficit increases.

Phase II :
• In addition to QRs being intensified, various measures like heightened tariffs,
rebates for export, special tourist exchange rates, and other price interventions are
used to offset the undesired effects of the system.

• QRs continue to be relied upon to control BoP deficits.

Phase III :
• During this phase an attempt is made to systematize changes introduces in Phase I

• The phase starts with a formal exchange rate change accompanied by removal of
surcharges and other methods introduced in Phase II.

• Phase III being a tidying up operation, can result in country re-entering Phase II .
 However reliance on QRs is reduced in which case country enters Phase IV.

Phase IV : A country is said to enter Phase IV if -

• Responses to changes introduced in Phase III are encouraging for extension of

liberalization.

• A favourable response in the form of increased foreign exchange earnings takes

place which results in gradual relaxation of QRs

Phase V : In this Phase,

• The exchange regime is fully liberalized.

• There is full convertibility on current account.

• QRs are no longer used to regulate BoP

The Phase chronology of India’s Foreign Trade

regime for time period 1950-1992 is as follows : -

1950-1956 (Phase IV) –

• The period 1950-1956 also includes the First Five-Year Plan.

• It was a period of good harvest along with equilibrium in the BoP (import demand
more or less equaled export earnings).

• QRs were not imposed.

1956-1962 (Phase I) – Highlights of the period were :

• This period coincided with the Second Five-Year Plan which laid emphasis on
heavy industrialisation and thus led to severe BoP crisis in 1957.

• Govt. imposed a regime of QRs on imports instead of adopting appropriate

macroeconomic policies.

• Both the QRs and the industrial licensing were selective resulting in development
of certain industries only through import substitution.

• Foreign aid flows increased to 3% in 1960, which were less than 0.5% in pre-
1956 period.

1962-1966 (Phase II) –

• During this period export subsidization was introduced in 1962, though QRs on
imports initiated in 1957 continued. This was done to offset the penalties being
imposed on exports.

• Two exogenous events in the form of :

 Indo-Pakistan war in 1965, which resulted in suspension of foreign

trade

 A major drought in the agricultural year 1965-66

Adversely affected traditional exports and increased need for food imports.

• Import duties were increased.

• A deliberate attempt was made to devaluate Indian currency ( known as de-facto

devaluation) in the form of export subsidization and increasing the import duties.
However the impact was selective.

• Towards the end of the period, Industrial licensing system was loosened.

• Also, later on, external large scale aid was resumed as well as access to short term
credit.
1966-1968 (Phase III) –

• It is in this period that first step towards liberalization took place in the form of
devaluation of Rupees by 57.5% along with elimination of export subsidies and
reduction of import duties.

• Two droughts, 1 in 1965-66 followed by another in 1966-67, resulted in rise in

prices, adverse effects on traditional exports and an industrial recession induced
by shortage of agro-based raw materials

• As a result of all this, economic liberalization was stalled.

• Political problems further gave rise to economic difficulties. Congress party led
by PM Indira Gandhi saw huge erosion of support . It did not help the Govt. that
external aid promised at the time of devaluation did not materialize.

• Hence steps towards liberalization introduced with devaluation were soon

abandoned.

1968-1975(Phase II) -
During the period, 1968-75, India was back in Phase II and this implied abandonment of
liberalization. It further led to:
 Rise in import premium

 Re-establishment of export subsidies

 Stringent industrial licensing

Also, the country faced several exogenous shocks which are enumerated as follows:
1. The Bangladesh war in 1971 led to refugee inflows which created severe
economic pressures.

2. Repeated bad weather conditions during 1971-75 led to stagnant agricultural

output and double digit inflation for 2 years continuously in 1971-72 and 1973-
74.

3. With the collapse of Bretton-Woods system, India linked rupee to pound in 1971
and to a basket of currencies in 1975. With depreciation of pound against dollar,
rupee depreciated mildly but devaluation was halted since rupee was linked to
basket of currencies.

4. The first oil shock occurred in 1973.

The main highlights of this period are:
• Import policy became more restraining

• Scarcity of foreign exchange became more acute

• Import allocation criteria was subject to marginal conditions and became more
complex

• Tariffs were escalated

1975-1985(Phase III) -
In contrast to the previous period,
• the foreign exchange availability improved dramatically and the net reserved of
foreign exchange also went up

• the pressure on BOP was reduced due to the reduction in public investment and
slow industrial growth

• the green revolution led to increases in the output of wheat and rice, increasing
the public foodgrain stock and reducing foodgrain imports

• The QR regime was relaxed and import allocation rules were made simpler.
However, Protective quotas to shield domestic industry from import competition
remained intact.

• The second oil shock in 1979 failed to make an impact on the QR regime because:

i) There was substantial increase in work remittances

ii) Discovery and development of crude oil in Bombay High

1985-Mid 1991 (Phase III continued) -

In this period, the government made an attempt to bring stability to the EXIM policy and
proposed that it would cover a period of 3 years to reduce uncertainty. But this couldn’t
be achieved due to frequent changes in the policy.
The QRs were relaxed more than the previous period and this gave rise to OGL-open
general license. OGL means license to import without quantitative restrictions.
 Many items under OGL were non-competitive imports

 The share of value of imports under OGL was modest

Mid-1991 to present -
The famous phase of 1991 saw a major policy change in the history of the Indian
economy. The reason for such drastic measures is as follows:
 The foreign reserves weren’t enough to suffice for even three weeks of imports

 There was a huge fiscal deficit of nearly 9% of GDP

It was then that the Rao-Singh reforms were introduced. The chief elements of the
reforms are:
 Devaluation of rupee

 Abolition of import licensing

 Replacement of cash subsidies for exports through

(a) EXIM scrips(free salable rights to imports linked to exports)

(b) Partial convertibility of rupee

 Abolition of industrial licensing except for 18 industries

 Relaxation of MRTP Act

 Easing of FDI requirements

 Allowance of private investment in some public sector industries

The above mentioned reforms clearly indicate the arrival of Phase IV. If the full
convertibility of rupee on the current account is realized, the economy would be fully
liberalized.

The Anatomy of Pre-1991 Exchange Control

System

Some important terms:

• Import Replenishment Licenses: - It is the quantity processed in a
continuous fashion and at each step. E.g. Dhirubhai Ambani exported spices at a
loss and used replenishment license to import Rayon. He then exported Rayon at a
loss and again used replenishment license to import Nylon.
• Import Entitlement Schemes: - E.g. The certificate of Employment
(C.O.E) under this scheme was instituted initially by the Government of
Singapore, is a program designed to reduce car ownership and hence the number
of vehicles on roads.

• Effective Exchange Rate: - It is a multilateral exchange rate which is a

weighted average of exchange rate of domestic and foreign currencies with the
weight of each foreign currency equal to its share in the trade. It measures the
average price of a home good relative to the average price of goods of the trading
partners using the share of the trade with each country as the weight for that
country. Thus if the index increases, the purchasing power of that country’s
currency is higher against the currency of the trading partners.

The pre-1991 exchange control system divided the imports into 3 main
categories: consumer goods, capital goods and intermediate goods (such as raw
material, components etc). The import of consumer goods other than the ones
canalized and imported by state agencies (food grains, sugar etc) was not
permitted. The import of other goods was divided into the following licensing
categories: non-permissible, limited permissible, automatic permissible and
recently, OGL.

1) An elaborate administrative machinery (a policy statement) was used for the

allocation of permissible imports by:
• The sector of use i.e. private and public
• Type of good i.e. consumer, capital and intermediate
• The industry
• Firm within industries
2) The imports of canalized goods also grew in importance. The 1988-1991
statement listed almost 60 items, the imports of which were canalized through
public sector agencies, consisting of a variety of goods such as steel,
petroleum products, fertilizers etc.
3) The import control regime led to a lower effective exchange rate for exports
than that for imports on an average and for each and every industry.
4) The scheme for export subsidization, initiated in 1962 took 2 major forms:
• Direct subsidies through fiscal measures
• Indirect subsidies through Import Entitlement Schemes that entitled
exporters to scarce and restricted imports.
• Some small promotional activities included budgetary allocations for
the development of the market.
5) Similar to the category of non-permissible and restricted imports, there were
also non-permissible and restricted exports. In 1988 there were 172 such
 products, 67 of which could just not be exported. A major difference here was
that export of items not on the list of restricted items could be made without a
license which was not the case for import items(except personal baggage).
6) Under export assistance, the major fiscal measures were tax drawback
schemes. These schemes included refunds of indirect taxes including import
duties on inputs used in exports. Also exemptions from sales taxes, cash
compensation schemes and rail freight concessions were used for export
assistance.
7) The exporters were permitted to import certain restricted raw materials and
components with the help of Import Entitlement Certificates, now called
Import Replenishment licenses.
8) The difference between import entitlement certificate scheme and the import
replenishment license scheme was that under the former the value of
entitlement allowed to the exporter was equal to twice the content imported;
on the other hand under the latter the value of the license was equal to the
actual import content.
9) Under the import replenishment license scheme the exporters were registered
and classified under various categories:
• Manufacturer exporter
• Merchant exporter
• Export house
• Deemed exporter- refers to those domestic producers of intermediaries
who sold a part of their output to exporters)
10) But it is not economically efficient to help exporters through import
replenishment scheme.
11) A cash support scheme was initially introduced to compensate for the taxes
not refunded under the duty drawback scheme. This scheme was later
extended to compensate for a lot of factors which included losses incurred on
exports when the domestic demand was inadequate to use the capacity
installed entirely. The rates of compensatory support also varied widely across
products with no clear rationale.
12) The reason for most of the export assistance schemes was that Indian
exporters needed to be compensated because of the excess costs they incurred
as compared to their competitors because of some distortions in the Indian
Economy.
13) Conclusion: Just like the case of import controls, export incentive schemes
were made complex without any need to do so. By removing import licensing
and introducing partial convertibility of the rupee, the 1992 reforms
eliminated the complexity and variance in the incentives across goods under
the import replenishment and compensatory cash support schemes.

Conclusion
India’s development strategy was inward-oriented, and self-reliance was an
important objective which has resulted in a diversified industrial structure.
However, most of India’s industries are not internationally competitive in terms of
either cost per unit or product quality.

Indian planners did not view foreign trade as an engine of growth, they tried to
minimize import demand and viewed exports as a necessary evil mainly to
generate foreign exchange earnings to meet part of the import bill. However, to
achieve sustained, rapid, equitable and efficient growth, India must abandon it’s
inward oriented, capital intensive and inefficient development strategy.

The RAO SINGH reforms are vital steps towards a market based economy. These
reforms are based on understanding of what went wrong with Indian development
strategy.

Four decades of dis-regime can’t be replaced by market- friendly economic

management in one year. A phased program to reduce excessively high tariffs
would enhance credibility.

Successful negotiations with labor unions in public and organized pvt. Sector
must be carried out for smooth transformation from job protection in inefficient
industry to seeking better jobs in a liberalized economy in which employment
opportunities are rapidly growing and plentiful.

Full convertibility of rupee on current account would help in bringing down

export subsidies..