REPORT FOR THE FINAL PROJECT BUSINESS ENVIRONMENT Term III TOPIC: ECONOMIC REFORMS IN INDIA

Submitted to:
Prof. SubhasankarChattopadhyay

Submitted by:
Group 10 Section B GauravModi(2009082) HemantPunamiya(2009086) AsbahFarooqui(2009096) AshishPariath(2009100) Janam Dave (2009112)

INTRODUCTION
India's business environment has evolved and transformed itself at a much faster pace in the recent years. India is now one of the most attractive destinations for doing business because of its booming economy, a relatively good GDP and other economic indicators. All of this has become possible because of the economic reforms which were initiated in 1991. India has not looked back since then. Introduction of economic reforms has enabled India to break free from the shackles of financial turmoil and head towards attaining economic self-sufficiency. It unshackled what was then called a caged tiger. Economic reforms have had a considerable impact in improving living conditions of the common man of India.

ECONOMIC POLICIES OF PRE-LIBERALIZED INDIA

Economic policy followed by the Indian Government after independence was very much influenced by the principle of socialism and the colonial experience. Indian economic policy post-independence was marked by protectionist attitude with strong focus on import substitution, intervention by the state in financial and labour markets, industrialization & a large public sector. Moreover, the structural economic problems inherited at independence worsened because of the costs associated with the partition of British India. The cost involved in settlement of the refugees post partition had a severe impact on Indias financial condition. The industrial policies of independent Indias first prime-minister, Jawaharlal Nehru, emphasized greatly on encouraging the growth of heavy industries and manufacturing units. However, because of regulations, interventions and controls put in place by the state, such policy resulted in the impairment of productivity, quality and profitability. As a result, Indian economy grew with an anemic growth rate and there was an escalation in the unemployment levels in the economy which was characterized by poverty on a large scale. India ran into trade deficits post independence which increased in magnitude in the 1960s. Borrowing money from abroad or the private sector was not an option for the Indian government during that time since the government was running under budget deficit rather than budget surplus.As a result, it had to issue bonds to RBI so as to increase the money supply resulting in inflation. Moreover, devaluation of the Indian currency was a serious problem during the mid 1960s. Foreign aid which was a key factor in preventing devaluation of Indian currency was stopped by many countries, like the

USA, which were friendly towards Pakistan during the Indo-Pak war of 1965. Also, there was a severe drought in the mid 1960s that led to devaluation of the Indian rupee. The Indian Economy grew a rate of 3.5% and at an annual rate of 1.0 percent per capita during the period of 1950-1980.Although Indian leaders expected favourable outcomes of implementing the strategy based on direct and indirect state intervention, such strategy resulted in discouraging the judicious use of natural business acumen and abilities of the population. License Raj which lasted for over 4 decades was an important factor which resulted in economic stagnation of India. In License Raj, upto 80 government agencies had to be satisfied before private companies could produce something and if the private companies were granted permission to produce, then government would regulate production. This is how License raj impeded Indias economic progress. In the late 1980s, Rajiv Gandhi Government reduced corporate taxes and relaxed restrictions on capacity expansion. Although these steps resulted in an increased growth rate, it also resulted in an increase in fiscal deficit and a deteriorating current account. Disintegration of the Soviet Union and the first Gulf war resulted in an increase in the oil price which led to a major balance-of-payments crisis for India. In order to avoid the crisis, the P. V. Narsimha Rao led Indian Government along with the then finance minister Dr. Manmohan Singh made sweeping changes in Indias economic policy which propelled India towards the path of economic progress.

1991 INDIAN ECONOMIC CRISIS: TRIGGER FOR ECONOMIC REFORMS By the end of 1990s, India was in the midst of a severe balance-of-payments crisis. This economic crisis was primarily due to the large and growing fiscal imbalances over the 1980s. The gross fiscal deficit of the government rose from 9% of GDP in 1980-81 to 12.7% in 1990-91. As stated earlier, disintegration of Soviet Union, which was Indias main trade partner, and the first Gulf war increased Indias oil import bill, reduced Indias exports and eventually Indias credit dried up and investors took their money out of the Indian economy. Indias foreign exchange reserves had dried upto such an extent that India could only finance three weeks worth of imports. India was now only weeks away from defaulting on its external payments obligations. Owing to drought and large government budget deficits, there was a sharp rise in prices due to inflation. India now had to airlift gold in order to pledge it with IMF for a loan so that India could recover from this crisis. This threatening crisis was eventually tackled by the duo of Prime Minister P. V. Narsimha Rao and Finance minister Dr. Manmohan Singh, who ushered in several economic reforms in the Indian economy.

ECONOMIC POLICIES OF POST-LIBERALIZED INDIA

India embarked on the path of economic reforms only in 1991 when it was faced with the balance-of-payment crisis; hence it was a latecomer to this entire concept of economic reforms as compared to other countries around the world having good economic conditions. Unlike some of the East Asian economies, which achieved high growth and lower poverty levels through policies focusing on greater export orientation and encouragement of private sector, India realized much later that it needs to make a systemic shift to a more open economy with greater emphasis on market forces, a major role of the private sector and relooking the role of Indian government in managing the economic affairs of the country. Economic reforms initiated by the Indian Government can be broadly classified into macro-economic reforms and micro-economic reforms. Wide range of macroeconomic reforms were undertaken which can be divided into y y y y Fiscal Policy Monetary Policy Trade Policy Exchange Rate Management

FISCAL POLICY In India, the tax system for direct as well as indirect taxes was very complex. Maximum marginal personal income tax rates as well as corporate tax rate were very high. As a result, over the entire reform process, the personal income tax as well as corporate tax rates have been brought down to 30% along with significant simplification. Similarly, indirect taxes in the form of custom tariffs and domestic excise duties were at high levels. An intensive programme of continuous reforms spanning over 15 years have resulted in the rates of custom duties getting reduced from the 1991 levels of 110 percent to a peak of 12.5 percent in 2006. There has been a significant simplification of the excise tax structure to achieve a central rate of 16%. Moreover, excise which is levied at the manufacturing stage is now levied as Value Added Tax in order to avoid cascading. Also, the introduction of service tax which levies tax from the whole economy has reduced excessive burden on one sector i.e. the manufacturing sector.Moreover, transformation of state level sales taxes to Value Added Tax (VAT) has made the state tax system more rational and uniform. Initiative like the introduction of Fiscal Responsibility and Budget Management Act (FRBM) in 2004 requires the government to eliminate the revenue

deficit and reduce its fiscal deficit to 3% of GDP by 2009. Thus, overall, fiscal reform process over the past 15 years has been wide ranging.

MONETARY POLICY As far as reforms in the monitory policy are concerned, large number of measures has been taken by the government. In the 1970s and the 1980s, monetary policy was almost non-existent. Some of these measures include elimination of automatic monetization, reduction of statutory pre-emption of the lendable resource of the banks and deregulation of the interest rate. Because of these measures, the country has become successful in restoring the independence of the monetary policy and the central bank. Also, there was a subsequent shift from direct to indirect instruments of monetary policy. All these changes have resulted in the reduction of average inflation rates from an average of 7-8 percent over the period of the first forty years since Indias independence to around 5% since the late 1990s.

EXERNAL SECTOR REFORMS Over a long period of time due to existing trade restrictions, the exchange rate was overvalued. Hence the first step during the implementation of economic reforms was an ex ante real devaluation of the exchange rate. The trade system underwent massive changes with the introduction of some sort of rationalization in the tariff structure. As mentioned earlier, by implementing such reforms, the peak rate of tariff reduced from 400 % to 12.5% for non-agriculture products. The same effect has not been observed for agricultural products because of the stubbornness of the developed countries in reducing their farm subsidies. More recently, India has begun to play an active role in trade negotiations by participating in number of trade agreements with different countries around the world. Thus, with the changes in the exchange rate management and the effective implementation of the trade reforms the current account is now open along with limited capital account convertibility.

MICRO-ECONOMIC REFORMS Some of the major areas where microeconomic reforms have taken place are agriculture, infrastructure, industrial sector, capital markets and the financial sector.

REFORMS IN THE INDUSTRIAL SECTOR: First major reform introduced in this sector was the industrial deregulation. System of licensing of industries was eliminated, legislative restrictions on expansion plans of large companies were lifted, and reservation of industries for investment only by the public sector was removed. Moreover, restriction on foreign investment was made to do away with and the new policy welcomed foreign direct investment into India. Such reforms encouraged competition in the market. REFORMS IN THE INFRASTRUCTURE SECTOR: Sensing the need of increased investment in the infrastructure sector, the government permitted the involvement of private sector in infrastructure which had restricted earlier. This necessitated formation of regulatory authorities and introduction of new legislations. One of the success stories is the exponential growth of telecom sector. As far as reforms in the field of roadways are concerned, some of them are: financing highway construction through imposition of fuel cess, commissioning of National Highway Development Project and Prime Ministers Gram Sadak Yojna or the Rural Roads Programme. Moreover, government allowed private operators along with formation of Tariff Authority of Major Ports in order to regulate and develop Indias ports. Reforms were made in the area of civil aviation also by allowing operation of new private airlines, new private airports and beginning of an open skies policy. However, reforms have not been entirely successful in some sectors of infrastructure such as power. State electricity boards continue to suffer from loses because of inadequate tariff and distribution losses. Private sector expansion in this sector has been limited because of the threat of insecurity of payment. Urban infrastructure and railways are some of the other sectors wherein reforms have taken place but still a long way to go so as to achieve success. REFORMS IN THE FINANCIAL SECTOR: Measures encouraging competition were one of the major trademarks of financial sector reforms. Operational autonomy and partial disinvestment of public ownership in public sector banks, listing of almost all public sector banks, permission for FDI and portfolio investment in banking, entry of foreign and new private banks were some of the major steps taken as part of financial sector reforms. Transparency in the accounts and the operations of the banks has increased because of the introduction of partial private sector ownership in the public sector bank. Thus, it improved the financial health of the Indian banking system. Insurance sector was also not left behind; new private insurance

companies were introduced with limited foreign ownership. Before reforms, all insurance was in the public sector, with just one life insurance Company and four general insurance companies. This move necessitated formation of Insurance Regulation & Development Authority (IRDA) so as to regulate the insurance industry. There were reforms made in the capital market structure as well with the formation of the capital market regulator named the Securities and Exchange Board of India (SEBI), a new modern technology oriented stock exchange named the National Stock Exchange (NSE). Moreover, private sector mutual funds were allowed along with the removal of Controller of Capital Issues (CCI) who controlled the issuance of securities and administered their prices. However, there is one area which needs considerable attention and that area is the corporate bond market. REFORMS IN THE AGRICULTURE SECTOR: Among all the sectors contributing to the economy, this sector has had a relatively little impact through economic reforms. Effectiveness of trade reforms in agriculture has been constrained because of the lack of progress at WTO negotiations and reluctance of developed countries in reducing their farm subsidies. Nevertheless, there have been number of significant reforms in the agriculture sector also such as removal of constraints on inter-state movement of food grains, restructuring of the public distribution system & allowing forward trading in most agricultural commodities. However, one needs to focus on this sector in order to revive a stagnating agricultural economy.