Chapter II - Economic Reforms in Nutshell - Revised

8/12/2019 Chapter II - Economic Reforms in Nutshell - Revised

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Economic Reforms and Employment Growth in India Economic Reforms in Nutshell

CHAPTER II

Economic Reforms in Nutshell

There are many important years in the history of India, but as far as economic

history is concerned, the year 1991 has definitely to be termed as a landmark. It

saw fundamental changes in the economic policies of the country. In the beginning

of the year, the country faced a severe economic crisis, which was partly triggered byserious balance of payments situation. The crisis made the government of the day

to have a fresh look at the economic policies. The need for having drastic changes

in the economic policies was realied and this led to the initiation of economic

reforms. It was realied that the roles of state and market have to be redefined, if

productivity and efficiency of the system have to be improved. !ince its introduction

in 1991, economic reforms have covered several areas. In the following paragraphs,

the reforms that have been undertaken in some of the areas so far have been

mentioned in brief.

1. Removal of Industrial Licensing

Industrial licensing in India is governed by the Industries "#evelopment and

$egulation% &ct, 19'1. In the pre(reforms era, the country practiced a system of

industrial licensing under which a license was re)uired before setting up any large

industrial unit. It was thought the licensing system would enable best allocation of

the available resources. *owever, the system only led to delay, harassment, lower

production and inefficiency. This led to a change in the mindset and it was realied

that in order to have a sustained growth in productivity, enhance gainful employment,

attain optimum utiliation of human resources, attain international competitiveness

and transform India into a ma+or partner in the global arena, industrial licensing

policy need to be liberalied. &ccordingly, the list of items re)uiring compulsory

licensing has been coming down in the past few years. Today, all industrial

undertakings are eempt from obtaining industrial license to manufacture, ecept for

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"i% industries reserved for the -ublic !ector "ii% industries retained under compulsory

licensing "iii% items of manufacture reserved for the small scale sector and "iv% if the

proposal attracts locational restriction. &s regards locational restrictions, it has to be

noted that industries located within ' km. of the periphery of the standard urban

area limits of a city with a population of more than one million re)uire a license. This

condition, however, does not apply to electronics, computer software, printing and

certain other non/polluting industries and units located within designated industrial

areas.

2. Removal of Restrictions on oreign Investment

In the pre(reforms era, foreign investment was not fully welcome. In fact, it

was restrictive. In most areas, it was limited to 02. 3a+ority ownership was an

eception rather than the rule. It was feared that foreign investment would restrict

the growth of domestic industries. The result was lower investment and lesser

growth. Today, the scenario is different and foreign investment is being welcomed in

a big way. -romotion of foreign direct investment forms an integral part of India4s

economic policies. 5veryone realies that foreign direct investment can accelerate

economic growth by infusing capital, technology and modern management practices.

6e now have a liberal and transparent foreign investment regime where most

activities are opened to foreign investment on automatic route without any limit on

the etent of foreign ownership. The 7overnment has now allowed 12 8#I under

automatic route in printing of scientific and technical magaines, periodicals and

+ournals, petroleum product marketing, oil eploration in both small and medium

sied fields and also for petroleum product pipeline. 8#I up to 12 is now permitted

for natural gas:;7 pipeline with prior 7overnment approval. !ome of the recent

initiatives taken to further liberalie the 8#I regime, inter alia, include opening up of

sectors such as insurance "2. In

the civil aviation sector, 8#I up to >2 is allowed in domestic airlines. In case of

airports, 8#I can go up to 12 with 7overnment4s approval.

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!. Reduction in Im"ort #uties and Phasing out of $uantitative Restrictions

In order to protect domestic industries, import substitution formed a ma+or

plank of India4s foreign trade policy. The Indian economy was over(protected and

inward looking till 1991. This policy only led to domestic industries producing low

)uality goods at high prices. The high cost of imports also adversely affected import

of modern technology. This led to technological lag and the eport industries also

could not show good performance.

The fallacy of having high customs duties was realied and the government

started undertaking reforms in this sector. The peak rate of customs duties, which

was as high as per cent in 1991, came down to 0'2 in due to progressive

decline in the rates over the past few years. The average tariff duty in 1991(9 was

1?2, along with a very large number of separate tariff rates across commodity

groups and also coupled with many eemptions. In 1(, the average import duty

"total% was 0=.12 and this was reduced to 00.=2 in (0. The peak rate of

customs duties now stands at 1'2 "as proposed in the @udget '(


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li)uidity re)uirements through which banks were re)uired to invest in government

securities have been drastically reduced. Bommercial banks are increasingly

entering new businesses such as merchant banking, underwriting, mutual funds and

leasing, usually through subsidiaries. Bomputeriation of bank operations has been

taken up on a very large scale. To enhance competition, many new private sector

banks, including some more foreign banks have been allowed entry into the market.

$@I supervision over commercial banks and other financial institutions including non(

bank financial companies has been strengthened. Issues relating to autonomy of

bank managements are being given due attention.

-. Li'eralisation of Ca"ital )ar*et

Bapital market is a ma+or vehicle for converting savings into investment. It is

also the preferred investment destination of foreign savings. The capital market has

been considerably liberalied. Borporates are now free to issue capital and price

their issues. 8oreign Institutional Investors "8IIs% are now permitted to invest in the

Indian market. The Indian companies have been allowed to access foreign markets

for raising e)uity and debt finance.

There was a free for all atmosphere in the stock market prior to the

introduction of regulation of capital market. There were many scandals and

scams in the stock market, which pauperied many small investors, before the

stock market came under the control of the government. The setting up of !5@I

"!tock 5change @oard of India% has greatly helped the government to keep an eye

on the stock market and regulate it to protect small investors. !5@I has been able to

control insider trading, regulate large ac)uisition of shares and improve the trading

practices in stock echanges. It has been able to revamp the governing boards of

stock echanges, which till recently were predominantly the domain of the broker

community. The dematerialiation of shares has been introduced. !tock 5changes

have introduced screen(based trading.

. Entr( of Private ,ector in Pu'lic ,ector Areas

The most laudable measure taken under the process of economic reforms, is

the opening up of areas to private sector hitherto reserved for the public sector. &

few of these areas are the telecom, power, T.C and $adio broadcasting, and the civil

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aviation. Today, there are many players in the telecom and civil aviation sectors, and

T.C and $adio broadcasting.

-ower sector reforms were initiated in 1991 to encourage competition in each

sub element of the sector, namely, generation, transmission and distribution under

an independent and transparent regulatory regime. The Bentral 5lectricity

$egulatory Bommission "B5$B% has been set up at the national level and !tate

5lectricity $egulatory Bommissions "!5$B% has been set up at state levels. Today,

private sector can involve itself in generation, transmission and distribution.

/. Privatisation

In the post Independence era, till the beginning of economic reforms, the

industrial scenario was dominated by the public sector. It was believed that if the

country has to be economically self(reliant, then public sector should play a dominant

role in the economy. The Industrial -olicy $esolution of 19'< and the adoption of the

socialist pattern of society led to deliberate enlargement of public sector. The

general thinking in the government was that a dominant public sector would go a

long way in reducing the ine)uality of income and wealth and also advance the

general prosperity of the nation. This was because the goal of public sector is public(

good and not profits. 8urther, since, in the first few years of Independence, private

capital was lacking, the Bentral government had to make large investment in heavy

industry, fuel and infrastructure. There was also a school of thought that profits made

by public enterprises can be ploughed back into the economy and this can push up

growth of industrial sector further. The different and fleible pricing policy with regard

to public sector undertakings was also advanced as an argument for having more

and more undertakings in the public sector. The government can follow a policy of

average price being e)ual to or higher or lower than the average cost depending on

the type of commodity being manufactured by the public enterprise.

6ith the passage of time, many of the public undertakings started making

losses and had to depend on budgetary support for their survival. The reasons were

poor management, non(accountability, corruption, political interference, lackadaisical

attitude of workers etc. The losses started mounting and this changed the mindset of

the government with regard to public enterprises. It was realied that government

should move away from manufacturing activities and concentrate more on social

sectors. 3any eminent economists argued that the government must not venture into

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those areas where the private sector can undertake the +ob efficiently. The

government also started feeling that the role of state should be that of a regulator

and a facilitator rather than of the producer. &ccordingly, the government initiated

reforms in the public sector, through privatiation and disinvestments of public sector

enterprises. !o far "Dune, '%, 1> public enterprises have been privatied. !ome

of these are 3odern 8ood Industries :imited, @harat &luminum Bompany :imited,

B3B :imited, I@- Bompany :imited, C!;:, IT#B, 3aruti Edyog :imited, Indian

-etrochemical Borporation :imited etc. The disinvestments done from 1991(9 to

>(' generated total revenue of about $s. >=.< thousand crore against a target

of about $s. 9 separate rates into which commodities were grouped. Today, the maimum

rate of ecise is 12. There may

ultimately be a single B5;C&T "Bentral Calue &dded Ta% of 1


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only three ta slabs as far as income ta is concerned. The minimum rate is 12

and the maimum is 02. There is a surcharge of 12, but the same is leviable only

on taable income of $s.1 lakh and above. There is no ta on annual income up to

$s.1 lakh. &s far as corporate ta is concerned, it is now 02 for domestic

companies. There is also a surcharge of 12.

11. Introduction of ,ervice Ta&

!ervice ta was introduced in 199> in order to eplore new avenues for

taation and bring more people into the ta net. In the beginning, the service ta rate

was '2 and was levied only on three services, vi., service rendered by the

telegraph authorities to the subscribers in relation to telephone connections, service

provided by the insurer to the policyholder in relation to general insurance business,

and service provided by a stockbroker. !ervice ta is now firmly on board today and

covers more than crore in 199>(9' for the central government but

the revenue has been going up very sharply every year. The total revenue from

central service ta was $s.


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cent by the end of the 5leventh 8ive Gear -lan. 3any states have already reduced

the rate of !tamp #uty. 6ith regard to rationaliation of property ta, not only the

rate has been brought down in #elhi, but the methodology for assessing the property

ta has also been changed from ratable value to plinth area of the property.

1!. #o3nsi4ing ,taff in 5overnment

The implementation of recommendations of the 8ifth -ay Bommission led to a

sharp increase in government wage bills, resulting in a high growth rate of non(

developmental ependiture thereby causing a large fiscal deficit. The mounting non(

developmental ependiture became a matter of deep concern for the central

government and therefore, the government set up an 5penditure $eforms

Bommission in 8ebruary, to go into various aspects of government ependiture

and make recommendations to bring down government4s ependiture. The

5penditure $eforms Bommission submitted its report in 1 volumes. !ome of its

recommendations are being implemented, which includes downsiing the staff in

central government. The central government has already reduced its staff strength

in many of its departments and the eercise is continuing.

1%. Pension Reforms

The upward revision of pay and allowances of Bentral 7overnment

5mployees due to recommendations of various -ay Bommissions has definitely

been increasing the non(developmental ependiture of the government. In this

connection, the sharp escalation in the wage bill and pension payments of Bentral

7overnment made the government not only to start downsiing the staff, but also

find resources for payment of pensions. Bonse)uent to the implementation of the

recommendations of the 8ifth Bentral -ay Bommission, the salary bill and pension

outgo of the Bentral 7overnment civil ministries and departments including defence

services "ecluding Telecom, -ost H $ailways% escalated sharply by 00.< per cent

and 0' per cent respectively. &s a proportion of net revenue receipts "of Bentral

7overnment%, ependiture on pensions after increasing from 0.9 per cent in 199(91

to =.92 in 1999(, started declining from 1( to reach '.? per cent in 0(

> "$evised 5stimates%. The compound annual average growth rate of the pension

outgo of the Bentral 7overnment was 12 during the 199s.



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Enfunded pensions have been a ma+or fiscal drag world over. Feeping in

view the ever(increasing burden of pension payments, the Bentral 7overnment, in

order to lessen its burden, has introduced a new restructured defined contribution

pension system. The ;ew -ension !ystem ";-!%, which has been introduced with

effect from Danuary >, is applicable to all new entrants to 7overnment service,

ecept armed forces. The ;-! will be available, on voluntary basis, to all persons

including self(employed professionals and others in the unorganied sector.

1+. Introduction of 6alue Added Ta&

ne of the important ta reforms that has been undertaken recently is the

introduction of !tate(level Calue &dded Ta to replace the sales ta. C&T is

considered as one of the best practices in taation all over the world. The C&T

system has been introduced in India with effect from &pril '. The underlying

principle behind adoption of C&T is that taes on commodities and services must be

based on consumption "on consumers% and not on sales "traders%. ne of the ma+or

advantages of C&T over sales ta is that the former is non(cascading. C&T is a multi(

point levy on each of the entities in the supply chain with the facility of set(off of input

ta / that is , the ta paid at the stage of purchase of goods by a trader and on

purchase of raw materials by a manufacturer. nly the value addition in the hands of

each of the entities is sub+ect to ta. 8or instance, if a dealer purchases goods for

$s.1 from another dealer and a ta of $s.1 has been charged in the bill, and he

sells the goods for $s.1 on which the dealer will charge a ta of $s.1 at 1 per

cent, the ta payable by the dealer will be only $s., being the difference between

the ta collected and the ta of $s.1 already paid on the purchases of $s.1.

Thus, the dealer has paid ta at 1 per cent on $s. being the value addition in his

hands.

1-. Reduction in ,u'sidies

!ubsidies have always formed a ma+or component of non(development

ependiture of the government. ver the years, a number of subsidies, both direct

and indirect, have come into eistence. !ubsidies eist in almost all the sectors of

the economy. $ealiing that the economy cannot continue to bear the burden of

subsidies and that many of the subsidies are accruing to the non(intended

beneficiaries, the Bentral 7overnment has adopted a target(oriented approach and



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is slowly bringing down non(transparent and non(targeted subsidies. The Tenth -lan

has emphasied the need for progressive reduction in fertilier subsidy as well as

elimination of petroleum subsidy. The subsidy on :-7 has been drastically reduced.

The need for identifying subsidy element in irrigation, water charges, bus fares etc.,

and reducing the subsidy element in a phased manner, has also been emphasied in

the Tenth -lan.

1. Enactment of iscal Res"onsi'ilit( and 7udget )anagement 8R7)9Act: 2!

& landmark step taken by the Bentral 7overnment for the purpose of bringing

down fiscal deficit is the enactment of 8iscal $esponsibility and @udget 3anagement

"8$@3% &ct, 0 "as amended%. The 8$@3 &ct has been operationalised with the

notification of rules in Duly >. Ender the provisions of the &ct and the rules, the

7overnment is mandated to eliminate revenue deficit by 3arch 9 and reduce

fiscal deficit to an amount e)uivalent to 0 percent of 7#- by 3arch ?. $evenue

deficit constituted more than =2 of fiscal deficit in the past few years. $ising

interest payments, ependiture on subsidies, pay and allowances, and pensions

coupled with a near stagnant ta(7#- ratio have mainly contributed to the

worsening of revenue balance. The revenue deficit reached a peak of >.> per cent

of 7#- in 1( and remained at the same level in (0. It declined to 0.< per

cent of 7#- in 0(> "provisional%. !ince the 8$@3 &ct has been

operationalised, the revenue deficit may start earning down and may be fully

eliminated by 9.

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Chapter II - Economic Reforms in Nutshell - Revised