LIBERALISATION

INTRODUCTION:

The objective of liberalisation is to induct competitive-forces

into the economy. More specifically, liberalised industrial
policies are targeted to increase competition and to obtain
efficient outcomes in industry. In a world without market
imperfections and externalities, liberalised markets would lead
to a first-best Pareto optimal situation.

But in a second-best world of imperfections, it becomes

important to trace the implications of these liberalisation
policies. Liberal industrial policies can have competitive
outcomes only in the absence of entry barriers. Liberalisation
policies remove artificial barriers to entry by new firms, and
allow capacity expansion of incumbent firms.

However, the existence of natural barriers indicates imperfect

competition as reflected in the industry. Economic liberalization
of India means the process of opening up of the Indian
ecomony to trade and investment with the rest of the world. Till
1991 India had a import protection policy wherein trade with the
rest of the world was limited to exports.

1|Page
Foriegn invetment was very difficult to come into India due to a
bureaucratic framework. After the start of the economic
liberalization, India started getting huge capital inflows and it
has emerged as the 2nd fastest growing country in the world.

The economic liberalisation in India refers to ongoing economic

reforms in India that started on 24 July 1991. After
Independence in 1947, India adhered to socialist policies.
Attempts were made to liberalize economy in 1966 and 1985.
The first attempt was reversed in 1967. Thereafter, a stronger
version of socialism was adopted. Second major attempt was in
1985 by the then Prime Minister Mr. Rajiv Gandhi/Rajeev
Gandhi. The process came to a halt in 1987, though 1966 style
reversal did not take place. In 1991, after India faced a balance
of payments crisis, it had to pledge 20 tons of gold to Union
Bank of Switzerland and 47 tons to Bank of England as part of
a bailout deal with the International Monetary Fund (IMF).

In addition, IMF required India to undertake a series of

structural economic reforms. As a result of this requirement, the
government of P. V. Narasimha Rao and his finance minister
Manmohan Singh (currently the Prime Minister of India) started
breakthrough reforms, although they did not implement many of
the reforms IMF wanted.

2|Page
The new neo-liberal policies included opening for international
trade and investment, deregulation, initiation of privatization,
tax reforms, and inflation-controlling measures.

The overall direction of liberalisation has since remained the

same, irrespective of the ruling party, although no party has yet
tried to take on powerful lobbies such as the trade unions and
farmers, or contentious issues such as reforming labour laws
and reducing agricultural subsidies.

Thus, unlike the reforms of 1966 and 1985 that were carried out
by the majority Congress governments, the reforms of 1991
carried out by a minority government proved sustainable world.

The fruits of liberalisation reached their peak in 2007, when

India recorded its highest GDP growth rate of 9%. With this,
India became the second fastest growing major economy in the
world, next only to China. The growth rate has slowed
significantly in the first half of 2012.

An Organisation for Economic Co-operation and Development

(OECD) report states that the average growth rate 7.5% will
double the average income in a decade, and more reforms
would speed up the pace.

3|Page
Indian government coalitions have been advised to continue
liberalisation. India grows at slower pace than China, which has
been liberalising its economy since 1978.

The McKinsey Quarterlystates that removing main obstacles

"would free India’s economy to grow as fast as China’s, at 10
percent a year".

There has been significant debate, however, around

liberalization as an inclusive economic growth strategy. Since
1992, income inequality has deepened in India with
consumption among the poorest staying stable while the
wealthiest generate consumption growth .

For 2010, India was ranked 124th among 179 countries in

Index of Economic Freedom World Rankings, which is an
improvement from the preceding year.

The Pre-liberalization Era – Prior to 1991

The Post Liberalization Era -- The Present Era

PRE-LIBERALIZATION :

India has been following a highly protective industrial and

foreign trade regime since 1951.

4|Page
The protective regime controlled not only entry into industry and
capacity expansion but also technology, output mix and import
content. Due to high tariffs before the liberalization period, most
Indians firms enjoyed protection of some kind or the other. Free
imports were not forthcoming.

Before the process of reform began in 1991, the government

attempted to close the Indian economy to the outside world.

The Indian currency, the rupee, was inconvertible and high

tariffs and import licensing prevented foreign goods reaching
the market. Manufacturers had a field day as this situation
continued for a long time, leading to the creation of artificial
scarcity even for basic items.

The liberalisation of Indian economy started gradually in the

1980's and major economic liberalisations (structural
adjustment programs) began from 1991.

Due to the policies of Indian government:

• India had “A Balance of Payments” crisis in 1991 which

pushed the country to near bankruptcy. With India’s
foreign exchange reserves at $1.2 billion in January 1991
and depleted by half by June, barely enough to last for

5|Page
 roughly 3 weeks of essential imports, India was only
weeks way from defaulting on its external balance of
payment obligations. The caretaker government in India
headed by Prime Minister Chandra Sekhar’s, 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 airlift 47 tons of gold to the Bank of England
and 20 tons of gold to the Union Bank of Switzerland to
raise $600 million.

• The Rupee devalued and economic reforms were forced

upon India.

• India central bank had refused new credit and foreign

exchange reserves had reduced to the point that India
could barely finance three weeks worth of imports .

LIBERALISATION:

In general, liberalisation refers to a relaxation of previous

government restrictions, usually in areas of social or economic
policy.It refers to loosening or removal of controls so that
economic development gets encouragement.

6|Page
It includes abolition of those economic policies,rules,
regulations, administrative controls and procedures which
impede economic development.In other words economic
liberalisation is a new economy policy of promoting market
determine determined economic decisions rather than
bureaucratic arbitrary economic decisions.

ECONOMIC LIBERALISATION IN INDIA

The economic liberalisation in India refers to ongoing

economic reforms in India that started on 24 July 1991 and are
still being followed.

Attempts were made to liberalize economy in 1966 and 1985.

And finally in 1991, after India faced a balance of payments
crisis ,new economic policies were introduced leading to
economic liberalisation of india.

The Policies of Liberalization Included the Following:

 Opening the Gate for International Trade and Investment.

 Deregulation (The removal of government controls from an

industry or sector, to allow for a free and efficient
marketplace).

7|Page
  Freedom for expansion and production.

 Increase in the investment limit of the small industries.

 Tax Reforms.

 Initiation of Privatization.

 Inflation Controlling Measure

 Freedom to import capital goods and technology.

Government liberalisation policies have been structured

toRevitalize Indian industry by infusing it with a greater degree
of competition.

As opposed to earlier policies which directed investment in

industry to what were understood to be 'nationally desirous' in a
protected environment, liberalisation allows a manufacturer
greater liberty in selecting investment levels and output
patterns according to the dictates of the market. Liberalisation,
by systematically deregulating industry and cutting down
restrictions on trade (especially imports), aims at infusing
greater competition into the industrial sector and thereby
increasing growth and efficiency.

8|Page
Liberalisation policies in India had a modest beginning in the
late 1960s to remedy the foreign exchange and fiscal problems
faced by the economy. The relative merit of the market as
opposed to state directed development began gaining support
onaccount of three problems facing the economy from the late
1960s.The first was the prolonged stagnation in the industrial
sector .

Liberalisation of industrial and trade policies will improve

industrial efficiency by:

(a) providing greater access to imported intermediate inputs ,

capital goods and technology:

(b) exposing domestic producers to competition, external and

internal, and thereby force them to reduce costs, and

(c) lifting the growth and size of firms so as to exploit scale

economies.

Improvement in efficiency and the resultant reduction in costs

will stimulate domestic demand and enable India's industrial
products to compete abroad, thereby relaxing demand-side
constraints on industrial growth."

9|Page
C Goldar 1990:603^ Until 1991 there was no one official policy
statement setting out explicitly what the new economic policy
was and what it intended to achieve. The novelty of the policy
was perceived only when changes in policy and procedures
relating to industrial licensing, exchange rate policy, import
policy along with some observations about the need for
rationalising and simplifying the systems of fiscal and
administrative procedures were pieced together, (policies that
are directed at the industrial sector can be classified into two
categories:

(a) domestic,.Iiberaiisation

(b) trade liberalisation. This distinction is made because in the

Indian context these two have not been implemented in
tandem. Domestic liberalisation not only pre-dates trade
liberalization but has been more systematic.

DOMESTIC LIBERALISATION

Domestic; liberalisation policies sought to redefine the contours

o-f the state and market in -favour of the market in the domestic
sphere of economic activity. These policies were aimed at
deregulation and privatisation.

10 | P a g e
To translate these objectives into policy terms, the government
formulated the following measures to facilitate capacity and
output expansion and to remove procedural impediments to
investment and growth of firms.

Delicensing: A number of industries (apart from the small-scale

sector) were progressively delicensed by the time the New
Licensing Industrial Policy CNILP3 was enunciated in 1991.

NILP delicensed all industries irrespective of size of investment

or the ownership of the undertaking except 18industries which
still required licensing. The number of industries was later
reduced to 15.

Broadband!ng: Diversification in specified industries was

permitted without obtaining an industrial license, initially subject
to the condition that the firm did not come "under the purview of
Monopolies and Restrictive Trade Practices CMRTP3 Act &
Foreign Exchange Regulations Act EFERA3.

This policy was designed to introduce some flexibility into the

licensing mechanism and to enable manufacturers to utilize
their capacities more efficiently and fine tune their product mix
in response to market demand. This scheme commenced with
the machine tools industry in 1983, and the list grew steadily.

11 | P a g e
In August 1988, the government announced that the broadband
mg facility would be available for companies that came under
the purview of the MRTP and FERA in Appendix A. and would
be subject to export obligations in respect of non— Appendix A
companies.

This policy measure lost its relevance due to the liberalised

licensing policy in the NILP C19913.Re-endctrsement al'
Capacity: Licensed capacity in selected industries was
increased by an additional 257.

Over and above the highest production level achieved during

the previous five years. Also, automatic growth was allowed.

This policy became redundant after the NILP C19913 when

licensing was limited to a small list of industries. Minimum
Economic Scale: Minimum capacities of operation were
prescribed in select industries in order to exploit economies of
scale.

This was with a view to increase efficiency in units that could

not exploit scale, economies because of the stringent licensing
laws. As on February1990, 106 products in 14 broad industrial
groups had a prescribed minimum economic scale of operation.

12 | P a g e
• Opening up the Public Sector: Areas that were earlier
under the exclusive purview of the public sector were
gradually opened up to the private sector. The policies of
broadbanding, re-endorsement of capacity and the
prescription of MES were part of the earlier liberalization
packages before the large-scale delicensing in the NILP
C19911made them redundant.

• Amongst these policies, the stipulation of MES was aimed

at increasing the efficiency of industries where size was
pivotal to efficiency. If firms had been constrained by small
size in the pre-1iberalisation period, they could expand to
MES and beyond to obtain efficiency gains.

• But for the new firms,since entry had to be large-scale?,

the cost of entry increased creating an entry barrier. This
policy thereby threw up two problematic outcomes when
dealing with the question of MES and the anti-competitive
outcomes of such a policy in terms of concentration and
firm size.

• Industrial organization lias shown that the relationship

between size of entry and the anti—competitive effect of
large sire is not so simple.

13 | P a g e
IMPACT OF LIBERALIZATION ON INDIAN ECONOMY:

• Total foreign investment rising from

US$ .132 billion in 1991–92 to
US$ 5.3 billion in 1995–96.

• Annual growth in GDP(shown in graph below)

As we can see in the above graph the GDP increasing

continuously after 1991 and rising upto 7 times in 2010.

 Arrival of New Technology or Development of

Technology.

 Development of Infrastructure.
14 | P a g e
 Identity at World Level

 Increase Consumption and Adaptation of New Lifestyle

By the mid-90s, the private capital had surpassed the public

capital. The management system had shifted from the
traditional family based system to a system of qualified and the
liberalization era has been the emergence of a strong, affluent
and buoyant middle class with significant purchasing powers
and this has been the engine that has driven the economy
since.

 Increase in Employment

 Increase Our Currency Value (INR)

 On agriculture

 On education

 On export and import

 On money market

 On human resources
15 | P a g e
 On life styles

 The low annual growth rate of the economy of India before

1980, which stagnated around 3.5% from 1950s to 1980s,
while per capita income averaged 1.3%. At the same
time, Pakistan grew by 5%, Indonesia by 9%, Thailand by
9%, South Korea by 10% and in Taiwan by 12%.

 Only four or five licences would be given for steel,

electrical power and communications. License owners
built up huge powerful empires.

 A huge public sector emerged. State-owned enterprises

made large losses.

 Income Tax Department and Customs Department

manned by IAS officers became efficient in checking tax
evasion.

 Infrastructure investment was poor because of the public

sector monopoly.

 Licence Raj established the "irresponsible, self-

perpetuating bureaucracy.

16 | P a g e
 LIBERALISATION CAN BE DIVIDED AS FOLLOWING:-

Components of
liberalisation

Industrial
in
liberalisation Fiscal
liberalisation

Financial
Trade
liberalisation
liberalisation

INDUSTRIAL LIBERALIZATION:

Industrial Sector was among the first sectors to be liberalized in India in

a series of measures.

Industrial licensing has been abolished except in a small number of

sectors where it has been retained on strategic considerations.

 Reduction in the reservation of public sector:

The list of industries reserved solely for the public sector --which used to
cover 18 industries, including iron and steel.
Heavy plant and machinery, telecommunications and telecom
equipment, minerals, oil, mining, air transport services and electricity

17 | P a g e
generation and distribution --has been drastically reduced to three:
defense aircrafts and warships, atomic energy generation, and railway
transport.

 Abolition of industrial licensing:

Industrial licensing by the central government has been almost

abolished except for a few hazardous and environmentally sensitive
industries.

 Facilitated easy access to foreign technology

 Restriction were removed on expansion

 Opening the economy to FDI.

FOREIGN DIRECT INVESTMENT IN INDIA

Liberalizing foreign direct investment was another important part of

India’s reforms, driven by the belief that this would increase the total
volume of investment in the economy, improve production technology,
and increase access to world markets.

The policy now allows 100 percent foreign ownership in a large number
of industries and majority ownership in all except banks, insurance
companies, telecommunications and airlines.

18 | P a g e
Procedures for obtaining permission were greatly simplified by listing
industries that are eligible for automatic approval up to specified levels of
foreign equity (100 percent, 74 percent and 51 percent).

Potential foreign investors investing within these limits only need to

register with the Reserve Bank of India. For investments in other
industries, or for a higher share of equity than is automatically permitted
in listed industries, applications are considered by a Foreign Investment
Promotion Board that has established a track record of speedy
decisions.

In 1993, foreign institutional investors were allowed to purchase shares

of listed Indian companies in the stock market, opening a window for
portfolio investment in existing companies.

 Foreign investment is more than 24% in the equity capital of units

manufacturing items reserved for the small scale industries.

 After reforms in 1992, huge amounts of foreign direct investment

came into India.

 Foreign Investment Promotion Board (FIPB) is a competent body

to consider and recommend foreign direct investment.

 In 1993, foreign institutional investors were allowed to purchase

shares of listed Indian companies in the stock market.

 The below graph shown the significant increase in foreign direct

investment(FDI) after the economic reforms and liberalization.
19 | P a g e
The Important Reform Measures (Step Towards liberalization
privatization and Globalization):

• Indian economy was in deep crisis in July 1991, when foreign

currency reserves had plummeted to almost $1 billion; Inflation
had roared to an annual rate of 17 percent; fiscal deficit was very
high and had become unsustainable; foreign investors and NRIs
had lost confidence in Indian Economy. Capital was flying out of
the country and we were close to defaulting on loans. Along with
these bottlenecks at home, many unforeseeable changes swept
the economies of nations in Western and Eastern Europe, South
East Asia, Latin America and elsewhere, around the same time.
These were the economic compulsions at home and abroad that
called for a complete overhauling of our economic policies and
programs.

20 | P a g e
• Major measures initiated as a part of the liberalization and
globalization strategy in the early nineties included the following:

• Devaluation: The first step towards globalization was taken with

the announcement of the devaluation of Indian currency by 18-19
percent against major currencies in the international foreign
exchange market. In fact, this measure was taken in order to
resolve the BOP crisis.

• Disinvestment-In order to make the process of globalization

smooth, privatization and liberalization policies are moving along
as well. Under the privatization scheme, most of the public sector
undertakings have been/ are being sold to private sector

TRADE LIBERALIZATION:

‘Trade liberalisation' is the term for the process whereby a country opens
up its markets to international trade i.e. reduces the taxes (known as
tariffs) and other limits (such as quotas) on goods coming in and out. It
also often comes alongside increased rights for investors, pressures to
privatize as well as imposed regulatory changes to comply with
international standards.

Trade liberalisation can be a good thing in the right circumstances – if it's

phased in correctly at the right time in a country's development. However
forcing countries to 'liberalise' their economies prematurely (for example
through aid conditionality or trade agreements) has led to disastrous
economic and social consequences.

21 | P a g e
Import licensing was abolished relatively early for capital goods and
intermediates which became freely importable in 1993, simultaneously
with the switch to a flexible exchange rate regime.

Import licensing had been traditionally defended on the grounds that it

was necessary to manage the balance of payments, but the shift to a
flexible exchange rate enabled the government to argue that any
balance of payments impact would be effectively dealt with through
exchange rate flexibility.

Although India’s tariff levels are significantly lower than in 1991, they
remain among the highest in the developing world because most other
developing countries have also reduced tariffs in this period. The
weighted average import duty in China and southeast Asia is currently
about half the Indian level.

The government has announced that average tariffs will be reduced to

around 15 percent by 2004, but even if this is implemented, tariffs in
India will be much higher than in China which has committed to reduce
weighted average duties to about 9 percent by 2005 as a condition for
admission to the World Trade Organization.

22 | P a g e