Liberalisation implies a reduction in government intervention and free play of market forces at the national and international level.
India’s economic policy was substantially liberalised after 1991. India has made fairly liberal commitments in e-commerce and services. The foreign investment regime governing foreign direct investment, portfolio investment, and venture capital was liberalised to attract foreign capital.
The policy-makers killed a number of bribing opportunities by abolishing industrial licensing. Industrial licensing had ensured that the government will decide which Indian company will produce how much of a good for the large Indian domestic market.
The domestic producer had an interest in obtaining licenses and increasing capacity, both of which were possible by obliging government officials and politicians. Innovation and efficiency was not the hallmark of Indian manufacturing industry, as rents to officials and politicians easily helped those secure advantages in the Indian market.
Tarifis, Qerrotas and Rupee Convertibility
India’s abolishing all quantitative restrictions (QRs) two years ahead of the World Trade Organization schedule on March 31, 2001, is a significant event in India’s trade policy. Quantitative restrictions restrict trade with a certain country to a certain quantity, no matter what the demand may be.
The US had successfully challenged India’s QRs in the WTO’s dispute settlement proceedings on the grounds that India could no longer maintain them on balance of payments grounds. India lost the case in December 1998, and used international commitments to pursue domestic reform.
The removal of QRs has boost retail trade in India. Indian tariffs were reduced drastically. Industrialists depended on high customs duties to protect themselves against the low productivity and quality of Indian products. The simple average tariff came down from 125 percent in 1990-1991 to 35 percent in 1997-1998.
The import-weighted tariff over the same period came down from 87 per cent to 30 percent. India has entered the Information Technology Agreement that will bring down Indian tariffs on information technology goods to zero by 2005. India entered into a textile agreement with the US and the EU in 1995.
It removed fibres, yarns, and industrial fabrics from the restricted list. Most textile exports of the US and the EU would gain free entry into India by 2005. In return, the US agreed to provide increased market access and a total phase out of quotas by 2005. The EU agreed to remove all restrictions on Indian handloom products, increase its quota by Rs. 3 billion, and completely phase out quotas by 2004. Foreign exchange controls were relaxed. After 1991, the Rupee was steadily allowed to become fully convertible on all current account transactions by 1994. The market now determines largely the Rupee-Dollar exchange rates.
Earlier, Indian industrialists had depended on an overvalued exchange rate, which made intermediate goods imports cheap but excessively dependent on import licenses and foreign exchange granted by the GOI.
After 1994, the largely market determined exchange rate of the Rupee made imports expensive and exports cheap. The devaluation of the exchange rate increased the competitiveness of Indian exports.
Investment by a foreign company in India can lead to jobs, access to technology, and, better products. Low US interest rates in the 1990s saw the average FDI to emerging markets more than double from 1985 – 1990 ($ 142 billion per year) to 1996 ($350 billion). FDI began to trickle intolndia following a shift in the government towards, foreign investment in the 1990s.
The Foreign Exchange Regulation Act (1973) was amended to liberalize foreign investment in India. Automatic approval of foreign equity up to 51 per cent is granted in 48 sectors.
Foreign equity up to 74 per cent is allowed in many sectors and 100% foreign equity is allowed in some infrastructure areas such as ports and roads. Insurance sector, banking, telecommunications, and civil aviation have been opened for foreign investment. India has signed bilateral treaties with countries like the UK, France, Germany, and Malaysia, as well as a double taxation treaty with the US. It has become a member of the World Bank’s Multilateral Investment Guarantee Agency from 1992. Finance Minister Yashwant Sinha liberalised the taxation of venture capital funds with a view to establishing the Silicon Valley connection.
Incubators, which are mostly nonprofit entities, provide finance and infrastructure support to young entrepreneurs at an early stage of commercial development. Venture Capital Funds do not need SEBI approval after the 2001 budget. India’s rising competitiveness in the software sector has resulted in the simplification of procedures regarding Indian companies accessing foreign funds, and the acquisition of foreign assets.
The GO1 has granted permission to Indian firms to freely raise resources via American Depository Receipts and Global Depository Receipts. These firms may spend up to 50 per cent of the resources raised to acquire overseas companies.
The policy for portfolio investment has been liberalised. Portfolio investment relates to the investment of fund managers in rich countries who invest the savings of rich country citizens all over the world to earn the highest returns. Before 2000, foreign institutional investors (FIIs) were allowed to invest up to 24 per cent of the equity of an Indian company.
This could be increased to 30 per cent subject to the approval of a company’s board of directors and the passage of a resolution at the company’s general meeting. The Union Budget of 2001 kept the equity limit for portfolio investment at 40 per cent subject to the approval of a company’s board of directors.
In September 2001, the Reserve Bank raised the equity limit for foreign institutional investors in a sector to the equity limit permitted for foreign direct investment in that sector. Any participation in a company’s equity above 24 per cent will require the company board’s approval. This implies that FIIs can theoretically invest up to 100 per cent equity in companies in sectors like power, oil, pharmaceuticals, software, and hotels.
The results of India’s liberalization have been impressive. India has recorded one of the fastest growth rates (annual growth rate of 6 per cent per annum) in the world between 1993 and 2000. Inflation had been controlled below the 5 per cent level. At the decade’s end, India’s foreign exchange reserves were approximately $40 billion and could cover nine months of imports. This was sufficient to withstand a Gulf War type oil price hike without panic. India emerged as a major software producer and one of the world’s leading outsourcing locations.
Foreign firms took advantage of the cheap availability of highly skilled work force to carry out advanced research and development activities in India. India’s exports of gems and jewellery grew more rapidly in the 1990s than in the 1980s. Gems and jewellery maintained its pre-eminent status in India’s export basket.