Economic Reform - Highlights


Ajit Kumar AJIT KUMARWISDOM IAS, New Delhi.

 What do you mean by Economic Reform?

  - It is an economic policy instrument
  - To change the behavior of economic agents (public & private)
  - To achieve economic growth targets (physical and social) through greater efficiency and effectiveness
  - Essence is dismantling state control over economy
  - State yielding to the market (privatisation), opening trade and investment, tax reform, and inflation control (neo- liberalism)
  - Greater benefits to all sections of society

When was it started?
 The first attempt was made in 1966 which was reversed in 1967 and a stronger version of socialism was adopted.
The second major attempt was made in 1985 by Prime Minister Rajiv Gandhi which came to a halt in 1987
Finally, in 1991 PM Narsimha Rao was forced to adopt the reform.

Why reform started in 1991?
Reform was crisis driven-
- BoP crisis – Forex reserve came down to 1.1 b $ while CAD increased to 5.5 b $ (2.2% of GDP)
- Highly increased external debt 22.8%  of GDP (62.3 b $)
 - Mounting internal debt – 53% 0f GDP
  - Massive NRI deposit outflow  (1,3 b $)- loss of investor confidence.

What led to crisis?
- The root cause of the crisis was the large and growing fiscal imbalance due to mounting government expenditures in form of subsidies and unbridled consumption expenditure under policy of populism = inflation
 - The gross fiscal deficit of the government (center and states) rose to 12.7 percent in 1990-91due to fall in resource mobilization (Revenue expenditure outpacing revenue receipts)
- subsidies grew at faster rate
- Inflation – more than 10%
- Gulf war in 1990
 - Political instability- V.P.Singh - Mandal Report

What were measures taken under the Reform ?
The post-crisis adjustment program featured macroeconomic stabilization and structural reforms.
(a) Macroeconomic Stabilization – India pledged 20 tonnes of gold to Union Bank of Switzerland and 47 tonnes to Bank of England; taken loans from multilateral financial institutions and donor countries reduction in fertilizer and sugar subsidy.
Policy adopted for macroeconomic stabilization-
- Reduction in Fiscal deficit
- Reduction in non-plan expenditure
- Revenue generation by broadening tax base, rationalizing tax rates and non-tax sources
-Resource mobilization from public services
Low and Stable inflation by controlled money supply, faster growth, freezing fuel prices, etc.
-  BoP adjustment – by improved invisible account; and more export earnings
 (b) Structural Reforms    
Objectives of the structural reform were –
-         Shift resources from non-traded goods to traded goods sectors and from government sector to private sector
-         Improve resource utilisation by opening economy and reducing government intervention  
-         Rely more on price mechanism instead of control 
-         Wind down  PSUs

What were the reforms adopted?
Reforms adopted included –
-         Industrial Policy Reforms – New Industrial Policy 1991
-         Financial sector reform - Bank reform
-         Trade Policy Reforms- Coverage of import from export; Devaluation of rupee
-         Promoting Foreign Investment    
-         Current Account Convertibility and Call for full Capital Account Convertibility
-         Tax reform
The policy adopted was called LPG.
The concepts of liberalization, privatization and globalization (LPG) are actually closely related to one another.

Liberalisation

What it means?
Liberalization means elimination of state control over economic activities. It implies greater autonomy to the business enterprises in decision-making and removal of government interference in economy.
The major aspects of liberalization in India are:
1. Providing more opportunity to private enterprises and capital
2. Removal of restrictions on movements of goods and services.
3. Tax rates has been reduced and rationalized
4. Pricing of goods to be done by producers
5. Liberalisation of capital and money market
6. Abolition of  licensing : NIP’1991 abolished licensing for most industries except 5 industries of strategic significance.
7.Liberalization of Foreign Investment - While earlier prior approval was required by foreign companies, now automatic approvals were given for Foreign Direct Investment (FDI) to flow into the country.
8. Relaxation of Locational Restrictions:  No requirement anymore for obtaining approval from the Central Government for setting up industries anywhere in the country except those specified under compulsory licensing or in cities with population exceeding one million.
9. Liberalization of Foreign Technology imports: In projects where imported capital goods are required, automatic license would be given for foreign technology imports up to 2 million US dollars.
10. Phased Manufacturing Programmes : Under PMP any enterprise had to progressively substitute imported inputs, components with domestically produced inputs under local content policy.
11.Public Sector Reforms : Greater autonomy was given to the PSUs (Public Sector Units) through the MOUs
12. MRTP Act: Monopolies and Restrictive Trade Practises Act has been abolished
13. Foreign Exchange Regulation Act (FERA) was liberalized in 1993 and later Foreign Exchange Management Act (FEMA) 1999 was passed to enable foreign currency transactions
 
Privatization
 
What is privatization? Discuss advantages and disadvantages of privatization?
 
Privatization is the transfer of control of ownership of economic resources from the public sector to the private sector. Thus it refers to the private purchase of all or part of a public company.
 
The main aspects of privatization in India are as follows-
1. Denationalisation: Complete transfer of ownership of a public enterprise
2. Joint Venture: Partial introduction of private ownership
3. Disinvestment Policies: sale of a part of equity of a public company
4. Restriction on further expansion of PSUs
5. Dereservation of Public Sector
- Out of 17 reserved industries only 3 are reserved – (i) Atomic Energy, (ii) Atomic Energy Minerals, and (iii) Railways (many processes has been privatised)
- Reserved products for SSI gradually reduced to Zero
6. Autonomy to Public sector : Greater autonomy was granted to nine PSUs referred to as ‘navaratnas’ ( ONGC, HPCL, BPCL, VSNL, BHEL) to take their own decisions.
7. Transfer of management and control i.e. franchise, contract, lease, etc.
 
Advantages of Privatisation
-         Benefits to taxpayers
-         May lead to better quality and lower price as a result of competitions
-         No massive subsidy to loss making Units
-         Privatization can provide the necessary impetus to the underperforming PSUs
-         May brings about radical structural changes providing momentum in the competitive sectors
-         May leads to adoption of the global best practices along with management and motivation of the best human talent to foster sustainable competitive advantage and improvised management of resources
 
Disadvantages of Privatization
-         Private sector focuses more on profit maximization and less on social objectives unlike public sector that initiates socially viable adjustments in case of emergencies and criticalities
-         There is lack of transparency in private sector and stakeholders do not get the complete information
-         Privatization has provided the unnecessary support to the corruption and illegitimate ways of accomplishments of licenses
-         Privatization escalates inflation in general
-         International agencies may find difficult to finance private sectors
-         There is no guarantee that privatization would improve the productivity of PSUs
 
Globalization
 
What is globalization?
 
Globalization essentially means integration of the national economy with the world economy.
It implies a free flow of information, ideas, technology, goods and services, finance and even people across different countries and societies. It increases connectivity between different markets in the form of trade, investments and cultural exchanges.
 
The concept of globalization has been explained by the IMF (International Monetary Fund) as ‘the growing economic interdependence of countries worldwide through increasing volume and variety of cross border transactions in goods and services and of international capital flows and also through the more rapid and widespread diffusion of technology.’
 
The main elements of globalization are:
-          To open the domestic markets for inflow of foreign goods, India reduced customs duties on imports
-         The FDI policy of the GOI encouraged the inflow of fresh foreign capital by allowing 100 % foreign equity in certain projects under the automatic route
-         Outsourcing (PBO, KPO, LPO) is one of the important outcomes of the globalisation process

What are advantages and disadvantages of globalization?

Advantages of Globalization
A. For Developing Countries:
- Trade – Potential to increase their share in world trade
- Free flow of capital and technology enables developing countries to speed up the process of industrialization and lay the path for faster economic progress
- Labour may move towards developed countries
- Spread of technology may benefit developing countries
- There may be decline in the number of people living below the poverty line
B. For Developed Countries
- Will get new market for their products
- Will find better investment opportunity

Disadvantages of Globalisation
-         Domestic companies are unable to withstand competition from efficient MNCs
-         Development of indigenous technology may take a backseat
-         It increases the disparities in the incomes of the rich and poor
-         It leads to overcrowding of cities and puts pressure on the amenities and facilities available in urban areas
-         Globalization poses certain risks for any country in the form of business cycles, fluctuations in international prices, etc.

Economic Performance under First Generation Reform

Discuss economic performance under first generation reform
The primary adjustment has been successful by all standards
1. GDP growth rate - after an initial slowdown during 1992-94 (5%), growth picked up to over and above 7% during 1994-97. Subsequently, the growth declined to 6.3 per cent during 1997-2000.
2. At the end of January, 2000 the country’s total foreign exchange reserves amounted to US$ 34.90 billion, enough for 8 months of imports. Fears of default on balance of payments are no longer valid.
3. The rupee has been convertible on the current account and reforms for capital account are being undertaken almost every year.
4. The exchange rate has remained reasonably stable
5. Other macro-variables also indicate that the short-run growth is appropriate.
5. The debt-GDP ratio declined from 41 per cent (1991-92) to 23.5 per cent (1998-99), indicating that we are no longer on a path of debt accumulation.
6. The debt-service to current receipts ratio declined from 30 per cent (1991-92) to 18 per cent (1998-99), indicating that a larger share of current receipts is free for allocation in a more productive manner than on interest payments.
7. The short-run debt declined from 10.5 per cent of total debt (March 1991) to 4.7 per cent (September 1999).
8. Internal liabilities of the government that had burgeoned to 52 per cent of GDP (1990-91) has stabilized at about 46 per cent of GDP.
9.  Inflation rates since this has been reasonably stable
10. During 1992-97 software exports registered a 43 per cent growth and this rate of growth has continued
11. Foreign Direct Investment increased substantially. Proposals worth Rs. 12163 crore, and Rs. 20319 crore of foreign direct investment were sanctioned in the consecutive years of 1995-96 and 2000-01 respectively.
12. The tax revenue of the central government registered a sharp increase.
13. There has been a spectacular achievement in the sphere of poverty alleviation. The poverty ratio decreased from 36% in 1993 - 94 to 26.1% in 1999 – 2000 . 

Limitations –
1. Industrial production has tended to vacillate, however, Index of Industrial production (IIP) registered a 6.1 per cent per annum growth rate over 1993-2000
2. Slump in exports which recorded a negative growth rate of 3.9 per cent in 1998-99
3. During 1993-99 investments in agriculture have been growing slowly at 3.33per cent per annum.
4. The main thrust of new economic policy is to bring down fiscal deficit to 3 per cent of GDP. It has reduced but still the government is far away from its target.
5. Jobless growth

Second Generation Reform (2000-01 - ?)

Background
First generation reform was –
-         Crisis driven
-         Focused on industry first strategy, but inter-relation between industry and agriculture was forgotten. Thus strategy failed to create enough job opportunity and bring equality in society.
-         Advocated for agro-export, but much of it depended on external factors i.e. developed country’s protective tariff and non-tariff barriers.
India continued to struggle at WTO to reduce these barriers.
What was Philosophy behind adoption of second generation reform?
‘Growth is not an end in itself but a vehicle to increase employment and raise living standard’.
For this a sustainable, equitable and job creating growth path was targeted.

What are Development Strategy?
-         A higher rate of growth of GDP
-         Enlarge the employment potential
-         Decrease BPL population
-         Provide social services (education, health , sanitation, etc.) specially to poor
-         Reduce Regional disparities
-         While the first generation reform was based on executive and administrative measures, the second generation reform required legislative actions

What are important features?
-         It is development driven
-         Enlarge the base of reform to agriculture and SSIs
-         Shift emphasis from corporate sector to agriculture, agro- based industries, SSIs, and on improving infrastructure and social sectors like health education, food security, poverty, etc.
-         Central and State governments to work in harmony

What fiscal strategy has been adopted?
-         Reduce fiscal deficit to a limit of 3% for the Centre and 2% for states
-         Reduce revenue deficit to zero
-         Raise capital expenditure in rural infrastructure and stimulate growth in agriculture
-         Reduce subsidy on non-merit goods and hidden subsidy benefitting more to well-to-do people
-         Create environment of better cost recoveries on social services i.e. irrigation, power, roads, etc.

Discuss Significant Reform Undertaken
-         Fiscal Responsibility and Budget Management (FRBM) Act, 2003
-         Reduction in corporate tax rate from the existing levels of 36.75 percent to 30 percent for domestic companies and to 35 percent for foreign companies
-         Competition Act 2002
-         Banks being allowed to raise capital from the market to meet capital adequacy norms by diluting the government’s stake up to 52 per cent.
-         RBI released guidelines and invited applications for setting up payments banks and local area banks.
-          Promulgation of Insurances Laws (Amendment) Ordinance 2014
-         Ujwal DISCOM Assurance Yojna or UDAY provides for the financial turnaround and revival of Power Distribution companies (DISCOMs)

What are challenges still to overcome?
(a) Slow Infrastructure development – Roads, power
(b) Failure in increasing labour intensive manufacturing
(c) Not taking advantage of demographic dividend
(d) Slow social sector development – Education, health
(e) Governance Failures
(f) Lack of labour reform
(g) The combined deficit at the center and states exceeds 10 percent of GDP. Given an already high debt-to-GDP ratio of nearly 60 percent, this deficit is unsustainable; it is also crowding out private investment.
(h) Fertilizer and food subsidies pose yet another challenge.
(i) Economic reforms of the last decade have virtually bypassed agriculture.
(k) Financial sector reforms, particularly the reform of banking, remain a distant goal.

What are third and fourth generation reforms?

Third Generation Reform
-         Started with 10th Five Year Plan in 2002
-         Devaluation of the benefits of Economic Reforms
-         Inclusive Growth

Fourth Generation Reform
-         It is a non-official concept
-         Economic Development fully based on Information Technology
Note: Reforms of all four generations are being implemented simultaneously and they indicate directions and depths of the reform.

Ease of doing business – A form of structural liberalisation



Monday, 31st Oct 2016, 01:34:02 AM

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