Economic Reform

Transformation

Transformation of Indian economy has taken place in the era of economic reforms, with service sector share in GDP having gone to 64%, while that of agriculture shrinking to 17% (from 38%) and industry share remaining around 19%. Further, the domestic economy is far more integrated with global economy, which is visible from increasing trade volumes, financial inflows etc.

Timing of reforms: The economic reforms introduced during 1991 have been outcome, mainly of fiscal crisis and external payment crisis.

Economic Transformation — Real Sector

Initially, the real sector policy measures mainly focused on manufacturing sector which included:

a) Deregulation of industry by way of removing licensing requirement,

b) Overhauling public enterprises,

c) Enhanced role for private sector,

d) Abolition of MRTP Act,

e) Automatic approval route for FDI,

f) Reduction in import tariffs,

 g) Removal of quantitative restrictions on imports etc.

Service Sector: Entry of private sector and FDI introduced competition and state of the 'at technology which brought sea change in the services sector. The boom in Information Technology Enabled Services led to an era of services led growth and India emerged as global hub for BPO/KPO services in the world. The boom in information technology (IT) and information technology and Enabled Services CITES) resulted in services-led growth. India emerged as global hub for BPO / KPO services.

Agriculture sector: A series of measures were taken in agricultural sector also which include free movement of agriculture commodities, APMC Act permitting farmers to bypass the mandatory requirement of sale in the regulated markets, relaxation of restrictions under Essential Commodities Act 1955 introduction of future trading. (c) and (d) brought major changes in the pricing mechanism and national level commodity futures markets discover price instead of manipulation by local traders. Banks started allowing loans to farmers against warehouse receipts. Large companies directly source agriculture produce from farmers.

Growing demand for milk, poultry products and horticulture products, has induced substantial diversification towards allied activities which now account for nearly three-fifth of total primary sector output.  

With economic growth and rise in disposable incomes, the consumption basket has changed significantly.

Economic Transformation — Financial Sector

Financial sector reforms were carried as per recommendations of Narasimham Committee (1991 and 1998). Transformation of this sector helped in improving the services sector growth in a big way. The segment that covered the financial sector reforms are:

Money market: The measures included

 a) freeing of interest rates in money market,

b) Introduction of money market instruments like commercial paper, certificate of deposits, collateralized lending and borrowing obligations, introduction of screen based trading, making call money, a pure inter-bank market etc.

Govt. securities market: Before reforms, the Government was able to borrow at sub-market rates.

a) The concessionary financing to government was eliminated with introduction of market auction system and phasing out of automatic monetization with Ways and Means Advances (WMA).

b) Yield on g-securities provides a benchmark for pricing of securities in other markets.

Foreign Exchange market : The reforms include,

a) Introduction of market based exchange rate regime,

b) Adoption of current account convertibility and relaxation on capital account, led to emergence of active and vibrant forex market.

c) Exchange rates are market driven now.

Capital market:

a) The primary market witnessed a significant movement away from Controller of Capital Issue,

b) Introduction of free pricing and book building system,

 c) Mandatory disclosure,

d) Creation of SEBI,

e) In the secondary market, the measures include corporatization of exchanges, screen based trading replacing the open outcry system, introduction of options and futures replacing the erstwhile Badla system, rolling settlement replacing the 14 days settlement cycle, demitting of securities with Depositories etc.

Credit market: Prior to reforms, the banking operations on asset and liability side were broadly governed by RBI. In such situation competition was almost absent. The broader approach of reforms to this sector was to:

a) Bring more competition,

b) Allow operational autonomy to banks,

c) Building of risk management capacities,

d) Introduction of prudent norms on capital adequacy, asset classification, income recognition and provisioning, in line with best international practices. These measures transformed the banking system and brought soundness and operational efficiency.

Payment system: The measures include

a) Enactment of Payment and Settlement Systems Act 2007 which empowered RBI to regulate the payment and settlement system,

b) Introduction of ECS, RTGS, NEFT, Cheque Truncation system (CTS), free access policy for ATM.

 This made the payment system robust and sound.

Economic Transformation — Integration with the Global Economy

The economic reforms process facilitated integration of Indian economy with the global economy. This increased the participation in international trade and capital inflows. India's share of world exports increased to 1.5%. The gross volume of capital inflows amount to $ 428 billion in 2007-08. The important measures taken, in this respect include:

Trade liberalization: De-licensing of intermediary inputs and capital goods, progressive reduction in tariff rates, acceptance of IMF Article VIII obligations, thus making rupee convertible on current account.

Capital account: The approach to move towards full convertibility on capital was a cautious one. Many recommendation of SS Tarapore committee recommendations, have already been implemented.

Foreign Direct Investment: The policy to attract FDI started with introduction of automatic approval route, as per which RBI was empowered to approve investment up to 51% in select 34 priority industries. Presently, under this route 100% foreign investment is permitted except for limited categories like atomic energy, lotteries business etc. Again, the list for FDI cap below 100% is also quite short including broadcasting, print media, defense, insurance, asset reconstruction, investment companies, petroleum and air transport.

Portfolio investment: Such investment through FII, was opened up in 1992. Around this time, the Indian companies were also permitted to raise equity through GDR and ADR in Europe and American markets. The policy was liberalized by raising the 24% cap to total sectoral cap for foreign investment.

External commercial borrowing: Access to ECB, by Indian companies, further integrated the Indian economy to the world economy.

Outward flows: Outward capital flows were also permitted progressively. This has resulted into emergence of Indian MNCs

Issues and challenges

Though the structural transformation of Indian economy has brought improvement in terms of efficiency, competitiveness and productivity, but there are a number of issues, that remain to be addressed.

Poverty: Measured on the basis of consumption expenditure, there has been improvement in reducing the incidence of poverty. There has been 7-8% age points decline in poverty ratio in 2004-05, compared to 1993-94. But Gini Coefficient, a standard measure of income and expenditure inequality, has deteriorated to 36.2% in 2004 compared with 32.9% in 1993. This means, there is lot to be done, on this issue.

Socio-economic development: Human Development Index, a widely used indicator of socio-economic conditions has placed India at 128 out of 18o countries of the world. Compared to other nations India needs to bring improvement in terms of health and education services.

Agricultural investment: While the structural transformation from agriculture to services has been a positive feature, but the dependence of large population (about 65%) on agriculture, is keeping large majority of Indian population, in poverty. There is need to integrate the rural sector with urban economy, by creating infrastructure such as roads in rural areas, provision for electricity, cold storage chains to provide farm producers access to urban markets.

Labour reforms: There is need to review the labour laws so that these help in bringing market efficiency and productivity, promote entrepreneurship, create positive investment environment. Further, the disparity between the organized and unorganized sectors in terms of working conditions and protection of employees' rights also needs to be bridged.

Demographic dividend:  Share of working age group 15-64, around 65% in the population to take advantage of this dividend, large investment in human capital formation is required.

Financial inclusion: There is still a large portion of our population, which does not available banking facilities for various reasons including cost, availability etc. There is need to offer banking facilities to this poor section of the society to provide banking facilities at reasonable cost.