OVERVIEW
The Indian government’s economic policies during the first forty years following its liberation from British colonial authority were characterized by planning, control, and regulation. Periodically, there were attempts at market-oriented reform, mainly in reaction to pressures from the balance of payments, which led to policy measures that coupled the depreciation of the exchange rate with a loosening of limitations on the entrance of foreign capital. The latter, on the other hand, had a much smaller effect on actual inflows and were comparatively limited in scope. Despite this, many enterprises had foreign ownership, in part because of their pre-independence roots. Furthermore, domestic companies were permitted to enter into technology licensing agreements, which frequently included an equity share as well, in fields where the government placed a high priority. However, there remained a broad unease about foreign involvement in industry, especially in “non-essential” fields like consumer goods. This resulted in a number of significant regulatory measures in the late 1970s, forcing businesses to cap their foreign shareholdings at 40 percent. While most businesses complied, Coca-Cola and IBM, two well-known businesses that didn’t, were asked to cease their operations in India. In the early 1980s, the Indian government eased its foreign investment policy in response to a severe balance of payments problem and a sizable loan from the International Monetary Fund. This led to several cooperative ventures in the automotive sector, involving technical and financial ties between Japanese and Indian businesses. A few years later, Japanese two-wheeler companies joined up with significant Indian firms to reenter the home market. Once more, a number of agreements between component producers in the two nations followed the initiatives. A more flexible trade and investment climate was also extended to other important areas, such as the computer industry.
The significant opening occurred in 1991, in the wake of another external crisis. This time, the government introduced a number of internal and external reforms that significantly altered the business environment, going considerably farther than it had in the past. Significantly expanding the variety of operations that foreign enterprises might engage in and loosening the requirements for entry were two of the main elements of this new strategy. The reform’s advancement and the changing FDI pattern over the last ten years are first described in this chapter. We then present the most important findings from our FDI survey.
THE INDIAN ECONOMY REFORMS
Before 1991, a significant portion of economic activity was regulated and supported by the government, giving it considerable control over industrial activity. The development plan dissuaded foreign investments and imports, and it distributed the few domestic resources by licensing manufacturing activities. As a result, the domestic industry was heavily protected against both domestic and foreign competition, thanks to licenses and reservations, as well as import bans and high levies. Strict entrance barriers were maintained because licensing restrictions dominated industrial policy. The Industries Development and Regulation Act (1951) required all businesses to obtain government clearance before opening a new production facility or expanding their operations. In addition, permission was needed if the company intended to switch up the production line. Furthermore, the permit that was given was highly restricted in terms of the product, capacity, and location. A license was awarded after a multi-stage, heavily bureaucratic procedure that included some governmental control by domestic incumbent businesses. This and other initiatives caused the economy to become extremely bureaucratized. Additionally, a lot of industries, like the textile industry, were designated for the small-scale sector, which made it impossible for domestic companies operating in these industries to benefit from economies of scale and turned them off to multinational corporations. The government also had authority over a company’s option to leave. Without permission from the government, manufacturers were not permitted to downsize their workforce or cease operations. Although preventing unemployment was the goal, the industrial economy’s inefficiencies were also encouraged. Prior to the 1990s, import substitution was the main focus of Indian trade strategy. Several types of import restrictions were put in place. To exert control over the importers, import licensing was enforced in line with the goal of achieving self-sufficiency. Additionally, imports were channelized, meaning that a single agency—typically a public sector company—was able to import a given commodity.
Due to high input prices brought on by import restrictions and high tariff rates, Indian producers were no longer competitive on the global market. In addition, export limitations were placed on a few commodities for reasons related to the environment, low domestic costs, and accessible availability. Because of this, local industry functioned in a closed off setting with little access to global markets and goods. Foreign investment was severely restricted under FDI policy. Since few foreign businesses were permitted to hold an equity stake greater than 40%, many refrained from utilizing their most advanced technologies in India. Due to the lack of foreign technology and money, the economy was unable to reach globally competitive production levels and quality standards. The goal of financial sector policy was not to raise enough money from domestic and international sources. The state imposed strict regulations on the financial industry. Since their nationalization in 1969 and the early 1980s, all of the major banks have been held by the government. It implemented pricing controls, credit rationing, and low interest rates on loans for small businesses and farmers. In fact, the Harrod-Domar growth paradigm served as the foundation for Indian planning, forcing the government to concentrate on mobilizing savings for investment. Price fixing and directed credit were the root causes of the financial repression that existed. Equity raising through the market was likewise limited. The price and the amount of capital were determined by the government. In addition to interest rates, the government’s arm, the Controller of Capital Issues (CCI), was responsible for granting prior approval for initial public offerings and other equity issues. When making functional and operational choices, banks were free to disregard market factors, and private sector involvement was discouraged. Due to a lack of competition and government control over interest rates, financial institutions’ profitability remained low. Public sector policy, in addition to trade and industrial policies, sets apart some sectors only for the public sector. Additionally, the public sector was involved in nearly every aspect of the economy, including consumer products, tourism infrastructure and services, and petroleum. Almost all infrastructure-related businesses, including telecom, power, and aviation, were under the control of the public sector. Reservations lowered the motivation to be efficient by reducing competition. Inadequate research and development efforts, outdated technology, inadequate management, and an excess of personnel all played a part in the decline of public sector initiatives. Most importantly, these businesses were incredibly inefficient due to non-commercial goals and government meddling in their daily operations. Small-scale industrial policy provided defense against both internal and foreign rivalry. The main way this was accomplished was by reserving specific product lines just for small businesses. Excise reductions and rebates that were based on annual turnover instead of fixed capital expenditure helped the smaller businesses. Financial assistance was also provided on more lenient terms through government-owned banks. Preferential government purchases and input supplies also helped small businesses. The Indian industrial system was insufficient, both financially and technologically, to summarize the effects of policies before 1990. However, the 1990s saw the emergence of well-established domestic incumbents, which had an impact on FDI and entrance methods. Inefficiencies, excessive reservations, high costs, bad management, noncompetitiveness, import limitations, a lack of export focus, and deterrents to foreign investment were the main issues that persisted. Some of these problems were the focus of reforms that were introduced in the early 1990s. Manufacturers were heavily reliant on domestic growth, so a more global strategy was implemented. The goal of liberalizing economic policy was to promote investment and hasten the expansion of the economy. The 1991 announcement of a new industrial policy resulted in the delicensing of industry and the preference for competition over protection as the intended policy environment. With the exception of eighteen industries, all prior requirements for permissions and licenses were eliminated for any investments or expansions. In a matter of years, industrial licenses were limited to just five categories. Companies now have more freedom to choose where to locate their plants, make investments, and expand thanks to delicensing. The amount of bureaucracy in the investing procedures was greatly decreased. A reduction in entry restrictions led to increased involvement from the private sector. Through the removal of tariffs, quantitative limitations, and foreign exchange control, trade reforms removed the anti-import bias. Before the reforms, the Indian economy was among the most protected in the world, but it is now comparable to other emerging nations. Trade changes have been ongoing throughout the 1990s, and this pattern of continual implementation is anticipated to continue. Additionally, the government relaxed its FDI regulations. Numerous restrictions that were previously placed on direct and portfolio investments were lifted. The technical and financial collaboration approval process was entirely redesigned. The Reserve Bank of India (RBI) would automatically approve several enterprises. After a corporation is incorporated in India, Indian law does not distinguish between companies that are owned by Indians and those that are not. Both foreign-owned and Indian enterprises are subject to the same procedures. In the majority of manufacturing industries, foreign-owned enterprises, like Indian companies, are now exempt from licensing requirements for production.
