SMU BBA6 BB0029 ECONOMIC REFORMS PROCESS IN INDIA

ASSIGNMENT PROGRAM	BBA
SEMESTER	6
SUBJECT CODE & NAME	BB0029 ECONOMIC REFORMS PROCESS IN INDIA

Q1. Explain privatization through disinvestment in India.

Ans. Disinvestment: Disinvestment is a process where Government sells its equity holding to private sectors. In other ways it is a privatization process where private parties are given shareholding in Government undertakings either wholly or partially. The Rangarajan committee recommended the program of disinvestments in 1991-92. The disinvestments commission was established under the chairmanship of Shri. G. V. Ramkrishnan. He was given the task of long term planning of disinvestment To speed up the disinvestment process, the Government of India has set up a separate Department of disinvestment The amount realized from disinvestments will be used for meeting expenditure in social sector, restructuring the PSE's and for retiring public debt. An attempt has been made in this paper to study the progress and process of disinvestment of PSE's in India.

According to Anjila Saxena (2001) bureaucratic, trade union and valuation of PSU's disinvestment. Fair valuation and transparency is disinvestments process are equally important to make this exercise free from criticism and better public acceptance, B.K.S. Prakasa Rao and S.V. Ramana Rao (2001) found that disinvestment process through liberalization and privatization leads to cost reduction, quality of service and operational efficiency.

Improvement of management and operating performance is a precondition for successful privation. They further observed that a strong private sector and strong growth potential are essential for attaining higher degree of national output.

DISINVESTMENT IN INDIA’S PUBLIC SECTOR: - Disinvestment of a percentage of shares owned by the Government in public undertakings emerged as a policy option in the wake of economic liberalization and structural reforms launched in 1991. Initially, it was not conceived as privatization of existing undertakings but as limited sales of equity with the objective of raising some resources to reduce budgetary gaps and providing market discipline to the performance of public enterprises in general.

    A comprehensive policy on public sector was set out in the Industrial Policy Statement of July 24, 1991 - the year when the country had to tide over an unprecedented economic crisis reflected in its internal and external finances. The steps adumbrated included a review of public sector investments to focus on strategic and essential infrastructure enterprises and new procedures to tackle chronically sick and loss-making units.

    The ambit of disinvestment was gradually widened in the latter half of 1990s by the subsequent coalition governments to make a clear distinction between strategic and non-strategic enterprises so as to bring down Government share holding to 26 per cent in non-core undertakings through gradual disinvestment or strategic sale while retaining majority holding (51 per cent) in strategic undertakings.

    A Disinvestment Commission was set up in 1996 to carefully examine withdrawal of public sector from non-core, non-strategic areas with assurance to workers of job security or of opportunities for retraining and re-employment. The Commission, in its three-year term, gave its recommendations on 58 enterprises referred to it and proposed, instead of public offerings as in the past, strategic trade sales involving change in ownership/ management for 29 and 8 undertakings respectively. In other cases, there was to be offer of shares or closure and deferment of disinvestment.

    By strategic sale, privatization was envisaged though confined to non-strategic areas. The classification was redefined by Government in 1999 to include only defense-related, atomic energy undertakings and railway transport among strategic enterprises and treat all other undertakings as non-strategic. This major decision of the Government also stipulated that reduction of its stake going down to less than 51 per cent or to 26 per cent would not be automatic but would be governed by consideration as to whether continued presence of the public sector in an enterprise was required to prevent concentration of power in private hands. A Department of Disinvestment was established early in 2000 to give an impetus to the program of disinvestment and privatization.

    In a policy statement while presenting the Union Budget for 2000-01 last year, the Finance Minister, Shri Yashwant Sinha, said the main elements were restructuring and reviving potentially viable PSUs; Closing down PSUs which cannot be revived ; bringing down Government equity in all non-strategic PSUs to 26 per cent or lower, if necessary; and fully protecting the interests of workers. Over the last three years, the Finance Minister had listed in his budget speeches some major public undertakings for sizeable disinvestment or restructuring in the oil, telecom and aviation sectors. These are yet to take off. The utilization of receipts from disinvestment/privatization was to be for meeting expenditure in social sectors, restructuring of PSUs or retiring public debt.

Disinvestment process:

• Objectivity & transparency were the key requirements in the whole disinvestment process. As it was the first case of disinvestment for the Indian Government, the disinvestment process evolved as the transaction progressed.
• After the issue of the advertisement for inviting bids from the potential partners, it took around 10 months to complete the disinvestment process.
• The advisors carried out a review of the company and gave advice on the extent, mode and methodology for the disinvestment. The issues requiring action by the management/ approval of the GOI were identified and steps taken to ensure that the process moved smoothly and shareholder value was maximized.
• The Cabinet gave its approval and the necessary agreement was entered into with the strategic partner in December 1999. After the full payment against the shares and execution of share transfer agreement, the management of the company was handed over to the strategic partner in July 2000.

Q2. Briefly discuss the reforms in the banking sector during 1992-2001. Ans. Economic Reforms of the Banking Sector In India: Indian banking sector has undergone major changes and reforms during economic reforms. Though it was a part of overall economic reforms, it has changed the very functioning of Indian banks. These reforms have not only influenced the productivity and efficiency of many of the Indian Banks, but have left everlasting footprints on the working of the banking sector in India. These are some of the import reforms regarding the banking sector in India. 1.      Reduced CRR and SLR: The Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) are gradually reduced during the economic reforms period in India. By Law in India the CRR remains between 3-15% of the Net Demand and Time Liabilities. It is reduced from the earlier high level of 15% plus incremental CRR of 10% to current 4% level. Similarly, the SLR Is also reduced from early 38.5% to current minimum of 25% level. This has left more loan able funds with commercial banks, solving the liquidity problem. 2.      Deregulation of Interest Rate: During the economic reforms period, interest rates of commercial banks were deregulated. Banks now enjoy freedom of fixing the lower and upper limit of interest on deposits. Interest rate slabs are reduced from Rs.20 Lac to just Rs. 2 Lac. Interest rates on the bank loans above Rs.2 Lac are full decontrolled. These measures have resulted in more freedom to commercial banks in interest rate regime. 3.      Fixing prudential Norms: In order to induce professionalism in its operations, the RBI fixed prudential norms for commercial banks. It includes recognition of income sources. Classification of assets, provisions for bad debts, maintaining international standards in accounting practices, etc. It helped banks in reducing and restructuring Non-performing assets (NPAs). 4.      Introduction of CRAR: Capital to Risk Weighted Asset Ratio (CRAR) was introduced in 1992. It resulted in an improvement in the capital position of commercial banks, all most all the banks in India has reached the Capital Adequacy Ratio (CAR) above the statutory level of 9%. 5.      Operational Autonomy: During the reforms period commercial banks enjoyed the operational freedom. If a bank satisfies the CAR then it gets freedom in opening new branches, upgrading the extension counters, closing down existing branches and they get liberal lending norms. 6.      Banking Diversification: The Indian banking sector was well diversified, during the economic reforms period. Many of the banks have stared new services and new products. Some of them have established subsidiaries in merchant banking, mutual funds, insurance, venture capital, etc which has led to diversified sources of income of them. 7.      New Generation Banks: During the reforms period many new generation banks have successfully emerged on the financial horizon. Banks such as ICICI Bank, HDFC Bank, UTI Bank have given a big challenge to the public sector banks leading to a greater degree of competition. 8.      Improved Profitability and Efficiency: During the reform period, the productivity and efficiency of many commercial banks has improved. It has happened due to the reduced Non-performing loans, increased use of technology, more computerization and some other relevant measures adopted by the government. With these reforms, Indian banks especially the public sector banks have proved that they are no longer inefficient compared with their foreign counterparts as far as productivity is concerned. Q3. Discuss the impact of convertibility both in current account and capital account. Ans. "Current Account” and “Capital Account” Convertibility: Current account includes all transactions, which give rise to or use of our National income, while Capital Account consist of short term and long term capital transactions. As per FEMA "capital account transaction" means a transaction which alters the assets or liabilities, including contingent liabilities, outside India of persons resident in India or assets or liabilities in India of person’s resident outside India. Those which are not Capital Account transactions are current Account transactions. Current Account Transactions covers the following: 1.      All imports and exports of merchandise 2.      Invisible Exports and Imports (sale/purchase of services 3.      Inward private remittances to & fro 4.      Pension payments (to & fro) 5.      Government Grants (both ways) Capital Account transactions consist of the following: 1.      Direct Foreign Investments (both inward & outward) 2.      Investment in securities (both ways) 3.      Other Investments (both ways) 4.      Government Loans (both ways 5.      Short-term investments on both directions. The substance of convertibility is to dispense with the discretionary management of foreign exchange and exchange rates and to adopt a more liberal and market driven exchange allocation process. All transactions are still conducted within the framework of exchange controls, as prescribed by the RBI. Full convertibility on current account is manifested as below: On trade account and on account of the receipt side of the invisibles, the rupee is fully convertible at market determined exchange rates. The payment side of the invisible and receipts and payments of capital account are subject to exchange control However, exchange rates for all these permissible transactions are undertaken at the free market exchange rates Capital Account is deemed convertible when residents and non-residents are allowed to effect such transactions without any restrictions i.e. without prior permission of the RBI. In such a context without any restrictions Indians should be able to secured foreign direct investment from abroad. Foreigners at their discretion should be able to make portfolio investments in this country. Presently these transactions are subject to prior permission of R.B.I. However R.B.I. is following a constructive and promotional approach and encouraging foreign investments in India. Indian Industrialist having good projects for direct foreign investment or foreign institutional investors desiring to make portfolio investments in this country are encouraged and they do not face problems on account of exchange control by R.B.I. Exchange control is limited to exchange monitoring. In a strict sense a currency can be considered convertible, only if both residents and non-residents have full freedom to use and exchange it for any purpose whatsoever, at some definite rate of exchange. However in practice large numbers of currencies are considered convertible with various degrees of restrictions and controls. The International Monetary Fund provides a working definition of convertibility under Article VIII, which states as under: “No member shall, without the approval of the fund, impose restrictions on making of payment and transfers for current transactions.” The IMF concept considers convertibility only for current account transactions, thus leaving at the discretion of the country to regulate flows on capital account. Generally countries with currency convertibility have practiced various degrees of controls to suit their national interests from time to time. Thus currency convertibility implies absence of restrictions on foreign exchange transactions and not necessarily on trade or capital flow. This point has been clarified properly by IMF, which states as under:- “Thus, although measure formulated as quantitative limitation on imports will have the indirect effect, it is not for that reason a restriction on payments within the meaning of the provision…Restrictions on trade do not become restrictions on payment within the meaning of Article VIII, because they are imposed for balance of payments reasons”. Under the present floating system, exporters can realize their entire export earnings at the free market rate. All imports, including the Government imports consisting of petroleum, food, fertilizers and defense have to be paid at free market rates. The substance of convertibility efforts is to dispense with the discretionary management of foreign exchange and exchange rates and to adopt a more liberal and market driven exchange allocation process. It needs to be noted that here that the full convertibility does not mean the unrestricted use of the rupee for all types of India’s external transactions. All transactions are still conducted within the framework of exchange controls, as prescribed by the R.B.I.  Q4. Write notes on VAT, MODVAT and Service Tax. Ans. VAT: VAT is a multi-stage tax levied at each stage of the value addition chain, with a provision to allow input tax credit (ITC) on tax paid at an earlier stage, which can be appropriated against the VAT liability on subsequent sale. VAT is intended to tax every stage of sale where some value is added to raw materials, but taxpayers will receive credit for tax already paid on procurement stages. Thus, VAT will be without the problem of double taxation as prevalent in the earlier Sales tax laws. One of the many reasons underlying the shift to VAT is to do away with the distortions in our earlier tax structure that carve up the country into a large number of small markets rather than one big common market. In the earlier sales tax structure tax is not levied on all the stages of value addition or sales and distribution channel which means the margins of distributors/ dealers/ retailers at large not subject to sales tax earlier.  MODVAT: MODVAT abbreviates Modified Value Added Tax. The scheme is intended to avoid cascading effects of duty. Before the introduction of this scheme, barring some duty relief schemes provided to some specified goods, the inputs first suffered duty and the duty so paid became a part of the cost of the final product and the final product again suffered some duty. However, under MODVAT scheme duty becomes payable at the value added at each stage of production as against on the gross value including duty paid in earlier stages of production. The scheme envisages taking of credit of duty paid on inputs as well as on capital goods. SERVICE TAX: Service Tax is a central tax which has been imposed on the consumers of selective services and is latest addition to the genus of indirect taxes like Customs and Central Excise duty. According to the mechanism adopted for collection, it is to be collected by the C. Excise Department. The Service Tax in India was introduced in 1994 by way of Chapter V to the Finance Act, 1994 and to begin with the services rendered by Stock-brokers, General Insurance Companies and Telephone connection providers were brought within the ambit of these provisions. Other services were added to the fold during subsequent years and as a results of those additions services of Stock Brokers, Insurance, Telephone, Pager services, Advertising services, Courier services, Man power Recruitment Agents, Consulting Engineers, Custom House Agents, Steamer Agents, Mandap Keepers, Air Travel Agents, Clearing and Forwarding Agents, Rent a Cab Scheme Operators, Architects / Interior Decorators, Practicing Chartered Accountants, Practicing Cost Accountants and Practicing Company Secretaries, Management Consultant, Real Estate Agents, Security and Detective Agencies, Credit Rating Agencies, Market Research Agencies, Under Writers, Tour Operators, Commercial Training and Coaching Centre, Maintenance & Repair Service, Banking & Financial Services, Sound Recording Services, Cargo Handling Service, Business Auxiliary Service, Franchise Service, Commissioning & Installation Service. Q5.  Do you think poverty can be reduced through policies of inclusive growth? Justify. Ans. Poverty is the state of human beings who are poor. That is, they have little or no material means of surviving—little or no food, shelter, clothes, healthcare, education, and other physical means of living and improving one's life. Some definitions of poverty, are relative, rather than absolute, poverty reduction would not be considered to apply to measures which resulted in absolute decreases in living standards, but technically lifted people out of poverty. Poverty reduction measures, like those promoted by Henry George in his economics classic Progress and Poverty are those that raise, or are intended to raise, enabling the poor to create wealth for themselves as a means for ending poverty forever. In modern times, various economists within the georgism movement propose measures like the land value tax to enhance access by all to the natural world. Some people undertake voluntary poverty due to religious or philosophical beliefs. For example, Christian monks and nuns take a "vow of poverty" by which they renounce luxury. Poverty reduction measures have no role in regard to voluntary poverty. Poverty reduction measures and other attempts to change the economies of modern hunter-gatherers are not addressed in this article. Hunter-gatherers, also called "foragers" live off wild plants and animals, for example, the Hadza people of Tanzania and the Bushmen of southern Africa. Theirs is a special case in which their poverty relative to the developed countries is intertwined with their traditional way of life. Governmental attempts to modernize the economies of the Hadza people, the Bushmen, and other hunter-gatherers have resulted in political, legal, and cultural controversies. They have often met with failure. Poverty occurs in both developing countries and developed countries. While poverty is much more widespread in developing countries, both types of countries undertake poverty reduction measures. Poverty has historically been accepted in some parts of the world as inevitable as non-industrialized economies produced very little while populations grew almost as fast making wealth scarce. Geoffrey Parker wrote that "In Antwerp and Lyon, two of the largest cities in western Europe, by 1600 three-quarters of the total population were too poor to pay taxes, and therefore likely to need relief in times of crisis." Poverty reduction, or poverty alleviation, has been largely as a result of overall economic growth.  Food shortages were common before modern agricultural technology and in places that lack them today, such as nitrogen fertilizers, pesticides and irrigation methods.  The dawn of industrial revolution led to high economic growth, eliminating mass poverty in what is now considered the developed world. World GDP per person quintupled during the 20th century. In 1820, 75% of humanity lived on less than a dollar a day, while in 2001, only about 20% do. Today, continued economic development is constrained by the lack of economic freedoms. Economic liberalization requires extending property rights to the poor, especially to land Financial services, notably savings, can be made accessible to the poor through technology, such as mobile banking. Inefficient institutions, corruption and political instability can also discourage investment. Aid and government support in health, education and infrastructure helps growth by increasing human and physical capital. Poverty alleviation also involves improving the living conditions of people who are already poor. Aid, particularly in medical and scientific areas, is essential in providing better lives, such as the Green Revolution and the eradication of smallpox. Problems with today's development aid include the high proportion of tied aid, which mandates receiving nations to buy products, often more expensive, originating only from donor countries. Nevertheless, some believe (Peter Singer in his book The Life You Can Save) that small changes in the way each of us in affluent nations lives our lives could solve world poverty. Q6. Has the FDI flows in the current times helped India? Elaborate. Ans. Foreign Direct Investment Flows to India: FDI inflows to India remained sluggish, when global FDI flows to EMEs had recovered in 2010-11, despite sound domestic economic performance ahead of global recovery. The paper gathers evidence through a panel exercise that actual FDI to India during the year 2010-11 fell short of its potential level (reflecting underlying macroeconomic parameters) partly on account of amplification of policy uncertainty as measured through Kauffmann’s Index. FDI inflows to India witnessed significant moderation in 2010-11 while other EMEs in Asia and Latin America received large inflows. This had raised concerns in the wake of widening current account deficit in India beyond the perceived sustainable level of 3.0 per cent of GDP during April-December 2010. This also assumes significance as FDI is generally known to be the most stable component of capital flows needed to finance the current account deficit. Moreover, it adds to investible resources, provides access to advanced technologies, assists in gaining production know-how and promotes exports. A perusal of India’s FDI policy vis-à-vis other major emerging market economies (EMEs) reveals that though India’s approach towards foreign investment has been relatively conservative to begin with, it progressively started catching up with the more liberalized policy stance of other EMEs from the early 1990s onwards, inter alia in terms of wider access to different sectors of the economy, ease of starting business, repatriation of dividend and profits and relaxations regarding norms for owning equity. This progressive liberalization, coupled with considerable improvement in terms of macroeconomic fundamentals, reflected in growing size of FDI flows to the country that increased nearly 5 fold during first decade of the present millennium. Though the liberal policy stance and strong economic fundamentals appear to have driven the steep rise in FDI flows in India over past one decade and sustained their momentum even during the period of global economic crisis (2008-09 and 2009-10), the subsequent moderation in investment flows despite faster recovery from the crisis period appears somewhat inexplicable. Survey of empirical literature and analysis presented in the paper seems to suggest that these divergent trends in FDI flows could be the result of certain institutional factors that dampened the investors’ sentiments despite continued strength of economic fundamentals. Findings of the panel exercise, examining FDI trends in 10 select EMEs over the last 7 year period, suggest that apart from macro fundamentals, institutional factors such as time taken to meet various procedural requirements make significant impact on FDI inflows. This paper has been organized as follows: Section 1 presents trends in global investment flows with particular focus on EMEs and India. Section 2 traces the evolution of India’s FDI policy framework, followed by cross-country experience reflecting on India’s FDI policy vis-à-vis that of select EMEs. Section 3 deals with plausible explanations of relative slowdown in FDI flow to India in 2010-11 and arrive at econometric evidence using panel estimation. The last section presents the conclusions.