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The Economic reforms in India

The economic reforms initiated in 1991 introduced far-reaching measures, which changed the working
and machinery of the economy.

Reforms in Industrial Policy

Industrial policy was restructured to a great extent and most of the central government industrial
controls were cancelled. Massive deregulation of the industrial sector was done in order to
bring in the element of competition and increase efficiency.

Industrial licensing by the central government was almost abolished except for a few
hazardous and environmentally sensitive industries.

The list of industries reserved solely for the public sector -- which used to cover 18 industries,
including iron and steel, heavy plant and machinery, telecommunications and telecom equipment,
minerals, oil, mining, air transport services and electricity generation and distribution was
drastically reduced to three: defense aircrafts and warships, atomic energy generation, and
railway transport. Further, restrictions that existed on the import of foreign technology were
withdrawn.

Under New Industrial Policy the industries have been freed to a large extent from the licenses and

other controls.
Efforts have been made to encourage foreign investment. Investment decision by companies has
been facilitated by ending restrictions imposed by the MRTP Act. Similarly, Foreign Exchange
Regulation Act (FERA) has been replaced with Foreign Exchange Management Act (FEMA).

Reforms in Trade Policy

Trade policy means the policy through which the foreign trade is controlled and regulated. As a
result of liberalization, trade policy has undergone tremendous changes. Especially the foreign
trade has been freed from the unnecessary controls.

Before the reforms, trade policy was characterized by high tariffs and pervasive import
restrictions. Imports of manufactured consumer goods were completely banned. The economic
reforms sought to phase out import licensing and also to reduce import duties.

Import licensing was abolished relatively early for capital goods and intermediates which
became freely importable in 1993, simultaneously with the switch to a flexible exchange rate
regime. Quantitative restrictions on imports of manufactured consumer goods and agricultural
products were finally removed on April 1, 2001, almost exactly ten years after the reforms
began, and that in part because of a ruling by a World Trade Organization dispute panel on
a complaint brought by the United States.

Under New Trade Policy the age-old restrictions have been eliminated at one go. Some of the
chief characteristics of the New Trade Policy are as follows:
a) Reduction in Restrictions of Export-Import: Restrictions on the exports-imports have
almost disappeared leaving only a few items.
b) Reduction in Export-Import Tax: Export-import tax on some items has been
completely abolished and on some other items it has been reduced to the minimum level.
c) Easy Procedure of Export-Import: Import-export procedure has been simplified.
d) Establishment of Foreign Capital Market: Foreign capital market has been established
for sale and purchase of foreign exchange in the open market.

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e) Full Convertibility on Current Account: In 1994-95, Full convertibility became

applicable on *current account.
*Current Account: Transactions with the foreign countries are placed in two
categories: (i) transaction with current account, for example, import-export,
(ii) Capital account transactions, like investment.

Full Convertibility: In short, full convertibility means unrestricted sale and

purchase of foreign exchange in the foreign exchange market for the purpose of
payments and receipts on the items connected with current account. It means that
there is no government restriction on the sale and purchase of foreign exchange
connected with current account. On the other hand, sale and purchase of foreign
exchange connected with capital account can be carried on under the rates
determined by the Reserve Bank of India (RBI)
Providing Incentive for Export: Many incentives have been allowed to Export- oriented Units
(EOU) and Export Processing Zones (EPZ) for increasing export trade.

Fiscal Reforms

The policy of the government connected with the income and expenditure is called fiscal policy. The
greatest problem confronting the Indian government is excessive fiscal deficit. In 1990-91, the fiscal
deficit was 8% of the GDP. (It is important to understand the meaning of fiscal deficit and GDP.)
(i) Fiscal Deficit: A fiscal deficit means that the country is spending more than its income,
(ii) Gross Domestic Product (GDP): The GDP is the sum total of the financial value of all the produced
goods and services during a year in a country. Generally, the financial deficit is calculated in the form of
GDPs percentage. Presently, the government of India is making efforts to take it to 4%.
Solutions of Fiscal Deficit
In order to handle the problem of fiscal deficit, basic changes were made in the tax system. The following
are the major steps taken in this direction:
a) The rate of the individual and corporate tax has been reduced in order to bring more people in the
tax net.
b) Tax procedure has been simplified.
c) Heavy reduction in the import duties has been implemented.

Monetary Reforms

Monetary policy is a sort of control policy through which the central bank controls the supply of
money with a view to achieving the objectives of the general economic policy. Reforms in this policy
are called monetary reforms. The major points with regard to the monetary reforms are given below:
a) Statutory Liquidity Ratio (SLR) has been lowered. The banks have been allowed freedom to
decide the rate of interest on the amount deposited.
b) New standards have been laid down for the income recognition for the banks. (By
recognition of income, we mean what is to be considered as the income of the bank. For example,
should the interest on the bad debt be considered as the income of the bank directions have been
issued in this context.
c) Permission to collect money by issuing shares in the capital market has been granted to
nationalize banks.
d) Permission to open new banks in the private sector has also been granted.

Capital Market Reforms

The market in which securities are sold and bought is known as the capital market. This market is the
pivot of the economy of a country. The government has taken the following steps for the development of
this market:
a) Under the Portfolio Investment Scheme, the limit for investment by the NRIs and foreign
companies in the shares and debentures of the Indian companies has been raised. (Portfolio
Investment Scheme means investing in securities.)
b) In order to control the capital market, the Securities and Exchange Board of India (SEBI) has
been established.
c) The restriction in respect of interest on debentures has been lifted. Now, it is decided on the basis
of demand and supply.
d) The office of the Controller of Capital Issue which used to determine the price of shares to be
issued has been dispensed with. Now, the companies are free to determine the price of the shares.
e) Private sector has been permitted to establish Mutual Fund.
f) The registration of the sub broker has been made mandatory

Phasing out Subsidies

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Cash Compensatory Support (CCS) which was earlier given as export subsidy has been stopped. CCS
can be understood with the help of an example.
If an exporter wants to import some raw material which is available abroad for 100, but the same
material is available in India for 120 and the governments wants the raw material to be purchased
by the exporter from India itself for the protection of indigenous industries, the government is
ready to pay the difference of 20 to the exporter in the form of subsidy.
The payment of 20 will be considered as CCS. In addition to this, the CCS has been reduced in
case of fertilizers and petro products.

Dismantling Price Control

The government has taken steps to remove price control in case of many products. (Price Control means
that the companies will sell goods at the prices determined by the government.) The efforts to remove
price control were mostly in respect of fertilizers, steel and iron and petro products. Restrictions on
the import of these products have also been removed.

Impact of Reforms in India

Due to Economic reforms India has already marked its presence as one of the fastest growing economies of the
world. It has been ranked among the top 3 attractive destinations for inbound investments. Since 1991, the
regulatory environment in terms of foreign investment has been consistently eased to make it investor-friendly.

Recent policy measures

100% FDI allowed in medical devices
FDI cap increased in insurance & sub-activities from 26% to 49%
100% FDI allowed in the telecom sector.
100% FDI in single-brand retail.
FDI in commodity exchanges, stock exchanges & depositories, power exchanges, petroleum
refining by PSUs, courier services under the government route has now been brought under the
automatic route.
Removal of restriction in tea plantation sector.
FDI limit raised to 74% in credit information & 100% in asset reconstruction companies.
FDI limit of 26% in defence sector raised to 49% under Government approval route. Foreign
Portfolio Investment up to 24% permitted under automatic route. FDI beyond 49% is also allowed
on a case to case basis with the approval of Cabinet Committee on Security.
Construction, operation and maintenance of specified activities of Railway sector opened to 100%
foreign direct investment under automatic route.
Types of investors

Individual:

Foreign Venture Capital Institutions(FVCI)

Pension/Provident Fund

Financial Institutions

Foreign Trust

Sovereign Wealth Funds

NRIs / PIOs

Private Equity Funds

Partnership / Proprietorship Firm

Others

Foreign Institutional Investors:

Company:

Note: Citizen or entity from Bangladesh & Pakistan can invest only under the government route also
investor from Pakistan cannot invest in defence, space, atomic energy and sectors prohibited for foreign
investment.

Sectors with restrictions

Sectors where Foreign Direct Investment is prohibited:

Lottery Business including Government /private lottery, online lotteries, etc.

Gambling and Betting including casinos etc.
Chit funds

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Nidhi company-(borrowing from members and lending to members only).

Trading in Transferable Development Rights (TDRs)
Real Estate Business (other than construction development) or Construction of Farm Houses
Manufacturing of Cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes
Activities / sectors not open to private sector investment e.g. Atomic Energy and Railway Transport (other
than construction, operation and maintenance of (i) Suburban corridor projects through PPP, (ii) High
speed train projects, (iii) Dedicated freight lines, (iv) Rolling stock including train sets, and
locomotives/coaches manufacturing and maintenance facilities, (v) Railway Electrification, (vi) Signaling
systems, (vii) Freight terminals, (viii) Passenger terminals, (ix) Infrastructure in industrial park pertaining
to railway line/sidings including electrified railway lines and connectivity to main railway line and (x)
Mass Rapid Transport Systems.)
Services like legal, book keeping, accounting & auditing.

Sectors with Investment caps

Petroleum Refining by PSU (49%)

Teleports (setting up of up-linking
HUBs/Teleports), Direct to Home
(DTH), Cable Networks (Multisystem operators (MSOs) operating at
national, state or district level and
undertaking upgradation of networks
towards
digitalization
and
addressability), Mobile TV and
Headend-in-the-Sky
Broadcasting
Service (HITS) (74%)
Cable Networks (49%)
Broadcasting content services- FM
Radio (26%), up linking of news and
current affairs TV channels (26%)
Print Media dealing with news and
current affairs (26%)
Air transport services- scheduled air
transport (49%), non-scheduled air
transport (74%)

Ground handling services Civil

Aviation (74%)
Satellitesestablishment
and
operation (74%)
Private security agencies (49%)
Private Sector Banking- Except
branches
or
wholly
owned
subsidiaries (74%).
Asset reconstruction company
beyond 49% and up to 100%
Public Sector Banking (20%)
Commodity exchanges (49%)
Credit information companies
(74%)
Infrastructure
companies
in
securities market (49%)
Insurance and sub-activities (49%)
Power exchanges (49%)
Defence (49% above 49% to CCS)

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Permissions for FDIs are given under following routes

Under this route no Central Government permission is required.

Automatic Route:

Government Route:

Under this route applications are considered by the Foreign Investment Promotion Board (FIPB).
Approval from Cabinet Committee on Security is required for more than 49% FDI in defence. The
proposals involving investments of more than INR 12 billion are considered by Cabinet committee on
economic affairs(CCEA)
The Indian company receiving FDI either under the automatic route or the government route is required
to comply with provisions of the FDI policy including reporting the FDI and issue of shares to the
Reserve Bank of India.

Economic progress post-1991

The initiation of economic reforms in the 1990s saw India gradually breaking free of the low growth trap
which was euphemistically called the Hindu growth rate of 3.5 per cent per annum. Real GDP growth
averaged 5.7 per cent per annum in the 1990s, which accelerated further to 7.3 per cent per annum in
2000s.
The 2000s encompassed the growth trajectory with an annual average GDP growth of about 9 per cent for
the 5-year period 2004-08. Growth in all the sub-sectors of the economy, including agriculture, accelerated
during this period. However, this growth process was interrupted by the global financial crisis. Subsequently,
the average growth slowed down to 7.8 per cent during 2009-11 with a noticeable slowdown in both
agriculture and industry.

Reforms in the financial sector

Financial sector reforms

During the last fifteen years, the Indian financial system has been incrementally deregulated and
exposed to international financial markets along with the introduction of New Financial
instruments and products.

Until the early 1990s,the banking sector suffered from lack of competition, low capital base, low
productivity and high intermediation cost. But financial sector reforms initiated in India helped financial
system to grow.
The main thrust of reforms in the financial sector was on the creation of efficient and stable financial
institutions and markets. Reforms in respect of the banking as well as non-banking financial institutions
focused on creating a deregulated environment and enabling free play of market forces while at the
same time strengthening the prudential norms and the supervisory system.
Reforms in the commercial banking sector had two distinct phases. The first phase of reforms, introduced
subsequent to the release of the Report of the Committee on Financial System, 1992 (Chairman: Sri M.
Narasimham), focused mainly on enabling and strengthening measures.
The second phase of reforms, introduced subsequent to the recommendations of the Committee on
Banking Sector Reforms,1998 (Chairman: Sri M. Narasimham) placed greater emphasis on structural
measures and improvement in standards of disclosure and levels of transparency in order to align the Indian
standards with international best practices.
Later The Financial Sector Legislative Reforms Commission (FSLRC), headed by Justice B.N.
Srikrishna, was set up by Ministry of Finance in March 2011 to review, simplify and rewrite the legal
and institutional structures of the financial sector. most important of the recommended changes by
FSLRC are:
The decision to merge the roles of the Securities and Exchange Board of India, the Forward
Markets Commission, Insurance Regulatory and Development Authority, and Pension Fund
Regulatory and Development Authority into a single regulator called the Unified Financial
Agency (UFA), on the grounds that all financial activity other than banking and the payments
system, which would continue to be regulated by the Reserve Bank of India (RBI), should be
brought under a single authority.
The continuation of the Financial Stability Development Council (FSDC) with the mandate to
monitor and address systemic risk, which is to be led by the finance ministry.
The creation of a Resolution Corporation that would identify institutions that are threatened by
insolvency and resolve the problem at an early stage.
The creation of a Public Debt Management Agency that would take the responsibility of public
debt Management away from the RBI.

The enactment of the Banking Laws Amendment Act 2012 is expected to make the regulatory and
supervisory powers of the RBI more effective and facilitate banks in raising funds from the capital market
required for expansion of banking business.
Pension reforms in India facilitated the flow of long-term savings for development but also help establish
a credible and sustainable social security system in the country by the name New Pension scheme (NPS).
Swavalamban Scheme is an important scheme aimed at universal inclusion of poorer sections of Indian
society into the pension network.

2014-15 a year of financial sector reforms

The year 2014-15 could well go as one of long-pending financial sector reforms, expected to
have a lasting impact. From governance issues of the banking sector to higher foreign direct
investment and overhaul of the monetary policy framework, with inflation targeting as the aim,
these would shape the banking and financial sector for a long while.
Some of the initiatives taken or announced were thematically in continuation of the post
liberalization banking reforms. This would include improving of governance, strengthening
stressed assets resolution and recovery mechanism, etc.
New initiatives, too, like getting started on differentiated bank licensing. Also in FY15, we saw
financial institutions taking concrete steps to deal with digital technologies and their potential for
disruption. The macro framework itself looks poised for major shifts, with announcements
relating to implementation of a new Indian Financial Code or realignment of regulatory
responsibilities between different regulators. For example SEBI took over Forwards market
Commission

New banks, New types: As early as in April last year, the Reserve Bank of India (RBI) awarded
universal bank licences to two entities, infra financier IDFC and micro lender Bandhan
Financial Services. These were issued after more than a decade. The process, completed in April,
was started in February 2010.
Also for the first time, RBI opened the sector for differentiated bank licences. Over 100 applications
were received, from those who wanted to set up Payments banks and Small Finance Banks. Big
corporate entities like Reliance, Bharti Airtel and the Aditya Birla Group had applied for
payment banks. RBI is in the process of vetting the bids and is expected to award licences in the
next few months.
Governance in Banks: Recommendations of the P J Nayak committee to review governance
issues in banks hasn't been accepted fully but the government has shown an intention to start the
reform process. The Narendra Modi-led government has already split the chairman and managing
directors post in public sector banks and invited applications from those in private banks to head
the state-run ones, at market-linked pay.
Capital infusion in public Sector banks: Public sector banks (PSBs) reeling under the pressure of
stressed assets have seen their capital position worsening due to higher provisioning. Their
capital raising ability from the market is also constrained due to poor valuations. However, breaking
the tradition of infusing capital in banks that need it most, the government decided to do so in
banks which are more efficiently run, sending a signal that banks must be run efficiently to
survive.
Infra financing: After an announcement in the Union Budget, the RBI has allowed banks to raise
funds via long-term bonds for financing to the infrastructure sector. For these, they dont have
to meet the cash reserve ratio, statutory liquidity ratio or priority sector norms. This will help
lenders to boost infrastructure and affordable housing financing. In addition, The RBI had introduced
a flexible financing scheme in July. Popularly known as the 5:25 scheme, it allows banks to extend longterm loans of 20-25 years to match the cash flow of projects, while refinancing them every five or seven
years.

Growth of Banking : Amid a slowing economy, when interest rates are high (RBI has reduced the
policy rate by 50 basis points only since January), bank loan growth was the slowest in more
than a decade. According to RBI data, loan growth till March 6 was 10.2 per cent (year on year) as
compared to 14.3 per cent in the same period of the previous year. Deposit growth also slowed in
the year, at 11.6 per cent as compared to 15.1 per cent the previous year.
Monetary policy: The year also saw the central bank shifting to an inflation targeting framework,
with the mandate to keep inflation below six per cent by January 2016 and four per cent, with a
variation of two per cent on both sides, in the years after. However, a monetary policy committee, as
suggested by the Urjit Patel panel is yet to be set up and the government and central bank are in
talks on this.RBI, however, stands to lose some of its functions, like managing the governments

debt. The Union Budget has proposed setting up of a Public Debt Management Office,
independent of RBI.
Flashback 2014-15: financial sector milestones
APRIL
After a gap for more than a decade, new bank licences were awarded by the Reserve Bank of
India (RBI) to two applicants, IDFC & Bandhan Financial Services
A new monetary framework kicks in, with 6 reviews per year as compared to 8 earlier
JULY
To boost infra financing CRR/SLR exemption announced for banks for funds raised via infra
bonds
RBI issues draft norms for payments and small banks; for the first time a process to issue
differentiated licences initiated
AUGUST
CBI arrests Syndicate Bank Chairman and Managing Director (CMD) S K Jain over alleged
bribery charges. Jain later sacked by the government, which, in an unprecedented move, cancels
all CMD appointment decisions taken by the previous government
Prime Minister Narendra Modi launches Pradhan mantri Jan Dhan Yojana a scheme for opening
bank accounts to foster financial inclusion. More than 130 million accounts opened in a matter of
five months
NOVEMBER
Kotak Mahindra Bank accounted it will acquire ING Vysya Bank to become the fourth largest
private bank in the country
DECEMBER
Goverment splits chairman and managing directors post in public sector banks, signalling its
intention to initiate long-pending reforms in the banking sector
Government issues ordinance to allow foreign firms to have 49 per cent stake in insurance
companies, a decision that was stuck for several years
JANUARY
In a first, government calls bankers for a brainstorming session, christened as Gyan Sangam, to
chart the road ahead for the banking sector
RBI brings out final guidelines on banks becoming insurance brokers
FEBRUARY
RBI gets 41 applications for payments bank licence, 72 for small finance bank licence
Government allocates capital to public sector banks based on their efficiency, clearly indicating its
stance perform or perish
CEO position in government banks opened for private sector players with market-linked
remuneration
Union budget starts implementing proposals of the Financial Sector Legislative Reforms
Commission, which takes away some important functions of the central bank like government
debt management
MARCH
Insurance Bill passed by both Houses of the Parliament
SBI, the countrys largest lender, says it will dilute its stake in its general insurance venture