A PDF

BUSINESS
ENVIRONMENT

Shaikh Saleem
Director
Maulana Azad Educational Trust's
Millennium Institute of Management
Aurangabad, Maharashtra, India

Second Edition

Delhi • Chennai • Chandigarh

Contents
FOREWORD
PREFACE TO THE SECOND EDITION
PREFACE
ABOUT THE AUTHOR
1 Business Environment
Introduction
Meaning and Definition
Salient Features
Importance of the Study
Environmental Factors
Business Environment and Strategic Management
Market Opportunities
Distribution of Household by Income, 1990–2000
Recent Political Environment
Recent Economic and Financial Environment
Case
Summary
Key Words
Questions
References
2 Planning in India
The Emergence of Planning
The Planning Commission
The National Development Council
Objectives of Planning in India
Five-Year Plans
Distribution of Public Sector Outlay of Each Plan
Tenth Five-Year Plan (2002–07)
Five-Year Plans—Achievements and Failures

Eleventh Five-Year Plan (2007–12)
Liberalisation and Planning
Case
Summary
Key Words
Questions
References
3 Industrial Policy
Historical Background
Government’s Role
Meaning and Objectives of Industrial Policies
Industrial Policies
Evaluation of the New Industrial Policy
New Trade Policy of 1991
The New Small-Scale Sector Policy of 1991
Recent Policies for Micro and Small Enterprises (MSE) Sector
Case
Summary
Key Words
Questions
References
4 Industrial Licensing
Industrial Licensing in India
Objectives of Industrial Licensing
Industrial Licensing Act of 1951
Industrial Licensing Policy
Policy Decisions
Recent Industrial Licensing Policy
Summary
Key Words
Questions
References
5 India’s Monetary and Fiscal Policy
Monetary Policy of India
Concept and Meaning of Monetary Policy
Objectives of the Monetary Policy
Differences Between Monetary Policy and Fiscal Policy
Meaning of CRR and SLR
Impact of the Monetary Policy
Measures to Regulate Money Supply
Meaning of Some Monetary Policy Terms
The Monetary Policy and IMF
RBI’s Monetary Policy Measures
RBI’s Monetary Policy, 2008–09
Fiscal Policy of India
Concept and Meaning of Fiscal Policy
Objectives of the Fiscal Policy
Fiscal Policy and Economic Development
Techniques of Fiscal Policy
Merits or Advantages of Fiscal Policy of India
The Shortcomings of the Fiscal Policy of India
Suggestions for Necessary Reforms in Fiscal Policy
Fiscal Policy Reforms
Fiscal Policy Statement, 2008–09
Fiscal Policy—An Assessment
Conclusions
Case
Summary
Key Words
Questions
References
6 Economic Trends
The Indian Financial Systems
Indian Money Market

Indian Capital Market
Call Money Market
Bill Market
Financial System
Structure of the Financial System
Functions of the Indian Financial System: Promotion of Capital Formation
The Price Policy
Price Movement Since Independence
Objectives of Price Policy
Prices of Industrial Products
Control of Expenditure
Key Words
Questions
References
7 Stock Exchanges in India
Concept and Meaning of Stock Exchange
Types of Financial Markets
SEBI and Its Role in the Secondary Market
Products Available in the Secondary Market
Regulatory Requirements Specified by SEBI for Corporate Debt Securities
Broker and Sub-broker in the Secondary Market
SEBI Risk Management System
Investor Protection Fund (IPF)/Customer Protection Fund (CPF) at Stock Exchanges
Foreign Institutional Investors (FIIs)
Functions of Security Exchange Board of India
Powers of Security Exchange Board of India
Growth of Stock Market in India
Key Words
Questions
References
8 National Income
Meaning and Definition of National Income

Concepts of National Income
National Income Estimates in India
Methodology of National Income Estimation in India
Savings and Investments
Trends in National Income Growth and Structure
Causes for the Slow Growth of National Income in India
Suggestions to Raise the Level and Growth Rate of National Income in India
Major Features of National Income in India
Difficulties or Limitations in the Estimation of National Income in India
Key Words
Questions
References
9 Industrialisation and Economic Development
Concept and Meaning of Industrialisation
The Pattern of Industrialisation
Relative Roles of Public and Private Sectors
Inadequacies of the Programme of Industrialisation
Role of Industries in the Economic Development
Industries During the Plan Period
Recent Industrial Growth
Central Public Sector Enterprises (CPSEs)
Micro and Small Enterprises (MSEs)
Corporate Profitability and Investment
Industrial Sickness
Environmental Issues
Challenges and Outlook
Key Words
Questions
References
10 Foreign Trade Policy and Balance of Payments
Foreign Trade Policy and Balance of Payments
Main Features of India’s Trade Policy

Phases of India’s Trade Policy
India’s Foreign Trade Policy, 1991
Major Trade Reforms
Assessment of the New Trade Policy
Balance of Payments (BoPs)
Current Account Deficit (CAD)
Capital Account Deficit
Other Non-debt Flows
Key Words
Questions
References
11 Poverty in India
Concept, Meaning, and Definition of Poverty
People Living Under Poverty Line
Causes of Poverty in India
Historical Trends in Poverty Statistics
Poverty and Inclusive Growth
Factors Responsible for Poverty
Measures to Reduce Poverty
Poverty Alleviation Programmes
Poverty Alleviation Through Micro-credit
Outlook for Poverty Alleviation
Controversy over the Extent of Poverty Reduction
Case
Key Words
Questions
References
12 Unemployment in India
Concept, Meaning, and Types of Unemployment
Nature of Unemployment in India
Magnitude of Unemployment
Factors Responsible for Unemployment

Steps to Reduce Unemployment
Government Policy Measures to Reduce Unemployment
Overview of Unemployment and Underemployment
Case
Key Words
Questions
References
13 Inflation
Meaning and Definition of Inflation
Features of Inflationary Economy
Measures of Inflation
Inflation and Developing Economies
Demand-pull vs Cost-push Inflation
Causes of Inflation
Effects of Inflation
Global Inflation and India
Case
Key Words
Questions
References
14 Human Development
Concept of Human Development
Meaning and Importance of Human Resource
How to Attain Human Development
Human Development and Gender Situation
Growth of Human Development
Human Development Report (2007–08)
Overview of Human Development
Case
Summary
Key Words
Questions
References
15 Rural Development
Concept, Meaning, and Definition of Rural Development
Integrated Rural Development
Important Features of Rural Economy and Rural Society
Scope of Rural Development
Interdependence Between Rural and Urban Sectors
Strategies for Rural Development
Rural Water Supply and Sanitation
Women and Child Development
Rural Development: A Critical Analysis
Key Words
Questions
References
16 Problems of Growth
Parallel Economy
Regional Imbalances
Social Injustice
Case
Key Words
Questions
References
17 Direct and Indirect Taxes
Introduction
Income Tax
Corporate Tax
Wealth Tax
Excise Duties
Customs Tariff
Central Sales Tax (CST)
Modified Value Added Tax (MODVAT)

Central Value Added Tax (CENVAT)
Value Added Tax (VAT)
Case
Summary
Key Words
Questions
References
18 MRTP Act, FERA, and FEMA
Monopolies and Restrictive Trade Practices Act (MRTP), 1969
Foreign Exchange Regulation Act (FERA), 1973
Foreign Exchange Management Act (FEMA), 1999
Case
Key Words
Questions
References
19 Business Ethics
Ethics and Values
Relevance of Ethics in Business
Benefits of Ethical Business
Importance of Business Ethics
Values in Business
Inculcating Values in Management
Categories of Business Values
Need for Ethics in Global Change
Managing Ethics
Impact of Globalisation on Business Ethics
Business Ethics as Competitive Advantage
Business Ethics in India
Case
Summary
Key Words
Questions
References
20 Corporate Governance
Definition
The Need and Importance of Corporate Governance
Problems of Corporate Governance
Best Practices in Corporate Governance: An Indian and International Position Review
The Board—Key to Good Corporate Governance
Disclosure and Transparency: Partners of Good Governance
Executive and Non-Executive Directors
Brief Review of Overseas Development on Governance Issues
The Search for a New Approach to Corporate Governance
Code of Conduct for Corporate Governance
Measures to Improve Corporate Conduct
Corporate Governance and India
Challenges Before Managers
Corporate Governance and Some Indian Organisations
Regulatory Framework of Corporate Governance in India
Case
Summary
Key Words
Questions
References
21 Social Responsibility of Business
Origin and Growth of Concept
Definition Through Various Dimensions
The Need for Social Responsibility of Business
Social Responsibilities of Business Towards Different Groups
Barriers to Social Responsibility
Corporate Accountability vis-à-vis Social Responsibility
Challenges for Social Responsibility of Business
Emerging Perspectives for Corporate Social Responsibility

Social Responsibility of Business in India
Case
Summary
Key Words
Questions
References
22 Liberalisation
Background
Policy Changes
Economic Liberalisation
Meaning of Liberalisation
The Path of Liberalisation
Reform Achievements
Industrial Growth
Future Expectations
Liberalisation—An Assessment
Liberalisation and Growth of Indian Economy
Issues and Challenges
Case
Key Words
Questions
References
23 Privatisation and Disinvestment of PSUs
Public Sector Enterprises (PSEs)—The Necessity
A Decade of Performance
Concept, Meaning, and Objectives of Privatisation
Disinvestment Strategies
The Board for Reconstruction of Public Sector Enterprises (BRPSE)
The New Disinvestment Policy and Programme
Case
Summary
Key Words
Questions
References
24 Globalisation
Background
Views of Scholars on Globalisation
Studies on Globalisation
Efforts of Anglo-Americans
Salient Aspects of Globalisation
Role of Transnational Corporations (TNCs)
Concept and Meaning
Definition
Features
Globalisation is Inevitable
Ten Rules of Global Reforms
India and Globalisation
Government’s Measures Towards Globalisation
Globalisation and Its Impact on the Indian Industry
Effects of Globalisation
Pro-globalisation
Anti-globalisation
Globalisation—An Assessment
A Critical Appraisal of Globalisation
Threats to Globalisation
Case
Summary
Key Words
Questions
References
25 Foreign Investment
Meaning
Need for Foreign Investment
Adverse Implications of Foreign Investmen

Determinants of Foreign Investmen
Government Policies
New Policies
A Comparative Statistical Outline of FDI
Case
Summary
Key Words
Questions
References
26 Multinational Corporations
Origin
Meaning
Definition
Objectives
Reasons for the Growth of MNCs
Favourable Impact of MNCs
Harmful Effects of the Operations of MNCs on Indian Economy
Domination of MNCs over Indian Economy
Liberalisation and MNCs
Assessment
Future of MNCs
A Critique of MNCs
MNCs Deal a Blow to Domestic Companies
Case 1
Case 2
Summary
Key Words
Questions
References
27 India’s Import–Export Policies
Historical Perspective
Liberalisation Policy of Exim

Exim Performance
Exim Policies
India’s Exim Performance
Trade Scenario
Exports
Imports
Export Promotion Measures
Special Economic Zones (SEZs)
Agri-export Zones(AEZs)
Highlights of Foreign Trade Policy (FTP), 2004–09
Case
Summary
Key Words
Questions
References
28 Special Economic Zones in India
Concept and Meaning of SEZ
The History of SEZ
Definition of SEZ
SEZs in India
Benefits from SEZs
Important SEZs in India
Features and Facilities of SEZs in India
SEZ and Export Promotion
SEZ Policy of India: SEZ Act and SEZ Rule
Salient Features/Provisions of SEZ Rules
SEZ Controversy
SEZs—A Global Overview
Conclusion
Case
Key Words
Questions
References
29 International Business Environment
Nature of International Business Environment
Trends in the World Trade and Economic Growth
General Agreement on Tariffs and Trade (GATT)
General Agreement on Trade in Services (GATS)
International Organisations
International Monetary Fund (IMF)
World Bank (WB)
An Evaluation of IMF–WB
World Trade Organization (WTO)
International Finance Corporation (IFC)
Asian Development Bank (ADB)
United Nations Conference on Trade and Development (UNCTAD)
United Nations Industrial Development Organization (UNIDO)
International Trade Centre (ITC)
Generalized System of PQuestions (GSP)
Global System of Trade PReferences (GSTP)
Case
Key Words
Questions
References
30 World Trade Organization
Background
Meaning and Agreements
Functions
Principles of Trading
Provisions for Developing Countries
Other Provisions
The WTO Agreement
Liberalising Trade in Goods
Textiles—Back in the Mainstream Rules

Agriculture: Fairer Markets for All
Trade Remedies
Standards and Procedures
Administrative Procedures
Investment Measures
Disputes Settlement Mechanisms
Ministerial Meetings
Trade-related Intellectual Property Rights (TRIPS)
Trade-related Investment Measures (TRIMs)
Non-tariff Barriers (NTBs) and Dispute Settlement Mechanism
Anti-dumping Measures
Subsidies
Singapore Ministerial Meeting, 1996
Geneva Ministerial Meeting, 1998
Seattle Ministerial Meeting, 1999
Doha Ministerial Meeting, 2001
Cancun Ministerial Meeting, 2003
WTO from 2005 to 2008
Geneva Package, 2004
Hong Kong Ministerial Conference, December 2005
Key Outcomes and Timelines of the Hong Kong Ministerial Declaration of WTO
Recent WTO Proposals
Conclusion
Summary
Key Words
Questions
References
GLOSSARY
BIBLIOGRAPHY
About the Author
Shaikh Saleem, M.Com., LLB, MBA and Ph.D., is the director of the Maulana Azad Educational
Trust’s Millennium Institute of Management, Aurangabad. He has over 25 years of experience in
industry, teaching and research. His areas of expertise are Business Law, Business Economics and
Management. He has been awarded the Innovative B-School Leadership Award by the DNA and the
Stars of the Industry Group in 2009. Dr Saleem has published numerous research papers and articles
in various national and international journals and newspapers, notable among which are “Micro
Finance and Inclusive Growth”, “Social and Environmental Issues”, “Public Expenditure on Higher
Education”, etc. “Consequences of Iraq War! Who is responsible?”, “Nationalisation: The Way
Forward”, “Re-think Capitalism and Free Market” are some of the articles published by him in
national dailies.

In the loving memory of Dr Rafiq Zakaria, who showed us a new way of living.
Foreword
The business environment in India is undergoing a dynamic change; what was looked upon as an
underdeveloped nation is now regarded as a potential economic power, struggling to take strides in
the service industry, providing multinational companies with unparalleled opportunities. Already,
India is moving to tune in to the requirements of global markets and taking concrete steps to generate
more employment.
“Brain drain”, which had been the subject of extensive talk in corporate circles, has now been
replaced by “brain gain”. The Murthys and Premjis are gaining international recognition; the Tatas
are entering into several collaborations abroad.
However, the development process is still evolving. There has, no doubt, been an accelerated shift
from the traditional and inward-looking policy to a much more forward-looking framework. With
liberalisation and privatisation taking place in almost all major sectors of the economy, the nature and
extent of the role of the state is undergoing fundamental changes; these are excellent portents.
Reforms in all sectors are on the anvil, especially for the much neglected agriculture sector, which
is receiving special attention from the government. It is hoped that with the new measures introduced
it will transform rural India. In this changing environment of such gigantic dimensions, this book by
Dr Shaikh Saleem, detailing the various factors of what exists and what promises to change is a most
welcome effort. Dr Saleem is a scholar of repute and an administrator of high standing. He has had a
varied and rich educational background as well as industrial experience. His approach is analytical
and comprehensive. His book captures major areas of Indian economic development in recent years,
and attempts to analyze them and their impact on corporate adjustments and industrial management.
This book will provide a broad review of the various steps taken by successive governments since
independence. What had been done right? What has gone wrong? This book goes into all aspects of
economic development and presents an overall picture in all its hues. It contains a wealth of
information and I am sure the book will prove to be a valuable addition to the study of the complex
new challenges facing India today.

RAFIQ ZAKARIA
Preface to the Second Edition
The business environment has undergone momentous changes in the last few years and the world
economic scenario has altered significantly since the publication of our first edition in 2006.
The ongoing economic recession, which had its origin in the US, brought the entire world
economy in turmoil, having both direct and indirect impact on the economic development. It has also
compelled us to rethink capitalism and gratuitous privatisation without regulation even in those
countries which are traditionally committed to free trade.
In India, besides economy, political developments, which have a direct bearing on the shaping of
our economic policy, are also a matter of grave concern. The occurrence of such events in our
neighbourhood as the assassination of Benazir Bhutto and the subsequent turmoil in Pakistan, the
change of guards in Nepal as well as in Bangladesh, and the ethnic conflict in Sri Lanka have created
a major impact on the Indian politics. The 26/11 terrorist attack in Mumbai has also done enough
damage in matters of our security concerns and largely affected FDI in times of grave financial crisis.
Moreover, the world economic recession has compelled a large number of expatriate Indians to
return back home, thereby, adding to the unemployment problems.
The above developments, along with the overwhelming response and encouraging feedback from
the users of this book have prompted us to go for a revision of the first edition.
The revised edition presents a thorough overhaul of the earlier version and is updated with the
latest information and developments and also new chapters have been added to keep pace with the
rapidly changing economic and political scenario of the world.
Ten new chapters have been added to give a further impetus to the inclusiveness of the subject—
“Stock Exchanges in India”, “National Income”, “Industrialisation and Economic Development”,
“Foreign Trade Policy and Balance of Payments”, “Poverty in India”, “Unemployment in India”,
“Inflation”, “Human Development”, “Rural Development”, “Special Economic Zones in India”.
The first edition was profusely endorsed by various reputed institutions like the Indian Institute of
Management (IIM), Indore, IIM Lucknow, Osmania University, Gauhati University, Uttar Pradesh
Technical University and various other B-schools and colleges for their M.B.A., M.Com, B.Com,
B.B.A. and other management and economics courses.
I am very much hopeful that the revised edition will prove even more rewarding for the students,
academicians and researchers alike.
Preface
India’s economic policies during the pre-liberalisation era were characterised by strong centralised
planning, government ownership of basic and key industries, excessive regulation and control of
private enterprise, trade protectionism through tariff and non-tariff barriers, and a cautious and
selective approach towards foreign investment and MNCs, dependent on regime-guided and
bureaucracy-controlled quotas, permits and licenses.
During early 1980s, these inward looking economic policies began to be widely questioned. Policy
makers started realizing the drawbacks of this strategy, which curbed competitiveness and efficiency,
produced a much lower rate of growth than expected and led to inferior-quality, highcost domestic
production.
During the 1990s, the economy was virtually on the verge of financial disaster, threatened by the
precarious balance between payment and current account deficit, as well as a huge budget deficit.
Insufficient foreign exchange to meet import needs had resulted in gold being mortgaged to the Bank
of England to save the country from defaulting on international debt repayments. Restructuring the
economy was the only alternative available to stem this drift . Consequently, economic reforms were
introduced. The new industrial policy announced by the Government of India on 24 July 1991 proved
to be a watershed in the post-independence history of India.
In the newly liberalised industrial and trade environment, the government allowed competition and
market forces to guide investment decisions. It progressively assumed the roles of promoter,
facilitator and catalytic agent instead of a controller and licenser of private economic activities. With
progressive liberalisation, privatisation and globalisation, the business environment in India has
become increasingly international.
It is with this environment in mind that the University Grants Commission introduced Business
Environment as a subject for B.Com, B.B.A., M.Com and M.B.A. courses. This book has been written
in accordance with those B.B.A., B. Com, M.Com and M.B.A. courses outlined in the UGC model
curriculum.
The book has a number of distinguishing features, including thorough discussions on the
conceptual framework of each chapter, comprehensive coverage of government policies, and
detailed, student-friendly discussions on liberalisation, privatisation, globalisation and the WTO.
In each chapter, boxes containing brief information have been provided. The objective is to enable
students to test and affirm the knowledge acquired by them in a particular chapter. A large number of
tables containing statistical data are provided with an aim to support the conceptual input provided in
the text. At the end of each chapter, a case study has been discussed to help students analyse the
complex issues encountered in real-life business situations. Keywords, provided at the end of each
chapter, will help students understand the subject faster and enhance their vocabulary. A consolidated
list of all the resources referred to in each chapter is given next to the key words for ready reference.
This book has been designed to keep in view the standard requirements of students of business
management, commerce and economics at graduate and post graduate levels. It can, however, equally
serve the purpose of a business manager who needs to understand the business environment
configuration to make corporate decisions. Candidates aspiring to compete for professional courses
and jobs will also find it a valuable source.
I express my thanks and gratitude to all those who have helped, encouraged and supported me
through this project. My special thanks and gratitude to Dr. Rafiq Zakaria, founder of the Maulana
Azad Educational Trust and Society, an intellectual and educationist, who encouraged and supported
me in this endeavor and wrote the foreword to this book. His sudden death on 9 July 2005 has
deprived us of a visionary, a scholar and a statesman who rendered a yeoman’s service to the nation. I
dedicate this book to him for his immense efforts toward the cause of education.
My thanks also go out to Mrs Fatma Rafiq Zakaria, Chairperson of the Maulana Azad Educational
Trust and Society, for her support of the project. Thanks are due to my institutions—the Millennium
Institute of Management and the Tom Patrick Institute of Computer and Information Technology—
and their staff . Thanks are due to my staff, specially Mrs Vidya Gawli, Mr Imran Khan, Ms Afsha
Dokadia, Mr Asrar Ahmed and my family.
I alone am responsible for any mistakes and oversights that might have remained, and suggestions
for further improvement are always welcome.

SHAIKH SALEEM
CHAPTER 01
Business Environment
CHAPTER OUTLINE
Introduction
Salient Features
Importance of the Study
Business Environment and Strategic Management
Market Opportunities
Distribution of Household by Income, 1990–2000
Recent Political Environment
Recent Economic and Financial Environment
Case
Summary
Key Words
Questions
References
INTRODUCTION
Every business organisation has to interact and transact with its environment. Hence, the business
environment has a direct relation with the business organisation. Obviously then, the effectiveness of
interaction of an enterprise with its environment primarily determines the success or failure of a
business.
The environment imposes several constraints on an enterprise and has a considerable impact and
influence on the scope and direction of its activities. The enterprise, on the other hand, has a very little
control over its environment. The basic job of the enterprise, therefore, is to identify with the
environment in which it operates and to formulate its policies in accordance with the forces which
operate in its environment. Every business organisation has to tackle its internal and external
environment. For example, a committed labour force provides an internal environment of any
business, whereas the ecological factors determine the external environment. While the internal
environment reveals an organisation’s strengths and weaknesses, the external environment reflects the
opportunities available to the organisation and the threats it faces.
India has a developing economy with abundant natural resources, large population, and a low level
of per capita national income. Although a substantial liberalisation has been envisaged for the
country, the economic activities are still considerably controlled by the government. A low standard
of living, backed by a vicious cycle of poverty, for a considerable section of population and about
250 million people under the poverty line, coupled with a considerable concentration of economic
power in few hands, characterise the Indian economy.

A low standard of living, backed by a vicious cycle of poverty, for a considerable section of population and about 250
million people under the poverty line, coupled with a considerable concentration of economic power in few hands,
characterise the Indian economy.
MEANING AND DEFINITION
“Environment” literally means the surroundings, external objects, influences, or circumstances under
which someone or something exists. Keith Davis defines the environment of business as “the
aggregate of all conditions, events, and influences that surround and affect it” (Davis and Blomstrom
1971).

“Environment” literally means the surroundings, external objects, influences, or circumstances under which someone or
something exists.
There are two sets of factors—internal and external—which influence the business policy of an
organisation. The internal factors are known as controllable factors because the organisation has a
control over these factors. It can modify or alter such factors to suit the environment. The external
factors are known as uncontrollable factors because they are largely beyond the control of an
individual enterprise.

Business policies of an organisation are influenced by its environment, which is the aggregate of all conditions, events, and
influences that surround and affect it.
The internal environment consists of a large number of factors which contribute to the success or
failure of an organisation. It refers to all the factors within an organisation, which impart strength or
create weakness of a strategic nature. Strength is the inherent capacity of an organisation which can be
used to gain strategic advantage over its competitors. On the other hand, the weakness of an
organisation refers to its inherent limitation or constraint which creates a strategic disadvantage.
The important internal factors include the following:

1. Organisational resources,
2. Research and development, and technological capabilities,
3. Financial capability,
4. Marketing capability, and
5. Operations capability.
The term “business environment” generally refers to the external environment and includes factors
outside the firm which can lead to opportunities for or threats to the firm. Although there are many
external factors, the most important factors are economic, governmental, legal, technological,
geographical, and social.
SALIENT FEATURES
The nature of the environment is likely to determine, to a great extent, the role of the enterprise and
hence, the nature of the task and the role of the top management, in general, and that of the chief
executive, in particular. The salient and distinct features of the environment in which the enterprise
operates determine the nature of its business policy.
Public policies must be consistent with and conducive to creating confidence among business
enterprises, in particular, and people at large, in general. Obviously, government regulations need to
motivate the business community to make use of opportunities to actively participate in the task of
developing the economy, on the one hand, and increasing the living standards of the people, on the
other.
Rapid social change leading to a transformation of the society has become the order of the day.
Industrialisation and the resultant urbanisation have given birth to a certain level of social
disorganisation, while an industrial society has emerged in the place of a traditional social setup.
Now, the industrial workforce in India represents the most organised segment of our society. They
are, perhaps, most aware of their rights and are fighting for the same. The struggle for protecting
their interests is likely to be a continuing feature, particularly in the face of threats posed by the
adoption of newer technologies.

Industrialisation and the resultant urbanisation have led to a transformation in the social setup. It has given birth to an
industrial workforce, which is very organised and more conscious of its rights.
Every company’s policy is, in many ways, affected by its environment because the accomplishment
of its objectives depends largely on the degree of interaction of the enterprise with its environment.
The environment imposes several constraints on the enterprise and has a considerable impact and
influence on the scope and direction of its activities. The nature of business environment in India is
dominated by the government regulations with a view to ensure a certain level of economic life to the
people. Not only government regulations, but also any fluctuation in the environment has an impact
on the existing business canvas.
Taking care of the nature of business environment enables the corporate policymaker to
1. Perform the critical function of matching the needs of the society and the capacity of the goods and services to satisfy the needs
of the people,
2. Adapt the organisation itself to the dynamic conditions of the society,
3. Match the organisational policies and resources with the social needs, and
4. Contribute to the social responsibility of business.
Thus, a business policy should be matched with the specific needs of the customer, produces, and the
society at large. It means that the organisation has to focus itself on its environment.
A constant focus of the business organisation on critical aspects, such as customer satisfaction,
product development to satisfy specific needs of the society, how the products and services offered by
the organisation are capable of meeting the social and environmental needs, and so on, would enable
the organisational policies to identify with its business environment. Actually, environmental changes
strongly influence the organisation, through its customers, its market or channels of distribution
banking community, suppliers, and so on.

Any business organisation should keep its focus on critical aspects, such as product development and customer satisfaction,
with a view to meeting social and environmental needs.
IMPORTANCE OF THE STUDY
Before analysing the various external environmental factors, let us consider the importance of the
study of the business environment:
1. It helps an organisation to develop its broad strategies and long-term policies.

2. It enables an organisation to analyse its competitor’s strategies and, thereby, formulate effective counter strategies.
3. Knowledge about the changing environment will keep the organisation dynamic in its approach.
4. Such a study enables the organisation to foresee the impact of socio-economic changes at the national and international level on
its stability.
5. Executives are able to adjust to the prevailing conditions and, thus, influence the environment in order to make it congenial for
business.
ENVIRONMENTAL FACTORS
Many factors can be included in the category of environmental factors—social, economic, cultural,
geographical, technological, political, legal, and ecological factors; in addition to government
policies, labour factors, competitive market conditions, locational factors, emerging globalisation,
and so on. According to writers like W.F. Glueck and I.R. Jauch, the environment includes the factors
outside the firm which can lead to opportunities or threats to the firm. Although there are many
factors, the most important of the factors are socio-economic, technological, suppliers, competitors,
and government. We may examine some of these environmental factors briefly here.
Social Factors
Every business organisation operates within the norms of the society and exists primarily to satisfy its
needs. Hence, a business organisation has an important position in the social system. It has a social
responsibility. While the social factors influence the policy and strategy of business, the organisation
strives to satisfy the needs and wants of the society.

Every business organisation has a social responsibility. It operates within the norms of the society and strives to satisfy the
needs and wants of the society.
There are many social factors which affect the policy and strategy of corporate management.
Culture, values, tastes and preferences, social integration and disintegration, and so on must be a part
of the agenda of every business organisation. While social institutions are closely linked with
business organisations, business itself is a social institution. As observed by Keith Davis and Robert
Blomstrom, business is a “social institution performing a social mission and having a broad
influence on the way people live and work together” (Davis and Blomstrom 1971).
Economic Factors
Economic factors, such as per capita income, national income, resource mobilisation, exploitation of
natural resources, infrastructure development, capital formation, employment generation, propensity
to consume, industrial development, and so on, influence the business environment. Besides all these,
the economic performance of a country also determines the business environment. India’s economic
performance has been erratic in the 1980s. Although planned economic development has resulted in a
considerable economic growth over the years, political instability has resulted in a slow industrial
progress, price instability, high inflation rates, foreign-exchange crises, and so on. Above all, a
country’s progress is determined by its economic system too. The three types of “Economic Systems”
are given in Box 1.1.

The economic factors that influence a business environment are per capita income, national income, infrastucture
development, capital formation, resources mobilisation, exploitation of natural resources, etc.
Box 1.1 Economic Systems
There are three types of economic systems—capitalism, communism, and mixed.
1. Capitalism believes in private ownership of production and distribution facilities. The United States, Japan, and the United
Kingdom are examples of capitalist countries.
2. Communism is a system where the state owns all the factors of production and distribution. Cuba is an example of the last
remaining predominantly communist country.
3. Mixed economic system is one where the major factors of production and distribution are owned, managed, and controlled
by the state. France, Holland, and India are examples of mixed economies.
Cultural Factors
The cultural factors of a business environment should also be taken into consideration while scanning
the environment and during the policy formulation. Managers and policymakers in a global business
cannot disregard cultural variables like social and religious practices, education, knowledge, rural
community norms and beliefs, and so on, which are predominant in India, especially in the rural
society. Sociological and cultural factors are also very significant in the rural communities in India.
Social stratification plays a vital role in rural societies while cultural differences are unthinkable for
any international manager or even an urban Indian manager.
Geographical Factors
In a global business environment, geographical locations, seasonal variations, climatic conditions,

and so on, considerably affect the tastes and preferences of customers, and also prospects and the
labour force. The policies of the government regarding industrial locations are considerably
influenced by the pace of development in various geographical locations. Business policymakers,
particularly managers in a global business environment must, therefore, consider such geographical
factors analytically.

Geographical locations, seasonal variations, climatic conditions, and such other factors considerably affect the tastes and
preferences of customers. Hence, business policymakers must consider geographical factors analytically.
Technological Factors
Technology is considered to be one of the most important factors of any business environment. That
is why the government, in its industrial policy resolutions, industrial licensing policies, MRTP and
FERA regulations, and even in liberalisation policies, has assigned a great importance to
sophisticated technology and technology transfer. Foreign investment upto 100 per cent is allowed in
industries with sophisticated technology. Late Prime Minister Rajiv Gandhi’s vision of a modern India
was of a technology-based nation. Technology imports and foreign technical collaboration were
allowed for this purpose. Since technology develops rapidly, technological factors must be taken into
consideration by managers and policymakers.
Political Factors
The philosophy and approach of the political party in power substantially influences the business
environment. For example, the Communist-ruled state of West Bengal had the largest number of
industrial disputes and mandays lost through agitation. Similarly, during the Janata party rule at the
Centre, IBM and Coca Cola had to wind up their business. At the time of Congress rule, the stock
prices went up, whereas the stock market crashed during the unstable minority government of the
National Front. In the Kingdom of Saudi Arabia, the business environment and the social system are
regulated largely by Shariat (Islamic religious law). Thus, the management of business enterprises
and their policies are considerably influenced by the existing political systems.
Legal Factors
Every aspect of business is regulated by a law in India. Hence, the legal environment plays a very vital
role in business. Laws relating to industrial licensing, company formation, factory administration,
industrial disputes, payment of wages, trade unionism, monopoly control, foreign-exchange
regulation, shops and establishments, and so on are examples of what forms the legal business
environment in India. Some of these legislations are examined in other chapters.
Ecological Factors
Ecology deals with the study of the environment, biotic factors (plants, animals, and
microorganisms), abiotic factors (water, air, sunlight, soil), and their interactions with one another.
Man is expected to preserve the ecological factors for achieving a sustainable growth. A change in
any biotic or abiotic factor causes ecological imbalance. Industrial activities, automobiles, emission
of fumes or smoke and effluents, and so on, result in an environmental degradation. Hence,
environmental protection and preservation must be the responsibility of every organisation or an
individual. Pollution-free industrial activity is, therefore, considered to be a necessary condition of
industrial organisations. The Government of India is committed to the preservation of ecological
balance.

Protection of the environment and preservation of ecological balance is the responsibility of every business organisation.
Pollution-free technology and recycling of industrial wastes and effluents have become a corporate
concern now. Legislative measures have also been adopted for this purpose. Important legislations in
this connection are as follows:
1. The Water (Prevention and Control of Pollution) Act, 1974 provides for the prevention and control of water pollution;
2. The Air (Prevention and Control of Pollution) Act, 1981 aims at preventing, controlling, and reducing air pollution; and
3. The Environment (Protection) Act, 1986 ensures the protection and improvement in the quality of the environment.
The government’s concern for protecting the ecological environment and preventing it from
degradation and pollution is very evident in these Acts.
The Government Policies
The government policies provide the basic environment for business. For instance, the government’s
policy to open up the Indian economy to integrate it with the global economy has resulted in
liberalisation. Industrial policy resolutions and licensing policies, trade policies, labour policies,
location policies, export-import policies, foreign-exchange policies, monetary and fiscal policies,
taxation policies, and so on, pave the way for business environment.
Labour Factors
Although labour within the organisation constitutes its internal environment, general labour policies
and climate may form a part of the external environment. If militant trade unionism is widespread in a
particular industrial location, such militancy would become the labour climate there and would make
an external element. At the same time, a specific organisation may have a committed labour force,
which could be the strength of the internal environment of that organisation.
Competitive Market Condition
Competitive market condition is an important environmental factor, especially in a global business

environment. In a socialistic economic environment, the market is controlled by a centralised
authority—the government—whereas the competitive forces determine the market in a fully capitalist
economy. India, which has accepted a middle path, had been fostering both the conditions. As a result
of liberalisation, some characteristics integrating the Indian economy with the global economy have
emerged. As a result, a competitive market condition has emerged in India, creating a competitive
business environment. A situation of perfect competition now exists in respect of various products,
for example, automobiles, consumer durables, and so on. In a competitive situation, the market forces
of demand and supply must interact with each other, providing a business environment. As a part of
globalisation, a competitive market has come to stay.
Locational Factors
Locational policies are adopted by many countries for attaining an economic balance. The
establishment of the Tennesse Valley Authority (TVA) for a regional planning in the United States is
an example. In India, the metropolitan cities and their suburbs have been active with business and
industrial activities, while many areas have continued to remain backward. In order to develop the
backward areas and to attain economic balance, an industrial dispersal policy has been adopted by the
government to boost business in India. The government policy in India is, therefore, to achieve a
dispersal of industrial activities to underdeveloped locations and to avoid industrial concentration in
developed areas. Government policies, viz., industrial policy, industrial licensing policy, incentive
policy, taxation policy, and even credit facilities ensure the meeting of these objectives.
BUSINESS ENVIRONMENT AND STRATEGIC MANAGEMENT
The process of globalisation has progressed fast, hailing the end of communism and socialism.
Business corporations and conglomerates are projecting themselves as global corporate citizens.
They formulate their perspectives and strategic planning for the global market, while operational
strategies are drawn for the local market also. In this context, an important point to be considered in
their corporate policy and strategy would be the Economic Blocs.

The process of globalisation has led the business corporations and conglomerates to project themselves as global corporate
citizens. With increased participation in global economy, corporate managers need to account for the nature and
environment of the economic bloc where they propose to operate.
The European Economic Community (EEC), North Atlantic Treaty Organisation (NATO), “Third
World” neutralist bloc, the Organisation of American States (OSA), Arab bloc, Organisation of
African Unity, Organisation of Petroleum Exporting Countries (OPEC), Non-Aligned Movement
(NAM), Association of Southeast Asian Nations (ASEAN), Commonwealth countries bloc, South
Asian Regional Cooperation (SAARC) bloc, European Free Trade Association (EFTA), Latin
American Free Trade Association (LAFTA), Central American Common Market, and so on are
important associations in the global perspective. Any new bloc can come into existence at any time,
which should be reviewed by the global manager today.
Corporate managers, who make policies and strategies, must account for the nature and
environment of the bloc, where they propose to operate. For example, the EEC countries made a
common economic bloc with a common market and a common currency by 1999. A company might
operate in a global market, but it must have a specific strategy option for the EEC common market.
The EEC market accounts for about one-fifth of India’s total exports. Upgrading the quality of goods
exported to EEC became necessary because of high-quality specifications. All the 12 member
countries laid emphasis on the improvement in quality standards. Hence, the Bureau of Indian
Standards (BIS) had a monumental task in laying down high standards for Indian goods exported to
EEC countries. The BIS collaborated with the European Commission in the programmes relating to
industrial standards, quality assurance, conformance testing, information technology (IT),
electronics, and telecommunication for standardisation and certification on a mutual basis.
The concept of a single market has already gained ground. Since the EEC bloc has special standard
specifications, all the countries in the community follow the same standards. On account of stringent
measures of quality standards in the EEC, it is possible for EEC standards to be accepted as
international standards. Thus an economic bloc substantially influences the business policy of every
player in the market. In the meanwhile, the NAM is getting stronger and more globally acceptable.
In a globalised business environment, business policymakers and strategic managers must
formulate strategies and policies not only globally but locally, with an emphasis on individual
economic blocs. In the changed environment in which communist-socialism has become irrelevant,
economic blocs may gain greater importance.

In a globalised business environment, business policymakers and strategic managers must formulate strategies and policies
not only globally but locally, with an emphasis on individual economic blocs.
The globalisation of business may imply a one world with a free market where there would be a
closer cooperation among different states with greater mutual trade regime under trade agreements.
Greater closer cooperation can also be expected among the member countries of different economic
blocs. Every economic bloc may have its own common agenda of programme and common purpose,
which should be tackled by the corporate strategic planner. Preserving sustainable environment,
especially ecological environment, and answering the call for social responsibility of business would
become a part of the global corporate strategy.
The managers must take into consideration the following factors while designing the policies.
Risk Overview
Overall assessment. India’s main security concern is its relationship with Pakistan. India’s political
system is well-entrenched, though states are gradually taking on more powers. Corruption is a
serious concern and bureaucracy and vested interests have hindered reforms. The legal system is
relatively impartial, but suffers from delay in meting out justice. The main imbalance in the economy
stems from large fiscal deficits. Although efforts are under way to clarify the tax system, it is still
quite complex and remains heavily dependent on customs duties. Although the labour market is
highly regulated, poor transport infrastructure is likely to be a significant deterrent to investment.

Corruption is a serious concern and bureaucracy and vested interests have hindered reforms. The legal system is relatively
impartial, but suffers from delay in meting out justice. The main imbalance in the economy stems from large fiscal deficits.
Security risk. India has several geographically discrete security concerns. A number of anti-Indian,
Islamic, and Kashmiri militant groups operate in the disputed state of Kashmir, and India has fought
two wars with Pakistan over the territory. Tensions with Pakistan have eased of late as the Indian
Prime Minister has made peace overtures to Pakistan; confidence-building measures—mainly sports
and transport links—have been introduced. Possession of nuclear weapons by both nations
perpetuates concerns about a large-scale war, though Cold War is always going on in the form of
frequent attacks from both sides. Militant groups operate in north-east India, which is an important
area for the production of both tea and oil. The communal clashes between Hindus and India’s large
Muslim minority are not infrequent.
Political stability risk. In the general elections of 2004, the Congress party came up as the ruling
party. But to attain the majority in the Parliament, they had to take the support of the CPI, CPI (M),
RJD, and so on. The country is still ailing with the disease of coalition parties because of which no
concrete decisions can be reached in an easy way. The Congress party is trying hard to bring in a new
wave of economic reforms which are hanging in doldrums as the Leftists do not support a single
suggestion put up by the Congress party. Box 1.2 shows the details. Currently the country has got the
best combination of politicians sitting on ministerial positions; we have Dr. Manmohan Singh as the
Prime Minister (PM) and P. Chidambaram as the Finance Minister (FM). (A lot is expected from both
of them). The Indian economy is currently portraying an unjust growth. What the country currently
needs is a political leadership with vision, but the political instability is hampering India’s growth.
India can become a superpower provided we get the right kind of leaders with a stable political
tenure.

Box 1.2 Reforms with a Human Face—Agenda of the New Government—2004
Momentous changes in the political scenario are striking at the very basis of economic reforms.
People, in general, are concerned about the course of economic reforms, particularly
privatisation under a Congress–Left alliance at the Centre. Dr. Manmohan Singh, known as the
forerunner of economic reforms in India, in his first press conference after assuming the office
of prime minister, reiterated that reforms with a human face would continue. Outlining his agenda
for the economic reforms, he named five major priorities for his government:
1. Strategic PSUs like the ONGC and GAIL as well as nationalised banks to remain in public sector.
2. The government to strengthen road network programme; the Golden Quadrilateral programme not to be scrapped.
3. Development to be a key priority; reforms to aim at removing poverty and increasing the employment.
4. Commitment of government to build strong private–public partnerships (PPP).
5. Economic reforms with a human face to be pursued
Box 1.3 Risk Assumption for Different Economic Systems
1. Capitalism: Losses assumed by owners. Many transfer business risks to other businesses through insurance.
2. Socialism: People assume risks of state-owned industries. Losses recovered from taxes.
3. Communism: Economic production owned by the state. Risk assumed by the state. Losses reduce the standard of living.

Government effectiveness risk. This risk is high. The divergent interests of the members of
India’s coalition government have hindered the introduction of rapid reforms and have led to
concessions to groups affected by reforms, which have negated their intended impact. Although
senior civil servants are generally professional, those further down the line are often resistant to
change. The privatisation programme is continually hindered by vested interests, not wishing to lose
their power over state-owned companies. The Supreme Court has ruled that the sale of two major oil
refineries requires parliamentary approval, delaying further the privatisation. Significant red tape is
one of the main reasons behind the lack of foreign investment and the mass of regulations relating to
workplaces provide inspectors with opportunities to demand payment for overlooking the numerous
and outmoded regulations. Corruption is a major problem.
Legal and regulatory risk. Indian legal system is relatively impartial, free, and fair. It is also
notoriously slow. Disputes often take years to resolve and, as a result, many foreign companies build
in clauses allowing for international arbitration of disputes. The regulatory system is not immune
from policy reversals due to pressure from vested interests and inter-ministry rivalries. However,
more transparent regulatory systems are being introduced in the previously unregulated sectors. For
instance, as the power sector is broken up, new regulatory bodies are being established. The risk of
outright nationalisation is very small, but creeping nationalisation, in which the goalposts are
changed to the benefit of domestic companies, has caused the foreign companies to withdraw from
India. This has been particularly true in the power sector, which has seen an exodus of foreign
investors.

Indian legal system is relatively impartial, free, and fair. However, the regulatory system is not immune from policy reversals
due to pressure from vested interests.
Macro-economic risk. This risk is low in India. The economy was forecast to grow by 7.9 per cent
(at factor cost) in 2003–04. The major driver of growth was the services sector. Agriculture suffered
from poor rainfall in the second half of 2002 but rebounded strongly in 2003-04 as a result of the
above-normal rainfall. Spending on major infrastructure projects helped to sustain the industrial
output. Consumer price inflation was set to rise in 2004–05, as industrial bottlenecks emerged. The
major macro-economic imbalance is on the fiscal side—the combined national and state deficit is
more than 10 per cent of gross domestic product (GDP). Weak GDP growth in 2002–03 (April–
March) kept the deficit high, and the 2003–04 tax-cutting budget, accompanied by pre-election
spending, prevented the deficit from falling in 2003–04. As the economy picked up, the relatively
high interest rates have resulted in the “crowding out” of private investment. Substantial liquidity has
also supported fast growth, raising a slight risk of overheating.
Foreign trade and payments risk. India faces little risk of a trade embargo. Some sanctions were
imposed as a result of India’s nuclear tests in 1998, but the sanctions focused upon lending to India
rather than trade, and therefore, the sanctions have since been lifted. The tariff system is being
rationalised, but high import duties have been imposed on some sectors to protect domestic
industries. Non-tariff barriers have also been applied, though India removed all quantitative
restrictions in April 2001. Special import licences were also abolished. In 2002, India took several
steps to ease agricultural exports and, thereby, increase exports as a share of GDP. External
commercial borrowing has been liberalised over the past decade, though several stipulations are still
in force. In 2003–04, India announced steps to further liberalise capital account transactions; these
will, among other things, allow greater outward investment and make hedging easier. However, in the
event of an economic crisis, these changes could be withdrawn.

In 2002, India took several steps to ease agricultural exports and, thereby, increase exports as a share of GDP. In 2003–04,
it announced steps to further liberalise capital account transactions; these will, among other things, allow greater outward
investment and make hedging easier.
Tax policy risk. This risk is a moderate one. Indian tax system is heavily reliant on excise and
customs duties. The tax system is complex, with numerous allowances and surcharges. The
government hopes to consolidate all the states’ sales taxes into a single value-added tax (VAT), but
conflicts between the states and the Centre have resulted in delays; VAT was set to be imposed in April
2003, then in June, but was delayed owing to protests by shop-owners.
Finally, the VAT was introduced from April 1, 2005. India’s tax system is susceptible to tax evasion,
and the underground economy is estimated to be around half the size of the official economy. The
highest rate of tax on profits for foreign companies is 41 per cent, including a surcharge. Locally
incorporated companies are taxed at just under 36 per cent and are entitled to incentives available to
Indian companies. To address anomalies in the tax system, a government panel in November 2002
recommended that India’s tax system be massively overhauled to encourage voluntary compliance
and penalise non-compliance, but these recommendations have been ignored.

To address anomalies in the tax system, a government panel in November 2002 recommended that India’s tax system be
massively overhauled to encourage voluntary compliance.
Labour market risk. Indian labour market is restricted by a number of laws and regulations, of
which the most important are those concerning the retrenchment of employees. Companies
employing more than 100 workers need government permission to lay off workers and this
permission is often withheld. Such restrictions have hindered foreign investment in India.
Labour relations in India are relatively poor, but the incidence of strike action in the private sector
has declined in recent years. However, strikes in protest at proposed privatisation have been relatively
commonplace. Unions are generally company- rather than industry-based and are linked to national
labour groups, many of which are affiliated to political parties.
Financial risk. The recent strength of India’s currency, the rupee, has caused increasing concerns
among exporters. After years of depreciation, the rupee stabilised in mid-2002 and has since
appreciated, owing to dollar weakness, significant capital inflows, and the sustained current-account
surplus. There is a risk that tension with Pakistan could cause a sudden depreciation in the currency.
The banking sector is dominated by the state-owned banks. The level of non-performing loans is
high, though falling in part because of the development of asset-reconstruction companies. Given that
the dominant banks are state-owned and private banks have much lower portfolios of non-performing
loans, a systemic banking sector crisis is unlikely. The stock market has suffered from a number of
scandals but the long-run impact of several changes to improve stock market regulation should be
positive. Huge foreign inflows, exceeding US$7 bn in 2003, have supported a stock market boom.

After years of depreciation, the rupee stabilised in mid-2002 and has since appreciated, owing to dollar weakness,
significant capital inflows, and the sustained current-account surplus.
Infrastructure risk. India’s infrastructure risk is high. Port facilities are overstretched. Both road
and rail links are run down. Although the government has increased funding to both, progress is
likely to be slow. The rail network is not funded adequately and a rapid improvement is highly
unlikely. The power system is a significant hindrance to business. Politically motivated, free
provision of power to some sectors of the population has placed the electricity-supply companies in a
poor financial position. This, in turn, has affected electricity generation, so that power supplies are
erratic and companies, offices, and some private houses use their own back-up generating facilities.
Despite India’s successes in IT, computer and Internet access is not widespread. Air transport facilities
are being upgraded, particularly at the international airports. The retail system is developing rapidly
but remains generally backward. Shopping malls are being established, particularly in Delhi and
Mumbai.

In India, infrastructure risk is high. Although the government has increased funds for upgradation of infrastructural
facilities, like rail network, air transport, power generation, etc., progress is likely to be slow.
Country risk. Country risk is exposure to a loss in cross-border lending, caused by events in a
particular country. These events must be, at least to some extent, under the control of the government
of that country and not under the control of a private enterprise or an individual. Major sources of
country risk are contained in frequent swings in content, objectives, or implementation design of
macro-policies, including monetary policy, fiscal policy, anti-inflationary policy, exchange-rate
policy, foreign trade policy, policy towards foreign investments and multinational corporations,
industrial policy, agriculture policy, income policy, and policy towards major social sectors. All
cross-border lending in a country, whether to the government, a bank, a private enterprise, or an
individual, is exposed to country risk. Country risk is, thus, a border concept rather than a sovereign
risk, which is the risk of lending to the government of a sovereign nation. Further, only events that
are, at least to some extent, under the control of the government can lead to the materialisation of a
country risk.

All cross-border lending in a country, whether to the government, a bank, a private enterprise, or an individual, is exposed
to country risk. Country risk is, thus, a border concept rather than a sovereign risk.
The various country risk factors affect individual corporate organisations in a number of ways.
The effect varies from organisation to organisation, depending upon its vulnerability to such factors.
Many of these factors are interrelated and exert a joint impact. A fiscal deficit, for example, may be
followed by an increase in taxes and money supply, further leading to a rise in the rate of inflation.
Table 1.1 shows the above risks with their ratings too, as an overview.

Table 1.1 Risk Overview
Source: National Council of Applied Economic Research, India Market Demographics Report 2002.
Note: E = most risky; 100 = most risky.
The risk-rating model is run once a month.

Table 1.2 Checklist of Political Risk Indicators
Political Environment Foreig n Pressures Economic Pressures
Form of government
Government crisis
History of government stability Threat of war
Economic crisis
Legal system Military-related violence
Balance of payments
Party fractionalisation Diplomatic crisis, party political
Inflation rate
Religious or ethnic splits platforms
Exchange-rate volatility
Trade-dispute volatility of Alliances
Income distribution
electorate Role of military
Support of ruling party
Tax reforms
Methods of Assessing Environment Risk
All types of risks keep changing and a firm’s reaction or response depends mainly on its own
perception of assessment of risk. Therefore, large domestic firms and multinational enterprises are
more aware of the risk factors and are making efforts to reduce them. Some of the following
environment-risk assessment methods are useful for both domestic and foreign firms.

An organisation’s reaction or response to any kind of risk to the business environment depends on its own perception of
assessment of risk. To assess and analyse the risks, companies may follow certain methods like taking an expert opinion or
having checklists and rating systems.
Expert Opinion
The traditional method of analysing environmental changes relies on an expert’s opinion. The firm
seeks the subjective judgement of people who are well-informed about the current state of the
environment and its reading determinants. In this method, the questionnaires designed to assess
environment risks are sent to acknowledged experts, and their opinions, observations, and comments
are obtained. A variant of this method is the Delphi Technique in which a panel of experts is
constituted and they are asked to give an assessment or prediction of risk, individually and separately.
The process may be repeated and the final response is recorded as “risk assessment”.
Checklists
These consist of a number of economic, social, and political variables which affect the business
environment and point to some risk element in it. The risk, in turn, contains elements relating to the
various issues that the country is facing. This method gives a rough approximation of the business
environment risk and the future outlook. Checklists, as shown in Table 1.2, are used to assist in the
interpretation of the political system and co-national change.
Rating and Ranking Systems

This system is similar to the scoring system, whereby the country rating is done on the basis of a
number of economic, financial, political, and social parameters. Each of these parameters is weighed
according to its importance in the total environmental risk. The weighted parameters are assigned
scores according to the preset guidelines, and different sectors within a country are rated and ranked
on a scale.
Economic Methods
These methods are complex and sophisticated and are used to quantify economic risk and related
aspects. They are used for both estimation and forecasting. In such methods, we first identify the
factors (called independent variables) which affect environment risk (called dependent variables), and
establish a model of their cause-effect relationship. The relationship is specified in a functional form
that is usually stated as a mathematical equation (in a linear or a non-linear form), which involves
certain parameters whose values are estimated. In this approach, it is possible to state, quantitatively,
the strength of each variable (or causative factor) that affects or determines business environment
risk.
Managing Environment Risk
Developing the Local Economy

In order to develop good public relations around the area of location and to avoid any possible local
confrontation and criticism, it is a beneficial policy for a firm to contribute to the development of the
local economy. The firm may form joint ventures (JVs) with local shareholders. Participation of
local shareholders will also help to build links with the local community and provide the benefit of
local management’s advice and knowledge. The firm may make local purchases and employ local
people in unskilled or semi-skilled activities. This strategy is helpful for the firm to gain acceptance
by the people. Box 1.3 shows the risk assumption for different economic systems.

A business organisation should contribute to the development of local economy. Participation of local shareholders and
employment of local people in unskilled or semi-skilled activities are strategies that help an organisation to gain acceptance
by people.
Good Corporate Citizenship

The corporate behaviour, conforming to what is usually referred to as a good citizen policy, is one of
the most popular prescriptions for avoiding adverse political initiative. This is among the best
strategies to deal with political risk. Firms follow this policy by responding promptly to government
requests, contributing to national goals, and developing a corporate image. With such an image, a
firm may find it easy to obtain licences, permits, power connections, government land, and other
facilities from the government.
Tie-up and Collaboration with Other Firms

The firms can manage risks not by standing alone but by collaborating with other firms. This strategy
helps a firm to share its risk with other firms.
Private Insurance
Even after committing its resources, the firm can resort to private insurance schemes to hedge against
any future loss. The insurance premium will be proportional to the threat of asset loss.
Avoiding Politically Sensitive Products

The firms can reduce risk by avoiding product lines that affect exchange rates, national security, and
public health, or are contrary to the general beliefs and moral values of people, for example, alcohol,
cigarettes, and explosives.
Avoiding Sensitive Regions

The firms can avoid politically sensitive regions and choose safer or more peaceful locations.
Multiplant and multi-product firms are able to avoid risk to a considerable extent.
Maintaining Good Political Relations
Many business firms find it wise to maintain politically neutral postures, but it is commonly believed
that they must have normal to cordial relations with the political parties in power to have a say in the
government.
MARKET OPPORTUNITIES
Low-average income levels have prevented India’s huge population of more than one billion from
becoming a lucrative market for consumer goods. The vast majority of the population is preoccupied
with meeting basic daily needs. Even so, the existence of a large middle class, the estimated size of
which varies from 25 million to 350 million, offers considerable potential for manufacturers and
retailers. Table 1.3 gives in detail the related particulars.

Low-average income levels have prevented India’s huge population of more than one billion from becoming a lucrative
market for consumer goods.
India remains a predominantly agricultural society and is home to around 40 per cent of the
world’s poorest people; even the much-vaunted middle class has a limited disposable income. As a
result, the early enthusiasm of foreign companies, that are eager to tap India’s large market, has been
replaced by a more sober assessment of potential sales. The market for branded consumer goods,
such as clothing, colour televisions, and washing machines is now estimated to be just 50 million to
75 million though this exceeds the population of many developing countries. Limited and unreliable
supplies of water and electricity have forced foreign manufacturers of white goods to rethink their
approach—for example, by designing smaller and more efficient washing machines and
refrigerators. The demand for large- or even medium-sized cars is small. Better quality products
certainly appeal to India’s consumers, but price remains the major determinant.

India remains a predominantly agricultural society and is home to around 40 per cent of the world’s poorest people; even
the much-vaunted middle class has a limited disposable income.

Table 1.3 Market Opportunities

Table 1.4 Distribution of Household by Income, 1990–2000

DISTRIBUTION OF HOUSEHOLD BY INCOME, 1990–2000
Any detailed assessment of India’s broader market potential must start with income distribution,
though such data are, at best, less than reliable. Nevertheless, the National Council of Applied
Economic Research, an independent research organisation, periodically produces a set of benchmark
figures examining incomes. Its assessment for 1999–2000, as given in Table 1.4, showed that India
had about 176 million households; of these, only around 6.2 million earned more than Rs 140,000 a
year (at 1998/99 prices), equivalent to US$3,100 and could, therefore, be considered as affluent.
Foreign firms, marketing luxury items and other top-end goods, have tended to focus almost
exclusively on this segment of the population. A further 57-million households earned between
US$233 and US$3,100 a year; they can afford many kinds of basic consumer products, though not
necessarily top-of-the-range goods. It is this segment of the population that holds the greatest
potential for foreign firms that are selling in India.
RECENT POLITICAL ENVIRONMENT
In the run-up to the next general elections that are likely to be held sometime in 2009, there have been
significant changes in the political environment—both within and around the country.
The Congress party that came to power in the year 2004—albeit by a slender majority—had to
depend heavily on such diverse fragmented parties like Lalu Prasad’s Rashtriya Janata Dal (RJD) on
one side and Ram Vilas Paswan’s Lok Janshakti Party (LJP) on the other, and also regional parties
like Dravida Munnettra Kazhagam (DMK) and Nationalist Congress Party (NCP).
All these political parties have their own constituencies and respective agendas, which they apply
from time to time to pressurise the government. But the greatest pressure group that the Manmohan
Singh government has to face is the Left Front, which supports the government from outside too. The
Left parties are particularly vociferous in their opposition to the nuclear deal with the United States
and also privatisation of many of the core-sector PSEs (public sector enterprises).

All these political parties have their own constituencies and respective agendas, which they apply from time to time to
pressurise the government. But the greatest pressure group that the Manmohan Singh government has to face is the Left
Front, which supports the government from outside too.
In spite of all the problems, the combination of Dr. Manmohan Singh as the Prime Minister, Mr. P.
Chidambaran as the Finance Minister, and Mrs. Sonia Gandhi as the Chairperson of United
Progressive Alliance (UPA) has done a commendable job, at least on the economic front, where the
country has maintained a growth rate of around 8 per cent to 9 per cent.
There had also been significant changes in the neighbouring countries as well—particularly in
Pakistan, where the nine-year rule of General Pervez Musharraf has ended and Asif Ali Zardari is the
current president.
As an aftermath of the tragic assassination of Benazir Bhutto, on December 27, 2007, the
subsequent general elections brought her party, PPP (Pakistan Peoples Party) and her arch rival
Nawaz Sharif’s PML (N) (Pakistan Muslim League—Nawaz) closer. The combination worked
effectively to defeat General Musharraf’s sponsored parties. As a result, Pakistan has Mr. Gillani as
the new PM.
It is too early to envisage how the new government will function and what will be its policy visa-vis
India. However, Mr. Asif Ali Zardari, Co-chairman of PPP and husband of Benazir Bhutto, had shown
a lot of acumen in announcing that they would like to keep the Kashmir issue aside and concentrate on
improving the bilateral relations with India on the other fronts, including trade and technology.
There are also some positive developments in other countries like Bhutan and Nepal. In Bhutan, the
long feudal dynastic rule had come to an end, mainly due to the efforts taken by India and the people
of Bhutan,who have embraced democracy. Bhutan had, traditionally, very cordial relations with India
and the new democratic setup will be helpful for India to assist in the development of Bhutan.
Similarly, in Nepal, the 250-year-old dynastic rule too came to an end, as Maoists won the popular
mandate and Nepal was declared a republic on May 30, 2008; and the royal family was ordered to
vacate the palace, which would be converted into a museum. Although the Maoists are leaning
towards China, India’s traditional and cultural relations with the Himalayan state can further improve
as Nepal will constantly require India’s cooperation in many strategic areas as the country is far away
from the warm waters.
Among the other SAARC nations, Sri Lanka (inspite of LTTE problems) and Maldives in the Indian
Ocean are constantly increasing their trade relations with India, as presently both the countries have
stable governments. The only remaining trouble spot is Bangladesh, where there is still no political
stability and the country is presently facing a tug of war between the liberals and the fundamentalists.
Thus, in the above scenario, India remains the leader among the SAARC nations—not only because
of its imposing size and population, which, of course, provides a lucrative market for industrialised
countries, but also because of its mature political leadership and rapidly growing economy which
makes it a safe place for the investors to deal with.

India remains the leader among the SAARC nations—not only because of its imposing size and population, which, of
course, provides a lucrative market for industrialised countries, but also because of its mature political leadership and
rapidly growing economy which makes it a safe place for the investors to deal with.
Relations with China
Besides India, the other Asian giant China, which is larger than India both in terms of size and
population, has also progressed remarkably in the last two decades, inspite of adhering to
Communism. China’s rapid progress is a cause for concern, not only to other developed countries of
Asia—like Japan, Korea, and Malaysia, but it has also raised an alarm in the Western countries.
According to a recent survey, within a decade, most of the Chinese products including automobiles
will be seen dominating throughout the world.
The Chinese economic development is more pronounced and widespread than India, as China has
emphasised on an all-round development and focused more on the manufacturing sector (thanks
mainly to its cheap labour), rather than the service sector. One strong point, however, in India’s
favour is its growing educational population, especially in higher and technical education like the IT
sector, which is in a great demand worldwide, which has enabled and attracted many leading IT
companies to have trade and technological cooperation with India.

The Chinese economic development is more pronounced and widespread than India, as China has emphasised on an all-
round development and focused more on the manufacturing sector (thanks mainly to its cheap labour), rather than the
service sector.
The outsourcing carried out by the US and the European countries have, in fact, benefitted India’s
personnel to a great extent; thereby, boosting the trade in the service sector, particularly. However, the
growing influence of China as an economic power and its trade relations with other countries have
restrained India from condemning China on the recent Tibet issue; and because of its geographical
and political proximity with Pakistan, India is compelled to have better relations with China.
Other Developments
The political developments all over the world are having a significant effect on the Indian economy,
as new political equations are being developed. The receding Russian influence on India’s foreign
policy has given way for India to adopt a more liberal trade policy and has also given rise to market
economy and privatisation of many industries, which were hitherto the domain of PSEs alone. The
post-Cold War period and also the fall of the Communist regime of the erstwhile Soviet Union left the
world with only one unchallenged Super Power—the United States, thus, leaving most of the
countries to reconcile with the situation. This has boosted the trade and other relations between India
and the United States.
The 9/11 incident and the subsequent wars on Afghanistan and Iraq have also forced India to adopt
a more pragmatic policy towards the Middle East, which resulted in growing cooperation with Israel
in matters of defence and security to combat with what has now come to be known as “Islamic
Terrorism”.
Domestic Developments in Trade
Another significant development in the last few years is the growing importance of a large Indian
consumer market, which has encouraged many foreign brands to enter into trade pacts with the Indian
companies or to establish companies on their own. Retail has got particular attention, as it is the
second-largest sector in India after agriculture. This has given rise to organised retail sector or
corporate retail, resulting in the setting up of large retail chains and shopping malls across major
cities, which has now started to penetrate into medium and smaller towns as well. These chains are
being developed by major corporates from both India and abroad. Although these organised retailers
are at a nascent stage, they are bound to have a profound effect on the small retailers, even though the
consumers will hopefully be benefitted.

Indian consumer market, which has encouraged many foreign brands to enter into trade pacts with the Indian companies
or to establish companies on their own.

Although these organised retailers are at a nascent stage, they are bound to have a profound effect on the small retailers,
even though the consumers will hopefully be benefitted.
RECENT ECONOMIC AND FINANCIAL ENVIRONMENT
India has undergone a profound shift in the economic management. Since the mid-1980s, successive
reforms have progressively moved the Indian economy towards a market-based system. State
intervention and control over economic activity have been reduced significantly and the role of
private sector entrepreneurship has increased. To varying degrees, liberalisation has touched on most
of the aspects of economic policy, including industrial policy, fiscal policy, financial market
regulation, and trade and foreign investment.

India has undergone a profound shift in the economic management. Since the mid-1980s, successive reforms have
progressively moved the Indian economy towards a market-based system. State intervention and control over economic
activity have been reduced significantly and the role of private sector entrepreneurship has increased.
Overall, reform has had a major beneficial impact on the economy. The annual growth in GDP per
capita has accelerated from just 1.25 per cent in the three decades after independence to 7.5 per cent
currently, a rate of growth that will double the average income in a decade. Potential output growth is
currently estimated to be 8.5 per cent annually, and India is now the third-largest economy in the
world. Increased economic growth has helped to reduce poverty, which has begun to fall in absolute
terms.
Areas that have been liberalised have responded well. In the services sector, such as
communications, insurance, asset management, and IT, where government regulation has been eased
significantly or is less burdensome, the output has grown rapidly. In those infrastructure sectors
which have been opened to competition, such as telecoms and civil aviation, the private sector has
proven to be extremely effective and the growth has been phenomenal. At the state level, the economic
performance is much better in states with a relatively liberal regulatory environment than in the more
restrictive states.
Significant problems still remain unresolved and the next round of reforms need to focus on a
number of key areas. In the labour markets, the employment growth is concentrated in firms that
operate in sectors that are not covered by India’s highly restrictive labour laws. In the formal sector,
where these labour laws apply, the employment has been falling and firms are becoming more
capital-intensive despite abundant low-cost labour. Labour market reform is essential to achieve a
broader-based development and to provide sufficient and higher productivity jobs to the growing
labour force. In product markets, the inefficient government procedures, particularly in some of the
states, act as a barrier to entrepreneurship and need to be improved. Public companies are generally
less productive than private firms, and the privatisation programme should be revitalised. A number
of barriers to competition in financial markets and some of the infrastructure sectors, which are other
constraints on growth, also need to be addressed. The indirect tax system needs to be simplified to
create a true national market, whereas for direct taxes, the taxable base should be broadened and rates
lowered. Public expenditure should be reoriented towards infrastructure investment by reducing
subsidies. Furthermore, social policies should be improved to provide more benefits to the poor and
given the importance of human capital, the education system also needs to be made more efficient.
The reforms must continue if the government is to achieve its growth targets. The government’s
target of reaching a GDP growth of 10 per cent in 2011 is achievable only if reforms continue. In
addition, if the relatively restrictive states improve their regulatory frameworks, growth will be more
inclusive and income gaps across the states will narrow. The impressive response of the Indian
economy to past reforms should give the policymakers confidence that further liberalisation will
deliver additional growth dividends and foster the process of pulling millions of people out of
poverty.

The reforms must continue if the government is to achieve its growth targets. The government’s target of reaching a GDP
growth of 10 per cent in 2011 is achievable only if reforms continue. In addition, if the relatively restrictive states improve
their regulatory frameworks, growth will be more inclusive and income gaps across the states will narrow.
Although we forecast that the growth momentum of Asias second largest economy will subside, it
is still expected to remain robust. If growth for FY2007/08 (FY—fiscal year) reaches the central
bank’s forecast of 8.5 per cent expansion rate, this will only be marginally below the 8.6 per cent
average achieved over the past four years. Inflation remains the biggest threat to this outlook and the
supply-side factors, if not dealt with appropriately, will render these growth rates unsustainable.
Unfortunately, the infighting between groups in the United Progressive Alliance, India’s ruling
coalition, threatens to prevent any meaningful reform from taking place. Its communist allies have
already hampered many of the government’s privatisation plans, which the Prime Minister sees as
crucial to boosting the GDP growth to 10 per cent and are necessary to lift millions of the country’s
poor above the poverty line. Continuing down this path would, in effect, render the Congress party a
lame-duck administration, unable to push through any far-sighted reform measures during its current
term.
Following a protracted wrangling between India’s ruling Congress party and its communist allies,
the India-US Civilian Nuclear Energy Agreement appears to be on its last legs. This is a major
setback for the Premier Singh, who has staked his reputation on this “historic” landmark deal and
who, by succumbing to the Left’s demands in order to avoid early elections, has severely impaired his
credibility. The next 18 months could see the Indian National Congress kowtowing to its allies until
the 2009 elections, when only a stronger showing in parliament would allow it to reduce its reliance
on the Left.
Indian economy expanded by an impressive 9.3 per cent y-o-y (year-on-year) in Q1 FY2007/08
(April-March), buoyed by a strong growth in the manufacturing and services, which have fuelled the
inflation concerns. However, the recent global credit crunch and a strong rupee mean that the central
bank will hold off on hiking interest rates any further for the time being. On the whole, it appears as
though economic growth will begin to moderate in the coming quarters. This is because we expect a
tight monetary policy to eventually impact on the demand. However, given the positive spillover
effects of last year ’s robust growth rate of 9.4 per cent, we do acknowledge upside risks to our 8.2 per
cent growth forecast for FY2007/08.
The rapidly proliferating and much-heralded business prospects arising from India, mask a
fundamental development flaw facing the country. Despite a steady increase in inward investment
flows, our data points towards deterioration in India’s overall business environment, which has
suffered because of policy decisions that favour short-term investment strategies at the expense of
longer-term goals. The latter would require a marked improvement in the infrastructural
development. This trend is a concern as it threatens to accelerate the widening trend of regional
disparity and, consequently, India’s business environment rating has been revised down to 39.8 from
40.6.

The rapidly proliferating and much-heralded business prospects arising from India, mask a fundamental development flaw
facing the country. Despite a steady increase in inward investment flows, our data points towards deterioration in India’s
overall business environment, which has suffered because of policy decisions that favour short-term investment strategies at
the expense of longer-term goals.
India Food and Drink
In February 2008, India’s domestic alcoholic drinks industry achieved a major target. In BMI’s
(Business Monitor International) newly published India Food & Drink Report for Q 2008, we can
truly see the impact of WTO, which rejected complaints from the United States about the level of
import tariffs on international spirits in the country. Even after this whole episode, the investments
remained high in spite of a number of significant challenges.
The United States’ complaints were totally focused on the enormous dispel between Indian import
tariffs and those imposed by other regional markets. USA further claimed that India’s excise duties
amounted to unfair discrimination against imported brands. With the Indian spirits industry
amounting to over 1 billion litres per annum in 2007, the United State’s desire to gain a foothold is
understandable.
By 2012, we expect volume sales growth in the industry to stand at 25.8 per cent. Today, the major
barrier to the growth in the sale of alcohol in India is the low disposable income. In order to compete,
the Indian manufacturers have been forced to reduce price in order to secure customer loyalty.
Indian Automotives
India’s new vehicle sales continued to grow in FY2007/08, but at a slower rate than the previous
years. BMI has revised downwards its sales forecast for the year on the back of first-half sales, even
though the optimism for continued growth over the five-year forecast period still exists. Passenger
car sales for the month of September rose by 11.6 per cent to 105,822 units, while sales for the six
months from April to September were up by 13 per cent to 569,621 units. Commercial vehicle sales
increased by a little less than 1 per cent to 42,770 units, in September, and by 2.92 per cent, over the
next six months, to 212,181 units.
BMI now projects a total sale of 1.775 mn units in FY2007/08, though we expect sales to recover
over the next five years if interest rates can be lowered. BMI also believes that the commercial vehicle
segment can play a pivotal role in rescuing the slide, based on a number of new JVs announced in
recent months. Volvo Bus Body Technologies India, a 70:30 JVs between Sweden’s Volvo and India’s
Jaico Automobile, has set up a new production plant to produce fully-built buses for export as well as
domestic sale. The bus segment has also seen a tie-up between the domestic manufacturer Tata Motors
and Brazil’s Marco Polo to build the world’s largest integrated bus plant in India.
Despite the slowdown in sales growth, India still ranks second in BMI’s Business Environment
Ranking for the automotive industry in the Asia-Pacific region. Vehicle ownership is low, creating
potential for further sales growth, though with so many manufacturers already establishing
production operations and the industry running at a high level of capacity utilisation, the
opportunities for entering the market as a producer could be limited. In the meantime, India’s
production of CBUs is expected to rise by 63 per cent over the forecast period, which means India’s
output growth is above the average for the Asia-Pacific region, and the market scores highly as a
result.

Despite the slowdown in sales growth, India still ranks second in BMI’s Business Environment Ranking for the automotive
industry in the Asia-Pacific region. Vehicle ownership is low, creating potential for further sales growth, though with so
many manufacturers already establishing production operations and the industry running at a high level of capacity
utilisation, the opportunities for entering the market as a producer could be limited.
Maruti Suzuki, which led the market in FY2006/07, posted a growth of 18 per cent over the first six
months of FY2007/08, thanks to the heavy discounts and the launch of two new models—the Swift
Compact and the SX4 Sedan. In this period, however, Maruti was pipped by the US giant General
Motors (GM), which more than doubled its Indian sales on the back of its two new Chevrolet Compact
models, the Spark and the Aveo U-VA. GM’s sales for the six months to September 2007 rose by 140
per cent y-o-y to 20,695 units. Data from the Society of Indian Automobile Manufacturers (SIAM)
also showed that the manufacturers prominent in the larger Sedan segment, such as Honda and Ford,
saw sales decline.
Global Economic Environment
The global expansion is losing speed in the face of a major financial crisis. The slowdown has been
the greatest in the advanced economies, particularly in the United States, where the housing market
correction continues to exacerbate financial stress. Among the other advanced economies, the growth
in Western Europe has also decelerated, though growth in Japan has been more resilient. The
emerging and developing economies have, so far, been less affected by financial market
developments and have continued to grow at a rapid pace, led by China and India, even though growth
is beginning to slow in some countries. At the same time, headline inflation has increased around the
world, boosted by the continuing buoyancy of food and energy prices. In the advanced economies,
core inflation has edged upward in the recent months, despite slow growth. In the emerging markets,
headline inflation has risen more markedly, reflecting both strong demand growth and the greater
weight of energy.

The emerging and developing economies have, so far, been less affected by financial market developments and have
continued to grow at a rapid pace, led by China and India, even though growth is beginning to slow in some countries.
Commodity markets have continued to boom despite slow global activity. Strong demand from
emerging economies, which has accounted for much of the increase in commodity consumption in
recent years, has been a driving force in the price run-up, whereas biofuel-related demand has
boosted prices of major food crops. At the same time, supply adjustments to higher prices have
lagged, notably for oil and inventory levels in many markets have declined to medium to long term.
The recent run-up in commodity prices also seems to have been at least partly due to financial factors,
as commodities have increasingly emerged as an alternative asset class.
Recent financial market stress has also had an impact on foreign-exchange markets. The real-
effective exchange rate (REER) for the US dollar has declined sharply since mid-2007, as foreign
investment in US bonds and equities has been dampened by reduced confidence in both the liquidity of
and the returns on such assets, as well as by the weakening of US growth prospects and interest rate
cuts. The decline in the value of the US dollar has boosted net exports and helped to bring the US
current account deficit down to less than 5 per cent of GDP by the fourth quarter of 2007, which is
more than 1.5 per cent of GDP, lower than its peak in 2006. The main counterpart to the decline of the
dollar has been the appreciation of the euro, the yen, and the other floating currencies, such as the
Canadian dollar and some emerging economy currencies. However, exchange-rate movements have
been less marked for a number of countries that are with large current account surpluses—notably,
China and oil-exporting countries in the Middle East. Direct spillovers to emerging and developing
economies have been less pronounced than in the previous periods of global financial market
distress, even though capital inflows have moderated in recent months and issuance activity has been
subdued. A number of countries that had relied heavily on short-term cross-border borrowing have
been affected more substantially. Trade spillovers from the slowdown in the advanced economies
have been limited so far and are more visible in economies that trade heavily with the United States.
As a result, the growth among emerging and developed economies has continued to be generally
strong and broadly balanced across regions, with many countries still facing rising inflation rates
from buoyant food and fuel prices and strong domestic demand.

Recent financial market stress’ has also had an impact on foreign-exchange markets. The real-effective exchange rate
(REER) for the US dollar has declined sharply since mid-2007, as foreign investment in US bonds and equities has been
dampened by reduced confidence in both the liquidity of and the returns on such assets, as well as by the weakening of US
growth prospects and interest rate cuts.
Multilateral Initiatives and Policies
Broadly based efforts to deal with global challenges have become indispensable. In the event of a
severe global downturn, there would be a case for providing temporary fiscal support, in a range of
countries that have made good progress in recent years in securing sound fiscal positions. Providing
fiscal stimulus across a broad group of countries, which would benefit from stronger aggregate
demand, could prove much more effective than isolated efforts, given the inevitable cross-border
leakages from added spending in the open economies. It is still early to launch such an approach, but
it would be prudent for countries to start contingency planning to ensure a timely response in the
event that such support becomes necessary. Reducing risks associated with global current account
imbalances remains an important task. It is encouraging that some progress is being made in
implementing the strategy endorsed by the International Monetary and Financial Committee and the
more detailed policy plans laid out by participants in the IMF-sponsored Multilateral Consultation on
Global Imbalances aimed at rebalancing domestic demand across countries, with supportive
movements in REERs.

Broadly based efforts to deal ‘ with global challenges have become indispensable. In the event of a severe global downturn,
there would be a case for providing temporary fiscal support, in a range of countries that have made good progress in
recent years in securing sound fiscal positions.
CASE
Mahindra & Mahindra manufactures and markets jeeps and had a hold over a considerable portion of
the jeep market in India in the past. It was ranked sixth in the automobile sector of India in 2004, up
from the 10th rank in 2003. The following are the prominent jeeps that operate in the Indian market
currently—Mahindra-Voyager, Mahindra-Armada, and Mahindra-Commander. Mahindra & Mahindra
is now facing problems like cut-throat competition, price rise, and sluggish market for jeeps. In terms
of price competition, Mahindra & Mahindra has an upper hand when compared to Tata jeeps, whereas
Tempo Trax has comparatively a low price.
Realising the need to grow fast, the company formulated an export policy. It paid off well. They
formulated plans to develop and grow in a foreign market. The first step was participation in trade
fairs abroad, particularly in Hanover (Germany) and Paris (France). This has helped to popularise its
vehicle in those countries. Mahindra jeeps started selling in France, and jeep export became an
important marketing activity of the company. The company started manufacturing diesel engines in
collaboration with Peugeot of France.
As soon as the company came to know that Australia, Denmark, Italy, Norway, and Sweden could
prove to be potential markets, plans began to be made accordingly. The company estimated that it
would be able to export about 2,500 jeeps annually to Australia. In order to cater to the lower segment
of the market, the Mahindra jeeps in Australia faced competition from Japanese companies. Stringent
design rules and requirements also needed to be met in Australia.
The company is confident of meeting all such requirements. The government’s liberalisation
policy will also be helpful. The company’s new policy has to take into account the environmental
factors. The export policy, with a special reference to export market, also deserves a considerable
evaluation and analysis because environmental factors, such as technological, economical, social, and
political influences, relevant to strategic decisions, operate in an industry.
Mahindra & Mahindra assessed all the opportunities in the market as well as the impact of external
environment on their strategic planning before expanding the production. In 2004, Mahindra &
Mahindra showed a significant improvement compared to Maruti Udyog, ranked as the number one
automobile company, as is evident from the table that follows:

Case Question
In the case discussed above, which are the different environmental factors that lead to opportunities
and threats to Mahindra & Mahindra?
SUMMARY
A business environment comprises a number of environmental factors. It can be an “interface”,

linking various such environmental factors, making a common ground that determines or influences
the process of policy making in every business organisation that functions within such an
environment. An interaction of all such factors, or some of them, can also take place, while the
business organisation is expected to interact with the environment.
Any substantial change in the environment or in any of the factors of the environment is bound to lead
to corresponding changes in the business policy of the organisation. It is here that this interface
works. As observed elsewhere, the demand-supply factors, for example, work as an interface between
business organisations and business environment. While demand-supply factors make an environment
by themselves for the business organisation, they act as an interface between the aggregate
environment and the organisation.
Evidently, a business environment represented by certain dominating factors, which can be called a
micro-environment, such as government policies, legal provisions, competitive factors, inflation,
deflation or recession, acting as an interface between the organisation and its macro-environment,
provide opportunities, threats, or challenges to the organisation. In the colour TV case discussed
earlier, technological factors and competitive factors acted as micro-environment interface between
the colour TV manufacturers and the macro-environment. While a new entrant is concerned with the
existing environment, particularly the microenvironment, and the ways and means for the company to
fit in within the framework of the existing environmental interface, an existing company is more
interested in tracking the changing environmental factors.
During the course of scanning the business environment, a number of methods like economic and
technological forecasting, detailed demographic projections, national and international market
trends, changing trade relationship between governments, and so on, can be used for identifying
environmental changes. It is, however, not very easy to identify or accurately measure the changes in
the interface, in particular, or in the macro-environment, in general, though some factors can be
easily identified.
In a global environment, a competitive situation is bound to exist in the market; and hence, a
competitive marketing strategy in terms of market leader strategy, challenger strategy, niches
strategy, or follower strategy is appropriate. Such a strategy must ensure a defensive position for the
company in the competitive environment. In such situations, the environment itself acts as an interface
between the company and its competitor.
The structure of the industry, which includes the company and its competitors in addition to potential
entrants, suppliers, buyers, and so on determines the level of competition. Hence, the environment is
influenced by all of them in some manner or the other. The business policy of every player has,
therefore, to take cognisance of the threats posed by every other player including the new entrants.
Thus, subject to the influence of a number of factors, the business environment provides
opportunities and threats, while its internal environment provides its strengths and weaknesses.
A competitive business environment is an essential characteristic of globalisation. The nature of

competition varies in different economic systems. In the context of widespread globalisation process,
tremendous changes are taking place in the business environment of economic systems. Corporate
concern for international business environment is understandable in relation to the globalisation of
business. We may, therefore, throw some light on the international business environment here.
KEY WORDS
Business Environment
Country Risk
Cultural Factors
Economic Factors
Ecological Factors
Environmental Risk
Fiscal Policy
Geographical Factors
Globalisation
Labour Factors
Legal Factors
Infrastructure Risk
Monetary Policy
Political Factors
Political Stability Risk
Security Risk
Social Factors
Technological Factors
QUESTIONS
1. Define “business environment” and state the importance of its study.

2. What is business environment? Explain the different factors of business environment.
3. “Business environment is dynamic”. Discuss.
4. How does political environment influence the business policy of an organisation?
5. What are the economic factors affecting business policies?
6. How does the socio-cultural environment influences the business policy of an organisation?
7. Do you believe that political stability leads to business development and vice-versa? Discuss.
REFERENCES
Aswathappa, K. (2004). Essentials of Business Environment, 2nd ed. Mumbai: Himalya Publishing House.
Batra, G. S. and R. C. Dangwal (2002). Business Management and Globalisation. New Delhi: Deep & Deep Publications.
Bedi, S. (2004). Business Environment. New Delhi: Excel Books.
Chanchal, C. (2003). Foreign Investment in India: Liberalisation and WTO-The Emerging Scenario. New Delhi: Deep & Deep
Publications.
Cherunilam, F. (2000). Elements of Business Environment, 1st ed. Mumbai: Himalya Publishing House.
Cherunilam, F. (2004). Global Economy and Business Environment. Mumbai: Himalya Publishing House.
Chidambaram, K. and V. Alagappan (2003). Business Environment. New Delhi: Vikas Publishers.
Davis, K. and R. L. Blomstrom (1971). Business Society and Environment. New York: McGraw-Hill.
Ghosh, P. K. (2002). Business Environment. New Delhi: Sultan Chand.
Kalyani, I. and Paranjpe (2001). Business Environment and Development, 2nd ed. Mumbai: Himalya Publishing House.
Michale, V. P. (1999). Globalisation, Liberalisation and Strategic Management, 1st ed. New Delhi: Himalaya Publishing
House.
CHAPTER 02
Planning in India
CHAPTER OUTLINE
The Emergence of Planning
The Planning Commission
The National Development Council
Objectives of Planning in India
Five-Year Plans
Distribution of Public Sector Outlay of Each Plan
Tenth Five-Year Plan (2002–07)
Five-Year Plans—Achievements and Failures
Eleventh Five-Year Plan (2007–12)
Liberalisation and Planning
Case
Summary
Key Words
Questions
References
THE EMERGENCE OF PLANNING
The need for planned, coordinated economic development under government guidance was
recognised all along the freedom movement. In the 1930s, as the freedom struggle intensified, social
and economic aims also became more well defined. In December 1938, Subhash Chandra Bose, as the
Congress President, laid great stress on national planning and appointed a National Planning
Committee with Jawaharlal Nehru as its Chairman.
The so-called Bombay Plan (1944), a blueprint for economic development after independence, was
worked out by eight top industrialists, notably, Tata, Birla, and Shri Ram. It recommended a very
active role for the state in economic development. The Planning Commission was set up in March
1950. Its task was to make an assessment of the material, the capital, and the most effective utilisation
of these resources on a priority basis.
Recovering from the horrors of partition, by 1951, India started planning seriously for the future.
India’s economic history may be broadly divided into the following phases—the period from 1947 to
the mid-1950s, which was the preparatory phase in planning for development; the period from mid-
1950s to mid-1960s, characterised by rapid industrialisation; the period of late 1960s and the 1970s,
when the plans tried to focus on agriculture; and finally the phase of liberalisation starting tentatively
in the 1980s, and gearing up from 1991 to the present.
The period from independence to the mid-1950s signifies the preparatory phase in planning for
development. During the first phase, the main concern was to work out a broad framework for
planned development. Although a step in this direction had already been initiated with the formation
of the National Planning Commission, serious work in this direction gained momentum only after
1947. The Planning Commission set up in 1950 with Nehru as its Chairman undertook the task of
devising an appropriate development strategy through five-year plans.
Strong advocacy of planning came from an emerging sub-discipline of economics called
“Development Economics”. This advocacy was reiterated by the spectacular economic success of the
then USSR. The Industrial Policy Resolution of 1956 outlined Nehru’s vision of a socialistic pattern
of society. The public sector soon became the pivotal sector of the Indian economy and despite the
changes in governmental policies in 1971, 1979, 1980, and 1985, the provision of the Industrial
Policy Resolution remained intact till 1990. The public sector undertakings played a critical role in
the generation of surplus capital for the infrastructural development.

The Industrial Policy Resolution of 1956 outlined Nehru’s vision of a socialistic pattern of society, making the public sector
the pivot of Indian economy. Despite several changes in government policies in the subsequent years, this resolution
remained intact till 1990.
Generation of employment opportunities, removal of disparities, and alleviation of poverty were the
objectives of the public sector units.
Under Jawaharlal Nehru, India adopted a flexible plan strategy in order to bring about the
functional and structural transformation of the economy. This strategy of planning was adopted
keeping in mind the objectives, such as reduction in absolute poverty, unemployment, and
inequalities, and providing basic necessities and accelerating a balanced growth. The Indian socio-
economic order had been hard hit by the British handling of the Indian economy, by the Second
World War, and, ultimately, by the partition of India. The need to reorganise the economy and to
channelise it towards self-dependence became imperative. It would not be wrong to say that given the
monolithic problems, the early years, right through the mid-1960s, witnessed an optimistic
assessment of India’s potential and performance.

Under Jawaharlal Nehru, India adopted a flexible plan strategy in order to bring about the functional and structural
transformation of the economy. This strategy of planning was adopted keeping in mind the objectives, such as reduction in
absolute poverty, unemployment, and inequalities, and providing basic necessities and accelerating a balanced growth.
In the Second Plan, which was formulated in an atmosphere of economic stability, agriculture was
accorded a complementary role while the focus shifted to the industrial sector, especially to the
heavy-goods sector. The domestic industry was protected from foreign competition through high
tariff walls, exchange-rate management, controls and licences or outright bans. To begin with, P.C.
Mahalanobis introduced a single-sector model, based on variables of income and investment, which
was further developed into a two-sector model. The entire net output of the economy was supposed to
produce only two sectors—the investment goods sector and the consumer goods sector. The basic
strategy of the Second Plan was to increase the investment in heavy industries and also the
expenditure in services.
THE PLANNING COMMISSION
The Planning Commission of India was set up in March 1950 with Jawaharlal Nehru as its Chairman.
The Commission comprises eight members:
1. Prime Minister (Chairman),
2. Four full-time members (including Deputy Chairman),
3. Minister of Planning,
4. Minister of Finance, and
5. Minister of Defence.
The Planning Commission was set up in March 1950. This Commission comprises eight members: Prime Minister—who is
the Chairman of the Commission, four full-time members, Minister of Planning, Minister of Finance, and Minister of
Defence.
With a change in the government at the Centre, a new Planning Commission is always formed. The
main functions of the Planning Commission include:
1. Making real assessment of various resources and investigating the possibilities of augmenting resources;
2. Formulating plans;
3. Defining stages of plan implementation and determining plan priorities;
4. Identifying the factors retarding economic growth and determining the conditions for its successful implementation;
5. Determining plan machinery at each stage of the planning process;
6. Making periodic policy measures to achieve objectives and targets of plan; and
7. Making additional recommendations as and when necessary.
THE NATIONAL DEVELOPMENT COUNCIL
The National Development Council (NDC) has been working as the highest national forum for the
economic planning in India since August 6, 1952. Representatives of both, the Central and the State
government, come together in the NDC to finally approve all important decisions relating to
planning.
The NDC is composed of the following members:
1. The Prime Minister of India,
2. Chief Ministers of all states, and
3. Members of Planning Commission.
The NDC works as an advisory body where the state governments occupy an important position.
Functions
The following are the main functions of the NDC:

1. To review the National Plan periodically.
2. To consider important questions related to social and economic policy affecting national development.
3. To recommend various means of achieving aims and targets set out in the National Plan. The Council also recommends various
measures for achieving active participation and cooperation of the people, for improving efficiency in administrative services, for
ensuring fullest development in the backward regions and the backward sections of the community, and also for building up
resources for national development.
4. The NDC also takes the final decision regarding the allocation of Central assistance for planning among different states. The
“Gadgil formula” and all other systems followed in transferring Central assistance for plan to states are finalised by the NDC.
5. The NDC approves the draft plan prepared by the Planning Commission.
OBJECTIVES OF PLANNING IN INDIA
In a developing country like India, economic planning plays a very important role in economic
development. The fundamental objective of the economic planning of our country is to accelerate the
pace of economic growth and to provide social justice to the general masses. Thus “growth with
social justice” is the main objective of economic planning in India. The major objectives of economic
planning in India can be summarised as follows:
1. Attainment of higher rate of economic growth,

2. Reduction of economic inequalities,
3. Achieving full employment,
4. Attaining economic self-reliance,
5. Modernisation of various sectors, and
6. Redressing imbalances in the economy.
The fundamental objective of the economic planning of our country is to accelerate the pace of economic growth and to
provide social justice to the general masses. Thus “growth with social justice” is the main objective of economic planning in
India.
Let us now discuss these objectives in detail.
Economic Growth
Attainment of a higher rate of economic growth has received topmost priority in almost all the five-
year plans of the country. Given the acute poverty in the country, a higher rate of economic growth
would help to eradicate poverty and improve the standard of living of the people. The First Plan
envisaged a target of 11 per cent increase in national income against which 18 per cent growth in
national income was achieved. The Second, Third, and Fourth Plans envisaged annual growth rates of
5 per cent, 5.6 per cent, and 5.7 per cent, respectively, against which 4 per cent, 2 per cent, and 3.4 per
cent, respectively, were achieved. Again, the Fifth and Sixth Plans proposed annual growth rates of
4.37 per cent and 5.2 per cent against which 5 per cent and 5.2 per cent, respectively, were achieved.
The Seventh, Eighth, and Ninth Plans set targets of 5 per cent, 5.6 per cent, and 7 per cent annual
growth rate of national income, respectively, against which 6.02 per cent, 6.68 per cent, and 5.35 per
cent, respectively, were achieved. Thus, attaining higher rate of economic growth is a common
objective of all the five-year plans of our country.
Attaining Economic Equality and Social Justice

With its objective of growth scenario, expansion of employment opportunity, and poverty alleviation,
the Eighth Plan focused entirely on socio-economic condition. The Ninth Five-Year Plan endeavoured
to be sensitive to the needs of the poor, focused on the accelerated growth to realise the objective of
removal of poverty.
Reduction of economic inequalities and eradication of poverty have been the objective of almost
all the five-year plans of our country, particularly since the Fourth Plan. Following a faulty approach
in the initial planning process, economic inequality widened and poverty became acute. Under such
circumstances, the Fifth Plan adopted the slogan of “Garibi Hatao” for the first time. The Seventh
Plan document showed that nearly 37.4 per cent of the total population of the country fell below the
poverty line and the plan aimed to reduce this percentage to 29.2 per cent by 1990. Thus, to achieve
the target, various poverty alleviation programmes like the National Rural Employment Programme
(NREP), Composite Rural Training and Technology Centre (CRTTC), Crash Scheme for Rural
Employment Programme (CSREP), Rural Landless Employment Guarantee Programme (RLEGP),
and so on were introduced. But the performance of these programmes was not satisfactory.

Reduction of economic inequalities and eradication of poverty have been the objective of almost all the five-year plans of
our country. However, following a faulty approach in the initial planning process, economic inequality widened and poverty
became acute.
Achieving Full Employment
The Seventh Plan emphasised on the policy for accelerating the growth in food production,
increasing employment opportunities, and raising productivity. The Eighth Plan had its main focus on
human development. In order to achieve this goal, employment generation, population control,
literacy, education, health, drinking water, and provision of adequate food and basic infrastructure are
broadly considered as the priorities of the plan. The Ninth Plan incorporates a primary objective to
generate greater production employment in the growth process of various sectors and by adopting
labour-intensive technologies in the unemployment-prone areas.
India’s five-year plans have been laying stress on employment generation since the Third Plan. The
generation of more employment opportunities was an objective of both the Third and Fourth Plans.
But up to the Fourth Plan, employment generation never received its due priority. The Fifth Plan, in
its employment policy, laid a special emphasis on absorbing increment in labour force during the
plan period. The Sixth Plan accorded much importance to the reduction of incidence of
unemployment. It was estimated that employment would grow at the rate of 4.17 per cent per annum as
against the annual growth of labour force at 2.54 per cent. To achieve this target, major employment
programmes were introduced during the plan period—Integrated Rural Development Programme
(IRDP), NREP, Operation Flood II Diary Development Project, schemes in the villages and small
industries sector, the national scheme of Training Rural Youth for Self Employment (TRYSEM), and
various other components of the Minimum Needs Programme (MNP).

Employment generation has been one of the objectives of the Planning Commission since the Third Five-Year Plan. To
achieve the target, major employment programmes were introduced in the Sixth Plan period.
One of the major objectives of the Seventh Plan was a faster growth of employment opportunities.
Thus, the plan aimed that the employment potential would grow at 4 per cent as against the 2.6 per
cent growth in the labour force. Again, the Eighth Plan envisaged an annual employment growth of
2.6 per cent to 2.8 per cent over the next 10 years—1997–2006.
Attaining Economic Self-reliance
One of the very important objectives of Indian planning has been to attain economic self-reliance. But
the objective came to the forefront only with the Fourth Plan, when the plan aimed at elimination of
the import of food grains under PL480. The Fifth Plan also laid much importance on the attainment of
self-reliance. It aimed at achieving self-sufficiency in the production of food grains, raw materials,
and other essential consumption goods. The plan also emphasised the need for import substitution and
export promotion for attaining economic self-reliance. The Sixth Plan laid stress on strengthening the
impulses of modernisation for the achievement of economic and technological self-reliance. The
Seventh and Eighth Plans followed the path for achieving self-reliance.
Although India has achieved self-sufficiency in respect of food grains, it has not yet achieved self-
sufficiency in respect of edible oil. In the meantime, we have developed a number of import-substitute
industries, particularly, basic and capital goods industries, but the huge import of petroleum along
with some other items is a serious drain on foreign-exchange reserves—such that in 1991–92, the
country reached near-bankruptcy level with a huge external debt obligation. Thus, the objective of
self-reliance still remains unfulfilled.
The important component of the development policy and strategy envisaged under the Ninth Five-
Year Plan was self-reliance. Since self-reliance demanded balance of payments sustainability and
avoidance of excessive external debt, what was needed was a commitment to sound and prudent
macro-economic policies. Self-reliance also demanded that the most of investible resources be
generated domestically. The component of self-sufficiency was especially applicable to food and the
Ninth Plan targeted the higher growth rate of agriculture to tide over bad monsoon also.

The important component of the development policy and strategy envisaged under the Ninth Five-Year Plan was self-
reliance. Since self-reliance demanded balance of payments sustainability and avoidance of excessive external debt, what
was needed was a commitment to sound and prudent macro-economic policies.
Modernisation of Various Sectors
As far as technology was concerned, domestic capability was to be developed in that direction also
and the Ninth Plan proposed to implement the technology policy statement, called “Vision 2020”.
Another very important objective of the five-year plans was the modernisation of various sectors,
more specifically the agricultural and industrial sectors. The Fourth Plan laid much emphasis on the
modernisation of the agricultural sector that took the form of Green Revolution. Successive plans
also continued their efforts in the same direction but to a lesser extent. Box 2.1 lists the conditions that
determine the success of a plan.

Another very important objective of the five-year plans was the modernisation of various sectors, more specifically the
agricultural and industrial sectors. The Fourth Plan laid much emphasis on the modernisation of the agricultural sector
that took the form of Green Revolution.
The Sixth Plan categorically mentioned these objectives of modernisation for the first time.
Modernisation here meant those structural and institutional changes in economic activities, which
could transform a feudal and colonial economy into a progressive and forward-looking economy.
Thus, through condensation an economy may be diversified. It requires setting up of various types of
industries and advancement of technology. However, some sort of modernisation has always gone
against employment generation. Thus, the country is facing a conflict between the objective of
modernisation and the objective of removal of unemployment and poverty.
Redressing Imbalances in the Economy
Regional disparities and imbalances in the economy became so acute in India that they needed special
attention in our five-year plans. By regional development, we mean economic development of all the
regions by exploiting various natural and human resources and increasing their per capita income
and living standards. From the Second Plan onwards, the government realised the need for balanced
development. Thus, the Second, Third, Fourth, and Fifth plans laid emphasis on the redressal of
economic imbalances for attaining balanced regional development. The Sixth Plan aimed at a
progressive reduction in regional inequalities in the pace of development and in the diffusion of
technological benefits. The Seventh and Eighth plans also carried forward this objective of balanced
development in a systematic manner. The Ninth Plan has allotted more public investment in
infrastructural projects, in favour of the poor and less-developed states.

Box 2.1 Conditions for the Success of Planning
1. Central planning authority

2. Reliable statistical data
3. Specific objective
4. Fixation of targets and priorities
5. Strong and stable government
6. Fair and efficient administration
7. Mobilisation of resources
8. Proper balance in a plan
9. Proper development policy
10. Flexibility in planning
11. International relations
12. Public cooperation
Box 2.2 Plan Model
A Plan Model is a mathematical model designed to help in drawing up the plan of economic
development. A plan model is defined as an optimally balanced collection of targets or
quantitative measures with dates in the future, standing for certain objectives and certain proposed
steps leading to the attainment of those objectives.
The tasks of a plan model can be described as follows:

To provide a framework for assessing the soundness of the target of a plan, that might have been set by some less formal
methods,
To enable the making of quantitative projections for the economy over the plan period,
To provide a framework for the selection or preparation of projects for being integrated into a plan.

Besides these long-term objectives, the plans also laid importance on short-term objectives, such as
control of inflation, industrialisation, rehabilitation of refugees, building up of infrastructural
facilities, and so on. Box 2.2 details on the definition and the tasks of a plan model, which would help
in a better understanding of the five-year plans.
FIVE-YEAR PLANS
Let us now discuss the objectives of each five-year plan.
First Five-Year Plan (1951–52 to 1952–56)
The First Five-Year Plan of India had mainly two objectives:

1. To correct the disequilibrium in the economy caused by Second World War and the partition and
2. To initiate the process of an all-round balanced development for ensuring a rising national income and improvement in the
standard of living.

The objective of the First Five-Year Plan was to correct economic disequilibrium and initiate the process of an all-round
development.
Thus, the First Plan aimed at removing food crisis and shortages of raw materials, to develop
economic and social infrastructure, such as, roads, railways, irrigation and power projects, and
finally, rehabilitate refugees. The plan also tried to lay a foundation for the future development of the
economy, to attain social justice, and to contain inflationary pressures. The plan fixed the targets for
raising the rate of investment by 7 per cent and national income by 11 per cent.
Second Five-Year Plan (1956–57 to 1960–61)
India’s Second Five-Year Plan was a bit more ambitious and bolder in comparison to the First Plan.
The Second Plan tried to lay the foundations of industrial progress, made a strong case for rural
development, and also tried to achieve a socialistic pattern of society.

The Second Five-Year Plan aimed at laying the foundation of industrial progress and, at the same time, achieve a socialistic
pattern of society.
The Second Plan had the following four main objectives:
1. A sizeable increase in the national income to raise the level of living in the country,
2. Rapid industrialisation with particular emphasis on the development of basic and heavy industries,
3. A large expansion of employment opportunities, and
4. Reduction of inequalities in income and wealth and a more even distribution of economic power
Third Five-Year Plan (1961–62 to 1965–66)
The Third Plan accorded greatest importance to the achievement of balanced regional development. It
realised the need for a balanced approach and, thus, gave importance to the development of
agriculture and rapid industrialisation through the promotion and development of heavy industries.

The Third Plan accorded greatest importance to the achievement of balanced regional development.
The main objective of the Third Plan was to attain self-sustaining growth in the economy. The
following were the other objectives of the Third Five-Year Plan:
1. To secure an increase in the national income of over 5 per cent per annum, the pattern of investment being designed also to
sustain the rate of growth during the subsequent plan period,
2. To achieve self-sufficiency in food grains and increase agricultural production to meet the requirements of industry and exports,
3. To expand basic industries like steel, chemicals, fuel, and power and establish machine-building capacity, so that the
requirements of further industrialisation could be met indigeneously within a period of 10 years or so,
4. To utilise the manpower resources of the country to the fullest extent possible and to ensure a substantial expansion in
employment opportunities, and
5. To establish progressively, greater equality of opportunities and to bring about reduction in disparities in income and wealth and a
more even distribution of economic power.
Fourth Five-Year Plan (1969–70 to 1973–74)
The Fourth Plan aimed at two main objects:

1. Growth with stability and
2. Progressive achievement of self-reliance.
The Fourth Plan aimed at two main objects:
Growth with stability and

Progressive achievement of self-reliance.
Besides these two, the other objectives were as follows:
1. Attaining social justice and equality along with care of the weak and under-privileged, and the common man,
2. Generating more employment opportunities both in the rural and urban areas,
3. Assigning an increasing role to the public sector in the growth process, and
4. Correcting regional imbalances among different states.
The Fourth Plan set a target for increasing the national income by 5.5 per cent per annum and for
increasing the per capita income from Rs 522 in 1968–69 to Rs 643 in 1973–74.
Fifth Five-Year Plan (1974–75 to 1978–79)
The draft of the Fifth Plan was presented before the Parliament in December 1973 and the plan
became operative from April 1, 1974. The period of the Fifth Plan was originally scheduled to be
from 1974–75 to 1978–79. But with the formation of the Janata government at the Centre in March
1977, the Fifth Plan was terminated at the end of March 1978—a year before full term.
The Fifth Plan had two main objectives:
1. Removal of poverty and
2. Achievement of economic self-reliance.
The objects of the Fifth Five-Year Plan were removal of poverty and achievement of economic self-reliance.
The Fifth Plan designed certain special measures to increase the level of income and consumption of
the lowest 30 per cent of the population who were living below the poverty line. The plan paid more
attention to improving the lot of the rural poor. Moreover, for promoting social justice, the Fifth Plan
lunched the Minimum Need Programme for the first time. It was designed to provide a minimum
level of social consumption to all sections of people throughout the country. The plan aimed to
increase the per capita consumption expenditure of the lowest 30 per cent of the population from Rs
25 per month to Rs 29 per month. For achieving economic self-reliance, the Plan aimed at elimination
of special forms of external assistance, particularly food and fertiliser imports.

The Fifth Five-Year Plan aimed at growth with stability and progressive achievement of self-reliance.
Sixth Five-Year Plan (1980–81 to 1984–85)
After the termination of the Fifth Plan in 1977–78, the Janata government prepared its own draft of the
Sixth Plan (1978–83). However, after the fall of Janata–Lok Dal government, the Congress (I)
government drew up a new Sixth Plan (1980–85). This draft was approved by the NDC on February
14, 1981.
The Sixth Plan laid down the following objectives:
1. A significant step-up in the rate of growth of the economy by promoting efficiency in the use of resources and improved
productivity,
2. Strengthening the impulses of modernisation for the achievement of economic and technological self-reliance,

The Sixth Five-Year Plan aimed at providing impetus to the pace of economic development and strengthening the
impulse of modernisation and technological self-reliance.
3. Progressive reduction in the incidence of poverty and unemployment,

4. Speedy development of indigenous sources of energy with a proper emphasis on the conservation and efficiency in energy use,
5. Improving the quality of life of the people, in general, with special reference to the economically and socially challenged
sections through an MNP,
6. Strengthening the redistributive bias of public policies and services in favour of the poor and, thus, contributing to reduction in
inequalities of income and wealth,
7. Progressive reduction in regional inequalities in the pace of development and in the diffusion of technological benefits,
8. Promoting policies for controlling the growth of population through voluntary acceptance of the small family norms,
9. Bringing about harmony between the long-term and the short-term policies, and
10. Promoting the active involvement of all sections of the people in the process of development through appropriate education,
communication, and institutional strategies.
Seventh Five-Year Plan (1985–86 to 1989–90)
The NDC approved the Seventh Five-Year Plan draft on November 9, 1985. The plan laid emphasis on
development, equity, and social justice through the achievement of self-reliance, efficiency, and
increased production. The Seventh Plan emphasised the policy for accelerating growth in food grains
production, increasing employment opportunities, and raising productivity. Thus, the Seventh Plan
was mainly devoted to “food, work, and productivity”.

The Seventh Five-Year Plan laid emphasis on development, equity, and social justice through self-reliance, efficiency, and
increased production.
The NDC approved the following objectives for the Seventh Five-Year Plan:
1. Achievement of self-sufficiency in the production of food grains as well as increase in production of agro-raw materials like oil
seeds, cotton, and sugarcane by raising the rate of growth of production in the agricultural sector;
2. Generation of productive employment for maximum utilisation of human resources and solving the problem of unemployment
through the development of agriculture and industry in a manner that would create employment potential for a large number of
people;

Generation of productive employment for maximum utilisation of human resources and solving the problem of
unemployment through the development of agriculture and industry in a manner that would create employment
potential for a large number of people;
3. To promote efficiency and productivity through elimination of infrastructural bottlenecks and shortages by improving capacity
utilisation, and by promoting modernisation of plan and equipment and more extensive application and integration of science and
technology;
4. To promote equity and social justice through alleviation of poverty and reduction in inter-class disparities in respect of income
and wealth;
5. To improve the equality of life and standard of living of the people in general with a special reference to the economically and
socially weaker sections through an MNP;
6. To promote a speedy development of power generation and irrigation potential along with utilisation of existing capacities and
also to conserve energy along with promotion of non-conventional energy sources;
7. To ensure growth with stability by restraining inflationary pressures through non-inflationary financing;
8. To achieve self-reliance through attaining self-sufficiency in food grains and by reducing dependence on external finance
through export promotion and import substitution; and
9. To decentralise planning and to achieve full public participation in development works along with promoting active involvement
of all sections of population in the process of development through appropriate education, communication, and institutional
strategies.
Annual Plans (1990–91 and 1991–92)
After the completion of the Seventh Plan by March 1990, the Planning Commission initially decided
to launch the Eighth Plan as per its schedule—from April 1, 1990. Accordingly, the Planning
Commission approved the approach to the Eighth Five-Year Plan (1990–95) on September 1, 1989,
under the chairmanship of Rajiv Gandhi. The highlights of this approach were attainment of 6 per
cent growth in gross domestic product (GDP), a sharp regional focus, international competitiveness,
self-reliance, poverty alleviation, and people participation.

The highlights of this approach were attainment of 6 per cent growth in gross domestic product (GDP), a sharp regional
focus, international competitiveness, self-reliance, poverty alleviation, and people participation.
But after the 1989 General Election, the National Front government headed by V. P. Singh came to
power at the Centre. The NDC then approved a new approach to the Eighth Plan on September 18,
1990, and finalised the total outlay of the Eighth Plan at Rs 610,000 crore, including a public sector
outlay of Rs 335,000 crore. The total outlay of the Annual Plan 1990–91 was fixed at Rs 64,717 crore
including a public sector outlay of Rs 39,329 crore. The plan also envisaged a growth rate of 5.5 per
cent in GDP, a domestic savings rate of 22 per cent, and employment growth of 3 per cent per annum.
Following the collapse of the National Front government, the new government, headed by Chandra
Shekhar, expected to take a fresh look at the proposed size and other parameters of the Eighth Plan in
view of the adverse impact of the Gulf crisis on the country’s economy. The spurt in oil price
aggravated the country’s balance of payments position considerably. But before it could take a final
decision about the Eighth Plan, the Chandra Shekhar government collapsed, making way for another
General Election in the month of May–June 1991.
After the formation of a new Congress (I) government at the Centre, headed by P.V. Narasimha Rao,
on June 21, 1991, fresh discussions were held about the fate of Eighth Plan in the face of one of the
worst financial crises faced by the country. On July 19, Prime Minister Narasimha Rao announced in
Parliament that the Eighth Plan would start from April 1, 1992, taking the earlier two years (1990–91
and 1991–92) as Annual Plans.

On July 19, Prime Minister Narasimha Rao announced in Parliament that the Eighth Plan would start from April 1, 1992,
taking the earlier two years (1990–91 and 1991–92) as Annual Plans.
Eighth Five-Year Plan (1992–93 to 1996–97)
The approach paper of the Eighth Plan was approved by three different governments in 1989, 1990,
and 1991. But due to political changes, the Eighth Five-Year Plan could not commence from 1990–91.
Following the installation of the Congress (I) government in June 1991, the Planning Commission
was reconstituted with Pranab Mukherjee as its Deputy Chairman. The revised time frame of the
Eighth Plan was from 1992–93 to 1996–97.
In order to meet the challenges faced by the economy, the Eighth Plan finalised the following
objectives:
1. Generation of adequate employment opportunities to achieve near-full employment by the turn of the century,

The Eighth Five-Year Plan focused on the generation of adequate employment opportunities, containing
population growth, and strengthening of the infrastructure.
2. Containing population growth through people’s active cooperation and an effective scheme of incentives and disincentives,
3. Universalisation of elementary education and eradication of illiteracy among people in the age group of 15–33 years,
4. Provision of safe drinking water and primary health care including immunisation to all villages and the entire population and
complete elimination of scavenging,
5. Growth and diversification of agriculture to achieve self-sufficiency in food and generate surplus for exports,
6. Strengthening of the infrastructure (energy, transport, communication, irrigation) in order to support the growth process on a
sustainable basis.
The Eighth Plan concentrated on the above objectives considering its need for (a) a continued
reliance on domestic resources for financing a planned investment; (b) increasing the technical
capabilities for the continuous development of science and technology; and (c) modernisation of
competitive efficiency so that the economy of the country could keep pace with the global
development.
Ninth Five-Year Plan (1997–98 to 2001–02)
The NDC, in its meeting held on January 16, 1997, unanimously approved the draft approach paper
for the Ninth Five-Year Plan (1997–02) with a call for collective effort to raise Rs 875,000 crore for
implementing the plan.
The Planning Commission finalised the objectives of the Ninth Plan in conformity with the
Common Minimum Programme (CMP) of the United Front government and also in consultation with
the chief ministers of different states on maintenance of basic minimum services. The draft approach
paper of the Ninth Plan outlined the following important objectives for the plan:
1. Accelerating the rate of economic growth with stable prices,

The Ninth Plan focused on accelerating the rate of economic growth giving priority to agriculture and rural
development.
2. Giving priority to agriculture and rural development with a view to generating adequate productive employment and eradicating
poverty,
3. Attaining food and nutritional security for all, particularly the vulnerable sections of the society,
4. Providing basic minimum needs of safe drinking water, primary health care facilities, universal primary education, shelter, and
connectivity to all in a time-bound manner,
5. Containing the population growth of the country,
6. Ensuring environmental sustainability of the development process through social mobilisation and participation of people at all
levels,
7. Empowerment of women and all socially disadvantaged groups such as scheduled castes, scheduled tribes, and other backward
classes and minorities as agents of socio-economic change and development,
8. Promoting and developing people’s participatory institutions like Panchayati Raj Institution (PRIs), cooperatives, and self-help
group, and
9. Strengthening efforts to build self-reliance.
The aforesaid objectives were finalised to achieve “growth with equity” and were reflected in four
dimensions of the state policy:
1. Quality of life of the citizens,
2. Generation of productive employment,
3. Regional balance, and
4. Self-reliance.
The aforesaid objectives were finalised to achieve “growth with equity” and were reflected in four dimensions of the state
policy:
Quality of life of the citizens,

Generation of productive employment,
Regional balance, and
Self-reliance.
DISTRIBUTION OF PUBLIC SECTOR OUTLAY OF EACH PLAN
The distribution of public sector outlay from the First Plan to the Ninth Plan are given in Tables
2.1–2.10.

Table 2.1 Distribution of Public Sector Outlay in the First Plan
Expenditure (Rs
Heads Percentag e of Total
crore)
Agricultural and community development 291 15
Major and medium irrigation schemes 310 16
Power 260 13
Village and small industries 43 2
Industries and minerals 74 4
Transport and communication 523 27
Social services and miscellaneous 459 23
Total 1,960 100
Source: Plan documents, Planning Commission, Government of India.

Table 2.2 Distribution of Public Sector Outlay in the Second Plan
Expenditure (Rs
crore)
Agricultural and community development 530 11
Major and medium irrigation schemes 420 9
Power 445 10
Village and small industries 175 4
Industries and minerals 900 20
Transport and communication 1,300 28
Social services and miscellaneous 830 16
Total 4,600 100
Source: Second Five-Year Plan Review, India.

Table 2.3 Distribution of Public Sector Outlay in the Third Plan
Actual Expenditure
(Rs crore)
Agriculture and community development 1,089 12.7
Major and minor irrigation schemes 664 7.7
Power 1,252 14.6
Village and small industries 241 2.8
Organised industry and mining 1,726 20.1
Transport and communication 2,112 24.7
Social services and miscellaneous 1,492 14.4
Total 1 8,577 100
Source: Fourth Five-Year Plan, 1969–74 Draft, pp. 59–60.

Table 2.4 Distribution of Public Sector Outlay in the Fourth Plan
Actual Expenditure
(Rs crore)
Agriculture and irrigation 3,810 24
Power 2,450 15
Industry 3,630 23
Transport and communication 3,240 20
Social services 2,770 18
Total 15,900 100
Source: Plan documents, Planning Commission, Government of India.

Table 2.5 Distribution of Public Sector Outlay in the Fifth Plan
Outlay (1974–78)
Actual (Rs crore)
Agriculture and allied sectors 5,229 13.0
Irrigation and flood control 3,913 9.8
Power 7,491 18.7
Village and small industries 611 1.5
Industries and minerals 9,129 22.8
Social services and others 6,873 17.2
Total 40,097 100
Source: Compiled from RBI on Currency and Finance, 1979–80, Vol. II, pp. 98–99.

Table 2.6 Sectoral Distribution of Public Sector Outlay of the Sixth Plan
Actual Plan Outlay
(Rs crore)
Agriculture 6,624 6.1
Rural development 6,997 6.4
Special area programme 1,580 1.4
Energy 30,751 28.1
Industry and minerals 16,948 15.5
Science and technology 1,020 0.9
Social services 16,764 15.4
Total 190,292 100
Source: Seventh Five-Year Plan, 1985–90, Economic Survey 1987–88, Government of India.

Table 2.7 Plan Outlay of First Six Plans (Rs crore)
Source: Compiled from Planning Commission’s India Planning Experience—A Statistical Profile, February 1989 and other plans.

Table 2.8 Sectoral Allocation and Progress of Expenditure of the Seventh Plan Public Sector Outlay (Rs crore)
Source: Computed from the data given in Economic Survey 1989–90.

Table 2.9 Final Distribution of Public Sector Outlay in the Eighth Plan (1992–97) (Rs Crore)
Source: Planning Commission, Eighth Five-Year Plan, 1992–97, Vol. I; and Economic Survey 1996–97.
* At 1991–92 prices.
** At current prices: For 1992–93 and 1993–94 (Actuals), 1994–95 and 1995–96 (Revised Estimates), and for 1996–97 (Budget
Estimates).
Note: As per the revised budget classification.

Table 2.10 Distribution of Public Sector Outlay in the Ninth Plan (1997–02*)
Proposed Outlay (Rs Percentag e of Total
Heads
crore) Outlay
Agriculture and allied activities 36,658 4.2
Special programme 3,790 0.4
Energy 221,973 25.4
Transport 124,188 14.2
Communication 48,791 5.6
Science and technology 26,343 3.0
General economic services 15,569 1.8
General services 12,396 1.4
Total 875,000 100
Source: Ministry of Planning and Programme Implementation.

TENTH FIVE-YEAR PLAN (2002–07)
Introduction
The Tenth Five-Year Plan (2002–07) had been prepared against a backdrop of high expectation
arising from some aspects of the recent performance. GDP growth in the post-reforms period
improved from an average of about 5.7 per cent in the 1980s to an average of about 6.5 per cent in the
Eighth and Ninth Plan periods, making India one of the 10 fastest growing developing countries.
Encouraging progress has also been made in other dimensions. The percentage of impoverished
population continued to decline, even if not as much as was targeted. Population growth decelerated
to below 2 per cent for the first time in four decades. Literacy increased from 52 per cent in 1991 to
65 per cent in 2001 and the improvement is evident in all states. Sectors such as software services,
entertainment, and IT-enabled services (ITES) emerged as new sources of strength, creating
confidence about India’s potential to be competitive in the world economy.

The Tenth Five-Year Plan (200–207) had been prepared against a backdrop of high expectations that aroused from some
aspects of the then performance. Growth targets had, therefore, focused on the growth in per capita income on per capita
GDP. The Tenth Plan aimed at an indicative target of 8 per cent GDP growth for the period 2002–07.
These positive developments were, however, clouded by other features which became a cause for
concern. Although employment growth almost kept pace with the labour force growth, the incidence
of unemployment on a current daily status basis was relatively high at above 7 per cent. More than
half of the children in the age group of one to five years in rural areas were undernouished, with
female children suffering even more severe malnutrition. The infant mortality rate (IMR) stagnated at
72 per 1000 for several years. As many as 60 per cent of rural households and about 20 per cent of
urban households did not have a power connection. Only 60 per cent of urban households had taps
within their homes, and fewer had latrines inside the house.
The Tenth Plan provided an opportunity, at the start of the new millennium, to build upon the gains
of the past and address the weaknesses that had emerged. With large numbers of our population
continuing to live in abject poverty and alarming gaps in our social attainments even after five
decades of planning, policies and institutions needed to be modified based on past experience,
keeping in mind the changes that had taken place in the Indian economy and in the rest of the world.
Therefore, it was necessary to draw up a reform plan instead of merely having a resource plan.
Objectives
Traditionally, the level of per capita income has been regarded as a summary indicator of the
economic well-being of the country; growth targets have, therefore, focused on growth in per capita
income on per capita GDP. In the past, our growth rates of GDP have been such as to double our per
capita income over a period of nearly 20 years. Recognising the importance of making a quantum
jump compared with the past performance, the Prime Minister directed the Planning Commission to
examine the feasibility of doubling per capita income in the next 10 years. With population expected
to grow at about 1.6 per cent per annum, this target requires the rate of growth of GDP to be around
8.7 per cent over the Tenth and Eleventh Plan periods. The Tenth Plan should aim at an indicative
target of 8 per cent GDP growth for the period 2002–07. This is lower than the growth rate of 8.7 per
cent needed to double the per capita income over the next 10 years, but it can be viewed as an
intermediate target for the first half of the period. It is certainly a very ambitious target, especially in
view of the fact that GDP growth has decelerated to around 6 per cent at present. Even if the
deceleration is viewed as a short-term phenomenon, the medium-term performance of the economy
over the past several years suggests that the demonstrated growth potential over several years is only
about 6.5 per cent. The proposed 8 per cent growth target, therefore, involves an increase of at least
1.5 percentage points over the recent medium-term performance, which is very substantial.

Recognising the importance of making a quantum jump compared with the past performance, the Prime Minister directed
the Planning Commission to examine the feasibility of doubling per capita income in the next 10 years.
The plan includes not only an adequate level of consumption of goods and other types of consumer
goods but also an access to basic social services, especially education, health, availability of drinking
water, and sanitation. It also includes the expansion of economic and social opportunities for all
individuals and groups, reduction in disparities, and greater participation in decision making. It is
proposed that in addition to the 8 per cent, growth target, the targets given here should also be
considered as being central to the attainment of the objectives of the plan.

The plan includes not only an adequate level of consumption of goods and other types of consumer goods but also an
access to basic social services, especially education, health, availability of drinking water, and sanitation.
Targets
Reduction of poverty ratio by 5 percentage points by 2007 and by 15 percentage points by 2012,
Gainful employment to the addition to the labour force over the Tenth Plan period,
Universal access to primary education by 2007,
Reduction in the decadal rate of population growth between 2001 and 2010 to 16.2 per cent,
Increase in literacy to 75 per cent by 2007,
Reduction in infant mortality rate (IMR) to 45 per 1,000 live births by 2007 and to 28 by 2012, and
Reduction in maternal mortality ratio (MMR) to 2 per 1,000 live births by 2007 and to 1 by 2012.
In order to emphasise the importance of ensuring balanced development for all states, the Tenth Plan
should include a state-wise breakdown of the broad development targets, including targets for growth
rates and social development. These state-specific targets should take into account the potentialities
and constraints present in each state and the scope for improvement in performance, given these
constraints. This will require a careful consideration of the sectoral pattern of growth and its regional
dispersion. It will also focus attention on the nature of reforms that will have to be implemented at the
state level to achieve the growth targets set for the states.

In order to emphasise the importance of ensuring balanced development for all states, the Tenth Plan should include a
state-wise breakdown of the broad development targets, including targets for growth rates and social development.
Growth, Equity, and Sustainability
It is important to emphasise that the equity-elated objectives of the plan which are extremely important
are intimately linked to the growth objective and attainment of one may not be possible without the
attainment of the other. External markets are an extremely important source of demand and they need
to be tapped much more aggressively for many sectors. However, given the size of the economy and
the present relative size of exports, much of the demand needed to support high growth will have to
come from the domestic economy itself. Although growth has strong, direct poverty-reducing effects,
the frictions and rigidities in part of the Indian economy can make these processes less effective.
There are several ways in which this can be achieved.

Although growth has strong, direct poverty-reducing effects, the frictions and rigidities in part of the Indian economy can
make these processes less effective.
First, the agricultural development must be viewed as a core element of the plan since growth in
this sector is likely to lead to the widest spread of benefits, especially to the rural poor, including
agricultural labour. Also, since the majority of women workers are engaged in agriculture,
investment in this sector has enormous implications for gender equality and must be designed to have
the maximum impact on this dimension.
Second, the growth strategy of the Tenth Plan must ensure rapid growth of sectors which are most
likely to create high-quality employment opportunities and deal with the policy constraints which
discourage growth of employment. Those sectors include construction, real estate and housing,
transport, small-scale industry (SSI), modern retailing, entertainment, ITES, and a range of other new
services which need to be promoted through supportive policies. One activity which has the potential
to stimulate most of these sectors through backward and forward linkages is “tourism”.
In pursuance of the Ninth Plan objective of empowering women as agents of socio-economic
change and development, the National Policy on Empowerment of Women was adopted in April 2001.
Accordingly, a National Plan of Action (NPA) is being formulated to ensure the requisite access of
women to information, resources, and services. The Tenth Plan shall stress upon the effective
implementation of the NPA.

In pursuance of the Ninth Plan objective of empowering women as agents of socio-economic change and development, the
National Policy on Empowerment of Women was adopted in April 2001.
Population
During the Tenth Plan, the major focus of the family welfare programme will be on ensuring that
families have improved access to healthcare facilities providing appropriate high quality of health
care to enable them to achieve their reproductive goals. This, in turn, will enable the country to
achieve the goals set in the National Population Policy of 2000. Irrespective of their socioeconomic
status, the majority of the population try to access public sector facilities for ante-natal care (60 per
cent), immunisation (90 per cent), and sterilisation (86 per cent). During the Tenth Plan, there will be
continued commitment to provide essential primary health care, emergency, and life-saving services
in the public domain. Services under national disease control and family welfare programmes will be
provided free of cost to all according to their need.

During the Tenth Plan, there will be continued commitment to provide essential primary health care, emergency, and life-
saving services in the public domain.
Quality and Productivity of Employment

In order to address the concerns of equity in a sustainable manner, it is necessary not only to ensure
that all adult people looking for work are employed, but also to ensure that they are employed at
levels of productivity and income which are necessary for them to afford a decent life. The slowdown
in the rate of population growth, an increase in the share of the aged, and an increasing participation
of the younger age group in education are likely to moderate the growth of labour force and, to that
extent, the pressure on the need for employment creation is reduced. The challenge, however, is to
bring about a qualitative change in the structure and pattern of employment in terms of promoting
growth of good-quality work opportunities. The employment strategy in the Tenth Plan needs,
therefore, to focus on employment growth and on the qualitative aspects of employment. In order to
enable the poor to access the opportunities and to ensure consistency between the requirement and
availability of skills, emphasis will need to be placed on skill development.

In order to enable the poor to access the opportunities and to ensure consistency between the requirement and availability
of skills, emphasis will need to be placed on skill development.
Resources and Other Measures
In this section, we examine the macro-economic implications of the target of 8 per cent growth for
the Tenth Plan period with a particular focus on the implications for domestic and external resource
mobilisation and the incremental capital output ratio (ICOR). Our assessment is based on the
assumption that the broad strategy of the plan will be to rely on a combination of increased
investment and improvement in efficiency based on unlocking of hidden capacities in the economy,
unleashing repressed productive forces and entrepreneurial energies, and upgrading technology in all
sectors, all of which will improve efficiency in all economic activities. This will require an
acceleration in the process of moving towards a market economy, with rapid dismantling of policy
constraints, procedural rigidities, and price distortions. It will also require that the essential
institutional structure necessary for the orderly operation of a market economy be strengthened
significantly. Tables 2.11 and 2.12 show programmes and sectoral allocations in detail.

Table 2.11 Programmes that Generated Additional Employment During the Tenth Plan
Development Initiative Employment Opportunities (million)

Agriculture and allied activities 3.55
Greening the country through agro-forestry 2.50
Energy plantation for bio-mass power generation 2.01
Rural sectors and small and medium industries 7.06
Education and literacy 1.70
Employment through information and communication Technology (ICT) 0.70
Health, family, and child welfare services 0.80
Total 19.32
Source: Planning Commission, Tenth Five Year-Plan, 2002–07.

Table 2.12 Sectoral Allocations of Public Sector Resources for the Tenth Plan
Tenth Plan
Sectors
Amount Percentag e
Agriculture and allied activities 58,933 3.9
Special area programmes 20,879 1.3
Sub-total (1+2+3+4) 305,055 20.0
Energy 403,927 26.5
Transport 225,977 14.8
Communications 98,968 6.5
Science, technology, and environment 30,424 2.0
General economic services 38,630 2.5
General services 16,328 1.0
Total 1,525,639 100.0
Source: Planning Commission, Tenth Five-Year Plan, 2002–07.

The challenge the economy has to face to reach an average growth of 8 per cent per annum over
the Tenth Plan period must be assessed against a base-run scenario. Table 2.13 presents two
alternative growth rates for the Tenth Plan, one as a base scenario and the other as a target scenario.
The base scenario is described as one emerging from current macro-economic trends supplemented
by the fiscal measures which are already in the pipeline. For the first two years, the growth
improvement in the target scenario from the base scenario is based mainly on the utilisation of the
existing slack in the economy. The additional policy efforts needed therefrom, are reflected in the
difference in the growth trajectory of the last three years of the Tenth Plan, that is, between 6.6 per
cent and 8.7 per cent. In the target scenario, the Tenth Plan ends with over 9 per cent growth rate in the
terminal year and also includes provision for a further acceleration in the Eleventh Plan period.

In the target scenario, the Tenth Plan ends with over 9 per cent growth rate in the terminal year and also includes provision
for a further acceleration in the Eleventh Plan period.
Table 2.14 provides the macro-economic parameters of the two alternative scenarios and a
comparison of the two gives the dimensions of efforts to be made to meet the 8 per cent growth target
of the Tenth Plan. Past experience shows that the average gestation lag of the Indian economy as a
whole is about two and a half years. In such a situation, the productive capacity that will be available
in the first two years of the Tenth Plan has already been determined by the investment made by the
current year 2000–01. As it happened, the two years most relevant for the beginning of the Tenth Plan
period, 1999–2000 and 2000–01, recorded relatively low investment rates ranging between 23.3 per
cent and 24 per cent of GDP. In this light, the increase in investment rate to 32.6 per cent in the
targeted scenario calls for a significant increase in the domestic savings to nearly 29.8 per cent and
the foreign saving (current account balance of the balance of payments) to 2.8 per cent from the
present level of 1.5 per cent. This is reasonable in the light of the experience of other emerging
countries. The more difficult task is to increase the public sector saving from 2.4 per cent to 4.6 per
cent, and, especially, the government saving from a negative level to 1.7 per cent of GDP in the target
growth scenario. As the economy is likely to move more on the market-based private sector
activities, an increase in the savings rate of the private corporate sector from 4.9 per cent to 5.8 per
cent has been regarded to be achievable. The household sector saving will remain almost at the same
percentage level.

The more difficult task is to increase the public sector saving from 2.4 per cent to 4.6 per cent, and, especially, the
government saving from a negative level to 1.7 per cent of GDP in the target growth scenario.

Table 2.13 Alternative Growth Paths for the Tenth Plan

Table 2.14 Macro-economic Parameters for the Tenth Plan—A Comparison
Heads Base line Targ et

Average GDP growth rate (per cent p.a.) 6.5 8.0
Gross investment rate (per cent of GDPmp) 27.8 32.6
Implicit ICOR 4.28 4.08
Current account deficit 1.5 2.8
Gross domestic savings (of which) 26.3 29.8
Public sector (of which) 2.4 4.6
Government -0.6 1.7
Public enterprises 3.0 2.9
Private corporate sector 4.9 5.8
Household sector 19.0 19.4

Table 2.15 presents the fiscal corrections needed to reach the target scenario from the base one.
The average fiscal deficit of the Centre needs to be reduced from 2.8 per cent to 2.6 per cent of GDP
at current market prices. This is in line with the targets set in the “Fiscal Responsibility and Budget
Management Bill” proposed by the government. This will need to be accompanied by a reduction in
the consolidated fiscal deficit of the Centre and states from 4.4 per cent of GDP in the base-line
scenario to 3.3 per cent in the target scenario. It will also be necessary to ask for a reduction in the
revenue deficit by nearly 1 per cent on the average both in the states and in the Centre in the Target
scenario from the Base one.

The average fiscal deficit of the Centre needs to be reduced from 2.8 per cent to 2.6 per cent of GDP at current market
prices. This is in line with the targets set in the “Fiscal Responsibility and Budget Management Bill” proposed by the
government.
Table 2.16 provides the possible scenario of the receipts and expenditures of the Central
government as a percentage of GDP. The details are given in the Annexure 1. As it is shown in the
table, the 8 per cent growth scenario will need significant efforts and several policy changes to
increase the revenue rates from 9 per cent average of GDP in the Ninth Plan to 10.2 per cent in the
Tenth Plan. This again seems to be an achievable target since the percentage has already been
achieved in the recent past. Revenue expenditure should be reduced from 12.5 per cent to 10.7 per cent
through reduction in subsidies and downsizing. The rationale behind this is given in the following
paragraph. What all the above means is the revenue deficit of the Central government must be reduced
to hardly 0.5 per cent over the Tenth Plan period and the non-plan expenditure may be reduced from
11.5 per cent to 9.5 per cent and the fiscal deficit from 5 per cent to 2.6 per cent, close to the target set
by the Ministry of Finance.
The suggested measures for fiscal correction and consolidation have to be viewed against recent
developments in finances of both the Central and the state governments.

Table 2.15 Fiscal Correction in the Tenth Plan—A Comparison
(Per cent of GDP at Market Prices)

Heads
Base-line Targ et
Consolidated fiscal deficit 4.4 3.3
Gross centre 2.8 2.6
Net centre 2.0 1.8
States 2.4 1.5
Consolidated revenue deficit 2.9 0.8
Centre 1.8 0.5
States 1.1 0.3

Table 2.16 Target Growth Scenario—Fiscal Parameters of the Central Government
(Percentag e of GDP)
Heads
Ninth Plan Tenth Plan
Revenue receipts 9.1 10.2
Revenue expenditure 12.5 10.7
Revenue deficit 3.4 0.5
Total expenditure 15.4 14.0
(a) Plan expenditure 3.9 4.5
(b) Non-plan expenditure 11.5 9.5
Non-debt capital receipts 0.8 1.2
Fiscal deficit 5.0 2.6

ANNEXURE-1 Central Government Finances at 8 per cent Growth

Central Finances
The fiscal situation of the Central government deteriorated continuously in the 1990s and, especially,
during the Ninth Plan. The combined balance of current revenues of the Centre and the states declined
from a negative of Rs 13,324 crore in 1996–97 or 1 per cent of GDP to Rs 92,969 crore or 4.8 per
cent of GDP in 1999–2000. This occurred because of a substantial increase in interest payments and
the increased wages and salaries on account of the Fifth Pay Commission award and, equally
importantly, because the revenue receipts of Centre as a proportion of GDP declined from 11.3 per
cent in 1989–90 to 9.3 per cent in 2000–01. The shortfall between the revenue receipts and expenditure
(non-plan) has been increasing and is around 3.4 per cent of the GDP. The Central government has
bridged this gap through consistently high public borrowings including borrowing from small
savings—the most expensive source of capital receipts for the government. As a result, debt service
payments of the Central government have risen inexorably from about 30 per cent of tax revenue in
1980–85 to about 70 per cent at present. A rise in debt service burden has meant that revenue deficit,
which was 17 per cent as a proportion of fiscal deficit in 1980–85, has now increased to about 50 per
cent. In other words, nearly half of the current borrowings go to financing current expenditure.

The fiscal situation of the Central government deteriorated continuously in the 1990s and, especially, during the Ninth
Plan. The combined balance of current revenues of the Centre and the states declined from a negative of Rs 13,324 crore in
1996–97 or 1 per cent of GDP to Rs 92,969 crore or 4.8 per cent of GDP in 1999–2000.
State Financing
The finances of the state governments have deteriorated precipitously in the 1990s. The states’ balance
from current revenue (BCR) has deteriorated continuously, declining from Rs 3,118 crore in 1985–86
to Rs 220 crore in 1992–93, after which it turned negative and reached Rs 32,306 crore in the year
2000–01! During the same period, the states’ overall debt multiplied manifold from a level of Rs
53,660 crore in 1986–87 to Rs 418,583 crore in 2000–01. The consolidated revenue deficit for the
states for 1999–2000 (Revised Estimates) is 2.9 per cent of the gross domestic product (GDP) and the
gross fiscal deficit (GFD) of the states touched a level of 4.9 per cent of GDP, surpassing the previous
level of 4.2 per cent in 1998–99. Table 2.17 gives details in regard to the financing pattern of the State
Plan.

The finances of the state governments have deteriorated precipitously in the 1990s. The states’ balance from current revenue
(BCR) has deteriorated continuously, declining from Rs 3,118 crore in 1985–86 to Rs 220 crore in 1992–93, after which it
turned negative and reached Rs 32,306 crore in the year 2000–01!
The deterioration in the finances of the state in recent years is, largely, an outcome of the fact that
in the face of a limited resource base, the states had to cope with a significant growth in their
committed expenditure. These include wages and salaries, pensions and interest payments, which
account for a major proportion of the non-plan expenditure and, together, absorb a sizeable part of
the revenue receipts. The pension liabilities of 14 major states have increased by 200 times, from Rs
100 crore in 1975–76 to Rs 20,000 crore in 1998–99. It has, thus, increased from just 2 per cent of
revenue receipts in 1980–81 to about 12 per cent in 1999–2000 and is likely to touch 20 per cent by
the end of the Tenth Plan.
A major cause for concern on the revenue front is the near stagnation in the states’ tax-GDP ratio at
around 5.4 per cent throughout the 1980s and 1990s. While the borrowings of the state governments
have grown sharply, a major portion of the borrowed funds are being diverted to bridging the
revenue gap, leaving very little funds for investment in core sectors. Revenue deficit accounted for 60
per cent of the GFD in 1999–2000 as against only 28.3 per cent in 1990–91. As a result, there has been
a deceleration in the growth of the capital expenditure from 37 per cent to 17 per cent between 1980
and 1998. More importantly, not only has the share of plan expenditure to total expenditure of the state
government declined over successive plans, but the allocations for the social sectors have also
suffered in the process. Plan expenditure has fallen from 27 per cent of the total state expenditure in
the Sixth Plan to only 19 per cent in the Ninth Plan. The share of states in the overall plan expenditure
has fallen from 52 per cent in the Fifth Plan to 37 per cent in the Ninth Plan. Besides, Central
assistance hardly increased in the Ninth Plan when compared to the previous plan. On the other hand,
the contribution of the BCR to the financing of state plans, which was as high as 28 per cent in the
Sixth Plan has now fallen to (–) 52 per cent! Thus, the state governments are borrowing more and
more to finance non-plan revenue expenditures rather than capital expenditures. This can only lead to
further worsening of the fiscal situation in the coming years. If reckless borrowing is not kept in
check, some states may be forced to declare financial emergency in the Tenth Plan!

A major cause for concern on the revenue front is the near stagnation in the states’ tax-GDP ratio at round 5.4 per cent
throughout the 1980s and 1990s. While the borrowings of the state governments have grown sharply, a major portion of the
borrowed funds are being diverted to bridging the revenue gap, leaving very little funds for investment in core sectors.

Table 2.17 Financing Pattern of State Plan (All figures at 1993–94 prices)
# The scheme of financing of Annual Plan 2001–02 used in the table is as per official level discussions

The share of states in the overall plan expenditure has fallen from 52 per cent in the Fifth Plan to 37 per cent in the Ninth
Plan. Besides, Central assistance hardly increased in the Ninth Plan when compared to the previous plan.
In fact, in many states, most plan funds are also being used for payment of salaries. Staff that was
being paid out of non-plan budget earlier is now being shown against the plan in a complete reversal
of what used to happen in the early decades of planning when, after each plan period, the staff was
shifted from plan to non-plan. There are several implications of fiscal insecurity on the delivery of
programmes.
First, often the Government of India (GOI) funds are diverted for paying salaries, and not passed
on to the development departments for months and years, thus defeating the very purpose of the
intention of funding of social sector schemes by the Centre. In such a scenario, neither can the
commitment of the field staff be sustained, nor can people’s participation so essential for the success
of programmes be encouraged. Second, states do not release the counterpart funds in time, leading to
further uncertainty about the availability of funds at the field level. Third, lack of counterpart funds
leads states to demand Centre’s Social Sector scheme (CSSs) to be funded entirely by GOI, which
dilutes the sense of ownership of states with development schemes. When states do not contribute, the
political and bureaucratic leadership does not put its weight behind the implementation of such
schemes. Fourth, some states are unable to find counterpart funds for CSSs, and hence are not able to
draw the earmarked allocations. Since CSSs generally require only 25 per cent contribution from the
states, in effect, it means that if the states could pay Re 1 less to their staff, they could get Rs 3 from
GOI to spend on development programmes.

When states do not contribute, the political and bureaucratic leadership does not put its weight behind the implementation
of such schemes.
Lastly, even when some projects/programmes are completed, its sustainability is a serious concern.
The precarious financial position in many cases prevents the state governments from taking up
committed liabilities of the project such as repairs or maintenance after completion, thus drastically
reducing the life of the project. There can be no investment in future if the states are forever obsessed
with ways and means of trying to make ends meet by excessive borrowing from the market or by
diverting funds from GOI, meant for development purposes to salaries.
The following decisions have to be made to achieve the fiscal corrections needed at the Centre:
1. Gross budgetary support for the plan should be steadily increased as a percentage of GDP to 5 per cent by the terminal year of
the plan, implying an average annual growth of 18.3 per cent per annum.
2. Reduction in the number of government employees by 2 per cent per year, with no new recruitment during the five-year period.
All additional requirements should be made through redeployment and rationalisation of various ministries.
3. Non-plan expenditure excluding interest payments, defence allocations, and pay and allowances held constant in real terms to
current level implying annual growth rate of 5 per cent.
4. Gross tax (including diesel cess) to GDP ratio rising from 9.16 per cent in 2001–02 to 11.7 per cent in 2006–07 implying
buoyancy of 1.44 per cent.
5. Disinvestment process to be accelerated to yield Rs 16,000 to Rs 17,000 crore per year on the average over the first three
years of the Tenth Plan.
6. Higher tax revenue should be achieved mainly through buoyancy and expansion of the tax base. Besides, a widespread and
bold imposition of user charges of all non-merit goods.
7. For tax revenues to increase as a share of GDP, an imposition of indirect taxes on the services sector is imperative. This can
essentially be achieved by the imposition of a widespread value-added tax (VAT) on all sectors of the economy. This would
mean levying tax at every stage of value addition from production to sale of both goods and services. Levying such a tax will
require an amendment to the Constitution along with the achievement of the consensus with the states so that it becomes feasible
to do so. The VAT came into force with effect from April 1, 2005 and majority states implemented the VAT.
In expenditure control, there are two areas which need special focus. The first is subsidies, both direct
and implicit, which are estimated to form a substantial proportion of GDP. The definition, magnitude,
utility, and justification of these subsidies merit consideration, particularly since this is precisely the
area with the highest potential for savings. The same considerations would also apply to various
cross-subsidisation mechanisms that are currently in force. We have discussed some measures to
reduce food subsidy in the next chapter. The second is the pension liability of the government, which
is the fastest growing component of current expenditures. At present, these liabilities are unfounded
and represent a claim on the general revenues.
A good deal of public sector investment is directed for provision of public services. The pattern
and conditions of the provision of such infrastructure services has been done in such a way that the
public has got used to not paying economic charges for these services. The include above
infrastructure services power, water supply, irrigation, and transport, among other key services. The
Finance Ministry has calculated that hidden subsidies on non-merit goods amount to as much as 10.7
per cent of GDP on an annual basis. It is no wonder that the combined fiscal deficit of the Centre and
the states amounts to almost 10 per cent of GDP. In the case of power alone, the losses resulting from
lower-than-economic pricing to the agriculture and domestic sectors amount to almost Rs 25,000
crore a year. It is primarily the absence of appropriate pricing of public services and the lack of will
to collect the levied charges that has caused the large fiscal imbalance that afflicts the country.

A good deal of public sector investment is directed for the provision of public services. They include key services, such as
power, water supply, irrigation, and transport, among others. The Finance Ministry has calculated that hidden subsidies on
non-merit goods amount to as much as 10.7 per cent of the GDP on an annual basis.
The argument for not charging appropriate user charges has essentially been based on equity
considerations. It is argued that the poor are not able to pay adequately for these essential public
services. This argument ignores the fact that it is the better-off sections of the society that consume
most of such services and, therefore, benefit from these services. In fact, if the better-off are made to
pay, it would then become possible to provide essential services to reach the poor. The fiscal health of
both the Central and state governments can improve dramatically over, say, a five-year period if this
correction is made. But this reform cannot be done by mere announcement. It needs research, public
awareness, public education, and persuasion. The Central government must lead this campaign and
forge an understanding and consensus with state governments, who must do the same with local
bodies.
The External Sector
The acceleration in growth rate cannot take place without tapping into the opportunities offered by the
international economy in terms of markets, investment, and technologies. But in doing so,
vulnerabilities have to be identified and addressed. This is, particularly, important in view of the
emerging trends in the international economy which suggest that the period of very high growth in
world trade is coming to an end. World trade growth has declined dramatically this year and appears
likely to remain well below that of the last decade for some time. The slowdown of the US economy
and its role as an engine of growth for world trade is an important factor. In the second half of the
1990s, China gradually became a competitor for South East Asian exports. In the first decade of the
21st century, Indian producers are likely to feel the heat of China’s competition. The nature of the
world trading system has also changed, with an increasing trend towards regional trading blocs in
which India’s participation is minimal. We must gear up to meet these competitive challenges by
accelerating our domestic reforms to create conditions for competitive advantage by domestic and
foreign-invested enterprises in the country.

The acceleration in growth rate cannot take place without tapping into the opportunities offered by the international
economy in terms of markets, investment, and technologies. But in doing so, vulnerabilities have to be identified and
addressed. This is, particularly, important in view of the emerging trends in the international economy which suggest that
the period of very high growth in world trade is coming to an end.
A high rate of GDP growth will necessarily be associated with a high rate of growth of imports.
This is, particularly, true given the extent of dependence on imports of energy and the limited
likelihood of expanding domestic energy sources rapidly enough. The recent liberalisation of
imports will also have a role to play. In such a situation, sustained high rates of growth of exports will
be essential for keeping the current account deficit within manageable limits. Rapid export growth
will also be necessary for aggregate demand reasons, since a steady increase in the rate of domestic
savings implies that the rate of domestic consumption growth will be less than the rate of growth of
output. Therefore, external markets will have to be sought for sustaining high levels of capacity
utilisation. Exports can also stimulate product and process innovation to meet the challenges of the
global market. In industries with significant economies of scale, exports also help in bringing down
the average cost of supply by more efficient phasing of lumpy capacities.

Rapid export growth is necessary for aggregate demand reasons, since a steady increase in the rate of domestic savings
implies that the rate of domestic consumption growth will be less than the rate of growth of output.
At present, the Indian economy suffers from two principal infirmities in expanding its exports
rapidly—the share of tradeables in GDP has been falling steadily, and the tradeable sectors continue
to be dominantly inward-looking. Measures for reversing these attributes are essential for sustainable
growth. Unless capacities are created in India, specifically, for the export market, it is unlikely that the
export growth targets can be met. There are, of course, exceptions, but excessive reliance on a limited
number of goods and services exposes the economy to vulnerability.
The most effective means of encouraging an outward orientation is to lower tariffs on imports so
that the anti-export bias both in policies and mind-sets get corrected. Protection, if at all necessary,
should be provided mainly through the exchange rate mechanism. In recent years, there have been
periods when the real exchange rate was appreciated, but they reflect more on the inability of the
Indian economy to absorb all available investible resources than any other factor. With investment
demand growing strongly, this should not be a source of concern.
Most importantly, it is necessary to recognise that rapid growth and development will not be
possible without a greater integration with the international economy. In order to make most of the
opportunities available, it is essential that India evolves a positive agenda for its future negotiations at
the World Trade Organization (WTO). Until now, the strategy has been defensive and status-quoits.
While this was perfectly appropriate for an inward-looking development strategy, it is not so now.
The Tenth Plan will evolve a strategic position for our inter-national negotiations.

Most importantly, it is necessary to recognise that rapid growth and development will not be possible without a greater
integration with the international economy. In order to make most of the opportunities available, it is essential that India
evolves a positive agenda for its future negotiations at the World Trade Organization (WTO).
The Financial Sector
With the steady reduction in the share and role of the public sector in the economy, the importance of
financial intermediation activities has increased, and will continue to do so. It is becoming evident,
however, that the organised financial sector in India is either unable or unwilling to finance a range
of activities that are of crucial importance both for growth and development. Agriculture,
unorganised manufacturing, and many types of infrastructure are instances of such sectors. Recent
financial sector reforms have naturally focused primarily on improving the viability and stability of
financial institutions, without adequately addressing this issue. It is necessary, therefore, to consider
methods of encouraging the financial sector to finance such activities without impinging on its
viability or compromising on prudential concerns.

Recent financial sector reforms have naturally focused primarily on improving the viability and stability of financial
institutions, without adequately addressing this issue. It is necessary, therefore, to consider methods of encouraging the
financial sector to finance such activities without impinging on its viability or compromising on prudential concerns.
The most important issue in this context is the utility and effectiveness of subsidised interest rates
for various purposes and segments of people. The evidence suggests that, on the one hand, financial
institutions are reluctant to make such loans and advances since they are not in their interest; and, on
the other hand, these benefits are systematically misused by the powerful and influential. Often, the
actual beneficiary ends up bearing a higher effective interest rate than would be available in the
normal course. It appears more important to ensure a smooth flow of resources than providing
limited amounts with subsidy.
Finally, there is a serious shortage of long-term risk capital in India, which will need to be bridged
if rapid growth is to be achieved. In addition, excessive reliance on debt instruments by savers for
meeting their long-term income flow requirements places pressure on the level and structure of
interest rates. A judicious mix of interest and capital gains incomes is necessary to balance the needs
of both savers and investors. Therefore, a widening and deepening of the capital market, including
equity and long-term debt, with adequate regulatory over-sight, is central to the process of a sustained
growth in savings and investment in the country over the longer run.
Sectoral Policy Issues
Pursuit of a strategy for achieving 8 per cent growth in the Tenth Plan will call for bold departures
from existing policies in each of the major sectors. Some of the critical issues which need to be
addressed in individual sectors are discussed here.
Agriculture and Land Management

The policy approach to agriculture, particularly in the 1990s, has been to secure increased production
through subsidies in inputs, such as power, water, and fertiliser, and by increasing the minimum
support price rather than through building new capital assets in irrigation, power, and rural
infrastructure. This strategy has run into serious difficulties. Deteriorating state finances have meant
that subsidies have “crowded out” public agricultural investment in roads and irrigation and
expenditure on technological upgrading. Apart from the inability to create new assets, the lack of
resources has eroded expenditure on maintenance of canals and roads. The financial unavialability of
the State Electricity Boards (SEBs), only partly due to subsidies on agricultural power supply, has
made it difficult to expand power supply in uncovered rural areas and contributed to the low quality
of rural power. These problems are particularly severe in the poorer states.

The policy approach to agriculture, particularly in the 1990s, has been to secure increased production through subsidies in
inputs, such as power, water, and fertiliser, and by increasing the minimum support price rather than through building new
capital assets in irrigation, power, and rural infrastructure.
The equity, efficiency, and sustainability of this approach are questionable. The subsidies have
grown in size and are now financially unsustainable. Some of the subsidies, for example, the fertiliser
subsidy, are really meant to cover the high cost of the fertiliser industry. Other subsidies, for
example, the under-pricing of power and irrigation, do not improve income distribution in rural
areas and may also be environmentally harmful. Excessive use of subsidised fertiliser has created an
imbalance between N, P, and K, whereas excessive use of water has produced waterlogging in many
areas.
It is necessary to evolve a new approach to agricultural policy based on a careful assessment of
current constraints and possibilities. A sober and careful assessment of our resources indicates that
both land and water will be crucial constraints on our efforts to expand production in agriculture. As
a nation, we are already in a situation where the extent of forest cover has declined alarmingly.
Although in recent years there has been some improvement, we are a long way from our eventual
target. In such a situation, we see little possibility of increase in the cultivated area in the country, and,
indeed, perhaps, an eventual decline as urban demand and environmental imperatives lead to
conversion of some agricultural land. There is, therefore, no alternative but to focus on raising the
productivity of our land in a manner which is sustainable over the longer term.

It is necessary to evolve a new approach to agricultural policy based on a careful assessment of current constraints and
possibilities. A sober and careful assessment of our resources indicates that both land and water will be crucial constraints
on our efforts to expand production in agriculture.
Nevertheless, every effort needs to be made to bring presently uncultivated land into productive
use, whether in agriculture or in forestry. For this, it will be essential to evolve a comprehensive land-
use policy which will lay out the contours of the ownership and institutional framework that will
encourage the productive utilisation of such lands. Furthermore, in order to optimise the utilisation of
our land resources, state governments may take such initiatives as deemed appropriate to remove
impediments in the way of productive utilisation of cultivable land, including tenurial reforms. The
Tenth Plan must also focus on increasing work opportunities for and productivity of women farmers.
Increasing women’s access to productive land by regularising leasing and sharecropping of
uncultivated agricultural land by women’s groups, encouraging collective efforts in bringing
wastelands under cultivation, and providing policy incentives to women in low-input subsistence
agriculture, will have immediate benefits in terms of household food security and women’s
empowerment.

Over the years, poverty alleviation programmes of various types have expanded in size and, today,
there is a wide variety of such programmes which absorb a large volume of resources. The plan
provision for rural development is Rs 7,000 crore, for food subsidy Rs 13,000 crore, and for
kerosene and LPG subsidy about Rs 12,000 crore, making a total of Rs 32,000 crore. Against this, the
provision for irrigation is Rs 1,700 crore and for afforestation Rs 400 crore. We need to examine
whether the resources used for poverty alleviation scheme and for various types of subsidies in the
name of the poor, may or may not be more effective in alleviating poverty, if directed to various
types of basic infrastructural asset creation programmes in rural areas.

Over the years, poverty alleviation programmes of various types have expanded in size and, today, there is a wide variety of
such programmes which absorb a large volume of resources.
Several evaluations of the IRDP show that the projects undertaken under the programme suffer
from numerous defects, including, especially, sub-critical investment levels; unviable projects; lack
of technological and institutional capabilities in designing and executing projects utilising local
resources and expertise; illiterate and unskilled beneficiaries with no experience in managing an
enterprise; indifferent delivery of credit by banks (high transaction cost, complex procedure,
corruption, one-time credit, poor recovery); overcrowding of lending in certain projects, such as
dairy; poor targeting and selection of non-poor; absence of linkage among different components of
the IRDP; rising indebtedness; and scale of IRDP outstripping the capacity of government and banks
to absorb. A disturbing feature of the IRDP in several states has been rising indebtedness of the
beneficiaries of IRDP. Besides, the programme for upgrading skills, TRYSEM, was not dovetailed
with IRDP. There were non-existent training centres and non-payment of stipend in some cases.
However, the programme for women, DWCRA, did well in some states (AP, Kerala, Gujarat).
IRDP was restructured in 1999 to address some of its shortcomings. The Swarna Jayanti Gram
Swarozgar Yojana (SGSY), which replaced IRDP, is a holistic programme based on a group
approach with selection of viable activities. The objective is to help the poor to generate adequate
levels of income to bring them above the poverty line on a sustained basis. This should be possible
without any subsidy, which in many cases leads to corruption. The subsidy amount should instead be
used for increasing the revolving fund given to self-help groups.

The Swarna Jayanti Gram Swarozgar Yojana (SGSY), which replaced IRDP, is a holistic programme based on a group
approach with selection of viable activities. The objective is to help the poor to generate adequate levels of income to bring
them above the poverty line on a sustained basis.
During the Tenth Plan, it is suggested that:

SGSY should be transformed into a micro-finance programme to be run by the banks and other financial institutions, with no
subsidy.
Funds to gram sabhas should be extended only when the people contribute, either in cash or in kind, say 15 per cent in normal
blocks and 5 per cent in tribal/poor blocks. This will instil a sense of ownership in the community.
There should be a single-wage employment programme to be run only in areas of distress. The focus should be on undertaking
productive works and their maintenance, such as rural roads, watershed development, rejuvenation of tanks, afforestation,
irrigation, and drainage. The payment of wages should be mainly in the form of food grains with some cash component. This will
improve self-targeting.
Rural development funds should also be used for enhancing the budgetary allocation of successful rural development schemes
that are being run by state governments, or for meeting the state contribution for donor-assisted programmes for poverty
alleviation.
Grassroots women’s groups should be empowered and encouraged to implement selected poverty alleviation schemes,
particularly, food-for-work schemes in areas affected by natural disasters.
Special efforts should be made to strengthen the economy of the marginal and small farmers, forest-produce gatherers, artisans,
unskilled workers, and others. The poor should not only benefit from growth generated elsewhere, but they should also
contribute to growth.
Special efforts must be made to encourage development of tiny and village industries suited for rural areas to provide non-farm
employment in rural areas.
Public Distribution System and Food Security

Despite a hefty increase in the annual food subsidy from Rs 2,450 crore in 1990–91 to Rs 9,200 crore
in 1999–00 and to Rs 13,000 crore in 2000–01, all is not well with the Targeted Public Distribution
System (TPDS) in India. There is 36 per cent diversion of wheat, 31 per cent diversion of rice, and 23
per cent diversion of sugar from the system at the national level. TPDS does not seem to be working
in the poorest north and north-eastern states. The allocation of poorer states such as UP, Bihar, and
Assam was more than doubled as a result of shifting to TPDS in 1997. Yet, due to poor off-take by the
states and even poorer actual lifting by the BPL families, the scheme has not made any impact on the
nutrition levels in these states.
It is important to emphasise that these initiatives are resource neutral. They do not require the
investment of significant public resources but they will help to improve agricultural income
generation. In addition, the proposed changes discussed here will reduce the surplus with the FCI, as
well as reduce leakages. There would thus be massive saving in the food subsidy that can then be used
for direct income transfer to the poorest and for improving land and water productivity in the poorer
areas.
New initiatives have been taken in India in the field of decentralised procurement of food grains.
Some state governments have, for instance, initiated their own food procurement operations. More
such initiatives should be encouraged in the future. Under such a situation, it is conceivable that some
of the FCI godowns (with staff) are transferred to the state governments. In this context, the task of
maintaining buffer stocks will become the joint responsibility of the Central and state governments.
Deficit states should be encouraged to buy directly from surplus states, and they should be
compensated for transport and storage and so on. These states will most probably hire private
agencies to do so, which will bring private expertise into the field.

New initiatives have been taken in India in the field of decentralised procurement of food grains. More such initiatives
should be encouraged in the future.
Forests
Forests are natural assets and provide a variety of benefits to the economy. The recorded forest area
is about 23 per cent of the geographical area of the country but 41 per cent of the area has degraded
and, hence, is unable to play an important role in environmental sustainability and in meeting the
forest produce needs of the people, industry, and other sectors.
The existing policy, laws, rules, regulations, and executive orders should be reviewed for
removing constraints in holistic development of forestry with people’s participation. Areas where
action by government is needed relate to the following:
Focus on farm forestry has been surprisingly diluted since 1991 despite its enormous potential, especially in agriculturally
backward areas. There are better social returns in promoting agro-forestry models in the rain-fed or semi-arid regions, which
contain most of India’s marginal lands. It is in this sector that we need to take a big initiative. Similarly, tree plantation on
marginal land and wastelands belonging to the poor is not encouraged.
Integrated land-use planning is not being attempted, and common lands adjacent to forests have been getting a low priority in
this field after 1991.
Continuing subsidies on government auctions of wood and bamboo industries, which acts as a disincentive to industry, to pay a
remunerative price to farmers. Governments need to examine the pattern of subsidy to forest-based industries and wipe out that
subsidy in a time-bound manner to improve valuation of forests. This will also give a big boost to farm forestry.
Government must review the tariff structure on forest-based products such as timber and pulp, keeping in view the incentive
effect on farmers.
Agro-forestry, mountains, watershed development, river valleys, arid areas, and wastelands afforestation programme should be
given priority.
Research and technological development must increase productivity, production of new products, value addition, improved
marketing, export, and productive employment generation.
Promotion of coastal shelterbelt plantations for prevention of natural calamities.
The existing policy, laws, rules, regulations, and executive orders should be reviewed for removing constraints in holistic
development of forestry with people’s participation.
Industrial Policy Issues

The industrial sector will have to grow at over 10 per cent to achieve the Tenth Plan target of 8 per
cent growth for GDP. This represents a major acceleration from its past performance; the sector grew
at only about 7 per cent in the Eighth and Ninth Plan periods taken together. Besides, this acceleration
has to take place in an environment which will be significantly different from the past.

The industrial sector will have to grow at over 10 per cent to achieve the Tenth Plan target of 8 per cent growth for GDP.
Two differences are particularly important. First, industry will have to face much stronger
international competition, as our domestic market is now more open with quantitative restrictions
(QRs) on imports having been removed with effect from April 1, 2001. Second, the relative role of
the public sector as a distinct entity will decline in the course of the Tenth Plan as the incremental
capacities will be mainly in the private sector, and the process of disinvestment converts many of the
existing public sector enterprises from government-controlled enterprises to non-government
enterprises in which government may have a minority stake, but the units will either become board-
managed or will be managed by a strategic investor. In either case, they will not be part of the public
sector.
The Tenth Plan must, therefore, focus on creating an industrial policy environment in which
private sector companies, including erstwhile public sector companies, can become efficient and
competitive. The specific policy issues that deserve special attention are discussed here.
The removal of QRs on imports is an important step in opening the economy to foreign
competition. However, while QRs have been removed, import protection is still very high. It is
estimated that India’s import-weighted tariffs have declined from around 90 per cent at the start of the
reforms to around 34 per cent in 2001–02 but this reduced level is three times higher than the level
prevailing in East Asia. It is now well recognised that while industrial protection may appear to help a
particular sector, it also raises domestic costs and make downstream industrial activity uncompetitive.
The net effect is to make industry as a whole uncompetitive in world markets. Recognising this, the
developing countries the world over have steadily reduced the level of protection over the past 10
years. The government has announced that India’s tariff levels will be brought to the East Asian levels
in a three-year period and a plan for a phased reduction will be announced before the Budget for
2002–03. This is, in our view, the right approach and will give the Indian industry a clear indication
of the pace at which the transition will be made. Care, however, will have to be taken to ensure that
adequate safeguards are provided for ensuring a level-playing field and to prevent dumping and other
forms of misuse.

The removal of QRs on imports is an important step in opening the economy to foreign competition.
SSIs, has a vital role to play in the process of industrialisation, providing a vehicle for
entrepreneurship to flourish and a valuable entry point for new entrepreneurs who can start small and
then grow. SSIs are also vehicles for achieving a broader regional spread of industry. Since SSIs are
generally more employment-intensive per unit of capital than a large-scale industry, they are also a
source of much-needed employment. Khadi and village industries also have an important role to play,
especially in promoting non-farm employment in rural areas.
The Tenth Plan must ensure that policies towards the small-scale sector are supportive.
Liberalisation of controls at the state level can help in this process. Equally important is the need to
ensure that adequate credit is made available to SSI units. A proactive policy encouraging banks to
meet the needs of SSI, while maintaining all necessary banking diligence in credit appraisal is very
necessary. Procedures for credit approval and disbursement in the public sector banks need to be
modernised to ensure quick response.

The Tenth Plan must ensure that policies towards the small-scale sector are supportive. Liberalisation of controls at the state
level can help in this process.
Labour Policy
Finally, it is essential to take a fresh look at the structure of labour laws. Our present laws are far too
rigid since they do not allow firms to retrench labour or downsize without the permission of the
appropriate government, which in most cases is the state government. This permission is almost
never given. Unfortunately, these provisions which were meant to protect employment have actually
served to discourage growth of employment. The inability to shed labour in times of difficulty
encourages entrepreneurs to avoid hiring labour. It is important to note that rigidity in labour laws
represents a greater burden for the labour-intensive industries than for capital-intensive industries,
where the labour force is small and excess labour can be more easily carried, or alternatively,
Voluntary Retirement Scheme (VRS) packages can be worked out which do not pose a huge burden.

Our present laws are far too rigid since they do not allow firms to retrench labour or downsize without the permission of the
appropriate government, which in most cases is the state government.
Science and Technology

Recognising that the comparative advantage in the globally integrated, knowledge-based world
economy today is shifting to those with brain power to absorb, assimilate, and adopt the spectacular
developments in science and technology and harness them for national growth, the Tenth Five-Year
Plan will give a special thrust to the field by leveraging on the strong institutional science and
technology framework built in post-independent India.
Innovative technologies will be generated to meet the Indian needs and to preserve, protect, and add
value to India’s indigenous resources, its vast biodiversity, and its rich traditional knowledge.
Technology plurality—an appropriate mix of traditional, conventional, and modern technology—will
be harnessed to enhance the national productivity to the maximum.
Technology will be used as a tool to give India a competitive position in the new global economy.
For example, Indian exports today derive their comparative advantage through resource and labour
rather than differentiation and technology. Therefore, increasing India’s share in high-tech products,
deriving value from technology-led exports and export of technology will be given a major thrust.

Increasing India’s share in high-tech products, deriving value from technology-led exports and export of technology will be
given a major thrust.
Social Infrastructure
Education: Our performance in the field of education is one of the most disappointing aspects of our
developmental strategy. Out of approximately 200 million children in the age group of 6–14 years,
only 120 million are in schools and net attendance in the primary level is only 66 per cent of
enrolment. This is completely unacceptable and the Tenth Plan should aim at a radical transformation
in this situation. Education for all must be one of the primary objectives of the Tenth Plan. The Sarva
Shiksha Abhiyan, which has been launched to achieve this objective, indicates a strong reiteration of
the country’s resolve to give the highest priority to achieve this goal during the plan period. It should
also be our resolve that the process of integrating our educational system with the economic needs of
the people and of the nation must begin at the primary school stage itself.
Universalising access to primary education and improvement of basic school infrastructure must
be a core objective of the Tenth Plan. This would mean targeting the provision of one teacher for
every group of 40 children for primary and upper primary schools, opening of a primary
school/alternate schooling facility within 1 km of every habitation, provision of free textbooks to all
SC/ST children and girls at the primary and upper primary school, management and repair of school
buildings through school management committees, provision of opportunities for non-formal and
alternative education for out-of-school children in the most backward areas and for those segments of
the population that have not been reached in response to local needs and demands articulated at the
grass-root level.

Access to primary education and improvement of basic school infrastructure must be a core objective of the Tenth Plan.
The Mid-day Meal Programme has made a difference in attendance and retention wherever a
proper, cooked meal is served. The practice of providing only grains followed by some state
governments, and that also not according to the prescribed norms in all cases, is vitiating the very
purpose of the scheme. The state governments must make efforts to provide hot, cooked meals.
If it is not possible to cover all the primary schools, efforts must be made to cover all schools in the
backward and tribal areas, so that at least the children who badly need this extra nutrition are covered.
Health: Improvement in the health status of the population has been one of the major thrust areas in
social development programmes of the country. This was to be achieved through improving the
access to and utilisation of health, family welfare, and nutrition services with a special focus on
under-served and under-privileged segments of population. Technological improvements and
increased access to health care have resulted in a steep fall in mortality, but the disease burden due to
communicable diseases, non-communicable diseases, and nutritional problems continue to be high. In
spite of the fact that norms for creation of health care infrastructure and manpower are similar
throughout the country, there remain substantial inter-state/inter-district variations in the availability
and utilisation of health care services and health indices of the population.
Data from National Social Survey Organisation (NSSO) indicate that escalating health-care costs is
one of the reasons for indebtedness not only among the poor but also in the middle-income group. It
is, therefore, essential that appropriate mechanisms be explored by which the cost of severe illness
and hospitalisation can be borne by individual/organisation/state, and affordable choice can be made.
Global and Indian experience in this area, including efforts at risk pooling, cross-subsidy at local
levels, social insurance, health insurance/health maintenance organisations have to be reviewed and
appropriate steps initiated.

Escalating health-care costs is one of the reasons for indebtedness not only among the poor but also in the middle-income
group. It is, therefore, essential that appropriate mechanisms be explored by which these costs can be borne by
individual/organisation/state, and affordable choice can be made.
Nutrition: Currently, the major nutrition-related public health problems are chronic energy
deficiency; micro-nutrient deficiencies, such as anaemia due to iron and folic acid deficiency,
Vitamin A deficiency, iodine-deficiency disorders, chronic energy excess, and obesity and associated
health hazards.
As a Tenth Plan strategy, efforts have to be made to move from untargeted food supplementation to
fully operationalising growth monitoring, including screening pre-natal women, in order to identify
onset under-nutrition and initiate appropriate health and nutritional interventions. Another necessary
step is to move from treatment of infection when children are brought, to prevention, early detection,
and management of infections through improved access to health care, which would prevent any
deterioration in the nutritional status of children.

As a Tenth Plan strategy, efforts have to be made to move from untargeted food supplementation to fully operationalising
growth monitoring, including screening pre-natal women, in order to identify onset under-nutrition and initiate appropriate
health and nutritional interventions.
Electric power: The power sector has been suffering from serious problems which were identified
as far back as 10 years ago. Although a number of corrective measures have been taken, they are yet
to yield the desired results. The outcome is that the power sector faces an imminent crisis in almost
all states. No SEB is recovering the full cost of power supplied, with the result that they make
continuous losses on their total operations. These losses cannot be made good from state budgets,
which are themselves under severe financial strain. As a result, the SEBs are starved of resources to
fund expansion and, typically, end up even neglecting essential maintenance. The annual losses of
SEBs at the end of the Ninth Plan were estimated at Rs 24,000 crore and this led to large outstanding
dues to central PSUs, NTPC, NHPC, CIL, railways, and others amounting to Rs 35,000 crore.
The reasons for the huge losses of the SEBs are well known. Power tariffs do not cover costs
because some segments, especially agriculture, but also household consumers, are charged very low
tariffs, while industry and commercial users are overcharged. However, the overcharged segments do
not always pay the high charges because theft of electricity, typically with the connivance of the staff
in the distribution segment, is very high. Of the electricity charges billed only 80 per cent are actually
collected. These large issues were hidden by claiming a large absorption of electricity in agriculture
which is unmetered, which enabled SEBs to claim transmission and distribution (T&D) losses of
around 24 per cent. However, when actual losses were calculated more precisely in states undertaking
power sector reforms, it was found that the actual T&D loss were as high as 45 per cent to 50 per
cent. Operational efficiencies in generation are also very low in some states. Overstaffing is rampant.
Political interference in the management of SEBs has become the norm in most states, making it
difficult to ensure high levels of management efficiency.

The reasons for the huge losses of the SEBs are well known. Power tariffs do not cover costs because some segments,
especially agriculture, but also household consumers, are charged very low tariffs, while industry and commercial users are
overcharged.
Coal: It is a primary energy source which is available in plenty in the country and is also the
cheapest fuel for power generation. Coal production will fall below the target for the Ninth Plan but
this has not presented a problem because thermal power generation capacity has not expanded as
targeted. For the Tenth Plan period, however, if electric power is to expand to support 8 per cent
growth, a substantial expansion in domestic coal production will be needed. The gestation period for
a coal mine is considerably longer than that of a power plant; this means that coal production
planning should have in mind not only the requirement of the Tenth Plan but also the Eleventh Plan.

If electric power is to expand to support 8 per cent growth, a substantial expansion in domestic coal production will be
needed.
A major policy constraint affecting the coal sector is the fact that it is the only energy sector that is
not open to private investment except for captive mining. At a time when the petroleum sector has
been opened to private investment, there is no reason why commercial mining of coal should not be
thrown open also. A proposal for amending the Coal Mines (Nationalisation) Act, 1973 has been
introduced in Parliament in 2000. Early passage of this amendment is a necessary step for attracting
private investment in this important area. Opening the sector for private investment will not only
improve total supplies, but also ensure an improvement in quality because of the pressure of
competition.
It should be noted, however, that amendment of the Coal Mines (Nationalisation) Act may not be
sufficient to attract private investment in this important area. It will also be necessary to make other
amendments to overcome the hurdle placed in the way of private mining in notified tribal areas by the
Samatha Judgment. The procedures for environmental clearance also need to be greatly simplified so
that potential private investors face clear and transparent rules.
Hydrocarbons: The government has already evolved “India Hydrocarbon Vision—2025”, which
lays down the framework to guide the approach and policies in this sector. Our dependence on
imported oil is increasing. It is expected to be about 70 per cent by the beginning of the Tenth Plan
and is likely to increase further in the course of the plan period. It is also likely that the use of gas for
power generation will increase rapidly in the coming years. Efforts should be made to increase
indigenous production of oil and gas. Arbitrary administrative restrictions on consumption and
imports of petroleum products are not the solution and will affect the economic growth of the
country. The correct approach would be to allow the scarcity value of such exhaustible natural
resources to be reflected in prices. This will create an incentive for conservation and efficient use of
petroleum products. This underscores the importance of ensuring that the Administrative Price
Mechanism (APM) for petroleum products is dismantled on schedule by April 2002, and petroleum
price determination shifts to market-based pricing at the start of the Tenth Plan. Complete price
deregulation and operation of an efficient market in the petroleum sector needs the establishment of
prudential rules and regulations by a statutory regulatory authority. Therefore, setting up of
regulatory mechanisms needs to be expedited to ensure smooth transition from APM to market-
driven pricing mechanism.

Complete price deregulation and operation of an efficient market in the petroleum sector needs the establishment of
prudential rules and regulations by a statutory regulatory authority.
Non-conventional energy: There is a significant potential to meet the basic energy requirement of
people (viz., cooking and lighting), both in the rural and urban areas, in an economically efficient
manner through non-conventional and renewable sources of energy. The emphasis has to be on
preparing a time-bound plan for progressive electrification covering groups of users or a village as
a whole. Wherever feasible, community systems have to be put up to meet and manage the energy
requirements in the villages. People’s participation through panchayats, other local bodies,
cooperatives, and NGOs, is to be secured in planning and implementation of such programmes. In
addition, other energy users would have to be encouraged to use these energy forms for their
particular applications. The approach has to be decentralised and based on a judicious mix of public
and private investment.

People’s participation through panchayats, other local bodies, cooperatives, and NGOs, is to be secured in planning and
implementation of such programmes.
Railways
Considering India’s continental size, geography, and resource endowment, it is natural that railways
should have a lead role in the transport sector—not to mention other considerations, such as greater
energy efficiency, eco-friendliness, and relative safety.
However, Indian Railways has experienced a continuous decline in its position relative to the road
transport system. Some reduction in share in favour of road transport was to be expected and is in
line with trends elsewhere, but there is a reason to believe that in India this has been excessive. This
has happened primarily because of policy distortions, which need to be corrected urgently.
There is also a need to contain burgeoning administrative costs. Expenditure on staff has been
increasing at a rapid pace, reflecting a considerable overstaffing combined with large Pay
Commission increases. The burden on the Railways for pension payments is, particularly, onerous.
Corrective action in these areas is urgently needed. The aim should be that staff cost including
pension remains within the level of 45 per cent of gross traffic receipt up to the year 2010. This will
imply that the staff strength will have to be reduced to around 12 lakh and maintained at that level.

Expenditure on staff has been increasing at a rapid pace, reflecting a considerable overstaffing combined with large Pay
Commission increases. The burden on the Railways for pension payments is, particularly, onerous. Corrective action in
these areas is urgently needed.
If the provisions of rail transport services, which lacks consumer focus at present, is to be replaced
by a system which provides services in line with consumer needs, it will require restructuring of
Indian Railways. The Railways should concentrate on its core function, that is running of transport
services on commercial lines, while spinning off non-core/peripheral activities, such as
manufacturing units, into individual corporations. These can remain in the public sector for the time
being, but should operate like any other public sector unit on commercial accounting principles.
Restructuring of even the core functions of Indian Railways appears to be desirable in order to
improve efficiency and to better meet the objectives of the organisation.

The Railways should concentrate on its core function, that is running of transport services on commercial lines.
Restructuring of even the core functions of Indian Railways appears to be desirable in order to improve efficiency.
Greater emphasis has to be laid on the completion of existing projects, and a proper prioritisation
of all ongoing projects has to be made to ensure that resources are not spread too thinly across
projects. Capacity on the saturated high-density corridors needs to be augmented, particularly, on the
Golden Quadrilateral, by undertaking doubling, opening up of alternative routes through new lines,
gauge conversion, and so on. The programme of containerisation needs to be accelerated, not only to
promote inter-modal transport but also as a strategy for increasing its own market share and catering
to high-value traffic. It would also be necessary to ensure that projects aimed at raising revenue and
capacity must achieve their objective.

Greater emphasis has to be laid on the completion of existing projects, and a proper prioritisation of all ongoing projects
has to be made to ensure that resources are not spread too thinly across projects.
During the Tenth Plan, the Railways should also enlarge the scope of private sector participation
gradually in acquiring rolling stock through innovative leasing schemes, and aim at upgrading safety
infrastructure through induction of technical aids to support human element and enhance asset
reliability.
Roads
Our road network is not up to the requirement of a rapid growth in an internationally competitive
environment in which Indian industry must compete actively with other developing countries.
Improvement in the national highway network should have high priority in the Tenth Plan.
Completion of the ongoing work on the Golden Quadrilateral and the North–South/East–West
corridor projects must have top priority in the Tenth Plan. More generally, the existing deficiencies in
the road network should receive higher priority than the extension of the network itself. In the longer
run, it may be necessary to plan and take preliminary action for expressways to be built in future on
those sections where they can be commercially justified.
Rural road connectivity is an extremely important aspect of rural development. Substantially
enhanced rural road accessibility should be achieved in the Tenth Plan by linking up all villages with
all-weather roads through the Prime Minister ’s Gram Sadak Yojana. However, while constructing
rural roads, connectivity of public health centres, schools, market centres, backward areas, tribal
areas, and areas of economic importance should be given priority.

Rural road connectivity is an extremely important aspect of rural development. Substantially enhanced rural road
accessibility should be achieved in the Tenth Plan by linking up all villages with all-weather roads through the Prime
Minister’s Gram Sadak Yojana.
Ports
The functioning of major ports under various Port Trusts is characterised by operational inflexibility
partly due to the structure of the decision-making process and partly due to outdated labour practices.
This introduces delays in shipments and additional costs, all of which makes our exports
uncompetitive. Radical reforms are needed in this area including corporatisation of the major ports
within a short period of time and induction of private investors in port development. Fortunately, this
is one area where the experience with private investment has been good.

Radical reforms are needed in this area including corporatisation of the major ports within a short period of time and
induction of private investors in port development.
Productivity improvement at major ports will be another important thrust area in the Tenth Plan.
Through productivity improvement, it is expected, a capacity equivalent of 11 MT–15 MT could be
added during the plan. The augmentation of capacity and improvement in productivity should make
for a situation where berths wait for ships rather than ships for berths.
Telecommunications
Telecommunications is a critical part of infrastructure and one that is becoming increasingly
important, given the trend of globalisation and the shift to a knowledge-based economy. Until 1994,
telecommunication services were a government monopoly. Although telecommunications expanded
fairly rapidly under this arrangement, it was recognised that capacities must expand much more
rapidly and competition must also be introduced to improve the quality of service and encourage
induction of new technology. Telecommunications has become especially important in recent years
because of the enormous growth of information technology (IT) and its potential impact on the rest
of the economy. India is perceived to have a special comparative advantage in IT or in ITES, both of
which depend critically on high-quality telecommunications infrastructure. Telecommunication has
also become extremely important for a wide range of rural activities, and this importance will only
increase as the process of diversification of rural economic opportunities gains momentum.
Universal service obligation must, therefore, be insisted upon for all providers of telecom services.
The telecommunications policy in the Tenth Plan must, therefore, provide IT and related sectors
with world-class telecommunications at reasonable rates. Formulating a policy for the sector faces an
additional challenge because technological change in telecommunication has been especially fast and
is constantly leading to major changes in the structure of the telecommunication industry worldwide.
With its technological and cost advantages, Internet telephony should be opened up. Tariff
rebalancing with the objective of cost-based pricing, transparency, and better targeting of subsidies
should be the guiding principles for tariffs. Convergence of data, voice, and image transmission and
use of wide bandwidth and high-speed Internet connectivity have added new dimensions to infotech
and entertainment which need to be taken into account in the policy regime. Such convergence of
services and appropriate changes in the licensing regime are needed to optimise the utilisation of
resources with a least cost of provision and encourage competition across the country in services and
among the service providers.

Formulating a policy for the telecommunication sector faces an additional challenge because technological change in
telecommunication has been especially fast and is constantly leading to major changes in the structure of the
telecommunication industry worldwide.
Conclusion
The last decade of the 20th century has seen a visible shift in the focus of development planning from
the mere expansion of production of goods and services and the consequent growth of per capita
income to planning for enhancement of human well-being. The notion of human well-being itself is
more broadly conceived to include not only consumption of goods and services in general, but also
more, specifically, ensuring that the basic material requirements of all sections of the population,
including especially those below the poverty line, are met and that they have access to basic social
services, such as health and education. Specific focus on these dimensions of social development is
necessary because experience shows that economic prosperity measured in terms of per capita GDP
does not always ensure enrichment in quality of life, as reflected, for instance, in the social indicators
on health, longevity, literacy, environmental sustainability, and so on. The latter must be valued as
outcomes that are socially desirable, and, hence, made direct objectives of the development process.
They are also valuable inputs in sustaining the development process. In addition to social
development measures in terms of access to social services, an equitable development process must
provide expanding opportunities for advancement to all sections of the population. Equality of
outcomes may not be a feasible goal of social justice but equality of opportunity is a goal for which
we all must strive.

The concept of human well-being includes not only consumption of goods and services in general but more specifically
ensuring that the basic material requirements of all sections of the population are met and that they have access to basic
social services such as health and education.
The development process must, therefore, be viewed in terms of the efficiency with which it uses
an economy’s productive capacities, involving both physical and human resources, as a means to
attain the desired social ends (and not just material attainment). To this end, it is absolutely essential to
build up the economy’s productive potential through high rates of growth without which we cannot
hope to provide expanding levels of consumption for the population. However, while this is a
necessary condition, it is not sufficient. It becomes imperative, therefore, to pursue a development
strategy that builds on a policy focus on exploiting synergies among economic growth, desirable
social attainments, and growing opportunities for all.
As we set out to discuss the approach to the First Five-Year Plan of the new millennium and the
tenth since our independence, we can justifiably take pride in having reversed the worst inequities of
our colonial past and succeeded in building an economy of considerable economic diversity and
strength within a framework of federal democracy. Much has been attained and yet much more needs
to be done. The economy has the potential to achieve much more than it has done in the past 10 years
and this achievement is, indeed, necessary if India is to take her rightful place in the comity of nations.
However, achievement of this potential requires a decisive action.
In many aspects, the development policy in future must make a break from the past. The
government had, over the years, taken on itself too many responsibilities, with the result that it not
only marginalised individual initiative but also succeeded in imposing severe strains on its financial
and administrative capabilities. More importantly, in the face of momentous changes in the domestic
economic policy in the last decade and an equally fast-paced integration of our economy with the
emerging global order, investment planning is no more the only, or the only predominant, or even
the most effective instrument of pursuing development. Planning has to necessarily go beyond
undertaking mere budgetary allocations among competing sectors and regions. It has to address with
greater vigour, the need to release latent energies and stimulate private initiative in various facets of
our development process. Ultimately, we have to plan for an environment that provides ample
opportunities for all to actualise their potential individually, as also collectively, for the nation as a
whole.

The government had, over the years, taken on itself too many responsibilities, with the result that it not only marginalised
individual initiative but also succeeded in imposing severe strains on its financial and administrative capabilities.
To this end, the approach to the Tenth Five-Year Plan proposes to shift the focus of planning from
merely resources to the policy, procedural, and institutional changes, which are considered essential
for every Indian to realise his or her potential. In view of the continued importance of public action in
our development process, increasing the efficiency of public interventions must also take high
priority. These measures collectively are expected to create an economic, political, and social
ambience in the country which would enable us to realise the Prime Minister ’s vision. The minimum
agenda on which there must be full political agreement, and for which the approval of the NDC is
sought, is listed below:
1. Reduction of Centrally sponsored schemes through transfer to states, convergence, and weeding out.
2. Expansion of project-based support to states.
3. Support to states made contingent on agreed programme of reforms.
4. Adoption of “core” plan concepts at both Centre and states.
5. Preference to be given to completion of existing projects than to new projects. Identification to be done by joint team from the
states, central ministries, and Planning Commission.
6. Plan funds to be permitted for critical repair and maintenance activities as decided by a joint team.
7. Greater decentralisation to People’s Representative Institutions (PRIs) and other people’s organisations.
8. Privatisation/closure of non-strategic PSUs at both Centre and states in a time-bound manner.
9. Reduction in subsidies in a time-bound manner to provide more resources for public investment.
10. Selected fiscal targets to be achieved at both Centre and states.
11. Accelerating tax reforms to move towards a full-fledged VAT in a time-bound manner.
12. Legal and procedural changes to facilitate quick transfer of assets, such as repeal of SICA, introduction and strengthening of
bankruptcy and foreclosure laws, and so on.
13. Reform of labour laws.
14. Reconsideration of all policies affecting the small-scale sector.
15. Adoption of a model blueprint for administrative reforms.
16. Reform and strengthening of judicial systems and procedures.
The approach to the Tenth Five-Year Plan proposes to shift the focus of planning from merely resources to the policy,
procedural, and institutional changes, which are considered essential for every Indian to realise his or her potential.
FIVE-YEAR PLANS—ACHIEVEMENTS AND FAILURES
Five decades of planning experience has witnessed achievements and failures in different sectors of
the economy. At best, the planning experience has proved to be a mixed blessing. Table 2.18 explains
the growth performance in all nine five-year plans.
Economic planning through public sector has been successful in laying a strong infrastructure in the
economy. It has provided congenial conditions for investment initiatives by the private sector. It is
also true that public sector has been mainly responsible for the development of such industries as iron
and steel, non-ferrous metals, petroleum, fertilisers, heavy engineering, coal, electricity, armament,
transport, and communications.

Economic planning through public sector has been successful in laying a strong infrastructure in the economy. It has
provided congenial conditions for investment initiatives by the private sector.
A major achievement of economic planning is the increase in food grains production from 50
million tonnes in 1950–51 to 208.9 million tonnes in 1999–2000, recording a four-fold increase over
a period of half a century. However, the increase in per capita availability of food grains per day has
been modest: from 395 grams in 1951 to 466 grams in 2000. This is attributable to the enormous
increase in production that has helped the country to achieve a considerable degree of self-sufficiency
in terms of food requirements and tide over recurring food shortages reminiscent of the 1960s and
1970s. The breakthrough has been achieved as a result of substantial public investment in irrigation,
agricultural research and extension schemes, subsidised inputs, credit facilities, and price-support
programmes.

A major achievement of economic planning is the increase in food grains production from 50 million tonnes in 1950–51 to
208.9 million tonnes in 1999–2000, recording a four-fold increase over a period of half a century.
Through economic planning, India has successfully maintained a reasonable degree of price
stability during the post-independence period. The annual rate of inflation, with some exceptions, has
remained a single digit through better management of demand and supply of essential commodities. A
vast public distribution system has been built up to contain the prices of essential goods.

Table 2.18 Growth Performance in the Five-Year Plan
(Per cent per annum)

Plan Period
Targ et Actual
First Plan (1951–56) 2.1 3.60
Second Plan (1956–61) 4.5 4.21
Third Plan (1961–66) 5.6 2.72
Fourth Plan (1969–74) 57 2.05
Fifth Plan (1974–79) 4.4 4.83
Sixth Plan (1980–85) 5.2 5.54
Seventh Plan (1985–90) 5.0 6.02
Eighth Plan (1992–97) 5.6 6.02
Ninth Plan (1997–02) 6.5 5.35
Source: Tenth Five-Year Plan, 2002–07, Planning Commission, Government of India.

Note: The growth targets for the first three plans were set with respect to national income. In the Fourth Plan it was net domestic product.
In all plans, thereafter, it has been GDP at factor costs.

Successive plans have stressed the need to develop the backward regions of the country. In
promoting a regional balanced development, the public sector has played an important role as many
public enterprises are located in the most backward areas of the country. It has helped these areas in
terms of development of infrastructure, employment opportunities, and growth of ancillary
industries.

Successive plans have stressed the need to develop the backward regions of the country. In promoting a regional balanced
development, the public sector has played an important role as many public enterprises are located in the most backward
areas of the country.
In the beginning, the planning process relied on the automatic benefits of growth as a means to
eradicate poverty. The unsatisfactory results of this approach forced the government to attack poverty
directly through rural development and rural employment schemes. Some major poverty alleviation
schemes of the government launched since the late 1980s are 1. Integrated Rural Development
Programme (IRDP), 2. The National Rural Employment Programme (NREP), and 3. Rural Landless
Employment Guarantee Programme (RLEGP).
Summing up the achievements of planning, the Eighth Five-Year Plan (1992–97) observed,
Growth has brought about a structural change in the economy. This has surfaced in the form of a shift in the sectoral composition of
production, diversification of activities, advancement of technology and a gradual transformation of a feudal and colonial economy
into a modern industrial nation. The composition of national income has changed steadily over the planning years. While the share of
agriculture and allied activities in the GDP has declined, that of the tertiary sector has increased. The expansion of services has not
only been conducive for employment generation but also for better efficiency of the system and better quality of life.
The composition of national income has changed steadily over the planning years. While the share of agriculture and allied
activities in the GDP has declined, that of the tertiary sector has increased.
In spite of achievements in agriculture and capital goods sector, economic planning has performed
poorly in several areas. The rate of growth in real gross national product (GNP) envisaged in
successive plans has generally ranged between 5 per cent and 5.5 per cent. However, during the first
three decades of economic planning (1951–80), the economy progressed at a modest average growth
rate of 3.5 per cent per annum. If we take into account the annual growth rate of population (around 2
per cent), the growth rate of per capita real income would turn out to be very modest.
The massive backlog of unemployment in rural as well as in urban areas is a glaring failure of the
planning process. The undue emphasis on heavy industries is partly responsible for the present
serious unemployment problem. The ICOR is quite high (around 6) in the Indian economy due to a
host of factors including higher interest rate and long gestation period of projects. The reduction in
ICOR can be achieved by giving priority to investment in agriculture, rural work programmes, and
village and small industries. Furthermore, ICOR can be lowered if investment projects are completed
on time.
The benefits of development under the plans have not trickled down to the poorest sections of
society. In the rural sector, the policy of land reforms has virtually failed. The growth of black money
in urban areas has led to a wasteful expenditure by the urban elite. The slogan of establishment of a
socialistic pattern of society has remained on paper only. The widening economic disparities among
various classes and regions have caused social tensions.

The benefits of development under the plans have not trickled down to the poorest sections of society. In the rural sector, the
policy of land reforms has virtually failed. The growth of black money in urban areas has led to a wasteful expenditure by
the urban elite.
India’s internal and external debt has reached alarming proportions. The country is virtually caught
in a debt trap. Moreover, the budgets of the Central and state governments are showing huge deficits
of a chronic nature. The fiscal policy has failed to contain budgetary deficits with the result that
deficit financing has to be resorted to on a large scale.
The experience of economic planning in India over the last five decades has been a mixed blessing.
Commenting on the achievements and failures of economic planning, the Ninth Five-Year Plan
(1997–02) remarked
During the past fifty years, there has been an overall progress in all areas of social concern. Yet, the achievements are mixed, with
stark contrasts and disparities. The chronic food deficit economy of the fifties and the sixties has been transformed into a self-
sufficient one and an elaborate food security system is in place to enable the country to face even droughts without any imports or
foreign help. Yet, more than 300 million people live below the poverty line and millions of children remain undernourished.
During the past fifty years, there has been an overall progress in all areas of social concern. Yet, the achievements are
mixed, with stark contrasts and disparities.
ELEVENTH FIVE-YEAR PLAN (2007–12)
Objectives and Challenges
On the eve of the Eleventh Five-Year Plan, our economy is in a much stronger position than it was a
few years ago. After slowing down to an average growth rate of about 5.5 per cent in the Ninth Five-
Year Plan period (1997–98 to 2001–02), it has accelerated significantly in the recent years. The
average growth rate in the last four years of the Tenth Plan period (2003–04 to 2006–07) is likely to
be a little over 8 per cent, making the growth rate as 7.2 per cent for the entire Tenth Plan period
Although the above detail is below the Tenth Plan target of 8 per cent, it is the highest growth rate
achieved in any plan period.
This performance reflects the strength of our economy and the dynamism of the private sector in
many areas. Yet, it is also true that the economic growth has failed to be sufficiently inclusive,
particularly after the mid-1990s. Agriculture has lost its growth momentum from that point on and,
subsequently, has entered a near-crisis situation too. Jobs in the organised sector have not increased
despite faster growth. The percentage of our population below the poverty line is declining but only
at a modest pace. Malnutrition levels too appear to be declining but the magnitude of the problem
continues to be very high. Many people still lack access to basic services, such as health, education,
clean drinking water, and sanitation facilities, without which they cannot claim their share in the
benefits of growth. Although women have increased their participation in the labour force as
individuals, they continue to face discrimination and are subject to increasing violence: one stark
example of which is the declining child sex ratio.
Despite the problems, most of the commoners have tried to cope with their livelihood issues. Many
have participated in a collective action by trying to improve their social and economic conditions.
Empowerment of PRIs is ongoing but much remains to be done. Civil society organisations have
gained strength and are making new experiments to reach the unreached, often in partnership with
PRIs. Women are participating in meetings of PRIs and are leading group actions for a better life.
A Vision for the Eleventh Plan
The Eleventh Plan provides an opportunity to restructure policies, to achieve a new vision based on
faster, more broad-based, and inclusive growth. It is designed to reduce poverty and focus on
bridging the various divides that continue to fragment our society. The Eleventh Plan must aim at
putting the economy on a sustainable growth trajectory with a growth rate of approximately 10 per
cent by the end of the plan period. It will create productive employment at a faster pace than before
and target robust agriculture growth at 4 per cent per year. It must seek to reduce disparities across
regions and communities by ensuring access to basic physical infrastructure as well as health and
education services to all. It must recognise gender as a cross-cutting theme across all sectors and
must commit to respect and promote the rights of a commoner. The first steps in this direction were
initiated in the middle of the Tenth Plan based on the National CMP (NCMP) adopted by the
government. The above steps must be further strengthened and consolidated into a strategy for the
Eleventh Plan.

The Eleventh Plan must aim at putting the economy on a sustainable growth trajectory with a growth rate of approximately
10 per cent by the end of the plan period. It will create productive employment at a faster pace than before and target
robust agriculture growth at 4 per cent per year.
Rapid growth is an essential part of our strategy for two reasons. Firstly, it is only in a rapidly
growing economy that we can expect to sufficiently raise the incomes of the mass of our population
to bring about a general improvement in living conditions. Secondly, rapid growth is necessary to
generate the resources needed to provide basic services to all. Work done within the Planning
Commission and elsewhere suggests that the economy can accelerate from 8 per cent per year to an
average of around 9 per cent over the Eleventh Plan period, provided appropriate policies are put in
place. With the population growing at 1.5 per cent per year, the 9 per cent growth in GDP would
double the real per capita income in 10 years. This must be combined with policies that will ensure
that this per capita income growth is broad based, benefitting all sections of the population,
especially, those who have thus far remained deprived.
A key element of the strategy for inclusive growth must be an all-out effort to provide the mass of
our people the access to basic facilities, such as health, education, clean drinking water, and so on. In
the short run, the above essential public services impact directly on welfare but in the longer run, they
determine the economic opportunities for the future.

A key element of the strategy for inclusive growth must be an all-out effort to provide the mass of our people the access to
basic facilities, such as health, education, clean drinking water, and so on.
It is important to recognise that access to the above basic services is not necessarily assured simply
by a rise in the per capita income. Governments at different levels have to ensure the provision of
these services, and this must be an essential part of our strategy for inclusive growth. At the same
time, it is important to recognise that better health and education are the necessary pre-conditions for
sustained long-term growth.
Even if we succeed in achieving broad-based and inclusive growth, there are many groups that may
still remain marginalised. They include primitive tribal groups, adolescent girls, the elderly and the
disabled who lack family support, and the children below the age of three and the others who do not
have strong lobbies to ensure that their rights are guaranteed. The Eleventh Plan must pay special
attention to the needs of these groups.
The private sector, including farming, micro, small, and medium enterprises (MSMEs), and the
corporate sector, has a critical role to play in achieving the objective of faster and more inclusive
growth. This sector accounts for 76 per cent of the total investment in the economy and an even larger
share in employment and output. MSMEs, in particular, have a vital role to play in expanding the
production in a regionally balanced manner and generating widely dispersed off-farm employment.
Our policies must aim at creating an environment in which entrepreneurship can flourish at all levels,
not just at the top.

The private sector, including farming, micro, small, and medium enterprises (MSMEs), and the corporate sector, has a
critical role to play in achieving the objective of faster and more inclusive growth. This sector accounts for 76 per cent of
the total investment in the economy and an even larger share in employment and output.
To stimulate private investment, policy-induced constraints and excessive transaction costs need to
be removed. To increase the number of successful entrepreneurs, a competitive environment must be
created that encourages new entrants and provides enough finance for efficient enterprises to expand.
Competition also requires policies to curb restrictive practices, particularly those that deter entry, for
example, preemptive acquisition of property. To achieve such an environment, it is imperative that the
reforms agenda be pursued with vigour. Although licensing controls and discretionary approvals
have been greatly reduced, there are many remnants of the control regime that still need drastic
overhaul. Quantitative controls, where they exist, should give way to fiscal measures and increased
reliance on competitive markets, subject to appropriate, transparent, and effective regulations. The
burden of multiple inspections by government agencies must be removed and tax regimes
rationalised. A major component of the Eleventh Plan must be to design policies that spur private
sector investment while encouraging the competition itself by guarding against monopolistic
practices. Continued commitment to the developmental and social roles of banking is important to
ensure that the benefits are widespread.

To stimulate private investment, policy-induced constraints and excessive transaction costs need to be removed. To increase
the number of successful entrepreneurs, a competitive environment must be created that encourages new entrants and
provides enough finance for efficient enterprises to expand.
Even while encouraging the private sector growth, the Eleventh Plan must also ensure a substantial
increase in the allocation of public resources for the plan programmes in critical areas. This will
support the growth strategy and ensure inclusiveness. The above resources will be easier to mobilise
if the economy grows rapidly. A new stimulus to public sector investment is particularly important in
agriculture and infrastructure and both the Centre and the states have to take steps to mobilise
resources to make this possible. The growth component of this strategy is, therefore, important for
two reasons:
a. It will contribute directly by raising income levels and employment, and
b. It will help finance programmes that will ensure more broad-based and inclusive growth.
Even while encouraging the private sector growth, the Eleventh Plan must also ensure a substantial increase in the
allocation of public resources for the plan programmes in critical areas.
All this is feasible but, by no means, it is an easy task. Converting something that is potential into a
reality is a formidable endeavour and will not be achieved if we simply continue on a business-as-
usual basis. There is a need for both the Centre and the states to be self-critical and evaluate
programmes and policies to see what is working and what is not. Programmes designed to achieve
specific objectives often fail to do so even though substantial expenditure is incurred on them. It is,
therefore, necessary to focus on outcomes rather than outlays, including a disaggregated level to
examine their impact on different groups and genders. The practice of gender budgeting already
begun by the Central government should extend to the states, so that performance is judged on the
basis of gender-disaggregated data. Particular attention must also be paid to SCP/TSP (special
component plan/tribal sub-plan) guidelines for expenditure and monitoring of outcomes.

Programmes designed to achieve specific objectives often fail to do so even though substantial expenditure is incurred on
them. It is, therefore, necessary to focus on outcomes rather than outlays, including a disaggregated level to examine their
impact on different groups and genders.
The Strengths of Our Economy
The strengths of our economy are reflected in the macro-economic indicators in Table 2.19, which
compare the position in the Tenth Plan with that of the Ninth Plan. When compared to the Ninth Plan,
the pace of growth of our economy has accelerated and our macro-economic fundamentals are sound
now.
Domestic savings rates have been rising and have reached 29.1 per cent in 2004–05.
The combined fiscal deficit of the Central and State governments is higher than what it should be, but has been falling and the
Budget Estimates for 2006–07 suggest it may come down to 7 per cent.
Inflation has been moderate despite the sharp hike in international oil prices.
As of August 25, 2006, our foreign exchange reserves are at a very comfortable level at $165.3 bn.
The current account was in surplus during the first two years of the Tenth Plan but in deficit to the
extent of 1.0 per cent of the GDP in the third year, that is, 2004–05, the deficit is estimated to have
risen to around 1.3 per cent of the GDP during 2005–06 reflecting the revival of investment and also
the impact of high oil prices; but a deficit of this order is eminently financeable.

Table 2.19 Macro-economic Indicators
Ninth Plan Tenth Plan

Heads
(1997–98 to 2001–02) (2002–03 to 2006–07)
GDP growth (%) of which 5.5 7.2
Agriculture 2.0 1.7
Industry 4.6 8.3
Services 8.1 9.0
Gross domestic savings (% of GDP, at market prices) 23.1 28.2
Gross domestic investment (% of GDP, at market prices) 23.8 27.5
Current account balance (% of GDP, at market prices) -0.7 0.7
Combined fiscal deficit of Centre and states (% of GDP at market prices) 8.8 8.4
Foreign exchange reserves (US$ bn) 54.2 165.3
Rate of inflation (based on WPI) 4.9 4.8
Notes:
1. The growth rate for 2006–07 is as projected by the Economic Advisory Council to the Prime Minister.
2. Gross savings rate, gross investment rates, and the current account balance are expressed in current prices and are averages for the plan. For the Tenth plan, these
are the averages of the first three years, i.e., for the years 2002–03 to 2004–05.
3. Combined fiscal deficit is the average of the plan. For the Tenth plan, it is the average of the first four years of the plan, i.e., for the years 2002–03 to 2005–06.
4. Foreign exchange reserves are as on March 29, 2002 for the Ninth plan and March 31, 2006 for the Tenth Plan.
5. The rate of inflation for the Tenth Plan is the average up to January 2006.

As a result of economic reforms implemented by successive governments over the past decade and
a half, our economy has matured in several important aspects. It is now much more integrated into the
world economy and has benefitted from this integration in many ways. The outstanding success of IT
and ITES has demonstrated what Indian skills and enterprise can do—given the right environment.
Similar strength is now evident in sectors, such as pharmaceuticals, auto components, and, more
recently, textiles. The above gains in competitiveness need to spread to other sectors too.

As a result of economic reforms implemented by successive governments over the past decade and a half, our economy has
matured in several important aspects. It is now much more integrated with the world economy and has benefitted from this
integration in many ways.
One of the benefits derived from global integration is the increased inflow of foreign direct
investment (FDI). FDI increased from an average of $3.7 bn in the Ninth Plan period to an average of
$5.7 bn in the first four years of the Tenth Plan. This, however, is still below potential. The NCMP
states that the country needs and can absorb three times the amount of FDI that it gets. This is a
reasonable target and can be achieved in the Eleventh Plan.
In the longer run, there is another important potential strength arising from our demographic
trends. Our dependency rate (ratio of dependent to working-age population) is falling whereas in
industrialised countries and even in China, it is rising. The presence of a skilled young population in
an environment where investment is expanding and the industrial world is ageing, could be a major
advantage. It is important to realise, however, that we can reap this demographic dividend only if we
invest in human resource development and skill formation in a massive way, and create productive
employment for our relatively young, working population.

It is important to realise, however, that we can reap this demographic dividend only if we invest in human resource
development and skill formation in a massive way, and create productive employment for our relatively young, working
population.
Some Major Challenges
The strengths enumerated so far are real and provide a sound base on which the Eleventh Plan can
build. Yet, several challenges remain.
Agricultural Crisis: Regaining Agricultural Dynamism

One of the major challenges of the Eleventh Plan will be to reverse the deceleration in agricultural
growth from 3.2 per cent observed between 1980 and 1996–97 to a trend average of around 2.0 per
cent, subsequently. This deceleration is the root cause of the problem of rural distress that has
surfaced in many parts of the country and has even reached crisis levels in some. Low farm incomes,
because of inadequate productivity growth, have often combined with low prices of output and with
lack of credit at reasonable rates, to push many farmers into crippling debt. Even otherwise,
uncertainties seem to have increased (regarding prices, quality of inputs, and also weather and pests),
which, coupled with unavailability of proper extension and risk insurance have led farmers to despair.
This has also led to a widespread distress migration, a rise in the number of female-headed
households in rural areas, and a general increase in women’s work burden and vulnerability. In 2004–
05, women accounted for 34 per cent of principal and 89 per cent of subsidiary workers in
agriculture, higher than in any previous round of the National Sample Survey.

One of the major challenges of the Eleventh Plan will be to reverse the deceleration in agricultural growth from 3.2 per cent
observed between 1980 and 1996–97 to a trend average of around 2.0 per cent, subsequently.
The crisis of agriculture is not a purely distributional one that arises out of the special problems of
small and marginal farmers and landless labour. In fact, agricultural deceleration is affecting farms
of all sizes. To reverse this trend, corrective policies must not only focus on the small and marginal
farmers who continue to deserve special attention, but also on the middle and large farmers who
suffer from productivity stagnation arising from a variety of constraints.
It is vital to increase agricultural incomes as this sector still employs nearly 60 per cent of our
labour force. A measure of self-sufficiency is also critical for ensuring food security. A second green
revolution is urgently needed to raise the growth rate of agricultural GDP to around 4 per cent. This
is not an easy task as the actual growth of agricultural GDP, including forestry and fishing, is likely to
be below 2 per cent during the Tenth Plan period. The challenge, therefore, is to at least double the
rate of agricultural growth and, to do so, recognise demographic realities, particularly the increasing
role of women.

It is vital to increase agricultural incomes as this sector still employs nearly 60 per cent of our labour force. A measure of
self-sufficiency is also critical for ensuring food security.
Changing Employment Patterns

Doubling the growth of agricultural GDP to 4 per cent per annum will improve the rural employment
conditions by raising the real wages and reducing the underemployment. However, even if this is
attained, an overall growth of 9 per cent will further increase income disparity between agricultural
and non-agricultural households, unless around 10 million workers, currently in agriculture, find
remunerative non-agricultural employment. To make this possible, and absorb all new entrants into
the labour force, non-agricultural employment has to increase at over 6 per cent per annum during
the Eleventh Plan. This poses a major challenge not only in terms of generating non-agricultural
employment but also in matching its required location and type. Care has to be taken to manage the
resulting livelihood changes and to ensure that employment is generated at all levels of skill in non-
agricultural sector. The inadequacy of widely dispersed and sustainable, off-farm productive
employment opportunities is a basic cause of most divides and disparities. Growth without jobs can
neither be inclusive nor can it bridge divides. All avenues for increasing employment opportunities,
including those that can be provided by micro and small enterprises (MSEs) need to be explored. If
we fail to do so, the demographic dividend can turn into a demographic nightmare. Thus,
employment creation and raising employability is another major challenge for the Eleventh Plan.

The inadequacy of widely dispersed and sustainable, off-farm productive employment opportunities is a basic cause of most
divides and disparities. Growth without jobs can neither be inclusive nor can it bridge divides.
Providing Essential Public Services to the Poor

A key element of the Eleventh Plan strategy should be to provide essential education and health
services to those large parts of our population who are still excluded from the above categories.
Education is the critical factor that empowers participation in the growth process, but our
performance has been less than satisfactory, both overall as well as in bridging gender and other
divides. Overall literacy is still less than 70 per cent and rural female literacy less than 50 per cent
with corresponding rates even lower among the marginalised groups and minorities. Although the
Sarva Shiksha Abhiyan has expanded the primary school enrolment, it is far from providing a quality
education. Looking ahead, we cannot be satisfied with only universal primary education, but we must
move towards universal secondary education too, as quickly as possible. In the area of health, there
continue to be large gaps in the most basic services, such as mother and child care, clean drinking
water, and access to basic sanitation facilities; the poor do not have even a minimum access.

Education is the critical factor that empowers participation in the growth process, but our performance has been less than
satisfactory, both overall as well as in bridging gender and other divides.
Although both education and curative health services are available for those who can afford to pay,
quality service is beyond the reach of the commoners. Other privately provided services are of highly
variable quality. In this situation, access to essential services can only be through public financing. In
most cases, this means public provision or partnership with non-profit and civil society
organisations.
A major institutional challenge is that even where service providers exist, the quality of delivery is
poor and those responsible for delivering the services cannot be held accountable. Unless such
accountability is established and cutting-edge service providers are trained, it will be difficult to
ensure a significant improvement in delivery even if large resources are made available.

A major institutional challenge is that even where service providers exist, the quality of delivery is poor and those
responsible for delivering the services cannot be held accountable.
Increasing Manufacturing Competitiveness

Although growth in manufacturing sector has accelerated when compared to the Ninth Plan, it is
unlikely to exceed 8 per cent in the Tenth Plan. This is unacceptably low. If we want our GDP to grow
at 9 per cent, we have to target a 12 per cent growth rate for this sector.
Our remarkable success in ITES has prompted some observers to conclude that China has a
comparative advantage in manufacturing, whereas India has the same in services. It has, thus, been
suggested that we should concentrate on the growth of high-value services. This approach is
simplistic. India’s performance in the ITES and other high-end services is clearly a source of strength
that must be built upon. However, India cannot afford to neglect manufacturing. We meet most of the
requirements for attaining a double-digit growth rate in this sector. We have a dynamic,
entrepreneurial class that has gained confidence in its ability to compete. We have skilled labour and
excellent management capability even though this is an area where supply constraints will soon
emerge. There are, however, some important constraints that limit our competitiveness, especially, in
labour-intensive manufacturing, and the Eleventh Plan must address these issues on a priority basis.
A major constraint in achieving faster growth in manufacturing that needs immediate attention is
the inadequacy of our physical infrastructure. Our roads, railways, ports, airports, communication,
and, above all, power supply, are not comparable to the standards prevalent in our competitor
countries. This gap must be filled within the next 5–10 years if our enterprises are to compete
effectively. In the increasingly open-trading environment that we face today, our producers must
compete aggressively not just to win export markets, but also to retain domestic markets against the
competition from imports. Indian industry recognises the above fact and no longer expects to survive
on protection. But they do expect a level-playing field in terms of quality infrastructure. Development
of infrastructure is, therefore, to be accorded a high priority in the Eleventh Plan.

A major constraint in achieving faster growth in manufacturing that needs immediate attention is the inadequacy of our
physical infrastructure. Our roads, railways, ports, airports, communication, and, above all, power supply, are not
comparable to the standards prevalent in our competitor countries.
Developing Human Resources

Decades ago, we had emphasised on quality higher education by setting up IITs (Indian Institute of
Technology) and other premier educational institutions. This has paid us rich dividends. However,
there are emerging signs that rapid growth can result in shortage of high-quality skills needed in
knowledge-intensive industries. One area of concern is that we are losing our edge on the tracking of
pure sciences. To continue our competitive advantage and ensure a continuous supply of quality
manpower, we need large investments in public sector institutions of higher learning. This should be
accompanied by a fundamental reform of the curriculum as well as service conditions to attract a
dedicated and qualified faculty. Expanding capacity through private sector initiatives in higher
learning needs to be explored while maintaining quality standards.

To continue our competitive advantage and ensure a continuous supply of quality manpower, we need large investments in
public sector institutions of higher learning.
At the present pace of economic development, the country cannot train everyone to become skilled
professionals and even university-level education to all cannot be ensured. But our industries require
skills in specific trades, and, unfortunately, India has historically lagged behind in the area of
technical/vocational training. Even today, enrolment rates in Industrial Training Institutes (ITIs) and
other vocational institutes, including nursing and computer training schools, are only about a third of
that in higher education. This is quite the opposite of other Asian countries which have performed
better than us in labour-intensive manufactures. Vocational training institutes need to be substantially
expanded not only in terms of the people they train but also in the number of different skills and
trades for meeting the industry requirements, as well as creating opportunities for self-employment.

Vocational training institutes need to be substantially expanded not only in terms of the people they train but also in the
number of different skills and trades for meeting the industry requirements, as well as creating opportunities for self-
employment.
Protecting the Environment

Our concern for environmental issues is growing along the lines of global concern. In the short run,
there may seem to be a trade-off between environmental sustainability and economic growth, but in
the longer run, we must take recourse to the complementarities between environmental sustainability
and human well-being. We have already seen that neglect of environmental considerations. For
example, profligate use of water or deforestation has devastating effects. The threat of climate change
poses a real challenge to future generations. Our development strategy, therefore, has to be sensitive
to these concerns and should ensure that threats and trade-offs are appropriately evaluated.

The threat of climate change poses a real challenge to future generations. Our development strategy, therefore, has to be
sensitive to these concerns and should ensure that threats and trade-offs are appropriately evaluated.
Improving Rehabilitation and Resettlement Practices

Our practices regarding rehabilitation of those displaced from their land because of development
projects, conflicts, or calamities, are very deficient. These deficiencies have caused many people to
feel vulnerable, and there is anger because of forced exclusion and marginalisation. In particular, the
costs of displacement, borne by our tribal population, have been unduly high. Compensation has been
tardy and inadequate, leading to unrest and insurgency in many regions. This discontent is likely to
grow exponentially if the benefits from the enforced land acquisition are seen accruing to private
interests, or even to the state at the cost of those displaced. To give the displaced people, especially
women, their due rights, it is necessary to frame a transparent set of policy rules that address
compensation, proper resettlement, and rehabilitation, and also give project-affected people a
permanent stake in project benefits. Moreover, these rules need to be given a legal format in terms of
the rights of the displaced.

To give the displaced people, especially women, their due rights, it is necessary to frame a transparent set of policy rules
that address compensation, proper resettlement, and rehabilitation, and also give project-affected people a permanent stake
in project benefits. Moreover, these rules need to be given a legal format in terms of the rights of the displaced.
Improving Governance
Good governance and transparency should be ensured in the implementation of public programmes,
and also in government’s interaction with the ordinary citizens. Corruption is now seen to be endemic
in all spheres of life. Better design of projects, implementation mechanisms, and procedures can
reduce the scope for corruption. Much more needs to be done by both the Centre and the States to
lessen the discretionary power of government, ensure greater transparency and accountability, and
create awareness among citizens. The Right to Information (RTI) Act empowers people to demand
improved governance, and as government, we must be ready to respond to this demand.

Much more needs to be done by both the Centre and the States to lessen the discretionary power of government, ensure
greater transparency and accountability, and create awareness among citizens.
Justice delayed is justice denied. Quick and inexpensive dispensation of justice is an aspect of good
governance which is of fundamental importance in a successful society. India’s legal system is
respected for its independence and fairness but it suffers from notorious delays in dispensing justice.
The poor cannot access justice because delays cost money. Fundamental reforms are needed to give
justice to two essential attributes: speed and affordability.
Disparities and Divides
Even as we address the specific challenges listed earlier, we must deal with the perception that
development has failed to bridge the divides that afflict our country and may even have sharpened
some of them. Some of these perceptions may be exaggerated, but they exist nonetheless. The
Eleventh Plan must seek to bridge these divides as an overarching priority.

Even as we address the specific challenges listed earlier, we must deal with the perception that development has failed to
bridge the divides that afflict our country and may even have sharpened some of them.
There are many divides. Foremost among them is the divide between the rich and the poor. As
explained in Chapter 11, poverty is declining, but only at a pace which is no longer acceptable, given
the minimalist level at which the poverty line is fixed. There is also a divide between those who have
access to essential services, such as health, education, drinking water, sanitation, and so on, and those
who do not. Groups that have hitherto been excluded from our society, such as SCs, STs, some
minorities, and OBCs continue to lag behind the rest.
Another important divide relates to gender. It begins with the declining sex ratio, goes on to
literacy differential between girls and boys, and culminates in the high rate of maternal mortality. The
extent of bias is self-evident. The statistics given in Table 2.20 are reflective of the trend but do not
tell the whole story. Differentials in educational status and economic empowerment are heavily biased
against women. Special, focused efforts should be made to purge society of this malaise by creating
an environment for women to become economically, politically, and socially empowered. Measures
to ensure that society recognises women’s economic and social worth, and accounts for the worth of
women’s unpaid work, will be a concomitant of this.
The divide between urban and rural India has become a truism of our times. The Central
government has already adopted a multi-pronged strategy to reduce this divide in its various
dimensions. For example, the Bharat Nirman programme addresses the gaps in rural infrastructure,
and covers irrigation, road connectivity, housing, water supply, electrification, and telephony; the
National Rural Employment Guarantee Act (NREGA) attempts to ensure a social safety net as it
provides guaranteed employment in rural areas; and at the same time, has the capacity to build rural
infrastructure, especially, if resources from other programmes are pooled in; the Sarva Shiksha
Abhiyan and National Rural Health Mission are ambitious programmes for providing elementary
education and primary health services, respectively. All these programmes indicate the priority being
given by the government to rural development and are meant to give a new hope to rural India. Even
while making the above provisions for rural India, the Eleventh Plan must also provide basic
amenities to the growing number of poor in urban areas.

Table 2.20 Status of Some Socioeconomic Indicators
Notes:
1. For the years 1990–91 and 2003–04.

2. The poverty estimates given are for 1993–94 and the latest estimates are based on the NSS 2004–05 Survey, which is comparable with 1993–94.
3. Calculated from the information based on Census 1991 and 2001.
4. Based on SRS.
5. Percentage below 2 standard deviation from the mean of an international reference population.

Regional backwardness is another important issue. Differences across the states have always been a
cause of concern but there exists imbalances within the states as well. Backward districts of otherwise
well-performing states present a dismal picture of intra-state imbalance and neglect. Unless the Centre
and the states together deal with this problem on a priority basis, discontent, injustice, and frustration
will breed extremism. The spread of Naxalite movement to more than hundred districts in the country
is a warning sign. There is anger and frustration where communalism has left scars. This is the direct
fallout of the failures of the state apparatus to create an environment where the bulk of the people reap
the benefits of development.

Regional backwardness is another important issue. Differences across the states have always been a cause of concern but
there exists imbalances within the states as well. Backward districts of otherwise well-performing states present a dismal
picture of intra-state imbalance and neglect.
Special efforts must be made to give the people a sense of fairness, dignity, and hope. The
Backward Regions Grant Fund is meant to address the problem of regional imbalance so that the
growth momentum is maintained.
Brief Policy Approaches of the Eleventh Plan
Prepared after widespread consultations, the approach paper is the first step in defining the objectives
and targets of the Eleventh Plan, and identifying the associated challenges and implications for the
policy. A number of important conclusions emerge which need to be considered by both the Central
and the state governments as we move to formulate the detailed strategy for the Eleventh Plan.
Objectives and Targets

A major advantage in formulating the Eleventh Plan is that India’s economic fundamentals have
improved enormously, and we now have the capacity to make a decisive impact on the quality of life
of the mass of our people, especially, on the poor and the marginalised. This objective cannot be
achieved, however, if we simply follow a business-as-usual approach. Let alone acceleration, even if
the rate of growth in the last few years is to be sustained, it needs support. Besides all these, growth
has not been sufficiently inclusive thus far, and this is a significant shortcoming that needs to be
corrected.
Traditionally, the rate of growth of GDP has been at the centre of planning and for good reasons. In
a low-income country, it is only through rapid economic growth that the production base of the
economy can be expanded to sustain a higher standard of living for the people. A faster growing
economy also makes it easier to generate the resources needed to finance many of the social
development programmes. However, both arguments also highlight the fact that growth is not an end
in itself but is a means to an end which must be defined in terms of multi-dimensional, economic, and
social objectives. The Eleventh Plan must, therefore, not only set targets for the rate of growth of
GDP, but must also set monitorable targets for other dimensions of performance, reflecting the
inclusiveness of this growth.

The Eleventh Plan must, therefore, not only set targets for the rate of growth of GDP, but must also set monitorable targets
for other dimensions of performance, reflecting the inclusiveness of this growth.
The monitorable targets that emerge from this approach paper are given in Box 2.3. The Eleventh
Plan should be formulated in a manner, whereby, these national targets are further disaggregated into
appropriate targets for individual states. Policies and programmes must then be identified both at the
Central and State levels to ensure that these targets are achieved by the end of the Eleventh Plan
period.
The growth target for the Eleventh Plan must build on the average growth of 8 per cent in the last
four years of the Tenth Plan. A feasible objective is to accelerate from 8 per cent growth at the end of
the Tenth Plan to 10 per cent by the end of the Eleventh Plan, yielding an average GDP growth rate of
about 9 per cent in the Eleventh Plan. Achievement of this target and continued growth rate of 10 per
cent in the Twelfth Plan would lead to a doubling of per capita income over the next two plan periods.
The structure of growth should also be such as to promote a wide spread of benefits. Doubling
agricultural GDP growth to around 4 per cent is particularly important in this context. This must be
combined with policies to promote rapid growth in non-agricultural employment so as to create 70
million job opportunities in the Eleventh Plan. If these objectives are achieved, the percentage of
people in poverty could be reduced by 10 percentage points by the end of the plan period.

A feasible objective is to accelerate from 8 per cent growth at the end of the Tenth Plan to 10 per cent by the end of the
Eleventh Plan, yielding an average GDP growth rate of about 9 per cent in the Eleventh Plan.
The basic objective of the Eleventh Plan must be to extend access to essential public services, such
as health, education, clean drinking water, sanitation, and so on, to those who are deprived of them.
Our failure on this count is a major reason for the wide-spread dissatisfaction and the feeling of
exclusion from the benefits of growth. Recognising that the provision of good quality education is the
most important equaliser in society, the Sarva Shiksha Abhiyan has tried to universalise elementary
education. The focus must now be on reducing the drop-out rate from 52 per cent in 2003–04 to 20
per cent and also on achieving a significant improvement in the quality of education. The literacy rate
must be increased to 85 per cent and the gender gap in literacy narrowed to 10 percentage points.
Compulsions that force a child to work must be removed so that every child can go to school.

The basic objective of the Eleventh Plan must be to extend access to essential public services, such as health, education,
clean drinking water, sanitation, and so on, to those who are deprived of them.
It is also time to bridge the large gaps in health-status indicators which currently place India below
some of the world’s poorest countries. The Eleventh Plan must ensure a substantial improvement in
health indicators, such as maternal mortality, infant mortality, total fertility rate, and malnutrition,
particularly among children, and set monitorable targets for these areas. Success in this area involves
convergence of multiple efforts in many sectors other than health and family welfare. Supply of safe
drinking water and access to sanitation for all must be the top priority. In addition, we must address
the lack of education, especially in women, which has severely limited our ability to improve
nutrition and control neo-natal diseases.

The Eleventh Plan must ensure a substantial improvement in health indicators, such as maternal mortality, infant mortality,
total fertility rate, and malnutrition, particularly among children, and set monitorable targets for these areas.
Box 2.3 Monitorable Socio-economic Targets of the Eleventh Plan
Income & Poverty

Accelerate growth rate of GDP from 8% to 10% and then maintain at 10% in the Twelfth Plan in order to double the per
capita income by 2016–17.
Increase agricultural GDP growth rate to 4% per year to ensure a broader spread of benefits.
Create 70 million new work opportunities.
Reduce educated unemployment to below 5%.
Raise real-wage rate of unskilled workers by 20%.
Reduce the headcount ratio of consumption poverty by 10 percentage points.
Education
Reduce dropout rates of children from elementary school from 52.2% in 2003–04 to 20% by 2011–12.
Develop minimum standards of educational attainment in elementary school, and by regular testing monitor effectiveness of
education to ensure quality.
Increase literacy rate for people of age seven years or more to 85%.
Lower gender gap in literacy to 10 percentage points.
Increase the percentage of each cohort going to higher education from the present 10% to 15% by the end of the Eleventh
Plan.
Health
Reduce infant mortality rate (IMR) to 28 and maternal mortality ratio (MMR) to 1 per 1000 live births.
Reduce total fertility rate to 2.1.
Provide clean drinking water for all by 2009 and ensure that there are not slip-backs by the end of the Eleventh Plan.
Reduce malnutrition among children of age group 0–3 to half its present level.
Reduce anaemia among women and girls by 50% by the end of the Eleventh Plan.
Women and Children

Raise the sex ratio for age group 0–6 to 935 by 2011–12 and to 950 by 2016–17.
Ensure that at least 33% of the direct and indirect beneficiaries of all government schemes are women and girl children.
Ensure that all children enjoy a safe childhood, without any compulsion to work.
Infrastructure
Ensure electricity connection to all villages and BPL households by 2009 and round-the-clock power by the end of the
Plan.
Ensure all-weather road connection to all habitation with population 1,000 and above (500 in hilly and tribal areas) by
2009, and ensure coverage of all significant habitation by 2015.
Connect every village by telephone by November 2007 and provide broadband connectivity to all villages by 2012.
Provide homestead sites to all by 2012 and step up the pace house construction for rural poor to cover all the poor by
2016–17.
Environment
Increase forest- and tree cover by 5 percentage points.
Attain WHO standards of air quality in all major cities by 2011–12.
Treat all urban waste water by 2011–12 to clean river waters.
Increase energy efficiency by 20 percentage points by 2016–17.

The Eleventh Plan must also pay special attention to gender equity and help create an enabling
environment for the social, economic, and political empowerment of women. The shameful practice
of female foeticide, which is reflected in low and falling sex ratio for age group 0–6 must be stopped.
The plan must focus on ways of improving women’s socio-economic status by mainstreaming gender
equity concerns in all sectoral policies and programmes. Special efforts must be made to ensure that
the benefits of government schemes accrue in appropriate proportions to women and girls.

The Eleventh Plan must also pay special attention to gender equity and help create an enabling environment for the social,
economic, and political empowerment of women.
Protection of the environment is extremely important for our well-being, but it is even more so for
future generations who will bear the brunt of environmental degradation. The Eleventh Plan must aim
at significant improvements in this area. Forest cover must be increased by 5 percentage points.
Determined steps must be taken at the level of state government to improve air quality in all major
cities to meet World Health Organization’s (WHO) standards. As our rivers and water bodies are
seriously threatened by unrestricted discharge of effluents and sewage, urban waste water must be
fully treated. This essential requirement to clean up our rivers should receive priority attention from
state governments, especially, in areas of large urban and industrial concentration. Moreover,
appropriate policies must be designed and implemented to increase energy efficiency by 20
percentage points and, thus, limit the harmful effect of carbon combustion on the environment.

Protection of the environment is extremely important for our well-being, but it is even more so for future generations who
will bear the brunt of environmental degradation. The Eleventh Plan must aim at significant improvements in this area.
In addition to the monitorable targets listed in Box 2.3, many new social interventions are needed to
help achieve the objective of inclusiveness. Some important interventions proposed in this approach
paper are listed in Box 2.4.
Policies for Faster and More Inclusive Growth
The approach paper has identified areas where new policy initiatives are needed to achieve the 9 per
cent growth target and its desired sectoral composition. These areas will be spelt out in greater detail
in the plan. Some critical issues, however, can be identified at this stage.
Investment Requirements
One set of issues concerns the aggregate resource requirement. An average growth rate of 9 per cent
over the Eleventh Plan period will require an increase in domestic investment rates from 27.8 per cent
in the Tenth Plan to 35.1 per cent in the Eleventh Plan. Half of this increase is expected to come from
private investment in agricultural farms, small and medium enterprises, and in the corporate sector.
The rest will come from public investment, with a focus on critical infrastructure sectors.

An average growth rate of 9 per cent over the Eleventh Plan period will require an increase in domestic investment rates
from 27.8 per cent in the Tenth Plan to 35.1 per cent in the Eleventh Plan.
Private investment has been buoyant in the last two years and this buoyancy can be expected to
continue as long as GDP growth prospects remain favourable. Nevertheless, steps must be taken to
continuously improve the investment climate. The Central government has already done much in this
area to encourage private investment, both domestic and foreign, by creating a competitive
environment which encourages entrepreneurship. These policies have yielded positive results and
must continue to be strengthened.
It is particularly important to take steps to encourage entrepreneurship and expansion among small
and medium enterprises. State governments have a major role to play in this context by improving the
investment climate. Many state governments are taking steps in this direction but much more can be
done, such as streamlining of multiple taxes and reduction of the rigours of the Inspector Raj. As far
as the Centre is concerned, it must ensure that there is financial inclusion for MSMEs and that the
financial system functions in a way that supports the investment needs of MSMEs. Innovative forms of
financing to help start or expand new businesses, such as micro-finance, venture capital funds, private
equity funds, and so on, must be encouraged.

It is particularly important to take steps to encourage entrepreneurship and expansion among small and medium
enterprises. State governments have a major role to play in this context by improving the investment climate.
Public Investment and the Plan Size

The approach paper draws attention to the need for increments in public investment in several areas.
These increments would have to come from a combination of investment undertaken through the plan
budgets of the Central and the state governments and increased investment by the public sector,
financed by internal and extra-budgetary resources. The plan size will need to make provision for the
addition to the public investment, financed through budgets of the Central and state governments and
also the planned expansion in public services, much of which is not investment but revenue
expenditure.

Box 2.4 Important New Social Interventions
Provide one year of pre-school education for all children to give those from underprivileged backgrounds a head start.
Expand secondary schools with provision of hostels and vocational education facilities to assure quality education to all
children up to Class X.
Expand facilities for higher and technical education of quality with emphasis on emerging scientific and technological fields
Provide freedom and resources to select institutions so that they attain global standards by 2011–12.
Provide emergency obstetrics-care facilities within 2 hours travel from every habitat.
Ensure adequate representation of women in elected bodies, state legislatures, and the Parliament.
Provide shelter and protection to single women, including widows, handicapped, deserted, and separated women.
The plan size will need to make provision for the addition to the public investment, financed through budgets of the Central
and state governments and also the planned expansion in public services, much of which is not investment but revenue
expenditure.
Given the constraints on the fiscal deficit imposed by the Fiscal Responsibility and Budget
Management (FRBM) legislation, achievement of the desired plan size will depend critically upon
achieving an increase in the tax revenues as a proportion of GDP and a fall in non-plan expenditure as
a percentage of GDP. Determined action on both fronts should make it possible to achieve a level of
GDP for the plan (Centre and states combined), which, expressed as a ratio of GDP, is 2.5 percentage
points of GDP higher than what it was in the Tenth Plan. The increase in tax revenues depends
critically upon achievement of the growth targets and good revenue buoyancy. Fortunately, the
experience in recent years holds great promise for revenue buoyancy both for the Central and the
state governments. Effective control on non-plan expenditure in practice means control of subsidies,
especially, untargeted subsidies that are not aimed at the poor and vulnerable sections. It also means
levying of rational user charges in many areas to limit the demands for budgetary support.
Policies Towards Agriculture

The objective of doubling the growth rate of agricultural GDP to 4 per cent per annum is critical to
ensure the inclusiveness of growth. This, however, poses major policy challenges in the immediate
future. It is necessary to adopt region-specific strategies, focusing on the scope for increasing yields
with known technologies and the scope for viable diversification, keeping in mind marketing
constraints. It is necessary to improve the functioning of the agricultural development administration,
especially, the extension system, which is the key to bridging the knowledge gap. Particular attention
must to be paid to water management problems in the dry land rain-fed areas. Implementation of a
region-specific strategy depends critically upon state-level agencies. The Central government can, at
best, help by providing financial assistance and policy guidance.

The objective of doubling the growth rate of agricultural GDP to 4 per cent per annum is critical to ensure the inclusiveness
of growth. This, however, poses major policy challenges in the immediate future.
These issues have been comprehensively examined by the National Farmers Commission, which
has submitted its reports containing several recommendations. The NDC Committee on Agriculture is
expected to submit its report in December 2006. The Eleventh Plan will draw on these reports, clearly
defining the relative roles of the Centre and the states to shape a credible strategy for agriculture.
Promoting Access to Health and Education

Achieving the Eleventh Plan targets for health and education requires a greatly expanded role for the
state in these areas. This is because access to essential public services, such as health, education, clean
drinking water, and sanitation is not an automatic outcome of rising incomes. It calls for a deliberate
public intervention to ensure delivery of these services. It is in this context that the National Rural
Health Mission has been launched in order to improve the access and availability of quality health
care, sanitation, and nutrition. Achievement of these targets also requires a conscious effort in
capacity mobilisation of the state at various levels to provide such services through public action.
This can be supplemented wherever possible by private effort, but there is no doubt that even after
allowing a scope for expanded supply by the private sector, the bulk of the responsibility will fall on
the public sector. For this reason, plan expenditure in education and health will have to increase
substantially. However, mere increases in expenditure will not suffice unless accountability is also
improved. For locally delivered services, such as elementary education and health, more active
supervision by the PRIs can make a difference. For secondary and higher education, as well as for
tertiary health care, other methods of monitoring performance and enforcing accountability are
necessary. Both the Centre and the states have to cooperate in finding ways to improve monitoring
and enforce accountability. Measures to bring about effective devolution to PRIs will help improve
local involvement and accountability. Civil society organisations can play a major role in assisting
PRIs in this area.

Achieving the Eleventh Plan targets for health and education requires a greatly expanded role for the state in these areas.
This is because access to essential public services, such as health, education, clean drinking water, and sanitation is not an
automatic outcome of rising incomes.
Developing Infrastructure
The biggest constraint on rapid growth in the years ahead will be the lack of physical infrastructure.
The deficiencies in our roads, ports, railways, airports, electric power system, and also various types
of urban infrastructure must be overcome during the Eleventh Plan period if the industrial sector is to
achieve the targeted growth of 10 per cent. Both the Centre and the states have responsibility in this
area as different types of infrastructure fall under different jurisdictions.
A start had been made in the Tenth Plan to address these gaps in infrastructure, but much more
needs to be done. Public investment in this area must be increased. However, the total resources
required to correct the infrastructure deficit exceed the capacity of the public sector. The strategy for
infrastructure development must, therefore, encourage public-private partnerships (PPP) wherever
possible. However, the PPP strategy must be based on principles which ensure that PPPs are seen to be
in the public interest in the sense of achieving an additional supply at a reasonable cost. PPP must
serve to put private resources into public projects and not the other way round.

The deficiencies in our roads, ports, railways, airports, electric power system, and also various types of urban
infrastructure must be overcome during the Eleventh Plan period if the industrial sector is to achieve the targeted growth of
10 per cent.
Rural Infrastructure
The development of rural infrastructure is crucial for ensuring inclusiveness and for giving a new
deal to rural areas. The Bharat Nirman Programme had made a good start in the Tenth Plan and will
continue into the Eleventh Plan. The programmes must be adequately funded and vigorously
implemented so that every village has road connectivity, drinking water, rural housing, and rural
telecom connectivity. Homestead sites must be provided to all by 2012. The implementation of the
NREGA Programme and the Backward Regions Grant Fund provides two additional sources of
funding infrastructure development in the most backward districts of our country.

The development of rural infrastructure is crucial for ensuring inclusiveness and for giving a new deal to rural areas. The
Bharat Nirman Programme had made a good start in the Tenth Plan and will continue into the Eleventh Plan.
Special Focus on Weaker Sections

Despite special programmes for the development of the weaker sections, there are many groups in
our society that do not benefit adequately from development. The Eleventh Plan must pay special
attention to the needs and requirements of the SCs, STs, minorities, and other excluded groups to
bring them at par with the rest of the society. The Central and the state governments’ implementation
of the special plan for SCs and STs leaves much to be desired. These two strategic policy initiatives to
remove socio-economic disparities should receive special attention in the Eleventh Plan. The 15-point
programme for the welfare of minorities circulated to all state governments must be implemented
with a serious concerted effort. The strategy for faster and more inclusive growth outlined in this
approach paper presents formidable challenges and requires determined action by both the Centre and
the states. Achieving these targets will not be an easy task, but it is definitely feasible. The knowledge
that the economy is in many ways better placed today than it has ever been should help us achieve
such ambitious targets.

The Eleventh Plan must pay special attention to the needs and requirements of the SCs, STs, minorities, and other excluded
groups to bring them at par with the rest of the society.
LIBERALISATION AND PLANNING
India’s adoption of liberalisation came after more than six months of negotiations with the World
Bank, starting from January 1991. However, the series of reforms that were initiated in the country
did not evolve through discussion or dialogue in any forum within India. The content and
implementation of reforms was not debated in Parliament nor did it come up as the subject of
discussion in any tripartite form comprising representatives of transparency, extremely essential in a
democracy. The reforms were announced as a package in July 1991 by the newly installed minority
government led by P. V. Narasimha Rao. They consisted of a two-pronged economic policy:
1. The IMF-inspired macro-economic stabilisation that would focus on reducing the twin deficits in balance of payments and
2. A comprehensive programme for structural changes of the economy in the fields of trade, industry, foreign investment, public
sector among others, which was inspired by the World Bank.
India’s adoption of liberalisation came after more than six months of negotiations with the World Bank, starting from
January 1991. However, the series of reforms that were initiated in the country did not evolve through discussion or
dialogue in any forum within India.
The series of measures undertaken were expected to contribute not only to macro-economic
stabilisation but also to ensure higher growth, the benefits of which, it was felt, would automatically
percolate to the poor. There is no doubt that the package of reforms were a conditionality imposed by
the World Bank and the International Monetary Fund (IMF) as the basis for giving financial assistance
to India to tide over the foreign-exchange crises. As such, the social consequences of the reforms
were not taken into consideration before their implementation. They signified a sharp break from
India’s economic and socialist political culture; nevertheless, they were implemented without a hitch.
Although the government claimed later that the new economic measures were a part of a well-thought
out and well-considered long-term programme contention, it is obvious that the pressure of
economic crisis pushed the government to make compromises and commitments and adopt policies
which were a startling break from the ethos of Indian planning. Economic liberalisation in India
brings sharply into focus the relative failures of the democratic experience. It reflects on the inability
of a democratic state to fight off effectively the devils of want, hunger, and deprivation.

There is no doubt that the package of reforms were a conditionality imposed by the World Bank and the International
Monetary Fund (IMF) as the basis for giving financial assistance to India to tide over the foreign-exchange crises. As such,
the social consequences of the reforms were not taken into consideration before their implementation.
The Structural Adjustment Policy (SAP) of the Indian government and terms of liberalisation and
globalisation, deregularisation, and privatisation pose more threats than opportunities for the
agriculture-based development which forms the focus of the plans. Apart from agriculture, concern
also arises about the public sector in the new set-up. It is not only in the doldrums but also faces an
uncertain future. The Exit Policy has not been all that successful. The Ninth Plan also focused on the
introduction of a countrywide Employment Assurance Scheme (EAS) to tackle unemployment as well
as underemployment through PRIs. Its objective of equity is reflected in the seven basic services—
safe drinking water, primary health, primary education, public housing to the poor, nutritional
support to children, connectivity of villages by roads, and public distribution system targeted at the
poor. All this shows a continued heavy reliance on planning even while the new economic policy
entails fundamental and far-reaching changes as far as economic development goes.

The Structural Adjustment Policy (SAP) of the Indian government and terms of liberalisation and globalisation,
deregularisation, and privatisation pose more threats than opportunities for the agriculture-based development which forms
the focus of the plans.
That liberalisation is incompatible with planning is obvious. The question that arises is—is
liberalisation warranted and does it augur well for the common man, the poor, the unemployed, the
undernourished, and the undereducated? What would be the implications of a free market economy
on the eradication of poverty, unemployment, inequalities, gender disparities, and the multitude of
problems that plague the country. The efficacy of planning also comes to be seriously questioned in
view of the kind of laissez fairism that liberalisation entails. Notwithstanding its noble projections,
planning in India is up against a new adversary in liberalisation.

The efficacy of planning also comes to be seriously questioned in view of the kind of laissez fairism that liberalisation
entails. Notwithstanding its noble projections, planning in India is up against a new adversary in liberalisation.
CASE
Not for nothing have all political parties, barring the constituents of the United Progressive Alliance
(UPA) governing at the Centre, taken serious exception to the formal induction of representatives of
the International Monetary Fund (IMF), the World Bank, the Asian Development Bank (ADB), and
McKinsey & Company into the Planning Commission of India.
The move is as ill-advised as it is objectionable. The Deputy Chairman of the Planning
Commission justified the move on the argument that they have been brought in only to assist in the
mid-term review of the Tenth Plan, and not to oversee the functioning of the Commission as a whole.
He feels that being outsiders, they would be able to bring to bear their critical professional judgement
on the appraisal, drawing on their exposure to situations in other countries; whereas one set of
official within the government, undertaking the similar exercise, and going over the work of another
set of officials, might be inhibited in exposing gaps and deficiencies in performance in an equally
frank and forthright manner. Also, the role the foreign agencies was meant to be strictly advisory, and
not binding on the government whose power and authority to take final decisions would continue to
remain, without its independence being in any way allowed to be compromised or diluted.
The matter is not as simple as it is made out and begs a whole host of questions:
Will the representative of foreign agencies be invited to attend meetings of only the expert groups
connected with the mid-term review or of all bodies set up under the aegis of the Commission?
Will they, under the guise of reviewing the Tenth Plan, have the freedom to comment on issues
directly or indirectly related to the whole range of economic policies?
Will their access to official data be restricted only to open, unclassified documents or be extended
to cover whatever is relevant to the material under discussion in meeting?
Are the various sections of the Commission under obligation or instruction to accede to their
requests for information over and above what is furnished to them?
Can they, on their own, call on officials and hold private consultations?
Will the summary records of the proceedings explicitly record their views and suggestions?
Does their participation in meetings and discussions entail payment of any fees?
The Deputy Chairman is being rather simplistic in assuming that the role of foreign agencies being
advisory in nature somehow gives the government the right to overrule them and take independent
decisions on issues according to its best lights and in the best interests of the country.
It is astonishing and, at the same time, disappointing that both the Deputy Chairman and Chairman,
having dealt for so many years with the kind of foreign agencies now given entrée into India’s
corridors of power, should have failed to take note of some factors that compulsively and, even
routinely, determine their behaviour in their relations to other countries.
The first set of factors has to do with their organisational culture and style of functioning. Being
largely peopled by self-centred and presumptuous know-alls, lacking in humility, and unfamiliar with
the complexities and diversities of countries like India, they act on knee-jerk reflexes and impose
their quick fixes based on the premise “one size fits all”.
They have a few simplistic prescriptions that they seek to thrust down the throat of countries
without taking account of conditions peculiar to them. Those prescriptions are privatise government
undertakings, devalue the current, extract user fees, eliminate subsidies, remove tariffs, let prices find
their levels however high, open the doors for foreign investors, and so on.
Here are a few examples from the writings of Western critics on their mind-set.
The IMF Secretariat with 2,300 staffers’ works in secret, drawing up policies for the 80 countries
under its control, largely without their participation and without the knowledge of the world. This
shows the IMF’s monopoly of power over policies. The role of the IMF and the World Bank is of
concern. The conditions placed on their loans often force countries into rapid liberalisation with scant
regard to the impact on the poor.
The problem with foreign agencies with their noses in the air is that they do not take it well if the
advice they give is rejected for good reasons. They hold it against the client and the government
concerned, sometimes going to the extent of influencing the opinion of investors, financing
institutions, collaborators, and other governments against it.
Since realpolitik plays an invisible and significant role in the functioning of these agencies, one
cannot also be sure whether their advice is truly objective or subserves some other extraneous
interests. Again, as has happened in some other countries, the initial foothold may end up as a
repetition of “The story of the Arab and The Camel”.
Case Question
By considering both sides of the coin, give your view about the induction of representatives of
foreign agencies into the Planning Commission of India.
SUMMARY
Formulated against the backdrop of the Second World War and the partition of the country, the First
Five-Year Plan accorded high priority to agriculture, irrigation, and power projects. It endeavoured
to solve the food crisis, reduce dependence on food grain imports, and ease the raw material
problem, especially, in jute and cotton. As such, almost 45 per cent of the resources were allocated to
agriculture while the industry got a paltry 4.9 per cent. Although an ad hoc type of plan conceived in
haste, the First Plan was successful in so far as national income rose to 18 per cent, per capita income
to 11 per cent, and per capita consumption to 9 per cent. However, the plan could hardly be called a
“farsighted” one. In fact, it was a loose affair that put together a set of important projects and did not
have a strong analytical base. According to John P. Lewis, the First Five-Year Plan was based on a bad
procedural mode. It was simply a collection of discrete state and ministerial projects with very little
independence.
In the Second Plan, which was formulated in an atmosphere of economic stability, agriculture was
accorded a complementary role while the focus shifted to the industrial sector, especially to the heavy
goods sector. The domestic industry was protected from foreign competition through high tariff
walls, exchange rate management, controls and licences, or outright bans. To begin with, P. C.
Mahalanobis introduced a single-sector model based on variables of income and investment, which
was further developed into a two-sector model. The entire net output of the economy was supposed to
produce only two sectors—the investment goods sector and the consumer goods sector. The basic
strategy of the Second Plan was to increase the investment in heavy industries and also the
expenditure on services.
The Third Plan aimed at increasing the national income by 30 per cent from Rs 145 bn in 1950–61 to
Rs 190 bn by 1965–66. It aimed at increasing the per capita income by 17 per cent. It also targeted a 30
per cent increase in agricultural production and a 70 per cent in industry. It laid stress on the need to
mobilise domestic as well as external resources. However, whether on account of spillovers of the
Mahalanobis model or on account of the inability of the planners to make certain changes in long-
term plans introduced under the Second Plan, the Third Five-Year Plan failed to bring about any
noticeable progress in the agricultural and the industrial sectors. Other major exogenous shocks
came when two successive monsoons failed. This not only led to a drastic fall in food production but
also had a deep negative impact on the overall growth prospects. The plan period was also marked by
two wars—the Chinese war in 1962 and the Pakistan war in 1965. As a result, the period following the
Plan was fraught with inflationary pressures and a staggering balance of payment crisis. With a kind
of disillusionment setting in, during the period between 1966 and 1969, the Five-Year Plans were
abandoned and three annual plans were adopted.
The disappointing results of the first three Five-Year Plans necessitated a change. There was a
concerted effort to make the Fourth Plan, launched in 1969, more realistic and attuned to the socio-
economic problems faced by the country. At the time of formulation of the plan, it was felt that the
GDP growth and a high rate of capital accumulation alone may not help to achieve economic self-
sufficiency. So the emphasis shifted to education and employment. The Fourth Plan which was to
work within the framework of actual plan targets had two principal objectives. It aimed at maintaining
growth with stability and an accelerating progress towards the Nehruvian dream of self-reliance.
Keeping in mind the agrarian nature of the Indian economy, the Fourth Plan gave priority to
agricultural development. The strategy it adopted was known as the Green Revolution in popular
parlance. This marked the third phase of India’s developmental planning.
During the Fourth Plan period, the country had faced severe inflationary pressures. The Fifth Plan,
therefore, concentrated on reigning in inflation and achieving stability in the economic situation. With
then Prime Minister Indira Gandhi’s slogan of “Garibi Hatao”, this plan re-emphasised the objectives
—removal of poverty and attainment of economic self-reliance. Among other things, it envisaged an
expansion of productive employment, adequate procurement and distribution system for essential
consumption goods to the poor at reasonable rates, vigorous export promotion, and import
substitution, to put the economy on the road to self-reliance. Several new economic as well as non-
economic variables such as nutritional requirements, health and family planning, and so on, were
incorporated in the planning process. Poverty was defined in terms of minimum level of
consumption. Stress was laid on the upliftment of backward classes and backward regions. However,
the issue of land reforms continued to be neglected and the focus on technological modernisation
continued.
Like the Fifth Plan, the Sixth Plan also aimed at structural transformation of the economy with a view
to achieving a high, sus tained rate of growth. The basic objectives continued to be removal of
poverty and unemployment. The Sixth Plan sought to achieve higher production target and a
concomitant increase in employment opportunities for the poorest section of society. The Sixth Plan
emphasised the need for a sharper redistribution of the share of the poorer sections in national
income, consumption, and utilisation of public services. By adopting the IRDP, the Sixth Plan aimed at
raising 12 million households in the rural sector above the poverty line. At the same time, the NREP
aimed at providing employment opportunity and utilising manpower for economic development. The
Sixth Plan also gave importance to the Minimum Need Programme introduced in the Fifth Plan. The
Congress government returned to power in 1980 and, thereafter, sought to simultaneously focus on
improvement in agriculture as well as industry in order to achieve rapid economic growth.
The Seventh Plan that was formally launched with the Budget for 1985–86 laid down three immediate
objectives. It aimed at accelerating the growth in food grain production, increasing employment
opportunities, and raising productivity. In order to attain these objectives, the Seventh Plan proposed:
1. Action to sustain and enhance the momentum of economic expansion;
2. Adoption of effective promotional measures to raise productivity and incomes of the poorer sections of the population, poorer
regions, and poorer states;
3. Expansion and qualitative improvement in facilities for health education and other basic amenities; and
4. Measures for bringing about a sharp reduction in the rate of population growth.
The Seventh Plan aimed at a direct attack on the problems of poverty, unemployment, and regional
imbalance. The plan also gave high priority to the development of human resources, increasing the
level of education, expanding health services, and providing basic needs.
The Eighth Plan also attempted to lift the economy from the mire of licence permits. After the
demolition of licence quotas and the granting of market orientation to the economy, the very
functioning of the economy underwent a structural transformation. The role of the public sector was
restricted and the state intervention was selective and supportive of the private sector. In fact, private
enterprises including foreign private investors have been permitted over a much larger space than
ever before and state intervention has been confined to strategic areas like defence, infrastructure,
social sectors, and correction of market failures. The terms and conditions governing the flow of
capital and goods and services with other countries have been eased. This type of “indicative
planning” placed the Eighth Five-Year Plan on a different footing from other previous plans.
The Ninth Five-Year Plan undertook the task of ushering in a new era of people-oriented planning.
Thus, not only the governments at the Centre and the states but also the people at large, particularly,
the poor, would participate in what was described by the Planning Commission as a participatory
planning process. This was initiated with a view to assure equity while, at the same time, to target the
areas of vulnerability and weakness as exposed by the Eighth Five-Year Plan. Thus, even as India
embarked on a process of opening up of its economy, planning still remained an important
component of development policy and strategy.
The United Front government led by Prime Minister Deve Gowda, in consultation with the 13 parties
that constituted the Front, adopted the CMP that formed the basis for the objective of the Ninth Five-
Year Plan. The underlying objective “growth with equity” emerged obviously in the four important
dimensions of state policy:
1. Quality of life of the citizen,
2. Generation of productive employment,
3. Regional balance, and
4. Self-reliance.
However, it goes without saying that such objectives may not be necessarily attained by the free
operation of market forces.
The Tenth Five-Year Plan (2002–07) represented a subtle shift in India’s development perspective with
agriculture moving centre stage. At the same time, emphasis has been laid on improving the quality of
governance. In fact, the Tenth Plan has devoted a separate chapter to the issue. It is indeed an eye
opener that the Planning Commission has now accepted governance as one of the most important
constraints to growth and sought to make rectifications. Among the new features focused in the Tenth
Plan the rapid growth of labour force is one. Keeping in view the looming danger of increase in
unemployment, the Tenth Plan targets have been fixed accordingly. The plan also addresses the issue
of poverty and the unacceptably low levels of social indicators. For the first time, it has broken down
the national targets to state-level so as to harness the states within the Indian Union in the larger
development programme along with the Centre. While approving the approach paper to the plan, the
NDC made mandatory a set of objectives. These included the doubling of per capita income in 10
years, an 8 per cent growth of GDP per annum, and harnessing the benefits of growth for improving
the quality of life. In keeping with the policy of economic liberalisation, the Tenth Plan also provides
for a government organisation and a voluntary organisation, an interface. In fact, in the approach
paper to the plan itself, 11 targets that can be monitored had been laid down that provided for
increased partnership between the government sector and the voluntary sector.
KEY WORDS
Central Financing
Economy
Economic Inequality
Economic Self-Reliance
External Sector
Financial Sector
Fiscal Deficit
Five-Year Plan
Gross Domestic Product (GDP)
National Plan of Action (NPA)
National Development Council (NDC)
Planning Commission
Targeted Public Distribution System (TPDS)
Quantitative Restrictions (QRs)
State Financing
Sustainability
Inflation
QUESTIONS
1. Explain the main objectives as incorporated in the various five-year plans in India.
2. Explain the objectives, outlay, sectoral allocation, and achievements of the first three five-year plans in India.
3. Write a short note on the Planning Commission of India.
4. Explain the background, outlay, sectoral allocation, and targets of the Annual Plans for 1990–91 and 1991–92.
5. Analyse the objectives and public sector outlay of the Ninth Plan of India.
6. Analyse the highlights, priorities, sectoral targets, outlay, and macro-parameters of the Tenth Plan.
7. Analyse the failures of planning in India.
8. Suggest various measures for the success in economic planning in the country.
REFERENCES
Adhikary, M. (2001). Economic Environment of Business, 8th ed. New Delhi: Sultan Chand.
Datt, R. and K. P. M. Sundharam (2005). Indian Economy. New Delhi: Sultan Chand.
Desai, S. S. M. and N. Bhalerao (2000). International Economics. 2nd ed. Mumbai: Himalya Publishing House.
Ghosh, B. N. and R. Ghosh (2000). Fundamentals of Monetary Economics, 2nd ed. Mumbai: Himalaya Publishing House.
Kumar, N. and R. Mittal (2002). Economic Development and Planning. New Delhi: Anmol Pub.
Kumar, N. and R. Mittal (2002). Monetory Economy. New Delhi: Anmol Pub.
Mithani, D. M. (2005). The Essence of International Economics, 1st ed. Mumbai: Himalaya Publishing House.
Mittal, A. C. and S. P. Sharma (2001). Indian Planning: Issues and Policies. New Delhi: RBSA Pub.
Planning Commission, Government of India (2005). India’s Five Year Plans: Complete Documents: First Five Year to Tenth
Five Year Plan, 1951–56 to 2002–07. New Delhi: Academic Foundation.
Trivedi, I. V. (2004). Emerging Dimensions of Economic Scenario. New Delhi: RBSA Pub.
CHAPTER 03
Industrial Policy
CHAPTER OUTLINE
Historical Background
Government’s Role
Meaning and Objectives of Industrial Policies
Industrial Policies
Evaluation of the New Industrial Policy
New Trade Policy of 1991
The New Small-scale Sector Policy of 1991
Recent Policies for Micro and Small Enterprises (MSE) Sector
Case
Summary
Key Words
Questions
References
HISTORICAL BACKGROUND
East India Company
The Britishers came to India in the year 1600 as traders of the East India Company. Attracted by
stories of the fabulous wealth of India, Englishmen were eager to establish commercial contacts with
the East. During the British rule in India, the government policy towards industry and business was
indifferent. The first century of British rule saw the decline of nearly all indigenous industries for
many reasons—technological, economic, and political.

During the British rule in India, the government policy towards industry and business was indifferent. The first century of
British rule saw the decline of nearly all indigenous industries for many reasons—technological, economic, and political.
The Britishers did not become a ruling power in India until the second half of the 18th century till it
was only a trading concern. Thereafter, events of greater importance took place in the interior of
Bengal. It was a period of gradual disintegration of the Mughal Empire. Soon after the death of
Emperor Aurangzeb, the controlling and powerful unifying force that existed in the country under his
rule declined, and India became a battleground of rival principalities. The East India Company took
full advantage of this chaotic situation and, gradually, established itself as the unrivalled master of the
Indian subcontinent.
Modern industrial enterprises in India developed only after 1850. Its earliest manifestations came in
the wake of the construction of railways, which made it essential to have modern workshops for
repair and maintenance of the rolling stock. The development of railways ended the isolation of the
villages, made the world market available to the Indian producer, facilitated both foreign and
domestic trade, and created the necessary condition for the growth of large-scale industry.

Modern industrial enterprises in India developed only after 1850. Its earliest manifestations came in the wake of the
construction of railways, which made it essential to have modern workshops for repair and maintenance of the rolling stock.
The first isolated attempt at officially encouraging the growth of large-scale industry took place
around 1900. The Madras Government, under the guidance of Sir Alford Chatterton, started a bold
policy of surveying industrial possibilities, assisting private enterprises, improving technical
education, and starting pioneer industries with state resources.

The first isolated attempt at officially encouraging the growth of large-scale industry took place around 1900.
First World War
The outbreak of the First World War brought an end to the policy of hostility between British Bengal
Chamber of Commerce and the Government, and forced on the government a more progressive
policy that included selective encouragement of some industries and protective tariff in order to meet
war demands. There was an urgent need for a new constructive economic policy. This led to the
appointment, in 1916, of the famous Indian Industrial Commission to examine and report the
possibilities of a further industrial development in India and submit recommendations for a
permanent policy of industrial stimulation.

Indian Industrial Commission was set up in 1916 to examine and report the possibilities of industrial development in India
and submit recommendations for a policy of industrial growth.
The Commission presented its report in 1918. Its proposals were based upon the fundamental
principles that in the future the government must play an active part in the industrial development of
the country. It summarised the industrial situation by saying that India was a country rich in raw
materials and industrial possibilities but poor in manufacturing accomplishments. The main
recommendations of the Commission fell under four headings.
First, it proposed an improved departmental organisation for the encouragement and control of
industries. Second, suggestions were made to improve technical training and education and also to
improve the conditions in factories and industrial centres. Third, there were proposals for the
reorganisation of the scientific staff of the industrial departments. Fourth, recommendation was made
for technical and financial aid to industries, encouragement of industrial cooperatives, and provision
of improved transport and freight facilities.
The Government of India accepted these recommendations in principle, but little could be done
immediately due to the war and post-war problems of reorganisation and the difficulty of
coordinating industrial policy with the political reforms of 1919 and with the recommendations of the
Fiscal Commission (1921–22).
Second World War
The Second World War was a major watershed in the development of government-business relations
in India. For one, as India became the main supply base of the Allied War efforts in the Far Eastern
and Middle Eastern fronts, its industrial development received a tremendous boost from the
substantial orders for locally manufactured goods and through setting up of a large number of new
industrial units in the fields, hitherto, the inconceivable.

As India became the main supply base of the Allied War efforts in the Far Eastern and Middle Eastern fronts, its industrial
development received a tremendous boost from the substantial orders for locally manufactured goods and through setting
up of a large number of new industrial units.
Secondly, in response to the needs of war-time economy, the government, in a bid to conserve and
control the resources of the country and under the provisions of the Defence of India Rules, brought
about a series of controls affecting various aspects of the economy, for example, import, export,
capital investment, and foreign exchange.
These controls become a permanent picture of the economic landscape, as these were found to be
useful weapons by the government not only after the war, but even after independence to meet the
needs of planned development.
During the two brief years that intervened between the end of the war (1945) and independence
(1947), government efforts were mostly directed at dealing with shortages that developed in a large
numbers of items, both consumer goods as well as essential war materials.
In almost all the industries, for example, cotton, textile, cement, steel, sugar, and paper, production
showed a steep downward trend caused by the fall in demand, overworking of the plants during the
war, non-availability of capital equipment, shortage of many materials, general unrest in the country,
and transport and distribution bottlenecks.
Reconstruction programmes were talked of, but not pursued owing to the prevailing uncertainty,
and the difficulty in importing capital goods. Government efforts were mainly directed at price and
distribution controls through emergency powers in respect of a whole range of articles like cotton,
textile, woollens, paper, coal, steel, mica, and petroleum and petroleum products.
GOVERNMENT’S ROLE
Pandit Jawaharlal Nehru laid the foundation of modern India. His vision and determination have left a
lasting impression on every facet of national endeavour since independence. It is due to his initiative
that India now has a strong and diversified industrial base and is a major industrial nation of the
world. The goals and objectives set out for the nation by Pandit Nehru on the eve of independence
were as follows:
1. Rapid agricultural and industrial development of the country,

2. Rapid expansion of opportunities for gainful employment,
3. Progressive reduction of social and economic disparities, and
4. Removal of poverty and attainment of self-reliance.
The goals and objectives set out for the nation by Pandit Nehru on the eve of independence were (a) agricultural and
industrial development, (b) generation of employment opportunities, (c) removal of poverty, and (d) alleviation of economic
and social disparity.
These objectives remain as valid today as they were at the time Pandit Nehru first set them out before
the nation. Any industrial policy must contribute to the realisation of these goals and objectives at an
accelerated pace.
The emergence of India as an independent nation on August 15, 1947 was the beginning of the new
glorious era in the history of our country. Initial government efforts were directed towards
improving the climate of industrial relations. On April 7, 1948, Parliament adopted an Industrial
Policy Resolution laying down the broad objective of the government policy in the field of industrial
development and demarcating the respective shapers for public and private sector. The government
also took steps to clarify its policy towards foreign capital in a policy statement made by the Prime
Minister on April 6, 1949.

The emergence of India as an independent nation on August 15, 1947 was the beginning of the new glorious era in the
history of our country. Initial government efforts were directed towards improving the climate of industrial relations.
Since 1950–51, India has passed through ten five-year plans and several annual plans and is now in
the Eleventh five-Year Plan. The financial and the balance of payment crises that the nation faced from
the onset of the 1990s compelled the acceptance of deregulation, reduced role for public sector,
making the public sector efficient and surplus generating, and much reliance in general on the private
sector for industrial and infrastructure development.

The financial and the balance of payment crises that the nation faced from the onset of the 1990s compelled the acceptance
of deregulation, reduced role for public sector, making the public sector efficient and surplus generating, and much reliance
in general on the private sector for industrial and infrastructure development.
The vastly enlarged role for the private sector indicates that India is in step with the prevailing
dominant trend in government–business relationship in the world scene. The government has a
crucial role to play in the context of the emerging liberalisation of business. In this context, the
following aspects deserve special consideration:
Government role as a promoter, caretaker, and regulator,
Promoting and protecting the small-scale sector,
Facilitating the revival of sick units,
Facilitating the development of Indian companies for the global market,
Promoting inflow of foreign capital and technology,
Promoting and maintaining ecological balance,
Promoting the social role of business,
Developing adequate infrastructural facilities for the overall development of the economy, and
Formulating and operating industrial policies conducive to balance industrial and economic growth.
MEANING AND OBJECTIVES OF INDUSTRIAL POLICIES
Meaning
Industrial policy means rules, regulations, principles, policies, and procedures laid down by
government for regulating, developing, and controlling industrial undertakings in the country. It
prescribes the respective roles of the public, private, joint, and cooperative sectors for the
development of industries. It also indicates the role of the large, medium, and small-scale sector.

Industrial policy means rules, regulations, principles, policies, and procedures laid down by government for regulating,
developing, and controlling industrial undertakings in the country.
It incorporates fiscal and monetary policies, tariffpolicy, labour policy, and the government attitude
towards foreign capital, and role to be played by multinational corporations in the development of the
industrial sector.
After independence, the Government of India has formulated policies for industrial growth and
development. For regulating these industrial policies, adequate measures were also adopted by way of
industrial licensing policies. These polices have substantially regulated the business environment in
the country.

After independence, the Government of India has formulated policies for industrial growth and development. These polices
have, substantially, regulated the business environment in the country.
Objectives
Industrial policy statements have been announced from 1948 onwards. A number of objectives have
been projected by the Government of India while making industrial policy declarations. Some of the
important objectives can be identified as follows:
Achieving a socialistic pattern of society,
Preventing undue concentration of economic power,
Achieving industrial development,
Achieving economic growth,
Reducing disparities in regional development,
Developing heavy and capital goods industry,
Providing opportunities for gainful employment,
Expanding the public sector for achieving socialism,
Achieving faster economic growth,
Achieving a self-sustained economy,
Alleviating poverty,
Protecting and developing a healthy small-scale sector,
Building up a large and growing cooperative sector,
Updating technology and modernisation of industry, and
Liberalisation and globalisation of economy.
Many measures have been adopted by the Central government for the accomplishment of these
industrial policy objectives.
INDUSTRIAL POLICIES
We examine the following industrial policy resolutions and the important aspects involved in the
industrial policies:
Industrial Policy Resolution of 1948.
Industrial Policy Resolution of 1956.
Industrial Policy Statement of 1973.
The New Industrial Policy of 1991.
Industrial Policy Resolution of 1948
The Government of India announced its first Industrial Policy Resolution on April 6, 1948. The
policy resolution laid stress on the role of the state in the development of industry. The industrial
activities were divided into four broad areas:
1. Items under the central government control—arms and ammunition production and control of atomic energy, ownership and
control of railway transport, and others;
2. Items under the state government control—coal, iron and steel, aircraft manufacture, shipbuilding, manufacture of telephones,
telegraphs, and wireless apparatus;
3. Items of basic importance planned and regulated by the Central government— salt, automobiles, tractors, heavy machinery,
fertiliser, cement, sugar, paper, and so on; and
4. Items for the private sector—all other items left to the private sector.
Highlights of Policy
The 1948 policy resolution visualised a mixed economy. It aimed at laying the foundation for India’s
economic and industrial development through such an economy which was guided by the desire for
establishing a strong industrial base in India.

The 1948 policy resolution visualised a mixed economy. It aimed at laying the foundation for India’s economic and
industrial development through such an economy which was guided by the desire for establishing a strong industrial base
in India.
Although foreign investment, know-how, and technology were felt to be necessary for building up
a proper industrial base, it was felt that, as a rule, the major interest in ownership and effective
control should always be in Indian hands.
Industrial Policy Resolution of 1956
After the introduction of the Industrial Policy Resolution of 1948, a number of changes took place in
the country. India became a republic, the First Five-Year Plan was envisaged, socialistic pattern of
society was accepted as the national policy, public sector was assigned the task of raising the pillars
of economic structure, and so on. Besides, the concept of a mixed economy was widely recognised as
the basis for the national economic policy. All these aspects paved the way for a new approach and the
second Industrial Policy Resolution was announced on April 30, 1956. The basic objectives of the
policy included the following:
1. Speeding up the process of industrialisation in India,
2. Developing heavy and capital goods industries,
3. Expanding an effective public sector,
4. Accelerating the rate of economic growth,
5. Building up a large and growing cooperative sector,
6. Encouraging private sector industries,
7. Preventing private monopolies,
8. Developing small-scale, village, and cottage industries,
9. Achieving balanced economic development,
10. Participation of workers in management, and
11. Maintenance of industrial peace.
The concept of a mixed economy was recognised as the basis for the national economic policy.
With these objectives in mind, a new approach was given to the industrial sector of India. A new
vision was announced in respect of the industrialisation of the country. It provided guidelines to and
laid the foundation for a well-planned industrial backbone in the country.
The Industrial Policy Resolution of 1956 gave the broad policy framework of industrial
development in India. In spite of the considerable changes that took place from time to time, this
resolution remained the Magna Carta for Indian industry till its replacement by the July 1991
industrial policy, which, in many aspects, sought to return to the spirit of 1956.

The Industrial Policy Resolution of 1956 gave the broad policy framework of industrial development in India. In spite of the
considerable changes that took place from time to time, this resolution remained the Magna Carta for Indian industry till its
replacement by the July 1991 industrial policy, which, in many aspects, sought to return to the spirit of 1956.
The classification of industries under three heads, viz., Schedule A, Schedule B, and Schedule C,
made in this policy are still being followed. In fact, all following industrial policy resolutions kept
these classifications in mind while defining industries. The following industries were placed in the
first and second categories, respectively. The third category was included in the remaining where
future development would generally be left to the initiative and enterprise in the private sector.
Classification of Industries
Schedule “A”
Arms and ammunitions and defence equipment,
Atomic energy,
Heavy castings and forging of iron and steel,
Iron and steel,
Heavy plant and machinery required for iron and steel production. Mining, machinery tools, and other basic industries,
Heavy electrical plant,
Coal and lignite,
Mineral oils,
Mining of iron ore, manganese ore, chrome ore, gypsum, gold, diamonds, and sulphur,
Mining and processing of copper, zinc, lead, tin, wolfram, and molybdenum,
Minerals as per Atomic Energy Order, 1953,
Aircraft,
Air transport,
Railway transport,
Shipbuilding,
Telephone and telephone cables and telegraph and wireless instruments, excluding radio-reviewing sets, and
Generation and distribution of electricity.
Schedule “B”
Other minerals excepting minor minerals defined in the Minerals Concession Rules, 1949, Section “B”,
Aluminum and other non-ferrous metals not included in Schedule “A”,
Ferro alloys and tool steels,
Machine tools,
Manufacture of drugs, dyestuffs, plastics, and other basic and intermediate products required by chemicals industries,
Antibiotics and other essential drugs,
Fertilizers,
Synthetic rubber,
Carbonisation of coal,
Chemical pulp,
Road transport, and
Sea transport.
Industries placed under Schedule “A” were treated as the exclusive responsibility of the state.
Schedule “B” industries were progressively state owned. Schedule “C” industries were left for the
private sector. In schedule “A”, 17 industries were included whereas in Schedule “B”, 12 industries
were listed.
The resolution made it clear that division of industries into separate categories did not imply that
they were being placed in watertight compartments. It was open to the state to start any industry not
included in Schedule “A” and Schedule “B” when the needs of planning so required. The Industrial
Policy Resolution of 1956 had a positive approach to industrialisation in many ways which are as
follows:

1. Rapid industrial growth backed by balanced regional development was the backbone of the policy.
2. Appropriate manpower development and industrial harmony between public, private, and large and small sectors were the basic
ideals of the policy.
3. Small sector was encouraged in such a way that even some of the items of Schedule “A” were allowed to be taken up by small
enterprises.
4. Providing exclusive incentive system, direct subsidies, and differential tax rates protected the small-scale sector.
The resolution made it clear that division of industries into separate categories did not imply that they were being placed in
watertight compartments.
Thus, a new direction was given to industrial development in India in the Industrial Policy Resolution
of 1956, and it laid the foundation for all future developments.
Industrial Policy Statement of 1973
An industrial policy statement was made in a press note on February 2, 1973. It was an extension of
the Industrial Policy Resolution of 1956. It was specifically mentioned that Industrial Policy
Resolution of 1956 would continue to govern the industrial policy for achieving the objectives of
growth, that is social justice and self-reliance in the industrial sector. The main features of Industrial
Policy Statement of 1973 were as follows:
1. The statement declared that the state would be directly responsible for the future development of industries.
2. The role of public sector was further stressed in attaining a socialistic pattern of society. Both the public and private sector were
assigned specific roles.
3. As an initiative towards the development of joint sector units, they were supposed to function under the direction of the
government.
4. Foreign investment was allowed only in specific industries. All foreign investment proposals were screened with special
reference to technological expertise, export possibilities, and overall effect on the balance of payment position, subject to
Foreign Exchange Regulation Act (FERA) and monopoly-restrictive trade practices (MRTP) restrictions.

All foreign investment proposals were screened with special reference to technological expertise, export
possibilities, and overall effect on the balance of payment position.
5. Small-scale and cooperative sectors were assigned a special role to play. Small and medium sectors were given preferential
treatment.
6. In the area of agricultural produce, cooperative enterprises were encouraged.

Box 3.1 Quantitative Restrictions
Ever since 1991, when the economic reforms process started, there has been gradual dismantling
of Quantitative Restrictions (QRs).
At present, QRs have been lifted from more than 95 per cent of the products which were earlier
subject to such restrictions on balance of payments (BoP) grounds. Restrictions on the remaining,
less than 5 per cent products, balance of payments have been maintained on the grounds of health,
safety, and moral conduct. However, no major import surge has taken place as a result of the
removal of such restrictions. Further, the import duty rates have been lowered on a large number
of product groups. The average collection rate, defined as the ratio of realised import revenue,
including basic additional and special custom duties, and countervailing duty as a percentage of
the import value of the product for an overall import, has gradually fallen from 47 per cent in
1990–91 to 21 per cent in 2000–01.

Thus, a fresh approach to industrialisation was made in Industrial Policy Statement of 1973 within the
framework of the Industrial Policy Resolution of 1956.
Industrial Policy Statement of 1977
The Janta Party came to power in March 1977. The Janta Party government presented to Parliament
an industrial policy on December 23, 1977. This policy was considered to have made a new approach
to the industrial development in India. The government claimed that they had introduced this dynamic
industrial policy for removing the distortions of the past. The Industrial Policy Statement of 1977
aimed at utilising ideal resources for enhancing the living conditions of the masses. The major
objectives set in the policy were as follows:
1. Preventing of monopoly and concentration of economic power,

2. Maximising production of consumer goods, and
3. Making industry responsive to social needs.
The Janta government’s industrial policy was basically aimed at making use of the available human
resources for the maximum benefit of the masses. It was a consumption-oriented and labour-intensive
industrial policy. It aimed at maintaining the close interaction of the agricultural-and industrial sector.

The industrial policy of the Janta Party government was aimed at making use of the available human resources for the
maximum benefit of the masses.
The thrust area of this policy was the generation of rural employment opportunities. The first
priority of the policy was to develop the small village and cottage industrial sector. The small-scale
sector consisting of 180 items was expanded to accommodate 500 items. An annual industrial review
was proposed for ensuring:
1. That the industrial units could take care of the national requirements,
2. That the efficiency principle was fulfilled, and
3. That the production would be maintained economically and was qualitatively acceptable.
The basic elements of the Janta government’s industrial policy were as follows:
1. Development of small-scale industries, cottage industries, tiny sector units, village and household industries,
2. Encouraging the large-scale industrial units for meeting the minimum needs of the population,
3. Reversing the process of growth of large industries which grew with the help of funds from public financial institutions,
4. Public sector was to be used as a producer and supplier of essential consumer goods,
5. Import of technology only in high-priority areas, and
6. Restricted foreign collaboration—the ownership and control were to remain in Indian hands.
The Industrial Policy Statement of 1977 was an indirect reflection of the 1956 policy, with minor
deviations. The thrust area of industrial policy was small-scale industry. An important contribution of
the 1977 policy was the setting up of District Industries Centre (DIC) in every district for the
development of the small-scale sector. It continues to function effectively. Speedy action was also
planned to issue licences in time and timely implementation of approved projects.

An important contribution of the 1977 policy was the setting up of District Industries Centre (DIC) in every district for the
development of the small-scale sector.
New Industrial Policy Statement of 1980
After the fall of the Janta Party government, the Congress came to power again in 1980. The Union
Minister of State announced the new industrial policy on July 23, 1980. The Congress government
was committed to rapid and balanced industrialisation for benefitting the common masses. The socio-
economic objectives of the 1980 Industrial Policy were as given below:
1. Optimum utilisation of the installed capacity,
2. Higher employment generation,
3. Achieving higher productivity and maximum production,
4. Development of industrially backward areas,
5. Promotion of agro-based industries,
6. Faster promotion of export-oriented and import-substitution industries,
7. Consumer protection against high prices and bad quality,
8. Promoting economic federalism with spread of investment in rural as well as urban areas, and
9. Revival of the economy by overcoming infrastructural gaps.
The following policy measures were specified to achieve these objectives:

1. Promoting the process of rural industrialisation,
2. Removing regional imbalances,
3. Regulating the excess capacity in the private sector,
4. Efficient operational management of the public sector,
5. Developing small-scale sector by increasing the limit of investment,
6. Automatic expansion in large-scale industrial units, and
7. Dealing with industrial sickness effectively.
The New Industrial Policy Statement of 1980 was a growth-oriented industrial policy. The factors
considered by this policy were, import–export, labour relations, pollution control, ecological
balance, merger and amalgamation, correcting industrial sickness, pricing policy, takeover of sick
units, foreign collaboration and investment. The Industrial Policy Statement of 1980 was a balanced
industrial policy aimed at developing the industrial sector in India.

The Industrial Policy Statement of 1980 was a balanced industrial policy aimed at developing the industrial sector in India.
New Industrial Policy of 1991
Despite the impressive growth performance of the New Industrial Policy Statement of 1980, serious
budgetary and fiscal deficits of the government and balance of payment crises led India to a critical
economic and financial situation. The country was almost on the brink of defaulting international
payments. There was no other alternative but to introduce a new regulatory and liberal economic
reign.

Box 3.2 Vanishing Companies / Promoters
An offshoot of the liberalisation measures and capital market reforms has been the problem of
vanishing companies, which has assumed serious proportion in recent years in India.
Although the government and the regulatory agencies have initiated several measures to tackle
this problem, still, sustained and stepped-up efforts are required to ensure that companies do not
vanish in the way they have vanished in recent past.
The criteria defined jointly by SEBI and the Department of Company Affairs on July 2002 to term
a company as vanishing is
1. Non-compliance with listing requirement with the respective stock exchange and Registrar of Companies for two years;
2. Non-submission of required reports to and absence of correspondence with regional exchanges for two years; and
3. Non-availability at the registered office for inspection by the stock exchange.

As a part of the liberalisation, a new industrial policy was announced by the Government of India
in two parts, on July 24, 1991 and August 6, 1991, respectively. Some of the major aspects of the
industrial policy were as follows:

1. Industrial licensing dispensed with exception in 18 items.

2. Foreign Direct investment (FDI) up to 51 per cent of equity allowed in high-priority industries.
3. The threshold of the assets of MRTP companies and dominant undertakings removed.
4. Automatic clearance introduced for import of capital goods, provided foreign-exchange requirement for such import are met
through foreign equity.
5. Automatic permission for foreign technology agreements in high-priority industries up to a sum of Rs 1 crore granted.
6. Foreign equity proposals need not be accompanied by foreign technology agreement.
7. Existing and new industrial units provided with broad-banding facility to produce any article so long as no additional investment
in plant and machinery is involved. Exemption from licensing will apply to all substantial expansion of existing units.
8. Pre-eminent role of public sector in eight core areas including arms and ammunitions, mineral oils, rail transport, and mining of
coal and mineral.
9. Part of government’s shareholding in public sector is proposed to be disinvested, which will be offered to mutual funds,
financial institutions, general public, and workers.
10. Chronic loss-making public sector units to be referred to the Board of Industrial and Financial Reconstruction (BIFR) for
formulation of revival schemes.
11. A simplified procedure for new projects was introduced to manufacture goods not covered by compulsory licensing. Even a
substantial expansion of a project requires submitting a memorandum in the prescribed form to the secretariat for industrial
approvals.
12. Decisive contribution was expected from foreign investment including foreign corporate bodies, foreign individuals, and non-
resident Indians.
13. Industrial policy for the small-scale sector announced on August 6, 1991 provided a four-point scheme to provide financial
support to this sector.
As a part of the liberalisation, a new industrial policy was announced by the Government of India in two parts, on July 24,
1991 and August 6, 1991, respectively.
An analysis of Table 3.1 reveals that the contributions of agriculture and industry to the increase in
GDP were record lows over the period of 1997–98 to 2003–04. Growth (increment) has been
propelled by the services sector to the tune of two-thirds. These trends have some important
implications.

Table 3.1 Indian Economy: Sectoral Sources of Growth, 1951–2004

First, the “poor showing” of agriculture in regard to its contribution to output increases, needs a bit
of attention. It is a fact of life that in growing and maturing economies, agriculture’s overall share in
GDP and, hence, its contribution to successive GDP increments will keep falling. Thus, while due
attention must be focused on the performance of the agricultural sector and more so on the welfare of
the farming community (far too many have taken their lives in some states in recent years), one need
not be unduly alarmed by the falling contribution of the sector to GDP increases.
Second, and more alarming, is the dwindling contribution of the industrial sector to GDP increase.
The relatively low contribution of industry in 2003–04 must be attributed in part to the structural
adjustments now going on in the sector, basically getting rid of it fast and getting set to compete. One
hopes that the industry-declining senerio will not last long and all will be well soon. How can that
happen? On the supply side there is hardly any problem since if not domestic firms, MNCs will set up
shop and produce. (One can see this most visibly in the auto sector.)
If there is demand, industry will produce. That demand could be domestic as well as external.
Domestic demand, in my view, will be most severely constrained by lack of upward mobility of the
relatively low-income families. The demand constraint is with reference to all sorts of consumer
durables and services. Unless income increases reach the bottom and middle of the income ladder, the
industrial demand and output will not pick up at a relatively rapid pace. Put in an oversimplified
fashion, whoever could buy the white goods, bought but there are millions who have the desire but
not the demand backed by purchasing power.

Unless income increases reach the bottom and middle of the income ladder, the industrial demand and output will not pick
up at a relatively rapid pace.
Finally, the growing importance of services in GDP should be taken with due caution. World over,
estimation of services sector output and value added (which is what enters GDP) is at best an
approximation, unlike in the goods-producing sectors, where the material inputs and output are
relatively more clear-cut and distinct. Before concluding, it is worth looking at how the Chinese have
moved forward on the growth front. See Table 3.2. It is industry and not services that has propelled
the increase in Chinese GDP since 1990.

It is industry and not services that has propelled the increase in Chinese GDP since 1990.

Table 3.2 China: Sectoral Sources of Growth, 1980–2002
Objectives
The objectives of the 1991 policy included:
1. Reducing or minimising the bureaucratic control of the industrial economy of India,

2. Liberalisation of industrial and economic activities for integrating the Indian economy with the world economy,
3. Removing restrictions on foreign direct investment,
4. Freeing the domestic entrepreneur from excessive MRTP restrictions, and
5. Streamlining the role of public sector enterprises.
Among the areas covered, the most important ones are:
1. Industrial licensing,
2. Foreign investment,
3. Technology transfer and import of foreign technology,
4. Public sector policy,
5. Policy relating to MRTP Act, and
6. An exclusive small-sector policy.
Specific policy initiatives were made in respect to all these policy areas. These aspects are briefly
examined here.
Industrial Licensing
In tune with the emerging trends of globalisation of business, the 1991 industrial policy initiated a
number of measures to liberalise the licensing system in India. Industrial licensing was abolished for
all industries except a list of 18 areas (consisting of many items) presented in Schedule II.
Compulsory licensing is necessary in these areas for various reasons like security and strategic
factors, social reasons, safety aspects, environmental issues, production of hazardous goods and
elitist consumption goods, and so on. The basic thrust of the policy was to liberalise the industrial
sector so as to minimise the bureaucratic restrictions.

In tune with the emerging trends of globalisation of business, the 1991 industrial policy initiated a number of measures to
liberalise the licensing system in India.
Foreign Investment
Greater liberalisation was offered for foreign investment from foreign corporate bodies, individuals, and non-resident Indians. In
high-priority areas requiring heavy investment and advanced technology, direct foreign investment was allowed up to 51 per cent
foreign equity. According to a government notification of October 28, 1991, NRIs and OCBs (Non-resident Indians and Overseas
Corporate Bodies) were allowed to invest upto 100 per cent foreign equity in high-priority industries, tourism-related industries,
hotels, shipping, and hospitals with repatriation benefits. The scheme for up to 100 per cent foreign investment on export-oriented
industries and projects, for the revival of sick units, also continued.
Greater liberalisation was offered for foreign investment from foreign corporate bodies, individuals, and non-resident
Indians.
Besides all these, NRI equity holding up to 100 per cent was also permitted in export-oriented deep-
sea fishing industry, oil exploration industry, and advanced diagnostic centres with full repatriation
benefits. In line with the interest of IMF, the NRI and OCB proposals were allowed automatic
clearance and provided foreign equity covers on the foreign-exchange requirements for import of
capital goods. One condition of such automatic approval was that dividend payment in terms of
foreign exchange must be balanced by export earnings for a period of seven years.

NRI equity holding up to 100 per cent was also permitted in export-oriented deep-sea fishing industry, oil exploration
industry, and advanced diagnostic centres with full repatriation benefits.
No indigenous clearance would be required for import of new capital goods financed by NRIs
from their own resources abroad if they were not covered by Appendix I, Part A of the Exim Policy
of 1990–93. Items not covered by any of these conditions required prior clearance under the existing
procedures.
Foreign Technology
In order to update the technology base and to ensure adequate technological competence, adequate
incentives were provided for technology imports. Automatic approvals were proposed for
technology-import agreements relating to high-priority areas within specified conditions. Facilities
were also made available for other industries for similar agreements, provided they did not involve
free foreign exchange. Indian companies were given the freedom to negotiate the terms of technology
transfer with their foreign collaborators in accordance with their commercial requirements.

In order to update the technology base and to ensure adequate technological competence, adequate incentives were
provided for technology imports.
Foreign technology agreements in high-priority industries (Annexure III) up to Rs 1 crore were

given automatic permission. Royalty on domestic sales was allowed at the rate of 5 per cent and on
exports at the rate of 8 per cent, subject to a total payment of up to 8 per cent of sales over a period of
10 years from the date of agreement or seven years from the commencement of production. The
same principle would be applicable in other industries also, provided no free foreign exchange is
required. No permission was required for hiring foreign technicians and foreign testing of
indigenously developed technologies.
Public Sector Policy

A new approach to the public sector was visualised in the Industrial Policy Statement of 1991. The
priority areas for the growth of public sector in future were identified, viz.:
1. Essential infrastructure goods and services,

2. Exploration and exploitation of oil and mineral resources,
3. Technology development and building of manufacturing capabilities in areas crucial for the long-term development of the
economy, and also in the areas where private sector investment is inadequate, and
4. Production of items of strategic importance, like defence equipment.
Public sector enterprises in these areas were identified to be strengthened. Such high-priority areas
and areas which generated substantial profits were identified for a greater degree of autonomy, while
private enterprise was welcomed in such areas for providing a competitive structure. Disinvestment
of the public sector equity share capital was also visualised.
A new approach to perennially loss-making public enterprises was made, necessitating a
considerable dilution of the original concept of the public sector. Since almost one-third of the losses
accumulated by the public sector was the contribution of the loss-making private enterprises which
were taken over by government, the government had to make a specific approach for this category of
enterprises.
The government realised that the time had now come to evaluate the actual contribution of the
public enterprises, particularly with reference to its viability. In the context of the huge losses to the
tune of Rs 8,500 crore made by the public sector, such a revised policy was necessary. Of the loss-
making units, 54 units had already been referred to the BIFR. A parliamentary sub-committee was
appointed by the Government of India in 1992 to prepare a comprehensive report on the viability of
these sick public sector units. In this context, the Financial Dimensions and Macro Parameters of the
Eighth Plan (1992–97) produced by the Planning Commission in 1991 is worth a mention. The
Planning Commission called for a reexamination and reorientation of the government’s role in
public sector. The paper suggested,

A parliamentary sub-committee was appointed by the Government of India in 1992 to prepare a comprehensive report on
the viability of sick public sector units.
Learning from the global experience in development as well as experience of difficulties in our own country which has ultimately
culminated into high inflation and fiscal crisis threatening to halt even our modest pace of development. It is increasingly realised that
the role of the public sector should be very selective.
Thus, only a selective role was assigned to the public sector. Core areas, such as energy, transport,
communication, irrigation, elementary education and literacy, health and population control, drinking
water, rural roads, specific problems of the poor, unemployed, and underdeveloped regions, and so
on would continue to get the attention of the government.
Another important policy in respect of the public sector was that it was brought under the MRTP
Commission with effect from September 27, 1991. The areas reserved for the public sector were
limited to items like arms and ammunition, and allied items of defence equipment, defence aircraft
and warships, atomic energy, coal and lignite, mineral oils; mining of iron ore, managanese ore,
chome ore, gypsum, sulphur, gold and diamond; mining of copper, lead, zinc, tin, molybdenum and
wolfram; minerals specified in the schedule to the Atomic Energy (Control of Production and Use)
Order 1953, railway transport, and so on.

The public sector was brought under the MRTP Commission with effect from September 27, 1991.
Under the changed conditions, the government decided to go ahead with a gradual disinvestment of
selected public sector units primarily to the tune of up to 20 per cent, first Rs 2,500 crore and, then, Rs
3,500 crore in 1992–93. In order to rehabilitate the affected workers, a National Renewal Fund was
proposed to be formed with an investment of Rs 1,000 crore.
Policy Relating to MRTP Act

In accordance with the liberalisation process, a number of measures were adopted to liberalise the
MRTP restrictions on large and MRTP companies. In an ordinance promulgated by the Central
government, provisions in both the MRTP Act and the Companies Act for pre-entry restrictions on
establishment of new undertakings and expansion of the existing ones were amended. Provisions
relating to acquisition or transfer of shares of MRTP undertakings was deleted from the MRTP Act
and new provisions were introduced and in the Companies Act as Sections 108-A to 108-I, covering
acquisition and transfer of shares of dominant undertakings.
Similarly, provisions relating to registration under Section 26 to the MRTP Act was deleted.
Existing provisions in the MRTP Act were amended to eliminate the requirement of prior approval
for the projects and proposals for merger, amalgamation, and takeover by MRTP companies. At the
same time, the MRTP Commission was vested with additional powers for taking more effective action
in providing better protection to consumer interests. The government considered the need for
bringing in public sector and cooperative undertakings, having monopoly practices under the
provision of the MRTP Act. However, government-controlled and owned companies dealing in arms
and ammunition and allied items of defence equipment, defence aircraft and warships, atomic energy,
minerals specified in the schedule to Atomic Energy (Control of Production and Use) Order 1953,
and industrial units under currency and coinage (a division of the Ministry of finance, Department of
Economic Affairs), and so on were exempted from the control of the MRTP Act.

The government considered the need for bringing in public sector and cooperative undertakings, having monopoly
practices under the provision of the MRTP Act.
In an ordinance promulgated by the Central government on September 27, 1991, pre-entry

restrictions in connection with the establishment of new undertakings and expansion of existing units
were lifted. This, reportedly, resulted in the entry of a number of large MNCs, on the one hand, and
expansion of many large domestic enterprises to be multinationals themselves, on the other. It would
facilitate the expansion and diversification of Indian companies, whereas foreign companies could
take it as an incentive to enter the Indian market in a big way.

In an ordinance promulgated by the Central government on September 27, 1991, pre-entry restrictions in connection with
the establishment of new undertakings and expansion of existing units were lifted.
Exclusive Small-sector Policy

An important aspect of the industrial policy of 1991 was the introduction of an exclusive small-sector
policy. A small industrial policy was announced by the Government of India vide notification dated
April 2, 1991, and the press note dated August 6, 1991, so as to make it a vibrant sector to maximise
its contribution in terms of growth of output, exports, and employment. For this purpose, a
considerable magnitude of deregulation was visualised to minimise the bureaucratic controls.
Revised norms have been fixed to define small-scale, ancillary, and tiny industries in terms of
investment limits in plant and machinery as follows:

An important aspect of the industrial policy of 1991 was the introduction of an exclusive small-sector policy.

Investment in Plant and Machinery on Ownership, by Lease or by Hire
Type of Units in the Small-scale Sector
Purchase up to
Small-scale industry Rs 60 lakh
Ancillary units/export-oriented units Rs 75 lakh
Tiny units Rs 5 lakh

Units which manufacture parts, components, sub-assemblies, tooling, intermediates, rendering
services, and supplying or rendering or proposing to supply or render at least 50 per cent of their
production or total services, as the case may be, to one or more other units for production of other
articles are considered to be ancillary units, provided that no such undertaking shall be a subsidiary
or owned or controlled by any other undertaking. A small-scale unit which undertakes to export at
least 30 per cent of the annual production by the third year is considered to be an export-oriented unit
(EOU).

A small-scale unit which undertakes to export at least 30 per cent of the annual production by the third year is considered
to be an export-oriented unit (EOU).
The service sub-sector which includes all industry-related services, irrespective of location, is
brought under the banner of “small sector” Similarly, the small-scale sector, including tiny
enterprises, has been made eligible for additional support on a continuing basis, including
institutional finance, priority in government purchase programmes, and relaxation from certain
provision of labour laws.
Other important measures adopted to help the small-scale sector are also worth mentioning. The
single-window loan scheme has been enlarged to cover projects up to Rs 20 lakh with a working
capital margin up to Rs 10 lakh, while composite loans under the single-window scheme, which were
available only through State Financial Corporations and the State Small Industries Development
Corporations (SSIDCs), would be channelised through commercial banks also in order to facilitate
access for a larger number of entrepreneurs.

The single-window loan scheme has been enlarged to cover projects up to Rs 20 lakh with a working capital margin up to
Rs 10 lakh.
Specific financial support measures were also adopted. Adequate flow of credit on normative basis
would be made available to viable operations while quality of delivery would be maintained. An
important policy to provide access to small-scale units to the capital market for encouraging
modernisation and technological upgradation was announced. For this purpose, other industrial
undertakings were allowed equity participation up to 24 per cent in the SSI units, which was an
important deviation from the existing norms. Similarly, in order to expand the employment
opportunities, ancillarisation and sub-contracting were encouraged.
Factoring services were proposed through the Small Industries Development Bank of India (SIDBI)
for solving the problem of delayed payment to small-scale units. Such services have been proposed to
be operated though commercial banks throughout the country. The government had expressed
concern to solve the financial problems of the small-scale sector.
Infrastructural facilities were proposed to be provided extensively. It was proposed to set up a
Technology Development Cell (TDC) in the Small Industries Development Organisation (SIDO),
which would provide technology inputs to improve the competitiveness and productivity of the small-
scale sector. The TDC is expected to coordinate the activities of the tool rooms and Process cum
Product Development Centres (PPDs).

Technology Development Cell (TDC) was proposed to be set up in the Small Industries Development Organisation (SIDO)
to provide technology inputs to improve the competitiveness of the small-scale sector.
The export potentiality of the small-scale sector was visualised to be streamlined. SIDO’s role as a
nodal agency for export promotion of the small-scale sector was stressed, while an Export
Development Centre was proposed to be set up under SIDO to improve the export of small-scale
units. While a link between National Small Industries Corporation (NSIC) and Small-Scale Industries
Development Corporation (SSIDC) was stressed to improve the marketing efforts of the small-scale
sector, it was also proposed to market mass consumption goods under a common brand name.

A link between National Small Industries Corporation (NSIC) and Small-Scale Industries Development Corporation
(SSIDC) was stressed to improve the marketing efforts of the small-scale sector.
In order to improve productivity, efficiency, and cost effectiveness of the small-scale sector, a
programme of modernisation and technological upgradation was proposed. Industry Associations
were assigned the responsibility of providing facilities for common testing and quality counselling,
while institutions like IITs and selected engineering colleges were expected to serve as Design and
Development Centres and Technological Information Centres. These efforts were proposed to cope
with modernisation and technological upgradation needs and quality specifications.
The Small-Scale Industrial Policy of 1991 emphasised the need for promoting entrepreneur-ship,
particularly for developing the first-generation entrepreneurs. A large number of entrepreneurship
development programme (EDP) trainers and motivators were proposed to be trained for this purpose.
Industry associations were to be encouraged to contribute in this respect. Multi-disciplinary “Barefoot
Managers” would find additional employment opportunities, while women entrepreneurs would
receive entrepreneurship training.

The Small-Scale Industrial Policy of 1991 emphasised the need for promoting entrepreneurship, particularly for developing
the . first-generation entrepreneurs.
Adequate steps were to be taken to promote the handloom sector. The Janata Cloth Scheme was
proposed to be replaced by an omnibus project package scheme under which adequate funds would be
provided for the modernisation of looms, providing training facilities, providing better designs,
better dyes and chemicals, and providing assistance in marketing. While assistance would be provided
for production and marketing of handicrafts, activities of the Khadi and Village Industries Boards and
Khadi and Village Industries Commission were to be expanded. In order to expand the non-farm
employment opportunities in the rural areas, promotion of rural and cottage industries was identified.
Similarly, the ongoing developmental programmes relating to weaker sections like scheduled castes,
scheduled tribes, and women would be extended throughout the country.
Thus, an all-round development of the small industries sector consisting of small, ancillary, tiny,
khadi, and village industries was visualised in the small-sector industrial policy of 1991. In order to
supplement the industrial policy, a major trade policy was also announced by the Government of
India on July 4, 1991.

Thus, an all-round development of the small industries sector consisting of small, ancillary, tiny, khadi, and village
industries was visualised in the small-sector industrial policy of 1991.
India’s Foreign Trade Policy of 1991
The trade policy announced by the then Union Commerce Minister P. Chidambaram on July 4, 1991,
had its roots in earlier policies, particularly policies from 1985 onwards. These policies took impetus
from the Abid Hussain Committee recommendations.
The Abid Hussain Committee on Trade Policies (1984) submitted its report in December 1984. The
report contained major recommendations regarding export-promotion policy and strategy, import
policy, technology imports, and so on. In respect of the export-promotion policy and strategy, the
committee’s recommendations included rationalisation of the duty drawback system, exemption of
cash compensatory support (CCS) and 50 per cent of the exports profit from income tax,
reformulation of import replenishment (REP) system for export production, exemption of export
production from capacity-licensing provision, exchange entitlement scheme for exporters, and so on.
With regard to import policy, the committee felt the need for canalisation of imports to be treated as
an exception. As far as possible, import substitution should be found out and the policy of restricting
imports of non-essential consumer goods should continue. At the same time, essential capital goods
for rapid modernisation should be included under Open General Licence (OGL). As far as
technology imports were concerned, the committee felt that import of technology must be liberalised.
Hence, foreign technology imports without foreign equity participation should be placed under OGL
subject to appropriate ceilings on lump-sum payments and royalties for a specified maximum period,
while imports above the ceiling should be selective. De-escalation of the level of protection was
visualised for an efficient import substitution. The committee’s recommendations provided
background material for the trade policy from 1985 onwards.

The Abid Hussain Committee on Trade Policies (1984) contained major recommendations regarding export-promotion
policy and strategy, import policy, technology imports, and so on.
According to the Export–Import (EXIM) Policy announced by the then Commerce Minister V.P.
Singh on April 12, 1985, a three-year trade policy came into effect which aimed at facilitating
production through easier and quicker access to imported inputs, stability of export–import policy,
strengthening the export production base, upgrading technological base, and so on. About 201 items
of industrial use were decanalised. The “Import–Export Pass-Book Scheme” was introduced with
effect from October 1, 1985, to reduce delays in obtaining licences under the duty exemption scheme.
Import of computer or computer-base systems up to Rs 16 lakh was allowed for own use. Imports of
76 items of raw materials and components was placed under the limited permissible list.
Minor modification was made in the import–export policy announced in March 1988, according to
which 745 items, including 200 items of life-saving equipment, 108 items of drugs, and 99 items of
machinery were placed under OGL. While 26 items of import were decanalised, the import REP
scheme was broadened. Certain other administrative liberalisation for export and trading houses,
condition of import by permanent returnees of NRIs, extension of the pass-book scheme to domestic
manufactures, and so on were also introduced.
The Export–Import policy announced on April 30, 1990, terminated the 1988 policy one year ahead
of schedule. The ongoing effort for liberalisation was further stimulated by the 1990 policy. The list
of items imported under OGL was expanded to include 82 capital goods items, expanding the total list
from 1,261 to 1,343 items. An important policy decision in the context of modernisation was about
the import of instruments required for modernisation and technological upgradation. Such items
could be imported either under supplementary licensing as capital goods, or against REP licences and
additional licences. Automatic licensing, under which 10 per cent of the value of the previous year ’s
licence could be imported, introduced in the 1990 trade policy is worth mentioning. Similarly, REP
licensing scheme was expanded and simplified.

The Export–Import policy announced on April 30, 1990, terminated the 1988 policy one year ahead of schedule. The
ongoing effort for liberalisation was further stimulated by the 1990 policy.
Registered exporters, trading houses, and star trading houses were given place of prominence. For
example, important raw materials, such as petroleum products, fertilisers, oils and oil seeds, feature
and video films, newsprint, cereals, phosphoric acid, ammonia, and so on, which were placed under
public sector agencies, were allowed to be imported by trading houses and star trading houses too. In
order to obtain licences, net foreign exchange (NFE) earnings were introduced as a condition for
registered exporters. Registered manufacturers and exporters who were regularly exporting for a
period of three years were, on the other hand, permitted to import capital goods up to an amount of
Rs 10 crore at a concessional customs duty of 25 per cent, on condition that they take up an export
obligation of three times the value of imports within a period of four years. Moreover, import REPs
at the rate of 10 per cent of NFE earnings were allowed on export of services, such as computer
software, overseas management and consultancy services, contracts, advertising, and so on.

Registered manufacturers and exporters who were regularly exporting for a period of three years were, on the other hand,
permitted to import capital goods up to an amount of Rs 10 crore at a concessional customs duty of 25 per cent.
An export house having export earnings of not less than Rs 5 crore and a trading house with Rs 20
crore would be eligible for the above benefits as well as for additional licences for import of raw
materials, components, consumables and tools, and capital goods permissible under OGL. Export
houses, which had an average annual foreign exchange earnings (for the previous three years) of Rs
75 crore were considered as star trading houses, which were granted special additional licences
equivalent to 15 per cent of the NFE earned in the preceding year. Blanket advance licensing was also
introduced for manufacturers–exporters who earned a minimum NFE of not less than Rs 10 crore
during the preceding three years. However, the import–export pass-book scheme introduced in
January 1986 was withdrawn in 1990.

Blanket advance licensing was also introduced for manufacturers–exporters who earned a minimum NFE of not less than
Rs 10 crore during the preceding three years.
The Foreign Trade Policy of 1991 visualised the suspension of CCS, uniform rate of REP (30 per
cent) on Free-on-board (FOB) value, abolition of supplementary licences except in respect of the
small-scale sector and production of life-saving drugs and equipment, abolition of unlisted OGL, and
removal of import licensing for capital goods and raw materials (barring a small negative list). The
government could draw enthusiastic notes from the average annual growth rate of about 17 per cent
during the period from 1986–87 to 1989–90, due to the liberalisation policy of the Rajiv Gandhi
government, and initiated the following liberalisation measures:
1. Exim scrip (REP for export-based imports) was made to be freely traded. A uniform rate of 3 per cent of FOB value of all
exports was fixed as REP as against the variable rates (5 per cent–20 per cent) that existed. (Special rates on books and
magazines, and certain metal-based handicrafts and gems and jewellery were retained.)
2. Greater incentive has been provided for exporters with low level of imports.
3. All supplementary licences have been abolished except those of the small-scale industry SSI sector and production of life-
saving drugs and equipment. All additional licences entitled to export houses have been abolished. However, a REP rate of 30
per cent and an additional REP of 5 per cent have been granted on FOB value to export houses.
4. All items in unlisted OGL, and all items earlier listed in limited permissible list (Appendix 3A and 3B), and PMP units (Appendix
6) shall be imported through REP scheme.
5. REP rate for advance licence exports has been increased from 10 per cent to 20 per cent of NFE earnings. Advance licensing,
which was an alternative to REP for making imports against exports, was expected to be less attractive to exporters as a result.
6. It was proposed to review the entire canalisation process and decanalise all items except those which are indispensable.
7. In the light of liberalisation, CCS was suspended with effect from July 3, 1991.
Foreign Exchange Certificates (FECs) were to be introduced in place of exim scrips in due course
(the rupee was expected to be fully convertible in three to five years).
A new package of incentives was announced for EOUs and Export-Promotion Zones (EPZs) on
August 3, 1991, which included higher rates of exim scrips. Even though the basic rate of exim scrips
would be 30 per cent of the FOB value of export, items like agricultural products, electronics, bulk
drugs, marine products, and certain category of engineering goods were eligible for 40 per cent.
EOUs and EPZs would also be eligible for 30 per cent of the NFE earnings. Administrative
procedures were simplified and advance licences were to be issued within 15 days from the date of
application, while exim scrips were to be issued within 48 hours once the application accompanied by
the bank certificate for the realisation of export proceeds. Sixteen items of exports and 20 items of
imports were simultaneously decanalised and placed under OGL. The government expressed its
desire to progressively eliminate licensing and restrictions, so that capital goods, raw materials, and
components could be placed under OGL in due course. Thus, a liberalised trade policy to suit the
liberlisation in industrial policy was announced by the government.

A new package of incentives was announced for EOUs and Export-Promotion Zones (EPZs) on August 3, 1991, which
included higher rates of exim scrips.
EVALUATION OF THE NEW INDUSTRIAL POLICY
The liberalisation process started in 1973 and was carried forward in 1985, 1988, and 1990. It
culminated in a manner of opening up of the economy with the industrial policy of 1991, in
consonance with the globalisation process emerging all over the world. The Licence Raj gave way to
an open economy in which all industrial activities, except a list of 18 items, were freed from the
clutches of licensing. Besides all these, a formidable number of MRTP and FERA restrictions were
liberalised in order to cope with the need for integrating the Indian economy with the world economy.
The investment limit of MRTP companies was removed and many of bureaucratic restrictions done
away with.

The Licence Raj gave way to an open economy in which all industrial activities, except a list of 18 items, were freed from the
clutches of licensing.
In the face of acute shortage and scarcity of foreign exchange, it was proper on the part of
government to lay down all-out policy measures to strengthen the inflow of foreign capital. Although
investments from non-resident Indians, foreign corporate bodies, and foreign investors were
encouraged, foreign equity participation in Indian companies up to 51 per cent was normalised.
Meanwhile, foreign investment up to 100 per cent stood permissible in export-oriented units and
sophisticated technology-based industries. This was a welcome sign for foreign investors. These
measures made a dramatic impact on India’s foreign-exchange reserve, which grew from a level of
$425 mn to $1,600 mn. Although critics (political critics) did not favour the government policy of
inducing the inflow of foreign capital indiscriminately, Dr. Manmohan Singh’s foreign capital policy
dramatically improved the country’s foreign exchange position which substantially embellished
India’s image before international bodies and foreign governments. Moreover, India could recoup
from financial sickness, in spite of critiques based on factors, such as dividend payments,
repatriation, and intellectual property rights.

In the face of acute shortage and scarcity of foreign exchange, it was proper on the part of government to lay down all-out
policy measures to strengthen the inflow of foreign capital.
The public sector policy, which invited widespread criticism from various political quarters,
particularly from communist and socialist thinkers and their political allies, deserves a special
mention here. The classification of public sector enterprises in the industrial policy of 1991 is worth
mentioning in the context of the government policy adopted:
1. Public enterprises in the reserved category or in high-priority areas or the units, which make reasonable or substantial profit,
should be strengthened.
2. Public sector units, which may not be successful presently but are potentially viable, must be restructured and placed on a
strong footing.
3. Chronically sick public sector units making heavy losses must either be closed down or its ownership transferred to private
hands. The government, thus, strongly felt the need for keeping viable units. The units, to be retained under the public sector,
must be effectively and profitably managed, and chronically loss-making enterprises disowned.

Chronically sick public sector units making heavy losses must either be closed down or its ownership transferred to
private hands.
It, therefore, necessitates that the government makes fundamental decisions on whether most of the
units in consumer goods, textiles, contract and construction projects, technical consultancy, and so on,
should continue to function. The most basic question in this respect is about the future of the
workforce, since thousands of workers and executives are involved. They must either be retrained
and absorbed in alternative employments or parted with through golden-handshake schemes. The
government’s concern for the workers has been declared by responsible quarters in unequivocal
terms. The National Equity Fund raised by the government may play a role in this respect.
Public sector units, which have been acting as monopoly houses under the direct protection of the
government ever since the introduction of first Industrial Policy Resolution in 1948, are now
expected to face competition. They can grow faster in a competitive atmosphere, with the resources
and attention of the government. This, however, needs waiting and watching, particularly when they
are subjected to MRTP restrictions. However, in the context of globalisation, integration with the
global economy, and competitive marketing environment, the future of the public sector needs to be
watched further.

Public sector units, which have been acting as monopoly houses under the direct protection of the government are now
expected to face competition. They can grow faster in a competitive atmosphere, with the resources and attention of the
government.
An exclusive, small industrial policy announced by the government reveals its concern for
developing a vibrant small industrial sector in India to function complementarily to the large
industrial sector, free from hurdles and obstructions. However, bureaucratic restrictions, corruption,
and red tapism still stand on the way of the development of small-scale sector, and mere policy may
not be sufficient enough to nurse and nourish the small-scale sector.
The minority United Front Government which came to power in 1996 ruled for a period of less
than 20 months under two Prime Ministers, first under H.D. Deve Gowda and then I.K. Gujral with the
help of Congress. They followed the policies of the Congress government and, hence, no substantial
change took place in the industrial policy.
One policy change took place was the definition of the small-scale industry. After the resignation
of the Gujral government, the Government and its policy have enhanced the investment limit in small-
scale industries from Rs 65 lakh to a massive Rs 3 crore vide their notification of December 15, 1997.
Such a policy decision taken by a caretaker government was criticised by the think-tank of the BJP.
That sort of a decision is bound to have adverse effects since the benefits which are applicable to
small entrepreneurs will be grabbed by powerful individuals or big business houses. A huge
investment of Rs 3 crore would be possible only for a rich investor. This can affect the very
development of a small-scale sector itself in a negative manner.

One policy change took place was the definition of the small-scale industry. After the resignation of the Gujral government,
the Government and its policy have enhanced the investment limit in small-scale industries from Rs 65 lakh to a massive Rs
3 crore vide their notification of December 15, 1997.
After the mid-term elections in February 1998, a coalition government of 18 political parties under
the leadership of A.B. Vajpayee came to power in March 1998. They followed almost the same
liberalisation policy initiated by Narsimha Rao government. However, the economic sanctions
declared by many countries against India as a result of the Pokhran nuclear blasts considerably
affected foreign investment in India.
NEW TRADE POLICY OF 1991
The Government of India announced its new trade policy in support of its liberalisation policy in
1991, which stemmed from the announcements of July 4, 1991 and August 13, 1991. The trade regime
was liberalised by streamlining and strengthening advance licensing systems and decanalising 16
export and 20 import items. A new package of incentives was also provided for 100 per cent export
units and processing zones. Some important aspects of the trade policy statement made by Union
Commerce Minister P. Chidambaram in the Lok Sabha were as follows:
1. As a whole, promotion of export, moderation of growth of import, and simplification of procedure are the general objectives of
the 1991 trade policy.
2. Advance licensing system was strengthened. (Provision of substantial manufacturing activity as a basic requirement for advance
license was dispensed with. Procedures have been streamlined and the number of documents have been reduced.)
3. A “transferable advance license” scheme for general area has been introduced in the items like textiles, engineering goods, and
leather goods.
4. Exporters are allowed to dispose of the materials imported against advance licenses by way of REP without prior approval in
cases where no MODVAT (modified value, added tax) facility was availed of on the domestic material used in exports.
5. Considerable reduction in the licensing and in the number and types of licenses has been outlined.
6. Supplementary licenses for import of items in Appendices 3, 4, and 9 of the Exim Policy (1990–1993) have been abolished.
7. Additional licenses issued to export houses and trading firms as an incentive earlier have been abolished with effect from April
1, 1992.
8. The procedure for obtaining bank guarantee and legal undertaking from different categories of exporters has been liberalised.
9. It is decided to appoint a high-level committee to outline modalities for eliminating restrictions and licensing.
10. Sixteen items of exports, including castor oil, coal and coke, polyethylene, (ID) colour, picture tubes and assemblies of colour
TV containing colour TV picture tubes, khansari, molasses, sugar, iron grade bauxite ore exposed cinematographic films, video
tape, and cinema film, have been reanalysed.
11. Sixteen import items have been decanalised and placed under REP so as to import against exempted scrapes; another six import
items are decanalised and put under OGL.
12. Export houses, trading houses, and star trading houses, are given leeway to import a wide range of items against additional
licenses.
A trade policy is an important arm of the liberalisation policy, since trade between various countries
is the crux of global business. Import restrictions practised in India had to be removed for making
liberalisation more meaningful. The government, therefore, acted in this direction also.
THE NEW SMALL-SCALE SECTOR POLICY OF 1991
Small enterprises have emerged as a dynamic and vibrant sector of the economy. At 2004, it accounts
for 55 per cent of industrial production, 40 per cent of exports, and over 88 per cent of manufacturing
employment. Although their relative importance tends to vary inversely with the level of
development, their contribution remains significant in the country. The small-scale enterprises have
being playing a significant role in the economics and social development of the country. Over the
years, small enterprises have emerged as leaders in the industrial sector in India. In recognition of
their significance and stature, the new government announced policy measures for promoting and
strengthening the small, tiny, and village enterprises, on August 6, 1991, for the first time in post-
independence period. The new policy on tiny, small, and village enterprises envisages almost a U-turn
in policy stimulants and structure of micro and small enterprises in the country.

Small enterprises have emerged as a dynamic and vibrant sector of the economy, presently accounting for 55 per cent of
industrial production, 40 per cent of exports, and over 88 per cent of manufacturing employment.
Objectives
The primary objective of the small-scale industrial policy during the 1990s would be to impart more
vitality and growth impetus to the sector, so that the sector can contribute in terms of growth of
output, employment, and export. The other objectives are as follows:
1. To decentralise and delicense the sector,

2. To deregulate and debureaucratise the sector,
3. To review all statutes, regulations, and procedures and effect suitable modifications wherever necessary,
4. To promote small enterprise, especially industries in the tiny sector,
5. To motivate small and sound entrepreneurs to set up new green enterprises in the country,
6. To involve traditional and reputed voluntary organisations in the intensive development of Khadi and Village Industrial
Commission (KVIC) through area approach,
7. To maintain a sustained growth in productivity and attain competitiveness in the market economy, especially in the international
markets,
8. To industrialise the backward areas of the country,
9. To accelerate the process of development of modern small enterprises, tiny enterprises, and village industries through
appropriate incentives, institutional support, and infrastructure investments.
Salient Features of New Policy
1. Equity participation up to 24 per cent by other industrial undertakings (including foreign companies).
2. Legislation to limit financial liability of new or non-active partner-entrepreneurs to the capital invested.
3. Hike in investment limit for tiny sector, up from Rs 2 lakh to Rs 5 lakh.
4. Services sector to be recognised as tiny sector.
5. Support from National Equity Fund for projects upto Rs 10 lakh.
6. Single-window loans to cover projects up to Rs 20 lakh. Banks too to be involved.
7. Relaxation of certain provision of labour laws.
8. Sub-contracting Exchanges to be set up by industry associations.
9. Easier access to institutional finance.
10. Factoring services through SIDBI to overcome the problem-delayed payments. Also, legislation to ensure payment of bills.
11. Women enterprises redefined.
12. Marketing of mass consumption items by National Small Industries Corporation under common brand name.
13. Composite loan under the single-window scheme also to be given by banks.
14. Tiny sector to be accorded priority in government purchase programme.
15. Priority to SSIs and tiny units in allocation of indigenous raw materials.
16. Promises to deregulate and debureacratise small and tiny sectors.
17. PSUs and NSIC to help market products through consortia approach, both domestically and internationally.
18. Janata Cloth Scheme to he replaced by a new scheme which will provide fund for loom modernisation.
19. Compulsory quality control for products that pose rise to health and life.
20. Legislation to ensure payment of small-scale industries bills.
21. A special monetary agency to be set up for the small-scale sector’s credit needs.
22. A new scheme of integrated infrastructure development to be implemented.
23. A TDC to be set up.
24. Incentive and services package to be delivered at the district level.
25. An export development centre to be set up.
26. KVIC and board to be expanded.
27. Investment limit of ancillary units and EOU raised to Rs 75 lakh.
28. Traditional village industries to be given greater thrust.
In pursuance of the objectives of the policy statement, the Government of India decided to take a
series of initiative in respect of policies related to the following areas.
Small-scale Industries
1. Financial support.
2. Infrastructure facilities.
3. Marketing and exports.
4. Modernisation.
5. Promotion of entrepreneurship.
6. Simplification of rules and procedures.
7. Tapping resources.
Tiny Sector
1. Investment.
2. Broadening the concept of service sector.
3. Locational.
4. Simplification of rules.
Handloom Sector
1. Project package scheme.
2. Welfare packages scheme.
3. Organisation and development scheme.
4. NHDC as a nodal agency.
Handicraft Sector
1. Extending services like supply of raw materials and so on.

2. Market development support and expansion of training facilities.
3. Other village industries.
4. Improving quality.
5. Ensuring better flow of credit from financial institution.
6. Thrust on traditional village industries.
7. Setting up of functional industries estates.
8. Upgrading training programmes.
9. Coordinating with development programmes.
RECENT POLICIES FOR MICRO AND SMALL ENTERPRISES (MSE) SECTOR
Worldwide, the micro and small enterprises (MSEs) have been accepted as the engine of economic
growth and for promoting equitable development. The MSEs constitute over 90 per cent of the total
enterprises in most of the economies and are credited with generating the highest rates of
employment growth and account for a major share of industrial production and exports. In India too,
the MSEs play a pivotal role in the overall industrial economy of the country. It is estimated that in
terms of value, the sector accounts for about 39 per cent of the manufacturing output and around 33
per cent of the total exports of the country. Further, in recent years, the MSE sector has consistently
registered higher growth rate compared to the overall industrial sector. The major advantage of the
sector is its employment potential at low capital cost. As per available statistics, this sector employs
an estimated 31 million persons spread over 12.8 million enterprises and the labour intensity in the
MSE sector is estimated to be almost four times higher than the large enterprises.

The MSEs constitute over 90 per cent of the total enterprises in most of the economies and are credited with generating the
highest rates of employment growth and account for a major share of industrial production and exports. In India too, the
MSEs play a pivotal role in the overall industrial economy of the country.
To help the MSEs in meeting the challenges of globalisation, the government has taken several
initiatives and measures in the recent years. First and foremost among them is the enactment of the
“Micro, Small, and Medium Enterprises Development Act, 2006”, which aims to facilitate the
promotion and development and to enhance the competitiveness of MSMEs. (Refer to Box 3.6). The
Act came into force from October 2, 2006. Other major initiatives taken by the government are
setting up of the National Manufacturing Competitiveness Council (NMCC) and the National
Commission of Enterprises in the Unorganised Sector (NCEUS). Further, in recognition of the fact
that delivery of credit continues to be a serious problem for MSEs, a policy package for stepping up
credit to small and medium enterprises (SME) was announced by the government with the objective to
double the credit flow to the sector within a period of five years. The government has also announced
a comprehensive package for promotion of micro and small enterprises, which comprises the
proposals/schemes having direct impact on the promotion and development of the micro and small
enterprises, particularly in view of the fast-changing economic environment, wherein “to be
competitive” is the key to success.

To help the MSEs in meeting the challenges of globalisation, the government has taken several initiatives and measures in
the recent years.
Box 3.3 Major Initiatives in the Petroleum Sector During 2007–08
The Coal Bed Methane (CBM) Policy was approved in July 1997. Since then, 26 CBM blocks have
been awarded for exploration and production of CBM gas. About 6 TCF reserves have already
been established in four CBM blocks. The First commercial production of CBM commenced
from July 2007. The work relating to the launch of CBM IV has started.
The seventh round of NELP was launched on December 13, 2007, under which bids have been
invited for 57 (29 onland, 9 shallow water, and 19 deep-water blocks) exploration blocks.
Reserve replacement ratio has been decided to be maintained at more than one during the Eleventh
Five-Year Plan period. The Assam Gas Cracker Project was formally launched in April 2007.
Initiatives have been taken to meet the demand for gas through intensification in domestic
exploration and production activities, LNG import, CBM, underground coal gasification, gas
hydrates, and transnational gas pipelines, etc.

Box 3.4 Coal: Policy Developments During 2007–08
During April–December 2007, 45 coal blocks with geological reserves of 11,384.49 MT were
allocated to the government and private companies.
Guidelines have been framed for undertaking detailed exploration by allottees of unexplored coal
blocks in public and private sectors.
To encourage private investment in development of new technologies, a notification specifying

coal gasification and liquefaction as end uses has been published in the Gazette of India on July
12, 2007.
New Coal Distribution Policy has been notified on October 18, 2007.
The royalty rates on coal and lignite have been revised in July 2007 on the basis of a formula
consisting of ad valorem plus a fixed component.
The Administrative Staff College of India, Hyderabad, appointed as a consultant for preparing the
report on the appointment of a Coal Regulator, has submitted a draft report.
A proposal to confer Nav Ratna status on Coal India Limited (CIL) has been submitted to the
Department of Public Enterprises. An order has been issued to confer Mini Ratna Category-I
status on six coal companies, including CIL.
To ensure the free play of market forces, a system of e-auction for sale of about 20 per cent of the
total production has been introduced.
For securing metallurgical coal supplies overseas by the PSUs, a proposal for formation of a
Special Purpose Vehicle (SPV) has been approved. The CIL has committed to contribute Rs 1,000
crore in the SPV as equity out of the total authorised capital of Rs 3,500 crore.
The Expert Committee on the Road Map for Coal Sector Reforms has submitted its report which
is being examined by the government.

The Ministry of Micro, Small, and Medium Enterprises (MSMEs) performs its tasks of formulation
of policies and implementation of programmes mainly through two central organisations. They are
as follows:

The Ministry of Micro, Small, and Medium Enterprises (MSMEs) performs its tasks of formulation of policies and
implementation of programmes mainly through two central organisations.
Micro, Small, and Medium Enterprises Development Organisation
The Micro, Small, and Medium Enterprises Development Organisation (earlier known as Small
Industries Development Organisation) set up in 1954, functions as an apex body for sustained and
organised growth of micro, small, and medium enterprises. As an apex/nodal organ, it provides a
comprehensive range of facilities and services to the MSMEs through its network of 30 Small
Industries Service Institutes (SISIs), 28 branch SISIs, four Regional Testing Centres (RTCs), seven
Field Testing Stations (FTSs), six Process-cum-Product Development Centres (PPDCs), 11 Tool
Rooms, and two Specialised Institutes, viz., Institute for Design of Electrical Measuring Instruments
(IDEMI) and Electronics Service and Training Centre (ESTC).

The Micro, Small, and Medium Enterprises Development Organisation (earlier known as Small Industries Development
Organisation) set up in 1954, functions as an apex body.
National Small Industries Corporation Limited
The National Small Industries Corporation, since its inception in 1955, has been working with its
mission of promoting, aiding, and fostering the growth of micro and small enterprises. It has been
working to promote the interest of micro and small enterprises and to enhance their competitiveness
by providing integrated support services under marketing, technology, finance, and Support services.

The National Small Industries Corporation, since its inception in 1955, has been working with its mission of promoting,
aiding, and fostering the growth of micro and small enterprises.
The corporation has been introducing several new schemes from time to time for meeting the
change aspirations of the micro and small enterprises. The main objective of all these schemes is to
promote the interest of the micro and small enterprises and to put them in competitive and
advantageous positions. The schemes of NSIC have been found to be very useful in stimulating the
growth of micro and small enterprises in the country. The information pertaining to the schemes
planned to be continued/implemented in the Eleventh Plan period by the corporation with government
support is given as follows.
Performance and Credit Rating

NSIC, in consultation with Rating Agencies and Indian Banks Association, has formulated
Performance and Credit Rating Scheme for small industries. The scheme is aimed at creating
awareness amongst small enterprises, about the strengths and weaknesses of their existing operations,
and at providing them with an opportunity to enhance their organisational strengths and credit
worthiness. The rating under the scheme serves as a trusted third-party opinion on the capabilities and
creditworthiness of the small enterprises. An independent rating by an accredited rating agency has a
good acceptance from the banks/financial institutions, customers/buyers, and vendors. Under this
scheme, rating fees to be paid by the small enterprises is subsidised for the first year only and that is
subject to a maximum of 75 per cent of the fee or Rs 40,000, whichever is less.

NSIC, in consultation with Rating Agencies and Indian Banks Association, has formulated Performance and Credit Rating
Scheme for small industries.
Marketing Assistance Scheme

This is an ongoing old scheme. Marketing, a strategic tool for business development, is critical for
the growth and survival of small enterprises in today’s intensely competitive market. One of the
major challenges before the small enterprises is to market their products/services.
NSIC acts as a facilitator to promote marketing efforts and enhance the competency of the small
enterprises for capturing the new market opportunities by way of organising or participating in
various domestic and international exhibitions/trade fairs, buyer–seller meets, intensive campaigns,
seminars, and consortia formation. NSIC helps small enterprises to participate in
international/national exhibitions/trade fairs at the subsidised rates to exhibit and market their
products. Participation in these events provides small enterprises an exposure to the
national/international markets.

NSIC acts as a facilitator to promote marketing efforts and enhance the competency of the small enterprises for capturing
the new market opportunities.
Buyer–seller meets are being organised to bring bulk buyers/government departments and micro
and small enterprises together on one platform. This enables the micro and small enterprises to know
the requirements of bulk buyers, on the one hand, and help the bulk buyers to know the capabilities of
micro and small enterprises for their purchases, on the other hand. Intensive campaigns and seminars
are organised all over the country to disseminate/propagate the various schemes for the benefit of the
small enterprises and to enrich the knowledge of small enterprises regarding latest developments,
quality standards, and so on.
In addition, the Ministry has three national-level entrepreneurship development institutes, viz.,
Indian Institute for Entrepreneurship (IIE), Guwahati; National Institute for Entrepreneurship and
Small Business Development (NIESBUD), Noida; and National Institute for Micro, Small, and
Medium Enterprises (NIMSME), Hyderabad.

The Ministry has three national-level entrepreneurship development institutes, viz., Indian Institute for Entrepreneurship
(IIE), Guwahati; National Institute for Entrepreneurship and Small Business Development (NIESBUD), Noida; and National
Institute for Micro, Small, and Medium Enterprises (NIMSME), Hyderabad.
Definition of Micro, Small, and Medium Enterprises
A. Manufacturing Enterprises
1. A micro enterprise, where the investment in plant and machinery does not exceed Rs 25 lakh;
2. A small enterprise, where the investment in plant and machinery is more than Rs 25 lakh but does not exceed Rs 5 crore; and
3. A medium enterprise, where the investment in plant and machinery is more than Rs 5 crore but does not exceed Rs 10 crore.
B. Service Enterprises
1. A micro enterprise, where the investment in equipment does not exceed Rs 10 lakh;
2. A small enterprise, where the investment in equipment is more than Rs 10 lakh but does not exceed Rs 2 crore; and
3. A medium enterprise, where the investment in equipment is more than Rs 2 crore but does not exceed Rs 5 crore.
Performance of MSE Sector
As per the third All India Census held for the year 2001–02, there were 105.21 lakh enterprises
(registered and unregistered) in the country, out of which 13.75 lakh were registered working
enterprises and 91.46 lakh, unregistered enterprises. Their contribution to production was Rs 282,270
crore and to employment was 249.32 lakh persons. It is estimated that during 2006–07 (provisional),
the number of units has increased to 128.44 lakh 123.42 lakh in the previous year, registering a
growth rate of 4.1 per cent. The value of production at current prices is estimated to have increased by
15.8 per cent to Rs 497,842 crore from Rs 429,796 crore. The employment is estimated to have
increased to 312.52 lakh from 299.85 lakh persons in the previous year. The MSE sector has been
registering a higher growth rate than the overall industrial sector in the past few years consistently.
Infrastructure Development
For setting up of industrial estates and to develop infrastructure facilities like power distribution
network, water, telecommunication, drainage and pollution-control facilities, roads, banks, raw
materials, storage and marketing outlets, common service facilities and technological back up
services, and so on, for MSMEs, the Integrated Infrastructural Development (IID) Scheme was
launched in 1994. The scheme covers districts, which are not covered under the growth centres
Scheme. The scheme covers rural as well as urban areas with a provision of 50 per cent reservation
for rural areas and 50 per cent industrial plots are to be reserved for the tiny units. The scheme also
provides for upgradation/strengthening of the infrastructural facilities in the existing old industrial
estates. The estimated cost to set up an IID Centre is Rs 5 crore (excluding cost of land). The Central
government provides 40 per cent (up to a maximum of Rs 2 crore) in case of general states and up to
80 per cent (up to a maximum of Rs 4 crore) for Northeast Region (including Sikkim), J&K,
Himachal Pradesh, and Uttrakhand, as grant and remaining amount could be loan from
SIDBI/Banks/financial Institutions or the state funds. For the promotion and development of MSEs in
the country, cluster approach is one of the thrust areas of the Ministry in the Eleventh Plan. The IID
Scheme has been subsumed under the Micro and Small Enterprise Cluster Development Programme
(MSECDP). All the features of the IID Scheme have been retained and will be covered as ‘‘New
Clusters’’ under MSECDP.

For setting up of industrial estates and to develop infrastructure facilities.
The Integrated Infrastructural Development (IID) Scheme was launched in 1994.
Technology Upgradation in MSE Sector

The opening up of the economy has exposed MSE sector to global and domestic competition. With a
view to enhancing the competitiveness of this sector, the government has taken various measures,
which include: (i) Assistance to Industry Associations for setting up of testing centres and to state
governments and their autonomous bodies for modernisation/expansion of their quality marking
centres; (ii) Regional testing centres and field testing stations to provide testing services and services
for quality upgradation; (iii) Implementation of MSECDP, under which 91 clusters have been taken
up, including national programme for the development of toy, stone, machine tools, and hand-tool
industry in collaboration with UNIDO; (iv) A scheme of promoting ISO 9000/14001 Certification
under which SSI units are given financial support by way of reimbursing 75 per cent of their
expenditure to obtain certification, subject to a maximum of Rs 75,000 per unit; and (v) Setting up of
a biotechnology cell in SIDO.

With a view to enhancing the competitiveness of this sector, the government has taken various measures,
Further, a scheme on credit-linked capital subsidy was launched in the year 2000 to facilitate
technology upgradation of small enterprises. Under the scheme, capital subsidy of 12 per cent was
provided on institutional finance availed by the SSI units for induction of well-established and
improved technology in select sub-sectors/products up to a maximum ceiling of Rs 40 lakh. The
scheme has been revised with effect from September 29, 2005. Under the revised scheme, the rate of
upfront capital subsidy has been enhanced to 15 per cent and ceiling on loan has been raised to Rs 1
crore, the admissible capital subsidy is calculated with reference to purchase price of plant and
machinery, instead of the term loan disbursed to the beneficiary unit.

A scheme on credit-linked capital subsidy was launched in the year 2000 to facilitate technology upgradation of small
enterprises.
Measures for Export Promotion

Export promotion from the MSE sector has been accorded a high priority. The following schemes
have been formulated to help MSEs in exporting their products:
1. Products of MSE exporters are displayed in international exhibitions and the expenditure incurred is reimbursed by the
government;
2. To acquaint MSE exporters with latest packaging standards, techniques, and so on, training programme on packaging for
exporters are organised in various parts of the country in association with the Indian Institute of Packaging;
3. Under the MSE Marketing Development Assistance (MDA) Scheme, assistance is provided to individuals for participation in
overseas fairs/exhibitions, overseas study tours, or tours of individuals as member of a trade delegation going abroad. The
scheme also offers assistance for
a. Sector-specific market study by MSE Associations/Export Promotion Councils/Federation of Indian Export
Organisation;
b. Initiating/contesting anti-dumping cases by MSE Associations; and
c. Reimbursement of 75 per cent of the one-time registration fee and annual fee (recurring for first three years) charged by
GS1 India (formerly EAN India) for adoption of bar coding.
Entrepreneurship and Skill Development

The Ministry conducts Entrepreneurship Development Programmes (EDPs) to cultivate the skill in
unemployed youths for setting up MSEs. Further, under the Management Development Programmes
(MDPs), existing MSE entrepreneurs are provided training on various areas to develop skills in
management to improve their decision-making capabilities, resulting in higher productivity and
profitability. To encourage more entrepreneurs from SC/ST, women, and physically challenged
groups, The Ministry of MSME provides a stipend of Rs 500 per capita per month to them during the
period of the training.

The Ministry conducts Entrepreneurship Development Programmes (EDPs) to cultivate the skill in unemployed youths for
setting up MSEs.
Box 3.5 Policy Developments and New Initiatives in Information Technology

The Special Incentive Package Scheme (SIPS) to encourage investments for setting up
semiconductor fabrication and other micro- and nano-technology manufacturing industries was
announced in March 2007. The incentives admissible would be 20 per cent of the capital
expenditure during the first 10 years for units located in Special Economic Zones (SEZs) and 25
per cent for units located outside SEZs.
A Task Force has been constituted to promote the growth of electronics in IT hardware
manufacturing industry.
The Department of Information Technology has unveiled various components of the National e-
Governance Plan (NeGP) covering 27 Mission Mode Projects (MMP) and eight support
components to be implemented at Central, State, and local government levels, at an estimated cost
of Rs 23,000 crore over the next five years. The government has approved the approach, strategy,
key components, and the implementation framework for NeGP with the vision: “Make all
Government services accessible to the common man in his locality through common service
delivery outlets and ensure efficiency, transparency and reliability of such services at affordable
costs to realise the basic needs of the common man”.
The government has approved a scheme for facilitating the establishment of one lakh broadband
Internet-enabled common service centres in the rural areas in the public–private partnership
mode.
The government has approved a scheme for establishing the State Wide Area Networks (SWANs)
across the country in 29 states/6 UTs (union territories) with a total outlay of Rs 3,334 crore with
Central assistance component of Rs 2,005 crore over a period of five years. The scheme
envisages to provide Central assistance to states/UTs for establishing SWANs for states/UTs
headquarters up to the block level with a minimum bandwidth capacity of 2 Mbps.
The Department of Information Technology is setting up Nano Electronic Centres at the Indian
Institute of Technology, Mumbai and the Indian Institute of Science, Bangalore, with an outlay of
about Rs 100 crore to carry out R&D activities in nano-electronics devices and materials.
The software tools and fonts for 10 Indian languages, viz., Hindi, Tamil, Telugu, Assamese,
Kannada, Malayalam, Marathi, Oriya, Punjabi, and Urdu, have been released in the public domain.
The Information Technology Amendment Bill, introduced in the Parliament in December 2006,
was referred to the Parliament Standing Committee which has presented its report to both the
Houses of Parliament.

Box 3.6 Implementation of the MSME Development Act, 2006
For implementation of the MSMED Act 2006, notifications of rules were to be issued by the
Central and state governments. The Central notifications are as follows:
Principal notification in July 2006 that MSMED Act becomes operational from October 2, 2006.
Notification in September 2006 for the Rules for National Board for Micro, Small, and Medium
Enterprises (NBMSMEs) to be constituted under the Act.
Notification in September 2006 for the constitution of the Advisory Committee. Notification in
September 2006 for classifying enterprises.
Notifications in September and November 2006 declaring DICs (District Industries Centres) in the
states/union territories (UTs) as “Authority” with which the entrepreneurs’ memorandum could be
filed by the medium enterprises.
Notification in September 2006 for the form of memorandum to be filed by the enterprises,
procedure of its filing and other matters incidental thereto.
Notification in October 2006 for exclusion of items while calculating the investment in plant and
machinery; Notification in May 2007 for constitution of NBMSMEs.
Notification in May 2007 for dividing the country into six regions, and notification in June 2007
for the amendment of EM format.
About 28 states/UTs have notified the authority for filing of entrepreneurs’ memorandum, 17
states/UTs have notified rules for MSEFCs, and 15 states/UTs have notified constitution of
MSEFCs.
CASE
The Kerala State Industrial Development Corporation (KSIDC) has mooted an amalgamation
arrangement of a number of troubled seafood processing units to form a single entity, in a bid to help
them overcome their present financial crises.
There are around 90 sick seafood units in India, against many of whom the Debt Recovery,
Tribunal has initiated pr oceedings. Collectively, these units owe around Rs 260 crore to various
banks and financial institutions. More than half of this amount is accumulated interest on loans.
KSIDC, which has around 20 units, conducted a study on the seafood industry before coming up with
the proposal for amalgamation, an official said.
The Seafood Exporters Association of India (SEAI) and the Forum of Revival and Reconstruction
of Seafood Export Industries in India are now supporting the proposal which suggests that 10 or
more units be amalgamated into one company so that it will have a stronger financial base and better
economies of scale.
As a first step towards this plan, six units in Kerala have come together to be amalgamated into a
single firm. However, this unit now requires approvals of their tenders to go ahead with the scheme
for amalgamation, which is an optional scheme for the forum.
According to SEAI, the seafood unit started incurring losses and eventually turned sick because of
a number of reasons that were “beyond their control”. Incidents, such as “blacklisting of cooked
shrimp” by the United States and, “ban on Indian seafood” announced by the European Economic
community (EEC) are factors that contributed to the weakening of the industry. On the other hand,
processing units had to invest in modernising their facilities to remain competitive in the global
markets, but they are facing financial problems. There is not sufficient raw material available and
competition in the sector is unhealthy too.
The SEAI and the Forum are now seeking the help of the Indian Banks Association and the Finance
Ministry to settle their dues to the banks.
According to SEAI, a similar model of amalgamation was tried out successfully in Iceland 20 years
ago. About 100 sick, traditional seafood units in the country were amalgamated into 10 units to
achieve a turnaround.
Case Questions
What are the reasons for sickness of seafood units? Do you support the strategy of SEAI for revival
and reconstruction?
SUMMARY
India started her quest for industrial development after independence in 1947. The Industrial Policy
Resolution of 1948 not only defined the broad contours of development, it also delineated the role of
the state in industrial development both as an entrepreneur and as an authority. The Industrial Policy
Resolution of 1956 categorised industries which could be the exclusive responsibility of the state or
would progressively come under state control and others.
Earmarking the pre-eminent position of the public sector, it envisaged private sector coexisting with
the state, and private sector attempted to give flexibility to the policy framework.
The Industrial Policy Statement of 1973 identified high-priority industries where investments from
large industrial houses and foreign companies would be permitted. The Industrial Policy Statement of
1977 laid emphasis on decentralisation and on the role of small-scale-, tiny-, and cottage industries.
The Industrial Policy Statement of 1980 focused attention on the need for promoting competition in
the domestic market, technology upgradation, and modernisation. The policy laid the foundation for
an increasingly competitive export base and for encouraging foreign investment in high-technology
areas. A number of policy and procedural changes were introduced in 1985 and 1986 that aimed at
increasing productivity, reducing costs, and improving quality.
The industrial policy initiatives undertaken by the government since July 1991 have been designed to
build on the past industrial achievements and to accelerate the process of making Indian industry
internationally competitive. The process of reform has been continuous.
KEY WORDS
Ancillary Units
Exim Policy (Export–Import policy)
Exim Scrip
Export Development Centre
Export House
Export-Promotion Zones
Foreign Exchange Certificates (FECs)
Foreign Investment
Industrial Policy
Open General Licence (OGL)
Public Sector
Registered Exporters
Replenishment (REP)
Sick Unit
Small-Scale Industry (SSI)
Technology Development Cell (TDC)
Technology Transfer
Tiny Units
Trading House
QUESTIONS
1. Discuss the main features of the Industrial Policy Resolution of 1956.

2. Review the industrial policies of the Government of India since 1948.
3. Discuss the main features of the Industrial Policy of 1977.
4. List the main features of the Industrial Policy Statement of 1980.
5. The Industrial Policy Resolution of 1956 is recognised and regarded as the Magna Carta of Indian industrialisation. Discuss.
6. Explain the importance and role of industries in the economic development of the country.
7. Discuss the role of private sector in the light of New Industrial Policy of 1991.
8. Analyse the recent slowdown in industrial sector and the factors responsible for the same.
9. Explain the role played by the public sector undertakings in the industrial development of the country.
10. Examine critically the new Small-Scale Industrial Policy of 1991.
11. Explain the role played by the small-scale sector in employment generation in the country.
12. Explain the role played by the private sector in the industrial development of the country.
13. Trace the evaluation of industrial policies in India after independence.
14. Write a note on the Industrial Policy Statement of 1991. Discuss critically the provisions incorporated in the policy to encourage
foreign investments.
REFERENCES
Government of India. India 2004: A Reference Annual, Complied and Edited by Research, Reference, and Training Division,
Publications Division, Ministry of Information and Broad Casting, Government of India.
House.
Mittal, A. C. and S. P. Sharma (2002). Industrial Economics: Issues and Policies. Jaipur: RBSA Pub.
Nambiar, V. (2003). Liberalisation and Development (Agenda for Economic Reforms). New Delhi: Commonwealth.
Prasad, C. S. (2005). India: Economic Policies and Performance: 1947–48 to 2004–05: Year-Wise Economic Review of the
Indian Economy Since Independence. New Delhi: New Century Pub.
Sengupta, D. N. and A. Sen (2004). Economics of Business Policy. New Delhi: Oxford University Press.
Virmani, A. (2004). Accelerating Growth and Poverty Reduction: A Policy Framework for India’s Development. New Delhi:
Academic Foundation.
CHAPTER 04
CHAPTER OUTLINE
Industrial Licensing in India
Objectives of Industrial Licensing
Industrial Licensing Act of 1951
Policy Decisions
Recent Industrial Licensing Policy
Summary
Key Words
Questions
References
INDUSTRIAL LICENSING IN INDIA
The Constitution of India in its Preamble and the Directive Principles of State Policy laid down that a
state has the power to control and regulate economic activities. The Directive Principles of State
Policy specifically require the state to direct its policy towards securing the following:
1. Equal right of men and women to adequate means of livelihood

2. Distribution of ownership and control of the material resources of the community to the common good
3. To ensure that the economic system does not result in concentration of wealth and means of production to the common detriment
4. Equal pay for equal work for both men and women
5. To protect the health and strength of workers and tender age of children.
The Constitution of India in its Preamble and the Directive Principles of State Policy laid down that a state has the power to
control and regulate economic activities.
The Constitution of India imposed two important limitations on the powers of the Central government
in the matter of regulation of business, which are as follows:
1. Division of powers between the states and the Central government
2. Fundamental rights
The Constitution of India imposed two important limitations on the powers of the Central government in the matter of
regulation of business, which are as follows:
Division of powers between the states and the Central government

Fundamental rights
It is important to note that much of the powers that the Central government in India exercises in the
economic field is not derived from the Constitution of India, but from the system of planning that has
been in operation since 1951. The Planning Commission that was created in 1950, as an executive
organ of the Central government, is charged with the responsibility of determining the size of the
five-year plans and the annual plans of the state, including the pattern of financing and allocating a
Central plan assistance to the states. The Planning Commission also determines the plan size of the
Central ministries and approves all major plans and projects of these ministries. Planning assumes a
commanding position in India’s economic system.

The Planning Commission that was created in 1950, as an executive organ of the Central government, is charged with the
responsibility of determining the size of the five-year plans and the annual plans of the state, including the pattern of
financing and allocating a Central plan assistance to the states.
OBJECTIVES OF INDUSTRIAL LICENSING
The basic objectives of industrial licensing are as follows:
1. Planned industrial development through appropriate regulations and controls

2. Balanced industrial growth and development by regulating the, proper location of industrial units and check regional disparities
3. Directing industrial investment in accordance with plan priorities
4. Ensuring government control over industrial activities in India
5. Regulating the industrial capacity as per targets set for planned economy
6. Preventing concentration of industrial and economic power and monopoly
7. Checking unbalanced growth of industrial establishments and ensuring economic size of industrial units
8. Encouraging healthy entrepreneurship, while discouraging unhealthy competition, monopoly, and restrictive industrial practices
9. Broadening the industrial base in India through new entrepreneurship development and ensuring industrial dispersion
10. Protecting of small-scale industries against undue competition of large-scale industries
11. Utilising full capacity of large-scale industries
12. Utilising appropriate technology and
13. Licence was necessary to carry on an industrial activity. Licensing is mandatory in respect of starting a new unit, change in
product, manufacturing a new product, effecting a substantial expansion by an established unit.
INDUSTRIAL LICENSING ACT OF 1951
Industrial licensing became a part of the industrial economy of India with the passing of Industries
(Development and Regulation [D&R]) Act, 1951. Hence, before we go into the details of industrial
licensing, a brief discussion of the salient features of this Act is relevant.

Industrial licensing became a part of the industrial economy of India with the passing of Industries (Development and
Regulation) Act, 1951.
The Industries (Development and Regulation [D&R]) Act of 1951
This Act came into effect on May 8, 1952. It had three important objectives:
1. To implement the industrial policy
2. To ensure regulation and development of important industries and
3. To ensure planning and future development of new undertakings
An industrial undertaking, according to the Act, pertains to a scheduled industry carried on in one or
more factories by any person or authority, including the government. At the same time, a factory
means any premises, including the precincts, thereof, in any part of which a manufacturing process is
being carried on or so is ordinarily carried on
1. with the aid of power if 50 or more workers are working or were working, thereon, on any day of the preceding 12 months; or
2. without the aid of power if 100 or more workers are working or were working, thereon, any day of the preceding 12 months.
Further, in no part of such premises should any manufacturing process be carried on with the aid of
power. The Act defined “scheduled industry” in Section 3(1) as any of the industries specified in the
First Schedule of the Act, which includes 38 industries engaged in the manufacture or production of
any of the articles mentioned under each of the headings or subheadings given in the schedule.
An owner, according to Section 3(f), in relation to an industrial undertaking, is a person who or the
authority which, has the ultimate control over the affairs of the undertaking. Where the said affairs
are entrusted to a manager or managing director, such manager or managing director shall be
deemed to be the owner of the undertaking. The Act applies to the whole of India, including the State
of J&K, and to the industrial undertakings, manufacturing any of the products mentioned in the First
Schedule, that is, where the manufacturing process is carried on
1. with the aid of power, and employing or employed on any day of the preceding 12 months 50 or more workers; or
2. without the aid of power, provided that 100 or more workers are working or worked on any day of the preceding 12 months.
The Act applies to the whole of India, including the State of J&K, and to the industrial undertakings, manufacturing any of
the products mentioned in the First Schedule, that is, where the manufacturing process is carried on.
The Act is applicable to industrial undertakings.
Provisions of Industries (D&R) Act of 1951
The Act contains 31 sections which can be broadly classified as

1. Sections dealing with Preventive Provision,
2. Curative Provision,
3. Creative Provision, and
4. Other Provisions.
The Act contains 31 sections which can be broadly classified as
Sections dealing with Preventive Provision,

Curative Provision,
Creative Provision, and
Other Provisions.
Preventive Provisions
Three types of provisions are included in the preventive provisions, viz., registration and licensing
provisions, investigation provisions, and revocation of licence provisions. Owners of all the existing
undertakings other than the Central government were expected to get their industrial establishments
registered within a stipulated period, according to Section 10 of the Act. Extensive provisions were
made in the Act for industrial licensing, viz.,
1. Licensing of new undertakings

2. Production of new products
3. Licensing for expansion
4. Shifting location and
5. Licensing to carry on business itself
Section 11 of the Act stipulates that no person or authority, including a state government (other than
the Central government), shall establish a new industrial establishment without a licence issued by the
Central government, while Section 11A stipulates that no industrial establishment (other than those
owned by the Central government) registered under Section 10 or licensed under Section 11 shall
produce or manufacture a new product without any licence from the Central government. According
to the Section 13, no industrial undertaking (other than the Central government) can make substantial
expansion without a licence issued by the Central government. Generally speaking, any expansion
exceeding 25 per cent of the existing capacity can be considered substantial. This section also
provides that the location should not be changed without a proper licence granted for establishing
new undertakings, or manufacturing new products on finding that the licence failed to establish or
take effective steps to implement the licence within the time allowed, without a reasonable cause.
Curative Provisions
Curative provisions include
1. Taking over the management or control industrial enterprises, and

2. Control of supply, price, and distribution of certain commodities.
Section 18A empowers the Central government to authorise any person or body of persons to take
over or control any industrial undertaking if it is confirmed, after investigation, that the concerned
undertaking has failed to comply with the directions issued under Section 16 of the Act, and that an
undertaking subject to investigation, under Section 51, is found being managed in a manner
detrimental to the scheduled industry concerned or detrimental to public interest. In such cases, the
period of takeover can be to a maximum of 12 years, first for five years and then can be extended by
further two-year periods. Section 18AA provides for taking over even without an investigation.
According to Section 18FA, the Central government can authorise any person or body of persons
to take over, any industrial undertaking under liquidation, with the permission of the concerned High
Court. Section 18FC, at the same time, empowers the Central government to sell an undertaking as a
running concern or to reconstruct the same in the interest of the general public or in the interest of the
shareholders of the company. In order to ensure equitable distribution and fair prices of any article or
class of articles relating to any scheduled industry, the Central government may, by a notified order,
exercise control of price, supply, or distribution.

In order to ensure equitable distribution and fair prices of any article or class of articles relating to any scheduled industry,
the Central government may, by a notified order, exercise control of price, supply, or distribution.
Creative Provisions
Creative provisions represent the Central government’s concern for cooperation with industry,
labour, and consumers. Development Councils consisting of members capable of representing the
interests of the scheduled industry or group of industries, persons with special knowledge, persons
representing the interest of workers, and people representing the Second Schedule of the Act also laid
down the functions of such councils.
The Central government has retained the powers to license, take over, permit expansion, or levy
and collect any cess on goods manufactured in any scheduled industry. Section 9 of the Act provides
for the levy and collection of cess on all goods manufactured in any scheduled industry. In
contravention of the provisions of the Act or for a false statement made by any person, a fine up to Rs
5,000 and/or imprisonment up to six months are provided in the Act. Thus, the Industries
(Development and Regulation) Act, 1951 has made extensive provisions for industrial licensing and
regulations.

The Central government has retained the powers to license, take over, permit expansion, or levy and collect any cess on
goods manufactured in any scheduled industry. Section 9 of the Act provides for the levy and collection of cess on all goods
manufactured in any scheduled industry.
Licensing was mandatory in respect of

a. Starting a new unit,
b. Manufacturing a new product by an established unit,
c. Effecting a substantial expansion by an established unit, and
d. Changing a part or whole of an established undertaking, if the articles manufactured come under the First Schedule of the
Industries (D&R) Act. Actually speaking, in order to carry on business (an industrial activity) licence was necessary.
Letter of Intent
Any industrial activity, beyond the exemption limit, has to obtain a licence from the Secretariat for
Industrial Approvals (SIA), a division of the Ministry of Industrial Development, in advance. An
application that satisfies all the necessary conditions would be approved. If no further clearances like
foreign collaboration, capital goods imports, and so on are involved, no further conditions are to be
fulfilled, and an industrial licence is normally issued. A licence is initially valid for two years. The
commercial production must start within this period. However, this period may be extended twice for
one year each, provided the ministry is convinced by valid reasons.

Any industrial activity, beyond the exemption limit, has to obtain a licence from the Secretariat for Industrial Approvals
(SIA), a division of the Ministry of Industrial Development, in advance.
The Administrative Ministry should be approached for extension of time. Production as per the
licensed capacity must start within the specified period.
However, if some more clarification on important aspects, such as foreign collaboration, capital
goods imports, and so on are to be provided or conditions have to be fulfilled, a Letter of Intent (LOI)
would be granted. An LOI was initially valid for 12 months. Further, two extensions of six months
each were also provided for. Later, in 1988, the period for LOI was extended to three years. In the
event of the concern’s inability to convert the LOI to an industrial licence within the stipulated period
of three years, the LOI holder may apply for an extension. Under normal circumstances, no LOI will
be extended beyond a maximum period of five years.

An LOI is granted if clarification on foreign collaboration, capital good imports is provided. It is issued for three years and
cannot be extended beyond a maximum period of five years.
An LOI is converted to an industrial licence by the Government of India for setting up an industrial
undertaking, provided the applicant has made all financial arrangements for the project, and other
arrangements for the movement of raw materials and finished goods. Adequate steps must also be
taken by the applicant for prevention of pollution, effluent disposal, installing pollution-control
equipment, and so on. The holder of an LOI must obtain government permission for import of capital
goods, for foreign collaboration, and foreign tie-ups, if any. The Central government must also be
informed of the manufacturing programme in a phased manner, which should be carried out to its
satisfaction.
Thus, industrial licensing has become an essential aspect of the industrial policy of the Government
of India. There are, however, some areas of exception. Certain exemptions are granted for obtaining
industrial licences.
Exemptions from Licensing
Although licensing is widespread, 27 broad categories of industries are exempted from licensing.
These include automotive ancillaries, agricultural implements, cycles, leather goods, glassware, and
so on. Export-oriented units (EOUs), import-substitution items, latest technology industries, capital
goods industries, which produce mass consumption goods for lower and middle classes, are
considered for exemption if they are not monopolies and restrictive trade practices (MRTP) and
Foreign Exchange Regulation Act (FERA) companies and if the items are not reserved for the small-
scale sector. However, even multinationals are permitted to hold equities up to 49 per cent in selected
small-scale industries according to a government decision taken in 1995. Besides, exemption was
granted for 82 bulk drugs and their formulations. Re-endorsement of licensed capacity and group
licensing for 32 groups was considered.
Exemptions were specifically granted in the following items:
1. Items relating to an industry which is not included in the First Schedule of the Act
2. Items to be manufactured in an undertaking which does not come under the definition of a “factory” under the Industries (D&R)
Act, 1951
3. Items manufactured in the delicensed sector of investment up to Rs 25 crore in fixed assets in non-backward areas and up to Rs
75 crore in backward areas (earlier limits were Rs 15 crore and Rs 60 crore, respectively)
4. Expansion which does not come under substantial expansion, that is, up to 25 per cent of the existing capacity
5. Small-scale units subject to certain conditions and
6. Items which do not fall under the definition of “new article”
Spectacular exemptions were announced in July 1991 in a Notification (477-E) by the Government of
India. Except in respect of 18 items, industrial licensing was done away with. Industrial undertakings
have been exempted from the operation of Section 10, 11, 11A, and 13 of the Industries (D&R) Act,
1951 subject to fulfillment of certain conditions. Section 10 refers to the requirement of registration
of existing industrial units. Section 11 refers to the requirement of licensing of new industrial
undertaking. Section 11A deals with licences for the production of new articles. Section 13 refers inter
alia to the requirement of licensing for effecting substantial expansion.

Spectacular exemptions were announced in July 1991 in a Notification (477-E) by the Government of India. Except in
respect of 18 items, industrial licensing was done away with.
Industrial Licensing: A Critical Approach
Ever since the introduction of industrial licensing policy, it underwent considerable amount of
revision, even though it was subjected to widespread criticism. Some of the grounds under which it
has been criticised may, therefore, be relevant here.

Ever since the introduction of industrial licensing policy, it underwent considerable amount of revision, even though it was
subjected to widespread criticism.
It is argued that most of the objectives of industrial licensing could not be achieved in spite of its
operation for over four decades. It could not considerably regulate industrial location. Although
concentration of industries to given areas and state could not be restricted, concentration of economic
power has been progressively going on. Similarly, industrial investment, particularly private
investment, could not be fully streamlined in accordance with the plan priorities. On the contrary, it
stood in the way of unrestricted industrial growth in the country. Although the government could
ensure some control on industrialisation, it resulted in red-tapism, corruption, and nepotism. At the
same time, it could not fully succeed in preventing concentration of monopoly and economic power.
Much control could also not be put on technology utilisation.
Even though channelising investment in priority areas was one of the most important objectives of
economic planning for which industrial licensing was considered to be a tool, this objective could not
be achieved in the expected manner. Heavy and capital goods industries were encouraged in the initial
stages for which public sector investment was channelised. A balanced industrial development could
not be achieved as expected, though some amount of success could be achieved through public sector
policies. The development of an industrial base which the Indian economy could achieve through
planned efforts cannot be ignored. But this success is not the result of industrial licensing. On the
contrary, licensing, it is widely criticised, stood in the way of unrestricted industrial development.

Even though channelising investment in priority areas was one of the most important objectives of economic planning for
which industrial licensing was considered to be a tool, this objective could not be achieved in the expected manner.
Curbing monopoly, concentration of economic power, and accumulation of resources were the
aims of industrial licensing when it was introduced. The Indian economy is subject to these ills even
after more than four decades of industrial licensing. At the same time, it acted as an obstruction, on
the one hand, and facilitated corruption, red tapism, and bureaucratic pressure, on the other hand. The
Dutt Committee rightly pointed out the fact that licensing helped the large and monopoly houses to
grow further. This was, primarily, because economic factors were seldom taken into consideration
while technical considerations guided the licensing decisions. The Monopolies Inquiry Commission
had indicated, as early as 1965, that large and monopoly houses were well placed and well informed
to gain most of the licences issued, since they had a greater comparative advantage.

Curbing monopoly, concentration of economic power, and accumulation of resources were the aims of industrial licensing
when it was introduced.
Amalgamations, takeovers, and virtual purchases of small houses by large monopoly houses were
not rare. Thereby, large houses became larger and dominant undertakings became monopoly houses.
Large and monopoly business houses, or units associated with them, enjoyed a comparative
advantage, while new entrants and potential entrepreneurs were scared away, particularly because of
administrative lapses, bureaucratic restrictions, corrupt practices, and disenchantment with the
restrictive practices in the administrative ministries. The potential entry of new entrepreneurs was,
therefore, minimised.
The Licensing Committee considered the cases under the criteria, which it deemed fit from time to
time, without well-defined policy guidelines. A long list of pending cases existed though cases which
received their attention by hook or by crook could get their clearance. Large and influencial business
houses could influence the officials easily and could get their cases cleared in time. Thus, large
business houses grew larger, defeating the very objective of licensing. Moreover, many unviable
projects were approved and many viable projects were pushed to the background. Actually, the
method of choosing the cases itself was not based on any relevant criterion.

Large and influencial business houses could influence the officials easily and could get their cases cleared in time. Thus,
large business houses grew larger, defeating the very objective of licensing.
Although influential persons and business houses could obtain clearance within the expected time
frame by various ways, it was a time-consuming affair in respect of most of the cases, which affected
the enthusiasm of the entrepreneurs and initiators. Such an inordinate delay on the part of the
licensing mechanism substantially retarded the very industrial growth and killed the initiatives of
many entrepreneurs, which was noted by the Estimates Committee of 1967–68.
The Licence Raj Period had been a period of restrictions, red-tapism, and corruption. Restrictions
on large houses, items of commodities, the quantity produced, expansions, and everything connected
to industry, characteristised the Licence Raj. The MRTP Act and FERA also stood in the way of
industrial development and industrialisation. At the same time, proliferation of uneconomic units,
promoted by influential business houses and individuals, was the order of the day.
While licensing acted as an obstruction against unrestricted industrial growth, it did not provide
any clear-cut guidelines about industrial location. Hence, there was a concentration of industries in
and around potential urban centres while other areas remained industrially undeveloped, resulting in
an unbalanced industrialisation.
Foreign investment was restricted from time to time, not only with the help of industrial licensing
policy, but with the help of the MRTP Act and FERA. This affected the inflow of foreign capital,
technology, and processes and, thereby, the speedy modernisation of the industrial sector. Some
multinationals like Coca Cola and IBM even had to wind up their direct operations in India. The
government later realised the mistake of this policy and introduced the liberalisation policy.

Due to the industrial licencing policy along with MRTP Act and FERA, the inflow of foreign capital, technology, processes,
and, thereby, the speedy modernisation of the industrial sector were adversely affected. In spite of the criticism, licensing
had an important role to play in regulating, controlling, and coordinating the economic activities in the formative stage of
the economy of free India.
Inspite of the criticism levelled against the licensing policy, licensing had an important role to play
in regulating, controlling, and coordinating the economic activities in the formative stage of the
economy of free India. However, when the government felt the need for greater liberalisation,
economic liberalisation was introduced without hesitation. Although licensing has been relaxed
gradually, it is still in force for some items.
INDUSTRIAL LICENSING POLICY
The industrial licensing policy was laid down to be complementary to the industrial policy resolution
announced by the Government of India from time to time. Industrial licensing in India can be studied
in the following stages:

1. The Industries (D&R) Act, 1951

2. Industrial Licensing Policy, 1951–60
3. Industrial Licensing Policy, 1960–70
4. Industrial licensing policy, 1970–77
5. Industrial Policy Statement, 1980–90 and
6. Liberalisation in industrial licensing, 1991 and after
The industrial licensing policy was laid down to be complementary to the industrial policy resolution announced by the
Government of India from time to time.
Following are some of the details of each policy:
The Industries (D&R) Act of 1951
This Act has been described as “the single most important piece of economic development
legislation” in our legal structure. Along with the Companies Act, 1956, and the MRTP Act, 1969, it
can be said to confer on the government powers of almost total regulation and control over the
working of the private industry and corporate sector in a manner that is almost unique.
Main Provisions
The important provisions of the Act are as follows:
1. All existing industrial undertakings in the scheduled industries, that is, industries which are listed in the First Schedule of this Act,
should be registered with the government within the prescribed period and issued with a certificate of registration (Section 10).
2. Section 11 of the Act says that no new industrial undertakings of a major size can be started in the scheduled industry.
3. It is provided in the Act that an industrial undertaking cannot change the location of unit without the express permission of the
Central government.
4. Section 12 states that the Central government can revoke the registration of licence, in case of any misrepresentation and so on
by the party concerned or failure on the part of the party to take effective steps.
5. Under Section 15 of the Act, the government can order an investigation into the working of an industrial undertaking.
6. The government can, under Section 16 of the Act, issue directions to the management in respect of prices, production, quality,
and other areas of its performance for the progress of the industry and country’s economic development if investigation demands
so.
7. Section 18 provides that in the event of the undertaking not carrying out these instructions, the government can take over its
management for a specific period and appoint an authorised controller to manage the company.
8. Section 18G gives the Central government comprehensive powers to control and regulate the supply, distribution, and prices of
any of the articles produced by an industry listed in Schedule A and no order made for this purpose can be called in question in a
court of law.
9. For the purpose of advising the Central government on matters concerning the D&R of scheduled industries, Section 5 of the Act
authorises the establishment of a Central Advisory Council (CAC) with necessary sub-committees and standing committees.
10. Development councils are to be constituted in respect of each scheduled industry or group of industries (Section 6).
The development councils along with the CAC for industries represent the more positive side of the
Act. The idea of such councils was borrowed from the development councils of UK and also shows
the influence of the French technique of indicative planning through the modernisation councils.
There was an important amendment to the Act in August 1984, to provide a legal basis for the
Central government—the right to issue notifications for reservation of specific products for small-
scale industry. The amended Act asserts the government’s right to issue such notification in the larger
public interest.

There was an important amendment to the Act in August 1984, to provide a legal basis for the Central government—the
right to issue notifications for reservation of specific products for small-scale industry.
Industrial Licensing Policy of 1951–60
Generally speaking, control and planning go hand in hand. Planned economic development has been
accepted as a national objective which obviously brings with it the economic control. Industrial
licensing has been accepted as a tool for economic control.

Planned economic development has been accepted as a national objective which obviously brings with it the economic
control. Industrial licensing has been accepted as a tool for economic control.
Industrial licensing prior to 1960 aimed at achieving the following among other things:
1. Development of industries and encouraging industrial activity in accordance with the plan priorities
2. Checking the concentration of economic power
3. Reduction of regional disparities
4. Proper allocation of foreign exchange
5. Development, protection, and encouragement of small-scale industries, and
6. Modernisation of technology and achievement of industrial growth
In the earlier years of industrial licensing, the licensing policy was generally welcomed by the private
sector industry, as a happy expression of the government’s declared policy of a mixed economy. Most
businessmen also welcomed this policy under which the government, through a system of licensing
and through an expanding public sector, would control all the strategic points of industry, but private
sector industry was also to play an important role in future industrial development.

In the earlier years of industrial licensing, the licensing policy was generally welcomed by the private sector industry, as a
happy expression of the government’s declared policy of a mixed economy.
The government’s policy in the 1950s and early 1960s was also liberal, allowing industrial licences
without much ado. However, with the gradual drift of the country’s economic policy towards the
“socialist pattern of society”, towards “sovereignty and supremacy of the public sector”, and towards
the goal of avoiding the concentration of economic power in the larger business houses, more and
more restrictions were sought to be introduced in the policy of industrial licensing in the late 1960s.
A wave of criticism of the licensing policy steadily followed. This policy, in early 1960s, came to
be the object of criticism from two opposite angles. The left-wing politicians and academicians
criticised it as having unduly helped the growth of large business houses and, thus, furthered the
concentration of economic power to common detriment. Leaders of private business and their
academic supporters criticised it as stifling the industrial growth of the country and, thus, creating
unemployment and large production gaps.

The left-wing politicians and academicians criticised it as having unduly helped the growth of large business houses and,
thus, furthered the concentration of economic power to common detriment.
Industrial Licensing Policy of 1960–70
The licensing policy came in for sharp criticism from S.G. Barve, Member of Planning Commission,
in 1966; from R.K. Hazari, who submitted two reports to the Planning Commission in 1967; from the
study team of the Administrative Reforms Commission on Economic Administration, which
submitted a report in 1967–68; and finally from the Industrial Licensing Policy Enquiry Committee
(Dutt Committee) in 1969.
The report of the Dutt Committee, 1969 was extremely critical. Its main conclusions were that the
working of the industrial licensing policy had not been consistent with the Industrial Policy
Resolution of 1956. That no specific instruction had been given to the licensing authorities, keeping
in view the general objective of preventing concentration of economic power and monopolistic
tendencies. That the licensing policy had, by and large, taken forward the growth of large industrial
houses and shut out other entrepreneurs. The report was also critical of some unethical practices
followed by a section of large business houses, for example, multiple applications in different names
for the same items, deliberate preemption of capacity.

The industrial licensing policy came in for sharp criticism from various committees. The main criticisms levelled against it
were promotion of large industrial houses and usage of some unethical practices followed by a section of large business
houses.
A major finding of the Committee was that the public financial institutions, in their lending
policies, had shown a great deal of preference for companies belonging to large business houses to
the exclusion of other entrepreneurs. Thus, some of these houses had built large private empires with
public money. The Committee recommended that, in such cases, the government should consider
converting at least a part of the low-yielding loan to high-yielding equity and, thus, change the
character of the enterprises from private sector enterprises to joint sector enterprises, in which the
government and private parties might share both equity holding and management. In fact, the
Committee recommended the joint sector as a main policy instrument against concentration of
economic power in private hands.
The report of the Dutt Committee ushered in a spell of restrictive licensing policy marked by
suspicion on the part of large business houses and, a generally negative attitude towards proposals
coming from them. For a few years what mattered more in a licence application was not the techno-
economic merits of the projects, but the source of its sponsorship. If it came from a large industrial
house or a foreign majority company, it had little chance of approval unless there were some special
reasons in its favour.

The report of the Dutt Committee ushered in a spell of restrictive licensing policy marked by suspicion on the part of large
business houses and, a generally negative attitude towards proposals coming from them.
Industrial Licensing Policies of 1970–80
Industrial Licensing Policy of 1970

Following the Dutt Committee Report and also the enactment of the MRTP Act, 1969, the Government
of India announced a new industrial licensing policy in February 1970. It banned the entry of large
industrial houses and foreign companies into any field except core industries, heavy investment
projects, and export-oriented projects. Several other restrictive policies followed:

It banned the entry of large industrial houses and foreign companies into any field except core industries, heavy investment
projects, and export-oriented projects.
1. The MRTP Act, 1969, that came into force on June 1,1970, introduced control over
a. All undertakings or groups of interconnected undertakings with assets of Rs 20 crore and above, and
b. The dominant undertakings in cases of substantial expansion or establishing new undertaking.
For such parties, getting an LOI or industrial license was not enough. A separate approval of the project by the Central
government under the new Act was also essential.
2. Following a recommendation made by the Dutt Committee Report, the government accepted the policy of convertibility of term
loans into equity, granted to industry, by public financial institutions; and it became the standard practice to insert a convertibility
clause, as a condition of approval, for all such projects which depended on substantial term loans.
3. In a bid to reduce the proportion of foreign shareholding in the foreign-majority companies, the government announced, in 1972,
a policy of dilution of the proportion of foreign holding by issuing fresh equity to the Indian public, whenever such a company
would launch a new project. The additional fresh capital to be issued was to bear a proportion of the project cost, according to a
graduated scale. Companies with foreign holding, of 75 per cent and above, had to issue fresh equity equivalent to 40 per cent.

Another industrial licensing policy was announced in February 1973, which refined the 1970 policy.
The definition of larger industrial houses, as recommended by the Dutt Committee and accepted by
the 1970 policy, viz., assets exceeding Rs 35 crore, was abandoned. In its place, the definition adopted
by Section 20 of the MRTP Act, viz., the assets of a company by itself or along with assets of
interconnected undertakings amounting to Rs 20 crore and above, was accepted. This removed the
contradiction between the definition of a large industrial house, for licensing proposes under the
1970 policy, and the conception of a large house, on the basis of interconnected undertaking, defined
in the MRTP Act.

Another industrial licensing policy was announced in February 1973, which refined the 1970 policy. The definition of
larger industrial houses, as recommended by the Dutt Committee and accepted by the 1970 policy, viz., assets exceeding Rs
35 crore, was abandoned.
The list of the core industries defined by the 1970 policy was also substantially enlarged. A
consolidated list of these industries was attached in Appendix 1 to this policy announcement. These
core industries of importance to the national economy or industries having direct linkage with such
core industries or industries with a long-term export potential, large houses, as now defined, and
foreign majority companies will now be eligible to participate in and contribute to the establishment
of industries listed in this appendix, provided the item of manufacture is not one reserved for the
public sector or the small-scale sector. The concept of heavy investment sector, that is investment of
over Rs 5 crore, was altogether abandoned.
The existing policy of reservation for the small-scale sector and the policy with regard to joint
sector as a promotional instrument were to continue, without allowing the joint sector to be used for
the entry of large houses, dominant undertakings, and foreign companies. There were also some
procedural changes in October 1973, creating a Project Approval Board (PAB) to deal with
composite applications, seeking approval under the four major procedural hurdles, simultaneously,
viz., licensing, MRTP, capital goods, and Foreign Investment Board.
The policy also introduced a common secretariat, viz., the SIA to receive and process all types of
applications concerning an industrial project—industrial licence applications, capital goods
applications, applications for foreign investment or foreign collaboration, applications under Section
21–22 of the MRTP Act.

From around 1974–75, in response to the need for greater productivity and efficiency in the industrial
economy in the wake of the shock of the oil price increases, first in 1973 and again in 1979, the
government initiated a number of measures to relax and liberalise licensing provisions.
Meanwhile the Janta Party government, which came to power after the General Elections of 1977,
announced a New Industrial Policy (NIP)Statement on December 23, 1977. It did not replace the
Industrial Policy Resolution of 1956 or the Industrial Licensing Policy of 1973, but only
supplemented them by redefining some of the priorities.

With the change of government at the Centre, the industrial policies keep getting revised. The new industrial policy
statement, issued in 1977, provided thrust mainly prioritising small-scale village, and tiny-sector industries in future
industralisation and secondly, geographical dispersal of industries from metropolitan centres to rural and backward areas.
The Licensing Policy of 1977 provided thrust mainly in two aspects:
1. Priority to small-scale, village, and tiny-sector industries in future industrialisation and

2. Geographical dispersal of industries from metropolitan centres to rural and backward areas
The other aspects covered in the policy were as follows:
3. To provide a fillip to the small-scale sector, over 500 items were reserved (subsequently raised to about 800) for the sector
4. To ensure locational redistribution of industry, licenses were to be issued to new industrial units, within certain limits of large
metropolitan cities having population of more than 10 lakh and in urban area with a population of more than 5 lakh, according to
the 1971 census.
5. A District Industrial Centre (DIC) in each district to help the growth of the small-scale sector. These centres were to have
adequate decision-making authority and expertise.
The Licensing Policy of 1977 provided thrust mainly in two aspects:
Priority to small-scale, village, and tiny-sector industries in future industrialisation and

Geographical dispersal of industries from metropolitan centres to rural and backward areas.
Industrial Policy Statement of 1980–90
The General Elections of 1980 and the return to power of the Congress Party brought about the
Industrial Policy Statement of 1980 and 1982. In pursuance of this policy, a new licensing policy was
adopted, aiming at reviving the economic infrastructure inhibited by the infrastructural gaps and
inadequacies in performance. The basic objective of the new licensing policy reflected a desire for
the fruit of industrialisation and economic progress, to be transmitted to a maximum number of
people both in rural and urban areas.

The basic objective of the new licensing policy reflected a desire for the fruit of industrialisation and economic progress, to
be transmitted to a maximum number of people both in rural and urban areas.
Under this policy, licensing was not required for an existing licensed undertaking to substantially
increase production capacity on the existing lines, if the total investment did not exceed Rs 3 crore
and if it did not require foreign exchange in excess of 10 per cent of ex-factory value of output or Rs
25 lakh, whichever was less.
An existing licensed undertaking did not require a fresh license to manufacture any new item from
Schedule I to the maximum of the licensed capacity. Similarly, any licensed unit could get liberal
permission to expand or to manufacture a new product, making use of its own wastes or effluents on
the recommendation of the Administrative Ministry. No industrial license was required for small-
scale units to produce any of the items reserved for the sector under the following conditions:

1. The unit should not belong to any dominant undertaking as defined in the MRTP Act.
2. The unit and other interconnected unit together should not possess assets exceeding Rs 20 crore.
3. In respect of foreign ownership, there should not be over 40 per cent equity owned by foreign companies or subsidiaries or
foreign individuals.
4. The items produced should not belong to the Schedule A category.
No industrial license was required for small-scale units to produce any of the items reserved for the sector
In March 1982, the government declared liberal licensing policy for industrial ventures to be started
in 87 industrially backward districts of 18 States. Overridding preference was given in the industrial
licensing policy to applicants, who proposed to establish their ventures in the above districts, with a
view to correct regional imbalances, on the one hand, and to ensure rapid industrialisation of the
backward areas, on the other. These districts were to get preferences over all other locations on a
priority basis.

In March 1982, the government declared liberal licensing policy for industrial ventures to be started in 87 industrially
backward districts of 18 States.
Various state governments and administrative ministries were also instructed to give pointed
attention to these districts, so that adequate infrastructural developments could be made in different
States. A facility of excess capacity was allowed for a specific list of selected items.
The policy further laid down that the Administrative Secretariat and the concerned Committee had
to take into account a number of factors such as project feasibility, potentiality for economies of
scale, production targets, and competence of entrepreneur prior to granting a licence.

The policy further laid down that the Administrative Secretariat and the concerned Committee had to take into account a
number of factors such as project feasibility, potentiality for economies of scale, production targets, and competence of
entrepreneur prior to granting a licence.
However, in the interest of the rapid industrialisation, automatic registration facilities were also
provided for items listed in Schedule V of the Exemption Notification of the Ministry of Industry
(February 16, 1973). Out of this list, 66 items were withdrawn in the notification of the Government
of India in April 1982. A number of such measures were adopted by the government from time to
time to achieve a balance and concerted industrial growth.
The new policy would also permit manufacturers to follow market trends more effectively,
changing products in response to shifts in demands. The overall licensed capacity would remain
unchanged and separate clearances would be required for foreign collaboration where necessary.
The process of liberalisation during 1984–85 culminated in certain policy decisions announced by
the new government on March 15, 1985, at the time of presentation of the 1985–86 Budget. The most
significant element was the decision to raise the asset limit for large houses from Rs 20 crore to Rs
100 crore.

The process of liberalisation during 1984–85 culminated in certain policy decisions announced by the new government on
March 15, 1985, at the time of presentation of the 1985–86 Budget. The most significant element was the decision to raise
the asset limit for large houses from Rs 20 crore to Rs 100 crore.
In May 1985, 22 industries were freed from both MRTP and FERA controls. Besides, 23 other
industries were delicensed for MRTP and FERA companies located in the Centrally declared
backward areas on January 30, 1986.

In May 1985, 22 industries were freed from both MRTP and FERA controls. Besides, 23 other industries were delicensed for
MRTP and FERA companies located in the Centrally declared backward areas on January 30, 1986.
The Industrial Licensing Policy of 1988 was another advance in the process of liberalisation.
According to government notification of June 3, 1988, industrial undertakings with fixed assets up to
Rs 50 crore were exempted from licensing if they were located in Centrally declared backward areas.
In the non-backward areas, this exemption limit was fixed at Rs 15 crore. Import liberalisation was
also enhanced from 15 per cent to 30 per cent of inputs.
The Janta Dal government, under the leadership of V.P. Singh, announced its new policy on May 31,
1990. It could be interpreted as an extension of the Janta Party government’s policy of 1977 to the
extent that it had considerable bias in favour of small-scale and rural industrialisation.
In order to make Indian industry more competitive internally, the government felt the need for
releasing the industry from bureaucratic obstructions and reducing the number of clearances. All new
units with an investment up to Rs 75 crore in Centrally notified backward areas and Rs 25 crore in
other areas were exempted from licensing. Import of capital goods was allowed to the tune of 30 per
cent of the plant and machinery. The EOUs and units located in Export Processing Zones (EPZs) with
an investment up to Rs 75 crore were delicensed. However, units set up by MRTP and FERA
companies required clearances under the provisions of these Acts.

In order to make Indian industry more competitive internally, the government felt the need for releasing the industry from
bureaucratic obstructions and reducing the number of clearances.
Industrial development is now considered as an interdisciplinary concept. It includes all the relevant
aspects of industrial activity in accordance with plan priorities. In a planned economy, adequate
control measures have to be exercised by the government for providing necessary direction to
industries, especially the private sector, to contribute their best towards the socioeconomic objectives
of the nation. Hence, government control measures should be viewed from this angle.

In a planned economy, adequate control measures have to be exercised by the government for providing necessary
direction to industries, especially the private sector, to contribute their best towards the socio-economic
The industrial and industrial licensing polices of the Government of India have a regulating and
controlling effect on the industrial activities in India. However, after 1973, it was widely felt that
greater liberalisation was required for achieving adequate growth of industrialisation in India. Hence,
the government initiated a number of measures to provide greater liberalisation.
Liberalisation in Industrial Licensing—1991 and After
Industrial licensing is governed by the Industries (D&R) Act, 1951. The Industrial Policy Resolution
of 1956 identified the following three categories of industries:
1. Those that would be reserved for development in the public sector

2. Those that would be permitted for development through private enterprises, with or without state participation
3. Those in which investment initiatives would emanate from private entrepreneurs
Over the years, keeping in view the changing industrial scene in the country, the policy has undergone
modifications. Industrial licensing policy and procedures have also been liberalised from time to
time. A full realisation of the industrial potential of the country calls for a continuation of this process
of change.

Over the years, keeping in view the changing industrial scene in the country, the policy has undergone modifications.
Industrial licensing policy and procedures have also been liberalised from time to time. A full realisation of the industrial
potential of the country calls for a continuation of this process of change.
In order to achieve the objectives of the strategy for the industrial sector for 1991 and beyond, it
was necessary to make a number of changes in the system of industrial approvals. Major policy
initiatives and procedural reforms were called for in order to actively encourage and assist the Indian
entrepreneur to exploit and meet the emerging domestic and global opportunities and challenges.
The bedrock of any such package of measures must be to let the entrepreneurs make investment
decisions on the basis of their own commercial judgement. The attainment of technological
dynamism and international competitiveness requires that enterprises must be able to respond swiftly
to fast-changing external conditions that have become the characteristic of today’s industrial world.
Government policy and procedures must be geared to assisting entrepreneurs in their efforts. This
can be done only if the role played by the government were to be changed from that only of
exercising control to one of providing help and guidance, by making essential procedures fully
transparent and eliminating the delays.
POLICY DECISIONS
In view of the consideration outlined above, the government decided to take a series of measures to
unshackle the Indian industrial economy from the chains of unnecessary bureaucratic control. These
measures complement the other series of measures being taken by the government in the areas of
trade policy, exchange-rate management, fiscal policy, financial sector reform, and overall macro-
economic management.
1. Industrial licensing will be abolished for all projects except for a short list of industries related to security and strategic
concerns, social reasons, hazardous chemicals, and overriding environmental reasons, and items of elitist consumption. Industries
reserved for the small-scale sector will continue to be so reserved.

The Abid Hussain Committee on Trade Policies (1984) contained major recommendations regarding export promotion
2. Areas where security and strategic concerns predominate will continue to be reserved for the public sector.
3. In projects where imported capital goods are required, automatic clearance will be given:
a. In cases where foreign capital goods availability is ensured through foreign equity.
b. If the CIF (cost, insurance, and freight) value of imported capital goods required is less than 25 per cent of the total
value (net of taxes) of plant and equipment, up to a maximum value of Rs 2 crore. In view of the current difficult
foreign-exchange situation, this scheme, (that is, 3[b]) will come into force from April 1992.
In other cases, the imports of capital goods will require clearance from the SIA in the Department of Industrial
Development according to the availability of foreign exchange resources.
4. In locations other than cities of more than one million population, there will be no requirement of obtaining industrial approvals
from the Central government except for industries subject to compulsory licensing. In respect of cities with population greater
than one million, industries other than those of a non-polluting nature such as electronics, computer software, and printing will be
located 25 kms outside the periphery, except in prior-designated areas.
A flexible location policy would be drawn up in respect of such cities (with population greater than one million) which require
industrial registration. Zoning and Land Use Regulation and Environmental Legislation will continue to regulate industrial
locations.
Appropriate incentives and the design of investments in infrastructure development will be used to promote the dispersal of
industry, particularly to rural and backward areas and to reduce congestion in cities.
5. The system of phased manufacturing run on an administrative case-by-case basis will not be applicable to new projects. Existing
projects with such programmes will continue to be governed by them.
6. Existing units will be provided a new broad-banding facility to enable them to produce any article without additional investment.
7. The exemption from licensing will apply to all substantial expansions of existing units.
8. The mandatory convertibility clause will no longer be applicable for term loans from financial institutions for new projects.
Procedural Consequences
9. All existing registration schemes (Delicensed Registration, Exempted Industries Registration, DGTD [Director General of
Technical Development]) will be abolished.
10. Entrepreneurs will, henceforth, be required only to file an information memorandum on new projects and substantial expansions.
11. The lists at Annexure II and Annexure III will be notified in the Indian Trade Classification (Harmonised System).
The Abid Hussain Committee on Trade Policies (1984) contained major recommendations regarding export promotion
Foreign Investment
1. Approval will be given for foreign direct investment (FDI) up to 51 per cent foreign equity in high-priority industries (Annexure
III). There shall be no bottlenecks of any kind in this process. Such clearance will be available if foreign equity covers the
foreign exchange requirement for imported capital goods. Consequent amendments to the Foreign Exchange Regulation Act
(1973) shall be carried out.
2. Although the import components, raw materials, and intermediate goods, and payment of know-how fees and royalties will be
governed by the general policy applicable to other domestic units, the payment of dividends would be made through the
Reserve Bank of India to ensure that outflows on account of dividend payments are balanced by export earnings over a period
of time.
3. Other foreign equity proposals, including proposals involving 51 per cent foreign equity, which do not meet the criteria under
first point given before, will continue to need prior clearance. Foreign equity proposals need not necessarily be accompanied by
foreign technology agreements.
4. To provide access to international markets, majority foreign equity holding up to 51 per cent will be allowed for trading
companies, primarily engaged in export activities. Although the thrust would be on export activities, such trading houses shall be
at par with domestic trading and export houses in accordance with the Exim Policy.
5. A special Empowered Board would be constituted to negotiate with a number of large international firms and approve FDI in
select areas. This would be a special programme to attract substantial investment that would provide access to high technology
and world markets. The investment programmes of such firms would be considered in totality, free from pre-determined
parameters or procedures.
Foreign Technology Agreements
1. Automatic permission will be given for foreign technology agreements in high-priority industries (Annexure III) up to a lump sum
payment of Rs 1 crore, with 5 per cent royalty for domestic sales and 8 per cent for exports, subject to a total payment of 8 per
cent of sales over a 10-year period from the date of agreement or seven years from the commencement of production. The
prescribed royalty rates are net of taxes and will be calculated according to the standard procedures.
2. In respect of industries other than those in Annexure III, automatic permission will be given, subject to the same guidelines as
above if no free foreign exchange is required for any payments.
3. All other proposals will need specific approval under the general procedure in force.
4. No permission will be necessary for hiring foreign technicians and foreign testing of indigenously developed technologies.
Payments may be made from blanket permits or free foreign exchange according to RBI (Reserve Bank of India) guidelines.
Public Sector
1. The portfolio of public sector investments will be reviewed with a view to focus the public sector on strategic, high-tech, and
essential infrastructure. Whereas some reservation for the public sector is being retained, there would be no bar for areas of
exclusivity to be opened up to the private sector. Similarly, the public sector will also be allowed an entry into areas not
reserved for it.
2. Public sector enterprises which are chronically sick and are unlikely to be turned around will, for the formulation of
revival/rehabilitation schemes, be referred to the Board for Industrial and Financial Reconstruction (BIFR), or other similar high-
level institutions created for the purpose. A social security mechanism will be created to protect the interest of the workers who
are likely to be affected by such rehabilitation packages.
3. In order to raise resources and encourage wider public participation, a part of the government’s shareholding in the public sector
would be offered to mutual funds, financial institutions, general public, and workers.
4. The boards of public sector companies would be made more professional and given greater powers.
5. There will be a greater thrust on performance improvement through the Memoranda of Understanding (MoU) systems through
which management would be granted greater autonomy and will be held accountable. Technical expertise on the part of the
government would be upgraded to make the MoU negotiations and implementation more effective.
6. To facilitate a fuller discussion on performance, the MoU signed between government and the public enterprise would be placed
in Parliament. While focusing on major management issue, this would also help to place maters on day-to-day operations of
public enterprises in their correct perspective.
MRTP Act
1. The MRTP Act will be amended to remove the threshold limits of assets in respect of MRTP companies and dominant
undertakings. This eliminates the requirement of prior approval of the Central government for establishment of new undertakings,
expansion of undertakings, merger, amalgamation, and takeover and appointment of directors under certain circumstances.
2. Emphasis will be placed on controlling and regulating monopolistic, restrictive, and unfair trade practices. Simultaneously, the
newly empowered MRTP Commission will be authorised to initiate investigations Suo moto or on complaints received from
individual consumers or classes of consumers in regard monopolistic, restrictive, and unfair trade practices.
3. Necessary comprehensive amendments will be made in the MRTP Act in this regard and for enabling the MRTP Commission to
exercise punitive and compensatory powers.
RECENT INDUSTRIAL LICENSING POLICY
With the introduction of the New Industrial Policy (NIP) in 1991, a substantial programme of
deregulation has been undertaken. Industrial licensing has been abolished for most items. Presently,
Industrial licensing is required in the following cases:
a. for manufacturing an item under compulsory licensing, or
b. if the project attracts locational restriction applicable to large cities with population of more than 10 lakh (according to 1991
census), or
c. when an item reserved for small-scale sector is intended to be manufactured by an undertaking other than small-scale industrial.
Only the following five industries are under compulsory licensing on account of security, strategies, and environmental concerns:
i. distillation and brewing of alcoholic drinks;
ii. cigars and cigarettes of tobacco and manufactured tobacco substitutes;
iii. electronic aerospace and defence equipment of all types;
iv. industrial explosives, including detonating fuses, safety fuses, gun powder, nitrocellulose, and matches; and
v. Specifies hazardous chemicals, that is, (i) Hydrocyanic acid and its derivatives, (ii) Phosgene and its derivatives, and (iii)
Isocyanates and disocyanates of hydrocarbon
With the introduction of the New Industrial Policy (NIP) in 1991, a substantial programme of deregulation has been
undertaken. Industrial licensing has been abolished for most items.
Industries not covered under compulsory licensing are required to file an Industrial Entrepreneurs
Memorandum (IEM) to Secretariat for Industrial Assistance (SIA), provided the value of investment
on plant and machinery of such unit is above Rs 10 crore.

Industries not covered under compulsory licensing are required to file an Industrial Entrepreneurs Memorandum (IEM) to
Secretariat for Industrial Assistance (SIA), provided the value of investment on plant and machinery of such unit is above Rs
10 crore.
A significant number of industries had earlier been reserved for public sector. The policy has been
liberalised progressively and presently, the areas reserved for the public sector are: (a) atomic
energy; (b) the substances specified in the schedule to the notification of the Government of India in
the Department of Atomic Energy number S.O.212(E), dated March 15, 1995; and (c) railway
transport.
The government continues to provide protection to the small-scale sector, inter alia, through the
policy of reserving items for exclusive manufacture in the small-scale sector. Recently, Micro, Small
and Medium Enterprises Development (MSMED) Act, 2006 has been enacted by the government. In
this Act, investment limit for micro, small, and medium enterprises have been prescribed as Rs 10
lakh, Rs 5 crore, and 10 crore, respectively. Industrial undertakings, other than the small-scale
industrial undertakings, engaged in the manufacture of items reserved for exclusive manufacture in
the small-scale sector, are required to obtain an industrial license and have undertaken export
obligation of 50 per cent of their annual production. However, the condition of licensing is not
applicable to industrial undertakings operating under 100 per cent Export-Oriented Undertakings
Scheme, in the export processing. The list of items reserved for manufacturing in the SSI Sector is
being reviewed from time to time. Presently, 114 items are reserved for manufacture in the small-
scale sector.

The government continues to provide protection to the small-scale sector, inter alia, through the policy of reserving items for
exclusive manufacture in the small-scale sector.
The list of items reserved for manufacturing in the SSI sector is being reviewed from time to time. Presently, 114 items are
reserved for manufacture in the small-scale sector.
Foreign Direct Investment (FDI)
Major Changes in the Recent Years

The Government of India embarked upon major economic reforms, since mid-1991, with a view to
integrating with the world economy, and to emerge as a significant player in the globalisation
process. Reforms undertaken include decontrol of industries from the stringent regulatory process,
simplification of investment procedures, promotion of foreign direct investment (FDI), liberalisation
of exchange control, rationalisation of taxes, and public sector divestment.
The FDI policy was liberalised progressively through review of the policy on an ongoing basis
and allowing FDI in more industries under the automatic route. The major changes made in the policy
aimed at rationalisation/simplification of procedures are listed below:

The FDI policy was liberalised progressively through review of the policy on an ongoing basis and allowing FDI in more
industries under the automatic route.
1. Policy Liberalisation/Rationalisation
a. FDI up to 100 per cent under the automatic route permitted in construction development projects, including housing, built-up
infrastructure, commercial complexes, and so on, subject inter alia, to minimum capitalisation, minimum area condition, and lock-
in period of original investment (refer to Press Note 2/2005). These conditions are not applicable to hospitals, hotels, SEZs, and
non-resident Indians.
b. FDI caps have been increased to 100 per cent and automatic route extended to coal and lignite mining for captive consumption’s
setting up of infrastructure relating to industry marketing in petroleum and natural gasas sector, and exploration and mining of
diamonds and precious stones.
c. FDI has been allowed up to 100 per cent on the automatic route in power trading and processing and warehousing of coffee and
rubber.
d. FDI has been allowed up to 51 per cent for “single brand” product retailing which requires prior government approval. Specific
guidelines have been issued for governing FDI for “single brand” product retailing.
e. FDI up to 49 per cent allowed with prior government approval in air transport services.
f. FDI up to 100 per cent allowed on the automatic route in greenfield airport projects. FDI up to 100 per cent also allowed in
existing airports but FDI beyond 74 per cent requires-prior government approval.
g. Mandatory divestment condition for B2B (business-to-business) e-commerce has been dispensed with.
h. FDI cap in basic and cellular telecom services has been enhanced from 49 per cent to 74 per cent. Detailed guidelines have
been notified vide Press Note 5 (2005 series), substituted by Press Note 3 (2007).
i. FDI is being allowed along with FII and portfolio investing within the ceiling of 20 per cent in the FM radio broadcasting
services.
j. FDI up to 49 per cent allowed with prior government approval for setting up uplinking hub/teleports.
k. FDI up to 100 per cent allowed with prior government approval for uplinking non-news TV channels.
l. FDI up to 26 per cent allowed in uplinking news and current affairs TV channels.
2. Procedural Simplification
a. FDI is permissible under the automatic route wherever the sectoral policy so specifies, except where the foreign investor has an
existing joint venture or technology/trademark agreement in the same field. In such cases, prior approval of the government is
required for FDI, irrespective of the sectoral policy permitting FDI on the automatic route (refer to Press Note 1 [2005]).
b. Transfer of shares from resident to non-resident (including NRIs) placed on the automatic route where initial investment is
allowed on the automatic route and where Press Note 1 [2005] is not attracted.
c. Conversion of ECBs and preference shares on the automatic route.
d. FDI in manufacturing sector, including those where an industrial licence is required, has been allowed on the automatic route
without any caps. Exceptions are manufacture of cigars and cigarettes and defence items, where prior government approval is
required for FDI and manufacture of items reserved for the small-scale sector. In the defence sector, FDI is permitted only up to
26 per cent. (refer to Press Note 4 [2006]).
ANNEXURE I
Proposed List of Industries to be Reserved for the Public Sector

1. Arms and ammunition and allied items of defence equipment, defence aircraft, and warships
2. Atomic energy
3. Coal and lignite
4. Mineral oils
5. Mining of iron ore, manganese ore, chrome ore, gypsum, sulphur, gold, and diamond
6. Mining of copper, lead, zinc, tin, molybdenum, and wolfram
7. Minerals specified in the Schedule to the Atomic Energy (Control of Production and Use) Order, 1953
8. Railway transport
ANNEXURE II
List of Industries in Respect of Which Industrial Licensing will be Compulsory
1. Coal and lignite

2. Petroleum (other than crude) and its distillation products
3. Distillation and brewing of alcoholic drinks
4. Sugar
5. Animal fats and oils
6. Cigars and cigarettes of tobacco and manufactured tobacco substitutes
7. Asbestos and asbestos-based products
8. Plywood, decorative veneers, and other wood-based products such as particle board, medium density fibre board, block board
9. Tanned or dressed fur skins
10. Paper and newsprint except bagasse-based units
11. Electronic aerospace and defence equipment: all types
12. Industrial explosives, including detonating fuse, safety fuse, gunpowder, nitrocellulose, and matches
13. Hazardous chemicals
14. Drugs and pharmaceuticals (according to the Drug Policy)
15. Entertainment electronics (VCRs, colour TVs, CD players, tape recorders)
Note: The compulsory licensing provisions would not apply in respect of the small-scale units taking up the manufacture of any of
the above items reserved for the exclusive manufacture in the small-scale sector.
ANNEXURE III
List of Industries for Automatic Approval of Foreign Technology Agreements and for 51 Per
Cent Foreign Equity Approvals
1. Metallurg ical industries

i. Ferro alloys
ii. Castings and forgings
iii. Non-ferrous metals and their alloys
iv. Sponge iron and pelletisation
v. Large-diameter steel-welded pipes of over 300 mm diameter and stainless steel pipes
vi. Pig iron
2. Boilers and steam-g enerating plants
3. Prime movers (other than electrical g enerators)
i. Industrial turbines
ii. Internal combustion engines
iii. Alternate energy systems like solar, wind, and equipment
iv. Gas/hydro/steam turbines up to 60 MW
4. Electrical equipment
i. Equipment for transmission and distribution of electricity, including power and distribution transformers, power relays,
high tension (HT) switch gear, and synchronous condensers
ii. Electric motors
iii. Electrical furnaces, industrial furnaces, and induction heating equipment
iv. X-ray equipment
v. Electronic equipment, components, including subscribers and telecommunication equipments
vi. Component wires for manufacture of lead in wires
vii. Hydro/steam/gas generators/generating sets up to 60 MW
viii. Generating sets and pumping sets based on internal combustion engines
ix. Jelly-filled telecommunication cables
x. Optic fibre
xi. Energy-efficient lamps
xii. Midget carbon electrodes
5. Transportation
i. Mechanised sailing vessels up to 10,000 DWT including fishing trawlers
ii. Ship ancillaries
iii.
a. Commercial vehicles, public transport vehicles—including automotive, commercial, three-wheeler, jeep-type
vehicles, and industrial locomotives
b. Automotive two wheelers and three wheelers
c. Automotive components/spares and ancillaries
iv. Shock absorbers for railway equipment
v. Brake systems for railway stock and locomotives
6. Industrial machinery
i. Industrial machinery and equipment
7. Industrial tools and equipments
i. Machine tools and industrial robots and their controls and accessories
ii. Jigs, fixtures, tools, and dies of specialised types and cross-land tooling
iii. Engineering production aids, such as cutting and forming tools, patterns and dies and tools
8. Ag ricultural machinery
i. Tractors
ii. Self-propelled harvester combines
iii. Rice transplanters
9. Earth-moving machinery
Earth-moving machinery and construction machinery and components thereof
10. Industrial instruments
Indicating, recording, and regulating devices for pressure, temperature, weight rate of flow levels, and the like
11. Scientific and electro-medical instruments and laboratory equipment
12. Nitrog enous and phosphatic fertilisers falling under
Nitrogenous fertilizers under “18 Fertilisers” in the First Schedule to IDR Act, 1951
13. Chemicals (other than fertilisers)
i. Heavy organic chemicals including petrochemicals
ii. Heavy inorganic chemicals
iii. Organic fine chemicals
iv. Synthetic resins and plastics
v. Man-made fibres
vi. Synthetic rubber
vii. Industrial explosives
viii. Technical grade insecticides, fungicides, weedicides, and the like
ix. Synthetic detergents
x. Miscellaneous chemicals (for industrial use only)
a. Catalysts and catalyst supports
b. Photographic chemicals
c. Rubber chemicals
d. Polyols
e. Isocynates, urethanes, and so on
f. Special chemicals for enhanced oil recovery
g. Heating fluids
h. Coal tar distillation and products therefrom
i. Tonnage plants for the manufacture of industrial gases
j. High-altitude breathing oxygen/medical oxygen
k. Nitrous oxide
l. Refrigerant gases like liquid nitrogen, carbon dioxide, and so on in large volumes
m. Argon and other rare gases
n. Alkali/acid-resisting cement compound
o. Leather chemicals and auxiliaries
14. Drug s and pharmaceuticals
According to the Drug Policy
15. Paper products
i. Paper and pulp including paper products
ii. Industrial laminates
16. Automobile accessories
i. Automobile tyres and tubes
ii. Rubberised heavy-duty industrial beltings of all types
iii. Rubberised conveyor beltings
iv. Rubber-reinforced and rubber-lined fire-fighting hose pipes
v. High-pressure braided hoses
vi. Engineering and industrial plastic products
17. Plate g lass
i. Glass shells for television tubes
ii. Float glass and plate glass
iii. HT insulators
iv. Glass fibre of all types
18. Ceramics
Ceramics for industrial uses,
19. Cement products
i. Portland cement
ii. Gypsum boards, wall boards, and the like
20. Hig h-technolog y reproductions and multiplication equipment
21. Carbon and carbon products
i. Graphite electrodes and anodes
ii. Impervious graphite blocks and sheets
22. Pretensioned hig h-pressure re-inforced cement concrete (RCC) pipes
23. Rubber machinery
24. Printing machinery
i. Web-fed high-speed off-set rotary printing machine having output of 30,000 or more impressions per hour
ii. Photocomposing/type-setting machines
iii. Multi-colour sheet-fed off-set printing machines of sizes of “18 x 25” and above
iv. High-speed rotogravure printing machines having output of 30,000 or more impressions per hour
25. Welding electrodes other than those for welding mild steel
26. Industrial synthetic diamonds
27. Biolog ical equipments
i. Photosynthesis improvers
ii. Genetically modified free-living symbiotic nitrogen fixer
iii. Pheromones
iv. Bio-insecticides
28. Extraction and upg rading of mineral oils
29. Pre-fabricated building material
30. Soya products
i. Soya texture proteins
ii. Soya protein isolates
iii. Soya protein concentrates
iv. Other specialised products of soyabean
v. Winterised and deodourised refined soyabean oil
31.
a. Certified high-yielding hybrid seeds and synthetic seeds
b. Certified high-yielding plantlets developed through plant tissue culture
32. All food-processing industries other than milk food, malted foods, and flour, but excluding the items reserved for small-
scale sector
33. All items of packag ing for food-processing industries excluding the items reserved for small-scale sector
34. Hotels and tourism-related industry
SUMMARY
Industrial licensing constituted the key element in Government of India’s industrial policy from 1951
to 1991. This meant a tight investment licensing system was administered primarily through the
Industries (D&R) Act, 1951 and was supplemented by a host of other regulatory laws and
administrative practices. Most of these regulations arose from the system of planning in India and
from the provision in the Constitution preaching a socialist pattern of society, equality of wealth, and
opportunities in general.
Until 1991, the inner core of policy and legal instruments consisted of the Industrial Policy
Regulation of 1956, the Industries (D&R) Act 1951, and Industrial Licensing Policy of 1973. Since
1978, it has become the practice to supplement the two policy documents mentioned above with yet
another document—Industrial Policy Statement of 1978, 1980, and 1982.
There were also several indirect but important controls. The most important among them was the
MRTP Act, Capital Goods Import Control, and government policy with regard to foreign investment
and foreign collaborations.
With the introduction of the NIP in 1991, a substantial programme of deregulation began to be
undertaken. Industrial licensing was abolished for all items except for six industries related to
security, strategic, or environmental concern. They are:
1. Distillation and brewing of alcoholic drinks,
2. Cigars and cigarettes of tobacco and manufactured tobacco substitutes,
3. Electronic, aerospace, and defence equipment,
4. Industrial explosives including detonating fuses, safety fuses, gunpowder, nitrocellulose, and matches,
5. Hazardous chemicals, and
6. Drugs and pharmaceuticals (according to the modified Drug Policy, 1994; as amended in 1999).
A significant number of industries had earlier been reserved for the public sector. In 2004, a decision
was taken to open the defence industry sector to the private sector with FDI permissible up to 26 per
cent. Now, the areas reserved for the public sector are:
1. Atomic energy,
2. Substances specified in the schedule to the notification of the Government of India in the Department of Atomic Energy number
S.O. 212 (E), dated March 15, 1995, and
3. Railway transport.
The government continues to provide protection to the small-scale sector, inter-alia, through the
policy of reserving items for exclusive manufacture in the small-scale sector. Industrial undertakings,
other than the small-scale industrial undertakings, engaged in the manufacture of items that are
reserved for exclusive manufacture in the small-scale sector, are required to obtain an industrial
licence and undertake an export obligation of 50 per cent of the annual production. However, the
condition licensing is not applicable to industrial undertaking operating under 100 per cent EOUs
Schemes, the EPZ and the Special Economic Zone (SEZ) Schemes. Industrial undertakings with
investments in plant and machinery up to Rs 1 crore qualify for the status of small-scale or ancillary
industrial undertaking from December 24, 1999. The investment limit for tiny units is Rs 25 lakh.
KEY WORDS
Licensing
Licence Raj
Curative Provisions
Creative Provisions
Letter of Intent (LOI)
Exemption
Preventive Provisions
Public Sector
MoU System
Delicensing
Scheduled Industries
Liberalisation
Exchange Rate
QUESTIONS
1. Describe the importance and objective of industrial licensing systems in India.

2. Assess the rationale of the industrial licensing policy and comment on the changes incorporated therein.
3. Explain the industrial licensing policy and liberalisation.
4. Explain the changes incorporated in the industrial licensing policies to attract foreign investment.
5. Explain the major changes in the policy directions of the government towards public sector enterprises in India.
6. Critically examine the performance of the public sector enterprises in India. Discuss their problems.
7. List the various support and control measures of the government on the private sector of the country.
8. Explain the measures to be followed for the revival of public sector enterprises in India.
9. What do you mean by privatisation? Critically examine the issues involved in privatisation.
10. Explain the reform process initiated by the government for the industrial development of the country.
11. Make a comparative study on the performance of the public and private sectors in India.
12. Examine the impact of the reform process on the industrial development of the nation.
13. Briefly analyse the provisions and objectives of the Industries (D&R) Act, 1951.
14. Discuss the effectiveness of the licensing systems in India.
15. The Government of India has been reviewing its industrial licensing from time to time. Is this a necessary step? Discuss.
REFERENCES
Datt, R. and K. M. P. Sundaram (2005). Indian Economy. Delhi: Sultan Chand.

Mankar, V. G. (1999). Business Economics. Delhi: Macmillan.
Sengupta, A. K. (2004). Government and Business, 4th ed. New Delhi: Vikas Publishers.
CHAPTER 05
India’s Monetary and Fiscal Policy
CHAPTER OUTLINE

Monetary Policy of India
Concept and Meaning of Monetary Policy
Objectives of the Monetary Policy
Differences Between Monetary Policy and Fiscal Policy
Meaning of CRR and SLR
Impact of the Monetary Policy
Measures to Regulate Money Supply
Meaning of Some Monetary Policy Terms
The Monetary Policy and IMF
RBI’s Monetary Policy Measures
RBI’s Monetary Policy, 2008–09
Fiscal Policy of India

Concept and Meaning of Fiscal Policy
Objectives of the Fiscal Policy
Fiscal Policy and Economic Development
Techniques of Fiscal Policy
Merits or Advantages of Fiscal Policy of India
The Shortcomings of the Fiscal Policy of India
Suggestions for Necessary Reforms in Fiscal Policy
Fiscal Policy Reforms
Fiscal Policy Statement, 2008–09
Fiscal Policy—An Assessment
Conclusions
Case
Summary
Key Words
Questions
References
I. MONETARY POLICY OF INDIA
CONCEPT AND MEANING OF MONETARY POLICY
Monetary policy is primarily concerned with the management of supply of money in a growing
economy and managing the rate of growth of money supply per period. In a growing economy, the
optimal conduit of monetary policy requires that the supply of money is grown to sub-order certain
well-defined social goals. Talking in terms of the annual rate of growth of money supply, the optimal
monetary policy requires that this rate of growth, on an average, is such as to be consistent with the
attunement of the desired social goals.

Monetary policy is primarily concerned with the management of supply of money in a growing economy and managing the
rate of growth of money supply per period.
It is universally admitted that the best combination of these social goals is growth with stability and
equity. Stability here means severe economic stability but, for all practical purposes, is generally
equated with the general price stability. It has been argued that, in the Indian context, the pursuit of the
above set of goals will mean a maximum feasible output and employment in every short run and also
promotion of a healthy balance-of-payment position in the medium run. The monetary and credit
policy is the policy statement, traditionally announced twice a year, through which the Reserve Bank
of India (RBI) seeks to ensure a price stability for the economy.

The monetary and credit policy is the policy statement, traditionally announced twice a year, through which the Reserve
Bank of India (RBI) seeks to ensure a price stability for the economy.
These factors include—money supply, interest rates, and the inflation. In banking and economic
terms, money supply is referred to as M3, which indicates the level (stock) of legal currency in the
economy. Besides, the RBI also announces norms for the banking and financial sector and the
institutions which are governed by it. Those norms would be banks, financial institutions, non-
banking financial institutions, Nidhis and primary dealers (money markets), and dealers in the
foreign exchange (forex) market. Historically, the monetary policy was announced twice a year—a
slack-season policy (April–September) and a busy-season policy (October–March) in accordance
with agricultural cycles. These cycles also coincide with the halves of the financial year.

Historically, the monetary policy was announced twice a year—a slack-season policy (April–September) and a busy-season
policy (October–March) in accordance with agricultural cycles. These cycles also coincide with the halves of the financial
year.
Initially, the RBI used to announce all its monetary measures twice a year in the monetary and
credit policy. The monetary policy has now become dynamic in nature as RBI reserves its right to
alter it from time to time, depending on the state of the economy. However, with the share of credit to
agriculture coming down and credit towards the industry being granted the whole year around, the
RBI, since 1998–99, has moved in for just one policy in April-end. However, a review of the policy
does take place later in the year.
OBJECTIVES OF THE MONETARY POLICY
The objectives are to maintain price stability and to ensure an adequate flow of credit to the
productive sectors of the economy. The stability for the national currency (after looking at prevailing
economic conditions), growth in employment, and income are also looked into. The monetary policy
affects the real sector through long and variable periods, while the financial markets are also
impacted through short-term implications.

The objectives are to maintain price stability and to ensure an adequate flow of credit to the productive sectors of the
economy.
There are four main “channels” which the RBI looks at. They are
1. Quantum channel: money supply and credit (affects real output and price level through changes in reserves money, money
supply, and credit aggregates).
2. Interest-rate channel.
3. Exchange-rate channel (linked to the currency).
4. Asset price.
DIFFERENCES BETWEEN MONETARY POLICY AND FISCAL POLICY
Two important tools of macro-economic policy are monetary policy and fiscal policy.
The monetary policy regulates the supply of money and the cost and availability of credit in the
economy. It deals with both the lending and borrowing rates of interest for commercial banks. The
monetary policy aims to maintain price stability, full employment, and economic growth. The RBI is
responsible for formulating and implementing monetary policy. It can increase or decrease the supply
of currency, as well as interest rate, carry out open-market operations (OMO), control credit, and
vary the reserve requirements. The monetary policy is different from fiscal policy as the former
brings about a change in the economy by changing money supply and interest rate, whereas fiscal
policy is a broader tool of the government.

The monetary policy aims to maintain price stability, full employment, and economic growth.
The fiscal policy can be used to overcome recession and control inflation. It may be defined as a
deliberate change in the government revenue and expenditure to influence the level of national output
and prices. For instance, at the time of recession the government can increase expenditures or cut
taxes in order to generate demand. On the other hand, the government can reduce its expenditures or
raise taxes during inflationary times. Fiscal policy aims at changing aggregate demand by suitable
changes in government expenditure and taxes.

The fiscal policy can be used to overcome recession and control inflation. It may be defined as a deliberate change in the
government revenue and expenditure to influence the level of national output and prices.
The annual Union Budget showcases the government’s fiscal policy.

MEANING OF CRR AND SLR
CRR, or cash reserve ratio, refers to a portion of the deposit (as cash) which banks have to keep/
maintain with the RBI. This serves two purposes. It ensures that a portion of bank deposit is totally
risk-free and secondly, it enables that RBI controls liquidity in the system, and, thereby, inflation.
Besides the CRR, banks are required to invest a portion of their deposit in government securities as a
part of their statutory liquidity ratio (SLR) requirements.

CRR, or cash reserve ratio, refers to a portion of the deposit (as cash) which banks have to keep/ maintain with the RBI.
The government securities (also known as gilt-edged securities or gilts) are bonds issued by the
Central government to meet its revenue requirements. Although the bonds are long-term in nature,
they are liquid as they can be traded in the secondary market. Since 1991, as the economy has
recovered and sector reforms increased, the CRR has fallen from 15 per cent in March 1991 to 5.5
per cent in December 2005. The SLR has fallen from 38.5 per cent to 25 per cent over the past decade.
IMPACT OF THE MONETARY POLICY
Impact of Cut in CRR on Interest Rates

From time to time, RBI prescribes a CRR or the minimum amount of cash that banks have to maintain
with it. The CRR is fixed as a percentage of total deposit. As more money chases the same number of
borrowers, interest rates come down.

From time to time, RBI prescribes a CRR or the minimum amount of cash that banks have to maintain with it. The CRR is
fixed as a percentage of total deposit. As more money chases the same number of borrowers, interest rates come down.
Impact of Change in SLR and Gilt Products on Interest Rates

SLR reduction is not so relevant in the present context for two reasons: First, as part of the reform
process, the government has begun borrowing at market-related rates. Therefore, banks get better
interest rates compared to what they used to get earlier for their statutory investments in government
securities.
Second, banks are still the main source of funds for the government. This means that despite a
lower SLR requirement, banks’ investment in government securities will go up as government
borrowing rises. As a result, bank investment in gilts continues to be high despite the RBI bringing
down the minimum SLR to 25 per cent a couple of years ago. Therefore, for the purpose of
determining the interest rates, it is not the SLR requirement that is important but the size of the
government’s borrowing programme. As government borrowing increases, interest rates, too, rise.

For the purpose of determining the interest rates, it is not the SLR requirement that is important but the size of the
government’s borrowing programme. As government borrowing increases, interest rates, too, rise.
Besides, the gilts also provide another tool for the RBI to manage interest rates. The RBI conducts
OMO by offering to buy or sell gilts. If it feels that interest rates are too high, it may bring them
down by offering to buy securities at a lower yield than what is available in the market.
Impact on Domestic Industry and Exporters

The exporters look forward to the monetary policy since the Central Bank always makes an
announcement on export refinance, or the rate at which the RBI will lend to banks which have
advanced preshipment credit to exporters. A lowering of these rates would mean lower borrowing
costs for the exporter.
Impact on Stock Markets and Money Supply

Most people attribute the link between the amount of money in the economy and movements in stock
markets to the amount of liquidity in the system. This is not entirely true. The factor connecting
money and stocks is interest rates. People save to get returns on their savings. A hike in interest rates
would tend to suck money out of shares into bonds or deposit; a fall would have the opposite effect.
This argument has survived econometric tests and practical experience.

A hike in interest rates would tend to suck money out of shares into bonds or deposit; a fall would have the opposite effect.
This argument has survived econometric tests and practical experience.
Impact of Money Supply on Jobs, Wages, and Output

At any point of time, the price level in the economy is determined by the amount of money floating
around. An increment in the money supply—currency with the public demand deposit, and time
deposit—increases prices all around because there is more currency moving towards the same goods
and services.
Typically, the RBI follows a least-inflation policy, which means that its money market operations as
well as changes in the bank rate are generally designed to minimise the inflationary impact of money
supply changes. Since most people can generally see through this strategy, it limits the impact of the
RBI’s monetary moves on jobs or production. The markets, however, move to the RBI’s tune because
of the link between interest rates and capital market yields. The RBI’s policies have maximum impact
on volatile forex and stock markets. The jobs, wages, and output are affected over the long run, if the
trends of high inflation or low liquidity persist for a very long period. If the wages move slower than
other prices, higher inflation will drive real wages lower and encourage employers to hire more
people. This, in turn, ramps up production and employment. This was the theoretical justification of a
long-term trend that showed that higher inflation and employment went together; whereas, when
inflation fell, unemployment increased.

The jobs, wages, and output are affected over the long run, if the trends of high inflation or low liquidity persist for a very
long period.
MEASURES TO REGULATE MONEY SUPPLY
The RBI uses the interest rate, OMO, changes in banks’ CRR, and primary placements of government
debt to control the money supply. OMO, primary placements, and changes in the CRR are the most
popular instruments used. Under the OMO, the RBI buys or sells government bonds in the secondary
market. By absorbing bonds, it drives up bond yields and injects money into the market. When it sells
bonds, it does so to suck money out of the system.
The changes in CRR affect the amount of free cash that banks can use to lend—reducing the amount
of money for lending cuts into overall liquidity, driving interest rates up, lowering inflation, and
sucking money out of markets. Primary deals in government bonds are a method to intervene directly
in markets, followed by the RBI. By directly buying new bonds from the government at lower than
market rates, the RBI tries to limit the rise in interest rates that higher government borrowings would
lead to.

The changes in CRR affect the amount of free cash that banks can use to lend—reducing the amount of money for lending
cuts into overall liquidity, driving interest rates up, lowering inflation, and sucking money out of markets.
MEANING OF SOME MONETARY POLICY TERMS
Bank Rate
Bank rate is the minimum rate at which the Central Bank provides loans to the commercial banks. It is
also called the discount rate. Usually, an increment in bank rate results in commercial banks
increasing their lending rates. Changes in bank rate affect credit creation by banks through altering
the cost of credit.
Cash Reserve Ratio

All commercial banks are required to keep a certain amount of its deposit in cash with RBI. This
percentage is called the cash reserve ratio or CRR. The current CRR requirement is 8 per cent.

All commercial banks are required to keep a certain amount of its deposit in cash with RBI. This percentage is called the
cash reserve ratio or CRR. The current CRR requirement is 8 per cent.
Inflation
Inflation refers to a persistent rise in prices. Simply put, it is a situation of too many buyers and too
few goods. Thus, due to scarcity of goods and the presence of many buyers, the prices are pushed up.
The converse of inflation, that is, deflation, is the persistent fall in prices. RBI can reduce the supply
of money or can increase can interest rates to reduce inflation.

Inflation refers to a persistent rise in prices. Simply put, it is a situation of too many buyers and too few goods.
Money Supply (M3)

This refers to the total volume of money circulating in the economy, and, conventionally, comprises
currency with the public and demand deposit (current account + savings account) with the public. The
RBI has adopted three concepts of measuring money supply. The first one is M1, which equals the
sum of currency with the public, demand deposit with the public, and other deposit with the public.
Simply put, M1 includes all coins and notes in circulation and personal current accounts too. The
second, M2 is a measure of money supply, including M1, personal deposit accounts government
deposit, and deposit in currencies other than rupee. The third concept, M3 or the broad money
concept, as it is also known, is quite popular. M3 includes net time deposit (fixed deposit), savings
deposit with post office saving banks, and all the components of M1.

This refers to the total volume of money circulating in the economy, and, conventionally, comprises currency with the public
and demand deposit (current account + savings account) with the public.
Statutory Liquidity Ratio (SLR)

Banks in India are required to maintain 25 per cent of their demand and time liabilities in government
securities and certain approved securities. These are collectively known as SLR securities. The
buying and selling of these securities laid the foundations of the 1992 Harshad Mehta scam.
Repo
A repurchase agreement or ready forward deal is a secured short-term (usually 15 days) loan given
by one bank to another against government securities. Legally, the borrower sells the securities to the
lending bank for cash, with the stipulation that at the end of the borrowing term, it will buy back the
securities at a slightly higher price, the difference in price representing the interest.
Open Market Operations (OMO)

The RBI, an important instrument of credit control, purchases and sells securities in OMO. In times of
inflation, RBI sells securities to mop up the excess money in the market. Similarly, to increase the
supply of money, RBI purchases securities.

In times of inflation, RBI sells securities to mop up the excess money in the market. Similarly, to increase the supply of
money, RBI purchases securities.
THE MONETARY POLICY AND IMF
One of the important conditionalities of the loan assistance granted by the International Monetary
Fund (IMF) to India since 1991–92, has been to lower its fiscal deficit as a proportion of the gross
domestic product (GDP) over the next three years. “Fiscal deficit” is defined as the excess of total
(government) expenditure over revenue receipts, grants, and non-debt capital receipts. This deficit is
met by loans of all kinds and from all sources—domestic and foreign (and is inclusive of all landings
by the Centre to the states and others). These loan funds were raised from the open-market loans,
subscribed by banks and other financial institutions under the pressure of statutory requirement (such
as the SLR for banks), small savings and, most of all, the net RBI credit to the government, which led
to automatic monetisation of the government debt and, thereby, to increase in money supply and in
prices. Moreover, the government debt was raised at relatively low administered rates, which induced
high-fiscal profligacy. The commercial sector was starved of ample bank credit and this credit was
too costly. The monetary policy was reduced to the status of a handmaid, confined to financing fiscal
deficits at administered rates, so as to minimise the interest cost to the government. Thus, high and
growing fiscal deficits lay at the root of several of Indian economic ills, including its serious
balance-of-payment problems. Therefore, it was imperative to lower significantly, as soon as
possible, the fiscal deficit–GDP ratio, without which all loan assistance by the IMF would have gone
down the drain. It is ironical that the same advice had been tendered several times by the RBI in its
annual reports. But the government did not pay any heed to it. However, coming from the IMF, it was
a dictate; that is, an essential condition for loan assistance, and the Government of India fell in line
readily.

High and growing fiscal deficits lay at the root of several of Indian economic ills, including its serious balance-of-payment
problems. Therefore, it was imper a tive to lower significantly, as soon as possible, the fiscal deficit–GDP ratio, without
which all loan assistance by the IMF would have gone down the drain.
Over the following two years, using a combination of revenue raising and expenditure- control
measures, the government has been able to bring down significantly the fiscal deficit–GDP ratio.
Thus, this ratio (at current market prices and in percentage terms) had the value of 8.4 for 1990–91
and had been brought down to the value of 6.2 for 1991–92 and the value of 5.0 for 1992–93.
RBI’S MONETARY POLICY MEASURES
Till recently, the RBI was greatly handicapped by the government’s fiscal policy in its role of
regulating the rate of growth of money supply. As pointed out in the previous section and at several
places in the book, “excess” deficit financing by the government has been a major source of increase
in H, which, in turn, has been largely responsible, for excessive increases in money supply year after
year. The RBI, in its annual reports, had been pleading unsuccessfully, for several years, that the
government must exercise checks on its very large budget deficits in the interest of monetary stability.
But to no avail. Unfortunately, as explained in the previous section, the Chakravarty Committee
(1985) had recommended a high annual rate of growth (of 14 per cent) of money supply. The external
IMF–World Bank pressure on the government since June 1991, to cut down its deficit and carry
through other structural reforms, has opened the gate for monetary policy reforms as well.

The RBI, in its annual reports, had been pleading unsuccessfully, for several years, that the government must exercise
checks on its very large budget deficits in the interest of monetary stability. But to no avail.
The RBI has been authorised to formulate the monetary policy of the country, with the objective to
accelerate the pace of economic development, for raising national income and the standard of living
as well as to control and minimise the inflationary spiral in prices in the country. Thus, the monetary
policy of the country aims to attain higher level of output and employment, price stability, exchange
stability, and balance of payment equilibrium.
Since the First Plan onwards, the RBI followed the monetary policy to attain “economic growth
with reasonable price stability”. Accordingly, the monetary policy pursued by the RBI wanted to
enhance the flow of currency and credit for meeting the increasing demand for investment funds for
attaining rapid economic development. Simultaneously, the monetary policy has also made a serious
attempt to control the inflationary trend in prices since 1973.

The monetary policy pursued by the RBI wanted to enhance the flow of currency and credit for meeting the increasing
demand for investment funds for attaining rapid economic development.
In recent years, the monetary policy of the country has been following two sets of objectives.
Firstly, the policy is trying to enhance the flow of bank credit in adequate quantity to industry,
agriculture and trade to meet the requirement, and also to provide special assistance for neglected
sectors and weaker sections of the community. Secondly, monetary policy of the RBI is also trying to
maintain internal price stability by controlling the flow of credit to the optimum level.
Credit Control
As per the RBI Act, 1934 and the Banking Regulation Act, 1949, the RBI has been empowered to adopt
credit control measures for proper regulation of the volume of credit. The credit control measures
are of two types, that is, quantitative controls and qualitative controls. While the quantitative controls
are trying to control the volume of credit in general the qualitative controls are trying to control the
volume of credit in a selective manner. The following are some of the measures adopted by RBI to
control credit.

The credit control measures are of two types, that is, quantitative controls and qualitative controls.
Bank Rate: By adopting a variation in the bank rate, the RBI is trying to influence the interest rate
charged by the commercial banks on its lending. Initially, the bank rate was fixed by the RBI at 2 per
cent till November 1951. After the bank rate was gradually raised to 12 per cent in October 1991 and,
then, reduced again gradually to 6 per cent in January 2009.
Open Market Operations (OMO): The RBI has also been empowered to buy and sell short-term
commercial bills and securities so as to control the volume of credit.
Cash Reserve Ratio (CRR): The variation in the CRR is another method of credit control pursued
by the RBI. As per RBI Act, 1934. The commercial have to keep certain minimum cash reserve with
the RBI. Accordingly, the CRR has been raised from 3 per cent in 1962 to 15 per cent in July 1989 and
then it, subsequently, declined to 5 per cent in January 2009.
Selective Credit Control (SCC): As per Banking Regulation, 1949, the RBI is empowered to
control credit on qualitative basis, that is, in a selective manner. Accordingly, the SCC was first
introduced in 1956. The SCC wanted to check speculation activities in the market and, thereby,
controls the flow of credit selectively. Since 1993–94, the RBI adopted stricter SCC. Accordingly,
stricter controls have been imposed on six broad groups of commodities, which include—food
grains, sugar, oilseeds, cotton, vegetable oil, and cotton textiles.
Regarding the effectiveness of SCC, the RBI quotes:
The efficacy of the selective credit controls should not be assessed mainly in terms of their positive influence on prices since the
latter primarily depends on the availability of supply of the relevant commodities relative to demand. The success of these controls
is to be judged in a limited sphere, viz., their impact on the pressure of demand originating from bank credit—in this sense, the
measures should be deemed successful, but for their operation it is likely that the price situation might have been somewhere worse.
The efficacy of the selective credit controls should not be assessed mainly in terms of their positive influence on prices since
the latter primarily depends on the availability of supply of the relevant commodities relative to demand. The success of
these controls is to be judged in a limited sphere, viz., their impact on the pressure of demand originating from bank credit—
in this sense, the measures should be deemed successful, but for their operation it is likely that the price situation might
have been somewhere worse.”
Box 5.1 defines the differences between the restrictive and the accouning monetary policy.
RBI’S MONETARY POLICY, 2008–09
The annual policy statement of the RBI is a laudable attempt to achieve the objective of growth with
stability. The underpinnings of the proposals are designed to ensure that while they tackle the current
problem of inflation, they do not, at the same time, derail the economy from the path of
growthexperienced in the recent period.
The objectives are clearly stated in terms of priorities which are price stability, well-anchored
price expectations, orderly conditions in financial markets, and the sustenance of the growth
momentum. The policy has been formulated in the background of certain important developments in
the economy. Thus, the annual inflation rate, which was subdued for the best part of last year, has
flared up recently above 7 per cent. This is, primarily, the result of a general shortage of basic
necessities of life such as foodgrains and edible oils.

The objectives are clearly stated in terms of priorities which are price stability, well-anchored price expectations, orderly
conditions in financial markets, and the sustenance of the growth momentum.
The cost-push to prices of industrial products flows from the increase in input prices due partly to
imported inflation. As a result of the preemptive measures taken by the RBI in the earlier quarters, the
expansion in non-food credit has come down to a manageable growth rate of 22.3 per cent in 2007–08
from 28.5 per cent in the previous year. Money supply, as measured by M3, rose by 20.7 per cent.
Although it was lower than the 21.5 per cent recorded earlier, it was still above the targeted 17.5 per
cent. However, Reserve Money increased by 30.9 per cent from 23.7 per cent in 2006–07. It was
primarily attributable to the inflow of foreign funds, the bulk of which was sterilised by the Central
Bank. Thus, during April–December 2007, the net capital inflows amounted to $81.9 bn from $30.1 bn
in the corresponding period of the previous year. It amounted to a growth of 172 per cent. The
accretion to forex reserves, excluding valuation changes, amounted to $67.2 bn during April–
December 2007 ($16.2 bn). The overhang of liquidity of balances under the liquidity adjustment
facility, market stabilisation scheme and the government added up to a record of Rs 273,694 on
March 27, 2008. It came down, subsequently, to Rs 243,879 crore on April 25, 2008.

The overhang of liquidity of balances under the liquidity adjustment facility, market stabilisation scheme and the
government added up to a record of Rs 273,694 on March 27, 2008. It came down, subsequently, to Rs 243,879 crore on
April 25, 2008.
Policy Measures
Thus, in the light of the foregoing developments, the foremost concern of the bank has been to deal
with the surplus liquidity, which can push the inflation rate higher. It is in this connection that the
Central Bank has chosen to raise the CRR by an additional 25 basis points from May 24. This is in
addition to the hikes announced only a few days ago.

Box 5.1 Restrictive vs Accounting Monetary Policy

Restrictive Monetary Policy
A restrictive monetary policy seeks to raise the rate of interest, reduce money supply growth rate
and restrict the flow of credit, and in, generally, aimed to fight inflation.
Liberal or Accommodating Monetary Policy

It is generally mean to ght recession and stimulate demand through credit liberalisation, monetary
expansion, and fall in rate of interest.

There is a clear warning that there could be a further increment in the CRR in the future, in addition
to other measures, if warranted. In doing so, the RBI has set a target of growth in money supply at the
rate of 16.5 per cent to 17 per cent in 2008–09 and an increment in non-food credit by 20 per cent. The
rate for M3 has been decided in the expectation of GDP growth rate of 8 per cent to 8.5 per cent.
Given the income elasticity of demand for money at 1.4, a statistic obtained from the bank under the
Right to Information Act (RIA), the real demand for money is around 12 per cent (at the higher
growth rate). The additional 5 per cent is intended to accommodate (generate, according to this
writer), inflation of 5 per cent. Repo and reverse-repo rates have been left unchanged for tactical
reasons. At first sight, it gives the impression that rates in the system will not be raised. But,
depending on the relative position of banks, there could be changes in deposit and lending rates since
they are no longer eligible to get interest from the RBI on the cash balances impounded.
For the first time in the recent years, the RBI has sought to undertake a review of loans to the years,
the RBI has sought to agricultural commodity sector by banks. It has been said that, in view of the
current public policy concern in regard to trading in food items, banks are required to review their
advances to traders in agricultural commodities, including rice, wheat, oilseed and pulses, as also
advances against warehouse receipts. They are further advised to exercise caution while extending
such advances to ensure that bank finance is not used for hoarding. The first such review should be
completed by May 15, 2008 and forwarded to the RBI for carrying out a further supervisory review
of the banks’ exposure to the commodity sector.

For the first time in the recent years, the RBI has sought to undertake a review of loans to the years, the RBI has sought to
agricultural commodity sector by banks.
II. FISCAL POLICY OF INDIA
CONCEPT AND MEANING OF FISCAL POLICY
The fiscal policy plays an important role on the economic and social front of a country. Traditionally,
fiscal policy is concerned with the determination of state income and expenditure policy. But with the
passage of time, the importance of fiscal policy has been increasing continuously given the need to
attain rapid economic growth. Accordingly, it has included public borrowing and deficit financing as
a part of fiscal policy of the country. An effective fiscal policy is composed of policy decisions
relating to entire financial structure of the government, including tax revenue, public expenditures,
loans, transfers, debt management, budgetary deficit, and so on. The policy also tries to attain a
proper balance between these aforesaid units so as to achieve the best possible results in terms of
economic goals. Harvey and Johnson, M. defined fiscal policy as “changes in government
expenditure and taxation designed to influence the pattern and level of activity”. According to G.
K.Shaw, “We define fiscal policy to include any design to change the price level, composition or
timing of government expenditure or to vary the burden, structure of frequency of the tax payment”.
Otto Eckstein defines fiscal policy as “changes in taxes and expenditure which aim at short run goals
of full employment price level and stability”.

The fiscal policy plays an important role on the economic and social front of a country. Traditionally, fiscal policy is
concerned with the determination of state income and expenditure policy.
OBJECTIVES OF THE FISCAL POLICY
In India, the fiscal policy is gaining its importance in recent years with the growing involvement of
the government in developmental activities of the country. The following are some of the important
objectives of fiscal policy adopted by the Government of India:
1. To mobilise adequate resources for financing various programmes and projects adopted for economic development;
2. To raise the rate of savings and investment for increasing the rate of capital formation;
3. To promote necessary development in the private sector through fiscal incentive;
4. To arrange an optimum utilisation of resources;
5. To control the inflationary pressures in economy in order to attain economic stability;
6. To remove poverty and unemployment;
7. To attain the growth of public sector for attaining the objective of socialistic pattern of society;
8. To reduce regional disparities; and
9. To reduce the degree of inequality in the distribution of income and wealth.
In India, the fiscal policy is gaining its importance in recent years with the growing involvement of the government in
developmental activities of the country.
In order to attain all these aforesaid objectives, the Government of India has been formulating its
fiscal policy by incorporating the revenue, expenditure, and public debt components in a
comprehensive manner.
FISCAL POLICY AND ECONOMIC DEVELOPMENT
One of the important goals of fiscal policy formulated by the Government of India is to attain rapid
economic development of the country. To attain sucheconomic development in the country, the fiscal
policy of the country has adopted the following two objectives:
1. To raise the rate of productive investment of both public and private sector of the country.
2. To enhance the marginal and average rates of savings for mobilising adequate financial resources, for making investment in
public and private sectors of the economy.
One of the important goals of fiscal policy formulated by the Government of India is to attain rapid economic development
of the country.
The fiscal policy of the country is trying to attain both these two objectives during the plan periods.
TECHNIQUES OF FISCAL POLICY
The following are the four important techniques of fiscal policy of India:
1. Taxation Policy
2. Public Expenditure Policy
3. Public Debt Policy
4. Deficit Financing Policy
The following are the four important techniques of fiscal policy of India:
Taxation Policy
Public Expenditure Policy
Public Debt Policy
Deficit Financing Policy
Policy of Taxation of the Government of India

One of the important sources of revenue for the Government of India is the tax revenue. Both the
direct and indirect taxes are being levied by the Government of India. Direct taxes are progressive by
nature and most of the indirect taxes are regressive in nature. Taxation plays an important role in
mobilising the resources for a plan. During the First, Second, and Third Plan, additional taxation
alone contributed nearly 12.7 per cent, 22.8 per cent, and 34 per cent of public sector plan
expenditure, respectively. The same shares during the Fourth, Fifth, Sixth, and Seventh Plan were 27
per cent, 37 per cent, 22 per cent, and 15 per cent, respectively.

One of the important sources of revenue for the Government of India is the tax revenue. Both the direct and indirect taxes
are being levied by the Government of India.
The total tax revenue collected by the Government of India stands at 72.13 per cent of the total
revenue of the government. Mobilisation of taxes by the government stands around 15 per cent to 16
per cent of the national income of the country during the recent years. The main objectives of taxation
policy in India include
1. mobilisation of resources for financing economic development;
2. formation of capital by promoting saving and investment through time deposit, investment in government bonds, in units,
insurance, and so on;
3. Attainment of quality in the distribution of income and wealth through the imposition of progressive direct taxes; and
4. Attainment of price stability by adopting anti-inflationary taxation policy.
Public Expenditure Policy of the Government of India

The public expenditure is playing an important role in the economic development of a country like
India. With the increase in the responsibilities of the government and with the increasing participation
of government in economic activities of the country, the volume of public expenditure in a highly
populated country like India is increasing at a galloping rate. In 1992–93, the public expenditure as
percentage of GDP was around 30 per cent. Public expenditure is an expenditure of the government
and is mostly related to the developmental activities, viz., development of infra-structure, industry,
health facilities, educational institutions, and so on. The non-developmental expenditure is mostly a
maintenance type of expenditure and is related to maintenance of law and order, defence
administrative services, and so on. The public expenditure incurred by the Government of India has
been creating a serious impact on the production and distribution pattern of the economy.

With the increase in the responsibilities of the government and with the increasing participation of government in economic
activities of the country, the volume of public expenditure in a highly populated country like India is increasing at a
galloping rate.
The following are some of the important features of the policy of public expenditure formulated by
the Government of India.
Development of Infrastructure: The development of infrastructural facilities, including
development of power projects, railways, roads, transportation system, bridges, dams, irrigation
projects, hospitals, educational institutions, and so on, involves huge expenditure by the government
as private investors are very much reluctant to invest in these areas, considering the low rate of
profitability and high risk involved in it.
Development of Public Enterprises: The development of heavy and basic industries is very
important for the development of an underdeveloped country. But the establishment of these industries
involves huge investment and a considerable proportion of risk. Naturally, private sector cannot take
the responsibility to develop these industries. Therefore, the development of these industries has
become a responsibility of the Government of India, particularly since the introduction of the
Industrial Policy, 1956. A significant portion of public expenditure has been utilised for the
establishment and improvement of these public enterprises.

The development of heavy and basic industries is very important for the development of an underdeveloped country.
Support to Private Sector: Providing the necessary support to the private sector for the
establishment of industry and other projects is another important objective of public expenditure
policy formulated by the Government of India.
Social Welfare and Employment Programmes: Another important feature of public expenditure
policy pursued by the Government of India is its growing involvement in attaining various social
welfare programmes and also on employment-generation programmes.
Policy of Deficit Financing of the Government of India

Following the policy of deficit financing as introduced by J.M. Keynes, the Government of India has
been adopting the policy for financing its developmental plans since its inception. The deficit
financing in India indicates loan taking by the government from the RBI in the form of issuing fresh
dose of currency. Considering the low level of income, low rate of savings, and capital formation, the
government is taking recourse to deficit financing in increasing proportion. Deficit financing is a
kind of forced savings. Accordingly, Dr. V.K.R.V. Rao observed,

The deficit financing in India indicates loan taking by the government from the RBI in the form of issuing fresh dose of
currency.
Deficit financing is the name of volume of those forced savings which are the result of increase in prices during the period of the
Government investment. Thus deficit financing helps the country by providing necessary funds for meeting the requirements of
economic growth but, at the same time, it also create the problem of inflationary rise in prices. Thus the deficit financing must be kept
within the manageable limit.
During the First, Second, Third, and Fourth Plan, deficit financing as percentage of total plan
resources was to be to the extent of 17 per cent, 20 per cent, 13 per cent, and 13.5 per cent,
respectively. But due to the adverse consequence of deficit financing through inflationary rise in price
level, the extent of deficit financing was reduced to only 3 per cent during the Fifth Plan.
But due to resource constraint, the extent of deficit financing again rose to 14 per cent and 16 per cent
of total plan resources, respectively. Thus, knowing fully well the evils of deficit financing, planners
are still maintaining a high rate of deficit financing in the absence of increased tax revenue due to a
large-scale tax evasion and negative contribution of public enterprises. But considering the present
inflationary trend in prices, the government should give lesser stress on deficit financing.

Knowing fully well the evils of deficit financing, planners are still maintaining a high rate of deficit financing in the absence
of increased tax revenue due to a large-scale tax evasion and negative contribution of public enterprises.
Public Debt Policy of the Government of India

As the taxation has got its own limit in a poor country like India due to poor taxable capacity of the
people, the government is taking a recourse to public debt for financing its developmental
expenditure. In the post-independence period, the Central government has been raising a good amount
of public debt regularly, in order to mobilise a huge amount of resources for meeting its
developmental expenditure. The total public debt of the Central government includes internal and
external debt.
Internal Debt: The Internal debt indicates the amount of loan raised by the government from
within the country. The government raises internal public debt from the open market by issuing bonds
and cash certificates and 15 years annuity certificates. The government also borrows for a temporary
period from RBI (treasury bills issued by RBI) and also from commercial banks.

The Internal debt indicates the amount of loan raised by the government from within the country.
External Debt: As the internal debt is insufficient, the government is also collecting loan from
external sources, that is, from abroad, in the form of foreign capital technical know-how and capital
goods. Accordingly, the Central government is also borrowing from international financing agencies
for financing various developmental projects. These agencies include World Bank, IMF, IDA, IFC
(Integrated Finance Corporation), and so on. Moreover, the government is also collecting inter-
governmental loans from various developed countries of the world for financing its various
infrastructural projects.

The Central government is also borrowing from international financing agencies for financing various developmental
projects.
The volume of public debt in India has been increasing at a considerable rate, that is, from Rs 204
crore during the First Plan to Rs 2,135 crore during the Fourth Plan and, then, to Rs 103,226 crore
during the Seventh Plan. During the Eighth Plan, the volume of internal debt of the Central
government was amounted to Rs 159,972 crore and that of external debt was to the extent of Rs 2,454
crore at the end of the second year of the Ninth plan, that is, in 1998–99 (BE), with the total
outstanding loan (liabilities) of the Central government at Rs 868,206 crore.
MERITS OR ADVANTAGES OF FISCAL POLICY OF INDIA
The following are some of the important merits or advantages of fiscal policy of Government of
India.
Capital Formation
The fiscal policy of the country has been playing an important role in raising the rate of capital
formation in the country, both in its public and private sectors. The gross domestic capital formation
as per cent of GDP in India has increased from 10.2 per cent in 1950–51 to 22.9 per cent in 1980–81
and, then, to 24.8 per cent in 1997–98. Therefore, it has created a favourable impact on the public and
private sector investment of the country.
Mobilisation of Resources
The fiscal policy of the country has been helping to mobilise considerable amount of resources
through taxation, public debt, and so on, for financing its various developmental projects. The extent
of internal resource mobilisation for financing plan has increased considerably from 70 per cent in
1965–66 to around 90 per cent in 1997–98. Box 5.2 defines the terms—monetary policy and fiscal
policy.

The fiscal policy of the country has been helping to mobilise considerable amount of resources through taxation, public
debt, and so on, for financing its various developmental projects.
Box 5.2 Monetary Policy and Fiscal Policy
Monetary Policy
It refers to all actions of the government or the Central government of a country which affect,
directly or indirectly, the supply of money, credits, rate of interest, and the banking system.
Basically it affects the cost and availability of credit in the economy.
Fiscal Policy
Fiscal policy is basically concerned with the use of taxes and government expenditure, through the
issues relating to non-tax revenue, government borrowing, and scal federalism are closely
associated with these factors for achieving predetermined objectives.
Incentives to Savings
The fiscal policy of the country has been providing various incentives to raise the savings rate, both
in household and corporate sector, through various budgetary policy changes, viz., tax exemption, tax
concession, and so on. Accordingly, the savings rate has increased from a mere 10.4 per cent in
1950–51 to 23.1 per cent in 1997–98.
Inducement to Private Sector

The private sector of the country has been getting necessary inducements from the fiscal policy of the
country to expand its activities. Tax concessions, tax exemptions, subsidies, and so on, incorporated
in the budgets have been providing adequate incentives to the private sector units engaged in industry,
infrastructure, and export sector of the country.

The private sector of the country has been getting necessary inducements from the fiscal policy of the country to expand its
activities.
Reduction of Inequality
The fiscal policy of the country has been making constant endeavour to reduce the inequality in the
distribution of income and wealth. Progressive taxes on income and wealth tax exemption, subsidies,
grant, and so on, are making a consolidated effort to reduce such inequality. Moreover, the fiscal
policy is also trying to reduce the regional disparities through its various budgetary policies.

The fiscal policy of the country has been making constant endeavour to reduce the inequality in the distribution of income
and wealth.
Export Promotion
The fiscal policy of the government has been making constant endeavours to promote export through
its various budgetary policies in the form of concessions, subsidies, and so on. As a result, the growth
rate of export has increased from a mere 4.6 per cent in 1960–61 to 10.4 per cent in 1996–97.

The fiscal policy of the government has been making constant endeavours to promote export through its various budgetary
policies in the form of concessions, subsidies, and so on.
Alleviation of Poverty and Unemployment

Another important merit of the Indian fiscal policy is that it is making constant effort to alleviate
poverty and unemployment problem through its various poverty eradication and employment
generation programmes, like, IRDP (Integrated Rural Development Programme), JRY (Jawahar
Rozgar Yojana), PMRY (Pradhan Mantri Rozgar Yojana), SJSRY (Swarna Jayanti Shahari Rozgar
Yojana), EAS (Employment Assurance Scheme), and so on.

Another important merit of the Indian fiscal policy is that it is making constant effort to alleviate poverty and unemployment
problem through
THE SHORTCOMINGS OF THE FISCAL POLICY OF INDIA

The following are the main shortcomings of the fiscal policy of the country.
Instability
The fiscal policy of the country has failed to attain stability in various fronts. The growing volume of
deficit financing has created the problem of inflationary rise in the price level. The Disequilibria in
its balance of payments has also affected the external stability of the country.

The Disequilibria in its balance of payments has also affected the external stability of the country.
Defective Tax Structure

The fiscal policy has also failed to provide a suitable tax structure for the country. The tax structure
has failed to raise the productivity of direct taxes and the country has been relying much on indirect
taxes. Therefore, the tax structure has become burdensome to the poor.

The fiscal policy has also failed to provide a suitable tax structure for the country.
Inflation
The fiscal policy of the country has failed to contain the inflationary rise in price level. The
increasing volume of public expenditure on non-developmental heads and deficit financing has
resulted in demand-pull inflation. The higher rate of indirect taxation has also resulted in cost-push
inflation. Moreover, the direct taxes has failed to check the growth of black money, which is again
aggravating the inflationary spiral in the level of prices.

The direct taxes has failed to check the growth of black money, which is again aggravating the inflationary spiral in the
level of prices.
Negative Return of the Public Sector

The negative return on capital invested in the public sector units (PSUs) has become a serious
problem for the Government of India. In spite of having a huge total investment to the extent of Rs
204,054 crore in 1998 on PSUs, the return on investment has remained mostly negative. In order to
maintain those PSUs, the government has to keep huge amount of budgetary provisions, thereby,
creating a huge drainage of scarce resources of the country.
Growing Inequality
The fiscal policy of the country has failed to contain the growing inequality in the distribution of
income and wealth throughout the country. The growing trend of tax evasion has made the tax
machinery ineffective for the purpose. Again, the growing reliance on indirect taxes has made the tax
structure regressive.

The fiscal policy of the country has failed to contain the growing inequality in the distribution of income and wealth
throughout the country.
SUGGESTIONS FOR NECESSARY REFORMS IN FISCAL POLICY
The following are some of the important measures suggested for necessary reforms of the fiscal
policy of the country.
Progressive Taxes
The tax structure of the country should try to infuse more progressive elements so that it can put a
heavy burden on the rich and less burden on the poor. Necessary amendments have to be made in
respect of irrigation tax, sales tax, excise duty, land revenue, property taxes, and so on.

The tax structure of the country should try to infuse more progressive elements so that it can put a heavy burden on the rich
and less burden on the poor.
Agricultural Taxation
The tax net of the country should be extended to the agricultural sector for tapping a huge amount of
revenue from the rich agriculturists.
Broad-based Tax Net

Tax net of the country should be broad-based so that it can cover an increasing number of population
having the taxable capacity.
Checking Tax Evasion

Adequate measures must be taken to check the problem of tax evasion in the country. Tax laws should
be made stricter for prosecuting the tax evaders. Tax machinery should be made more efficient and
honest to gear up its operations. Tax rate should be reduced to encourage the growing trend of tax
compliance.

Adequate measures must be taken to check the problem of tax evasion in the country.
Increasing Reliance on Direct Taxes
The tax machinery of the country should attach much more reliance on direct taxes instead of indirect
taxes. Accordingly, the tax machinery should try to introduce wealth tax, estate duty, gift tax,
expenditure tax, and so on.
Simplified Tax Structure

The tax structure and rules of the country should be simplified so that it can encourage tax
compliance among the people and can also remove the unnecessary harassment of the tax payers.

The tax structure and rules of the country should be simplified so that it can encourage tax compliance among the people
and can also remove the unnecessary harassment of the tax payers.
Reduction of Non-development Expenditure

The fiscal policy of the country should try to reduce the non-developmental expenditure of the
country. This would reduce the volume of unproductive expenditure and can reduce the inflationary
impact of such expenditure.
Checking Black Money

The fiscal policy of the country should try to check the problem of black money. In this direction,
schemes like VDIs should be repeated and tax rates should be reduced. Corruption and political
interference should be abolished. Smuggling and other nefarious activities should be checked.

The fiscal policy of the country should try to check the problem of black money.
Raising the Profitability of PSUs

The government should try to restructure its policy on public sector enterprises, so that its efficiency
and rate of return on capital invested can be raised effectively. PSUs should be managed in a rational
manner with least government interference and in commercial lines. Accordingly, the policy of
budgetary provisions for maintaining the PSUs should be, gradually, eliminated. Box 5.3 lists the
major areas of second wave of economic reform.

PSUs should be managed in a rational manner with least government interference and in commercial lines.
FISCAL POLICY REFORMS

In the meantime, the Government of India has introduced various fiscal policy reforms, which
constitute the main basis of the stabilisation policy of the country. In the recent years, the Government
of India has adopted some important measures of fiscal policy reforms as follows:
Reduction of Rates of Direct Taxes

The peak rate of income tax was reduced in 30 per cent in 1997–98 budget. This has resulted in an
increment in the share of direct taxes in total revenue of the country from 19 per cent in 1990–91 to
around 30 per cent in 1996–97.

Box 5.3 Second Wave of Economic Reform
Major areas of second wave of economic reform are as follows:
1. Fiscal Policy Reform

2. Monetary Policy Reform
3. Pricing Policy Reform
4. External Policy Reform
5. Industrial Policy Reform
6. Foreign Investment Policy Reform
7. Trade Policy Reform
8. Public Sector Policy Reform
Simplification of Tax Procedure

In recent years, as per the recommendation of Raja Chelliah or Taxation Reform Committee, several
steps have been taken to simplify that tax procedure in the successive budget. The 1998–99 budget has
introduced a series of tax simplification measures, viz., “ Saral”, “Samsdhan”, and “Samman”, which
it considered as an important step in right directions.
Reform in Indirect Taxes

Which induced introduction of ad-valorem rates, MODVAT scheme, and so on.
Fall in the Volume of Government Expenditure

The government undertook several measures recently. Accordingly, total expenditure of the
government under various heads had been reduced. As a result, total public expenditure as per cent of
GDP has declined from 19.7 per cent of GDP in 1990–91 to 16.4 per cent in 1996–97.
Reduction in the Volume of Subsidies

The Central government has been making a huge payment in the form of subsidies, that is, food
subsidies, fertiliser subsidies, export subsidies, and so on. Steps have been taken to reduce these
subsidies phase-wise.
Reduction in Fiscal Deficit

The Central government has been trying seriously to contain the fiscal deficit in its annual budget.
Accordingly, it has reduced the extent of fiscal deficit from 7.7 per cent of GDP in 1990–91 to 5.1 per
cent in 1998–99. But fiscal stabilisation necessitates containing the fiscal deficit to at least 3 per cent
of GDP.
Reduction of Public Debt

Recently, the Central government has been trying to reduce the burden of public debt. Accordingly,
the external debt as per cent of GDP which was 5.4 per cent in 1990–91 gradually declined to 3.2 per
cent in 1998–99 (BE). The internal debt as per cent of GDP has declined from 48.6 per cent in 1990–
91 to 49.8 per cent in 1998–99. Similarly, the total outstanding loan or liabilities as per cent of GDP
has also declined from 54.0 per cent to 49.1 per cent during the same period.
Disinvestments in Public Sector

Another important fiscal policy reforms introduced by the Government of India is to disinvest the
shares of the public sector enterprises. The government has disinvested, as part of its stake, in 39
selected PSUs since the disinvestments process began in 1992. Till 1998–99, it has raised around Rs
18,700 crore through disinvestments of share of PSUs. In the mean time, the government has
constituted a Disinvestments Commission to advise it on how to go about disinvesting the share of
PSUs out of 50 referred to it. The Commission has submitted eight reports covering 43 PSUs and has
undertaken diagnostic studies in 1998–99, in respect of these undertakings for giving
recommendations.
FISCAL POLICY STATEMENT, 2008–09
Fiscal Policy Overview
The growth trends for the last four years indicate a continuous upswing in the economy. Increasing
productivity, growth of service sector, and buoyancy in tax receipts associated with the growth and, to
some extent, improvement in tax compliance and enforcement, as a result of a more rational, liberal,
and efficient tax system, have contributed towards achieving quantitative goals set under the Fiscal
Responsibility and Budget Management (FRBM) Act. Reduction of fiscal deficit has been achieved
from 4.5 per cent of GDP in 2003–04 to 3.1 per cent of GDP in RE 2007–08. During the same period,
revenue deficit has declined from 3.6 per cent of GDP to 1.4 per cent. The advance estimate for
growth of GDP at factor cost at constant (1999–2000) prices in 2007–08 is pegged a 8.7 per cent,
which is the average growth of the last four years, albeit lower by 0.9 percentage points as compared
to 2006–07 (Quick Estimates 9.6 per cent ). The slowdown is triggered by lower than expected growth
in manufacturing sector, although services sector continued to record double-digit growth in the first
half of 2007–08. Improvement in deficit indicators has been achieved through growth in tax receipts,
which exceeded growth of revenue expenditure, notwithstanding an increment in non-plan revenue
expenditure, fuelled largely by a high-subsidy bill and interest payments. The process of fiscal
consolidation would continue to be sustained through improvement in tax–GDP ratio, moderate
growth in non-tax revenue, re-prioritisation, and improving the quality of expenditure—including
promotion of capital expenditure to boost infrastructure development while ensuring adequate
resources for social sectors like health and education.

Increasing productivity, growth of service sector, and buoyancy in tax receipts associated with the growth and, to some
extent, improvement in tax compliance and enforcement, as a result of a more rational, liberal, and efficient tax system,
have contributed towards achieving quantitative goals set under the Fiscal Responsibility and Budget Management (FRBM)
Act.
Fiscal Policy for the Ensuing Financial Year

Budget 2008–09 is being presented against the backdrop of the fiscal consolidation achieved during
the Tenth Plan period, which has provided a good foundation for making available, the resources
required to implement the objective of faster and more inclusive growth of Eleventh Plan. The
government’s commitment to ensure faster and more inclusive growth as also the need to address the
supply constraints on growth are intertwined in the fiscal policy objectives for the year. The
achievement on the inflation front has been significant but downside risks arising inter alia, from
rising energy prices, foodgrains and commodity prices, and continuing capital flows, which have
inflationary potential, are challenges that will need to be addressed through a mix of fiscal,
administrative, and monetary policy measures. Uncertainty associated with significant changes in
global macro-economic and financial environment also continue to be key concerns in fiscal policy
management.

The government’s commitment to ensure faster and more inclusive growth as also the need to address the supply constraints
on growth are intertwined in the fiscal policy objectives for the year.
Despite pressure from committed and non-discretionary expenditures on items like interest
payments, defence, pensions, salaries, subsidies, and so on, the fiscal policy for 2008–09 remains
committed to the overarching objectives of achieving faster and more inclusive growth by increasing
allocation for social sectors, including rural employment, education, and health; while, at the same
time, ensuring adequate resources for improving infrastructure to boost employment, investment, and
consumption levels.
With direct taxes as a percentage of total tax receipts exceeding the 50 per cent mark and the service
tax emerging as a promising source of revenue, the composition of receipts is changing. Buyoyancy
in tax revenues witnessed over the last three years is expected to continue through 2007–08. The state
governments will also benefit through higher devolution which register a growth of 17.7 per cent in
BE 2008–09 over RE 2007–08. The adoption of VAT by states/union territories (Uts)was a path-
breaking development in the area of tax reforms. The initial trend in revenue collection in the VAT-
implementing states has been quite impressive with the growth in the first seven months in states put
together, exceeding the compounded annual rate of growth achieved over the last five years in these
states.

The adoption of VAT by states/union territories (Uts)was a path-breaking development in the area of tax reforms.
Government’s Strategy to Pursue Fiscal Consolidation
Tax Policy
In recent years, tax policy has been governed by the overarching objective of increasing the tax–GDP
ratio for achieving a fiscal consolidation. This is sought to be achieved both through appropriate
policy interventions and a steadfast improvement in the quality and effectiveness of tax
administration. On the policy side, a strategy of moderate and few rates, removal of exemptions, and
broadening of the tax base has yielded good results. As for tax administration, the extensive adoption
of information technology solutions has enabled a less-intrusive tax system that fosters voluntary
compliance. In a broad sense, the relatively high buoyancy exhibited by direct taxes indicates that the
tax system is maturing. On the indirect-tax side, the objective is to integrate the taxes on goods
(central excise) and services and finally move to a comprehensive Goods and Services Tax (GST). It
is also the aim to improve the revenue yield from service tax in keeping with the contribution of the
service sector to GDP.

In recent years, tax policy has been governed by the overarching objective of increasing the tax–GDP ratio for achieving a
fiscal consolidation.
The relatively high buoyancy exhibited by direct taxes indicates that the tax system is maturing.
Indirect Taxes
Customs Duty
In the wake of the sharp appreciation of the rupee against the US dollar, the peak rate of customs duty on non-agricultural goods
has been maintained at 10 per cent.
Continuing the pace of reforms, the rate of customs duty on “project imports” has been reduced from 7.5 per cent to 5 per cent.
This will serve as an incentive for setting up of large projects and also encourage capacity expansion and modernisation of
existing industries.
For promotion of exports, customs duty reduction has been effected on specified machinery and raw materials for producing
sports goods, and also on cubic zirconia (rough and polished) and rough corals, used in the gems and jewellery sector.
To improve the availability of base metals in the country, import duty on “melting scrap of iron or steel” and “aluminium
scrap”—raw materials for the ferrous and non-ferrous sector, has been exempted.
To help conserve the country’s natural resource of chromium ores, and increased domestic availability of this scarce raw
material, export duty on chromium ores and concentrates has been increased.
For the Electronics and Information technology hardware sector, problem of inversion, arising on account of various FTAs and
PTAs, has been sought to be addressed by providing customs duty exemptions on specified raw materials on an end-use basis.
As a part of continued review of existing exemptions, customs duty on “naphtha imported for manufacture of specified polymers”
has been withdrawn.
Excise Duty
The general Cenvat rate has been reduced from 16 per cent to 14 per cent, that is, a reduction of 12.5 per cent in central excise
duty. This is likely to boost growth of the domestic manufacturing sector, which has suffered a slowdown.
Several sector-specific interventions have also been made to provide a fillip to growth through lower excise duties. The
important sectors are automobiles, paper, drugs, and pharmaceuticals, and food processing.
To provide clean drinking water, excise duty on water filtering and purifying devices has been reduced.
For replenishment of the National Calamity Contingency Fund, 1 per cent National Calamity Contingent Duty has been imposed
on mobile phones.
Specific rates of duty on cement clinker and non-filter cigarettes have been rationalised.
Service Tax
Widening of service tax base, simplification of law and procedure, improved tax administration, and an increment in tax
compliance continue to show higher buoyancy in service tax revenue collection during 2007–08 also. Service tax revenue
during the period April– December 2007, has grown by about 37 per cent when compared to the corresponding period of the
previous year.

Widening of service tax base, simplification of law and procedure, improved tax administration, and an increment
in tax compliance continue to show higher buoyancy in service tax revenue collection during 2007–08 also.
In order to facilitate small service providers and to ensure optimum utilisation of the administrative resources, threshold limit of
annual turnover to small service providers for full-service tax exemption has been increased from Rs 8 lakh to Rs 10 lakh
witheffect from April 1, 2008. This exemption would benefit about 65,000 small service providers.
In line with the government’s declared policy of broadening the tax base, the scope and coverage of services liable to service
tax is being further widened by adding more services and expanding the scope of some of the existing services.
Direct Taxes
Over the last four years, widespread reforms have been ushered into the direct-tax arena. The
touchstones of such reforms have been the following:
Distortions within the tax structure have been minimised by expanding the tax base and maintaining moderate tax rates.
Tax administration has been geared up to provide taxpayer services and also enhance deterrence levels. Both these objectives
reinforce each other and have promoted voluntary compliance.
Business processes have been re-engineered in the income-tax department throughextensive use of information technology, viz.,
e-filing of returns, issue of refunds througheCS and refund banks, selection of returns for scrutiny through computers, and so on.
These measures have modernised the department and enhanced its functional efciency.
The Union Budgets of 2006–07 and 2007–08 managed to consolidate the landmark achievements of
the 2005–06 Budget in the field of direct-tax reforms. In the Union Budget of 2007–08, some major
tax concessions provided in the income-tax statute were either eliminated or curtailed to broaden the
tax base. For example, the MAT base was expanded by bringing the profits of STPI units and export-
oriented units (EOUs) within its ambit, the rate of dividend distribution tax (DDT) for domestic
companies on distribution of profits to share holders was increased; new rates of DDT were specified
for money market mutual funds (MMMF) and liquid funds (LF) on distribution of income to unit
holders; and the non-chargeability of capital-gain tax on sale of a long-term capital asset, by
investing the same in certain bonds, was restricted to a maximum amount of Rs 50 lakh in a year.
The policy proposals in the Union Budget 2008–09 are intended to further consolidate the
achievements made in the last four years. Some of the major proposals are as follows:
1. Rationalisation of the personal income tax (PIT) rate structure for individuals, Hindu undivided families (HUFs), and so on, by
enhancing the threshold limit and revising the income slabs.
2. Introducing a transaction-based tax (Commodities Transactions Tax [CTT]), on the lines of securities transaction tax (STT), in
respect of commodities traded on recognised commodity exchanges.
3. Allowing STT, paid as a deduction from income, in case of assessees deriving business income from sale of securities, as against
the existing provisions of allowing a rebate from taxes.
4. Restricting the scope of the term “charitable purpose” by amending its definition and, thereby, bringing many “non-charitable”
activities into the tax net.
5. Enhancing the existing tax rate of 10 per cent to 15 per cent in respect of short-term capital gains, arising from the transfer of
short-term capital asset, being an equity share in a company or a unit of an equity-oriented fund, and where such transactions are
chargeable to STT.
6. Exempting interest income on bonds issued by companies listed on recognised stock exchanges, from the purview of TDS
provisions, so as to facilitate development and deepening of the bond market.
7. Introduction of a scheme for centralised processing of returns to provide better taxpayer services, in sync with the best
international practices, by harnessing India’s inherent advantage in the sphere of information technology.
8. Streamlining of certain procedural matters to offer improved taxpayer services.
The policy proposals in the Union Budget 2008–09 are intended to further consolidate the achievements made in the last
four years. Some of the major proposals are as follows:
The modernisation of tax administration for providing quality taxpayer services has been a constant
endeavour of the government. In this regard, the compulsory electronic filing of returns for
companies (introduced last year) was extended in the current year, to firms liable to audit under the
provisions of the Income-tax Act. While the response has been very positive from this segment of
assessees, what is most encouraging is that about 7 lakh taxpayers have voluntarily e-filed their
returns till January 31, 2008. It would not be out of place to mention here that the income-tax
department’s initiatives in this regard have been appreciated and recognised, and it has been conferred
with the “National E-governance Silver Award for Outstanding Performance in Citizen-centric
Services”. Further, the introduction of annexure-less returns for all categories of taxpayers (other
than non-profit organisations) is a noteworthy taxpayer service.

The modernisation of tax administration for providing quality taxpayer services has been a constant endeavour of the
government.
A key feature of all efficient tax administrations is an effective taxpayers’ information system. Over
the past few years, the income-tax department has gradually migrated to non-intrusive methods of
collecting and collating information about financial transactions of taxpayers. While the Annual
Information Return (AIR) system is already in place and has strengthened the department’s database,
the electronic filing of returns by different categories of assessees—as mentioned above—has added
an entirely new dimension to the department’s information bank. As more information about
taxpayers becomes available, the department would be able to hand out better taxpayers services while
simultaneously targeting tax evaders.

A key feature of all efficient tax administrations is an effective taxpayers’ information system.
Contingent and Other Liabilities

FRBM Rules envisage a cap of 0.5 per cent of GDP on the quantum of guarantees that the Central
government can assume annually. The present policy on government guarantees limits these
guarantees only to non-private sector entities. Within the ceiling prescribed under the rules, Central
government extends guarantees to loans from multilateral agencies, loans raised by public sector
entities, for example, FCI for cash credit limits, India Infrastructure Finance Company borrowings,
and so on. The stock of contingent liabilities in the form of guarantees given by the government has
slightly reduced from Rs 110,626 crore at the end of 2005–06 to Rs 109,826 crore at the end of 2006–
07. The number of guarantees during the same period has also gone down from 492 to 466. There
was no net accretion to the outstanding guarantees during the year 2006–07. In BE 2008–09,
drawdown from the government’s cash surplus is also envisaged as a source of financing the fiscal
deficit. As regards borrowings, the emphasis is on
1. Greater reliance on domestic borrowings over external debt,

2. Preference for market borrowings over higher cost instruments carrying administered interest rates,
3. Elongation of maturity profile of its debt portfolio and consolidation of the same and
4. Development of a deeper and wider market for government securities to improve secondary-market tradability.
FRBM Rules envisage a cap of 0.5 per cent of GDP on the quantum of guarantees that the Central government can assume
annually. The present policy on government guarantees limits these guarantees only to non-private sector entities.
As part of policy to elongate maturity profile, Central government has been issuing securities with a
maximum 30-year maturity for quite some time. With a view to passively consolidating its securities
portfolio, re-issues are favoured rather than the fresh issues. Government does not envisage any
difficulty in raising the necessary resources to finance the estimated market borrowings during FY
2008–09.
The window of market stabilisation scheme to assist RBI in its monetary policy objectives will
continue to be resorted to during 2008–09 in terms of the memorandum of understanding (MoU)
between the Central government and RBI. The MSS ceilings for 2008–09 has been retained at Rs
250,000 crore. The interest cost of operating MSS is estimated to be Rs 13,958 crore in BE 2008–09.
The role of Central government as a financial intermediary for state governments/UTs, CPSUs,
and so on, has been declining over a period of time. The decline is consistent with the development of
financial market in the country and spirit of economic reforms that envisages greater market scrutiny
and discipline, on the one hand, and desirability of affording the freedom to states to choose as to
how and from whom to borrow, on the other. Enhanced devolution through the state’s shares of taxes
has also contributed to the improved fiscal position of the states.

The role of Central government as a financial intermediary for state governments/UTs, CPSUs, and so on, has been
declining over a period of time.
Initiatives in Public Expenditure Administration

Improving quality of expenditure is the key to sustain fiscal reforms. Under the FRBMA, obligations
containing revenue expenditure and encouraging capital expenditure for productive assets are critical
to ensure fiscal correction. Approach to allocation is based on the plan and the non-plan criteria. Plan
expenditure is seen as a proxy to development expenditure. Therefore, containing non-plan
expenditure to free additional resources for meeting the objectives of priority schemes is central to
various expenditure management measures introduced from time to time. Further, the need for
efficient tracking of expenditure, improving the quality of expenditure, and enhancing the efficiency
and accountability of the delivery mechanism have been recognised as critical for better tracking of
the funds and to obtain value for money.

Improving quality of expenditure is the key to sustain fiscal reforms. Under the FRBMA, obligations containing revenue
expenditure and encouraging capital expenditure for productive assets are critical to ensure fiscal correction.
There is a shift in the focus from outlays to outcomes. Such a shift is expected to ensure that the budgetary provisions are spent to
achieve actual intended outcomes. The government presented an Outcome Budget in respect of its Plan Expenditure in August
2005 for the first time as a step to identify, monitor, and assess the actual outcomes. Outcome Budgets for 2008–09 are being
shortly presented by various individual ministries/departments.

There is a shift in the focus from outlays to outcomes.
There is emphasis on utilising money on time. Since, mere releasing of funds to implement entities does not ensure actual
expenditure; emphasis is placed on the timely utilisation of the released funds. Release of funds in the fourth quarter, particularly
in the month of March, is aligned with spending capacity during the remaining part of the year. Thus, excess funds/unutilised
funds in the hands of releasing entities are discouraged. Strict enforcement and discipline in this regard will continue.

There is emphasis on utilising money on time.

A revised and updated “General Financial Rules” has been implemented. The thrust of revised rules is on simplification of rules
and greater delegation of authority to administrative ministries in managing their financial affairs. This measure is intended to
speed up decisions while also ensuring accountability.

A revised and updated “General Financial Rules” has been implemented.
In a significant move towards sound cash management system, and to reduce rush of expenditure during the last quarter, a
quarterly, exchequer control-based expenditure management system is being implemented in respect of 23 Demands for Grants,
viz.,

A quarterly, exchequer controlbased expenditure management system is being implemented in respect of 23

Demands for Grants, viz.,
1. Department of Agriculture and Cooperation.

2. Department of Agricultural Research and Education.
3. Department of Fertilisers.
4. Department of Commerce.
5. Department of Telecommunications.
6. Department of Food and Public Distribution.
7. Department of External Affairs.
8. Department of Economic Affairs.
9. Indian Audit and Accounts Department.
10. Department of Revenue.
11. Direct Taxes.
12. Department of Health and Family Welfare.
13. Department of School Education and Literacy.
14. Department of Higher Education.
15. Ministry of Panchayati Raj.
16. Ministry of Petroleum and Natural Gas.
17. Ministry of Power.
18. Department of Rural Development.
19. Indirect Taxes.
20. Department of Road Transport and Highways.
21. Ministry of Textiles.
22. Department of Urban Development and
23. Department of Women & Child Development.
In a bid to improve transparency and accountability, ministries are being encouraged to release a summary of their monthly
receipts and expenditure to general public (through their website, etc.) and, in particular, disclose scheme-wise funds released to
different states. The consolidated monthly position of receipts and payments is put in public domain every month.

The consolidated monthly position of receipts and payments is put in public domain every month.
In order to ensure better expenditure discipline, the accounting department is expanding E-lekha programme to provide online
tracking of status on government receipt and expenditure, through various Central government ministries/departments, and also
to capture the online release status on the various Central/State schemes. The initiative has already been piloted through tracking
of release status on 27 flagship schemes, and is expected to cover all the Central schemes in a short period. In 2008–09, the
Controller General of Accounts through a plan scheme of the Planning Commission is set to undertake a programme for online
tracking and reporting on the expenditure under the various schemes of Government of India, through a robust online reporting
mechanism captured from the district/block levels. This initiative is expected to bridge the gaps that exist on reporting on an
outcome against outlays.

In order to ensure better expenditure discipline, the accounting department is expanding E-lekha programme to
provide online tracking of status on government receipt and expenditure, through various Central government
ministries/departments, and also to capture the online release status on the various Central/State schemes.
Ministries are advised to pay greater emphasis on explicit recognition of revenue constraints and should make only a realistic
projection of budgetary provisions required for various projects/schemes. Emphasis is placed for schemes proposed by ministries
and departments to be financially viable, and carry an internal rate of return of not less than the rate prescribed. And where such
quantification is not possible, the overall socioeconomic cost-benefit analysis of schemes to be indicated explicitly.

Emphasis is placed for schemes proposed by ministries and departments to be nancially viable, and carry an
internal rate of return of not less than the rate prescribed.
Review and rationalisation of user charges will continue with a view to increase non-tax revenue and reduce the operational
losses of commercial undertakings. Besides all these, further improvements are expected as return on investment improves and
temporary fiscal concessions are phased out as a result of improved performance of public sector enterprises.

Review and rationalisation of user charges will continue with a view to increase non-tax revenue and reduce the
operational losses of commercial undertakings.
Policy Evaluation
The past four years have been marked by an impressive revenue-led fiscal consolidation. The
performance in RE 2007–08 shows an improvement over BE 2007–08 achieved by revenue receipts,
exceeding the budgeted amount and non-plan expenditure getting moderated. Budget 2008–09 marks
the path of fiscal correction with an emphasis on quality in expenditure in accordance with the FRBM
goals. Continuation of the policy measures already implemented in the domain of tax policies,
expenditure management, and so on, and fresh initiatives being launched in these areas form the basis
of projections included in the FRBM statements.

Continuation of the policy measures already implemented in the domain of tax policies, expenditure management, and so
on, and fresh initiatives being launched in these areas form the basis of projections included in the FRBM statements.
FISCAL POLICY—AN ASSESSMENT
Economic Crisis
India faced a severe macro-economic crisis in 1991. A series of economic reforms, implemented in
response, have, arguably, supported higher growth and a more secure external payments situation.
Removal of controls and trade barriers, along with modernisation of regulatory institutions,
characterised reforms in industry, trade, and finance. However, growth marginally accelerated only in
the 1990s compared to the previous decade. At times, structural reforms seemed to have stalled, and
little progress has been made in areas such as labour market and bankruptcy reforms.

Growth marginally accelerated only in the 1990s compared to the previous decade. At times, structural reforms seemed to
have stalled, and little progress has been made in areas such as labour market and bankruptcy reforms.
Perhaps, the most striking aspect of reform is the lack of progress in restoring fiscal balance. A
high fiscal deficit of around 9.5 per cent of GDP, widely perceived as unsustainable, contributed to the
crisis of 1991. Containing this deficit was one of the key structural adjustments undertaken by the
Indian government at the time. This effort met with some success: the fiscal deficit came down to 6.4
per cent of GDP and growth accelerated to a peak of 7.5 per cent in 1996–97. From 1997–98 onwards,
however, growth has slowed and the deficit has widened, returning attention to India’s fiscal policy
and prospects. India’s current fiscal situation is potentially grave, and could lead to an economic
crisis (fiscal, monetary, and/or external) with severe short-term losses of output and even political
turmoil, or, alternatively and more subtly, many years of continued underperformance of the
economy.

Most striking aspect of reform is the lack of progress in restoring scal balance.
India’s current scal situation is potentially grave, and could lead to an economic crisis (scal, monetary, and/or external)
with severe short-term losses of output and even political turmoil, or, alternatively and more subtly, many years of continued
underperformance of the economy.
The prima facie solution to the looming problem is obvious: control fiscal deficits. The deeper
question is how is this to be achieved, and to what extent? One complicating factor is the existence of
off-budget items that are not accurately measured or monitored. The uncertainty associated with these
items makes formulating budgetary policies more challenging. Besides, fiscal policy obviously
cannot be analysed in isolation. Monetary and exchange-rate policies have to be considered in
conjunction with it, for achieving desired combinations of growth and stability under realistic
assumptions about sustainable capital inflows from abroad. Even on the fiscal side alone, this
perspective shifts the focus to considering optimal paths of public consumption, investment, taxes and
borrowing, rather than an emphasis on primary balances alone. Ultimately this broader framework
poses technical and empirical questions that would benefit from an explicit theoretical analysis as a
foundation for econometric modelling and estimation.
The Indian Fiscal Situation

Even before independence, there was a broad consensus, across the political spectrum, that once
independence was achieved, Indian economic development should be planned, with the State playing a
dominant role in the economy and achieving self-sufficiency across the board as a major objective
(Srinivasan 1996). Within three years of independence, a National Planning Commission was
established in 1950, charged with the task of drawing up national development plans. The adoption of
a federal constitution with strong unitary features, also in 1950, facilitated planning by the Central
government. Several Central government-owned enterprises were established and a plethora of
administrative controls (the so-called “license-quota-permit raj”) was adopted to steer the economy
towards its planned path. At the same time, fiscal and monetary policy remained quite conservative,
and inflation relatively low—the latter reflecting the sensitivity of the electorate to rising prices.
During 1950–80, India’s economic growth averaged a very modest 3.75 per cent per year,
reasonable by pre-independence standards, but far short of what was needed to significantly diminish
the number of poor people. The license-permit raj not only did not deliver rapid growth, but worse,
unleashed rapacious rent-seeking and administrative as well as political corruption (Srinivasan 1996).
In the 1980s, India’s national economic policymakers began some piecemeal reforms, introducing
some liberalisation in the trade and exchange-rate regime, loosening domestic industrial controls,
and promoting investment in modern technologies, for areas such as telecommunications. Most
significantly, they abandoned fiscal conservatism and adopted an expansionary policy, financed by
borrowing at home and abroad at increasing cost. The growth accelerated to 5.8 per cent during the
1980s, but the cost of this debt-led growth was growing macro-economic imbalances (fiscal and
current account deficits), which worsened at the beginning of the 1990s, as a result of external shocks,
and led to the macro-economic crisis of 1991.

The growth accelerated to 5.8 per cent during the 1980s, but the cost of this debt-led growth was growing macro-economic
imbalances (fiscal and current account deficits), which worsened at the beginning of the 1990s, as a result of external
shocks, and led to the macroeconomic crisis of 1991.
The crisis led to systemic reforms, going beyond the piecemeal economic reforms of the 1980s.
An IMF aid package and adjustment programme supported these changes. The major reforms
included trade liberalisation, through large reductions in tariffs and conversion of quantitative
restrictions to tariffs, and a sweeping away of a large segment of restrictions on domestic industrial
investment. Attempts were made to control a burgeoning domestic fiscal deficit, but these attempts
were only partially successful, and came to be reversed by the mid-1990s.

Attempts were made to control a burgeoning domestic fiscal deficit, but these attempts were only partially successful, and
came to be reversed by the mid 1990s.
Financial Repression
India has been a financially repressed economy, since at least the 1960s, and, especially since 1969,
when all major banks were nationalised. The links of financial repression to fiscal policy come about
through its implicit tax on the financial system, as well as through its growth consequences, which, in
turn, have implications for government finances. Repressionist policies include various interest rate
controls, directed credit programmes, and required liquidity and reserve ratios. An index based on
these measures (Demetriades and Luintel 1997) shows an increase in financial repression from 1961
through 1984. The index fell in 1985, reflecting a partial deregulation of deposit rate controls.
However, controls were re-introduced after a couple of years, and it was only in 1990 that financial
liberalisation appeared to take a firm hold.

Repressionist policies include various interest rate controls, directed credit programmes, and required liquidity and reserve
ratios.
The financial repression policies force the non-government sector, including publicly owned
commercial banks, to lend to the government at an interest rate below what would have prevailed in
the absence of such policies. The government is, therefore, able to reduce the borrowing cost of
financing its expenditures, as well as the need to monatise as an alternative financing mechanism,
which would instead constitute a politically unpopular inflation tax. One potential consequence of this
system is lower growth through negative impacts on the financial system. Further, borrowing at a rate
below that which would have cleared markets induces the government to borrow more than what it
would have at higher, market-clearing rates, besides reducing the interest cost of what it can borrow.
Fiscal Adjustment
A crisis resolution is almost always contentious as well as painful. For example, crises in Argentina
and Indonesia have had very higheconomic and social costs. India, at least for the moment, does not
appear to face an imminent crisis, especially on the external front. Since crises very often arise from
adverse shifts in expectations or confidence than from deterioration in fundamentals, this favourable
situation could change rapidly if there is a negative shock that affects confidence. The financial sector
is extremely fragile, and some public sector enterprises, particularly in the case of electric power and
irrigation, are bankrupt. Under these circumstances, one cannot rule out the occurrence of a crisis in
the future, which may begin in the banking sector, spill over to the rest of the financial sector, and
ultimately affect all parts of the economy. The fact that, until now, fiscal looseness has manifested
itself in foregone growth should not, therefore, lead to any complacency about its seriousness.

The financial sector is extremely fragile, and some public sector enterprises, particularly in the case of electric power and
irrigation, are bankrupt. Under these circumstances, one cannot rule out the occurrence of a crisis in the future, which may
begin in the banking sector, spill over to the rest of the financial sector, and ultimately affect all parts of the economy.
The World Bank (2003) projections of current trends, based on non-stochastic accounting
identities, and plausible assumptions about interest rates and growth, but without factoring in any
unanticipated shocks, suggest that by 2007, the general government fiscal deficit (excluding
contingent liabilities and public sector enterprise (PSE) losses) will cross 13 per cent of GDP, and the
debt–GDP ratio will increase from about 85 per cent to 103 per cent. Interest payments will absorb
almost 55 per cent of revenue in this case. Adding on contingent liabilities and PSE losses only
strengthens the case that current trends are unsustainable, that is, India cannot postpone fiscal
adjustment much longer by sacrificing growth. The projections of Roubini and Hemming (2004) tell
a similar story. On the positive side, precisely because a crisis is not imminent, India, currently, has
the opportunity to shape fiscal policy in an orderly manner. The real challenges in achieving this are
political rather than technical.
Financing Development Priorities

A major concern with any fiscal adjustment is its potential cost in slowing economic development,
and, in particular, its possible adverse effects on the poor, whose dependence on public services and
income support is larger than of the non-poor. There are two factors that suggest that such cost may
not be high. First, India is, at least for now, in a position to implement some fiscal adjustment before a
crisis possibly hits. This allows Indian government the opportunity to choose carefully how to go
about getting its fiscal house in order, without any constraints that would be imposed in a crisis
situation. There appears to be a reasonable technical consensus on needed reforms, and on how
sufficient political support can be mobilised to implement these reforms. These factors, in principle,
would moderate the cost of adjustment.

A major concern with any fiscal adjustment is its potential cost in slowing economic development, and, in particular, its
possible adverse effects on the poor, whose dependence on public services and income support is larger than of the non-
poor.
The second advantage—if it can be termed is, that in India, delivery of public services is very
inefficient in terms of cost-effectiveness. Improvements in efficiency can allow fewer rupees to
achieve the same or even greater benefits than is currently the case. Examples of such “X-
inefficiency” include the core administrative service at the Centre and the states, programmes such as
the Public Distribution System (PDS) for food, and PSEs, such as the SEBs. In many of these cases,
there will be losers, since public sector employees may currently be enjoying monetary rents or
leisure that will be lost. However, one can hazard that at least some of the leisure in inefficient
organisations is involuntary, and results in frustration rather than any utility gain. As for the impacts
on the poor, the World Bank (2003) is quite clear in its conclusions: “The burden of weak
administration falls particularly on the poor, who suffer from skewed government spending, limited
access to services, and employee indifference”. Thus, it seems that there is room for fiscal adjustment
that benefits rather than hurts the poor. In this context, it has also been noted in the past that a system
of explicit user charges often allows for more efficient as well as more equitable delivery of services.

“The burden of weak administration falls particularly on the poor, who suffer from skewed government spending, limited
access to services, and employee indifference”.
The efficiency of delivery of health and education in rural areas can be improved substantially,
either through restructuring government efforts, or bringing in private participants such as non-
governmental organisations or community groups. There is substantial evidence that institutional
innovations can improve efficiency. In either case, the gains come from improved incentives and
reduced transaction costs. Of course, there are many areas where more cannot be simply squeezed out
of the existing expenditures just by improving incentives for those responsible for the service
delivery. In particular, India still suffers from major bottlenecks in roads, ports, electric power, and
urban infrastructure.
In any case, if India is to achieve a fiscal adjustment that protects growth and development, it needs
to create conditions in its financial sector that will allow for the reduction of the risks associated with
imperfect information, as well as allow for mechanisms that allow participants to manage such risks
better. In addition to regulatory reforms in the financial sector, mechanisms for approval of foreign
direct investment (FDI) need to be streamlined further, and FDI to be opened up more. For example,
only if protecting small, but inefficient retailers, is deemed an appropriate social objective (even
though it may raise costs for the poor) and there is no other socially cost-effective means of
protection, does banning FDI in retailing make sense. On the other hand, new entrants, including
foreigners, can be required to provide urban infrastructure that is essential for efficient retailing.
While in some cases, attracting foreign investors requires the government to increase its investment
in infrastructure, if the opportunity is attractive enough (as is likely to be the case for retailing in
India’s large market), entrants will be willing to provide needed infrastructure. Alternatively,
requiring entrants to obtain a government license and auctioning of such licenses could generate
resources for the government to undertake investment in the needed infrastructure.

In any case, if India is to achieve a fiscal adjustment that protects growth and development, it needs to create conditions in
its financial sector that will allow for the reduction of the risks associated with imperfect information, as well as allow for
mechanisms that allow participants to manage such risks better.
In conclusion, fiscal adjustment does not have to imply a reduction in public services. There is
ample scope in India for improvements in the efficiency of delivery of services through internal
restructuring or private participation. Indeed, cost cutting may be necessary (though not sufficient)
for increased government productivity. Reasonable user charges can also lead to improved budgetary
positions without hurting the poor. For large-scale infrastructure projects, improvements in the
workings of the financial sector are the key to allowing for private participation in ways that allow
government budgets to be stretched further. All of these reforms involve political economy
challenges, and it is these challenges that are most difficult to overcome.

In conclusion, fiscal adjustment does not have to imply a reduction in public services. There is ample scope in India for
improvements in the efficiency of delivery of services through internal restructuring or private participation.
Long-term Fiscal Policy Challenges

We have argued that for various reasons, India’s loose fiscal policy has reduced growth below
potential without showing any discernible signs of an imminent crisis. However, if the fiscal
imbalances are not addressed and growth continues to fall short of potential, the risks of a
conventional crisis—fiscal, monetary, or external—will increase. According to some scenarios, in
which real interest rates stay relatively high and greater efficiencies in investment are only partially
realised, even fiscal reform that cuts the primary deficit substantially over the next three years will
just succeed in maintaining something like the current deficit–GDP ratio of about 10 per cent, and
debt will continue to accumulate, though less rapidly than in the last few years. This is a minimal
objective to aim for over the next few years. Critical elements of any scenario that does not lead to
almost certain crisis down the road are an increase in the tax–GDP ratio, and a reorientation of public
expenditure towards an efficient investment in physical infrastructure and human development, and
away from distortionary and in efficient subsidies.

If the fiscal imbalances are not addressed and growth continues to fall short of potential, the risks of a conventional crisis—
fiscal, monetary, or external—will increase.
The most serious, medium and long-term issue that must be anticipated is the future cost of the
pension system. Many of the conference papers emphasise this relatively recent addition to the causes
for concern with respect to India’s fiscal future. Although some demographic trends will help, by
increasing the proportion of the population that is of working age, the increase in life expectancy will
increase the number of years for which pensions are paid, relative to the number of working years.
Managing this problem by increasing the retirement age can be politically difficult if it reduces the
employment chances of young entrants. However, with sufficiently rapid growth of GDP and
employment, this difficulty will ease. Be that, as it may, Heller ’s paper quotes World Bank estimates
that the cash-flow deficit of the Employees’ Pension Scheme (EPS), which is a defined benefit
scheme, will grow to almost 1 per cent of GDP over the next few decades, even without increases in
coverage. If more employees are covered by the EPS as growth increases the relative size of the
formal sector, then the potential problem will grow accordingly.
The overall picture of the future of government pay and pensions, and social insurance schemes is
gloomy. However, attention to these factors not only allows the government to plan, but can also
increase the awareness of the need for an immediate fiscal adjustment on other fronts, if not this one.
One hopeful area, again, is tax reform. Heller (2004) points out that the tax treatment of pension
contributions is unduly generous, and also creates some perverse incentives. This is one area where
short-term remedies, such as phased reductions of tax preferences, ought to be politically feasible and
relatively easy to implement, once they are on the policy agenda.

The overall picture of the future of government pay and pensions, and social insurance schemes is gloomy. However,
attention to these factors not only allows the government to plan, but can also increase the awareness of the need for an
immediate fiscal adjustment on other fronts, if not this one.
In general, therefore, looking at the longer term and at broader public welfare concerns, can have
three benefits. First, it allows for better intertemporal planning of public expenditures within and
across categories. Second, it improves the pattern of near-term public expenditures towards spending
that reduces the chances of larger expenditures in the future. Third, it emphasises the need for a fiscal
cushion or self-insurance to meet unavoidable expenditures should they occur in the future.
CONCLUSIONS
What are the final lessons of the conference papers, and our own analysis? In this section, we provide
our summary answers, including some thoughts on priorities for action, then discuss some remaining
issues, with respect to the underlying theoretical framework, as well as policymaking and institutional
reform. Our long list of summary lessons goes as follows:
India’s fiscal situation requires immediate attention: high growth and low interest rates will not take care of the problem of long-
run sustainability of the debt, nor the risks of a crisis in the short or medium run.
In fact, the growth in recent years may have been significantly lower than earlier, if the fiscal deficits had not been so high.
A focus only on budget deficits can be misleading, because the problem of off budget and contingent liabilities is serious, and
shifting liabilities off budget without reducing systemic risk does not improve matters.
India’s external position is relatively strong, in terms of trade flows, forex reserves, and level and maturity structure of external
debt: to some extent, monetary and exchange-rate policies are biased by attempts to compensate for fiscal looseness.
However, high reserves and a conservative monetary policy may not be sufficient insurance against a crisis of confidence. There
are theoretical reasons and previous empirical evidence of high domestic debt and deficits being associated with such a crisis.
Furthermore, there are numerous potential sources of risk, including interest rate volatility as well as exogenous shocks.
Many of the risks facing the public sector are intertwined with the fragility of the banking sector, in general—there is, probably,
a two-way causality here that must be recognised explicitly in planning any adjustment. There are structural aspects of the
financial system, as well as the high availability of government bonds, that may be crowding out productive investment.
Neither comfort in India’s external position nor concerns about destabilising the financial sector should be an argument against
fiscal and financial reform: in fact, the good external situation gives India a window of opportunity to move forward with
structural reforms.
Financial sector reform needs to be broader and deeper than it has been so far, and reduction in the direct and indirect influence
of the government in this sector must continue.
A narrow focus on deficits or debts, even including off-budget liabilities, can lead to a neglect of long-run growth implications:
it is essential to examine public consumption, investment, taxation, and deficits in a framework that recognises these, which are
endogenously determined, along with the growth rate.
Available theoretical models surely leave a lot to be desired, but they have the ingredients of what is needed to make a
headway in empirically examining the optimal path of fiscal adjustment, as well as long run targets: current policy making in
India may still not fully appreciate the endogeneity of behavioural factors.
The coordination of fiscal policy with monetary and exchange-rate policies would be better than letting the latter adjust to fiscal
looseness, as seems to have been happening recently.
India’s democratic system and federal structures present challenges to fiscal policy that are common across all federal
democracies (including developed one), and are well recognised in theoretical terms.
However, given the potential improvements that can be made in policy, one has to search for institutional changes that will
provide the right incentives to policymakers: this applies to all reforms, not just fiscal reforms.
In order for this process to work, policymakers must have an incentive to act: one obvious idea is that reforms may need to be
bundled in ways that garner sufficient political support. This may be especially relevant where there are potential Centre–State
conflicts.
While the consequences of the Fifth Pay Commission Award and the states’ worsening fiscal positions are obvious and related
points of concern, both may be overstated. For example, the states’ budgetary position in the aggregate may have stabilised.
Furthermore, there is sufficient variation across the states (not all states implemented the award in full)to indicate that policy
matters, and the right incentive structures may lead to beneficialcompetition among the states in fiscal management.
However, the quality of expenditures at the Centre and the states overall has deteriorated, and the solution to this has to be a
rationalisation of government, both internally and through privatisation. Thus, expenditure restructuring must accompany
expenditure control.
Privatisation, when combined with increased competition, thus has a role that goes beyond any immediate contribution to
reducing fiscal deficits, viz., promoting efficiency in “public” service delivery, and merely changing ownership, without removing
government control, may not fulfill this second role. In the long run, however, the second role may be a more important
contribution to fiscal health.
The revenue-enhancing tax reform is critical at all levels, including Centre, states, and local governments. Although there is
ample room for improving the structure of indirect taxes, in particular (including moving away from inefficient internal border
taxes), improved tax administration and enforcement remains one of the most critical areas for internal government reform. Tax
reform is an essential step towards increasing government revenue, as well as reducing micro-economic distortions.
Institutional reforms such as improvements in the intergovernmental transfer system, borrowing mechanisms for state
governments, and budgeting practices and norms are all technically possible and may well be politically feasible.
Although fiscal adjustment requires some immediate attention, Indian governments have the opportunity to plan it intelligently,
rather than being straitjacketed by a crisis.
Therefore, measures such as hiking tariffs to raise revenue, or cutting productive expenditures, as ways of achieving a better
fiscal balance, are to be avoided.
CASE
The problem of India is not a lack of resource; it is the inability and/or unwillingness to mobilise
resources into the public sector. Indian economy is not facing a resource crisis, but it is confronting
the fiscal crisis.
The reasons are that the share of direct taxes had steadily declined over the years inspite of the fact
that both incomes and savings of the top 10 per cent of the households in the country had been steadily
increasing. The government is not showing any commitment towards placing greater reliance on the
direct taxes to mobilise resources. The government is unwilling to tax the rich and, therefore, it has
no other option except to fall back on indirect taxes and rely more than ever on borrowing from
those who expect interest and tax concessions, from temporarily parting with their resources, to
enable the government to continue its “development programmes”. Grave instersectoral imbalances
also exist in India’s tax structure because agricultural incomes are virtually tax free. The Raj
Committee had recommended introduction of an agricultural tax to remove this inequity, but the state
governments did nothing to implement the recommendations of this Committee. The long-term fiscal
policy also did nothing to eliminate this intersectoral inequity.
Failure of public sector enterprises to generate the contemplated re-investible surplus and small
surplus, which became available from these enterprises, was not attributable to improved efficiency.
The fiscal deficit reflects the total resource gap, whichequals the excess of total government
expenditure over government revenue and grants. The fiscal deficit, thus, fully indicates the
indebtedness of the government.
Case Question
Suggest some remedies for the new fiscal policy to face the fiscal crisis.
SUMMARY
Monetary policy in India has been formulated in the context of economic planning, whose main
objective has been to accelerate the growth process in the country. Economic planning in a country
like ours leads to an expansionary fiscal policy, under the compulsions of increasing demand to
expand both the plan and the non-plan expenditure. Monetary policy under those circumstances is
asked to play a difficult role, on the one hand, it is required to facilitate the role of a countervailing
force.
According to C. Rangarajan, over the years, the following factors have essentially guided the conduct
of the monetary policy. First, the monetary policy measures have generally been a response to the
fiscal policy. Secondly, monetary policy has been primarily acting through availability of credit, and
thirdly, the areas of operation of monetary policy did not remain confined to the factors related to the
regulation of money supply and keeping the prices in check.
Since the introduction of the economic reforms in 1991, the lowering of the CRR and the SLR and the
reduction in the bank rate clearly suggest that the entire concern of the monetary policy in the 1990s
has been to ensure an adequate expansion in the credit to assist the industrial growth.
The fiscal policy formulated by the Government of India has been creating a considerable impact on
the economy of the country. Taxation, public expenditure, and public debt have been increasing at a
considerable pace. The public sector of the country has also been expanded considerably. The country
has been able to attain a significant development of this industrial infrastructurial sector, but the
burden of taxation in our country is comparatively heavily and, thereby, it has been affecting the
saving capacity of the people. Moreover, with the failure of the fiscal policy of the country to check
the extent of the inadequacy in the distribution of income and wealth, and also the failure to solve the
problem of unemployment and poverty even after 50 years of planning, is highly alarming. The fiscal
policy has always failed to maintain the stability in the price level of the country. It would now be
better to study advantages and shortcomings of the fiscal policy of the country in a brief manner.
KEY WORDS
Monetary Policy
Credit Control
Fiscal Policy
Public Expenditure
Deficit Finanacing
Inflation
Public Debt
Economic Crises
Cash Reserve Ratio (CRR)
Bank Rate
Open-Market Operations (OMOs)
External Debt
Internal Debt
Tax
EPS
X-inefficiency
Fiscal Adjustment
Subsidies
Tax Evasion
QUESTIONS
1. Discuss the monetary policy measures announced by RBI recently.

2. What do you mean by monetary policy? Discuss its objectives and importance.
3. Define the fiscal policy of India. Analyse its objectives and techniques.
4. Analyse the merits and shortcomings of fiscal policy of India. Suggest necessary reforms in the fiscal policy of the country.
5. Evaluate fiscal policy of India and give suggestion for its reforms.
6. Discuss the recent fiscal policy announced by the Government of India.
REFERENCES
Dewett, K. K. (2002). Modern Economic Theory. New Delhi: Sultan Chand.

Fiscal Policy Statement, Government of India.
http://www.rediff.com/money/2002/apr/25tut.htm
Misra, S. K. and Puri V. K. (2000). Indian Economy. Mumbai: Himalaya Publishing House.
Paul, H. (2003). The Economic Way of Thinking, 10th ed. New Delhi: Pearson Education.
The Hindu Businessline. April 30, 2008.
CHAPTER 06
Economic Trends
CHAPTER OUTLINE

The Indian Financial Systems
Indian Money Market
Indian Capital Market
Call Money Market
Bill Market
Financial System
Structure of the Financial System
Functions of the Indian Financial System: Promotion of Capital Formation
The Price Policy

Price Movement Since Independence
Objectives of Price Policy
Prices of Industrial Products
Control of Expenditure
Key Words
Questions
References
I. THE INDIAN FINANCIAL SYSTEMS
INDIAN MONEY MARKET
Concept and Meaning of Money Market
A well-organised money market is the basis for an effective monetary policy. A money market may
be defined as the market for lending and borrowing of short-term funds. It is the market where the
short-term surplus investible funds of bank and other financial institutions are demanded by
borrowers comprising individuals, companies, and the government. Commercial banks are both
suppliers of funds in the money market and borrowers.

A money market may be defined as the market for lending and borrowing of short-term funds.
The Indian money market consists of two parts: the unorganised and the organised sectors. The
unorganised sector consists of an indigenous banker who pursues the banking business on traditional
lines and non-banking financial companies (NBFCs). The organised sector comprises the Reserve
Bank of India (RBI), the State Bank of India (SBI) and its associate banks, the 20 nationalised banks,
and other private sector banks, both Indian and foreign. The organised money market in India has a
number of sub-markets, such as the treasury bills market, the commercial bills market, and the inter-
bank call money market. The Indian money market is not a single homogeneous market but is
composed of several sub-markets, each one of which deals in a particular type of short-term credit.

The Indian money market consists of two parts: the unorganised and the organised sectors.
The Indian money market is not a single homogeneous market but is composed of several sub-markets, each one of which
deals in a particular type of short-term credit.
The Composition of the Indian Financial System
The Indian financial system which refers to the borrowing and lending of funds or to the demand for
and supply of funds, consists of two parts, viz., the Indian Money Market and the Indian Capital
Market. The Indian money market is the market in which short-term funds are borrowed and lent. The
capital market in India, on the other hand, is the market for medium and long-term funds.
Usually, we classify the Indian money market into organised sector and the unorganised sector. The
organised sector of the money market consists of commercial banks in India, which includes private
sector and public sector banks, and also foreign banks. The unorganised sector consists of indigenous
bankers, including the NBFCs. Besides these two, there are many sub-markets in the Indian money
market.
The Composition of the Indian Banking System
The organised banking system in India can be broadly divided into three categories, viz., the central
bank of the country known as the Reserve Bank of India (RBI), the commercial banks, and the
cooperative banks. Another and more common classification of banks in India is between scheduled
and non-scheduled banks. The Reserve Bank of India is the supreme, monetary and banking authority
in the country and has the responsibility to control the banking system in the country. It keeps the
reserves of all scheduled banks and, hence is known as the “Reserve Bank”.

The organised sector of the money market consists of commercial banks in India, which includes private sector and public
sector banks, and also foreign banks. The unorganised sector consists of indigenous bankers, including the NBFCs. Besides
these two, there are many sub-markets in the Indian money market.
Under the Reserve Bank of India (RBI) Act, 1934, banks were classified as scheduled banks and
non-scheduled banks. The scheduled banks are those which had been entered in the Second Schedule
of RBI Act, 1934. Such banks are those which have a paid-up capital and reserves of an aggregate
value, of not less than Rs 5 lakh, and which satisfy RBI that their affairs are carried out in the interests
of their depositors. All commercial banks—Indian and foreign, regional rural banks, and state
cooperative banks—are scheduled banks. Non-scheduled banks are those which have not been
included in the Second Schedule of the RBI Act, 1934. At present, there are only three non-scheduled
banks in the country. The scheduled banks are divided into commercial banks and cooperative banks.
The commercial banks are based on profit, while cooperative banks are based on cooperative
principle. A comparative analysis of global finance markets has been given in Box 6.1.

All commercial banks—Indian and foreign, regional rural banks, and state cooperative banks—are scheduled banks. Non-
scheduled banks are those which have not been included in the Second Schedule of the RBI Act, 1934.
Box 6.1 Comparative Analysis of Global Finance Markets
INDIAN CAPITAL MARKET
Capital market is the market for long-term funds, just as the money is the market for short-term
funds. It refers to all the facilities and the institutional arrangements for borrowing and lending term
(medium and long-term funds). It does not deal in capital goods but is concerned with the raising of
capital for the purpose of investment.

Capital market is the market for long-term funds, just as the money is the market for short-term funds.
The demand for long-term capital comes predominantly from private sector manufacturing
industries and agriculture, and from the government, not only for the purpose of economic overheads
like transport, irrigation, and power development but also on basic industries and, sometimes, even
consumer goods industries, as they require substantial sums from the capital market. The supply of
funds for the capital market comes largely from individual savers, corporate savings, banks,
insurance companies, specialised financing agencies, and the government. Among institutions we
may refer to the following:
1. Commercial banks are important investors, but are largely interested in government securities and, to small extent, debentures of
companies.
2. LIC (Life Insurance Corporation) and GIC (General Insurance Corporation) are gaining importance in the Indian capital market,
though their major interest is still in government securities;
3. Provident funds constitute a major medium of saving but their investment too are mostly in government securities; and
4. Special institutions set up since independence, viz., IFCI (Industrial Finance Corporation of India), ICICI (Industrial Credit and
Investment Corporation of India), IDBI (Industrial Development Bank of India), UTI (Unit Trust of India), and so on—generally
called Development Financial Institutions—aim at supplying long-term capital to the private sector.
The supply of funds for the capital market comes largely from individual savers, corporate savings, banks, insurance
companies, specialised financing agencies, and the government.
There are financial intermediaries in the capital market, such as merchant bankers, mutual funds,
leasing companies, and so on, which help on mobilising, saving and supplying fund to the capital
market. Like all markets, the capital market is also composed of those who demand funds
(borrowers) and those who supply funds (leaders). An ideal capital market attempts to provide
adequate capital at a reasonable rate of return for any business or individual proposition, which
offers a perspective yield high enough to make borrowing worthwhile. The rapid expansion of the
corporate and public enterprises since 1951 has necessitated the development of the capital market in
India. The Indian capital market is broadly divided as the gilt-edged market and the industrial
securities market. The gilt-edged market refers to the market for government and semi-government
securities, backed by the RBI. The securities traded in this market are stable in value and are much
sought after by banks and other institutions.

There are financial intermediaries in the capital market, such as merchant bankers, mutual funds, leasing companies, and
so on, which help on mobilising, saving and supplying fund to the capital market.
The Indian capital market is broadly divided as the gilt-edged market and the industrial securities market. The gilt-edged
market refers to the market for government and semigovernment securities, backed by the RBI. The securities traded in this
market are stable in value and are much sought after by banks and other institutions.
The industrial securities market refers to the market for shares and debentures of old and new
companies. This market is further divided as the new-issue market and the old capital market meaning
“the stock exchange”. The new-issue market—often referred to primary market, denotes the raising
of new capital in the form of shares and debenture, whereas the old-issue market deals with securities
already issued by companies. The old-issue market or the stock market exchange is also known as the
secondary market. Both markets are equally important, but often, the new-issue market is much more
important from the point of economic growth. However, the functioning of the new-issue market will
be facilitated only when there are abundant facilities for transfer of existing securities. Besides the
gilt-edged market and variable-yield industrial securities, the Indian capital market includes
development financial institutions and financial intermediaries.
CALL MONEY MARKET
One important sub-market of the Indian money market is the Call Money Market, which is the market
for short-term funds. This market is also known as “money at call and short notice”. The locations of
call money centres in India are given in Box 6.2. This market has actually two segments, viz., (a) the
call market or overnight market and (b) short notice market. The rate at which funds are borrowed
and lent in this market is called the “call money rate”.

One important sub-market of the Indian money market is the Call Money Market, which is the market for short-term funds.
This market is also known as “money at call and short notice”.
Box 6.2 Call Money Centres in India
Call money centres are mainly located in
1. Mumbai
2. Kolkata
3. Delhi
4. Chennai
5. Ahmedabad
6. Mangalore
Call money rates are market determined, that is, by demand for and supply of short-term funds. The
public sector banks account for about 80 per cent for the demand (i.e., borrowings), and foreign
banks and Indian private sector banks account for the balance of 20 per cent of borrowings. Non-
banking financial institutions, such as IDBI, LIC, GIC, and so on, enter the call money market as
lenders and supply up to 80 per cent of the short-term funds. The balance of 20 per cent of the funds is
supplied by the banking system. Although some banks operate both as lender and borrowers, others
are either only borrowers or only lenders in the call money market.

The public sector banks account for about 80 per cent for the demand (i.e., borrowings), and foreign banks and Indian
private sector banks account for the balance of 20 per cent of borrowings.
BILL MARKET
The bill market or the discount market is the most important part of the money market where short-
term bills normally up to 90 days are bought and sold. The bill market is further subdivided into
commercial bill market and treasury bill market. The 91-day treasury bills are the most common way
the Government of India raises funds for the short period. Some years ago, the government had
introduced the 182-day treasury bills which were later converted into 364-day treasury bills. In 1997,
the government introduced the 14-day intermediate treasury bills.

The bill market or the discount market is the most important part of the money market where short-term bills normally up to
90 days are bought and sold.
FINANCIAL SYSTEM
In a broad sense, finance refers to funds of monetary resources needed by individuals, business
houses, and the government. Individuals and households require funds essentially for meeting their
current requirements or day-to-day expenses or for buying capital goods (commonly known as
investment). A list of some investments in international money market is given in Box 6.3. A business
unit, a factory, or a workshop needs funds for paying wages and salaries, for buying raw materials,
for purchasing new machinery, or for replacing an old one, and so on. Traders require finance for
buying and stocking goods in their shops and godowns; whereas farmers for different periods and
for different purposes.

In a broad sense, finance refers to funds of monetary resources needed by individuals, business houses, and the
government.

Box 6.3 Global Instruments
The more common instruments which are available for investment and some investments in
international money market are:
1. International bank deposits (FD)
2. Certificates of deposits (CD)
3. Euro currency deposits
4. Euro commercial paper
5. Banker’s acceptance
6. Bills of exchange
7. Treasury bills and treasury bonds of major international markets, say New York, London, Frankfurt, and so on
8. Corporate bonds and junk bonds of short maturities
9. Floating-rate notes
10. Notes-issuance facility.
STRUCTURE OF THE FINANCIAL SYSTEM
The Financial System of India refers to the system of borrowing and lending of funds or the demand
for and the supply of funds to all individuals, institutions, companies, and of the government,
commonly. The financial system is classified into
a. Industrial Finance: Funds required for the conduct of industry and trade;
b. Agricultural Finance: Funds needed and supplied for the conduct of agriculture and allied activity;
c. Development Finance: Funds needed for development; actually, it includes both industrial finance and agricultural finance; and
d. Government Finance: Relates to the demand for and supply of funds to meet government expenditure.
The Financial System of India refers to the system of borrowing and lending of funds or the demand for and the supply of
funds to all individuals, institutions, companies, and of the government, commonly.
Indian financial system includes the many institutions and the mechanism that affects the generation of
savings by the community, the mobilisation of savings, and the effective distribution of the savings
among all those who demand the funds for investment purposes. Broadly, therefore, the Indian
financial system is composed of
a. The banking system, the insurance companies, mutual funds, investment funds, and other institutions that promote savings among
the public, collect their savings, and transfer them to the actual investors; and
b. The investors in the country are composed of individual investors, industrial and trading companies, and the government—these
investors enter the financial system as borrowers.
Indian financial system includes the many institutions and the mechanism that affects the generation of savings by the
community, the mobilisation of savings, and the effective distribution of the savings among all those who demand the funds
for investment purposes.
The stock exchanges in India facilitate the buying and selling of shares and debentures of existing
companies and, thus, help savers to shift from one type of investment to another.

The stock exchanges in India facilitate the buying and selling of shares and debentures of existing companies and, thus,
help savers to shift from one type of investment to another.
FUNCTIONS OF THE INDIAN FINANCIAL SYSTEM: PROMOTION OF CAPITAL FORMATION
The Indian financial system performs a crucial role in the economic development of India through
savings investment process, also known as “capital formation”. It is for this reason that the financial
system is sometimes called the “financial market”. The purpose of the financial market is to mobilise
savings effectively and allocate the same efficiently among the ultimate users of funds, via investors.
A high rate of capital formation is an essential condition for rapid economic development. The
process of capital formation depends upon
a. Increase in savings, that is, the resources that would have been normally used for consumption purposes can be released for
other purposes;
b. Mobilisation of savings, that is domestic savings collected by banking and financial institutions and placed at the disposal of
actual investors; and
c. Investment proper, which is the production of capital goods.
The Indian financial system performs a crucial role in the economic development of India through savings investment
process, also known as “capital formation”. It is for this reason that the financial system is sometimes called the “financial
market”.
The third stage or process is the real capital formation, but this stage cannot arise or exist without the
first two processes. Thus, the general public should save and be prepared to release real resources
from consumption goods to capital goods. The savings of the people should be mobilised by banking
and financial institutions. Finally, the savings of the people should be made available to investors to
produce capital goods. All these three steps or processes, though independent of each other, are
necessary for accumulation of capital. The importance of banking and financial institutions in the
capital formation process arises because those who save and those who invest in India are generally
not the same persons or institutions. The financial institutions and the banks act as intermediaries to
bring the savers and investors together.

The importance of banking and financial institutions in the capital formation process arises because those who save and
those who invest in India are generally not the same persons or institutions. The financial institutions and the banks act as
intermediaries to bring the savers and investors together.
Recent Trends in Money Market
The capital and commodity markets remained buoyant during 2007. Relatively, stable
macroeconomic conditions as reflected in the moderate rate of inflation, growth-conducive interest-
rate situation, improved fiscal conditions, and larger investor participation augured well for capital
and commodity markets, as measured in terms of volume and value of transactions.
Capital Market
The Indian capital market attained further depth and width in the business that was transacted during
2007. The Bombay Stock Exchange (BSE) Sensex, which had been witnessing an upswing since the
latter part of 2003, scaled a high of 20,000 mark at the close of calendar year 2007. The National
Stock Exchange (NSE) Index rose in tandem to close above the 6,100 mark at the end of 2007. Both
the indices more than tripled between 2003 and 2007, giving handsome yearly returns. Alongside the
growth of business in the Indian capital market, the regulatory and oversight norms have improved
over the years, ensuring a sound and stable market.

The Bombay Stock Exchange (BSE) Sensex, which had been witnessing an upswing since the latter part of 2003, scaled a
high of 20,000 mark at the close of calendar year 2007.
Primary Market
The primary capital market grew in 2006 and 2007 after the set back of 2005. The amounts raised and
the number of new issues which entered the market increased in 2007. The total amount of capital
raised through different market instruments during 2007 was 31.5 per cent higher than during 2006,
which itself had seen a rebound of 30.6 per cent over the lows of 2005 (refer to Table 6.1).
Component-wise, the private placement at Rs 111,838 crore (up to November 2007) accounted for
the major share during 2007. The total equity issues mobilised was Rs 58,722 crore, of which Rs
33,912 crore was accounted for by the initial public offerings (IPOs). During 2007, the total number
of IPOs issued was 100 when compared to 75 in the previous year.
In line with the rising trend in resources raised in the primary market, the net inflow of savings into
mutual funds increased by over 30 per cent in 2007 to Rs 138,270 crore (refer to Table 6.2). The
sharp increase in funds flowing into the mutual funds during 2007 was partly due to buoyant equity
markets and also due to the efforts made by the Indian mutual funds to introduce innovative schemes.
Income/debt-oriented schemes fared relatively better during the year compared to other schemes. The
private sector mutual funds outperformed the public sector mutual funds in terms of resource
mobilisation in 2007. The share of UTI and other public sector mutual funds in total amount, that
mobilised gradually, declined over the years to 17.8 per cent in 2006 and further to 12.7 per cent in
2007.

The sharp increase in funds flowing into the mutual funds during 2007 was partly due to buoyant equity markets and also
due to the efforts made by the Indian mutual funds to introduce innovative schemes.

Table 6.1 Resource Mobilisation Through Primary Market
Source: SEBI and RBI (for euro issues).

*Till November 2007.

Table 6.2 Trends in Resource Mobilisation (Net) by Mutual Funds
Source: SEBI.

Secondary Market
In the secondary market segment, the market activity expanded further during 2007–08 with BSE and
NSE indices scaling new peaks of 21,000 and 6,300, respectively, in January 2008. Although the
indices showed some intermittent fluctuations, reflecting change in the market sentiments, the indices
maintained their north-bound trend during the year. This could be attributed to the larger inflows
from foreign institutional investors (FIIs) and wider participation of domestic investors, particularly
the institutional investors. During 2007, on a point-to-point basis, Sensex and Nifty indices rose by
47.1 per cent and 54.8 per cent, respectively. The buoyant conditions in the Indian bourses were aided
by, among other things, like a relatively higher GDP growth among the emerging economies,
continued uptrend in the profitability of the Indian corporates, persistence of difference in domestic
and international levels of interest rates, impressive returns on equities, and a strong Indian rupee on
the back of larger capital inflows.

The buoyant conditions in the Indian bourses were aided by, among other things, like a relatively higher GDP growth
among the emerging economies, continued uptrend in the profitability of the Indian corporates, persistence of difference in
domestic and international levels of interest rates, impressive returns on equities, and a strong Indian rupee on the back of
larger capital inflows.
Among the NSE indices, both Nifty and Nifty Junior delivered annual equity returns making a
record (current year-end index divided by previous year-end index multiplied by 100) of 54.8 per cent
and 75.7 per cent, respectively, during the calendar year 2007 (refer to Table 6.3 and Figure 6.1).
While Nifty gave compounded returns of 34.4 per cent, Nifty Junior recorded compounded returns of
38.4 per cent per year between 2003 and 2007.

Table 6.3 Closing Values of NSE Indices (Nifty 50 and Nifty Junior at Month End)
Source: National Stock Exchange.

Fig ure 6.1 Movement of Indices of NSE and BSE

In terms of month-to-month movement, the NSE indices (Nifty and Nifty Junior) were subdued
during February and August 2007, while they showed a rising trend during the rest of the year. The
BSE Sensex (top 30 stocks) too echoed a similar trend (refer to Table 6.4). The sell-offin Indian
bourses in August 2007 could partly be attributed to the concerns on the possible fallout of the sub-
prime crisis in the West.
Although the climb of BSE Sensex during 2007–08 so far, was the fastest ever, the journey of BSE
Sensex from 18,000 to 19,000 mark was achieved in just four trading sessions during October 2007. It
further crossed the 20,000 mark in December 2007 and 21,000 in an intra-day trading in January
2008. However, BSE and NSE indices declined subsequently, reflecting concerns on global
developments. BSE Sensex yielded a compounded return of 36.5 per cent per year between 2003 and
2007. In terms of simple average, BSE Sensex has given an annual return of more than 40 per cent
during the last eight years. BSE-500 recorded a compounded annual return of 38 per cent between
2003 and 2007.

BSE Sensex yielded a compounded return of 36.5 per cent per year between 2003 and 2007. In terms of simple average,
BSE Sensex has given an annual return of more than 40 per cent during the last eight years.
Among the Asian stock markets, Chinese and Indonesian markets outperformed the Indian markets
in terms of cumulative performance over 2003 levels (refer to Table 6.5). While the BSE Sensex rose
by 47.1 per cent during 2007, SSE Composite Index (Shanghai, China) rose by 96.7 per cent, and the
Jakarta Composite Index (Indonesia) increased by around 52 per cent.Other international indices that
rose appreciably in 2007 were Hang Seng (Hong Kong) by 39.3 per cent, Kospi (South Korea) by
32.3 per cent, and Kuala Lumpur Comp Index (Malaysia) by 31.8 per cent (refer to Table 6.5). As the
stock indices scaled new heights, investors’ wealth as reflected in market capitalisation also rose
correspondingly. The market capitalisation in India nearly doubled in 2007. The markets were more
stable in 2007, as measured by the standard deviation of daily volatility of the Indian indices when
compared to the previous year (refer to Table 6.6). The priceto-earnings (P/E) ratio, which partly
discounts future corporate earnings, reflecting investors’ expectations of corporate profit, was higher
at around 27 by end-December 2007 when compared to around 21 at end-December 2006.

Table 6.4 Closing Value of BSE Indices (Sensex and BSE-500) at Month End
Source: Bombay Stock Exchange.

Table 6.5 Cumulative Change in the Movement of Global Indices
Source: Derived from various country sources.

*End-month closing.

Table 6.6 Equity Returns, Volatility, Market Capitalisation, and P/E Ratio
Source: National Stock Exchange and Bombay Stock Exchange.
*Standard deviation values.

It is, however, noted that in the period January 2006 to December 2007, the volatility of weekly
returns of Indian indices was higher when compared to indices outside India such as S&P 500 of the
United States and Kospi of South Korea (refer to Table 6.7). The valuation of Indian stocks as
reflected in P/E, multiples of around 27 times at end-December 2007, was the highest among the
select emerging market economies, such as South Korea, Thailand, Malaysia, and Taiwan (refer to
Table 6.8).

The valuation of Indian stocks as reflected in P/E, multiples of around 27 times at end-December 2007, was the highest
among the select emerging market economies, such as South Korea, Thailand, Malaysia, and Taiwan.
One of the important indicators to assess the size of the capital market is the ratio of market
capitalisation to GDP. In India as on December 30, 2007, market capitalisation (BSE-500) at US$1,638
bn was 150 per cent of GDP, which compares well with the other emerging economies as well as
select matured markets (refer to Table 6.9).

Table 6.7 Volatility of Weekly Returns on the Equity Markets (standard deviation)
Class of stocks Period
Jan 2005– Dec 2006 Jan 2006– Dec 2007
India
Top 50 (Nifty) 2.01 2.45
Next 50 (Nifty Junior) 2.41 2.85
Sensex 2.96 3.17
BSE 500 3.23 3.30
Outside India
US (S&P 500) 0.95 1.28
Korea (Kospi) 1.84 2.17

Table 6.8 P/E Ratios in Select Emerging Markets
Index/Market Mar 2007 Dec 2007

South Korea, KOSPI 11.36 15.04
Thailand, SET 10.59 19.92
Indonesia, JCI 19.54 18.43
Malaysia, KLCI 16.97 16.07
Taiwan, TWSE 17.92 20.14
BSE Sensex 20.50 27.67
S&P CNX Nifty 18.38 27.62
Source: SEBI and Bloomberg Financial Services.

Table 6.9 Market Capitalisation in Select Countries
Market Capitalisation (US$ bn) Market Capitalisation as % of

Country
as on December 30, 2007 GDP
China 4,459.48 137.3
India 1,638.20* 150.0
Japan 4,535.08 104.4
South Korea 1,103.34 116.2
United States 17,773.05 128.8
Source: Derived from various country sources.

*Market capitalisation of BSE 500.

The price of a security depends largely on demand and supply conditions and is influenced by the
impact of cost and liquidity. The liquidity and the impact cost are inversely related. While the impact
cost for purchase or sale of Rs 25 lakh for Nifty Junior portfolio improved marginally over the years
to 0.14 per cent during 2007, for the Nifty portfolio, it remained stable at 0.08 per cent during the last
few years (refer to Table 6.10). Both NSE and BSE continued to show an upward trend. During 2007,
both NSE and BSE spot market turnover showed a rise of over 60 per cent and 47 per cent,
respectively, over the previous year. In respect of NSE and BSE derivatives, the increase was around
70 per cent and 200 per cent, respectively (refer to Table 6.11).

The price of a security depends largely on demand and supply conditions and is influenced by the impact of cost and
liquidity. The liquidity and the impact cost are inversely related.
The spot market turnover (one-way) for NSE and BSE (together) amounted to Rs 4508,709 crore.
In the derivatives market, the NSE and BSE turnover added up to Rs 12,160,701 crore during 2007,
showing a quantum growth over the previous year. During 2007, as a proportion of market
capitalisation of Nifty, the turnover in NSE spot and derivative market was 87.8 per cent and 339 per
cent, respectively. The turnover in BSE spot and derivative market accounted for 22 per cent and 3 per
cent, respectively, of market capitalisation of BSE-500.
In terms of institutional players, both FIIs and mutual funds leveraged their activity in the equity
market during the year. While the net investment by FIIs in both spot and derivative markets witnessed
quantum increases during 2007, the corresponding gross buy/sell by FIIs too increased significantly.
In 2007, FIIs’ net activity (gross buy/gross sell) constituted 17.3 per cent of the spot market and 9 per
cent of the derivative market (refer to Table 6.11). The number of registered FIIs rose to 1,219 at the
end of 2007 from 1,044 in the corresponding period of last year; the number of sub-accounts also
increased to 3,644 from 3,045 over the same period. The assets under the management of mutual
funds grew by 1.7 times from Rs 3.23 lakh crore during 2006 to Rs 5.50 lakh crore in 2007.

In terms of institutional players, both FIIs and mutual funds leveraged their activity in the equity market during the year.

Table 6.10 Equity Spot Market Liquidity: Impact Cost (%)
Source: National Stock Exchange.

Table 6.11 Market Turnover
II. THE PRICE POLICY
PRICE MOVEMENT SINCE INDEPENDENCE
A proper study of price movements and the value of rupee since 1950–51 requires the existence of
wholesale price index (WPI) of all commodities with 1950–51 as the base year. The Government of
India started with such a price index. Unfortunately, the government gave up the series in the middle
of the 1960s and started a new series with 1960–61 as the base year. In fact, in its anxiety to prevent
people from making a real comparison of the continually rising price level and rapidly declining
purchasing power of the rupee since 1950–51, the government has been changing the base year every
decade—from 1950–51 to 1960–61, later to 1970–71, and finally to 1981–1982. The usual plea taken
by the government is that the new series has a considerably larger coverage of items, grades, and
markets, and that it is also based on a larger number of quotations. Whatever be the reasons, with the
change in the base every decade, however, we are not able to make any valid and broad comparison
of price movements since the economic planning was introduced in 1950–51.
Price Situation During 1951–71
One of the declared objectives of the First Plan was to combat inflationary pressures. Aided by
bumper crops, the First Plan largely succeeded in achieving this objective. At the end of the First Plan
period, the general price index number stood at 99 (with 1952–53=100) but the index number of food
articles had declined to about 95 and cereals and pulses stood lower at 88 and 77, respectively. Thus,
during the First Plan the price situation was very favourable.
The success of the First Plan and the favourable movement of prices encouraged the Government
of India to launch still more elaborate plans and undertake still greater degree of deficit financing.
Throughout the Second Plan period, there was a gradual and steady rise in prices; the price level rose
by 20 per cent by 1960–65. The price position during the Third Five-Year Plan deteriorated badly.
The Chinese invasion of India towards the end of 1962, the Indo-Pakistan conflict in 1965, and the
consequent increase in defence expenditure and, above all, the serious famine conditions of 1965–66
were responsible for rapid rise in prices. The price position became really difficult because of
extensive hoarding and black marketing in food grains and other essential goods. Between 1961 and
1966, the rise in the prices of foodstuffs was over 40 per cent, in cereals it was over 45 per cent, and
in pulses it was 70 per cent. The next two years were years of acute inflation when the index number
of wholesale prices shot up by 14 per cent and 11 per cent, respectively. The country was on the brink
of a galloping inflation. Fortunately, the bumper harvest of 1967–68 saved the situation and the
inflationary rise in prices was completely arrested.

The success of the First Plan and the favourable movement of prices encouraged the Government of India to launch still
more elaborate plans and undertake still greater degree of deficit financing.
Price Situation During the 1970s
The upward movement of prices during the Fourth Plan (1969–74) was extremely significant. The
rise in the general price level was rather slow in the beginning of the Fourth Plan but it gathered
momentum later. For instance, the rise in the price level during the first three years of the Fourth Plan
ranged between 7 points and 9 points. In the fourth and the final years, however, the price level rose
by 19 points and 47 points, respectively. Large influx of refugees from Bangladesh, heavy
expenditure of the government on the refugees, the widespread failure of Kharif crops in 1972–73,
and the complete failure of the takeover of wholesale trade in wheat resulted in an unprecedented rise
in price level during 1973–74, with all the characteristics of a galloping inflation. This was
aggravated by a per cent rise in crude oil prices towards the end of 1973 (refer to Box 6.4). The
worldwide inflation of this period and the depreciation in the external value of the rupee vis-a-vis
many currencies of the world, pushed up the costs of imports and aggravated the domestic price
inflation. Reflecting the cumulative impact of these factors, the WPI of all commodities stood at an
all-time high of 331 in September 1974 (with 1961–62=100).

The rise in the general price level was rather slow in the beginning of the Fourth Plan but it gathered momentum later.
The worldwide inflation of this period and the depreciation in the external value of the rupee vis-a-vis many currencies of
the world, pushed up the costs of imports and aggravated the domestic price inflation.
Box 6.4 Impact of Crude Oil Price Increase on Global Commodity Prices
Crude oil prices affect the prices of other commodities in the following ways:
Affect the prices of inputs which the primary commodities use, such as fertilizers and fuel.
Affect the transport cost of commodities over long distances.
Prices of commodities, which have energy-intensive production process, particularly metals, get affected because of an
increase in energy prices.
Affect the prices of the products which could become substitutes for crude or could be used as bio-fuels (like maize and
sugar for ethanol production or rapeseed and other oils for bio-diesel production).
Affect the prices of primary commodities which compete with the synthetic products made from crude (like cotton with man-
made fibres and natural rubber with synthetic rubber).
Affect the prices of commodities which can be substituted for crude as sources of energy (like coal, electricity, and gas).
Based on the annual data from 1960 to 2005 and a simple econometric model, the Working Paper of the World Bank
(Policy Research Working Paper No. 4333—Oil Spills on Other Commodities by John Baffes—August 2007) estimated
the degree of pass due to crude oil price changes to the prices of 35 other internationally traded primary commodities. The
elasticity for the non-energy commodity index was estimated at 0.16 indicating that 1 per cent pass through may impact the
commodity prices by 16 basis points. No estimates are available for India.
Source: Working Paper No. 4333, World Bank, August 2007.

This order of inflation created a veritable crisis in the country and an extreme lack of public
confidence in the ability of the government to manage the price situation. To check the rise in prices,
the government took a number of fiscal and monetary measures like the use of compulsory deposit
scheme (CDS) to impound part of the income of people, imposition of limits on declaration of
dividends and credit squeeze by the RBI. At the same time, the use of MISA (Maintenance of Internal
Security Act) against smugglers, hoarders, and black-marketers also had a favourable impact on the
situation. There was a dramatic change in the price front since September 1974 when the prices started
falling. The fall in the price level during this period was as follows:

To check the rise in prices, the government took a number of fiscal and monetary measures like the use of compulsory
deposit scheme (CDS) to impound part of the income of people, imposition of limits on declaration of dividends and credit
squeeze by the RBI.
The steep decline in prices during this period was of considerable significance to the economy in
that it created an environment of stability and confidence, gave relief to the public that had been
squeezed by inflation in the preceding two years, and helped greatly to dampen the psychology of
scarcity. The credit for checking the rise in the price level was given to the declaration of emergency
in June 1975. The trend of declining prices was unfortunately reversed by the third week of March
1976. Table 6.12 shows the price trend during 1975–76. The rise in prices since March 1976 till
March 1977 completely wiped out the decline in the prices of the previous two years. The level of
prices in April 1977, for example, was the same as that of in September 1974. The propaganda that
Emergency was a major factor for controlling prices was thus exploded.
Price Movement During Janata Rule (1977–79)
A review of price movement during 1977–78 and 1978–79 brings out the fact that the Janata Party
government was indeed successful in holding the price line and in fact, “the maintenance of price
stability has been a positive achievement of the government’s short-term demand and supply
management policies” (refer to Table 6.13).

Table 6.12 Price Trend During 1975–76 (1961–62=100)
Period WPI of all commodities

September 1974 331
March 1975 309
March 1976 283
Source: RBI Bulletin (various issues).

Table 6.13 Price Situation During the Janata Rule (1970–71=100)
WPI of all commodities 1970–

Period
71=100
March 1977 183
January 1978 184
January 1979 185
Source: Economic Survey 1981–82 and RBI Bulletin (various issues).

The conditions in the beginning of 1979 were highly suitable for the continuance of price stability.
The buffer stock of food grains had crossed over 20 million tonnes. The production of food grains
was a record 131 million tonnes. Industrial production had recorded a rise of 9.5 points in 1978 over
the previous year. Availability of critical industrial raw materials like cement, steel and other metals,
and coal, the lack of which restrained industrial growth in the past, was extremely satisfactory. At the
same time, the country had over Rs 5,000 crore worth of foreign exchange reserves, which could be
used effectively to import goods that were in short supply within the country. Despite these favourable
factors, the stability in price level which was managed with such a great effort was upset callously by
an inflationary budget introduced in February 1979 by the then Finance Minister, Mr. Charan Singh.
Besides the heavy dose of indirect taxation, the budget provided for an overall deficit of Rs 1,365
crore, a record again at that time which exerted pressure on prices. Prices started rising almost the
day after the budget was presented in the Parliament. In February 1979 the index number of wholesale
prices stood at 185 (1970–71=100), but by January 1980 it had risen to 224.

Despite these favourable factors, the stability in price level which was managed with such a great effort was upset callously
by an inflationary budget introduced in February 1979 by the then Finance Minister, Mr. Charan Singh.
Price Movement During the 1980s
The Congress Party which returned to power in January 1980 regarded inflation as its “number one”
problem. Initially, the price situation appeared to be hopeless. The poor agricultural crop of 1979–80
and the consequent adverse effect on industrial production and the hike in oil prices by 130 per cent in
1980 alone were responsible for boosting the price level still further (refer to Table 6.14).
The WPI rose by 38 points in 1980–81—an increase of 17.4 per cent over the previous year. A
vigorous anti-inflationary policy kept the rise in prices to moderate levels. The price level was
remarkably steady during 1982–83, though at a slightly higher level. This price stability was achieved
partly through credit restraint and also through an increase in the supply of essential goods via the
public distribution system. Unfortunately, this price stability was only short-lived as the price level
began to rise from the middle of January 1983. The re-emergence of inflationary pressure since
January 1983 was the result of the increase in the prices of certain items, such as pulses, oilseeds, and
other foodstuffs and an increase in the administered prices of a number of goods like coal, electricity,
cement, iron, steel and ferro-alloys, and so on.

The WPI rose by 38 points in 1980–81—an increase of 17.4 per cent over the previous year.
The government was prompt in taking anti-inflationary measures during 1983–84 on both demand
and supply side. On the demand side, the government made a series of adjustments in the cash reserve
ratio (CRR) of the commercial banks to check the growth of liquidity in the banking system. The
commercial banks were also asked to confine their lending operations within certain limits. In
January 1984, the government announced its decision to curtail the public expenditure by 3 per cent to
5 per cent, imposed a temporary ban on fresh government recruitment, and so on. The objective of
these monetary and fiscal measures was to check the increase in the volume of money supply in the
country and also to check effective demand.

The government was prompt in taking anti-inflationary measures during 1983–84 on both demand and supply side.
On the supply side, the government attempted to increase the supply of goods and services through
both short and long-term measures. Short-term measures included larger releases of wheat, rice,
sugar, and edible oils through the public distribution system and imports of food grains and edible
oils to augment the domestic availability. Long-term measures included steps taken to increase
production in critical areas. To some extent, the demand and supply management of the government
during the Sixth Plan (1980–85) was largely successful in containing the prices. The annual rate of
increase in prices during this period ranked around 7 per cent to 8 per cent.

To some extent, the demand and supply management of the gov-ernment during the Sixth Plan (1980–85) was largely
success-ful in containing the prices.

Table 6.14 Price Movement During the Sixth Plan (1970– 71=100)
Year WPI of all commodities % Variation over the previous year

1979–80 218 _
1980–81 256 17.8
1981–82 281 9.8
1982–83 289 2.9
1983–84 316 9.4
1984–85 338 7.0
Source: Compiled from Economic Survey 1988–89, the Government of India.

During the Seventh Plan period (1985–90), the wholesale prices moved upward rather steadily. The
annual rate of inflation during this period ranged between 4.7 per cent (1985–86) and 9.4 per cent
(1987–88) and averaged 7 per cent. The pressure on prices was due to the shortfall in production of
essential agricultural commodities in order to control inflationary rise of prices, during the Seventh
Plan period. RBI tightened the selective credit controls and took certain measures to mop up excess
liquidity. The availability of large stocks of rice and wheat, built over many years, was effectively
used to combat drought and inflation. The food reserves were used to supply food grains through
public distribution system, to special employment programmes, relief programmes, and so on. The
government took recourse to large imports of edible oils, pulses, rice, and sugar to maintain adequate
supplies. For some essential commodities, appropriate price bands were determined and suitable
market intervention operations were undertaken to maintain stability of prices. By and large, the
inflationary situation was under control during the 1980s.

During the Seventh Plan period (1985–90), the wholesale prices moved upward rather steadily.
Price Situation During the 1990s
The price rise since the beginning of 1990 was almost engineered by the government itself through
rise-administered prices and rise in indirect taxes. The increase in the prices of food grains on mere
political considerations and the Gulf surcharge, which raised the prices of petroleum products to an
unprecedented level in one single jump, were the other factors behind the recent rise in prices (refer
to Table 6.15). The inflationary pressure was concentrated on primary commodities such as food
grains, vegetables, sugar, and edible oils. The prices rose rapidly during 1990–91 and 1991–92 and
the average annual rates of inflation were 10.3 per cent and 13.7 per cent, respectively. The inflation
rate was controlled since then because of a better performance by the agricultural sector as also
because of the macro-economic corrections adopted by the government, including reduction in the
fiscal deficit and the resultant control in the expansion of money supply. The improvement in the
price situation was, particularly welcome to the poorer sections of the society, as some items of mass
consumption like cereals, pulses, and edible oils actually registered a drop in their prices during
1992–93 and 1993–94.

The prices rose rapidly during 1990–91 and 1991–92 and the average annual rates of inflation were 10.3 per cent and
13.7 per cent, respectively.
The price situation, however, took a severe turn from August 1993. The annual rate of inflation
started rising mainly because of heavy fiscal deficit resulting in the expansion of money supply with
the people. To this was added the rise in administered prices of inflationsensitive goods. The double-
digit inflation continued for the better part of 1994–95. Since then, the inflationary situation came
under control with a noticeable decline in the prices of primary food articles as well as manufactured
food products. During 1999–2000, the average annual rate of inflation was the lowest of about 3.3 per
cent (with 1993–94=100). It may be observed from the previous table that the Government of India has
changed the base period of the WPI from 1981–82 to 1993–94, thus making it difficult to compare the
movement of prices over the years.

The price situation, however, took a severe turn from August 1993. The annual rate of inflation started rising mainly
because of heavy fiscal deficit resulting in the expansion of money supply with the people.

Table 6.15 Price Movement During the 1990s
Source: RBI Handbook of Statistics on Indian Economy,

Table 29, Chapter 5, Economic Survey 2000–01, the Government of India.

OBJECTIVES OF PRICE POLICY
We may set out the important objectives of price policy suitable for India during the Tenth Plan
period:
a. The price policy should attain and maintain price stability primarily in respect of food articles, but, to the extent possible, in all
prices.
b. Aggregate demand should be made equal to aggregate supply; monetary and fiscal measures have an important role to play in
this sphere.
c. The price policy should provide necessary incentives to stimulate production of all essential consumer goods.
d. It should protect the vulnerable section of the community, by effectively checking the rate of increase of food grain prices (but
this should not reduce incentives to greater production in agriculture).
e. Price policies should be such as to establish some consistent relationship between agricultural prices, prices of manufactures, and
the prices of various services.
PRICES OF INDUSTRIAL PRODUCTS
Till now, the policy framework for determining the prices of industrial products was not fully
prepared. In the case of fertilizers, prices were fixed separately for each producer but in the case of
sugar and cement, prices were product-specific and varied between regions. The general approach
was to fix prices on a cost-plus basis but the details of the procedure varied. In the case of coal, the
price was fixed on the basis of actual costs. In many cases, certain standards of efficiency and capacity
utilisation were taken into account while fixing standard costs. The basis on which a return to capital
was allowed also varied. In the case of energy sector, there could be substitution between different
products and, hence, prices of such products as kerosene, soft coke, electricity, and LPG were fixed
after paying due regard to the impact on the demand for related goods and their consistency with
development strategy. Likewise, the pricing of different metals and other materials took into account
the substitution possibilities, which need to be encouraged or discouraged.
Finally, the prices of the most industrial products did not contain an element of subsidy. But in the
case of fertilizers, the final prices paid by the farmers were very much below the average cost of
production and a huge budgetary provision had to be made year after year (between Rs 5,000 crore
and Rs 6,000 crore a year). Even though fertilizer subsidy was justified from the point of view of
agricultural growth, the burden of subsidy had grown with the increase in the domestic production of
fertilizers. In the recent years, every government which assumed power at the Centre has announced
its intention to phase out fertilizer subsidy but none had the guts to implement it because of the
opposition of the farmers’ lobby.
CONTROL OF EXPENDITURE
The price policy designed to promote economic growth includes measures for controlling the
volume of public and private expenditures. The aim is to reduce any undue pressure in the limited
supply of consumption goods. Besides, the consumer goods should be available at prices regarded
reasonable from the point of view of the low-income groups. Non-essential and nonproductive
expenditure in both the public and private sectors must be reduced and, if possible, eliminated.

The price policy designed to promote economic growth includes measures for controlling the volume of public and private
expenditures. The aim is to reduce any undue pressure in the limited supply of consump-tion goods.
In this connection, particular emphasis should be laid on the reduction of non-plan expenditure or
the government. Ultimately, without government cutting down its expenditure it is impossible to
control inflation. The maximum economy in the Central government non-plan expenditure can be
effected through (a) cutting down subsidies of all types, (b) making government enterprises to earn
profits, (c) closing down all or most of the economic ministries, and (d) reducing the size of
bureaucracy. The state governments are also guilty of wasting precious resources by way of heavy
losses of their enterprises and undertakings. In practice, however, the governments both at the Centre
and at the State level are not serious about reducing the public expenditure.
The problem of a suitable price policy in a developing economy arises largely owing to the
existence of persistent pressure of inflation. Price stability need not mean freezing the price at a given
level. The slow and steady rise in the price level has all the virtues of a constant price level and has, in
addition, the power to infuse some amount of momentum to the economy. This has been the position
in India in the first three years of the Tenth Plan. A cumulative but a very slow rise in general price
level is, therefore, not only permissible but also, indeed, desirable. But the prices should not be
allowed to go out of control, as was our experience during 1973 and 1974, between 1980 and 1981,
and between 1990 and 1992.

The problem of a suitable price policy in a developing economy arises largely owing to the exis-tence of persistent pressure
of inflation.
International Prices of Select Commodities
In an open economy, the movement in the domestic prices of commodities depends on the behaviour
of their world prices. The pass through, however, is often incomplete and may be influenced by
administrative and fiscal interventions. International and domestic trends of inflation in respect of 12
commodity groups indicate that domestic inflation for comparable groups has been significantly
lower than the increase in the global commodity group indices (refer to Table 6.16 and Figures 6.2
and 6.3).

In an open economy, the movement in the domestic prices of commodities depends on the behaviour of their world prices.
Overall, four factors contributed to a global increase in the prices of commodities. Firstly demand
for food crops and edible oils increased because of a rapid rise in income in the developing
countries. A strong demand from the oil-exporting countries and increased use of these
crops/commodities in bio-fuels also pushed up their demand. The World Bank in its Global
Economic Prospects 2008 has indicated that, in 2006, bio-fuels accounted for 5 per cent to 10 per cent
of the global production of primary bio-fuel feed stocks. The United States used 20 per cent of its
maize production for bio-fuels, Brazil used 50 per cent of sugarcane for bio-fuels, and the European
Union used 68 per cent of its vegetable oil production for bio-fuels. Such large uses, by reducing the
availability of these products for food and feed, exerted pressure on prices.

Table 6.16 International and Domestic Trend of Inflation (%)
Note: Composition of World Price Index (WPI) items/groups as compared to World Price Commodities (WPC) as used in Table 4.20:
Energy (Fuel Group); Non-energy Commodities (all commodities excluding energy); Agriculture (Food Articles and Non-food Articles);
Beverages (Beverages Tobacco and Tobacco products); Food (Food Articles and Food products); Fats and oil (Edible Oils, Butter, and
Ghee); Grains (Cereals and Pulses); Other Food (Other Food Articles); Raw Materials (Non-food Articles and Minerals); Timber (Wood
and Wood Products); Other Raw Materials (Naphtha and Basis Metals Alloys and Metals Products); Fertilizers (Fertilizers); Metals and
Minerals (Basis Metals Alloys and Metals Products and Minerals).

Fig ure 6.2 Annual Inflation for Grains (Cereals and Pulses)

Fig ure 6.3 Annual Inflation for Edible Oils

Secondly, food prices also increased because of low output stocks. The global output of grains
declined from 2,016 million tonnes in 2005–06 to an estimated 1,993 million tonnes in 2006–07.
Global stocks as of January 2008 were estimated at 309 million tonnes when compared to 389 million
tonnes at the end of 2005–06 (US Department of Agriculture estimates).
Thirdly, the higher cost of cultivation due to an increase in the prices of fertilizers and fuels also
raised the price expectations. For the food grain-importing countries, an increase in the shipping
costs also raised the landed cost of the imported grains and edible oils. The current increase has both
a temporary component, low stock, and drought, and also a structural component, high energy prices;
and, therefore, is expected to persist longer.
Fourthly, the increase in the prices of metals was largely because of an increase in the demand
from the emerging economies, particularly China. The slower growth of the supplies due, in part, to
lower investment and delays in bringing new capacities contributed to the sustained increase. An
overall price increase in December 2007 when compared to the prices during 2005 (January–
December) was relatively higher for lead (165.9 per cent), tin (120.4per cent), copper (79.1 per cent),
zinc (70.4 per cent), and aluminium (25.5 per cent). Prices of steel, except steel rebar, were either flat
or declined.
The major reasons for an increase in the domestic prices during the year, albeit moderate when
compared to the previous year, were a build-up of inflationary pressure in the preceding months and
a mismatch in the demand and supply conditions. On the demand side, large capital inflows exerted
pressure on liquidity conditions. On the supply side, shortfalls in the domestic availability of wheat,
pulses, and edible oils in 2006–07 aggravated mismatches. The production of wheat averaged 69
million tonnes during 2004–06. The lower production led to lower procurement and decline in the
carry over stocks, which together resulted in a build-up of inflationary expectations.
This got compounded by a global decline in output and stocks, which was reflected in wheat prices
of US SRW wheat averaging US$345 per tonne in December 2007 when compared to an average of
US$136 per tonne during January–December 2005, US$159 in January–December 2006, and US$239
in January–December 2007. Similarly, in the case of pulses, the production during 2004–06 averaged
13.2 million tonnes, relative to a demand estimated at around 15 million tonnes. The production of
oilseeds also witnessed a decline of about 3.8 million tonnes in 2006–07. A shortfall in domestic
availability increased the vulnerability of the domestic prices to international price shocks.
Overall, inflation is likely to remain moderate in the coming months, as the policy measures taken
during the course of the year, work their own way through the system. The behaviour of agricultural
prices, including essential consumption items, will be critical, given falling poverty and rapidly
rising per capita income. Global prices are having a more pronounced impact on domestic prices as
the ability to meet shortfalls at affordable prices is being eroded by global shortages and rising
prices. Thus, we will continue to depend on enhancement of supplies through higher productivity and
efficient supply management to eliminate wastage. Domestic supply management is, therefore, critical
to stabilising inflation expectations, moderating pressures for upward revision of wages and prices,
and containing pressures for cost-push inflation through monetary and fiscal accommodation.

Domestic supply management is, therefore, critical to stabilising inflation expectations, moderating pressures for upward
revision of wages and prices, and containing pressures for costpush inflation through monetary and fiscal accommodation.
The parts of the economy characterised by market competition, such as manufacturing, have
responded to the increase in demand through higher investment and capacity creation. The supply-
side pressures are likely to be in sectors like agriculture that suffer from structural problems,
infrastructure sectors still characterised by a monopoly core that are heavily dependent on
government investment, and relatively slow, decision-making sectors such as urban land. Monetary
policy needs to address the inflationary expectations triggered by sub-sectoral price flare-ups arising
from mismatches in the demand and supply. The monetary policy also has to manage the stress
arising from a continued increase in capital flows and the consequential changes in the exchange rate,
exchange reserves, and liquidity. This is particularly challenging in a period of stagnancy or decline
in the production of durable consumer goods and deceleration in the global demand for our exports.

Monetary policy needs to address the inflationary expectations triggered by sub-sectoral price flare-ups arising from
mismatches in the demand and supply.
KEY WORDS
Capital Market
Money Market
Call Money Market
Bill Market
Financial System
Indian Banking System
QUESTIONS
1. Analyse the performance of commercial banks in India.

2. Analyse the progress of the regional rural banks in India. Evaluate the achievements of RRBs.
3. What do you mean by the Indian Money Market? Analyse the various constituents of the unorganised and organised money
market in India.
4. Discuss the recent trends in the capital market in India.
5. What do you mean by price policy? Discuss the price movements since independence.
6. Discuss the objectives of price policy in India and how the prices of industrial products are determined.
7. Discuss the recent price policy trends in an open economy.
8. Write short notes on:
i. Call Money Market
ii. Bill Market
iii. Structure of Financial System
iv. Expenditure Control
REFERENCES

Misra, S. K. and V. K. Puri (2000). Indian Economy. Mumbai: Himalaya Publishing House.
Paul, H. (2003). The Economic Way of Thinking, 10th ed. New Delhi: Pearson Education.
Travedi, I. V. and R. Jatana (2004). Economic Environment in India. Jaipur: University Book House.
CHAPTER 07
Stock Exchanges in India
CHAPTER OUTLINE
Concept and Meaning of Stock Exchange
Types of Financial Markets
SEBI and Its Role in the Secondary Market
Products Available in the Secondary Market
Regulatory Requirements Specified by SEBI for Corporate Debt Securities
Broker and Sub-broker in the Secondary Market
SEBI Risk Management System
Investor Protection Fund (IPF)/Customer Protection Fund (CPF) at Stock Exchanges
Functions of Security Exchange Board of India
Powers of Security Exchange Board of India
Growth of Stock Market in India
Key Words
Questions
References
CONCEPT AND MEANING OF STOCK EXCHANGE
Stock exchange is an organised marketplace, either corporation or mutual organisation, where

members of the organisation gather to trade company stocks or other securities. The members may
act either as agents for their customers, or as principals for their own accounts. It is a place where
securities are featured by the centralisation of supply and demand for the transaction of orders by
member brokers for institutional and individual investors. It is established to facilitate the buying and
selling of stocks.

Stock exchange is an organised marketplace, either corporation or mutual organisation, where members of the
organisation gather to trade company stocks or other securities.
Stock exchanges also facilitate the issue and redemption of securities and other financial
instruments, including the payment of income and dividends. The record-keeping is central but trade
is linked to such a physical place because modern markets are computerised. The trade on an
exchange is only by members and stockbrokers do have a seat on the exchange.
List of Stock Exchanges in India

Bombay Stock Exchange
Regional Stock Exchanges
National Stock Exchange
Ahmedabad Stock Exchange
Bangalore Stock Exchange
Bhubaneshwar Stock Exchange
Calcutta Stock Exchange
Cochin Stock Exchange
Coimbatore Stock Exchange
Delhi Stock Exchange
Guwahati Stock Exchange
Hyderabad Stock Exchange
Jaipur Stock Exchange
Ludhiana Stock Exchange
Madhya Pradesh Stock Exchange
Madras Stock Exchange
Magadh Stock Exchange
Mangalore Stock Exchange
Meerut Stock Exchange
OTC Exchange Of India
Pune Stock Exchange
Saurashtra Kutch Stock Exchange
Uttar Pradesh Stock Exchange
Vadodara Stock Exchange
TYPES OF FINANCIAL MARKETS
The financial markets can be broadly divided into money market and capital market.
Money Market
Money market is a market for debt securities that pay off in the short term usually less than one year,
for example, the market for 90-day treasury bills. This market encompasses the trading and issuance
of short-term non-equity debt instruments, including treasury bills, commercial papers, bankers’
acceptance, certificates of deposits, and so on.

Money market is a market for debt securities that pay off in the short term usually less than one year.
Capital Market
Capital market is a market for long-term debt and equity shares. In this market, the capital funds
comprising of both equity and debt are issued and traded. This also includes private placement
sources of debt and equity as well as organised markets like stock exchanges. Capital market can be
further divided into primary and secondary markets.

Capital market is a market for long-term debt and equity shares. In this market, the capital funds comprising of both equity
and debt are issued and traded.
Secondary Market
Secondary market refers to a market where securities are traded after being initially offered to the
public in the primary market, and/or listed on the stock exchange. Majority of the trading is done in
the secondary market. Secondary market comprises of equity markets and the debt markets. For the
general investor, the secondary market provides an efficient platform for trading of his securities.
For the management of the company, secondary equity markets serve as a monitoring and control
conduit—by facilitating value-enhancing control activities, enabling implementation of incentive-
based management contracts, and aggregating information (via price discovery) that guides
management decisions.

Secondary market refers to a market where securities are traded after being initially offered to the public in the primary
market, and/or listed on the stock exchange.
The Difference Between Primary Market and Secondary Market

In the primary market, securities are offered to public for subscription, for the purpose of raising
capital or fund. Whereas, the secondary market is an equity-trading avenue in which the already
existing/pre-issued securities are traded among investors. The secondary market could be either
auction or dealer market. While stock exchange is the part of an auction market, over-the-counter
(OTC) is a part of the dealer market.
SEBI AND ITS ROLE IN THE SECONDARY MARKET
Security Exchange Board of India (SEBI)
The SEBI is the regulatory authority established under Section 3 of SEBI Act, 1992, to protect the
interests of the investors in securities and to promote the development of, and to regulate, the
securities market and for matters connected, therewith, and incidental, thereto.

The SEBI is the regulatory authority established under Section 3 of SEBI Act, 1992, to protect the interests of the investors
in securities and to promote the development of, and to regulate, the securities market and for matters connected, therewith,
and incidental, thereto.
Role of SEBI in Regulating Trading in the Secondary Market
The following departments of SEBI take care of the activities in the secondary market:

Table 7.1
S. No. Name of the Department Major Activities
Registration, supervision, compliance monitoring, and inspections of all
Market Intermediaries Registration and
1. market intermediaries in respect of all segments of the markets, viz.,
Supervision Department (MIRSD)
equity, equity derivatives, debt, and debt-related derivatives
Formulating new policies and supervising the functioning and operations
(except relating to derivatives) of securities exchanges, their subsidiaries,
2 Market Regulation Department (MRD)
and market institutions, such as clearing and settlement organisations and
depositories (collectively referred to as “Market SROs”)
Derivatives and New Products Departments Supervising trading at derivatives segments of stock exchanges,
3.
(DNPD) introducing new products to be traded, and consequent policy changes
PRODUCTS AVAILABLE IN THE SECONDARY MARKET
Following are the main financial products/instruments dealt in the secondary market:
Equity
The ownership interest in a company of holders of its common and preferred stock.
Equity Shares
An equity share, commonly referred to as an ordinary share, also represents the form of fractional
ownership in which a shareholder, as a fractional owner, undertakes the maximum entrepreneurial
risk associated with a business venture. The holders of such shares are members of the company and
have voting rights. A company may issue such shares with differential rights as to voting, payment of
dividend, and so on. The various kinds of equity shares are as follows:

An equity share, commonly referred to as an ordinary share, also represents the form of fractional ownership in which a
shareholder, as a fractional owner, undertakes the maximum entrepreneurial risk associated with a business venture.
Rights Issue/Rights Shares: The issue of new securities to the existing shareholders at a ratio to those securities already held.
Bonus Shares: The shares issued by the companies to their shareholders, free of cost, by capitalisation of accumulated reserves
from the profits earned in the earlier years.
Preferred Stock/Preference Shares: The owners of these kinds of shares are entitled to a fixed dividend or a dividend calculated
at a fixed rate to be paid regularly before a dividend can be paid in respect of an equity share. They also enjoy priority over the
equity shareholders in payment of a surplus. But in the event of liquidation, their claims rank below the claims of the company’s
creditors, bondholders, or debenture holders.
Cumulative Preference Shares: A type of preference shares on which dividend accumulates, if remains unpaid. All arrears of
preference dividend have to be paid out before paying dividend on the equity shares.
Cumulative Convertible Preference Shares: A type of preference shares where the dividend payable on the same accumulates, if
not paid. After a specified date, these shares will be converted as the equity capital of the company.
Participating Preference Share: The right of certain preference shareholders to participate in profits after a specified fixed
dividend that was contracted for is paid. Participation right is linked with the quantum of dividend paid on the equity shares, over
and above a particular specified level.
Security Receipts: Security receipt means a receipt or other security, issued by a securi-tisation or a reconstruction company to
any qualified institutional buyer pursuant to a scheme, evidencing the purchase or acquisition by the holder thereof, of an
undivided right, title, or interest in the financial asset involved in securitisation.
Government Securities (G-Secs): These are sovereign (credit risk-free) coupon-bearing instruments, which are issued by the
Reserve Bank of India (RBI) on behalf of Government of India, in lieu of the Central government’s market-borrowing
programme. These securities have a fixed coupon that is paid on specific dates on half-yearly basis. These securities are
available in a wide range of maturity dates, from short dated (less than one year) to long dated (up to 20 years).
Debentures: Bonds issued by a company, bearing a fixed rate of interest, usually payable half-yearly on specific dates, and
principal amount repayable on a particular date on redemption of the debentures. Debentures are normally secured/charged
against the asset of the company in favour of a debenture holder.
Bond: A negotiable certificate evidencing indebtedness. It is normally unsecured. A debt security is generally issued by a
company, a municipality, or a government agency. A bond investor lends money to the issuer and, in exchange, the issuer
promises to repay the loan amount on a specified maturity date. The issuer usually pays the bond holder, periodic interest
payments over the life of the loan. The various types of bonds are as follows:
Zero Coupon Bond: Bond issued at a discount and repaid at a face value. No periodic interest is paid. The difference
between the issue price and redemption price represents the return to the holder. The buyer of these bonds receives only
one payment, at the maturity of the bond.
Convertible Bond: A bond giving the investor the option to convert the bond into equity at a fixed conversion price.
Commercial Paper: A short-term promise to repay a fixed amount that is placed on the market, either directly or through a
specialised intermediary. It is usually issued by companies with a high credit, standing in the form of a promissory note,
redeemable at par to the holder on maturity and, therefore, does not require any guarantee. Commercial paper is a money market
instrument issued normally for a tenure of 90 days.
Treasury Bills: Short-term (up to 91 days) bearer discount security issued by the government as a means of financing its cash
requirements.
REGULATORY REQUIREMENTS SPECIFIED BY SEBI FOR CORPORATE DEBT SECURITIES
The issue of debt securities having a maturity period of more than 365 days by listed companies (i.e.,
which have any of their securities, either equity or debt, offered through an offer document, and listed
on a recognised stock exchange; and also includes public sector undertakings, whose securities are
listed on a recognised stock exchange), on a private placement basis, must comply with the conditions
prescribed by SEBI, from time to time, for getting them listed on the stock exchanges. Further,
unlisted companies/statutory corporations/ other entities, if they desire so, may get their privately
placed debt securities listed on the stock exchanges, by complying with the relevant conditions.
Briefly, these conditions are as follows:
1. Compliance with the disclosure requirements under Chapter VI of the SEBI (Disclosure and Investor Protection) Guidelines,
2000, and listing agreements with the exchanges and provisions of the Companies Act, 1956.
2. Such disclosures may be made through the web site of the stock exchanges where the debt securities are sought to be listed, if
the privately placed debt securities are issued in the standard denomination of Rs 10 lakh.
3. The company shall sign a separate listing agreement with the exchange in respect of debt securities.
4. The debt securities shall carry a credit rating from a credit rating agency registered with SEBI.
5. The company shall appoint a debenture trustee, who is registered with SEBI, in respect of the issue of the debt securities.
6. The debt securities shall be issued and traded in demat form.
7. All trades with the exception of spot transactions, in a listed debt security, shall be executed only on the trading platform of a
stock exchange.
BROKER AND SUB-BROKER IN THE SECONDARY MARKET
Broker
A broker is a member of a recognised stock exchange, who is permitted to do trades on the screen-
based trading system of different stock exchanges. He is enrolled as a member with the concerned
exchange and is registered with SEBI.

A broker is a member of a recognised stock exchange, who is permitted to do trades on the screen-based trading system of
different stock exchanges.
Sub-broker
A sub-broker is a person who is registered with SEBI as such and is affiliated to a member of a
recognised stock exchange. You can contact a broker or a sub-broker registered with SEBI for
carrying out your transactions pertaining to the capital market.

A sub-broker is a person who is registered with SEBI as such and is affiliated to a member of a recognised stock exchange.
Agreement with the Broker or Sub-broker
For the purpose of engaging a broker to execute trades on your behalf, from time to time, and furnish
details relating to yourself, for enabling the broker to maintain a client registration form, you have to
sign the “member–client agreement”, if you are dealing directly with a broker. In case you are
dealing through a sub-broker, then you have to sign a “broker–sub–broker–client”— a tripartite
agreement. The “model tripartite agreement” between broker-sub-broker-client and know-your-client
form can be viewed from SEBI website at www.sebi.gov.in. The model tripartite agreement between
broker-sub-broker and clients is applicable only for the cash segment. The model agreement has to be
executed on a non-judicial stamp paper. The agreement contains clauses defining the rights and
responsibilities of client vis-à-vis broker/sub-broker. The documents prescribed are model formats.
The stock exchanges/stockbroker may incorporate any additional clauses in these documents,
provided the clauses are not in conflict with any of the clauses in the model document, as also the
rules, regulations, articles, byelaws, circulars, directives, and guidelines.
Risk Disclosure Document
In order to acquaint the investors in the markets of the various risks involved in trading in the stock
market, the members of the exchange have been required to sign a risk disclosure document with
their clients, informing them of the various risks like risks of volatility, risks of lower liquidity, risks
of higher spreads, risks of new announcements, risks of rumours, and so on.
Placing Orders with the Broker or Sub-broker

You can either go to the broker ’s/sub-broker ’s office or place an order over the phone/Internet or as
defined in the model agreement given above. The stock exchanges assign a unique order code
number to each transaction, which is intimated by the broker to his/her client and once the order is
executed, this order code number is printed on the contract note. The broker member has also to
maintain the record of time when the client has placed order and should reflect the same in the
contract note, along with the time of execution of the order.
Brokerage that a Broker or Sub-broker Can Charge
The maximum brokerage that can be charged by a broker has been specified in the stock exchange
regulations and, hence, it may differ from across various exchanges. As per the BSE and NSE
byelaws, a broker cannot charge more than 2.5 per cent brokerage from his clients. This maximum
brokerage is inclusive of the brokerage charged by the sub-broker. Further, SEBI (stockbrokers and
sub-brokers) Regulations, 1992 stipulates that a sub-broker cannot charge from his/her clients, a
commission which is more than 1.5 per cent of the value mentioned in the respective purchase or sale
note.

The maximum brokerage that can be charged by a broker has been specified in the stock exchange regulations and, hence,
it may differ from across various exchanges.
Charges Levied on the Investor by a Stockbroker/Sub-broker
The trading member can charge as follows:
1. Brokerage charged by a member broker.

2. Penalties arising on a specific default on behalf of a client (investor).
3. Service tax as stipulated.
4. Securities Transaction Tax (STT) as applicable.
The brokerage, service tax, and STT are indicated separately in the contract note.
Securities Transaction Tax (STT)
Securities Transaction Tax (STT) is a tax being levied on all transactions done on the stock
exchanges, at rates prescribed by the Central government from time to time. Pursuant to the enactment
of the Finance (No. 2) Act, 2004, the Government of India notified the STT Rules, 2004, and, thus,
STT came into effect from October 1, 2004.

Securities Transaction Tax (STT) is a tax being levied on all transactions done on the stock exchanges, at rates prescribed
by the Central government from time to time.
Rolling Settlement
In a rolling settlement, the trades executed during the day are settled based on the net obligations for
the day. Presently, the trades pertaining to the rolling settlement are settled on a T+2-day basis where
T stands for the trade day. Hence, trades executed on a Monday are typically settled on the following
Wednesday (considering two working days from the trade day).

In a rolling settlement, the trades executed during the day are settled based on the net obligations for the day.
The pay-in and pay-out of funds and securities are carried out on T+2 day.

Table 7.2
Heads Activity Day

Trading Rolling settlement trading T
Clearing Custodial confirmation T+1 working days
Delivery generation T+1 working days
Settlement Securities and funds pay-in T+2 working days
Securities and funds pay-out T+2 working days
Post settlement Valuation debit T+2 working days
Auction T+3 working days
Bad delivery reporting T+4 working days
Auction settlement T+5 working days
Close out T+5 working days
Rectified bad delivery pay-in and pay-out T+6 working days
Re-bad delivery reporting and pickup T+8 working days
Close out of re-bad delivery T+9 working days
Note: The above is a typical settlement cycle for normal (regular) market segment. The days prescribed for the above activities may
change in case of factors like holidays, bank closing, and so on. You may refer to scheduled dates of pay-in/pay-out, notified by the
exchange for each settlement from time-to-time.

SEBI RISK MANAGEMENT SYSTEM
SEBI’s primary focus is always to address the market risks, operational risks, and systematic risk.
SEBI is regularly and continuously reviewing its policies and drafting risk management policies to
control the above risks, to enhance the level of investors’ protection and to cater to the need of market
development.
The key risk management measures initiated by SEBI includes the following:
1. VAR-based margining system.
2. Specification of mark-to-market margins
3. Specification of intra-day trading limits and gross exposure limits
4. Real-time monitoring of the intra-day trading limits and gross exposure limits by the stock exchanges
5. Specification of time limits for payment of marginsv
6. Collection of margins on T+1 basis
7. Index-based market-wide circuit breakers
8. Automatic de-activation of trading terminals, in case of breach of exposure limits
9. VAR-based margining system has been put in place, based on the categorisation of stocks, which, in turn, based on the liquidity
of stocks, depending on its impact on cost and volatility. It addresses 99 per cent of the risks in the market.
10. Additional margins have also been specified to address the balance 1 per cent cases.
From time to time, SEBI has issued circulars modifying the present risk management framework to
move to upfront a collection of value at risk (VAR) margins (instead of margin collection on T+1
basis). As per SEBI’s revised framework (SEBI circular MRD/DOP/SE/Cir-07/2005), the liquid assets
deposited by the broker with the exchange should be sufficient to cover upfront VAR margins,
extreme loss margin, and MTM (mark to market losses). It has also been stated clearly by SEBI that
the exchanges would monitor the position of the brokers online on real-time basis, and there would
be an automatic de-activation of terminal on any shortfall of margin.
Redressing Investor Grievances
Office of Investor Assistance and Education (OIAE): You can lodge a complaint with OIAE
department of SEBI against companies for delay, non-receipt of shares, refund orders, and so on, and
with stock exchanges against brokers on certain trade disputes or non-receipt of payment/securities.

1. Arbitration: If no amicable settlement could be reached, then you can make an application for reference to arbitration under the
byelaws of the concerned stock exchange.
2. Court of Law.
You can lodge a complaint with OIAE department of SEBI against companies for delay, non-receipt of shares, refund orders,
and so on, and with stock exchanges against brokers on certain trade disputes or non-receipt of payment/ securities.
Arbitration
Arbitration is an alternative, dispute resolution mechanism provided by a stock exchange for
resolving disputes between the trading members and their clients, in respect of trades done on the
exchange.
Process for Preferring Arbitration

The byelaws of the exchange provide the procedure for arbitration. You can procure a form for filing
arbitration from the concerned stock exchange. The arbitral tribunal has to make the arbitral award
within three months from the date of entering upon the reference. The time taken to make an award
cannot be extended beyond a maximum period of six months from the date of entering upon the
reference.
Appointment of the Arbitrators
Every exchange maintains a panel of arbitrators. Investors may choose the arbitrator of their choice
from the panel. The broker also has an option to choose an arbitrator. The name(s) would be
forwarded to the member for acceptance. In case of disagreement, the exchange shall decide upon the
name of arbitrators.
INVESTOR PROTECTION FUND (IPF)/CUSTOMER PROTECTION FUND (CPF) AT STOCK EXCHANGES
Investor Protection Fund (IPF) is the fund set up by the stock exchanges, to meet the legitimate
investment claims of the clients, of the defaulting members who are not of speculative nature. SEBI
has prescribed guidelines for the utilisation of IPF at the stock exchanges. The stock exchanges have
been permitted to fix suitable compensation limits, in consultation with the IPF/CPF Trust. It has been
provided that the amount of compensation available against a single claim of an investor, arising out
of a default by a member broker of a stock exchange, shall not be less than Rs 1 lakh in case of major
stock exchanges, viz., BSE and NSE, and Rs 50,000/in case of other stock exchanges.

Investor Protection Fund (IPF) is the fund set up by the stock exchanges, to meet the legitimate investment claims of the
clients, of the defaulting members who are not of speculative nature.
Acts Governing Securities Transactions in India

In India, two Acts mainly govern securities transactions at present. They are as follows:
1. The Securities Contracts (Regulation) Act, 1956 and

2. The Securities & Exchange Board of India Act, 1992.
The paper-based ownership and transfer of securities have been a major drawback of the Indian
Securities Markets, since it often results in delay in settlement and transfers of securities and also
leads to “bad delivery”, theft, forgery, and so on. The Depositories Act, 1996 was, therefore, enacted
to pave the way for smooth and free transfer of securities.
The other relevant laws, which affect the capital market, are:
1. The Depositories Act, 1996

2. The Foreign Exchange Regulations Act, 1973
3. Arbitration and Conciliation Act, 1996
4. Companies Act, 1956
5. Debt Recovery Act (Bank and Financial Institutions Recovery of Dues Act, 1993)
6. Banking Regulation Act
7. Benami Prohibition Act
8. Indian Penal Code
9. Indian Evidence Act, 1872, and
10. Indian Telegraph Act, 1885.
The Securities Contracts (Regulation) Act of 1956

The Securities Contracts (Regulation) Act, 1956 (hereinafter referred to as the Act), containing a
mere 31 sections, keeps a tight vigil over all the stock exchanges of India since February 20, 1957.
The provisions of the Act were formerly administered by the Central government. However, since the
enactment of The Securities and Exchange Board of India Act, 1992, the Board established under it
(SEBI), concurrently, has powers to administer almost all the provisions of the Act.
By virtue of the provisions of the Act, the business of dealing in securities cannot be carried out
without a license from SEBI. Any stock exchange, which is desirous of being recognised, has to make
an application under Section 3 of the Act to SEBI, which is empowered to grant recognition and
prescribe conditions, including that of having SEBI’s representation (maximum three persons) on the
stock exchange and prohibiting the stock exchange from amending its rules without SEBI’s prior
approval. This recognition can be withdrawn in the interest of the trade or the public. SEBI is
authorised to call for periodical returns from the recognised stock exchanges and make enquiries in
relation to their affairs. Every stock exchange is obliged to furnish annual reports to SEBI. Stock
exchanges are allowed to make rules only with the prior approval of SEBI. The Central government
and SEBI can direct stock exchanges to frame rules. The recognised stock exchanges are allowed to
make bylaws for the regulation and control of contracts, subject to the previous approval of SEBI,
and SEBI has the power to amend the aforesaid bylaws. The Central government and SEBI have the
power to supersede the governing body of any recognised stock exchange and to suspend its business.

By virtue of the provisions of the Act, the business of dealing in securities cannot be carried out without a license from SEBI.
A public limited company has no obligation to have its shares listed on a recognised stock
exchange. But if a company intends to offer its shares or debentures to the public for subscription by
issue of a prospectus, it must, before issuing such prospectus, apply to one or more recognised stock
exchanges for permission—to have the shares or debentures, intended to be so, offered to the public,
to be dealt with in each of such stock exchange in terms of Section 73 of the Companies Act, 1956.
SEBI can, however, under the provisions of Section 21 of the Securities Contracts (Regulation) Act,
1956 compel the listing of securities by public companies, if it is of the opinion that it is necessary or
expedient in the interest of the trade or the public. In the event of the stock exchange refusing to list
the securities of any public company, an appeal to SEBI is provided under the Act. A company as per
the present provisions of law is obliged to get listed on the regional exchange, in addition to other
exchanges. (There has been a recommendation that this restriction be removed.)

A public limited company has no obligation to have its shares listed on a recognised stock exchange.
A company as per the present provisions of law is obliged to get listed on the regional exchange, in addition to other
exchanges.
The Securities and Exchange Board of India Act of 1992
The Securities and Exchange Board of India Act, 1992 (hereinafter referred as “The SEBI Act”) is
having retrospective effect, and is deemed to have come into force on January 30, 1992. Relatively, a
brief Act containing only 35 sections, the SEBI Act governs all the stock exchanges and the securities
transactions in India.

The Securities and Exchange Board of India Act, 1992 (hereinafter referred as “The SEBI Act”) is having retrospective
effect, and is deemed to have come into force on January 30, 1992.
A Board by the name of the Securities and Exchange Board of India (SEBI) consisting of one
Chairman and five members, one each from the Department of Finance and Law of the Central
Government, one from the RBI, and two other persons; and having its head office in Bombay and
regional offices in Delhi, Calcutta, and Chennai, has been constituted under the SEBI Act to
administer its provisions. The Central government has the right to terminate the services of the
Chairman or any member of the Board. The Board decides all questions in its meeting by a majority
vote, with the Chairman having a second or a casting vote.
Section 11 of the SEBI Act provides that it shall be the duty of the Board to protect the interest of
investors in securities, to promote the development of, and to regulate, the securities market by such
measures, as it thinks fit. It empowers the Board to regulate the business in stock exchanges, to
register and regulate the working of stockbrokers, sub-brokers, share-transfer agents, bankers to an
issue, trustees of trust deeds, registrars to an issue, merchant bankers, underwriters, portfolio
managers, investment advisors, and so on, to register and regulate the working of collective
investment schemes, including mutual funds, to prohibit fraudulent and unfair trade practices and
insider trading, to regulate takeovers, to conduct enquiries and audits of the stock exchanges, and so
on.

Section 11 of the SEBI Act provides that it shall be the duty of the Board to protect the interest of investors in securities, to
promote the development of, and to regulate, the securities market by such measures, as it thinks fit.
As all stock exchanges are required to be registered with SEBI under the provisions of the Act,
under Section 12 of the SEBI Act, all the stockbrokers, sub-brokers, share-transfer agents, bankers to
an issue, trustees of trust deed, registrars to an issue, merchant bankers, underwriters, portfolio
managers, investment advisors, and such other intermediary, who may be associated with the
securities markets, are obliged to register with the Board, and the Board has the power to suspend or
cancel such registration. The Board is bound by the directions given by the Central government, from
time to time, on questions of policy, and the Central government has the right to supersede the Board.
The Board is also obliged to submit a report to the Central government every year, giving true and
full account of its activities, policies, and programmes. Any one aggrieved by the Board’s decision is
entitled to appeal to the Central government.

As all stock exchanges are required to be registered with SEBI under the provisions of the Act.
FOREIGN INSTITUTIONAL INVESTORS (FIIS)
Foreign Institutional Investors (FIIs) including institutions such as pension funds, mutual funds,
investment trusts, asset management, or their power of attorney holders (providing discretionary and
non-discretionary portfolio management services), are invited to invest in all the securities traded on
the primary and secondary markets, including the equity and other securities/instruments of
companies, which are listed/to be listed on the stock exchanges in India—including the OTC
Exchange of India. These would include shares, debentures, warrants, and the schemes floated by
domestic mutual funds. To be eligible to do so, the FIIs would be required to obtain registration with
Securities and Exchange Board of India (SEBI). FIIs are also required to file with SEBI and another
application addressed to RBI, for seeking various permissions under FERA.
SEBI shall be granting registration to the FII, taking into account the track record of the FII, its
professional competence, financial soundness, experience, and such other relevant criteria. FIIs
seeking registration with SEBI should hold a registration from the Securities Commission, or the
regulatory organisation for the stock market, in its own country of domicile/incorporation.

SEBI shall be granting registration to the FII, taking into account the track record of the FII, its professional competence,
financial soundness, experience, and such other relevant criteria.
SEBI’s registration and RBI’s general permission under FERA to an FII will be for five years,
renewable for similar five-year periods later on. RBI’s general permission under FERA would enable
the registered FII to buy, sell, and realise capital gains on investments, made through initial corpus
remitted to India, subscribe/renounce rights offerings of shares, invest on all recognised stock
exchanges through a designated bank branch, and to appoint a domestic custodian for the custody of
investments held.

SEBI’s registration and RBI’s general permission under FERA to an FII will be for five years, renewable for similar five-year
periods later on.
The general permission from RBI shall also enable the FII to
1. Open foreign currency denominated account(s) in a designated bank. (These can even be more than one account in the same
bank branch, each designated in different foreign currencies, if it is required so by FII for its operational purposes.)
2. Open a special non-resident rupee account to which could be credited all receipts from the capital inflows, sale proceeds of
shares, dividends, and interests.
3. Transfer sums from the foreign currency accounts to the rupee account and vice versa, at the market rates of exchange.
4. Make investments in the securities in India out of the balances in the rupee account.
5. Transfer repatriatable (after tax) proceeds from the rupee account to the foreign currency accounts.
6. Repatriate the capital, capital gains, dividends, incomes received by way of interest, and so on, and any compensation received
towards sale/renouncement of rights offerings of shares, subject to the designated branch of a bank/the custodian being
authorised to deduct withholding tax on capital gains, and arranging to pay such tax and remitting the net proceeds at market
rates of exchange.
7. Register FII’s holdings without any further clearance under FERA.
There is no restriction on the volume of investment, either minimum or maximum, for the purpose of
entry of FIIs, in the primary/secondary market. Also, there is no lock-in period for the purpose of
such investments made by FIIs.

There is no restriction on the volume of investment, either minimum or maximum, for the purpose of entry of FIIs, in the
primary/secondary market.
The portfolio investments in primary or secondary markets will be subject to a ceiling of 24 per
cent of issued share capital, for the total holdings of all registered FIIs, in any one company. The
ceiling would apply to all holdings, taking into account the conversions, out of the fully and partly
convertible debentures issued by the company. The holding of a single FII in any company would also
be subject to a ceiling of 5 per cent of the total issued capital. For this purpose, the holdings of a FII
ground will be counted as holdings of a single FII.

The portfolio investments in primary or secondary markets will be subject to a ceiling of 24 per cent of issued share capital,
for the total holdings of all registered FIIs, in any one company.
The maximum holding of 24 per cent for all non-resident portfolio investments, including those of
the registered FIIs, will also include NRI corporate and non-corporate investments, but will not
include the following:
1. Foreign investments under financial collaborations (direct foreign investments), which are permitted up to 51 per cent in all
priority areas and
2. Investments by FIIs through the following alternative routes:
i. Offshore single/regional funds,
ii. Global depository receipts, and
iii. Euroconvertibles.
The disinvestment will be allowed only through stock exchanges in India, including the OTC
Exchange. In exceptional cases, SEBI may permit sales, other than through stock exchanges, provided
the sale price is not significantly different from the stock market quotations, where available. All
secondary market operations would be only through the recognised intermediaries on the Indian
Stock Exchange, including the OTC Exchange of India. A registered FII will not engage in any short-
selling in securities but will take a delivery of the purchased and give a delivery of the sold securities.

A registered FII will not engage in any short-selling in securities but will take a delivery of the purchased and give a
delivery of the sold securities.
A registered FII can appoint an agency approved by SEBI, to act as a custodian of securities and for
confirmation of transactions in securities, settlement of purchase and sale, and for reporting
information. Such custodian shall establish separate accounts for detailing on a daily basis the
investment capital utilisation and securities held by each FII for which it is acting as a custodian. The
custodian will report to the RBI and SEBI, semi-annually, as part of its disclosure and reporting
guidelines.
The RBI shall make available to the designated bank branches, a list of companies where no
investment will be allowed on the basis of the upper-prescribed ceiling of 24 per cent, having been
reached under the portfolio investment scheme. The RBI may, at any time, request by an order a
registered FII, to submit information regarding the records of utilisation of the inward remittances of
investment capital and the statement of securities transactions. RBI and/or SEBI may also, at any time,
conduct a direct inspection of the records and accounting books of a registered FII. FIIs investing
under this scheme will benefit from a concessional tax regime of a flat rate tax of 20 per cent on
dividend and interest income and a tax rate of 10 per cent on long term (one year of more) capital
gains.

FIIs investing under this scheme will benefit from a concessional tax regime of a flat rate tax of 20 per cent on dividend and
interest income and a tax rate of 10 per cent on long term (one year of more) capital gains.
FUNCTIONS OF SECURITY EXCHANGE BOARD OF INDIA
1. Subject to the provisions of this Act, it shall be the duty of the Board to protect the interests of the investors in securities and to
promote the development of, and to regulate, the securities market, by such measures as it thinks fit;

Subject to the provisions of this Act, it shall be the duty of the Board to protect the interests of the investors in
securities and to promote the development of, and to regulate, the securities market, by such measures as it thinks
fit.
2. Regulating the business in stock exchanges and any other securities markets;
3. Registering and regulating the working of stockbrokers, sub-brokers, share-transfer agents, bankers to an issue, trustees of trust
deeds, registrars to an issue, merchant bankers, underwriters, portfolio managers, investment advisors, and such other
intermediaries who may be associated with securities markets, in any manner;
4. Registering and regulating the working of the depositories, participants, custodians of securities, FIIs, credit-rating agencies, and
such other intermediaries as the Board may, by notification, specify in this behalf;
5. Registering and regulating the working of venture capital funds and collective investment schemes, including mutual funds;
6. Promoting and regulating self-regulatory organisations;
7. Prohibiting fraudulent and unfair trade practices relating to securities markets;
8. Promoting investors’ education and training of intermediaries of securities markets;
9. Prohibiting insider trading in securities;
10. Regulating substantial acquisition of shares and takeover of companies;
11. Can call for any information from, undertaking inspection, conducting enquiries and audits of the stock exchanges, mutual funds,
other persons associated with the securities market, intermediaries, and self-regulatory organisations in the securities market;
12. Can call for any information and any record from any bank or any other authority or board or corporation, established or
constituted by, or under any Central, State, or provincial act, in respect of any transaction in securities, which is under
investigation or enquiry by the Board;
13. Performing such functions and exercising such powers under the provisions of the Securities Contracts (Regulation) Act, 1956
(42 of 1956), as may be delegated to it by the Central government;
14. Levying fees or other charges for carrying out the purposes of this Section;
15. Calling from or furnishing to any such agencies, as may be specified by the Board, such information, as may be considered
necessary by it for the efficient discharge of its functions; and
16. Performing such other functions as may be prescribed.
POWERS OF SECURITY EXCHANGE BOARD OF INDIA
Save as, otherwise, provided in Section 11, if after making or causing to be made an enquiry, the
Board is satisfied that it is necessary—
1. in the interest of investors or orderly development of securities market; or

2. to prevent the affairs of any intermediary or other persons referred to in Section 12, being conducted in a manner detrimental to
the interest of investors or securities market; or
3. to secure the proper management of any such intermediary or person, it may issue such directions:
i. to any person or class of persons referred to in Section 12, or associated with the securities market; or
ii. to any company in respect of matters specified in Section 11A, as may be appropriate in the interests of investors in
securities and the securities market.
Investigation
1. Where the Board has a reasonable ground to believe that

i. the transactions in securities are being dealt with in a manner detrimental to the investors or the securities market; or
ii. any intermediary or a person associated with the securities market has violated any of the provisions of this Act or the
rules or the regulations made or directions issued by the Board there under,
It may, at any time, by an order in writing, direct any person (hereafter in this section referred to as the Investigating Authority)
specified in the order, to investigate the affairs of such intermediaries or persons associated with the securities market and to
report, thereon, to the Board.
2. Without prejudice to the provisions of Sections 235-241 of the Companies Act, 1956 (1 of 1956), it shall be the duty of every
manager, managing director, officer, and other employee of the company, and every intermediary referred to in Section 12, or
every person associated with the securities market to preserve and to produce to the Investigating Authority or any person
authorised by it in this behalf, all the books, registers, other documents, and record of, or relating to, the company or, as the
case may be, of or relating to, the intermediary or such person, which are in their custody or power.
3. The Investigating Authority may require any intermediary or person associated with securities market, in any manner, to furnish
such information to, or produce such books, or registers, or other documents, or record before it, or any person authorised by it
in this behalf, as it may consider necessary, if the furnishing of such information or the production of such books, or registers, or
other documents, or record is relevant or necessary for the purposes of its investigation.
4. The Investigating Authority may keep in his custody any books, registers, other documents, and record produced under sub-
section (2) or sub-section (3) for six months and, thereafter, shall return the same to any intermediary or person, who is
associated with securities market by whom or on whose behalf the books, the registers, the other documents, and the record are
produced,
i. provided that the Investigating Authority may call for any book, register, other document, and record, if they are
needed again; and
ii. provided further that if the person on whose behalf the books, registers, other documents, and record are produced
requires certified copies of the books, registers, other documents, and record produced before the Investigating
Authority. It shall give certified copies of such books, registers, other documents, and record to such person or on
whose behalf the books, the registers, the other documents, and the record were produced.
5. Any person, directed to make an investigation under sub-section (1) may examine on oath, any manager, managing director,
officer, and other employee of any intermediary or a person associated with securities market, in any manner, in relation to the
affairs of his/her business and may administer an oath accordingly and, for that purpose, may require any of those persons to
appear before it personally.
6. If any person fails without a reasonable cause, or refuses
i. to produce to the Investigating Authority or any person authorised by it in this behalf any book, register, other
document, and record, which it is his/her duty under sub-section (2) or sub-section (3) to produce; or
ii. to furnish any information which is his/her duty under sub-section (3) to furnish; or
iii. to appear before the Investigating Authority personally when required to do so under sub-section (5), or to answer any
question which is put to him/her by the Investigating Authority in pursuance of that sub-section; or
iv. to sign the notes of any examination referred to in the sub-section (7).
He/she shall be punishable with an imprisonment for a term, which may extend to one year, or with fine, which may extend to Rs
1 crore, or with both, and also with a further fine, which may extend to Rs 5 lakh, for every day after the first year during which
the failure or refusal continues.
7. The notes of any examination under sub-section (5) shall be taken down in writing and shall be read over to, or by, and signed
by, the person examined, and may, thereafter, be used as an evidence against him.
8. In the course of investigation, the Investigating Authority has a reasonable ground to believe that the books, the registers, the
other documents, and the record of, or relating to, any intermediary or any person associated with securities market, in any
manner, may be destroyed, mutilated, altered, falsified, or secreted. In that case, The Investigating Authority may make an
application to the Judicial Magistrate of the first class, having jurisdiction for an order for the seizure of such books, registers,
other documents, and record.
9. After considering the application and hearing the Investigating Authority’s appeal, if necessary, the Magistrate may, by order,
authorise the Investigating Authority
i. to enter, with such assistance, as may be required, the place or places where such books, registers, other documents,
and the record are kept;
ii. to search that place or those places in the manner specified in the order; and
iii. to seize books, registers, other documents, and the record, it considers necessary for the purposes of the investigation,
a. provided that the Magistrate shall not authorise seizure of books, registers, other documents, and record, of
any listed public company or a public company (not being the intermediaries specified under Section 12),
which intends to get its securities listed on any recognised stock exchange, unless such company indulges in an
insider trading or market manipulation.
10. The Investigating Authority shall keep in its custody the books, the registers, the other documents, and the record seized under
this Section, for such period not later than the conclusion of the investigation it considers necessary and, thereafter, shall return
the same to the company or the other body corporate, or, as the case may be, to the managing director or the manager or any
other person, from whose custody or power they were seized, and inform the Magistrate of such return:
i. provided that the Investigating Authority may, before returning such books, registers, other documents, and record, as
aforesaid, place identification marks on them or any part, thereof.
11. Save as, otherwise, provided in this Section, every search or seizure made under this Section shall be carried out in accordance
with the provisions of the Code of Criminal Procedure, 1973 (2 of 1974), relating to searches or seizures made under that Code.
Cease and Desist Proceedings
If the Board finds, after causing an enquiry to be made, that any person has violated, or is likely to
violate, any provisions of this Act, or any rules or regulations made there under, it may pass an order
requiring such person to cease and desist from committing or causing such violation:
i. provided that the Board shall not pass such order in respect of any listed public company or a public company (other than the
intermediaries specified under Section 12), which intends to get its securities listed on any recognised stock exchange, unless the
Board has reasonable grounds to believe that such company has indulged in an insider trading or market manipulation.
Consolidate Market Regulation Under SEBI
The Committee on Financial Sector Reforms has recommended consolidation of all market
regulation and supervision under SEBI and consolidation of all deposit-taking entities under the
banking supervisor. At present, the regulation of organised financial trading is handled by three
agencies: the RBI (government bonds and currencies), SEBI (equities and corporate bonds), and FMC
(commodities, futures). The committee, appointed by the Planning Commission and headed by Dr.
Raghuram Rajan, former Chief Economist of IMF, has observed that this separation of regulatory
responsibility among three agencies is a key defect of the Indian financial markets. The Committee
has recommended the merger of regulatory and supervisory functions for all organised financial
trading into SEBI.
Reduce Costs
In its report released today, the Committee said that the fragmentation of market supervision between
multiple regulatory authorities increases transaction costs, creates frictions, and reduces liquidity in
all markets. The consolidation of regulators will make it easier to deal with problems, arising out of
blurring of boundaries between different types of products.
It will also make it easier to get specialised professionals who can detect insider trading,
manipulation, and other abuses. “Merger of all market regulation into SEBI will reduce transaction
costs and improve liquidity in financial markets”, the report said.
Regulatory Overlaps
The report listed some examples of regulatory overlaps, such as an overlap between SEBI and the
Ministry of Corporate Affairs in the regulation of issuer companies, between SEBI and the RBI in the
regulation of FIIs, and exchange-traded currency and interest rate products, and between the RBI and
the state governments in the regulation of cooperative banks.
The overlapping regulatory structure also becomes a barrier to innovation, as any new product
might need approval from more than one regulator. The report said that, eventually, all cooperative
banks that are under the State Registrar of Cooperative Societies should be treated like commercial
banks and brought under the banking supervisor. There is also a need to streamline Tier 2 regulators,
such as NABARD (National Bank for Agriculture and Rural Development), SIDBI (Small Industries
Development Bank of India), and NHB (National Housing Bank). The Committee also said that there
is a need for a Financial Sector Oversight Agency, which will monitor the functioning of large,
systemically important, financial conglomerates as well as large, systemically important, financial
institutions that would otherwise be unregulated. The Committee has also called for an Office of the
Financial Ombudsman, which will monitor the selling of different products and the degree of
transparency about their pricing, risks, and deal with consumer grievances.
GROWTH OF STOCK MARKET IN INDIA

Stock Market in India and China Underperforms
The Indian stock market has emerged as one of the worst performers globally in the first three
months this calendar year, with concerns of a possible slowdown in the US economy and a surge in
commodity prices, impacting sentiments of emerging and developed equity markets, a report says.

The Indian stock market has emerged as one of the worst performers globally in the first three months this calendar year,
with concerns of a possible slowdown in the US economy and a surge in commodity prices, impacting sentiments of
emerging and developed equity markets, a report says.
According to a monthly review by global index provider Standard and Poor, or S&P, the world’s
emerging and developed equity markets were hit hard during the first quarter of 2008, losing 10.56
per cent and 8.95 per cent, respectively, during the period. “Near-record commodity prices, 10-year
US treasury rates approaching their lowest level, a struggling dollar and the potential global impact
of a perceived US recession all fuelled market volatility and uncertainty during the first quarter”,
S&P’s senior index analyst Howard Silverblatt said.
Among the emerging world equity markets, 15 of the 26 countries lost ground during the January-
March quarter this year, with India, China, and Turkey emerging as the worst performers. During the
first three months in 2008, Indian equity market lost 28.55 per cent, while China and Turkey witnessed
a fall of 24.65 per cent and 36.62 per cent, respectively. Emerging markets (EMs) that managed to
give positive returns despite the global concerns include Pakistan, Morocco, and Chile, which
emerged as some of the best performers during the first quarter.
Pakistan’s stock market has provided a return of 10.25 per cent in the period, Morocco performed
robustly giving gains of 23.81 per cent, and Chile gave 8.5 per cent positive returns, the S&P monthly
Global Stock Market Review said. In March, 10 of the 26 EMs gained, producing a weighted decline
of 5.11 per cent and an average increase of 3.44 per cent. The variance is due to the BRIC countries
(Brazil, Russia, India, and China) that represent 50.6 per cent of the value.
Brazil, which accounts for 15.3 per cent of the EM value, witnessed a loss of 7.99 per cent in
March. Both India (commanding 8.4 per cent of the market value) and China (cornering 14.8 per cent)
lost 12.4 per cent, respectively, in the month. Russia witnessed a marginal drop of 1.60 per cent for the
same period.
For the quarter as well, the BRIC countries showed notable losses. India reported a 28.6 per cent
loss, against a gain of more than 80 per cent in 2007. China was down by 24.7 per cent for the quarter
when compared with 69.8 per cent in 2007, and Brazil, which was up by 79.6 per cent last year, fell by
5.5 per cent for the quarter. Russia dropped by 11 per cent in the first quarter of 2008, the report
added. While monthly and quarterly performances were mixed for the EMs, 12-month returns remain
strongly positive, with 13 of the 26 markets still boasting an annual return in excess of 25 per cent
with only South Africa (down by 6.98 per cent) and Turkey (down by 3.11 per cent) in negative
territory.
In the 12-month period that ended on March 31, the Indian market has gained 31.56 per cent and
China 29.57 per cent. The Brazilian market returned more than 57 per cent and Russian 13 per cent in
the one-year period. In terms of the various sectors, eight of the 10 posted losses in March, with only
the industrial (0.19 per cent) and consumer staples (2.65 per cent) sectors posting gains. Among
others, telecommunications declined by 4.30 per cent, followed by materials at 3.77 per cent and
health care at 3.21 per cent.
India’s Premium over Other EMs Plunges
As expected, the numbers show that the next one year ’s price-earnings (P-E) estimates for the Indian
market has declined from a high of 25.62 at the end of last December to 18.53 at the end of March
2008. The fall in the Indian stock market in the past months has obviously led to lower valuations. But
what are our valuations now when compared with other markets? We take a look here at the P-E
estimates for the S&P/Citigroup broad market indices.

The fall in the Indian stock market in the past months has obviously led to lower valuations.
The data estimates the next one year ’s P-E multiples of various countries and regions on the basis
of consensus or the average of analysts’ earnings estimates computed by the Institutional Brokers’
Estimate System or IBES, an internationally recognised guide to consensus earnings forecasts. As
expected, the numbers show that the next one year ’s P-E estimates for the Indian market has declined
from a high of 25.62 at the end of last December to 18.53 at the end of March 2008. What is
interesting, however, is that the premium, that the Indian market commanded when compared with
other EMs, has been squeezed sharply between December and March.
According to the S&P/Citigroup indices, the premium for the Indian market over other EMs has
come down from 64 per cent at end-December to 38 per cent by March-end. That is slightly higher
than the premium at the end of June last year. In other words, the rise in valuation as a result of the
flood of money hitting Indian shores late last year has been corrected, though India continues to be
the most expensive market in terms of the S&P/Citigroup indices.
Interestingly, the S&P/Citigroup EM index used to trade at a discount to the World index till last
September until the emergence of the credit crisis in the West depressed the valuations in the
developed markets. At the end of March, however, the EM index was trading at a small premium of 6
per cent to the World index. But the US market had a forward P-E of 13.76 at the end of March,
slightly higher than the EM P-E of 13.42, though the premium for the US market has declined
substantially, since last June.
It can be argued that the P-E numbers do not mean much, as earnings will be revised downward as
the global slowdown takes hold. But if we assume that the revisions will affect all markets, we can
still draw conclusions on the basis of the relative P-Es. Clearly, valuations in the developed markets
have fallen more than those in the EMs, given that the credit crisis hurts them the most. India’s
premium over other EMs is now even lower than before when the credit crisis hit, implying that much
of the froth has been wiped off and the rise, and fall in our markets may, henceforth, be in tandem
with other EMs.

Clearly, valuations in the developed markets have fallen more than those in the EMs, given that the credit crisis hurts them
the most.
Where to Invest Now
Whether it is a bull run or a bear hug, the market throws up opportunities for those who look out for
them, and for those who invest wisely. Here are three broad scenarios for you to mull over,
depending on your outlook on the market. The first is the worst-case scenario: the period of great
returns is over, and it is now time for the bears to call the shots. At the other end of the spectrum is a
highly optimistic view of the “India’s Growth Story” going strong. Then, there is the perspective of
the realist—that it is impossible to predict which way the market is going to go. We leave it to you to
decide which category you belong to. But, while it is great to have your own beliefs and views, it is
worth if only you act upon them.

Whether it is a bull run or a bear hug, the market throws up opportunities for those who look out for them, and for those
who invest wisely.
The Pessimist
All the talk about the India’s Growth Story is simply, politically correct mumbo-jumbo. And the spiel
is being dished out by those who are too scared to face the truth. From now on, the market has only
one way to go, that is, downhill. Weak company results and the slowdown in the gross domestic
product (GDP) give the impression of a fatigued swimmer flailing for the shore.

All the talk about the India’s Growth Story is simply, politically correct mumbo-jumbo. And the spiel is being dished out by
those who are too scared to face the truth. From now on, the market has only one way to go, that is, downhill.
Inflation keeps raising its ugly head. Then there is the political gridlock over the Indo-US nuclear
deal. Elections are looming, bringing with them uncertainty—which the market hates. And that is only
on the local front. Globally, the threat of a US recession has turned into a reality. Ever heard how
capitalists talk about privatising profits and socialising losses? Well, the United States is certainly
socialising in a big way. The fall of the Wall Street firm “Bear Stearns Companies Inc.”, was probably
only the start. Anyone will realise that the world’s biggest economy has entered a full-blown bailout
mode, which goes beyond the usual strategy of cutting short-term interest rates that its central bank
has done several times.

Globally, the threat of a US recession has turned into a reality. Ever heard how capitalists talk about privatising profits and
socialising losses?
Globalisation is a double-edged sword. If India can benefit from an increasingly globalised

environment, can it be immune to a global weakness? And, to add fuel to the fire, the price of oil
remains alarmingly high. All right, the world may not have come to an end, but the bull run certainly
has. The bulls had a great time from 2003 to end-2007, and it is time for the bears to come out of
hibernation. The year 2008 is the year of the Great Indian Meltdown. We are facing it.

Globalisation is a double-edged sword. If India can benefit from an increasingly globalised environment, can it be immune
to a global weakness?
The Realist
It is amazing how opinionated people get at every turn of the market. A downturn, however
temporary, has the prophets of doom crawling out of the woodwork. And the moment the market
gains a bit, those perennial optimists start echoing each other ’s opinions. The fact is that no one
knows where the market is headed: up, down, or rangebound.
On the one hand, we do have the India’s Growth Story firmly rooted in domestic consumption. But,
on the other, the US recession is a reality, and it is foolish to presume that India will be insulated from
it.
GDP growth has slowed from the 9 per cent levels, but will continue to clock between 6 per cent
and 8 per cent. Not bad at all. But the battle with inflation and political uncertainty will continue.
But then, who knows if the market will ever rally substantially to give a good return on investment?
Do not believe anyone who predicts what is going to happen. Would anyone have predicted the sub-
prime crisis, which was barely a cloud on the horizon a year ago? In July 2007, Charles Prince, the
then chief executive of US financial firm, Citigroup Inc., said: “When the music stops, in terms of
liquidity, things will get complicated. As long as the music is playing, you have got to get up and
dance. We are still dancing”. Could anyone envisage then that his dancing days would end abruptly?
And then, at the start of this bull run, did anyone predict the Sensex, the BSE’s benchmark index,
would touch 20,000? That is the reality. No one knows what to expect.
The Optimist
One downturn, and everyone is convinced that the sky has fallen. It may have fallen elsewhere, but not
in India. Sure, living in an era of globalisation, we are bound to get hit. But, there is ample activity
within the Indian economy to soften the blow. Domestic demand, increasing employment numbers,
rising incomes, and a growing middle class, coupled with mounting customer credit and increased
infrastructure spending, will keep the economy on a roll. The demographics are strong enough to
ensure that consumption growth will be a key driver. Intra-regional trade will also reduce the impact
of a slowdown in the developed world. In terms of exposure to US consumption, India is the least
affected among the major Asian markets. There has been integration in Asian economies, and India
no longer exports only to the West.
The Economist recently reported that the four biggest emerging economies, which accounted for
two-fifths of global GDP growth last year, are the least dependent on the United States: Exports to the
United States accounted for just 4 per cent of India’s economy, while the figures for China, Brazil,
and Russia were 8 per cent, 3 per cent, and 1 per cent, respectively.

The Economist recently reported that the four biggest emerging economies, which accounted for two-fifths of global GDP
growth last year, are the least dependent on the United States: Exports to the United States accounted for just 4 per cent of
India’s economy, while the figures for China, Brazil, and Russia were 8 per cent, 3 per cent, and 1 per cent, respectively.
It is only natural that the Indian market reacts to the global turmoil. The capital market is sensitive
to global dips and short-term volatility, and it is something we must get accustomed to. The factors
driving the market are long term and structural in nature. Within this structural run, there will be
shorter-term cycles. And within different cycles, the sector leadership may differ. But the
fundamentals of the economy remain strong, and the prospects upbeat.
KEY WORDS
Stock Exchange
Corporatisation of Stock Exchanges
Demutualisation of Stock Exchanges
Money Market
Capital Market
Secondary Market
Security Exchange Board of India (SEBI)
QUESTIONS
1. How does the traditional structure of stock exchanges in India differ from modern structure?
2. Explain the role of SEBI in regulating Financial Markets in India?
3. Describe the process of demutualisation of stock exchanges?
4. List down the names of stock exchanges in India?
5. Discuss the growth of stock market in India?
6. Enumerate the various functions of stock exchange?
7. Explain the reasons of stock market volatality? Suggest measures you will adopt for protection of interest of investors?
8. Write short notes on
a. Powers of Security Exchange
b. Security Contract Act
REFERENCES
Agarwal, S. and H. Mohtadi (2004). “Financial Markets and the Financing Choice of Firms: Evidence from Developing
Countries”, Global Finance Journal, 15(1): 57–70.
Bombay Stock Exchange, Annual Reports, 1991–92.
Darrat, A. F. and T. K. Mukherjee (1986). “The Behavior of the Stock Market in a Developing Economy”, Economics Letters,
22(2–3): 273–278.
Daveri, F. (1995). “Costs of Entry and Exit from Financial Markets and Capital Flows to Developing Countries”, World
Development, 23(8): 1375–1385.
Friedmann, E. (1976). “Financing Energy in Developing Countries”, Energy Policy, 4(1): 37–49.
Hale, D. D. (1994). “Stock Markets in the New World Order”, The Columbia Journal of World Business, 29(2): 14–28.
Henry, P. B. (2000). “Do Stock Market Liberalizations Cause Investment Booms?”, Journal of Financial Economics, 58(1–2):
301–334.
Kenny, C. J. and T. J. Moss (1998). “Stock Markets in Africa: Emerging Lions or White Elephants?”, World Development,
26(5): 829–843.
Kim, Y. (2000). “Causes of Capital Flows in Developing Countries”, Journal of International Money and Finance, 19(2): 235–
253.
Lall, S. (1982). “The Emergence of Third World Multinationals: Indian Joint Ventures Overseas”, World Development, 10(2):
127–146.
Levine, R. and S. Zervos (1998). “Capital Control Liberalization and Stock Market Development”, World Development, 26(7):
1169–1183.
Machiraju, H. R. (2005). The Working of Stock Exchanges in India, 2 nd ed. New Delhi: New Age International.
Narsimham, M. (1992). Financial Sector Reform and the Capital Markets, The fourth phirozze, Jeejeebhoy’s Lecture.
Raghunathan, V. (1992). Stock Exchanges in Investments. New Delhi: Tata McGraw Hill.
Securities and Exchange Board of India, www.sebi.com.
Teweles, R. J., E. Bradley, and T. Teweles (1992). The Stock Market, 6th ed. New York: Wiley.
Mody, A. and A. P. Murshid (2005). “Growing up with Capital Flows”, Journal of International Economics, 65(1): 249–266.
Alfaro, L. and E. Hammel (2007). “Capital Flows and Capital Goods”, Journal of International Economics, 72(1): 128– 150.
CHAPTER 08
National Income
CHAPTER OUTLINE
Meaning and Definition of National Income
Concepts of National Income
National Income Estimates in India
Methodology of National Income Estimation in India
Savings and Investments
Trends in National Income Growth and Structure
Causes for the Slow Growth of National Income in India
Suggestions to Raise the Level and Growth Rate of National Income in India
Major Features of National Income in India
Difficulties or Limitations in the Estimation of National Income in India
Key Words
Questions
References
MEANING AND DEFINITION OF NATIONAL INCOME
Keynes’ concept of “national income” is somewhere between gross national product (GNP) and net
national product (NNP) (as discussed below). From GNP he subtracts only the “user cost”, that is,
reduction in the value of capital equipment actually used and not full depreciation. According to
present ideas, national income may be defined as the aggregate factor income (i.e., earning of labour
and property), which arises from the current production of goods and services (G&S) by the nation’s
economy. The nation’s economy refers to the factors of production (i.e., labour and property)
supplied by the normal residents of the national territory.

According to present ideas, national income may be defined as the aggregate factor income (i.e., earning of labour and
property), which arises from the current production of goods and services (G&S) by the nation’s economy.
To explain the above idea let us take an economy, where there are only two sectors: households and
firms. Firms are required to produce goods. To produce them, they require services of the factors of
production. Thus, the incomes of these factors arise in the course of production. The sales value of
net production must equal the sum total of payments made by the firms to the factors of production, in
the form of wages, rents, interest, and profits. These incomes in turn become the sources of
expenditure. Therefore, income flows from firms to households in exchange for productive services,
while products flow in return when expenditure by the households takes place.
Thus, there are three measures of national income of a country which are as follows:
1. As the sum of all incomes, in cash and kind, accruing to factors of production in a given time period, that is, the total of income
flows;
2. As the sum of net outputs arising in several sectors of the nation’s production; and
3. As the sum of consumers’ expenditure, government expenditure on G&S, and net expend iture on capital goods.
The total of income flows, net outputs, and final expenditures will be the same, but the significance of
each of them arises from the fact that they reflect the total operations of the nation’s economy, at the
level of three basic economic functions, such as, production, distribution, and expenditure. The
discussion of the various concepts of national income will make the meaning of national income
clear (refer to Figure 8.1).

The total of income flows, net outputs, and final expenditures will be the same, but the significance of each of them arises
from the fact that they reflect the total operations of the nation’s economy, at the level of three basic economic functions,
such as, production, distribution, and expenditure.

Fig ure 8.1 Selected Economic Indicators
aNovember 2007 (provisional).
b First advance estimates (kharit only).
cProvisional.
d Provisional average, April–December, 2007.
CONCEPTS OF NATIONAL INCOME
We study below the five important concepts of national income, viz., the gross national product
(GNP), net national product (NNP), national income, personal income (PI), and disposable income
(DI). This is the basic, social accounting measure of the total output or aggregate supply of G&S.
GNP is defined as the total market value of all final G&S produced in a year. It is a measure of the
current output of economic activity in the country.

GNP is defined as the total market value of all final G&S produced in a year. It is a measure of the current output of
economic activity in the country.
Two things must be noted in regard to GNP. They are as follows:
1. It measures the market value of the annual output. In other words, GNP is a monetary measure. There is no other way of adding
up the different sorts of G&S produced in a year, except with their money prices. But in order to know accurately the changes in
physical output, the figure for GNP is adjusted for price changes by comparing to a base year as we do when we prepare index
numbers.
2. For calculating GNP accurately, all G&S produced in any given year must be counted once, but not more than once. Most of
the goods go through a series of production stages before reaching a market. As a result, parts or components of many goods
are bought and sold many times. Hence, to avoid counting several times the parts of goods that are sold and resold, GNP only
includes the market value of final goods and ignores transactions involving intermediate goods.
What do we mean by “final goods”? Final goods are those goods, which are being purchased for
final use and not for resale or further processing. Intermediate goods, on the other hand, are those
goods, which are purchased for further processing or for resale. The sale of final goods is included
in GNP, while the sale of intermediate goods is excluded from GNP, why? Because the value of final
goods includes the value of all intermediate goods used in their production. For instance, the value of
cloth includes the value of cotton used in the making of cloth. The inclusion of intermediate goods
would involve double counting and will, therefore, give an exaggerated estimate of GNP.

Final goods are those goods, which are being purchased for final use and not for resale or further processing. Intermediate
goods, on the other hand, are those goods, which are purchased for further processing or for resale.
Another important thing to be borne in mind while calculating the GNP is that nonproductive
transactions should be excluded. These are purely financial transactions or transfer payments like
old-age pensions or unemployment doles which are merely grants or gifts or transactions relating to
existing shares or second-hand shares.
Net National Product (NNP)
The second important concept of national income is that of NNP. In the production of GNP of a year,
we consume or use up some capital, that is, equipment, machinery, and so on. The capital goods, like
machinery, wear out or depreciate in value, as a result of its consumption or use in the production
process. This consumption of fixed capital or fall in value of capital due to “wear and tear” is called
“depreciation”. When charges for depreciation are deducted from the GNP, we get NNP, which means
the market value of all final G&S after providing for depreciation. Therefore, it is called “national
income at market prices”. Thus, Net National Product (NNP) or National Income at Market Prices =
Gross National Product–Depreciation.

NNP, means the market value of all final G&S after providing for depreciation. Net National Product (NNP) or National
Income at Market Prices = Gross National Product−Depreciation.
National Income or National Income at Factor Cost (NI)
The difference between “national income at market prices” and “national income at factor cost” may
be clearly understood. National income at factor cost means the sum of all incomes earned by
resource suppliers for their contribution of labour, capital, and entrepreneurial ability, which go into
the year ’s net production. In other words, national income (or national income at factor cost) shows
how much it costs society, in terms of economic resources, to produce the net output. It is really the
national income at factor cost for which we use the term “National Income”. The difference between
national income (or national income at factor cost) and NNP (national income at market prices) arises
from the fact that indirect taxes and subsidies cause market prices of output to be different from the
factor incomes that are resulting from it.

National income at factor cost means the sum of all incomes earned by resource suppliers for their contribution of labour,
capital, and entrepreneurial ability, which go into the year’s net production.
Suppose a metre of mill cloth sold for Rs 5 includes 25p on account of the excise and sales tax. In
this case, while the market price of the cloth is Rs 5 per metre, the factors engaged in its production
and distribution would receive only Rs 4.75p a metre. The value of cloth at factor cost would thus be
equal to its value at market price less the indirect taxes on it. On the other hand, a subsidy causes the
market price to be less than the factor cost. Suppose a handloom cloth is subsidised at the rate of 20p a
metre and it is sold at Rs 2.80. Then, while the consumer pays Rs 2.80 per metre, the factors engaged
in the production and distribution of such cloth receive Rs 3 per metre. The value of the handloom
cloth at factor cost would thus be equal to its market price plus the subsidies paid on it. Thus, national
income (or national income at factor cost) is equal to NNP minus indirect taxes plus subsidies.
National Income or National Income at Factor Cost = Net National Product (NNP) (National Income
at Market prices) - Indirect Taxes + Subsidies.

National Income or National Income at Factor Cost = Net National Product (NNP) (National Income at Market prices) −
Indirect Taxes + Subsidies.
Personal Income (PI)

“Personal Income” (PI) is the sum of all incomes actually received by all individuals or households
during a given year. National income, that is income received, must be different for the simple reason
that some income which is earned through social security contributions, corporate income taxes, and
undistributed corporate profits is not actually received by households and, conversely, some income
which is received through transfer payments is not currently earned. (Transfer payments are old-age
pensions, unemployment doles, relief payments, interest payment on the public debt, etc.)

“Personal Income” (PI) is the sum of all incomes actually received by all individuals or households during a given year.
Obviously, in moving from national income, as an indicator of income earned, to PI, as an

indicator of income actually received, we must subtract from national income these three types of
incomes which are earned but not received, and add incomes received but not currently earned.
Therefore, Personal Income = National Income, Social Security Contributions, Corporate Income
Taxes, Undistributed Corporate Profits + Transfer Payments.

Personal Income = National Income, Social Security Contributions, Corporate Income Taxes, Undistributed Corporate
Profits + Transfer Payments.
Disposable Income (DI)
After a good part of PI is paid to government in the form of personal taxes like income tax, personal
property taxes, and so on, what remains of PI is called the “disposable income”.

After a good part of PI is paid to government in the form of personal taxes like income tax, personal property taxes, and so
on, what remains of PI is called the “disposable income”.
NATIONAL INCOME ESTIMATES IN INDIA
The National Income Committee (NIC) in its first report wrote,

A national income estimate measures the volume of commodities and services turned out during a given period, without duplication.
The estimates of national income depict a clear picture about the standard of living of the community. The national income statistics
diagnose the economic ills of the country and at the same 1 time suggest remedies. The rate of savings and investment in an economy
also depend on the national income of the country. Moreover, the national income measures the flow of all commodities and
services produced in as economy. Thus the national income is not a stock bat a flow. It measures the total prod uctive power of the
community during given period.
A national income estimate measures the volume of commodities and services turned out during a given period, without
duplication.
Further, the NIC has rightly observed, “National income statistics enable an overall view to be taken
of the whole economy and of the relative positions and inter-relations among its $ vario us parts”.
Thus, the computation of national income and its analysis has been considered as an important
exercise in economic literature.
National Income After Independence
After independence, the Government of India appointed the NIC in August 1949, with Prof. P.C.
Mahalanobis as its Chairman and Prof. D.R. Gadgil and Dr. V.K.R.V. Rao as its two members, so as to
compile national income estimates, rationally, on a scientific basis. The first report of this Committee
was prepared in 1951. In its first report, the total national income of the year 1948–49 was estimated at
Rs 8,830 crore and the per capita income of the year was calculated at Rs 265 per annum.

In its first report, the total national income of the year 1948–49 was estimated at Rs 8,830 crore and the per capita income
of the year was calculated at Rs 265 per annum.
The Committee continued its estimation works for another three years and the final report was
published in 1954. The report of this NIC provided complete statistics on the national income of the
whole country. The following were the main features of the NIC report.
1. Agriculture including forestry, animal husbandry, and fishery contributed about one-half of the national income of the country
during 1950–51.
2. Mining, manufacturing, and hand trades contributed nearly one-sixth of the national income of India.
3. Commerce, transport, and communication also contributed a little more than one-sixth of the total national income of the country.
4. Income earned from other services, such as professions and liberal arts, house property, and administrative and domestic
services contributed nearly 15 per cent of the total national income of the country.
5. Commodity production constituted nearly two-thirds share of the national income, whereas it contributed to the remaining one-
third of the national income of India.
6. In 1950–51, the share of the government sector contributed about 7.6 per cent of the net domestic.
7. In the computation of national income estimates, the margin of error was estimated at about 10 per cent.
NIC and CSO Estimates
During the post-independence period, the estimate of national income was primarily conducted by the
NIC. Later on, it was carried over by the Central Statistical Organisation (CSO). For the estimation of
national income in India, the NIC applied a mixture of “product method” and “income method”. This
Committee divided the entire economy into 13 sectors, from the six sectors, viz., agriculture, animal
husbandry, forestry, fishery, mining, and factory establishments, estimated by the output method. But
the income from the remaining seven sectors consisting of small enterprises, commerce, transport
and communications, banking and insurance, professions, liberal arts, domestic services, house
property, public authorities, and the rest of the world is estimated by the income methods.

During the post-independence period, the estimate of national income was primarily conducted by the NIC. Later on, it was
carried over by the Central Statistical Organisation (CSO).
The National Income Unit (NIU) of the CSO is nowadays entrusted with the measurement of
national income. This unit of CSO estimated the major part of national income from the various
sectors like agriculture, forestry, animal husbandry, fishing, mining, and factory establishments with
the help of product method. It is also applying the income method for the estimation of the remaining
part of national income raised from the other sectors. Till now, we have three different series in the
national income estimates of India. They include conventional series, revised series, and new series.

Till now, we have three different series in the national income estimates of India. They include conventional series, revised
series, and new series.
Conventional Series
The conventional series revealed national income data both at current prices and at 1948–49 prices,
covering the period from 1948–49 to 1964–65. Here, the contribution of all the 13 sectors were added
for obtaining an estimate of the net domestic product at factor cost, through the application of both
net-output method and net-income method. To arrive at the estimate of net national income, the net
income, from abroad, and net indirect taxes are added to the estimate of net domestic product at factor
cost. Moreover, for obtaining a series of national income at constant prices, this estimate is deflated at
the prices of the base year chosen.

The conventional series revealed national income data both at current prices and at 1948–49 prices, covering the period
from 1948–49 to 1964–65.
The Revised Series

The revised series show the national income data both at current prices and at 1960–61 prices, for the
period from 1960–61 to 1975–76. Later on, a new series was also started with 1970–71 as the base
year. Due to this difference in the base year and differences in weights used for the two series, the
estimates of national income revealed differences in its magnitudes.

The revised series show the national income data both at current prices and at 1960–61 prices, for the period from 1960–
61 to 1975–76.
CSO’s New Series

The NIU of CSO has prepared a new series on national income with 1980–81 as the base year, as
against the existing series with 1970–71 as the base year. This national income estimates have also
been projected backwards to prepare a total series of national income from 1950–51 onwards for the
sake of comparison. Taking this new series into consideration, the estimates of national income
aggregates have registered an increase in the new series as against 1970–71 series. Again the CSO has
prepared another new series on national income with 1993–94 as the base year, as against the existing
series with 1980–81 as the base year. Although the total national income has registered an increase in
the new series, the estimates of gross domestic savings (GDS) have revised downwards.

The NIU of CSO has prepared a new series on national income with 1980–81 as the base year, as against the existing series
with 1970–71 as the base year.
METHODOLOGY OF NATIONAL INCOME ESTIMATION IN INDIA
In India, the estimation of national income is being done by two methods, that is, product method and
income method.

In India, the estimation of national income is being done by two methods, that is, product method and income method.
Net-product Method
While estimating the gross domestic product (GDP) of the country, the contribution to GDP from
various sectors, like agriculture, livestock, fishery, forestry and logging, and mining and quarrying
is estimated with the adoption of product method. In this method, it is important to estimate the gross
value of product, bi-products, and ancillary activities and, then, steps are taken to deduct the value of
inputs, raw materials, and services from such gross value as follows:
1. In respect of other sub-sectors like animal husbandry, fishery, forestry, mining, and factory establishments, the gross value of
their output is obtained by multiplying the estimated output with their market price. From such gross value of output, deductions
are made, for the cost of materials used and depreciation charges are levied, so as to obtain net value added in each sector.
2. In respect of secondary activities, the computation of GDP is done by the production approach only for the manufacturing
industrials units (both registered and unregistered).
3. In respect of constructions activity, the estimates of the value of pucca construction are made by the commodity-flow approach
and that of the Kachcha construction are made by the expenditure method.
While estimating the gross domestic product (GDP) of the country, the contribution to GDP from various sectors, like
agriculture, livestock, fishery, forestry and logging, and mining and quarrying is estimated with the adoption of product
method.
Net-income Method
In India, the income from rest of the sectors, that is, small enterprises, commerce, transport and
communications, banking and insurance, professions, liberal arts, domestic activities, house property,
public authorities, and the rest of the world is estimated by the income method. Here, the income
approach is adopted to estimate the value added from these aforesaid remaining sectors. Here, the
process involves the measurement of aggregate factor incomes in the shape of compensation of
employees (wages and salaries) and operating surpluses in the form of rent, interest, profits, and
dividends. Following are the processes:
1. In order to measure the contribution of small enterprises, it is essential to make an estimation of the total number of workers,
employed in different occupations under small enterprises, through sample surveys and also to estimate the per capita average
earnings of such workers. After multiplying the total number of such workers employed by their average earning, the
contribution of small enterprises to national product is estimated.
2. In order to obtain the contribution of banking and insurance sector, necessary information is collected from their balance sheets,
so as to add the wages, salaries, directors’ fees, and dividends.
3. In order to derive the contributions of transport and communication, trade and commerce, professions, and liberal arts, the same
procedure as adopted by the small enterprises is followed.
4. Regarding the contribution of the public sector, the amounts related to wages, salaries, pensions, other benefits, dividend or
surpluses, and so on, are all added up to derive the same.
5. Again the contribution of house property to the national income is obtained by estimating the imputed value of net rental of all
houses, situated in both urban and rural areas.
6. Finally, by adding up the contribution of all different sectors to national income of the country, it is necessary to obtain the net
domestic product at factor cost. In order to derive the net national income at the current prices, it is necessary to add the net
income from abroad and net indirect taxes with the net domestic product at factor cost. This same estimate is then deflated at the
prices of the base year selected, to derive a series of national income at constant prices.
In order to derive the net national income at the current prices, it is necessary to add the net income from abroad and net
indirect taxes with the net domestic product at factor cost.
In India, the income from rest of the sectors, that is, small enterprises, commerce, transport and communications, banking
and insurance, professions, liberal arts, domestic activities, house property, public authorities, and the rest of the world is
estimated by the income method.
State of the Economy
The economy has moved decisively to a higher growth phase. Till a few years ago, there was still a
debate among informed observers that whether the economy had moved above the 5 per cent to 6 per
cent average growth, seen since the 1980s. There is no doubt that the economy has moved to a higher
growth plane, with growth in GDP at market prices (GDPmp) exceeding 8 per cent in every year since
2003–04. The projected economic growth of 8.7 per cent for 2007–08 is fully in line with this trend.
There was an acceleration in domestic investment and saving rates to drive growth and provide the
resources for meeting the 9 per cent (average) growth target of the Eleventh Five-Year Plan. Macro-
economic fundamentals continue to inspire confidence and the investment climate is full of optimism.
Buoyant growth of government revenues made it possible to maintain fiscal consolidation as
mandated under the Fiscal Responsibility and Budget Management Act (FRBMA). The decisive
change in growth trend also means that the economy was, perhaps, not fully prepared for the different
set of challenges that accompany fast growth. Inflation flared up in the last half of 2006–07 and was
successfully contained during the current year, despite a global hardening of commodity prices and
an upsurge in capital inflows. An appreciation of the rupee, a slowdown in the consumer goods
segment of industry, and infrastructure (both physical and social) constraints, remained of concern.
Raising growth to double digit will, therefore, require additional reforms.

There was an acceleration in domestic investment and saving rates to drive growth and provide the resources for meeting
the 9 per cent (average) growth target of the Eleventh Five-Year Plan.
Per Capita Income and Consumption
Growth is of interest, not for its own sake, but for the improvement in public welfare that it brings
about. Economic growth, and, in particular, the growth in per capita income, is a broad quantitative
indicator of the progress made in improving the public welfare. Per capita consumption is another
quantitative indicator that is useful for judging welfare improvement. It is, therefore, appropriate to
start looking at the changes in real (i.e., at constant prices) per capita income and consumption.

Economic growth, and, in particular, the growth in per capita income, is a broad quantitative indicator of the progress
made in improving the public welfare.
The pace of economic improvement has moved up considerably during the last five years
(including 2007–08). The rate of growth of per capita income as measured by per capita GDPmp (at
constant 1999–2000 prices) grew by an annual average rate of 3.1 per cent, during the 12-year period
from 1980–81 to 1991–92. It accelerated marginally to 3.7 per cent per annum, during the next 11
years from 1992–93 to 2002–03. Since then, there has been a sharp acceleration in the growth of per
capita income, almost doubling to an average of 7.2 per cent per annum (from 2003–04 to 2007–08).
This means that the average income would now double in a decade, well within one generation,
instead of after a generation (two decades). The growth rate of per capita income in 2007–08 is
projected to be 7.2 per cent, the same as the average of the five years to the current year.
The per capita, private, final consumption expenditure has increased in line with the per capita
income (refer to Figure 8.2). The growth of per capita consumption accelerated from an average of
2.2 per cent per year, during the 12 years from 1980–81 to 1991–92 to 2.6 per cent per year during the
next 11 years following the reforms of the 1990s. The growth rate has almost doubled to 5.1 per cent
per year, during the subsequent five years from 2003–04 to 2007–08, with the current year ’s growth
expected to be 5.3 per cent, marginally higher than the five-year average (refer to Table 8.1).

Fig ure 8.2 Growth in Per Capita Income

Table 8.1 Per Capita Income and Consumption (in 1999–2000 prices)
Notes:
Income is taken as GDP at market prices;
consumption is PFCE; and
per capita is obtained by dividing these by population.

The average growth of consumption is slower than the average growth of income, primarily because
of rising saving rates, though rising tax collection rates can also widen the gap (during some
periods). Year-to-year (y-t-y) changes in consumption also suggest that the rise in consumption is a
more gradual and steady process, as any sharp changes in income tend to get adjusted in the saving
rate.

The average growth of consumption is slower than the average growth of income, primarily because of rising saving rates,
though rising tax collection rates can also widen the gap (during some periods).
Economic Growth
The GDP at current market prices is projected at Rs 4,693,602 crore in 2007–08 by the CSO in its
advance estimates (AE) of GDP. Thus, in the current fiscal year, the size of the Indian economy at
market exchange rate will cross US$1 tn. At the nominal exchange rate (average of April–December
2007), the GDP is projected to be US$1.16 tn in 2007–08. The per capita income at nominal exchange
rate is estimated at US$1,021. According to the World Bank system of classification of countries as
low, middle, and high-income ones, India is still in the category of low-income countries.

According to the World Bank system of classification of countries as low, middle, and high-income ones, India is still in the
category of low-income countries.
The (per capita) GDP at purchasing power parity (PPP) is, conceptually, a better indicator of the
relative size of the economy than the (per capita) GDP at market exchange rates. There are, however,
practical difficulties in deriving GDP at PPP, and now we have two different estimates of the PPP
conversion factor for 2005. India’s GDP at PPP is estimated at US$5.16 tn or US$3.19 tn depending on
whether the old or the new conversion factor is used. In the former case, India is the third-largest
economy in the world after the United States and China, while in the latter it is the fifth largest (behind
Japan and Germany).
The GDP at factor cost at constant 1999–2000 prices is projected by the CSO to grow at 8.7 per cent
in 2007–08. This represents a deceleration from the unexpectedly high growth of 9.4 per cent and 9.6
per cent, respectively, in the previous two years. With the economy modernising, globalising, and
growing rapidly, some degree of cyclical fluctuation is to be expected. This was taken into account
while setting the Eleventh Five-Year Plan (from 2007–08 to 2011–12) growth target of 9 per cent
(both in the approach paper and in the NDC-approved plan). Given over the 9 per cent growth in the
last two years of the Tenth Five-Year Plan, it was argued that the Eleventh Five-Year Plan target could
be set at 10 per cent to 11 per cent, as 9 per cent had already been achieved. Maintaining the growth
rate at 9 per cent will be a challenge and raising it to two digits will be an even greater one.

Given over the 9 per cent growth in the last two years of the Tenth Five-Year Plan, it was argued that the Eleventh Five-Year
Plan target could be set at 10 per cent to 11 per cent, as 9 per cent had already been achieved.
Sectoral Contribution
The deceleration of growth in 2007–08 is generally spread across most of the sectors except
electricity, community services, and the composite category of “trade, hotels, and transport and
communications”. The deceleration in the growth of the agriculture sector is attributed to the
slackening in the growth of rabi crops. Manufacturing and construction, which grew at 12 per cent in
2006–07, decelerated by about 2.5 percentage points in 2007–08. The slower growth of consumer
durables (as reflected in the IIP) was the most important factor in the slowdown of manufacturing.
Cement and steel, the key inputs into construction, grew by 7.4 per cent and 6.5 per cent, respectively,
during April–November of 2007–08, down from 10.8 per cent and 11.2 per cent, respectively, in the
previous year, dampening the growth in the construction sector. There was also a deceleration in the
growth of revenue-earning freight traffic by railways, passengers handled at airports, and bank credit
in April–November of 2007–08, which formed the basis for the full-year assessment.

The slower growth of consumer durables (as reflected in the IIP) was the most important factor in the slowdown of
manufacturing.
The growth in 2006–07 initially estimated at 9.2 per cent in February 2007 was revised upwards to
9.4 per cent in May 2007 and further to 9.6 per cent in the Quick Estimates released by the CSO on
January 31, 2008. This suggests that upward adjustments in the 2007–08 projections are possible.
The observed growth of 7.8 per cent in the Tenth Five-Year Plan (2002–07), the highest so far for
any plan period, is only marginally short of the target of 8 per cent. The dismal growth rate of 3.8 per
cent during the first year of the plan was made up by an upsurge in growth in the next four years to an
average of 8.8 per cent. A notable feature of growth during the Tenth Five-Year Plan was the
resurgence of manufacturing. There was a sharp acceleration in the growth of manufacturing from
3.3 per cent during the Ninth Five-Year Plan to 8.6 per cent during the Tenth Five-Year Plan. The
average growth of manufacturing during the five years ending 2007–08 is expected to be about 9.1
per cent. The contribution of manufacturing to overall growth increased from about 9.6 per cent
during the Ninth Five-Year Plan to about 17.7 per cent during the Tenth Five-Year Plan.

The contribution of manufacturing to overall growth increased from about 9.6 per cent during the Ninth Five-Year Plan to
about 17.7 per cent during the Tenth Five-Year Plan.
The growth in the services sector continued to be broad based. Among the sub-sectors of services,
“transport and communication” has been the fastest growing, with growth averaging 15.3 per cent per
annum during the Tenth Five-Year Plan period followed by “construction”. The impressive progress
in the telecommunication sector and higher growth in rail, road, and port traffic played an important
role in the growth of this sector. Besides manufacturing, the two other sectors whose contribution to
growth has increased over the two plans are “construction and communications”. The contribution of
the construction sector increased to 10.8 per cent during the Tenth Five-Year Plan from 7.5 per cent
during the Ninth Five-Year Plan, while that of telecom increased to 11.4 per cent from 6 per cent over
the two plans. The growth of “financial services” comprising banking, insurance, and business
services, after declining to 5.6 per cent in 2003–04, bounced back to 8.7 per cent in 2004–05, 11.4 per
cent in 2005–06, and 13.9 per cent in 2006–07. Manufacturing, construction, and communication were
the leading sectors in the acceleration of growth during the Tenth Five-Year Plan, judged by their
increased contribution to growth.

Manufacturing, construction, and communication were the leading sectors in the acceleration of growth during the Tenth
Five-Year Plan, judged by their increased contribution to growth.
Agricultural growth, dependent as it is on the monsoon, continued to fluctuate, though the five-year
period ending 2007–08 had the second-lowest coefficient of variation (CV), since the five years
ending 1956–57. The CV for the Tenth Five-Year Plan was, however, higher than the 60-year average.
The overall growth during the Tenth Five-Year Plan was 2.5 per cent, the same as was in the Ninth
Five-Year Plan. The weather-induced fluctuations considerably influenced the GDP growth for
agriculture (refer to Table 8.2). In 2002–03, the cumulative rainfalls of north-east and south-west
monsoon were –33 per cent and –19 per cent, respectively, of the long-period averages (LPA).
Similarly, in 2004–05, the cumulative rainfall was –13 per cent and –11 per cent, respectively from
LPA for south-west and north-east monsoon. The secular decline in the share of agriculture sector in
GDP continued, with a decline from 24 per cent in 2001–02 to 17.5 per cent in 2007–08.

The secular decline in the share of agriculture sector in GDP continued, with a decline from 24 per cent in 2001–02 to 17.5
per cent in 2007–08.

Table 8.2 Rate of Growth of GDP at Factor Cost at 1999–2000 Prices (%)
Note: Plan period is simple average.

Aggregate Demand
The most important contribution to demand growth has come from investment, while the external
trade made a negligible or negative contribution. The growth of GDPmp accelerated from 3.8 per
cent in 2002–03 to 9.7 per cent in 2006–07, giving an average annual growth of 7.9 per cent for the
Tenth Five-Year Plan. The average rate of growth of gross capital formation (GCF), during the Tenth
Five-Year Plan, has more than tripled to 17.3 per cent per year from an average growth of 5.3 per cent
per annum in the Ninth Five-Year Plan. Consequently, its contribution to overall demand, as measured
by the increase in GDPmp, tripled from 19 per cent in the Ninth Five-Year Plan to 65 per cent in the
Tenth Five-Year Plan. The most important component of investment, viz., gross fixed investment
(GFI), grew by an average of 14.3 per cent per annum, during the Tenth Five-Year Plan period.

The most important contribution to demand growth has come from investment, while the external trade made a negligible or
negative contribution.
The most important component of investment, viz., gross fixed investment (GFI), grew by an average of 14.3 per cent per
annum, during the Tenth Five- Year Plan period.
The relative share of private consumption in GDP was 60.9 per cent while the gross fixed capital
formation (GFCF) had a share of 27 per cent (refer to Table 8.3). Although the average growth of
private final consumption expenditure (PFCE) accelerated somewhat to 5.9 per cent per annum from 5
per cent, its contribution to growth of demand declined from 59 per cent to 46 per cent between the
two plans. The contribution of net exports of G&S to overall demand also declined between the two
plans to a negative 5 per cent. Thus, the external trade has had a dampening effect on aggregate
demand during the just completed plan. Export growth, because of its spillo ver effects on productivity
and efficiency, can, however, still act as a driver of growth.
NAS (National Air Services) projections for 2007–08 show a deceleration in the GDPmp in line
with its growth at factor cost. They also show a deceleration in the growth of consumption, both
public and private, and an acceleration in the rate of growth of GFCF. The higher growth in the GCF
is projected to improve its share in GDPmp to 32.6 per cent in 2007–08, when compared to a share of
23.6 per cent in 2002–03. GDCF is projected to grow by 20 per cent and PFCE at 6.8 per cent in 2007–
08, both of them above the average of the just completed plan.

The external trade has had a dampening effect on aggregate demand during the just completed plan. Export growth,
because of its spill-over effects on productivity and efficiency, can, however, still act as a driver of growth.

Table 8.3 Growth of GDP at 1999–2000 Market Prices (%) — Annual and Plan Average
aChange in stocks was negative during 2001–02. Hence, growth rate has not been calculated.

SAVINGS AND INVESTMENTS
A notable feature of the recent GDP growth has been a sharply rising trend in gross domestic
investment (GDI) and saving, with the former rising by 13.1 per cent of GDP and the latter by 11.3 per
cent of GDP over a period of five years till 2006–07. The average investment ratio for the Tenth Five-
Year Plan at 31.4 per cent was higher than that for the Ninth Five-Year Plan, while the average saving
rate was also 31.4 per cent of GDP higher than the average ratio of 23.6 per cent during the Ninth
Five-Year Plan.

A notable feature of the recent GDP growth has been a sharply rising trend in gross domestic investment (GDI) and saving,
with the former rising by 13.1 per cent of GDP and the latter by 11.3 per cent of GDP over a period of five years till 2006–
07.
The reforms of 1990s transformed the investment climate, improved the business confidence, and
generated a wave of entrepreneurial optimism. This has led to a gradual improvement in the
competitiveness of the entire corporate sector, a resurgence in the manufacturing sector, and an
acceleration in the rate of investment. The FRBMA-mandated fiscal correction path was also helpful
in raising the credibility of the government with respect to fiscal deficits, in which India was at the
bottom of global rankings. This has improved perceptions about the long-term macro-economic
stability of the economy. Moderate tax rates, coupled with buoyant sales growth, increased the internal
accruals of the corporate sector. The improved investment climate and strong macro-fundamentals
also led to an upsurge in foreign direct investment (FDI). The combined effect of these factors was
reflected in an increase in the investment rate from 25.2 per cent of GDP in the first year of the Tenth
Five-Year Plan to 35.9 per cent of GDP in the last year. The higher investment was able to absorb the
domestic savings and also generated an appetite for absorption of capital inflows from abroad.
GDS, as a proportion of GDP, continued to improve, rising from 26.4 per cent in 2002–03 to 34.8
per cent in 2006–07, with an average of 31.4 per cent during the Tenth Five-Year Plan. The savings-
investment gap which remained positive during 2001–04 became negative, thereafter. In modern
economy, the excess of domestic savings over domestic investment suggests a deflationary situation
in which the demand has not kept pace with the increased capacity. Thus, the reversal of the savings-
investment balance should be viewed as a correction of the domestic, supply-demand balance,
occurring through an above-normal (and welcome) increase in the demand during 2005–06 and
2006–07.

The reversal of the savings– investment balance should be viewed as a correction of the domestic, supply–demand balance,
occurring through an above-normal (and welcome) increase in the demand during 2005–06 and 2006–07.
Savings
Both private and public savings have contributed to higher overall savings. Private savings have risen
by 6.1 per cent points of GDP over the Tenth Five-Year Plan period, while public sector savings
increased by 5.2 per cent of GDP. Both have increased steadily over this period, though private
savings appear to have reached a plateau in 2005–06 (refer to Table 8.4). The savings from the private
corporate sector were particularly buoyant, while the turnaround in public sector savings, from
negative to positive from 2003–04 onwards is heartening. The increase in private savings is due to a
(more than) doubling of the rate of corporate saving over the plan period. Savings of the household
sector were stable at 23 per cent to 24 per cent of GDP, averaging 23.7 per cent during the Tenth Five-
Year Plan. The physical and financial components of the household savings also remained stable.
With the upsurge in private corporate and public sector savings, the share of the household sector in
GDS declined from 94.3 per cent in 2001–02 to 68.4 per cent in 2006–07.

Both private and public savings have contributed to higher overall savings. Private savings have risen by 6.1 per cent
points of GDP over the Tenth Five-Year Plan period, while public sector savings increased by 5.2 per cent of GDP.

Table 8.4 Ratio of Savings and Investment to GDP (% at current market prices)
Note: Totals may not tally due to adjustment for errors and omissions.

Investments
In contrast to the increase in savings the increase in investment has been driven by the private
investment, which went up by 10.3 per cent of GDP over the five years of the Tenth Five-Year Plan.
This improvement was, in turn, driven by a private corporate investment, which increased by 9.1 per
cent of GDP over these five years. The private corporate sector investment improved from 5.4 per
cent of GDP in 2001–02 to 14.5 per cent in 2006–07. The upsurge in private corporate investment has
been visible even to the public as a “Capex” boom, and that is still continuing. The household
investment remained close to the plan average of 12.7 per cent of GDP throughout the period, while
the public sector investment increased by less than 1 per cent of GDP over the plan period.

In contrast to the increase in savings the increase in investment has been driven by the private investment, which went up by
10.3 per cent of GDP over the five years of the Tenth Five- Year Plan.
The National Accounts provide the data of the GDCF at constant 1999–2000 prices also. In terms of
constant prices, the ratio of gross investment to GDP is estimated to have increased from 25 per cent
in 2002–03 to 33.8 per cent in 2006–07. The GFCF accounted for more than 90 per cent of the
investment (refer to Table 8.4). The ratio of fixed capital formation to GDP is estimated to have
increased to 30.6 per cent in 2006–07.
TRENDS IN NATIONAL INCOME GROWTH AND STRUCTURE
Sectoral Investment and ICOR
It is useful to examine the growth of GCF (investment) by sectors, to see how much of the sector ’s
growth has been associated with the expansion of capacity. GCF in manufacturing grew at a phe-
nomenal 33.6 per cent per annum, during the Tenth Five-Year Plan period, the highest growth rate of
any sector. This confirms that the boom in the manufacturing growth rate is higher than for total
GDP, which is backed by a solid build-up of capacity. The fact that the calculated incremental capital
output ratio (ICOR) for this period at 8.9 is the second highest, after electricity sector ’s suggestion
that there may be some build-up of capacity ahead of and in anticipation of demand.

GCF in manufacturing grew at a phenomenal 33.6 per cent per annum, during the Tenth Five- Year Plan period, the
highest growth rate of any sector.
The 29.7 per cent per annum growth of investment in mining seems at first sight inconsistent with
the relatively low growth of GDP from this sector. However, given the long-gestation lags in many
types of mining projects, the increased investment could be a precursor of faster growth in the
Eleventh Five-Year Plan, though the first-year growth is not encouraging. Trade and hotels, with an
annual growth of 26.4 per cent during the five years of the Tenth Five-Year Plan, was the third-fastest
investor. With its very low ICOR of 0.7, it can play a vital role in generating higher employment with
a relatively low investment along with the construction sector (with the third-lowest ICOR).
Communication, a very fast-growing sector in terms of value added, had the lowest ICOR of 0.6,
confirming that the competition-induced productivity growth has played a key role in this reasonably
well, regulated sector (refer to Table 8.5).
The traditionally high ICOR of 16.7 for the electricity sector, re-emphasises the critical importance
of efficient planning and implementation of capacity-building, as well as the efficient use of this
capacity and of the electricity produced from it. Railways and other transport and services were the
remaining sectors in which the GCF growth exceeded 15 per cent (refer to Table 8.6). Finance and
business services, communication, and agriculture and allied sectors recorded significantly lower
growth. The ratio of GCF to GDP averaged 31 per cent during the Tenth Five-Year Plan. It, however,
was 94.1 per cent for electricity sector followed by manufacturing at 76.5 per cent. Trade and hotels
had the lowest GCF to GDP ratio of 6.2 per cent.

Finance and business services, communication, and agriculture and allied sectors recorded significantly lower growth. The
ratio of GCF to GDP averaged 31 per cent during the Tenth Five-Year Plan.
Consumption Basket
The National Accounts also provide data on disaggregated consumption expenditure of households in
eight broad categories. With rising per capita consumption, simple Engel curve analysis would
predict a decline in the share of consumption on food and an increase in luxuries, which in our
context include entertainment and durable goods. Food and beverages had the lowest average growth
of 3.2 per cent, during the Tenth Five-Year Plan, and its share declined from 48.1 per cent in 2001–02
to 42.1 per cent in 2006–07 (refer to Table 8.7). The growth of transport and communication,
education and recreation, and miscellaneous services by more than 10 per cent and the rising share of
furniture, appliances, and services are also consistent with the Engel curve analysis.

Food and beverages had the lowest average growth of 3.2 per cent, during the Tenth Five- Year Plan, and its share
declined from 48.1 per cent in 2001–02 to 42.1 per cent in 2006–07.

Table 8.5 Components of Domestic Investment (% to GDP at 1999–2000 market prices)
aAdjusted for errors and omissions.

Table 8.6 Sector Investment (1999–2000 prices) and ICOR

The erratic pattern of change in the consumption of clothing and footwear may be because the
middle-class households treat them as falling within a residual expenditure category. The high share
of expenditure on health care, despite a large and nominally free, public health care system stretching
into the villages, has been of concern, as the pattern is found even among the less well-off. The
decline in share to 4.4 per cent in 2006–07 after a peak of 5.2 in 2002–03 could be a positive indicator.
Inclusive Growth
Faster economic growth is also translating into more inclusive growth, both in terms of employment
generation and poverty reduction. The Tenth Five-Year Plan was formulated in the backdrop of the
concerns over jobless growth. Employment growth slowed to 1.25 per cent per annum during the
period from 1993–94 to 1999–2000, with 24 million work opportunities created during this period
(annual average of four million). The Tenth Five-Year Plan, therefore, set a target of creation of 50
million new opportunities on current daily status (CDS) basis.
The 61st Round of National Sample Survey Organisation (NSSO) Survey found that 47 million work
opportunities were created during the period from 1999–2000 to 2004–05, at an annual average of 9.4
million. The employment growth accelerated to 2.6 per cent during this period. The labour force,
however, grew at 2.8 per cent per year, 0.2 per cent point faster than the workforce, resulting in an
increase in the unemployment rate to 8.3 per cent in 2004–05 from 7.3 per cent in 1999–2000. These
rates based on the CDS approach are higher than those obtained by the usual status and weekly status
approaches, indicating a high degree of intermittent unemployment. Unemployment rate measured in
terms of number of persons, as per the usual, principal and subsidiary status basis, was only 2.5 per
cent in 2004–05.

The 61 st Round of National Sample Survey Organisation (NSSO) Survey found that 47 million work opportunities were
created during the period from 1999–2000 to 2004–05, at an annual average of 9.4 million.

Table 8.7 Private Final Consumption—Annual Growth and Share (%)

The proportion of persons, below the poverty line, declined from around 36 per cent of the
population in 1993–94 to 28 per cent in 2004–05, as per the uniform recall period. Based on the
mixed recall period, the number of persons below the poverty line has declined to 22 per cent in
2004–05 from 26 per cent in 1999–2000. Further, the growth of average monthly per capita
expenditure at constant prices between 1993–94 and 2004–05 (61st Round of NSSO) also indicates,
broadly, a similar growth across different rural and urban income classes, though it may have been
less uniform for urban than for rural population.
Inflation
GDP Deflators
The implicit deflator for GDPmp and its demand components is the most comprehensive measure of
inflation on an annual basis. The overall inflation, as measured by the aggregate deflator for GDPmp,
is projected to decline from 5.6 per cent in 2006–07 to 4.1 per cent in 2007–08 (refer to Table 8.8).
Thus, the inflation rate is projected to be identical to that of which in 2005–06. The counterpart of the
consumer price index (CPI), the most commonly used inflation rate for monetary purposes, is the
deflator for PFCE. Inflation, according to the PFCE deflator, jumped from 3 per cent in 2005–06 to
5.1 per cent in 2006–07 and is projected to be 5.5 per cent in 2007–08. The projected decline in the
overall inflation is, therefore, due to the deceleration in investment goods prices from 5.5 per cent
growth in 2006–07 to 4.3 per cent growth in 2007–08. This should have a positive effect on
investment.

The overall inflation, as measured by the aggregate deflator for GDPmp, is projected to decline from 5.6 per cent in 2006–
07 to 4.1 per cent in 2007–08.
The projected decline in the overall inflation is, therefore, due to the deceleration in investment goods prices from 5.5 per
cent growth in 2006–07 to 4.3 per cent growth in 2007–08.
Prices
Inflation, as measured by the wholesale price index (WPI), rose from 4.4 per cent in 2005–06 to 5.4
per cent in 2006–07 and is expected to return to around the 2005–06 rate for the full year 2007–08,
based on the 10 months that were completed. The composition will, however, be different, with a
much higher, primary-goods inflation, mainly because of primary non-food prices and a lower fuel-
price inflation, because of low pass-through of global oil prices. The latest flare-up in prices started
from a trough of around 4 per cent in February–March 2006 and (except for a short respite in July)
continued to accelerate till it peaked in March 2007. Since then, there is a declining trend till
December 2007. The annual headline inflation was 4.1 per cent on February 2, 2008. On February 15,
2008, a hike in fuel prices was announced, which is expected to add 19 basis points to the inflation
rate, as per preliminary estimates.
The increase in the prices of primary articles and mineral oils in June 2006, substantially con-
tributed to this firming-up. It started moderating from June 2007 onwards because of a number of
reasons: (1) a rollback in the increase in the prices of petrol and diesel at end-November 2006 and
mid-February 2007 to the pre-June 2006 levels, (2) improved availability of primary articles, and (3)
fiscal and monetary measures. The year-on-year (y-o-y) rate of inflation declined to less than 4 per
cent in mid-August 2007 after a gap of 67 weeks. The overall inflation has remained below 4 per cent
since then for 23 consecutive weeks, before inching up to 4.1 per cent in the last 2 weeks. Primary
articles, which had contributed to a substantial increase in the inflation in 2006–07 and in the first five
months of the current year, were also the major contributors to the deceleration in the rate of
inflation. The inflation of primary articles declined from 12.2 per cent on April 7, 2007, to 3.8 per
cent on January 19, 2008, the lowest level since early November 2005. There was also a deceleration
in the prices of manufactured products from over 6 per cent in April 2007 to less than 4.5 per cent in
the last 17 weeks (up to February 2, 2008).

The increase in the prices of primary articles and mineral oils in June 2006, substantially contributed to this firming-up.

Table 8.8 Implicit Deflators (%)
PFCEdm: Private final consumption expenditure in domestic market.

The group “fuel and power” has, however, witnessed an increase in inflation in the recent months.
An increase in the prices of coal and domestic pass-through of international price increase in crude
oil to petroleum products (POL—petroleum, oil, and lubricants), other than petrol and diesel,
contributed to this firming-up of inflation. At a disaggregated level, on January 19, 2008, the prices
of 132 manufactured products with a weight of 29.7 per cent, 10 items of fuel and power with a weight
of 10.1 per cent, and 41 primary articles with a weight of 6.8 per cent were the same or lower than a
year ago. The combined weight of these 183 commodities was 46.6 per cent. These commodities
substantially contributed to moderation in the inflation in the curr ent year. The close monitoring of
prices and appropriate policy interventions initiated in the last year and a half helped in maintaining
the price stability and reducing the impact of increase in the global prices on domestic consumers.

The close monitoring of prices and appropriate policy interventions initiated in the last year and a half helped in
maintaining the price stability and reducing the impact of increase in the global prices on domestic consumers.
Money Supply
The Reserve Bank of India’s (RBI) monetary policy stance is to serve the twin objectives of managing
the transition to a higher growth path and containing the inflationary pressures. For policy purposes
for the year 2007–08, the RBI assumed a real GDP growth of 8.5 per cent with an inflation close to 5
per cent, and targeted the monetary expansion in the range of 17 per cent to 17.5 per cent and the
credit expansion in the range of 20 per cent to 24 per cent, as consistent with envisaged growth and
inflation. In its mid-term review, the RBI reiterated the continuation of the policy stance that was
announced in April 2007, with an additional resolve “to be in readiness to take recourse to all
possible options for maintaining stability and the growth momentum in the economy in view of the
unusual heightened global uncertainties, and the unconventional policy responses to the developments
in financial markets”.

The Reserve Bank of India’s (RBI) monetary policy stance is to serve the twin objectives of managing the transition to a
higher growth path and containing the inflationary pressures.
The annual average growth of Money (M3) reached a trough of 13 per cent in 2003–04 and has
been on an accelerating trend since then, reaching 19.5 per cent in 2006–07. The cumulative (FY to
date) increase in the stock of M3 in 2007–08 has also remained above the cumulative growth in 2006–
07 and was 13.3 per cent on January 4, 2008, when compared to 12.2 per cent on January 5, 2006.
Thus, it is difficult to relate either the annual or the trend rate of growth of M3 to inflation, which has
been on a downtrend during this period, with two cycles peaking in August 2004 and March 2007.
This is, perhaps, because of the parallel process of monetary deepening of the informal economy that
is under way. The ratio of average M3 to GDP has increased from 44 per cent in 1990–91 to 71 per
cent in 2006–07. This could be attributed to the spread of banking services and the saving habit,
resulting in deposits, over a period of time. The monetisation of the economy, as measured by the
ratio of average M1 to GDP, has increased from 15 per cent in 1990–91 to 21 per cent in 2006–07.

The monetisation of the economy, as measured by the ratio of average M1 to GDP, has increased from 15 per cent in 1990–
91 to 21 per cent in 2006–07.
The average growth of bank credit to commercial sector (BCCS) also reached a low of 11.8 per
cent in 2003–04 and rose in the next two years to 28 per cent in 2005–06. However, in contrast to
money supply, the average credit growth slowed marginally to 26.8 per cent in 2006–07 and has
decelerated further in 2007–08. The cumulative (FY to date) increase in the credit extended by the
banking sector to the commercial sector during 2007–08 is less than that which was in 2006–07. The
cumulative increase in the non-food credit was 11.8 per cent by January 4, 2008, much slower than the
17.5 per cent increase till the corresponding date of 2007. This deceleration could be related to the
deceleration in growth of manufacturing and construction sectors and the consequent, slowdown in
demand for credit.
Nominal interest rates, as measured by the cut-off yield, at the auction on 91-day- and 364-day
treasury bills have followed a pattern similar to that of the money growth. The average cut-off yield
on 364-day (91-day) treasury bills reached a trough of 4.7 (4.6) per cent in 2003–04 and has been
rising since then. The yields averaged 7 (6.6) per cent during 2006–07. The yields have risen further
to an average of 7.5 (7) per cent in April–December 2007 from 6.8 (6.3) per cent in April–December
2006. The real cut-off yields, as measured using the trailing 12-month increase in the WPI, have
lagged this increase, by reaching a trough of –1.2 (–1.5) per cent in 2004–05 and rising, there after, to
1.6 (1.2) per cent in 2006–07. The latter were marginally higher than the average yield in 2005–06.
The real cut-off yields on 364-day (91) treasury bills have (more than) doubled to an average of 3.2
(2.7) per cent in April–December 2007 from 1.7 (1.2) per cent in April–December 2006. The doubling
of the real interest rate may have had a moderating effect on credit demand and consequently, on both
inflation and growth. It has also led to a widening of the interest differential between domestic and
global rates.

The doubling of the real interest rate may have had a moderating effect on credit demand and consequently, on both
inflation and growth. It has also led to a widening of the interest differential between domestic and global rates.
During 2006–07, the yield on 10-year Gsec hardened by 45-basis points over the level observed on
March 31, 2006, to reach 7.97 per cent on March 31, 2007. The yields moved to 8.32 per cent at end-
June 2007 but softened, subsequently, to reach 7.77 per cent as on January 4, 2008, which were 20
basis points over the end-March 2007 level. The acceleration in reserve money growth continued in
2007–08. The expansion in M0 (up to January 4, 2008) was 13.6 per cent when compared to 9.1 per
cent during the corresponding period of the previous year. The main driver of growth of M0 on
financial year as well as on an annual basis continued to be net foreign assets (NFA) of the RBI. The
NFA of the RBI expanded by 25.2 per cent in the current year (39.1 per cent on annual basis) when
compared to an expansion of 15.9 per cent (26.1 per cent on an annual basis), during the same period
of the previous year. The share of NFA in the aggregate reserve money increased to 122.2 per cent as
on March 31, 2007, as against 117.4 per cent on March 31, 2006. This ratio further increased to 134.7
per cent on January 4, 2008. With the continuing surge in capital flows during 2007–08 and the need
to regulate domestic liquidity, the MSS (market stabilisation scheme) limits were revised upward four
times to a level of Rs 250,000 crore during the year. During April–December 28, 2007, the liquidity
absorbed under MSS was Rs 96,742 crore with outstanding balances at Rs 159,717 crore. The higher
growth of the monetary variables (M0 and M3), despite the MSS operations, generated higher
liquidity in the system. The short-term liquidity variations were addressed by RBI through the
liquidity adjustment facility (LAF).

The higher growth of the monetary variables (M0 and M3), despite the MSS operations, generated higher liquidity in the
system. The short-term liquidity variations were addressed by RBI through the liquidity adjustment facility (LAF).
Balance of Payments (BoP)

The World Economic Outlook (WEO of IMF, October 2007) observed that the recent expansionary
phase in the global economy, with an average growth of 5 per cent, was the longest since the early
1970s. The WEO update on January 2008 has, however, revised these estimates based on the new PPP
exchange rates from the 2005 international comparison programme (ICP). There is considerable
uncertainty in quantifying the downside risk to global growth, arising from the downturn in housing
market and the sub-prime mortgage market crisis in the United States. The monetary policy actions by
the United States and other developed countries seem to have contained its immediate impact, though
more surprises in the next six months cannot be ruled out.

There is considerable uncertainty in quantifying the downside risk to global growth, arising from the downturn in housing
market and the sub-prime mortgage market crisis in the United States.
The Indian economy has been progressively globalising since the initiation of reforms. Trade, an
important dimension of global integration, has risen steadily as a proportion of GDP. Inward FDI has
taken off and there is a surge in the outward investment from a very low base, with net FDI continuing
to grow at a good pace. The surge of capital flows in 2007–08 is a third indicator that testifies to the
growing influence of global developments on the Indian economy. Capital flows, as a proportion of
GDP, have been on a clear uptrend during this decade. They reached a high of 5.1 per cent of GDP in
2006–07 after a below-trend attainment of 3.1 per cent in 2005–06. This is a natural outcome of the
improved investment climate and recognition of robust macro-economic fundamentals like high
growth, relative price stability, healthy financial sector, and high returns on investment. Even as the
external environment remained conducive, the problem of managing a more open capital account
with increasing inflows and exchange rate appreciation surfaced.
The current account has followed an inverted V-shaped pattern during the decade, rising to a
surplus of over 2 per cent of GDP in 2003–04. Thereafter, it had returned close to its post-1990’s
reform average, with a current account deficit of 1.2 per cent in 2005–06 and 1.1 per cent of GDP in
2006–07. The net result of these two trends had been a gradual rise in reserve accumulation to over 5
per cent of GDP in 2006–07. With capital inflows exceeding financing requirements, foreign
exchange reserve (FER) accumulation was of the order of US$15.1 bn in 2005–06 and US$36.6 bn in
2006–07. Thus, the rupee faced an upward pressure in the second half of 2006–07. Despite this, the
rupee depreciated by 2.2 per cent on an overall, yearly average basis. The excess of capital inflows
has risen to 7.7 per cent of GDP in the first half of 2007–08. FER increased by US$91.6 bn to
US$290.8 bn on February 8, 2008.

The current account has followed an inverted V-shaped pattern during the decade, rising to a surplus of over 2 per cent of
GDP in 2003–04. Thereafter, it had returned close to its post- 1990s’ reform average, with a current account deficit of 1.2
per cent in 2005–06 and 1.1 per cent of GDP in 2006–07.
Components of Capital Account Deficit

The composition of capital flows is also changing. Among the components of capital inflows,
foreign investment has been a relatively stable component, fluctuating broadly between 1 per cent and
2 per cent of GDP during this decade. However, it seems to have shifted to a higher plane from 2003–
04, with the average for the period from 2003–04 to 2006–07 roughly double than that was during the
period from 2000–01 to 2002–03. The relative stability of investment flows is primarily due to
steadily rising FDI. In contrast, debt flows have fluctuated much more, with net outflows in the three
years to 2003–04. The variations in debt flows have been primarily due to lumpy repayments on
government-guaranteed or government-related external commercial borr owings (ECBs). The ratio
of debt flows to GDP was on a downtrend till 2003–04 and a rising trend from 2004–05. Debt flows,
primarily ECBs, shot up on a net basis in 2006–07 to a level of US$16.2 bn. The trend in net capital
flows since 2003–04, therefore, seems to be broadly driven by the rising ratio of debt flows.

The ratio of debt flows to GDP was on a downtrend till 2003–04 and a rising trend from 2004–05.
The most welcome feature of increased capital flows is the 150 per cent increase in net FDI inflows
in 2006–07 to US$23 bn. The trend has continued in the current financial year with gross FDI inflows
reaching US$11.2 bn in the first six months. The FDI inflows were broad based and spread across a
range of economic activities like financial services, manufacturing, banking services, information
technology (IT) services, and construction. With FDI outflows also increasing steadily over the last
five years, the overall net flows (FDI balance in BoP [balance of payments]) have grown at a slower
rate.

With FDI outflows also increasing steadily over the last five years, the overall net flows (FDI balance in BoP [balance of
payments]) have grown at a slower rate.
The globalisation of Indian enterprises and planting of the seeds for the creation of Indian
multinationals have taken place in the last few years. An outward investment from India shot up to
US$14.4 bn in 2006–07 from less than US$2 bn in the period 2003–04. The trend continued in the
current year with an outward investment of US$7.3 bn in April–September 2007. The net FDI flows
were, therefore, a modest US$3.9 bn during this period. The proportion of payments to receipts under
FDI into India was in the range of 0.7 per cent to 0.4 per cent in 2005–06 and 2006–07, respectively.
This indicates the lasting and stable nature of FDI flows to India.

The proportion of payments to receipts under FDI into India was in the range of 0.7 per cent to 0.4 per cent in 2005–06
and 2006–07, respectively. This indicates the lasting and stable nature of FDI flows to India.
The increased volatility in Asian and global financial markets in 2006–07 affected the flow of
portfolio investment. The net portfolio flows became negative in May–July 2006 (reflecting the
slump in equity markets), picked up momentum in August–November 2006, only to slow again in
March 2007. They were, therefore, only US$7.1 bn in 2006–07 when compared to US$12.1 bn in
2005–06. Euro equities, which were relatively a minor component of portfolio flows (less than a
billion US dollars in the period from 1997–98 to 2004–05), rose to US$3.8 bn in 2006–07,
constituting 54.3 per cent of the total net portfolio flows. The inflow was US$18.3 bn in April–
September 2007, more than double the inflow during 2006–07. Underlying these were gross inflows
of US$83.4 bn and outflows of US$65.0 bn.
The rapid accretion of reserves and increased pressure on the rupee, necessitated raising the limit
on the MSS’s fund. The annualised return on the multi-currency, multi-asset portfolio of the RBI was
4.6 per cent in 2006–07, indicating that the effective fiscal cost of sterilisation may be 3.2 per cent.
The fiscal costs of sterilisation in 2007–08 are placed at Rs 8,200 crore. The search for an
appropriate policy mix for balancing a relatively open capital account, monetary policy indepen-
dence, and flexible exchange rate continues.

The search for an appropriate policy mix for balancing a relatively open capital account, monetary policy independence,
and flexible exchange rate continues.
Components of Current Account Deficit

The current account deficit (CAD) mirrors the saving–investment gap in the national income accounts
and, thus, constitutes the net-utilised foreign savings. The challenge is to leverage foreign inflows
(i.e., foreign savings and investment) to promote growth without having the long-term consequences
of external payment imbalances. The distinction between gross capital inflows and net inflows is
useful. As the latter must equal the CAD, there is no way in which the net uses of foreign saving can
increase without an increase in the CAD. The gross inflow can, however, increase to the extent that it
is offset by gross outflows in the form of build-up of FER, reduction in government external debt, or
outward investment by entrepreneurs. Higher gross inflows have value even if net flows do not
increase to the same extent, as they can improve competition in the real and financial sectors, improve
the quality of intermediation, and the average productivity of investment, and, thus, raise the growth
rate of the economy. The challenge for policy is to maximise these benefits while minimising the
costs of exchange rate management.

The rise and fall of the current account balance (as a ratio to GDP) during this decade has been driven largely by the G&S
trade balance, with the two having virtually the same pattern.
The rise and fall of the current account balance (as a ratio to GDP) during this decade has been
driven largely by the G&S trade balance, with the two having virtually the same pattern. The surplus
from factor income including remittances, which fluctuated between 2 per cent and 3 per cent of GDP,
has helped to moderate the substantial the deficit on the trade account. Both the trade (G&S) balance
and the factor surplus improved between 2000–01 and 2003–04 leading to an improvement of the
current account. Both reversed the direction, thereafter, resulting in a declining trend in the current
account. The peak values of the three as a proportion of GDP were –0.6 per cent, 2.9 per cent, and 2.3
per cent. In the past two years, the current account deficit, trade (G&S) deficit, and factor surplus have
averaged 1.15 per cent, 3.5 per cent, and 2.35 per cent of GDP, respectively.
The trends in the G&S trade deficit have, in turn, been largely driven by the merchandise trade
deficit since 2004–05. Between 2000–01 and 2003–04, the merchandise trade deficit was around 2 per
cent of GDP, and the rising services surplus resulted in an improving trend in the overall G&S trade
balance. From 2004–05, the merchandise trade balance has been deteriorating and despite the
continued rise in the services surplus, the overall G&S balance had followed the deteriorating trend
of the former.

From 2004–05, the merchandise trade balance has been deteriorating and despite the continued rise in the services
surplus, the overall G&S balance had followed the deteriorating trend of the former.
Private transfer receipts (mainly remittances) shot up by 49.2 per cent in 2007–08 (April–
September) over the first half of 2006–07 when they had increased by 19.2 per cent. Investment
income (net), which reflects the servicing costs on the payments side and return on foreign currency
assets (FCA) on the receipts side, grew by 60 per cent in 2007–08 (April–September) reflecting the
burgeoning FER. Net invisible surplus grew by 35.2 per cent to reach US$31.7 bn in 2007–08 (April–
September), equivalent of 6.1 per cent of GDP. Thus, higher invisible surplus was able to moderate,
partly, the higher and rising deficits on trade account. CAD was, therefore, placed at US$10.7 bn in
2007–08 (April–September), equivalent of 2 per cent of GDP for the half-year.
External Trade
India’s greater integration with the world economy was reflected by the trade openness indicator, that
is, the trade to GDP ratio, which increased from 22.5 per cent of GDP in 2000–01 to 34.8 per cent of
GDP in 2006–07. If services trade is included, the increase is higher at 48 per cent of GDP in 2006–07
from 29.2 per cent of GDP in 2000–01, reflecting a greater degree of openness.

India’s greater integration with the world economy was reflected by the trade openness indicator, that is, the trade to GDP
ratio, which increased from 22.5 per cent of GDP in 2000–01 to 34.8 per cent of GDP in 2006–07. If services trade is
included, the increase is higher at 48 per cent of GDP in 2006–07 from 29.2 per cent of GDP in 2000–01, reflecting a
greater degree of openness.
India’s merchandise exports and imports (in US$, on customs basis) grew by 22.6 per cent and 24.5
per cent, respectively, in 2006–07, recording the lowest gap between growth rates after 2002–03.
Petroleum products (59.3 per cent) and engineering goods (38.1 per cent) were the fastest growing
exports. The perceptible increase in the share of petroleum products in total exports reflected India’s
enhanced refining capacity and higher POL (petroleum, oil, and lubricants) prices. The rising share
of engineering goods reflected improved competitiveness. The value of POL imports increased by 30
per cent, with the volume increasing by 13.8 per cent and prices by 12.1 per cent in 2006–07. Non-
POL import growth at 22.2 per cent was due to the 29.4 per cent growth of gold and silver and 21.4
per cent growth of non-POL non-bullion imports, which were needed to meet the industrial demand.
In the first nine months of the current year, exports reached US$111 bn, nearly 70 per cent of the
year ’s export target. During April–September 2007, the major drivers of export growth were
petroleum products, engineering goods, and gems and jewellery. Machinery and instruments,
transport equipment, and manufactures of metals have sustained the growth of engineering exports.
There was a revival of the gems and jewellery sector, with export growth at 20.4 per cent for April–
September 2007, after a deceleration in 2006–07.
Imports grew by 25.9 per cent during April–December 2007 due to non-POL imports growth of
31.9 per cent, implying a strong industrial demand by the manufacturing sector and for export
activity. The merchandise trade deficit in April–December 2007 at US$57.8 bn was very close to the
trade deficit of US$59.4 bn for 2006–07 (full year). Despite the large overall trade deficit, there was a
large (but declining) trade surplus with the United States and UAE and a small surplus with the United
Kingdom and Singapore (till 2006–07). The surplus with the first three has continued in 2007–08. The
largest trade deficits are with Saudi Arabia, China, and Switzerland. The trade deficit with China has
increased further in April–September 2007.
A comparison of the commodity-wise growth of major exports to the United States, European
Union (EU), and the rest of the world provides a better idea of the impact of economic slowdown and
rupee appreciation. The manufactured exports to the United States decelerated sharply in 2006–07
because of demand slowdown while dollar depreciation was an additional factor in 2007–08. The
slowdown of exports to the EU was marginal because both factors were absent. In contrast, there was
a marginal acceleration in the manufactured exports to the rest of the world in the first half of 2007–
08. India’s exports of textiles, leather and manufactures, and handicrafts to United States performed
poorly in 2006–07, even though the rupee depreciated marginally. However, exports of all sub-
categories, including engineering goods and chemicals, have decelerated in the first half of 2007–08.
In the case of EU, the sharp deceleration in textiles and poor performance in handicrafts were
substantially offset by a reasonable growth in the other manufactures in 2006–07 and the first half of
2007–08. Leather and leather manufactures exports have performed well overall to EU and other
countries, while showing a decline in the case of the United States. Thus, there seems to be a greater
correlation between the demand in a partner country and the bilateral exchange rate, on the one hand,
and India’s bilateral exports at a disaggregated level, on the other, than is visible for the total Indian
exports to the world.

A comparison of the commodity-wise growth of major exports to the United States, European Union (EU), and the rest of the
world provides a better idea of the impact of economic slowdown and rupee appreciation.
The trade with the top 12 trading partners increased by over 11.2 percentage points since 2001–02
to reach 53.8 per cent of total in 2006–07. The share of the United States, the largest trading partner,
declined by 2.5 percentage points to 9.8 per cent in 2006–07, while China became the second-largest
partner in 2006–07 with its share increasing by 5.2 percentage points over the decade. China’s trade
share during April–October 2007 is even higher than that of the United States by Rs 600 crore.
India’s export of services grew by 32.1 per cent to US$76.2 bn in 2006–07. The software services,
business services, financial services, and communication services were the main drivers of growth.
The commercial services exports were almost 60 per cent of merchandise exports in 2006–07.
However, services exports grew by a disappointing 8.6 per cent in April–September 2007, due to a
decline in the value of non-software services, particularly, business and communication services.
India has continued to favour multilateral trading arrangements, which are both transparent and fair
to the developing economies. After the suspension of negotiations in July 2006, due to differences in
perceptions, safeguarding the interests of low-income and resources-poor agricultural producers,
along with making real gains in services negotiations and addressing growth and development,
concerns in industrial tariff negotiations.

India has continued to favour multilateral trading arrangements, which are both transparent and fair to the developing
economies.
Rupee Appreciation
With the demand for foreign exchange (debit side of BoP) not keeping pace with the supply side of
foreign exchange (credit side of BoP), the rupee appreciated by 8.9 per cent against the US dollar
during the current financial year between April 3, 2007 and February 6, 2008. The rupee appreciation
against the US dollar over the past 12 months on y-o-y basis (December 2007 over December 2006)
at 13.2 per cent was even higher. While the rupee appreciated against other major currencies as well
for most parts of the year, it was modest when compared to the rise against the US dollar. It even
depreciated marginally against the euro during the financial year (till February 6, 2008).

With the demand for foreign exchange (debit side of BoP) not keeping pace with the supply side of foreign exchange (credit
side of BoP), the rupee appreciated by 8.9 per cent against the US dollar during the current financial year between April 3,
2007 and February 6, 2008.
The appreciation of the rupee against the US dollar could be attributed to the effect of depreciation
of the US dollar against all the major currencies and the surge in capital flows. The REER (real-
effective exchange rate) (six currency, trade-based weights) that indicates the real competitiveness by
factoring the relative price levels, after depreciating in 2006–07, appreciated by 7.8 per cent in April–
January 2007–08. The appreciation of the rupee vis-à-vis the dollar, the main invoicing currency of
exports, compared to the lower appreciation of competing countries, coupled with the slow growth in
imports of major trading partners like the United States, affected the exports of some sectors with
low-import intensity. To mitigate the effect and facilitate an adjustment, the government announced
relief measures to selected sectors.
Stock Markets
Stock markets are an important instrument of financial intermediation. They saw an increased activity
in 2007–08. The primary market issue of debt and equity increased along with private placement. The
secondary market too showed a rising trend, notwithstanding the intermittent ups and downs in the
stock prices, responding mainly to global developments. The Bombay Stock Exchange (BSE) Sensex
rose from 13,072 at end-March 2007 to 18,048 as on February 18, 2008, while the National Stock
Exchange (NSE) index Nifty 50 rose from 3,822 to 5,277 during the same period. Both the indices
gave a return of around 38 per cent during this period. The higher net mobilisation of resources by
mutual funds showed that the investors were realising the importance of using intermediaries in risky
markets. All the other indicators of capital market, such as market capitalisation, turnover, and price-
earning ratio remained strong. The commodity market also showed signs of expansion in terms of
turnover and number of transactions during the year.

Stock markets are an important instrument of financial intermediation. They saw an increased activity in 2007–08.
Agriculture Production
The Directorate of Economics & Statistics in its second AE of agricultural production (February 7,
2007) has placed total food-grains production at 219.3 million tonnes, marginally higher than the
217.3 million tonnes in 2006–07 (final estimate). While the production of kharif foodgrains is
expected to be 5.3 million tonnes (4.8 per cent) higher than the production in 2006–07, rabi
production is expected to be lower by 3.3 million tonnes. The production of cereals is expected to be
205 million tonnes as against 203.1 million tonnes in 2006–07 (final estimate). The production of
pulses, however, is expected to remain almost at the last year ’s level. The production of oilseeds is
also expected to increase from 24.3 million tonnes in 2006–07 to 27.2 million tonnes in 2007–08.
Similarly, the production of cash crops, particularly cotton, is likely to remain buoyant.
There has been a loss of dynamism in the agriculture and the allied sectors in recent years. A
gradual degradation of natural resources through overuse and inappropriate use of chemical
fertilizers has affected the soil quality, resulting in a stagnation in the yield levels. Public investment
in agriculture has declined, and this sector has not been able to attract private investment because of
lower/unattractive returns. New initiatives for extending irrigation potential have had a limited
success during the Tenth Five-Year Plan and only a little over eight million ha could be brought under
irrigation and only three-fourths of that could be utilised. The agricultural extension system has
generally not succeeded in reducing the gap between crop yields that could have been obtained
through improved practices. The Government of India has launched the National Food Security
Mission and the Rashtriya Krishi Vikas Yojana to rejuvenate agriculture and improve farm income.
Since these programmes have only been launched in the current year, it is not possible to assess their
impact. A second green revolution, particularly in the areas which are rain-fed, may be necessary to
improve the income of the persons dependent on the agriculture sector.

There has been a loss of dynamism in the agriculture and the allied sectors in recent years. A gradual degradation of
natural resources through overuse and inappropriate use of chemical fertilizers has affected the soil quality, resulting in a
stagnation in the yield levels.
Industry and Infrastructure

The industrial sector witnessed a slowdown in the first nine months of the current financial year. The
growth of 9 per cent during April–December 2007, when viewed against the backdrop of the robust
growth witnessed in the preceding four years, suggests that there is a certain degree of moderation in
the momentum of the industrial sector. The consumer-durable goods sector, in particular, has shown a
distinct slowdown. This is linked to the hardening of interest rates and, therefore, to the conditions
prevailing in the domestic credit sector. In contrast, the capital goods industry has sustained a strong
growth performance during 2007–08 (April–December).

The industrial sector witnessed a slowdown in the first nine months of the current financial year. The growth of 9 per cent
during April–December 2007, when viewed against the backdrop of the robust growth witnessed in the preceding four
years, suggests that there is a certain degree of moderation in the momentum of the industrial sector.
At the product-group level, the moderation in growth has been selective. Industries like chemicals,
food products, leather, jute textiles, wood products, and miscellaneous manufacturing products
witnessed an acceleration in growth, while basic metals, machinery and equipments, rubber, plastic,
and petroleum products, and beverages and tobacco recorded lower but strong growth during April–
December 2007. Other industries including textiles (except jute textiles), automotives, paper, non-
metallic mineral products, and metal products slowed down visibly during the period. The slowdown
in the case of less, import-intensive sectors like textiles, is coincident with the decline in the growth of
exports arising from the sharp appreciation in the rupee vis-à-vis the dollar. Within automobiles,
while passenger cars, scooters, and mopeds witnessed a buoyant growth, the production of motor
cycles and three-wheelers slackened. In a nutshell, the industrial sector has produced mixed results in
the current fiscal.
The picture with regard to forward-looking variables such as investment, particularly in the
corporate sector, has been encouraging. The corporate profitability during the first half of 2007–08,
on the whole, increased in the manufacturing sector except for certain groups like textiles, food
products, and beverages. Higher profits backed by sound balance sheets were also reflected in an
increase in the planned corporate investment. The outstanding gross bank credit to the industrial
sector, which had increased (from end-March) very slowly during April–August 2007 picked up in
later months to touch 8.3 per cent during April–November 2007. These developments are also
reflected in the robust growth of the capital goods sector. The continued buoyancy in industrial and
corporate investment, thus, reflects the confidence in the growth prospects of the industrial sector.

The corporate profitability during the first half of 2007–08, on the whole, increased in the manufacturing sector except for
certain groups like textiles, food products, and beverages.
Accompanying the recent moderation in the industrial growth, the growth performance of some
segments of the infrastructure sector during April–December 2007–08, such as power generation and
movement of railway freight, as also the production of universal intermediates like steel, cement, and
petroleum, has shown a subdued performance. In the power sector, though the planned capacity
addition is unlikely to be achieved, the growth in capacity seen in the curr ent year is distinctly higher
than in the previous years. The movement of cargo, handled by major ports and air cargo (exports
and imports), has showed an improved performance when compared to the corresponding period last
year. With an increased rural penetration of mobile telephony, the telecom sector has continued its
strong growth.
The recent moderation in the growth of the industrial sector has raised concerns in some quarters
about the sustainability of the high growth of the sector. To deal with the situation emerging from the
slowdown of some export-oriented sectors of relatively low, import intensity, including textiles,
handicrafts, leather, and so on, the government took certain measures to tide over the situation in the
short run. But it needs to be emphasised that, over the medium term, there is little choice but to
improve productivity, even if there are issues pertaining to the exchange rate of currencies of
competing countries.
Social Sectors
As per the UNDP’s Human Development Report (HDR) 2007, in spite of the absolute value of the
human development index (HDI) for India, improving from 0.577 in 2000 to 0.611 in 2004 and further
to 0.619 in 2005, the relative ranking of India has not changed much. In consonance with the
commitment to faster, social sector development under the National Common Minimum Programme
(NCMP), the Central government has launched new initiatives for the social sector development
during 2007–08. Substantial progress was also made on the major initiatives launched in earlier
years. The new initiatives include Aam Admi Bima Yojana and Rastriya Swasthya Bima Yojana.

As per the UNDP’s Human Development Report (HDR) 2007, in spite of the absolute value of the human development index
(HDI) for India, improving from 0.577 in 2000 to 0.611 in 2004 and further to 0.619 in 2005, the relative ranking of India
has not changed much.
The share of the Central government expenditure on social services, including rural development,
in total expenditure (plan and non-plan), has increased from 10.97 per cent in 2001–02 to 16.42 per
cent in 2007–08. The National Rural Health Mission has successfully provided a platform for
community health action at all levels. Besides the merger of the Departments of Health and Family
Welfare in all the states, NRHM has successfully moved towards a single State- and District-Level
Health Society for effective integration and convergence. The concerted efforts at a decentralised
planning through preparation of District Health Action Plans under NRHM has helped in bringing
about intra-health sector and inter-sectoral convergence for effectiveness and efficiency. In all the
states, specific health needs of the people have been articulated for local action.
As universalisation of elementary education has become an important goal, it is also essential to
push this vision forward to move towards the universalisation of secondary education. It has,
therefore, been decided to launch a centrally sponsored scheme, viz., Scheme for Universalisation of
Access to Secondary Education (SUCCESS) and improvement of quality at the secondary stage
during the Eleventh Five-Year Plan. The main objective of the programme is to make secondary
education of good quality available, accessible, and affordable, to all young students in the age group
of 15–16 years (classes IX and X). The “demographic dividend” will manifest itself as a rise in the
working age population, aged 15–64 years, from 62.9 per cent in 2006 to 68.4 per cent in 2026. To tap
this dividend, the Eleventh Five-Year Plan focuses on ensuring a better delivery of healthcare, skill
development, and encouragement of labour-intensive industries.

As universalisation of elementary education has become an important goal, it is also essential to push this vision forward to
move towards the universalisation of secondary education.
Global Warming and Climate Change

Issues like global warming and the resultant climate change have gained importance in international
discussions. Globally, carbon trading, has grown rapidly in the recent years. There is, however, a
need to balance the harmful effects of human activity on global warming, against the need for poverty
reduction and economic growth in the developing and least-developed countries (LDC). The issue of
global social justice cannot be delinked from the issue of global public goods like the atmosphere.
The costs and benefits to the people living in different countries, and their respective contributions,
must be dealt with, in an integrated way.

Issues like global warming and the resultant climate change have gained importance in international discussions. Globally,
carbon trading, has grown rapidly in the recent years.
India is a party to the United Nations Framework Convention on Climate Change (UNFCCC) and its
Kyoto Protocol. The Protocol provides for three mechanisms that enable the developed countries
with quantified, emission limitation and reduction commitments to acquire greenhouse gas-reduction
credits from activities outside their own boundaries at relatively lesser costs. These are joint
implementation, clean development mechanism (CDM), and emission trading. Only CDM is
applicable to developing countries like India. Under the clean development mechanism, a developed
country would take up greenhouse gas-reduction project activities in a developing country, where the
costs of greenhouse gas-reduction project activities are usually much lower.
India’s CDM potential represents a significant component of the global CDM market. As on
January 31, 2008, 309 out of total 918 projects registered by the CDM Executive Board are from
India, which, so far, is the highest from any country in the world. The Indian National CDM Authority
has accorded Host Country Approval to 858 projects facilitating an investment of more than Rs
71,121 crore. These projects are in the sectors of energy efficiency, fuel switching, industrial
processes, municipal solid waste, and renewable energy. If all these projects get registered by the
CDM Executive Board, they have the potential to generate 448 million Certified Emission Reductions
(CERs) by the year 2012.
Sustained growth and resilience in the face of shocks, such as high energy and commodity prices
and a slow down in the world growth and import demand, have characterised the Indian economy in
the recent years. Indeed, in terms of growth, the fiscal period 2003–08 has been, perhaps, the best
ever, five-year growth performance in the history of independent India. Yet, there are a number of
challenges that need to be addressed if the current growth momentum has to be sustained in the
coming years. Chapter 2 highlights some of these challenges, policy options, and prospects for the
Indian economy. Some of the key indicators of growth momentum is given in Table 8.9.

Sustained growth and resilience in the face of shocks, such as high energy and commodity prices and a slow down in the
world growth and import demand, have characterised the Indian economy in the recent years.

Table 8.9 Key Indicators
Note: GDP and GNP figures are at a new series base 1999–2000.
QQuick estimates; AAdvance estimates.
a2 nd advance estimates, 2007–08.
b April–December, 2007.
cIndex of industrial production (base 1993–94=100).
d Index (with base 1993–94 = 100) at the end of fiscal year.
eAs on February 2, 2008.
fIndex (with base 1982 = 100) at the end of fiscal year.
g As on December, 2007.
hOutstanding at the end of financial year.
iAs on January 4, 2008 y-o-y growth.
jComputed over comparable data, i.e., April 1, 2005 due to 27 fortnights during 2006–07.
KApril–December, 2007 (provisional).
l Outstanding at the end of financial year.
mAt the end of February 8, 2008.
nPrevent change indicates the rate of appreciation (+) depreciation (–) of the Rupee vis-à-vis the US$.
o Average exchange rate for April–December, 2007.
pApril–December, 2007 on provisional over revised basis.

CAUSES FOR THE SLOW GROWTH OF NATIONAL INCOME IN INDIA
The growth rate of national income in India remained all along poor, particularly, in the first half of
our planning process. Between the First Plan and the Fourth Plan, the annual average growth rate of
national income varied between 2.5 per cent and 3.9 per cent. During the Fifth, Sixth, and Eighth Plan,
the annual average growth rate of national income ranged between 4.9 per cent, 5.4 per cent, and 6.8
per cent, respectively. It is only during the Ninth Plan, the annual rate of growth of national income in
India had touched the level of 5.5 per cent. Again in 2004–05, the rate of growth of national income
plunged down to 6.8 per cent, after reaching 9.0 per cent in 2003–04.

The growth rate of national income in India remained all along poor, particularly, in the first half of our planning process.
Thus, we have seen that the rate of growth of national income in India is very poor. Targets of
growth rate of national income remain all along unfulfilled. In this connection, Richard T. Gill has
observed that, “India’s rate of progress is pitifully meagre as against her actual needs. At her present
pace, India would remain a very poor nation at the end of the century and many segments of her
population would undoubtedly still be living in conditions of desperate poverty”.
The following are some of the important causes of slow growth of national income in India:
Hig h Growth Rate of Population: The rate of growth of population, being an important determinant of economic growth, is
also responsible for the slow growth of national income in India. Whatever increase in national income has been taking place, all
these are eaten away by the growing population. Thus, the high rate of growth of population in India is retarding the growth
process and is responsible for this slow growth of national income in India.

The high rate of growth of population in India is retarding the growth process and is responsible for this slow
growth of national income in India.
Excessive Dependence on Ag riculture: Indian economy is characterised by too much dependence on agriculture and thus, it
is primary producing. The major share of national income that is usually coming from the agriculture, which is contributing nearly
34 per cent of the total national income, engages about 66 per cent of the total working population of the country. Such
excessive dependence on agriculture prevents a quick rise in the level of national income as well as the per capita income, as the
agriculture is not organised on commercial basis rather it is accepted as a way of life. Excessive dependence on agriculture and
low land–man ratio, inferior soils, poor ratio of capital equipment, problems of land-holding and tenures, tenancy rights, and so
on, are also responsible for the slow growth of agricultural productivity which, in turn, is also responsible for the slow growth
of national income.

Excessive dependence on agriculture prevents a quick rise in the level of national income as well as the per capita
income, as the agriculture is not organised on commercial basis rather it is accepted as a way of life.
Occupational Structure: The peculiar occupational structure is also responsible for the slow growth of national income in the
country. At present, about 66 per cent of the working force is engaged in agriculture and allied activities, 3 per cent in industry
and mining, and the remaining 31 per cent in the tertiary sector. Moreover, the prevalence of high degree of underemployment
among the agricultural labourers, and also among the work force engaged in other sectors, is also responsible for this slow
growth of national income.

Prevalence of high degree of underemployment among the agricultural labourers, and also among the work force
engaged in other sectors, is also responsible for this slow growth of national income.
Low Level of Technolog y and its Poor Adoption: In India, the low level of technology is also mostly responsible for its
slow growth of national income. Moreover, whatever technology has been developed in the country is not properly utilised in its
production process, leading to the slow growth of national income in the country.

Whatever technology has been developed in the country is not properly utilised in its production process, leading
to the slow growth of national income in the country.
Poor Industrial Development: Another important reason behind the slow growth of national income in India is the poor rate of
development of its industrial sector. The industrial sector in India has failed to maintain a consistent and sustainable growth rate
during the planned development period and, more particularly, in the recent years. Moreo ver, the development of the basic
industry is also lacking in the country. All these have resulted in a poor growth in the national income of the country.

The development of the basic industry is also lacking in the country. All these have resulted in a poor growth in the
national income of the country.
Poor Development of Infrastructural Facilities: In India, the infrastructural facilities, viz., transport, communication, power,
irrigation, and so on, have not yet been developed satisfactorily, as per their requirement throughout the country. This has been
causing major hurdles in the path of development of agriculture and industrial sector of the country, leading to a poor growth of
national income.
Poor Rate of Saving s and Investment: The rate of savings and investment in India is also quite poor as compared to that of
the developed countries of the world. In the recent times, that is, in 1996–97, the rate of GDS was restricted to 26.1 per cent of
GDP and that of investment was 27.3 per cent of GDP in the same year. Such low rate of saving and investment has resulted in a
poor growth of national income in the country.
Socio-political Conditions: Socio-political conditions prevailing in the country are also not very much conducive towards a
rapid development. Peculiar social institutions like caste system, joint family system, fatalism, illiteracy, unstable political
scenario, and so on, are all responsible for the slow growth of national income in the country.

Socio-political conditions prevailing in the country are also not very much conducive towards a rapid
development.
In the mean time, the government has taken various steps to attain a higher rate of growth in its national income by introducing
various measures of economic reforms and structural measures. All these measures have started to create some impact on the raising
growth of the national income of the country.
SUGGESTIONS TO RAISE THE LEVEL AND GROWTH RATE OF NATIONAL INCOME IN INDIA
In order to raise the level and growth rate of national income in India, the following suggestions are
worth mentioning:
Development of Agricultural Sector

As the agricultural sector is contributing to the major portion of our national income, concrete steps
are to be taken for an all-round development of the agricultural sector, throughout the country at the
earliest. New agricultural strategy to be adopted widely throughout the country to raise its agricul-
tural productivity by adopting better HYV seeds, fertilisers, pesticides, better tools and equipments,
and scientific rotation of crops and other scientific methods of cultivation. Immediate steps are to be
taken to enhance the coverage of irrigation facilities, along with the reclamation of waste land.

As the agricultural sector is contributing to the major portion of our national income, concrete steps are to be taken for an
all-round development of the agricultural sector, throughout the country at the earliest.
Development of Industrial Sector

In order to diversify the sectoral contribution of national income, the industrial sector of the country
should be developed to a considerable extent. Accordingly, the small, medium, and large-scale
industries should be developed simultaneously, which will pave the way for attaining a higher level in
income and employment.

In order to diversify the sectoral contribution of national income, the industrial sector of the country should be developed to
a considerable extent.
Raising the Rate of Savings and Investment

For raising the level of national income in the country, the rate of savings and investment should be
raised and maintained to a considerable extent. The capital output ratio should be brought down
within the manageable limit. In this respect, the Ninth Plan document has set its objectives to achieve 7
per cent rate of economic growth, to enhance the rate of investment from 27 per cent to 28.3 per cent
and to reduce the capital output ratio from 4.2 per cent to about 4.0 per cent.

For raising the level of national income in the country, the rate of savings and investment should be raised and maintained
to a considerable extent.
Development of Infrastructure
In order to raise the level of national income to a considerable height, the infra-structural facilities of
the country should be adequately developed. Those facilities include transport and communication
network, banking and insurance facilities, and better education and health facilities, so as to improve
the quality of human capital.

In order to raise the level of national income to a considerable height, the infra-structural facilities of the country should be
adequately developed.
Utilisation of Natural Resources
In order to raise the size and rate of growth of the national income in India, the country should try to
utilise the natural resources of the country in a most rational manner to the maximum extent possible.
Removal of Inequality
The country should try to remove the inequality in the distribution of income and wealth by imposing
progressive rates of taxation, on the richer sections, and also by redistribution of wealth through
welfare and poverty-eradication programmes. Moreover, imposing higher rates of taxation on the
richer sections can also collect sufficient revenue for implementation of the plan.

The country should try to remove the inequality in the distribution of income and wealth.
Containing the Growth of Population

As the higher rate of growth of population has been creating a negative impact on the level of
national income and per capita income of the country, positive steps have to be taken to contain the
growth rate of population by adopting a rational population policy, and also by popularising the
family-planning programmes, among the people in general.
Balanced Growth
In order to attain a higher rate of economic growth, different sectors of the country should grow
simultaneously, so as to attain an inter-sectoral balance in the country.
Higher Growth of Foreign Trade

Foreign trade can also contribute positively towards the growth of national income in the country.
Therefore, positive steps to be taken to attain a higher rate of growth in the foreign trade of the
country. Higher volume of export can also pave the way for the import of improved and latest
technologies that are required for the development of a country.

Higher volume of export can also pave the way for the import of improved and latest technologies that are required for the
development of a country.
In order to develop the different sectors of the country, the government should liberalise the economy
to a considerable extent, by removing the unnecessary hurdles and obstacles in the path of
development. This would improve the productivity of different productive sectors. Under the
liberalised regime, the entry of right kind of foreign capital and technical know-how will become
possible to a considerable extent, leading to modernisation of industrial, infrastructural, and other
sectors of the country. This economic liberalisation of the country in the right direction will
ultimately lead the economy towards attaining a higher level of national income within a reasonable
time frame.
Therefore, in order to rise the size and growth rate of national income of the country, a rigoro us
and sincere attempt should be made by both public and private sector to undertake developmental
activities in a most realistic path, and also to liberalise and globalise the economy for the best interest
of the nation as a whole.

In order to rise the size and growth rate of national income of the country, a rigorous and sincere attempt should be made
by both public and private sector to undertake developmental activities in a most realistic path, and also to liberalise and
globalise the economy for the best interest of the nation as a whole.
MAJOR FEATURES OF NATIONAL INCOME IN INDIA
The trends and composition of national income estimates of India during post-independence period
shows the following major features:
Excessive Dependence on Agriculture

One striking feature of India’s national income is that a considerable proportion, that is, 27.8 per cent
of the national income is now being contributed by the agricultural sector Naturally, development of
this sector is very important considering its employment potential, marketable surplus, and necessary
support to the industry sector.
Poor Growth Rate of GDP and Per Capita Income

Poor growth rate of GDP and per capita income is another important feature of national income of
the country.
Unequal Distribution and Poor Standard of Living

The distribution of national income in India is most unequal. Due to the highly skewed pattern of
distribution of income, the standard of living of the majority of population of our country is very
poor.
Growing Contribution of Tertiary Sector

Another striking feature of India’s national income is that the contribution of tertiary sector has been
increasing continuously over the years, that is, from 28.5 per cent of total national income in 1950–51
to 54 per cent in 2006–07.
Unequal Growth of Different Sectors

In India different sectors are growing at unequal rates. During the period 1951–97, while the primary
sector has recorded a growth rate of 2.9 per cent the secondary and tertiary sectors have recorded a
growth rate of 6.3 per cent and 7.1 per cent, respectively.
Regional Disparity
Another striking feature of India’s national income is its regional disparity. Among all the states, only
six states of the country have recorded a higher per capita income over the national figure. Out of this
six states Punjab ranks the highest and Bihar ranks the lowest.
Urban and Rural Disparity

Urban and rural disparity of income is another important feature of our national income. The All
India Rural Household Survey shows that the level of income in urban areas is just twice that of the
rural areas, depicting a poor progress of rural economy.
Public and Private Sector

Another important feature of India’s national income is that the major portion of it is generated by the
private sector (75.8 per cent) and the remaining 24.2 per cent of the national income is contributed by
the public sector.
DIFFICULTIES OR LIMITATIONS IN THE ESTIMATION OF NATIONAL INCOME IN INDIA
National income estimation in India is subjected to various conceptual and practical difficulties. These
conceptual difficulties arise mostly in connection with personal and government administrative
service. In connection, the first report of the NIC mentioned:
Which part of the government’s general administration is service to business firms, enters into the value of its product and hence
should not be counted and which part is service to the people as individuals and consumers and should be counted likewise, in
considering what is consumption in the process of production and what is net product, the estimator merely, follows M judgment of
society which views net product as what is available either for consumption of individuals personally or collectively or for additions
to capital stock.
In addition to the conceptual difficulties, the estimation of national income in India is facing a number
of limitations or practical difficulties. These difficulties or limitations are as follows:
Non-monetised Output and its Transactions

In the estimation of national income or output, only those G&S, which are exchanged against money,
are normally included. But in an under-developed country like India, a huge portion of our total
output is still either being consumed at home or being bartered away by the producers in exchange of
other G&S, leading to the non-inclusion of huge non-monetised output in the national income
estimates of the country. This problem of non-monetised transactions is very much in the rural areas,
whose inclusion in NDP is really difficult. Till now, no proper method has been developed to find out
the total output of this farm output, consumed at home, and also to derive the imputed value of this
huge non-monetised output.

In the estimation of national income or output, only those G&S, which are exchanged against money, are normally
included.
Non-availability of Information About Petty Income

The national income estimates in India are also facing another problem of non-availability of
information about the income of small producers and household enterprises. In India, a very large
number of producers are still carrying on production at a family level or are running household
enterprises on a very small scale. Being illiterate, these small producers have no idea of maintaining
accounts and do not feel it necessary to maintain regular accounts as well. Under such a situation it is
really a difficult task to collect data. In this connection, the NIC wrote, “An element of guess-work,
therefore, invariably enters into the assessment of output especially in the large sectors of the
economy which are dominated by the small producer or the household enterprise”.

The national income estimates in India are also facing another problem of non-availability of information about the income
of small producers and household enterprises.
Lack of Differentiation in Economic Functions

In India, the occupational classification is incomplete and, thus, there is lack of differentiation in
economic functions. As national income statistics are collected by industrial origin, classification of
producers and workers into various occupational categories is very much essential.

In India, the occupational classification is incomplete and, thus, there is lack of differentiation in economic functions.
Unreported Illegal Income

In India, the parallel economy is fully operational as hidden or sub-terrainean economy. Thus, there is
a huge, unreported illegal income earned by those people engaged in such parallel economy, which is
not included in the national income estimates of our country. In 1983–84, the National Institute of
Public Finance and Policy made an estimate of black income, which was to the extent of 18 per cent to
21 per cent of our national income. Obviously, non-inclusion of such a huge illegal income makes the
national income estimates of the country as “underestimates”.

In India, the parallel economy is fully operational as hidden or sub-terrainean economy.
Lack of Reliable Statistical Data

The most important difficulty facing the national income estimation in India is the non-availability of
reliable statistical information. In India, the national income data are collected by untrained and
semiliterate persons like gram sevaks and, thus, the statistics are mostly unreliable. Although some
statistical organisations like NSSO are organised by the government for this purpose, these are
considered as inadequate. Thus, due to the dearth of reliable, adequate statistical data, the national
income estimates in India is still subjected to a high degree of error.

The most important difficulty facing the national income estimation in India is the non-availability of reliable statistical
information.
KEY WORDS
National Income
Gross National Product (GNP)
Net National Product (NNP)
User Cost
Factors of Production
Personal Income (PI)
Disposable Income (DI)
National Income Estimates
National Income Committee (NIC)
Central Statistical Organisation (CSO)
Product Method
Income Method
Conventional Series
Revised Series
New Series
Primary Sector
Secondary Sector
Tertiary Sector
QUESTIONS
1. What do you mean by national income? Explain its concepts.

2. What do you mean by national income estimates? Explain national income estimates during pre-independence and post-
independence of India.
3. Explain trends in the national income growth and structure.
4. What are the causes for slow growth of national income in India? Explain suggestion measures to raise the growth rate of
national income in India.
a. Features of national income in India.
b. Difficulties in estimates of national income in India.
c. Methodology of national income estimates in India.
REFERENCES
Budget Documents, Government of India.

Economic Survey of India 2007–08, Government of India Publication.
http://indiabudget.nic.in.
Plan Documents, Planning Commission of India.
CHAPTER 09
Industrialisation and Economic Development
CHAPTER OUTLINE
Concept and Meaning of Industrialisation
The Pattern of Industrialisation
Relative Roles of Public and Private Sectors
Inadequacies of the Programme of Industrialisation
Role of Industries in the Economic Development
Industries During the Plan Period
Recent Industrial Growth
Central Public Sector Enterprises (CPSEs)
Micro and Small Enterprises (MSEs)
Corporate Profitability and Investment
Industrial Sickness
Environmental Issues
Key Words
Questions
References
CONCEPT AND MEANING OF INDUSTRIALISATION
Industrialisation has a major role to play in the economic development of the underdeveloped
countries. The gap in per capita incomes between the developed and underdeveloped countries is
largely reflected in the disparity in the structure of their economies; the former are largely industrial
economies, while in the latter the production is confined predominantly to agriculture. Table 9.1
clearly reveals the positive relationship between the per capita income and the share of manufacturing
output (industry including construction). Undoubtedly, some countries have achieved relatively high
per capita incomes by virtue of their fortunate, natural resource endowments. Petroleum exporting
countries like Saudi Arabia, Kuwait, and UAE have achieved higher per capita income by exploiting
the strong advantage that they enjoy in international trade. But these countries are rather a special
case.

Industrialisation has a major role to play in the economic development of the underdeveloped countries.
The pattern of “growth through trade” in primary commodities was, however, realised in the 19th
century when industrialisation was closely linked with international trade, because (1) countries
previously isolated by high transport costs as well as other barriers came to specialise, and (2)
economic development through trade was diffused in the outlying area as the pattern of advance in the
rising industrial countries happened to be such as to cause a rapidly growing demand for crude
products of the soils, which those areas were well fitted to supply.
This traditional pattern of growth through trade is out of place now. As rising levels of per capita
consumption have gradually transformed the composition of demand for goods and services and as
technological changes have resulted in the more economic use of new materials or the creation of
synthetic substitutes, the growth of import demand of the advanced countries for most primary
products has lost the momentum of the earlier period and, currently, it lags behind the growth in their
domestic incomes and output. The volume of exports from the underdeveloped countries expanded at
a rate of 3.6 per cent per annum while the exports from the developed countries rose at the rate of 6.2
per cent. This export lag is accompanied by a deterioration in their terms of trade. Thus, in view of
the unfavourable trends in the world trade of primary commodities, industrialisation is the only
effective answer to the problems of underdeveloped countries. They can no longer depend upon trade
for their development but they have to activise the dynamic elements within their economies.

In view of the unfavourable trends in the world trade of primary commodities, industrialisation is the only effective answer
to the problems of underdeveloped countries.

Table 9.1 Percentage Industrial Distribution of Gross Domestic Product (GDP) and Per Capita Income (1994)
Source: World Development Report (1992) and (1996), World Bank.

Note: * Figures of GDP distribution are for 1985.

Besides the limitation of “trade gap”, these countries are facing a relentless increase of population,
combined with a likelihood of diminishing returns in agriculture which is instrumental in creating the
trap of poverty. The essential precondition for development (and to break this vicious circle) is an all-
round rise in all occupations right from low productivity to high productivity. In general, the net
value of output per person is higher in industry than in agriculture. In industry, the scope for internal
as well as external economies is greater than in other sectors and, certainly greater than in
agriculture. As industrialisation proceeds, the economies of scale and inter-industrial linkages
(complementarily) become more pronounced. It also leads to the creation of economic surplus in the
hands of industrial producers for further investment.

As industrialisation proceeds, the economies of scale and inter-industrial linkages (complementarily) become more
pronounced.
The industrial sector, which possesses a relatively high marginal propensity to save and invest,
contributes significantly to the eventual achievement of a self-sustaining economy, with continued
high levels of investment and rapid rate of increase in income as well as industrial employment.
Besides, the process of industrialisation is associated with the development of mechanical knowledge,
attitudes, and skills of industrial work, with experience of industrial management and with other
attributes of a modern society, which in turn, are beneficial to the growth of productivity in
agriculture, trade, distribution, and other related sectors of the economy. As a consequence of these
factors, any successful transfer of labour from agriculture to industry contributes to economic
development. Industrialisation is, thus, inseparable from substantial, sustained economic
development, because it is both a consequence of higher incomes and a means of higher productivity.
With the rise in the income levels, people tend to spend more on the manufactured goods than on
food. The differential income elasticity of demand confers an advantage on the manufacturing
countries, in the form of providing and expanding higher productivity market and makes it an
attractive occupation to effect population transfer so as to arrest the tendency of diminishing returns
in agriculture. Industrialisation acts as an instrument both in creating capacity to absorb excess labour
power and in catering for the diversification of the market that is required at the higher stages of
economic development.

Industrialisation is, thus, inseparable from substantial, sustained economic development, because it is both a consequence
of higher incomes and a means of higher productivity.
In many cases, the diversion of underemployed rural labour to non-agricultural occupations is an

urgent requirement for development. But it does not mean that industrial development can be
dissociated from progress in the agricultural sector. An improvement in productivity in agriculture
creates surplus, which can be utilised to support increasing labour force in industries. Besides
providing a large part of the sustenance for the growing urban population, the agricultural sector
supplies a market for the manufactured goods out of higher real incomes and a source of foreign
exchange to pay for the imported capital goods for industry; it also provides a source of capital for
industry through the medium of capital accumulated by traders and leads to the growth of an
exchange economy—all these factors promote the growth of the manufacturing industry. In fact,
unless agriculture is modernised substantially, industrial expansion is likely to proceed at a slow
speed due to lack of purchasing power in the hands of the bulk of population. The problem facing the
less-developed countries is, therefore, not the one of choosing between primary and secondary
activities but rather the one of ensuring a balanced expansion of all appropriate sectors of the
economy.

In fact, unless agriculture is modernised substantially, industrial expansion is likely to proceed at a slow speed due to lack
of purchasing power in the hands of the bulk of population.
THE PATTERN OF INDUSTRIALISATION
Although there is now, almost, a universal agreement on the importance of industrialisation, there is
still much debate regarding the proper pattern of industrial development. Historically, industrial
development has proceeded in three stages. In the first stage, the industry is concerned with the
processing of primary products: milling grain, extracting oil, tanning leather, spinning vegetable
fibres, preparing timber and smelting ores. The second stage comprises the transformation of
materials making bread and confectionery, footwear, metal goods, cloth, furniture, and paper. The
third stage consists of the manufacture of machines and other capital equipments to be used not for
the direct satisfaction of any immediate want but in order to facilitate the future process of
production. Hoffmann classified all the industrial output into two categories: consumer goods and
capital goods output, and also classified various stages in terms of the ratio of consumer goods
output to that of the capital goods output as follows: “In stage I the consumer goods industries are of
overwhelming importance, their net output being on the average five times as large as that of capital
goods industries”. This ratio is 2.5:1 in the second stage and falls to 1:1 in the third stage, and still
lower in the fourth stage. Both these types of classifications emphasise the increasing role of the
capital goods industries in the economy, as industrial development takes place.

Hoffmann classified all the industrial output into two categories: consumer goods and capital goods output, and also
classified various stages in terms of the ratio of consumer goods output to that of the capital goods output.
Although the general development of industry itself has proceeded from consumer goods to the
capital goods, there are many variations of this pattern, both in terms of the time taken to attain later
stages and in terms of the relative importance of each of the stages. The Soviet pattern of
industrialisation involves a straight jump from the first to the third stage whereas British pattern is
that of a gradual evolution. Similarly, underdeveloped countries may also evolve a different pattern
of industrialisation suitable to their economic conditions. It has been suggested that the pattern of
industrialisation in the underdeveloped countries to be guided primarily, by considerations arising
from the relative scarcity of capital. Since labour is relatively plentiful and capital is scarce, the
development of labour-intensive consumer goods seems quite legitimate. However, the basic premise
of this approach is inappropriate. The problem is not how to economise the use of capital (this has to
be done as an inevitable condition) but how to increase its supply. As most underdeveloped countries
do not produce these goods at home, the only alternative to increasing their supplies is through
imports. This depends upon the rate of growth in the exports of primary commodities and
manufactured goods. As it has been pointed above, the countries are facing an “export lag” in their
exports of primary commodities. Consequently, primary commodity exports do not seem to be a
reliable source of foreign exchange earning, in order to increase the import of capital goods.

It has been suggested that the pattern of industrialisation in the underdeveloped countries to be guided primarily, by
considerations arising from the relative scarcity of capital.
The alternative to the increase of exports of primary products from underdeveloped countries
would be to develop export-promoting, manufacturing industries. But the main trouble is that in
producing goods of this sort, say textiles, the advanced industrial countries themselves are likely to
have an overwhelming comparative advantage. This does not necessarily mean that export-
promoting, industries should not be developed, but it only means that specialisation in a few
industries for export is not a substitute for the growth of a diversified domestic industry. If, however,
the growth in foreign exchange earnings cannot be strengthened by the promotion of export
industries, the spread of import-substituting, consumer goods industries can release foreign exchange
for imports of capital goods. Import substitution is of two types:
1. the substitution of home-produced goods for imported goods, and
2. the substitution of capital goods imports for consumer goods imports.
Thus, if a country cannot increase its export earnings sufficiently, it can still increase its import of
capital equipment by cutting down its imports of consumer goods. This process of import substitution
itself creates import demand for certain ancillary goods, which are needed for the production of
those consumer manufactures. We are, thus, faced with a problem of choice between expansion of
export-oriented industries or of import-substitution industries. The capital available for investment in
an underdeveloped economy being limited, the allocation of funds to an export project reduces the
scope of investment oriented towards import substitution, If the export-oriented industries are
successful in stimulating exports, they increase the supply of foreign exchange and if import
substitution is effective, it releases foreign exchange, so that the effect of these alternatives on the
supply of foreign exchange is identical. How should we decide between these two alternatives?

The capital available for investment in an underdeveloped economy being limited, the allocation of funds to an export
project reduces the scope of investment oriented towards import substitution.
Although the effect of the development of these two types of industries on foreign exchange is
similar, yet an import-substituting industry strengthens the economic independence of the country;
whereas export-oriented prospect, on the contrary, increases its dependence on the fluctuations of
prices and volume of trade in foreign markets. Therefore, in general, an import-substitution project
should be preferred to an export-oriented project.
To sum up, the industrial development depends upon the rate of capital formation. Supply of capital
goods can be augmented either through imports or through domestic production. An increase in the
imports of capital goods depends upon the rate of growth of exports. Since the scope for the
expansion of the exports of primary commodities is limited, export-promoting, manufacturing
industries may be developed or, alternatively, certain import-substituting, domestic industries may be
developed, the effect of which will be to release foreign exchange for the imports of capital goods. In
addition, within the current volume of imports, capital goods may be substituted in the place of
consumer goods. Thus, export-promoting industries, import- substituting industries, and domestic
capital goods industries are not mutually exclusive alternatives. A simultaneous development of all
the three classes of industries will prove to be the most effective strategy of industrialisation. The
relative role of each is likely to vary with the particular economic circumstan ces of individual
countries as well as with their current phase of industrialisation.

Export-promoting industries, import- substituting industries, and domestic capital goods industries are not mutually
exclusive alternatives. A simultaneous development of all the three classes of industries will prove to be the most effective
strategy of industrialisation.
Structure of Effective Demand and Pattern of Industrial Development
A disquieting feature is that the pattern of industrial development that has emerged in the last five
decades reflects the structure of effective demand, which is determined by the distribution of incomes.
An unduly large share of resources is absorbed in production which relates directly or indirectly to
maintaining or improving the living standards of the higher-income groups. The demand of this
relatively small class, not only for a few visible items of conspicuous consumption but also for the
outlay on high-quality housing and urban amenities, aviation and superior travel facilities, telephone
services, and so on, sustains a large part of the existing industrial structure. This means that the
further expansion of industry is limited by the narrowness of the market.

A disquieting feature is that the pattern of industrial development that has emerged in the last five decades reflects the
structure of effective demand, which is determined by the distribution of incomes.
Consumer durables like refrigerators, air-conditioners, televisions, cars and scooters, and so on,
go to satisfy the wants of the richer sections of the community while the consumer non-durables like
sugar, tea, cotton, cloth, vanaspati, matches, and so on, enter into mass consumption. Between 1961
and 1974, the industries producing non-durables recorded a very slow growth rate (barely 2.6 per
cent) and this was an important factor for an inflationary rise in the price level. It resulted in wiping
out the increase in real wages and, consequently, ushered an era of strikes, which again slowed down
the production. On the other hand, the capitalist classes were able to appropriate the gains of inflation
and, thus, they boosted the demand for consumer durables. All this led to a distortion in the emerging
industrial structure which was deleterious to social welfare. Commenting on this development, Raj
writes:
If this continues, a pattern of industrial development based on high rates of growth of demand for luxury and semi luxury products
may well come to be regarded as the only way of maintaining a high rate of growth of output in this sector. The situation continues to
be similar during 1974–96 (refer to Table 9.2). It appeared the deceleration in consumer goods industries output, more especially of
non-durable consumer goods. The growth rate of all groups of goods has been modest since 1980–81 except for consumer
durables which has been zooming forward.
The growth rate of all groups of goods has been modest since 1980–81 except for consumer durables which has been
zooming forward.
Per Worker Consumption of Power

Since 1951 till now, the number of workers engaged in factories and mines has increased by nearly
three times; but during the same period, the per capita consumption of power for industries and mines
increased about 10-fold. Since the per worker electricity consumption for industrial purposes can be
taken as a good indicator of mechanisation or technological sophistication of the production
processes, it is an index of the growing capital intensity in the factory sector. Despite the 10-fold
increase in power consumption per worker, India is far below the corresponding levels that are
reached in developed countries.

Table 9.2 Average Annual Growth Rate of Production
Source: Handbook of Industrial Statistics (1987) and Economic Survey, 1997–98. Ministry of Industry, Government of India.

However, it is generally forgotten that 27 per cent of all workers in the manufacturing are
employed in factories; the remaining 73 per cent are employed in smaller establishments, which do
not use power. There is a need for a massive effort for electrification of production processes in
small-scale and cottage industries. This transformation would raise their productivity and, hence, the
income generated there from.

There is a need for a massive effort for electrification of production processes in small-scale and cottage industries. This
transformation would raise their productivity and, hence, the income generated there from.
RELATIVE ROLES OF PUBLIC AND PRIVATE SECTORS
A noteworthy feature of the changing industrial pattern in the planning era in India is the growth of
the public sector in a big way in the heavy and basic industries, the machine goods sector, engineering
industries, and so on. In 1997–98, though the public sector units accounted for only 7.0 per cent of the
number of factories in the country, they employed 32 per cent of the productive capital. Only 56 per
cent of the productive capital is employed by the private sector units, which account for 91 per cent of
the total number of factories. The high share of the public sector is accounted for by the fact that
investment made in this sector is largely heavy and basic industries are highly capital intensive.

A noteworthy feature of the changing industrial pattern in the planning era in India is the growth of the public sector in a
big way in the heavy and basic industries, the machine goods sector, engineering industries, and so on.
However, if we judge the contribution of different sectors in terms of employment and value added,
then it is evident that nearly 69 per cent of employment and 60 per cent of value added are contributed
by the private sector. The share of the public sector in employment and value added was only 24 per
cent and 28 per cent, respectively. The joint sector which represents the participation of both private
and public sectors in ownership, and management, has not yet become significant although its
contribution to the value added was 12 per cent and employment 6.7 per cent. The conclusion is
obvious: the private sector dominates the industrial scene in India (refer to Table 9.3).

The private sector dominates the industrial scene in India.
Interestingly, the annual wages received by a worker in the public sector are nearly at par with
those in the joint sector—Rs 62,936 and Rs 66,644, respectively. But the annual wages in the private
sector were Rs 32,342, that is, 51 per cent of the wages received by the workers in the public sector.

Table 9.3 Ownership Pattern in Indian Industries (1997–98)

Growth of Infrastructure
The rapid pace of industrial growth and the development of productive capacity have been marked by
a remarkable, though still inadequate, expansion of infrastructural facilities in the country, with
expansion and modernisation of coal, which is India’s primary fuel source by more than threefold,
and notable success in the exploration of oil and gas both on shore and offshore. The Sixth Plan
summed up the success in the infrastructure admirably. An efficient complex of refineries, pipelines,
storage, and distribution has been developed and India has entered the petrochemical age. A large
infrastructure has been built to sustain this subcontinental economy—a network of irrigation, storage
works, and canals; hydro- and thermal power generation; regional power grids; a largely electrified
and dieselised railway system; national and state highways on which a rapidly growing road transport
fleet can operate; and the telecommunications system covering most urban centres and linking India
with the world. The development of modern industry as well as of agriculture has stimulated the
growth of banking, insurance, and commerce, and required matching expansion and modernisation
of ports, shipping, and internal and external air services. The major beneficiaries of all these
services, as pointed out already, however, have been the wealthier sections of the population, both in
urban and rural areas.

The rapid pace of industrial growth and the development of productive capacity have been marked by a remarkable, though
still inadequate, expansion of infrastructural facilities in the country.
Science and Technology
A Significant progress has been recorded in the field of science and technology. India now ranks third
in the world, in respect of technological talent and manpower. Indian scientists and technologists are
working in many areas on the frontiers of today’s knowledge, as in agriculture and industry, in the
development of nuclear power and the use of space technology for communications and resource
development. For further industrial and scientific advance, with growing competence in adaptive
research and development, we need only a selective import of technology. The country has been able
to train a cadre of technical manpower which can handle cement factories, chemical and fertilizer
units, oil refineries, power houses, steel plants, locomotive factories, engineering industries, and so
on. More than a lakh-and-a-half degree and diploma holders are turned out by the technical
institutions. Similarly, in-plant training and sending brilliant young men and women abroad for
training in top skills has helped to generate skilled manpower and, thus, reduce the dependence on
foreign technicians and experts. However, small and cottage industries, and other rural activities, have
not received the research and development support that they require.

A significant progress has been recorded in the field of science and technology. India now ranks third in the world, in
respect of technological talent and manpower.
Small and cottage industries, and other rural activities, have not received the research and development support that they
require.
INADEQUACIES OF THE PROGRAMME OF INDUSTRIALISATION
Without underestimating the achievements of the process of industrial expansion initiated during the
planning era, it may be emphasised that much of the industrial growth is only apparent and not real.
Our reasons for this are as under: Firstly, the share of industry in the national income in 1948–49 was
17 per cent. In 1996–97, it was around 21 per cent, an increase of just 4 per cent in 50 years. Thus, in
the terms of contribution of national product, the share of manufacturing industry sector continues to
be low. In most of the developed nations, this share is between 30 per cent and 50 per cent.

In the terms of contribution of national product, the share of manufacturing industry sector continues to be low. In most of
the developed nations, this share is between 30 per cent and 50 per cent.
Secondly, the process of industrialisation has not been able to make a dent on the problem of
unemployment. The high capital intensity of public sector investment generated a very small amount
of employment. Factory employment absorbed only 2 per cent of the labour force. Myrdal studied the
spited effects of industrialisation on employment and also its back-wash effects in terms of
unemployment on the traditional sector. After a careful examination of the situation, Myrdal
observed:
The employment effects of industrialisation cannot be expected to be very large for several decades ahead, that is, until the region is
much more industrialised. For a considerable time the net employment effects may even be negative. This dimension of the problem,
as well as the wider consequences for labour utilisation out side the modern sector, is overlooked in the vision that sees
industrialisation as the remedy for “unemployment” and “underemployment”.
The employment effects of industrialisation cannot be expected to be very large for several decades ahead, that is, until the
region is much more industrialised.
Thirdly, the process of industrialisation’s rapid expansion of large sector resulted in a comparative
neglect of the small and medium sector. This is evidenced by the data of factories classified according
to the value of plant and machinery by the Annual Survey of Industries.
The structure of factories on the basis of plant and machinery reveals that in 1997–98, very large
factories (642) accounted for about 43 per cent of productive capital, 32 per cent of value added, but
only 10 per cent of total factory employment. Large factories (5,369) accounted for about 35 per cent
of productive capital, 32 per cent of valued added, and nearly 27 per cent of employment. Taking
these two groups together (large and very large factories) accounted for 78 per cent of productive
capital, 64 per cent of net value added, and about 37 per cent of employment. As against it, 59,131 tiny
factories (43.6 per cent of the total) accounted for only 1.4 per cent of productive capital, 4.0 per cent
of net value added, and 16.1 per cent of the employment. Similarly, 56,496 small factories accounted
for 41.7 per cent of the total, contributed 6.8 per cent of productive capital and 12.1 per cent of value
added, but 24.7 per cent of employment. Thus, there is a heavy concentration of productive capital in
large and very large factories, but their relative contribution to employment is much less. In
comparison with this, small and tiny factories accounting for only 6 per cent of productive capital
provide 34 per cent of total employment. The obvious conclusion is: Large and larger factories are
capital intensive but small and tiny factories are employment intensive.

There is a heavy concentration of productive capital in large and very large factories, but their relative contribution to
employment is much less.
Although the government has been proclaiming the policy of developing new growth centres so as
to diversify the industrial structure, its policies have only resulted in the concentration of industrial
development in the metropolitan areas, in the selected states, and among the top capitalists. Obviously,
as a deliberate policy, the promotion of small-scale sector in consumer goods, required for mass
consumption, can reconcile the objectives of higher growth and higher employment. Sufficient
attention has not been paid in this direction during the last four decades of planning. In this
connection, the Sixth Plan states: “The expansion of large-scale industries has failed to absorb a
significant proportion of the increment to labour force and led in some cases to a loss of income for
the rural poor engaged in cottage industries like textiles, leather, pottery, etc”.

The expansion of large-scale industries has failed to absorb a significant proportion of the increment to labour force and
led in some cases to a loss of income for the rural poor engaged in cottage industries like textiles, leather, pottery, etc”.
To sum up, the process of industrialisation has not generated sufficient growth potential, either in
terms of contribution of output or in terms of employment; and what is really serious is that the rate
of growth of industrialisation has been declining with every decade. The question of choice of
technique has, therefore, to be examined anew with reference to employment.
ROLE OF INDUSTRIES IN THE ECONOMIC DEVELOPMENT
The industries in India can be broadly classified into (1) organised industries and (2) unorganised
industries. The organised industries of the country include steel, petroleum, textiles, cement, fertiliser,
jute, tea, sugar, plywood, engineering, and so on. The unorganised industries of India include the
small and cottage industries, khadi and village industries, and so on. Both these organised and
unorganised industries are quite important for a large country with a huge size of population, and are
also playing an important role in the economy of the country. Steel, petroleum, cement, fertiliser,
engineering, and so on are some of the organised industries which have been playing an important
role to sustain the economic development process of the country.

Both these organised and unorganised industries are quite important for a large country with a huge size of population, and
are also playing an important role in the economy of the country.
Utilisation of Natural Resources

The utilisation of a huge volume of natural resources has become possible with the development of
these various types of organised and unorganised industries in the country. The country is still
passing a huge volume of various types of minerals, forests, and agro-based resources, which are
mostly unutilised or underutilised.

The country is still passing a huge volume of various types of minerals, forests, and agro-based resources, which are mostly
unutilised or underutilised.
Balanced Sectoral Development

From the very beginning, the Indian economy has been depending too much on agriculture, as a
major portion of the total population and capital are engaged in agriculture, which is again mostly
influenced by some uncertain factors. Flood and drought are common occurrences in the country
leading to a failure of crops in some or other areas of the country regularly. Thus, the Indian
economy has been facing an unbalanced sectoral development, and the growing industrialisation in
the country can attain balanced sectoral development and, thereby, can reduce the too-much
dependence of the economy on the agricultural sector.

The Indian economy has been facing an unbalanced sectoral development, and the growing industrialisation in the country
can attain balanced sectoral development and, thereby, can reduce the too-much dependence of the economy on the
agricultural sector.
Enhanced Capital Formation

With the growing industrialisation of the economy, the volume and rate of capital formation in the
country are gradually being enhanced due to an increase in the level of income and saving capacity of
the people in general.
Increase in National Income

Organised and unorganised industries are jointly contributing a good portion (i.e., around 24.7 per
cent in 1997–98) of the total national income of the country.
Increase in Job Opportunities

Development of industrial sector would increase the job opportunities for a huge number of
population of the country. Setting up of new industrial units can create job opportunities for millions
of unemployed persons and, thereby, can lesser the burden of unemployment problem. In India, more
than 19.4 million persons are employed in the organised, public sector industrial units and nearly, 8.4
million persons are employed in the organised, private sector industrial units.

In India, more than 19.4 million persons are employed in the organised, public sector industrial units and nearly, 8.4
million persons are employed in the organised, private sector industrial units.
Lesser Pressure on Land

Agricultural sector of the country is bearing the excessive pressure of population. About 66 per cent
of the total working population of the country is depending on agriculture for its livelihood. Due to
such excessive pressure of population, the agricultural sector remains backward. But the industrial
development of the country can lessen the burden of the agricultural sector by diverting and engaging
such excess population into the industrial sector of the country.

About 66 per cent of the total working population of the country is depending on agriculture for its livelihood.
Supplementing Export
The development of organised industries like tea, jute, and engineering, along with handicrafts
industry, are supplementing a good volume of export requirement of the country. By producing low-
cost product, the industrial sector can diversify the market of their products in different countries and
thereby can promote foreign trade.
Attaining Economic Stability

Too much dependence on agriculture makes the Indian economy an unstable one as it is very much
prone to natural calamities like flood and drought.
Accumulation of Wealth
The development of industries helps the country to accumulate higher volume of wealth for the
welfare of the nations, as the per capita output in industry is much more higher than that of
agriculture. Moreover, the development of industries assists the economy to develop its trading
activities, transport, communication, banking, insurance, and other infrastructural facilities.
Support to Agriculture
Development of industries can provide necessary support towards the development of agricultural
sector of the country. Agro-based industries like tea, jute, cotton textile, sugar, paper, and so on,
collect their raw materials from agriculture and, therefore, provide a ready market for the
agricultural implements and inputs like chemical fertilizers, pesticides, tools, equipments, and so on,
which are produced and marketed by the industrial sector of the country. Industries have played a
crucial role in this regard.

Development of industries can provide necessary support towards the development of agricultural sector of the country.
Development of Markets
Development of different industries has led to the development of markets for various raw materials
and finished products in the country.
Contribution Towards National Defence

Growing industrialisation in the country has facilitated the development of many strategic industries
like iron and steel, aircraft building, shipbuilding, chemical, ordinance factories, and so on. All these
have enriched and strengthened the national defence system of the country.
Contribution to Government Exchequer

With the gradual industrialisation of the economy the contribution of government revenue has also
been widened extensively, due to increasing collection of corporate taxes, sales taxes, and excise
duties. Moreover, the public sector enterprises are contributing a good amount of resources to the
Central exchequer in the form of dividend, corporate taxes, excise duty, and so on. The amount of
such contribution was Rs 22,087 crore in 1992–93.

The public sector enterprises are contributing a good amount of resources to the Central exchequer in the form of dividend,
corporate taxes, excise duty, and so on.
INDUSTRIES DURING THE PLAN PERIOD
During more than last four decades of planning, industrial pattern in India had undergone a
perceptible change. The following are some of these changes:
Development of Infrastructure
Infrastructural development is extremely essential for attaining a sound industrial development. Thus,
in the initial part of planning in the country, serious efforts were made for building basic
infrastructural facilities like power, transport, and communications along with the development of
heavy engineering industries.

Infrastructural development is extremely essential for attaining a sound industrial development.
Development of Heavy and Capital Goods Industries

Since the Second Plan onwards, the government put much emphasis on the development of heavy
machine-building industries and capital goods industries, with the sole intention to strengthen the
industrial base of the country. In the mean time, the country has developed various heavy industries
engaged in the products, engineering goods, and so on.
Enhanced Sectoral Contribution of the Industrial Sector in GDP

During the plan period, the sectoral contribution of industrial sector has gradually increased.
Accordingly, the share of industrial sector, in general (at 1980–81 prices), in GDP gradually
increased from 15.05 per cent in 1950–51 to 18.74 per cent in 1960–61, 22.4 per cent in 1970–71, 24.4
per cent in 1980–81 and then, to 27.8 per cent in 1990–91, and finally, to 29.20 per cent in 1995–96.
Rapid Expansions of Consumer Durables Industry in the 1980s

Due to the pursuance of the policy of liberalisation by the government during 1980s, the consumer
durables industries expanded at a faster rate leading to the significant increase in the production of
consumer durables. Accordingly, during the period from 1981–82 to 1998–89, the annual average
growth rate in the production of motorcycles and scooters increased by about 19 per cent, that of
televisions and other electronics increased by 28.7 per cent, and that of air conditioners and
refrigeration, and so on, increased by 12.2 per cent. Thus, the annual growth rate of consumer
durables increased gradually to 14.4 per cent during 1981–85 and then, to 16.9 per cent during 1985–
89, and finally, to 37.1 per cent in 1995–96.
Increasing Stress on Chemicals, Petro-chemicals, and Allied Industries in the 1980s

Another notable change in the industrial pattern during the 1980s was the rapid expansion of
chemicals, petrochemicals, and allied industries. During the 1980s, the average annual growth rate of
chemical and chemical products industries was nearly 11.2 per cent.
Massive Expansion of Public Sector

Another perceptible change in the pattern of industrialisation in the country was the massive
expansion of public sector, during the post-independence period. During the planning year, the total
number of public sector units had increased from just 5 in 1951 to 241 in 1995 and the total amount of
capital invested, also increased considerably from a mere Rs 29 crore to Rs 15,307 crore during the
same period. Thus, the public sector enterprises have been playing an important role in the growing
industrialisation of the country and have led to the increase in the production of basic metals, fuels,
non-ferrous metals, fertilizers, equipment, transportation and communication services, and so on.

Another perceptible change in the pattern of industrialisation in the country was the massive expansion of public sector,
during the post-independence period.
Industrial Development Under the Ninth Plan
The Ninth Plan (1997–2002) put an adequate stress on the development of the industrial sector. The
plan finally envisaged to achieve an annual growth rate of 8.5 per cent for the industrial sector. But
during the initial period of the Ninth Plan, that is, during 1997–98 and 1998–99, the annual growth
rate attained in the industrial sector were 6.6 per cent and 3.5 per cent, supported by a growth rate of
only 3.7 per cent in manufacturing, 6.6 per cent in electricity, and a negative growth rate of (–) 1.1 per
cent in mining.
RECENT INDUSTRIAL GROWTH
The first eight months of the current fiscal, that is, 2007–08, till November 2007, witnessed a
moderate slowdown in the growth of the industrial sector. The slowdown has mainly been on account
of the manufacturing sector. The mining and quarrying sector grew at a faster pace, while the growth
in electricity remained unchanged during April–November 2006. Nonetheless, the 9.2 per cent growth
achieved during April–November 2007 by the industrial sector, when seen against the backdrop of the
robust growth during the preceding four years, suggests that the buoyancy in this sector has
continued, albeit with a degree of moderation (refer to Table 9.4).

The first eight months of the current fiscal, that is, 2007–08, till November 2007, witnessed a moderate slowdown in the
growth of the industrial sector. The slowdown has mainly been on account of the manufacturing sector.
Two important changes have occurred in the growth pattern of the use-based industrial categories
during April–November 2007 when compared to the corresponding period in 2006 (refer to Table
9.5). Firstly, the capital goods have grown at an accelerated pace, over a high base attained in the
previous years, which augurs well for the required industrial capacity addition. Secondly, the
consumer durables basket that forms part of the index of industrial production (IIP) showed a
negative growth during the period, thereby, forcing a visible decline in the growth of the total
consumer goods basket, despite a reasonable growth in the non-durables. The contrasting patterns of
growth in capital goods and consumer durables are presented in Figures 1 and 2.

Table 9.4 Industry—Annual Growth Rate (%)a
Source: Central Statistical Organisation.

aBased on the Index of Industrial Production. Base Year: 1993–94 = 100.
b Figures for April–Nov of—2006–07.

Table 9.5 Industrial Production by USE-based Classification—Growth Rates (%)a

Only one out of the 17 two-digit industrial groups—metal products and parts—recorded a negative
growth during April–November 2007. Of the remaining 16 industry groups, four have registered
growth of less than 5 per cent, five have registered growth rates between 5 per cent and 10 per cent,
and four have registered growth rates between 10 per cent and 15 per cent. The remaining industry
groups, viz., “other manufacturing industries”, “basic metal and alloy industries”, “wood and wood
products”, and “furniture and fixtures”, which together accounted for 12.8 per cent weight of the IIP,
recorded growth rates in excess of 15 per cent.
About six out of the 17 two-digit industry groups, viz., food products, jute textiles, wood products,
leather products, chemicals and chemical products, and other manufacturing, surpassed during April–
November 2007 their respective growth rates in April–November 2006. During the current year,
seven industry groups exceeded the overall rate of growth of manufacturing while the remaining
grew at a lesser pace than the overall growth. Accordingly, substantial changes have occurred in the
point of contributions of different industry groups to the overall industrial growth from April–
November 2006 to April–November 2007 (refer to Table 9.6).
The contribution of a product group to the total manufacturing growth is determined by the value
of the index achieved by the product group, its weight, and its current rate of growth. Table 9.6 shows
that industrial items totalling 24 per cent of the total weight in the manufacturing accounted for 72 per
cent growth of the sector during April–November 2007. Interestingly, while one segment of
automobiles—commercial vehicles, jeeps, and passenger cars—catalysed manufacturing growth, the
slump in the production of motorcycles dampened it. Items like insulated cables/wires, telecom
cables, and so on; wood products; sugar; computer systems and their peripherals; and laboratory and
scientific equipments; drove growth with their outstanding production performance.

Fig ure 9.1 Growth in Capital Goods (month-on-month)

Fig ure 9.2 Growth in Consumer Durables (monthon- month)

Table 9.6 Industrial Production by Broad Industry Groups— Growth Rates (%)a
Note: Growth rates are estimated over the corresponding period of the previous year.
b Non-metallic mineral products.
CENTRAL PUBLIC SECTOR ENTERPRISES (CPSES)
There were 244 Central public sector enterprises (CPSEs) under the administrative control of various
ministries/departments as on March 31, 2007, with a cumulative investment of Rs 421,089 crore. The
largest investment is in the “industrial sector” comprising electricity, manufacturing, mining, and
construction sectors, which is about 62.58 per cent of the total financial investment. There were 16.14
lakh (excluding casual workers and contract labour) persons employed in 244 CPSEs; nearly one-
fourth of the employed persons were in the managerial and supervisory cadres. The major highlights
of the CPSEs during 2006–07 are given in Table 9.7.

There were 244 Central public sector enterprises (CPSEs) under the administrative control of various
ministries/departments as on March 31, 2007, with a cumulative investment of Rs 421,089 crore.

Table 9.7 Performance of CPSEs During 2006–07
Source: Department of Public Enterprises.

aPaid-up capital + share application money pending allotment + long-term loans.

The growth in turnover of CPSEs in the manufacturing sector was 64.62 per cent, followed by
services (18.91), mining (11.75), electricity (4.69), and agriculture (0.03) sectors. Out of the net profit
of Rs 81,550 crore earned during 2006–07, the profit of profit-making CPSEs (156) was Rs 89,773
crore and the total loss of loss-making enterprises (59) stood at Rs 8,223 crore. As many as 44 CPSEs
are listed on the stock exchanges of India. Market capitalisation of all listed CPSEs as a percentage of
market capitalisation of BSE was 18.35 per cent as on March 31, 2007.

The growth in turnover of CPSEs in the manufacturing sector was 64.62 per cent, followed by services (18.91), mining
(11.75), electricity (4.69), and agriculture (0.03) sectors.
The government has delegated enhanced financial and operational powers to the Navaratna,
Miniratna, and other profit-making public sector enterprises. Besides professionalising the Board of
Directors of CPSEs, the government has issued guidelines on corporate governance. The Board for
Reconstruction of Public Sector Enterprises (BRPSE) has been established to advise the government
on the revival of sick and loss-making enterprises. The BRPSE has made recommendations in 47
cases including two for closure till October 31, 2007. The proposals for revival of 26 CPSEs and
closure of two CPSEs have been approved. The total assistance approved by the government up to
December 2007 in this regard is Rs 8,285 crore including Rs 1,955 as crore cash assistance and Rs
6,330 crore as non-cash assistance.

The government has delegated enhanced financial and operational powers to the Navaratna, Miniratna, and other profit-
making public sector enterprises.
MICRO AND SMALL ENTERPRISES (MSES)
The micro and small enterprises (MSEs) provide employment to an estimated 31.2 million persons in
the rural and urban areas of the country. During 2003–07, the MSE sector registered a continuous
growth in the number of enterprises, production, employment, and exports (refer to Table 9.8). It is
estimated that there are about 128.44 lakh MSEs in the country as on March 31, 2007, accounting for
about 39 per cent of the gross value of output in the manufacturing sector.

The micro and small enterprises (MSEs) provide employment to an estimated 31.2 million persons in the rural and urban
areas of the country.
Under the micro, small, and medium enterprises development (MSMED) Act, 2006, the definitions
and coverage of the MSE sector were broadened, significantly. Further, the Act also defined the
medium enterprises for the first time. Informal estimates suggest the contribution of the MSME sector
to be much higher than those based on the third All India Census. To capture the data for the MSME
sector, the fourth census of MSME sector is being launched.

Table 9.8 Performance of Micro and Small Enterprises
Source: Office of the Development Commissioner (MSME).

Note: Figures in parenthesis indicate the percentage growth over the previous year.
aEstimates based on the definitions prior to enactment of MSMED Act, 2006.

Recently, major initiatives have been taken by the government to revitalise the MSME sector. They
include: (1) Implementation of the (MSMED) Act, 2006 (refer to Box 9.1). (2) A “Package for
Promotion of Micro and Small Enterprises” was announced in February 2007. This includes
measures addressing concerns of credit, fiscal support, cluster-based development, infrastructure,
technology, and marketing. Capacity building of MSME associations and support to women
entrepreneurs are the other important features of this package. (3) To make the Credit Guarantee
Scheme more attractive, the following modifications have been made: (a) enhancing eligible loan
limit from Rs 25 lakh to Rs 50 lakh; (b) raising the extent of guarantee cover from 75 per cent to 80
per cent for (i) micro-enterprises for loans up to Rs 5 lakh, (ii) MSEs operated or owned by women,
and (iii) all loans in the north-east region; and (c) reducing one-time guarantee fee from 1.5 per cent
to 0.75 per cent for all loans in the north-east region. (4) The phased deletion of products from the list
of items reserved for exclusive manufacture by micro and small enterprises is being continued. About
125 items were de-reserved on March 13, 2007, reducing the number of items reserved for exclusive
manufacturing in micro and small enterprise sector to 114. Further, 79 items were de-reserved
through a notification dated February 5, 2008.

Recently, major initiatives have been taken by the government to revitalise the MSME sector.
Box 9.1 Implementation of the MSME Development Act, 2006
For implementation of the MSMED Act, 2006, notifications of rules were to be issued by the
Central and state governments. The Central notifications are as follows:
Principal notification in July 2006 that MSMED Act becomes operational from October 2, 2006.
Notification in September 2006 for the Rules for National Board for micro, small, and medium enterprises (NBMSMEs) to
be constituted under the Act.
Notification in September 2006 for the constitution of the Advisory Committee.
Notification in September 2006 for classifying enterprises.
Notifications in September and November 2006 declaring DICs in the states/UTs as “Authority” with which the
entrepreneurs’ memorandum could be filed by the medium enterprises.
Notification in September 2006 for the form of memorandum to be filed by the enterprises, procedure of its filing, and other
matters, incidental thereto.
Notification in October 2006 for exclusion of items while calculating the investment in plant and machinery.
Notification in May 2007 for constitution of NBMSMEs.
Notification in May 2007 for dividing the country into six regions; and, notification in June 2007 for the amendment of EM
format.
28 states/UTs have notified the authority for filing of entrepreneurs’ memorandum, 17 states/UTs have notified rules for
MSEFCs, and 15 states/UTs have notified the constitution of MSEFCs.
Tourism
Global tourism continued to move upward during 2006 with the number of international tourist
arrivals worldwide reaching about 846 million (UNWTO [UN World Tourism Organisation]
estimates) and international tourism receipts scaling US$735 bn in the year. The aforesaid variables
grew at 5.7 per cent and 8.4 per cent, respectively, when compared to 2005. The rate of growth of the
tourism sector of India has been way above the world average in the last few years. The year 2006–07
is the fourth consecutive year of high growth in foreign tourist arrivals and foreign exchange
earnings from tourism (refer to Table 9.9).

The rate of growth of the tourism sector of India has been way above the world average in the last few years. The year
2006–07 is the fourth consecutive year of high growth in foreign tourist arrivals and foreign exchange earnings from
tourism.
The prospects for growth of tourism in India are bright. The overall development of tourism
infrastructure coupled with other efforts by the government to promote tourism, such as
appropriately positioning India in the global tourism map through the “Incredible India” campaign,
according greater focus in the newly emerging markets, such as China, Latin America, and CIS
(Commonwealth of Independent States) countries, and participating in trade fairs and exhibitions will
facilitate tourism growth. From the construction of Wholesale Price Index (WPI) and the Index of
Industrial Production (IIP), it is not possible to distinguish between input and output prices at the two-
digit level classification of industrial groups. This renders it difficult to verify the correspondence
between industrial input and output prices. It is observed that during April–November 2007, the
inflation of manufactured products, in general, has been slightly higher than their levels during the
corresponding period in 2006, while the growth has been lower. At the disaggregated level, for
instance, among food products, sugar recorded a phenomenal growth in production and recorded a
negative point-to-point inflation of –16.4 per cent during April–November 2007. Likewise, the
growth performance of edible oils has been generally poor, while their inflation has been 13.2 per
cent. The updated figures of inflation in terms of absolute manufacturing price indices can be further
perused from Table 9.10.
Although the overall inflation could be influenced most directly by monetary factors, the rate of
price change in specific segments like manufacturing (and product groups within) would be
significantly affected by changing demand conditions and input prices. In this context, it is the
movement in relative prices rather than absolute prices that becomes more relevant. The relative
inflation of a manufacturing product group has been measured as the rate of growth in the ratio of the
WPI of that product group to the overall WPI. As a rigorous treatment of relative manufacturing
prices is beyond the scope of this Section, a simple presentation of relative prices during 2005– 07 is
attempted in Table 9.11. While establishing correspondence between the WPI and the IIP, of the total
of 17 two-digit-level IIP groups, four groups pertaining to textiles are clubbed together. Similarly,
basic metals and metal products are combined, while “other manufacturing” is omitted.

Table 9.9 Foreign Tourist Arrivals and Foreign Exchange Earnings from Tourism
Source: Ministry of Tourism.
aFigures worked out using the new methodology.
b Revised Estimates.
cProvisional.
d Advance Estimates.

Table 9.10 Profits and Profitability of Corporates
Source: Reserve Bank of India.

Table 9.11 Manufacturing Relative Price Growth (%)
P=Provisional.

Table 9.11 shows that, on the whole, the relative manufacturing inflation that remained negative
during 2005–06 and 2006–07 turned positive during April–November 2007. Of the 12 industrial
product groups presented in the same table, product groups other than food products, textiles, and
transport equipments, and paper and paper products contributed towards this change.
During the period from 2005–06 to 2007–08, the rate of growth in relative prices remained
negative for food products, textiles, and transport equipments, while for beverages and tobacco
products, wood and wood products, and non-metallic mineral products, the same has been positive
during the period. Among the textile products, the growth performance has been sluggish, except for
jute textiles; yet, their inflation levels have been mild. In the face of a near-stagnation in the export
growth experienced during April–September 2007, mainly on account of appreciation of rupee, price
adjustments may have been attempted by the textile industry to remain internationally competitive.
The RBI Study of Corporates has revealed that among the textile corporates, net profit to sales ratio
has declined during the first half of the current fiscal. Among the six product groups exhibiting both
increasing and declining relative prices in different years, the annual fluctuations were most
pronounced in the case of leather and leather products.
CORPORATE PROFITABILITY AND INVESTMENT
The profits earned by companies affect their retained earnings and savings rate, their cost of capital,
and, consequently, their investment. The data on corporate profitability, relevant to the industrial
sector, presented here relate to a sample of non-government, non-financial, public limited companies
studied and analysed by the Reserve Bank of India (RBI). Net corporate profits (net of taxes) have
increased considerably for all industrial groups except food products and beverages and textiles
during the first half of the current fiscal. Corporate profitability too has been visibly higher for most
industrial groups in the first half of 2007–08 when compared to that of 2006–07 (refer to Table 9.10).
Nonetheless, the study has observed that the rates of growth in sales and the net profits are lower
during the first half of 2007–08, when compared to those of the first half of 2006–07. Table 9.10
presents the industry groups in the descending order of the ratio of net profits to sales during the first
half of 2007–08. It shows that there is a strong industry-specific pattern to the behaviour of corporate
profits and profitability.

The profits earned by companies affect their retained earnings and savings rate, their cost of capital, and, consequently,
their investment.
Higher profits, backed by sound balance sheets, would suggest higher capacity to invest, which is
reflected in the corporate investment plans for the medium term. The analysis of the inter-temporal
investment plans of the private corporate sector done by the RBI, on the basis of the study of 1,054
companies, which were sanctioned assistance by banks and other financial institutions in 2006–07,
brings out a bright picture. Analysing the phasing of capital expenditure of the companies over the
years, the RBI study estimated that the capital expenditure envisaged for 2006–07 amounted to Rs
155,038 crore, which shows an increase of 60.2 per cent over 2005–06. Further, it is estimated that the
total cost of the projects of the private corporate sector, which were sanctioned assistance in 2006–07,
went up to Rs 283,440 crore (against Rs 131,299 crore in 2005–06). Out of this, about 34 per cent has
been planned to be spent in 2007–08. Besides this, an additional capital expenditure has been
envisaged from the external commercial borrowings and domestic equity issuances.

Higher profits, backed by sound balance sheets, would suggest higher capacity to invest, which is reflected in the corporate
investment plans for the medium term.
Foreign Direct Investment
During April–November 2007, foreign direct investment (FDI) equity inflows stood at Rs 45,098
crore (US$11.14 bn) against Rs 33,030 crore (US$7.23 bn) during April–September 2006, signifying
a growth of 36 per cent in terms of rupee and 54 per cent in terms of US dollar (refer to Table 9.12).
From April 2000 to November 2007, Mauritius remained the predominant source country for FDI
to India, accounting for 44.24 per cent share of the cumulative total, followed by the United States
(9.37 per cent), the United Kingdom (7.98 per cent), and the Netherlands (5.81 per cent).

From April 2000 to November 2007, Mauritius remained the predominant source country for FDI to India, accounting for
44.24 per cent share of the cumulative total, followed by the United States (9.37 per cent), the United Kingdom (7.98 per
cent), and the Netherlands (5.81 per cent).

Table 9.12 Cumulative Equity Flow
Period Rs Crore US$ mn

August 1991–March 2007 232,041 54,628
April 2007–November 2007 45,098 11,141
August 1991–November 2007 277,139 65,769
April 2000–November 2007 216,534 49,070
Source: Department of Industrial Policy and Promotion.

During April–November 2007, the position of Mauritius remained still prominent (42.77 per cent).
While the shares of the United States (5.45 per cent), the United Kingdom (2.19 per cent), and the
Netherlands (4.51 per cent) were lower, those of Japan (5.72 per cent) and Singapore (8.73 per cent)
were higher. In the sectoral distribution of FDI inflows, financial and non-financial services secured a
growth of more than seven times during 2006–07, to secure the first spot in cumulative inflows,
displacing computer software and hardware. Along with services, the shares of sectors like
telecommunications, construction, housing, and real estate have buoyed during April–November
2007 (refer to Table 9.13).
Of the total FDI received, about 53.57 per cent came through the automatic route of the RBI, while
20.15 per cent came through the government-approval route, and the rest in the form of acquisition of
existing shares. Among the destinations of FDI inflows, Mumbai, New Delhi, Bangalore and Chennai
maintained the first four positions in that order (refer to Table 9.14). During the period of August
1991–November 2007, India received about 7,898 approvals for foreign technology transfer, of
which 81 were obtained during 2006–07 and 52 during April–November 2007.

During the period of August 1991–November 2007, India received about 7,898 approvals for foreign technology transfer,
of which 81 were obtained during 2006–07 and 52 during April–November 2007.

Table 9.13 Sectors Attracting Highest FDI Flows
aFinancial and non-financial services.
b Radio paging, cellular mobile, and basic telephone services.
cConstruction, including roads and highways.

Table 9.14 Region-wise Break-up of FDI Received (April 2000 to November 2007)
Reg ional Office of the RBI States Covered Share in FDI Inflows (%)
Mumbai Maharashtra, Dadra and
Nagar Haveli, Daman and Diu 25.14
New Delhi Delhi, parts of Uttar Pradesh 22.68
and Haryana
Bangalure Karnataka 7.03
Chennai Tamil Nadu and Puducherry 6.69
Hyderabad Andhra Pradesh 4.12
Ahmedabad Gujarat 2.84

FDI Policy
As a result of the comprehensive review of the FDI policy, wide-ranging policy changes were
notified in 2006, like extending automatic routes, increasing equity caps, removing restrictions,
simplifying procedures, and extending the horizon of FDI to vistas like single-brand product retailing
and agriculture. Of late, several steps have been initiated to facilitate FDI inflows which, among other
things, include: raising the equity cap in civil aviation, organising Destination India events in
association with CII (Confederation of Indian Industry) and FICCI (Federation of Indian Chambers of
Commerce & Industry), with a view to attract investments, activating the Foreign Investment
Implementation Authority (FIIA) towards a speedy resolution of investment-related problems; setting
up of National Manufacturing Competitiveness Council (NMCC) to provide a continuing forum for
policy dialogue, to energise the growth of manufacturing; regular interactions with foreign investors
through bilateral/regional/international meets and meetings with individual investors; and making the
web site of the Department of Industrial Policy & Promotion (www.dipp.nic.in) more user-friendly
with an online chat facility. About 4,500 investment-related queries have been replied during 2007–08.

As a result of the comprehensive review of the FDI policy, wide-ranging policy changes were notified in 2006, like extending
automatic routes, increasing equity caps, removing restrictions, simplifying procedures, and extending the horizon of FDI to
vistas like single-brand product retailing and agriculture.
Industrial Credit
The overall industrial credit, which slackened in the first half of 2007–08, is now showing signs of
recovery. During April–August 2007, the outstanding gross deployment of bank credit increased only
by 2.8 per cent from end-March 2007, while the corresponding increase stood at 8.5 per cent during
2006. However, the gap between the rates of credit growth between April–November 2006 and April–
November 2007 has substantially narrowed (refer to Table 9.15).
Table 9.15 further shows that there is a strong sectoral pattern to the growth of industrial credit.
Among the sectors that experienced high rates of production growth during April–November 2007,
credit growth also has been robust for jute textiles, leather and leather products, basic metals, and
engineering goods. The slackening of the credit growth in mining and quarrying, and wood products
has occurred over a high base achieved by the end-March 2007. Encouragingly, the outstanding credit
to “transport equipments” group, which has witnessed a slowdown in production, has grown
significantly from the end-March 2007. Besides, the near-doubling of the rate of credit growth to
infrastructure augurs well for many infrastructure-dependent industrial groups and for the economy
as a whole.
Industrial Relations
The continued decline in the number of strikes and lockouts indicates improved industrial relations.
The number of strikes and lockouts, taken together, was down by 5.7 per cent in 2006 (refer to Table
9.16). As per the available information, during the current year till November 2007, West Bengal
experienced the maximum instances of strikes and lockouts followed by Tamil Nadu and Gujarat.
Industrial disturbances were concentrated mainly in textiles, financial intermediaries (excluding
insurance and pension fund), engineering, and chemical industries.

The continued decline in the number of strikes and lockouts indicates improved industrial relations. The number of strikes
and lockouts, taken together, was down by 5.7 per cent in 2006.

Table 9.15 Industry-wise Deployment of Gross Bank credit

Table 9.16 Strikes and Lockouts (mandays lost: in million)
Source: Labour Bureau, Shimla
Note: Total may not necessarily tally due to rounding–off of figures.
P: Provisional.
a(January to November).
INDUSTRIAL SICKNESS
The Board for Industrial and Financial Reconstruction has so far received 7,158 references under the
Sick Industrial Companies (Special Provisions) Act (SICA), 1985. These references include 297 from
Central and state public sector undertakings (CPSUs and SPSUs). Out of the total references received,
5,471 were registered under Section 15 of the SICA, 1,857 references were dismissed as non-
maintainable under the Act, 825 rehabilitation schemes, including 13 by AAIFR/ Supreme Court, were
sanctioned, and 1,337 companies were recommended to be wound up. Of the 297 references for
PSUs, the references of 92 CPSUs and 122 SPSUs were registered up to December 31, 2007.

The Board for Industrial and Financial Reconstruction has so far received 7,158 references under the Sick Industrial
Companies (Special Provisions) Act (SICA), 1985.
ENVIRONMENTAL ISSUES
The development of a diversified industrial structure, based on a combination of large and small-
scale industries, along with growing population, has led to growing incidence of air, water, and land
degradation. Industrial effluents are a major source of water pollution. As regards solid wastes,
flyash, phospho-gypsum, and iron and steel slag are the main forms of solid wastes generated. Out of
2,744 industries identified under the 17 categories of polluting industries, 1,991 units have set up
pollution control devices to comply with the standards, 339 units have been closed, and action has
been taken against the 414 defaulting units up to June 2007 (refer to Table 9.17).
Policy Initiatives
Following the recommendations of the Swaminathan Committee and on reviewing the Coastal Regulation Zone (CRZ)
notification, so as to enable an environmentally sustainable use of coastal resources, pilot studies on drawing up the
vulnerability line for CRZ were initiated and are continuing.
The Prime Minister’s Council on Climate Change was constituted in June 2007 to coordinate national action for assessment,
adaptation, and mitigation of climate change. An Expert Committee the on impact of climate change has also been set up to study
the impact of anthropogenic climate change and to identify measures required therein.
Under the Clean Development Mechanism (CDM), set up under the Kyoto Protocol, India has registered 283 (so far the highest
by any country) out of 812 total projects registered by the CDM Board till October 2007.

Table 9.17 Projects Appraised for Environmental Clearence During April–December 2007
Source: Ministry of Environment and Forests.

Note: This includes proposals which were accorded environment clearance as per provisions of the EIA Notification, 2007.

CHALLENGES AND OUTLOOK
The industrial sector recorded a robust rate of growth in excess of 8 per cent during 2004–05 and
2005–06, and scaled an appreciable 11.6 per cent growth during 2006–07. The current fiscal till
November 2007 sustained the momentum, albeit with a slight moderation in certain sectors. While
industrial groups like food products, jute textiles, wood products, leather products, chemicals and
chemical products, and “other manufacturing” have grown at an accelerated pace, when compared to
2006–07, industries like non-metallic mineral products, cotton textiles and textile products,
automobiles, paper products, and metal products have suffered from a significant slackening in
growth. It is the visible downslide in the production of consumer durables that has been subjected to
anxious commentaries from different quarters. If the consumer goods sector had grown at the pace at
which it had grown during 2006–07, the overall industrial growth till November in the current year
would have closed in on that of the previous year.

The industrial sector recorded a robust rate of growth in excess of 8 per cent during 2004–05 and 2005–06, and scaled an
appreciable 11.6 per cent growth during 2006–07.
The growth of textiles, with very low import intensity, may have been affected adversely by the
recent appreciation of the rupee against the US dollar. The government has promptly taken measures
to mitigate the incidence of the slowdown. The downslide in consumer durables can partly be
attributed to the constrained demand conditions arising from adjustments in policy variables like the
interest rates. Yet, it needs to be appreciated that the automobile segments, including passenger cars,
jeeps, scooters, and mopeds have buoyed during the current fiscal. Besides, the current series of the
IIP based on the product baskets and weights assigned in 1993–94 has serious limitations in fully
capturing the post-reform dynamics of the consumer durables sector. This IIP series is under revision.
In short, the slowdown, shown by the available data on consumer durables, may not, in itself, be a
cause of serious concern in the long run, provided the overall buoyancy in growth and income is
maintained.

The growth of textiles, with very low import intensity, may have been affected adversely by the recent appreciation of the
rupee against the US dollar.
The slowdown, shown by the available data on consumer durables, may not, in itself, be a cause of serious concern in the
long run, provided the overall buoyancy in growth and income is maintained.
There are a number of positive developments that brighten the industrial outlook in the medium
term. First, there has been a commendable growth in the capital goods sector, especially in industrial
machinery, which, along with strong imports of capital goods, augurs well for the much-required
industrial capacity addition. Secondly, the inherent strength of industrial corporates, manifested in the
increase in profits and profitability and strong investment plans, confirms the strength of the growth
prospects in the medium term. Thirdly, the high-investment plans made for infrastructure during the
Eleventh Five-Year Plan are expected to gradually alleviate the infrastructural constraints to industrial
development. Moreover, the bourgeoning direct investment inflows in the liberalised-investment
regime supplement the domestic investment to a great extent.
The real challenge lies in strengthening the foundations for a sustained industrial growth. One of
the biggest challenges to sustaining and stepping up the industrial growth lies in removing the
infrastructural impediments in road—both rural and urban—rail, air, and sea transport and power.
The growth in infrastructure not only alleviates the supply-side constraints in industrial production,
but also stimulates the additional, domestic demand required for the industrial growth. Another issue
in the industrial growth is the swiftness and efficacy with which the skill deficit felt in many areas of
manufacturing is bridged. This will facilitate research and development and technological
innovations, which are urgently called for, in important industries like chemicals, automotives, and
pharmaceuticals.

The real challenge lies in strengthening the foundations for a sustained industrial growth. One of the biggest challenges to
sustaining and stepping up the industrial growth lies in removing the infrastructural impediments in road—both rural and
urban—rail, air, and sea transport and power.
Further, there is an imperative need to facilitate the growth of labour-intensive industries,

especially by reviewing labour laws and labour market regulations. This is, particularly, important in
reversing the current, not-so-encouraging, manufacturing employment trends. Besides, the growth in
many industries is constrained by the acute scarcity/depleting reserves of important raw materials like
coal, iron ore, natural gas, and forest resources. The Eleventh Five-Year Plan has placed its focus on
these challenges. While the strategies for the industrial development set out by the Eleventh Five-Year
Plan document are broadly tailored to address these issues, sectorally differentiated initiatives may be
required for skill upgradation, supply augmentation of inputs, and promotion of research and
development.

Further, there is an imperative need to facilitate the growth of labour-intensive industries, especially by reviewing labour
laws and labour market regulations.
KEY WORDS
Industrialisation
Underdeveloped Countries
Growth Through Trade
Trade Gap
Industrial Linkages
Primary Products
Consumer Goods
Capital Goods
Infrastructural Facilities
Balanced Sectoral Development
Enhanced Capital Formation
Gross Domestic Saving (GDS)
Gross Domestic Capital (GDC)
Infrastructure
Private Sector
Joint Sector
QUESTIONS
1. What do you mean by industrialisation? Explain the pattern of industrialisation in India since independence.
2. Discuss the relative role of public and private sectors in the industrial development in India.
3. Explain the inadequacies of the programmes of industrialisation in India and suggest the measures to overcome these
inadequacies.
4. What role do industries play in the economic development of the country.
5. How did the planning in India contribute for the development of industries in India.
6. Discuss the recent industrial growth and its impact on the economic development.
7. Discuss the contribution of PSUs in the economic development of the country.
8. What role did the small-scale industry play for the employment generation of the country.
9. State the initiatives taken by the government for the development of micro and small enterprises.
10. Discuss the FDI policy and its contribution for the industrial development of the country.
11. Discuss the state of tourism industry in India. What initiatives are required from the government for its development.
a. Industrial Credit.
b. Industrial Sickness.
c. Industry and Environment.
d. Performance of Corporate Sector.
REFERENCES
Bala, I. (2003). Foreign Resources and Economic Development. New Delhi: Discovery.
Budget Document, Government of India.
Government of India. Economic Survey of India 2007–08. New Delhi: Ministry of Finance.
Misra, S. N. (2004). Indian Economy and Socio-economic Transformation: Emerging Issuses and Problems: Essays in
Honour of Professor Baidyanath Misra. New Delhi: Deep and Deep Publications.
Travedi, I. V. and R. Jatana (2004). Economic Environment of India. Jaipur: University Book House.
CHAPTER 10
CHAPTER OUTLINE
Main Features of India’s Trade Policy
Phases of India’s Trade Policy
India’s Foreign Trade Policy, 1991
Major Trade Reforms
Assessment of the New Trade Policy
Balance of Payments (BoP)
Current Account Deficit (CAD)
Capital Account Deficit
Other Non-debt Flows
Key Words
Questions
References
FOREIGN TRADE POLICY AND BALANCE OF PAYMENTS
Advanced countries like Germany, the United States, Japan, and others have used their trade policy to
(a) restrict their imports and provide a sheltered market for their own industries so that they could
develop rapidly and (b) promote their exports so that their expanding industries could secure foreign
markets. In other words, trade policy has played a significant role in the development of the advanced
countries. India, however, did not have a clear trade policy before independence, though some type of
import restriction—known as discriminating protection—was adopted since 1923 to protect a few
domestic industries against foreign competition. It was only after independence that a trade policy, as
part of the general economic policy of development, was formulated by India.

Trade policy has played a significant role in the development of the advanced countries.
It was only after independence that a trade policy, as part of the general economic policy of development, was formulated
by India.
MAIN FEATURES OF INDIA’S TRADE POLICY
On the import side, India has been in a disadvantageous position vis-à-vis advanced countries, which
are capable of producing and selling almost every commodity at low prices. This meant that India
could not develop any industry without protecting it from any foreign competition. Import restriction,
commonly known as protection, was thus essential to protect domestic industries and to promote
industrial development. Since independence, the Government of India has broadly restricted the
foreign competition through a judicious use of import licensing, import quotas, import duties and, in
extreme cases, even banning the import of specific goods. The Mahalanobis strategy of economic
development through heavy industries, which India adopted since the Second Five-Year Plan, called
for (a) banning or keeping to the minimum the import of non-essential consumer goods, (b)
comprehensive control of various items of imports, (c) liberal import of machinery, equipment, and
other developmental goods to support heavy industry-based economic growth, and (d) a favourable
climate for the policy of import substitution.

Since independence, the Government of India has broadly restricted the foreign competition through a judicious use of
import licensing, import quotas, import duties and, in extreme cases, even banning the import of specific goods.
On the export side, to pay for its essential imports and to minimise the dependence on foreign
countries, expansion of exports was very essential. It was also realised that the market for many
goods within India may not be adequate to absorb that entire domestic production and, hence, a search
for markets elsewhere was a necessity. The Indian government had to play an important role to
promote exports through setting up of trading institutions, and through fiscal and other incentives.
Vigorous export promotion was emphasised after the Second Plan to earn foreign exchange, to
overcome the acute foreign exchange crisis. In the 1970s, importance of export promotion was again
emphasised because of mounting debt-service obligations and the goal of self-reliance (with zero net
aid).

Vigorous export promotion was emphasised after the Second Plan to earn foreign exchange, to overcome the acute foreign
exchange crisis.
PHASES OF INDIA’S TRADE POLICY
Five distinct phases in India’s trade policy can be noted as follows: the first phase pertains to the
period from 1947–48 to 1951–52; the second phase covering the period from 1952–53 to 1956–57;
the third phase from 1957–58 to June 1966; the fourth phase started after devaluation of the rupee in
June 1966; and the last phase after 1975–76.

Five distinct phases in India’s trade policy can be noted as follows: the first phase pertains to the period from 1947–48 to
1951–52; the second phase covering the period from 1952–53 to 1956–57; the third phase from 1957–58 to June 1966; the
fourth phase started after devaluation of the rupee in June 1966; and the last phase after 1975–76.
During the first phase up to 1951–52, India could have liberalised imports, but on account of the
restrictions placed by the United Kingdom on the utilisation of the sterling balances, it had to continue
wartime controls. Since our balance of payments (BoP) with the dollar area was heavily adverse, an
effort was made to screen imports from hard-currency areas and boost up exports to the above dollar
area, so as to bridge the gap. This also necessitated India to devalue her currency in 1949. By and
large, the import policy continued to be restrictive during this period. Besides this, restrictions were
also placed on exports in view of the domestic shortages.

The import policy continued to be restrictive during this period.
During the second phase (from 1952–53 to 1956–57), the liberalisation of foreign trade was
adopted as the goal of trade policy. Import licences were granted in a liberal manner. An effort was
also made to encourage exports by relaxing export controls, reducing export duties, abolishing
export quotas, and providing incentives to exports. Liberalisation led to a tremendous increase in our
imports, but exports did not rise appreciably. Consequently, there was a fast deterioration in our
foreign exchange reserves (FERs). This necessitated a reversal of trade policy.

Liberalisation led to a tremendous increase in our imports, but exports did not rise appreciably.
During the third phase, which began in 1956–57, the trade policy was re-oriented to meet the
requirements of the planned economic development. A very restrictive, import policy was adopted,
and the import controls further screened the list of imported goods. On the other hand, a vigorous
export promotion drive was launched. The trade policy assumed that a lasting solution to the BoP
problem lies in the promotion and diversification of our export trade. Not only should the export of
traditional items be expanded, but also the export of newer items should be encouraged. Similarly,
import-substitution industries should also be encouraged so that dependence on foreign countries be
lessened. It was in this period that India’s trade policy was thoroughly reviewed by the Mudaliar
Committee (l962).

The trade policy assumed that a lasting solution to the BoP problem lies in the promotion and diversification of our export
trade.
The fourth phase started after the devaluation of the rupee in June 1966. During this period, the
trade policy attempted to expand exports and strangely liberalised imports, too. Actually, export
promotion was given a big boost through the acceptance and implementation of the recommendations
of the Mudaliar Committee (1962). The major recommendations included an increased allocation of
raw materials to export-oriented industries, income-tax relief on export earnings, export promotion
through import entitlement, removal of disincentives, and setting up of Export Promotion Advisory
Council, a Ministry of International Trade, and so on. When these export-promotion measures did not
succeed and adverse BoP persisted, the Government of India undertook devaluation of the rupee in
1966, as a major step to check imports and boost exports. Initially, devaluation was not successful and
the adverse BoP worsened during the annual plans. But during the Fourth Plan, the trade policy was
quite successful in restricting imports and promoting exports. This period continued till 1975–76.

During the Fourth Plan, the trade policy was quite successful in restricting imports and promoting exports.
During the last phase (1975–76 onwards), the government adopted a policy of import
liberalisation, with a view to encourage export promotion. During the Janata rule (1977–79), import
liberalisation was also adopted to augment domestic supply of essential goods and to check rise in the
price level. Import–Export Policy of the Indian government attempted to achieve such objectives as:
(i) to provide further impetus to exports, (ii) to provide support to the growth of indigenous industry,
(iii) to provide for optimum utilisation of the country’s resource endowments, especially in
manpower and agriculture, (iv) to facilitate technology upgradation with a special emphasis on export
promotion and energy conservation, (v) to provide a stimulus to those engaged in exports and, in
particular, to manufacturing units contributing, substantially, to the export efforts, and (vi) to effect all
possible savings in imports. Thus, it is clear that the purpose of trade policy has been to stimulate
economic growth and export promotion via import liberalisation.

It is clear that the purpose of trade policy has been to stimulate economic growth and export promotion via import
liberalisation.
Import liberalisation, along with export promotion, at a time, when (a) prices of imported goods
were rising much faster and (b) foreign markets for Indian goods were depressed, has resulted in
huge adverse balance of trade and payments from 1979–80 onwards. Instead of curtailing imports, the
Tendon Committee (1981) recommended a policy of vigorous export promotion and further import
liberalisation, as a means of export promotion. The IMF Loan (1981) had also stipulated that India
should use export promotion and not import restriction, as the strategy for controlling adverse BoP.
Such a trade policy forced India almost into a debt trap, and the Indian bureaucrats were knocking at
the doors of Aid India Consortium and other advanced countries tried to bail India out.
While framing the Export–Import Policy (1985), the government was guided by the
recommendations of the Abid Hussain Committee. Whereas the Committee emphasised the need for
striking a balance between export promotion and import substitution, the government, in its wave of
import liberalisation, permitted a much greater quantum of imports in the name of export promotion
and capital goods imports for technological upgradation. Thus, grave distortions appeared in the
process of implementation of the recommendations of the Committee.

While framing the Export–Import Policy (1985), the government was guided by the recommendations of the Abid Hussain
Committee.
The first major attempt at liberalisation was made by the Rajiv Gandhi government. As a result, in
the four years from 1985–86 to 1989–90, exports surged forward, and the period witnessed a
recorded average annual growth of 17 per cent in dollar terms. Unfortunately, and unaccountably, the
exports declined by 9 per cent in 1990–91.

The first major attempt at liberalisation was made by the Rajiv Gandhi government.
INDIA’S FOREIGN TRADE POLICY, 1991
The Commerce Minister, Mr P. Chidambaram, announced a major overhaul of trade policy on July 4,
1991, entailing (i) suspension of cash-compensatory support, (ii) an enlarged and uniform REP
(replenishment) rate of 30 per cent of FOB (free on board) value, (iii) abolition of all supplementary
licences, except in the case of small-scale sector and producers of life-saving drugs/equipments, (iv)
abolition of unlisted OGL (open general licence), and (v) removal of all import licensing for capital
goods and raw materials, except for a small negative list in three years.

The then Commerce Minister, Mr. P. Chidambaram, announced a major overhaul of trade policy on July 4, 1991.
Rationale of Foreign Trade Policy
Giving the rationale for the new policy, the Commerce Minister noted as follows: for several
decades, trade policy in India has been formulated in a system of administrative controls and licences.
As a result, we have a bewildering number and a variety of lists, appendices, and licences. This
system has led to delays, wastage, inefficiency, and corruption. Human intervention, described as
discretion at every stage, has stifled enterprise and spawned arbitrariness.
The government, therefore, decided that while all essential imports like POL (petroleum, oil, and
lubricants), fertilizer, and edible oil should be protected, all other imports should be linked to exports
by enlarging and liberalising the REP licence system. For this purpose, the following major reforms
were announced.

The government, decided that while all essential imports like POL (petroleum, oil, and lubricants), fertilizer, and edible oil
should be protected, all other imports should be linked to exports by enlarging and liberalising the REP licence system.
MAJOR TRADE REFORMS
1. REP will become the principal instrument for export-related imports. To describe REP as a licence is a misnomer. Hence, it will
now be called “exim scrip” and can be freely traded.
2. All exports will now have a uniform REP rate of 30 per cent of the FOB value. This is a substantial increase from the present
REP rates, which vary between 5 per cent and 20 per cent of FOB value.
3. The new REP scheme gives a maximum incentive to exporters whose import intensity is low. For example, agricultural exports,
which earlier had very a low REP rate of 5 per cent or 10 per cent, will now gain considerably.
4. All supplementary licences shall stand abolished except in the case of the small-scale sector and for producers of life-saving
drugs/equipment. These two categories will be entitled to import both under OGL or through supplementary licences.
5. All additional licences granted to export houses shall stand abolished. However, export houses will enjoy a REP rate of 30 per
cent of FOB value, and will be granted an additional REP rate of 5 per cent of FOB value.
6. All items now listed in the Limited Permissible List. OGL items would, hereafter, be imported through the REP route.
7. The exim policy contains a category known as Unlisted OGL. This category stands abolished and all items falling under this
category may be imported only through the REP scheme.
8. Advance licensing has been an alternative to the REP route for obtaining imports for exporters. It is expected that many
exporters will find the REP route more attractive now. However, for exporters who wish to go through advance licensing, this
route will remain open. The REP rate for advance licence exports is being increased from 10 per cent of NFE (net foreign
exchange earnings) to 20 per cent of NFE.
9. In three years’ time, our objective will be to remove all import licensing for capital goods and raw materials, except for a small
negative list.
10. The goal of the government is to decanalise all items, except those that are essential.
11. In the light of the substantial liberalisation of the trade regime, and also the recent changes in exchange rates (after devaluation),
cash-compensatory scheme (CCS) was abolished from July 3, 1991.
12. In order to make this system more transparent and free, it is proposed that financial institutions may also be allowed to trade in
exim scrips.
13. In three–five years, the Commerce Minister hoped that the rupee will become fully convertible on the trade account.
On August 3, 1991, the Commerce Minister announced a new package of incentives for export-
oriented units (EOUs) and export-promotion zones (EPZs) by granting higher rates of exim scrips.
The new package stated:
1. The basic rate at which exim scrips would be issued against exports would be 30 per cent of foe value. Exports to hard-currency
areas will be eligible for exim scrips that are valid for hard-currency imports while exports to rupee-payment areas will be
issued exim scrips that are valid for imports from the latter areas only.
2. The basic rate of 30 per cent is inadequate for exports of certain products, such as value-added agricultural products,
electronics, bulk drugs and marine products, formulations, and certain categories of advanced engineering goods. These
products will be eligible for an additional exim-scrip entitlement of 10 percentage points, taking the total exim-scrips rate to 40
per cent of FOB value.
3. The EOUs and EPZ units, and exim scrips at 3096 of NFE earnings would also be available.
4. The 30 per cent of NFE rate of exim scrips would also be applicable to service exports, including software exports, which is a
thrust area. The definition of services under this category included other services, such as services of architects, textile designers,
artists, management consultants, lawyers, and so on. The benefit will be available to services exported by resident Indians for
which remittances are made to India.
On August 3, 1991, the Commerce Minister announced a new package of incentives for export-oriented units (EOUs) and
export-promotion zones (EPZs) by granting higher rates of exim scrips.

Table 10.1 Environment (annual % change unless otherwise noted)
Source: World Economic Outlook, October 2007, IMF.

The growing influence of global developments on the Indian economy was manifested in the surge in
capital inflows in 2007–08, a phenomenon observed earlier in the other emerging market economies.
This is a natural concomitant of the robust, macro-economic fundamentals like high growth, relative
stability in prices, healthy financial sector, and high returns on investment. Sometimes, it also reflects
the rigidities in the economy, particularly the interest differentials. Even as the external environment
remained conducive to the nation’s growth, the problems of managing a more open capital account
came to the fore, in terms of the economy approaching the limits of its absorptive capacity, with the
pace of adjustment becoming somewhat difficult in the short run. On the other side, the nation’s rapid
growth, in conjunction with the other major emerging market economies, helped to keep the global
growth momentum strong.

The growing influence of global developments on the Indian economy was manifested in the surge in capital inflows in
2007–08, a phenomenon observed earlier in the other emerging market economies.
Growth in the world trade volume of goods and services (G&S) decelerated from 9.2 per cent in
2006 to 6.6 per cent in 2007, and is projected to remain around the same levels in 2008 (refer to Table
10.1). The world trade prices, in contrast, were projected to rise sharply for manufactures, but likely
to moderate for oil and other commodities. However, with a sharp rise in oil prices of late, the
growth in value terms may remain high. With broad-based growth and relative stability, the pace of
net private capital flows to emerging market economies and developing countries accelerated with a
growth of 124 per cent in 2007, which posed adjustment problems in these economies.

Growth in the world trade volume of goods and services (G&S) decelerated from 9.2 per cent in 2006 to 6.6 per cent in
2007.
ASSESSMENT OF THE NEW TRADE POLICY

The New Trade Policy (NTP), 1991 aimed to cut down administrative controls and barriers, which act
as obstacles to the free flow of exports and imports. The basic instrument developed by the policy is
the exim scrip in place of REP licences. The purpose of this instrument is to permit imports to the
extent of 30 per cent on 100 per cent realisation of export proceeds. Obviously, the purpose is to
bridge the BoP gap. The trade policy has streamlined various procedures for the grant of advance
licences, as also permit imports, through exim scrips routes.

The New Trade Policy (NTP), 1991 aimed to cut down administrative controls and barriers, which act as obstacles to the
free flow of exports and imports.
Moreover, during 1988–89, out of the total imports of the order of Rs 34,202 crore, the imports
into government account were Rs 16,775 crore, that is, 49 per cent of the total. These canalised
imports would not be affected by the exim scrips instrument. Thus, the exim scrips would only affect
half of the imports. This may be the probable reason for the Commerce Minister to undertake
decanalisation of imports, so that the amenable area of the NTP could be enlarged.
Since the time of Mudaliar Committee in 1962, the country has been fed with the slogan of export
promotion through import entitlement. Various instruments have been forged, thereafter, but a long-
term view only underlines the fact that the country had failed to check the faster growth of imports
than that of exports during the last three decades. Under one pretext or another, the import window
was opened much wider, and this has continued. There is a strong need to exercise extreme caution in
liberalising imports, more so, inessential imports.

There is a strong need to exercise extreme caution in liberalising imports, more so, inessential imports.
To conclude, India’s trade policy since independence has been used as part of general economic
policy to develop the country and to diversify the economy. Initially, it took the form of restricting the
imports and boosting the exports. It also took the form of organising international trade and bilateral
and multilateral trade agreements. In the later years, trade policy has taken the form of export
promotion through import liberalisation. Formulated by bureaucrats under the influence and
guidance of Indian business houses and multinational giants, India’s trade policy did have an
important influence on the rapid development of the country, but it is basically responsible for
leading the country into the classical debt trap.

Formulated by bureaucrats under the influence and guidance of Indian business houses and multinational giants, India’s
trade policy did have an important influence on the rapid development of the country, but it is basically responsible for
leading the country into the classical debt trap.
BALANCE OF PAYMENTS (BOPS)
The BoP of India is classified into (a) BoP on current account and (b) BoP on capital account. The
current account of the BoP of India includes the following three items: (a) visible trade relating to
imports and exports, (b) invisible items, viz., receipts and payments for such services as shipping,
banking, insurance, travel, and so on, and (c) unilateral transfer such as donations. The current
account shows whether India has a favourable balance or deficit BoP in any given year. The BoP on
capital account shows the implications of current transactions for the country’s international financial
position. For instance, the surplus and the deficit of the current account are reflected in the capital
account, through changes in the FERs of country, which are an index of the current strength or
weakness of a country’s international payments position.

The BoP of India is classified into (a) BoP on current account and (b) BoP on capital account.
The strength, resilience, and stability of the country’s external sector are reflected by various
indicators, which include a steady accretion to reserves, moderate levels of current account deficit
(CAD), changing composition of capital inflows, flexibility in exchange rates, sustainable external
debt levels with elongated maturity profile, and an increase in the capital inflows. The current account
has followed an inverted “U” shaped pattern during the period from 2001–02 to 2006–07, rising to a
surplus of over 2 per cent of GDP (gross domestic product) in 2003–04. Thereafter, it has returned
close to its post-1990s reform average, with a CAD of 1.2 per cent in 2005–06 and 1.1 per cent of
GDP in 2006–07.

The current account has followed an inverted “U” shaped pattern during the period from 2001–02 to 2006–07.
The capital inflows, as a proportion of GDP, have been on a clear uptrend during the six years
(from 2001–02 to 2006–07) of this decade. They reached a high of 5.1 per cent of GDP in 2006–07,
after a somewhat modest growth rate of 3.1 per cent in 2005–06. The net result of these two trends has
been a gradual rise in reserve increase to reach 4 per cent of GDP in 2006–07 (refer to Figure 10.1).
With capital inflows exceeding financing requirements, FER increase was of the order of US$15.1 bn
in 2005–06 and US$36.6 bn in 2006–07 (refer to Table 10.2). As a proportion of GDP, the external
debt was 17.2 per cent, in 2005–06, and 17.9 per cent 2006–07, respectively.

Fig ure 10.1 Current a/c Balance, Total Capital a/c, and Reserve Change

Fig ure 10.2 Trade Balance, G&S Balance, and Non-factor Services (net)

The current account, after being in surplus during the period from 2001–02 to 2003–04, reverted to
a deficit in 2004–05. This was despite a robust growth in net invisible account fuelled by software
exports and private transfers. The CAD is attributable to the widening trade deficit, driven primarily
by the rise in the international prices of petroleum products and gold. Thus, large merchandise trade
deficit coexists with a lower deficit on the G&S, because of the surplus on non-factor services. Even
in the years when there were some surpluses on the current account, India had deficit on G&S account
and a relatively larger trade deficit too (refer to Figure 10.2).

Even in the years when there were some surpluses on the current account, India had deficit on G&S account and a
relatively larger trade deficit too.
The rising trend in capital inflows has been accompanied by a change in its composition. The most
welcome feature was the rise in gross foreign direct investment (FDI) inflows of US$23.0 bn in 2006–
07. With FDI outflows also increasing steadily over the last five years, the overall net flows have
moderated. The portfolio investment in the first half of 2006–07 was lower in comparison, because of
the initial slump in equity markets. Debt flows, primarily, external commercial borrowings (ECBs),
shot up from a level of 0.7 per cent of GDP in 1990–91 to 1.8 per cent in 2006–07. Thus, the rupee
faced upward pressure in the second half of 2006–07; but on an overall yearly average basis, it
depreciated by 2.2 per cent.

The rupee faced upward pressure in the second half of 2006–07; but on an overall yearly average basis, it depreciated by
2.2 per cent.
CURRENT ACCOUNT DEFICIT (CAD)
CAD mirrors the saving–investment gap in the national income accounts and, thus, constitutes foreign
savings. The challenge before the emerging market economies is to leverage foreign savings, and to
promote domestic growth without having the long-term consequences of external payment
imbalances. However, CADs, per se, need not necessarily enhance the productive capacity and, thus,
overall the GDP growth. This would depend on the underlying component factors that are leading to
the CAD. The distinction between gross capital inflow and net inflow is useful. As the latter must
equal the CAD, there is no way in which the net use of foreign savings can increase without an
increase in the CAD. The gross inflow can, however, increase to the extent, that it is offset by a gross
outflow in the form of build-up of FERs, a reduction in government external debt, or by an outward
investment, by entrepreneurs. Higher gross inflows have value even if the net flows do not increase to
the same extent, as they can improve the competition in the financial sector, the quality of
intermediation, and the average productivity of investment, and, thus, raise the growth rate of the
economy. The challenge before the government is to maximise these benefits while minimising the
costs of exchange-rate management.

The challenge before the emerging market economies is to leverage foreign savings, and to promote domestic growth
without having the long-term consequences of external payment imbalances.
Figure 10.3 shows that the rise and fall of the current account balance, during the period from
2000–01 to 2006–07, has been driven largely by the G&S balance, with the two having, virtually, the
same pattern as a proportion of GDP. The surplus from factor income including remittances, which
fluctuated between 2 per cent and 3 per cent of GDP has helped to moderate the substantial deficit on
the trade account. Both the trade (G&S) balance and the factor surplus had improved between 2000–01
and 2003–04, leading to an improvement of the current account, and both reversed direction,
thereafter, resulting in a declining trend in the current account. In the past two years, the CAD, trade
(G&S) deficit, and factor surplus have averaged 1.2, 3.5, and 2.0 per cent of GDP, respectively (refer
to Table 10.3).

Table 10.2 Balance of Payments: Summary
PR: Partially Revised; P: Preliminary; R: Revised.
a Figures include receipts on account of India Millennium Deposits in 2000–01 and related repayments, if any, in the subsequent years.
b Include, among others, delayed export receipts and errors and omissions.

The trends in the G&S trade deficit have, in turn, been largely driven by the merchandise trade
deficit since 2004–05. Between 2000–01 and 2003–04, the merchandise trade deficit was around 2 per
cent of GDP, and the rising non-factor services surplus resulted in an improving trend in the overall
trade balance (refer to Figure 10.3). From 2004–05, the merchandise trade balance has been
deteriorating and despite the continual rise in the non-factor services surplus, the overall G&S
balance has followed the deteriorating trend of the former (refer to Figure 10.3).

From 2004–05, the merchandise trade balance has been deteriorating and despite the continual rise in the non-factor
services surplus, the overall G&S balance has followed the deteriorating trend of the former.
Widening of merchandise trade was a way in which foreign savings could be absorbed, and growth
in exports and imports was a key component of the growth process. As a proportion of GDP, on BoP
basis, the exports rose from a level of 5.8 per cent in 1990–91 to reach a level of 14.0 per cent in
2006–07 (refer to Table 10.3). The average annual growth rate in the last five years has been placed at
a high of 23.5 per cent. However, the imports have grown even faster in the last five years at an annual
average of 28.2 per cent. As a proportion of GDP, on BoP basis, the imports in 2006–07 were placed
at 20.9 per cent of GDP. Thus, trade deficit widened to 6.9 per cent of GDP in 2006–07. The higher
trade deficit could be attributed to a rise in POL, as well as non-POL components in imports. A
continued uptrend in prices in the international markets and a rise in the price of gold were the major
contributors to this process.
Of the seven major components of non-factor services in the invisible account of the BoP, six
components—travel, transportation, insurance, financial services, communication services, and
business services—contributed on a net basis; only 9 per cent of the surplus on account of services
trade in 2006–07. Thus, the seventh component, viz., software services, comprising information
technology (IT) and IT-enabled services (ITES), was the main driver of the surpluses generated from
the non-factor services.

The seventh component, viz., software services, comprising information technology (IT) and IT-enabled services (ITES), was
the main driver of the surpluses generated from the non-factor services.
The net surplus from travel grew modestly in 2006–07. Travel receipts grew by 22.1 per cent on an
annual average basis for the last three years, reflecting in part, the attractiveness of India as a tourist
destination; travel payments were also catching up with the corresponding average annual growth at
24.3 per cent. The transportation payments exceeded receipts, resulting in a modest deficit. The
classification in BoP accounting system of software, business, financial, and communication under
the head “miscellaneous” allude to the recent nature of their importance. The growth in software
services receipts (both IT and ITES) was phenomenal at an annual average of 32.9 per cent in the last
five years. As per the revised data of the RBI, the growth in business services on a net basis, as made
available by RBI, was higher at 39.4 per cent in 2006–07; the other services, albeit posting lower
growth rates, have nevertheless helped to catalyse the growth process through appropriate technology
transfer from the rest of the world. Thus, higher levels of surplus arising from services helped to
moderate the overall G&S balance. As a proportion of GDP, G&S deficit was placed at 3.4 per cent of
GDP in 2006–07, which was lower than the level of 3.6 per cent of GDP in 2005–06.

Higher levels of surplus arising from services helped to moderate the overall G&S balance.
The private transfers continued its traditional role of being a major source for the invisible account
surplus, with an annual average growth at 13.5 per cent in the Five-Year period from 2002–03 to
2006–07. According to a report published by the World Bank, containing estimates of cross-country
data on migration and remittances, India topped the list of countries that received remittances.
Investment income (net), which reflects the servicing costs on the payment side and return on foreign
currency assets (FCA) on the receipt side, has remained negative over the years, indicating a higher
interest outgo. Investment income (net) was placed at US$(−)3.5 bn in 2002–03. With the rapid
building up of FCA, the credit side of investment income also grew as rapidly as the debit side. Given
the latter ’s higher base, the net investment income deteriorated to US$(−)6 bn in 2006–07.

According to a report published by the World Bank, containing estimates of cross-country data on migration and
remittances, India topped the list of countries that received remittances.

Fig ure 10.3 Current a/c Balance, G&S Balance, and Factor Balance

Table 10.3 Selected Indicators of External Sector
Source:RBI
Notes:
i. TC: Total capital flows (net).
ii. ECB: External commercial borrowing.
iii. FER: Foreign exchange reserves, including gold, SDRS, and IMF reserve tranche.
iv. GDPmp: Gross domestic product at current market prices.
v. As total capital flows are netted after taking into account some capital outflows. The ratios against item numbers 5, 6, and 7 may, in some years, add up to more
than 100 per cent.
vi. Rupee equivalents of BoP components are used to arrive at GDP ratios. All other percentages shown in the upper panel of the table are based on US$ values.

The current receipts in 2006–07 amounted to US$243.2 bn and the current payments were placed at
US$252.9 bn. The current receipts covered 96.1 per cent of the current payments in 2006–07.
Consequently, CAD was placed at US$9.8 bn in 2006–07 (US$9.9 bn in 2005–06).
The nature of the CAD is indicated by the contribution of the oil trade deficit and non-oil trade
deficit in conjunction with the surpluses on factor and non-factor services (refer to Table 10.4).
Based on the sharp upward movements in the exchange rates and FERs, there is a general
apprehension about the developments on the BoP front and their consequences in terms of
competitive losses and, thereby, on the growth prospects of exports. The BoP data for the first half of
the current financial year shows some deceleration in the growth in exports, from a level of 24.8 per
cent in 2006–07 (April–September) to 19.9 per cent in 2007–08 (April–September). Simultaneously,
the growth in imports in the first half of 2007–08 fell to 21.9 per cent from 24.7 per cent in 2006–07
(April–September). Based on BoP, the merchandise trade deficit rose to US$42.4 bn in 2007–08
(April–September), equivalent to 8.1 per cent of GDP from a level of US$33.8 bn in 2006–07 (April–
September), equivalent to 8.3 per cent of GDP. In the same reference period, a deceleration in the
software services exports to 15.2 per cent from 37.2 per cent led to a lower growth in the net invisible
surplus (17.5 per cent from 35.2 per cent). The receipts from business services actually declined from
US$8 bn in 2006–07 (April–September) to US$6.4 bn in 2007–08 (April–September) and, with
payments rising marginally, there was a decline of 91 per cent in 2007–08 in the net receipts. Thus, as
a proportion of GDP, G&S deficit rose to 5.3 per cent in 2007–08 (April–September) from a level of
4.7 per cent in 2006–07 (April–September).

As a proportion of GDP, G&S deficit rose to 5.3 per cent in 2007–08 (April–September) from a level of 4.7 per cent in
2006–07 (April–September).

Table 10.4 Decomposition of Current Account Deficit
Source: compiled from RBI (BoP data) and the Directorate General of Commerical Intelligence and Staistics (DGCI&S) trade data.
a Due to trade data divergence between BoP basis and DGCI&s, the totals may not add up.

The private transfers receipts (mainly remittances) shot up, year-on-year, by 49.2 per cent as
against 19.2 per cent in the corresponding period of the previous year. The investment income (net)
grew by 60.0 per cent in 2007–08 (April–September), reflecting the burgeoning FERs. Net invisible
surplus grew by 35.2 per cent to reach US$31.7 bn in 2007–08 (April–September), equivalent of 6.1
per cent of GDP. Thus, higher invisible surplus was able to moderate somewhat the rising deficits on
trade account, and CAD was placed at US$10.7 bn in 2007–08 (April–September), equivalent of 2.0
per cent of GDP.

Higher invisible surplus was able to moderate somewhat the rising deficits on trade account, and CAD was placed at
US$10.7 bn in 2007–08 (April–September), equivalent of 2.0 per cent of GDP.
CAPITAL ACCOUNT DEFICIT
Capital inflows can be classified by instrument (debt or equity), duration (short term or long term),
and nature (stable or volatile) of flows. Such taxonomy helps to calibrate the policy of liberalisation
of the capital account. Figure 10.4 shows that foreign investment (net) has been a relatively stable
component of total capital flows, fluctuating broadly between 1 per cent and 2 per cent of GDP,
during this decade. However, it seems to have shifted to a higher plane from 2003–04 with an average
for the period from 2003–04 to 2006–07, roughly double than that was found between 2000–01 and
2002–03. In contrast, the debt flows have fluctuated much more, with a down trend till 2003, which
resulted in net outflows in the three years to 2003–04, and a rising trend from 2004–05. The trend in
net capital flows since 2003–04, therefore, seems to be broadly driven by the rising ratio of debt
flows (refer to Figure 10.4). The variations in debt flows have been, primarily, due to lumpy
repayments on government-guaranteed or government-related ECB.

The trend in net capital flows since 2003–04, therefore, seems to be broadly driven by the rising ratio of debt flows
Net capital flows rose from a level of US$25.0 bn in 2005–06 to reach US$46.4 bn in 2006–07,
which implies a growth of 85.8 per cent. The major developments in 2006–07 include (i) a quantum
jump in ECBs (net), (ii) a significant rise in FDI inflows with a simultaneous rise in outward
investment, (iii) large inflows in the form of non-resident Indian (NRI) deposits, and (iv) an initial
fall in portfolio investment, which was somewhat compensated by a recovery in the latter half of the
year. The World Economic Outlook (WEO) reported that many emerging markets and developing
countries similarly experienced historically high levels of NFE inflows. The acceleration in gross
flows was sharper than the net flows. The net private capital flows to emerging market economies and
developing countries, after falling by 18.5 per cent in 2006, have risen again by 124.3 per cent to
reach US$495.4 bn in 2007. Thus, the net capital flows into India have been substantial in the current
financial year.

Fig ure 10.4 Total Capital a/c (net), Foreign Investment (net), and Debt Flows
ecb: External commercial borrowing; ea: External assistance; std: Short-term debt.

OTHER NON-DEBT FLOWS
In the BoP system of accounts of the RBI, the head “Other Capital” covers mainly the leads and lags in
export receipts (the difference between the custom data and the banking-channel data), funds held
abroad, and the residual item of other capital transactions not included elsewhere, such as flows
arising from cross-border financial derivative and commodity hedging transactions, migrant
transfers, and sale of intangible assets, such as patents, copyrights, trademarks, and so on. In 2006–07,
Other Capital (net), including banking capital, amounted to US$8.8 bn. Payments transaction like
short-term credits, which were earlier not captured explicitly elsewhere, were accounted under this
residual head, implicitly. In its Press Release dated December 29, 2007, reporting the BoP
developments for the second quarter, the RBI had, among other things, indicated some accounting
changes in this head (refer to Box 10.1).

In its Press Release dated December 29, 2007, reporting the BoP developments for the second quarter, the RBI had, among
other things, indicated some accounting changes in this head.
Box 10.1 Changes in the BoP System of Recording
The RBI, in conformity with the best international practices and as per the provisions of Balance
of Payments Manual 5 (BPM5) of the IMF, made certain changes in the system of recording BoP
flows. In the earlier system of recording of international transactions between residents and non-
residents, trade credits or credits for financing imports by Indian residents, extended by foreign
suppliers up to 180 days, were not covered explicitly, and were subsumed under the head “Other
Capital” or errors and omissions. However, such credit beyond 180 days was recorded and
reported. Usually, a very short-term credit, less than 180 days, get rolled over within a year and,
as such, they are recorded on a net basis only. However, using the internationally accepted
methodology as recommended in BPM5, the RBI started recording these transactions for both
BoP and external debt purposes. While in the case of BoP, where there was no change in the
overall balance as other capital and errors and omissions were lower to the extent that short-term
credits were higher, the total stock of outstanding external debt went up (details in the subsequent
section on external debt). Transactions by non-resident Indians (NRIs) in the non-resident
ordinary (NRO) account were earlier included under other capital in the capital account. The RBI
has, put in place, a reporting system and records these data separately. As such, transactions under
the NRO account have now been included under NRI deposits. Besides all these, the RBI, taking
cognisance of the importance of the services in the invisible account and the possibility of some
overlap between business services and software services of the ITES variety, had reviewed the
data that were reported by authorised dealers, revised the data that were produced by the business
services, and started providing greater details of the non-software services.
As per the RBI’s revised data on the other capital, leads and lags in export payments, which were
negative in 2005–06 and less than US$1 bn in 2006–07, shot up in April–September 2007 and
reached US$3.7 bn. In 2007–08, the advance that was received for effecting FDI (pending with
authorised dealers) amounted to US$2 bn. With other residual capital, of the order of US$2.1 bn,
the total net flows under other capital head was of the order of US$6 bn.

KEY WORDS
Annual Growth Rate

Primary Sector
Secondary Sector
Tertiary Sector
Public Sector
Organised Enterprises
Unorganised Enterprises
Trade Policy
Balance of Payments (BoPs)
Money Market
Call Money Market
Financial System
Indian Banking System
Wholesale Price Index (WPI)
QUESTIONS
1. What do you mean by trade policy? Explain the main features of India’s trade policy.
2. Explain India’s trade policy since independence.
3. What are the major trade reforms of India’s foreign trade policy, 1991?
4. Critically analyse the India’s NTP.
5. What do you mean by Balance of Payments, and how does it occur?
6. How is the deficit or surplus in BoP known?
7. Analyse the latest BoP position of India.
8. Suggest the measures to overcome the huge deficit in India’s BoPs.
a. urrent account deficit (CAD)
b. Capital account deficit
c. Causes of deficit BoP
d. Latest Trade Policy of India
e. Economic reforms and BoP
REFERENCES
Budget Document, Government of India.

Government of India. Economic Survey 2007–08. New Delhi: Ministry of Finance.
Mathur, B. L. (2001). Economic Policy and Performance. New Delhi: Discovery.
Nagarjuna, B. (2004). Economic Reform and Perspectives: Recent Developments in Indian Economy. New Delhi: Serials.
Reddy, K. C. (2004). Indian Economic Reforms: An Assessment. New Delhi: Sterling Pub.
Singh, R. K. (2004). Economic Reforms in India. Delhi: Abhi-jeet Pub.
CHAPTER 11
Poverty in India
CHAPTER OUTLINE
Concept, Meaning, and Definition of Poverty
People Living Under Poverty Line
Causes of Poverty in India
Historical Trends in Poverty Statistics
Poverty and Inclusive Growth
Factors Responsible for Poverty
Measures to Reduce Poverty
Poverty Alleviation Through Micro-credit
Outlook for Poverty Alleviation
Controversy over the Extent of Poverty Reduction
Case
Key Words
Questions
References
CONCEPT, MEANING, AND DEFINITION OF POVERTY
Poverty is a social phenomenon in which a section of the society is unable to fulfil even the basic
necessities of life. When a substantial segment of a society is deprived of the minimum level of living
and continues at a bare subsistence level, the society is said to be plagued with mass poverty. The
countries of the Third World invariably exhibit the existence of mass poverty, although pockets of
poverty exist even in the developed countries of Europe and America. The deprivation of minimum
basic needs of a significant section of the society, in the face of luxurious lives for the elite classes,
makes poverty more glaring.

Poverty is a social phenomenon in which a section of the society is unable to fulfil even the basic necessities of life. When a
substantial segment of a society is deprived of the minimum level of living and continues at a bare subsistence level, the
society is said to be plagued with mass poverty.
Two types of standards are common in economic literature: the absolute and the relative. In the
absolute standard, minimum physical quantities of cereals, pulses, milk, butter, and so on are
determined for a subsistence level and, then, the price quotations convert the physical quantities into
monetary terms. The aggregation of all the quantities included determines the per capita consumer
expenditure. The population, whose level of income (or expenditure) is below the figure, is
considered to be below the poverty line (PL). According to the relative standard, income distribution
of the population in different fractile groups is estimated, and a comparison of the “levels of living”
of the top 5 per cent to 10 per cent with the bottom 5 per cent to 10 per cent of the population, reflects
the relative standards of poverty. The defect of this approach is that it indicates the relative position of
different segments of the population in the income hierarchy.
The world is in a race between economic growth and population growth, and, so far, population
growth is wining. Even as the percentages of people living in poverty are falling, the absolute number
is rising. The World Bank defines “poverty” as living on less than $2 a day, and “absolute or extreme
poverty” as living on less than $1 a day.

Even as the percentages of people living in poverty are falling, the absolute number is rising. The World Bank defines
“poverty” as living on less than $2 a day, and “absolute or extreme poverty” as living on less than $1 a day.
In India, the subject of “defining poverty” was first posed at the Indian Labour Conference in 1957.
The “Working Group” of the Planning Commission recommended Rs 25 per person per month, for
urban and Rs 18 per person per month, for rural areas, at 1960–61 prices as the minimum expenditure
for providing the minimum nutritional diet of calories (2,100, for urban and 2,400, for rural per
person per day) intake, as well as to allow for a modest expenditure on items other than food (barring
health and education, which were expected to be provided by the government). This became the cut-
off amount and accordingly, people having expenditure below this were bracketed as being “below
the poverty line”. These figures have since been revised from time to time. While there are other
estimates as well, the estimates of the Planning Commission are as follows:

Table 11.1
(Rs/Month/Person)
Poverty line
At price level of
Urban Rural
1973–74 56.64 49.09
1976–77 71.30 61.80
1977–78 75.00 65.00
1987–88 152.13 131.80
1993–94 264.00 229.00
Source: Planning Commission documents.

Thus, the urban people whose expenditure fall below Rs 264 per person per month at the 1993–94
price level belong to the group of the people below PL. Others whose expenditure exceeded this
amount are above the line.
PEOPLE LIVING UNDER POVERTY LINE
Although the middle class has gained from the recent positive economic developments, India suffers
from a substantial poverty. The Planning Commission has estimated that 27.5 per cent of the
population was living below the PL in 2004–2005, down from 51.3 per cent in 1977–1978 and 36 per
cent in 1993–1994 (refer to Figure 11.1). The source for this was the 61st round of the National
Sample Survey Organisation (NSSO), and the criterion used was the monthly per capita consumption
expenditure, below Rs 356.35 for rural areas and Rs 538.60 for urban areas. Around 75 per cent of the
poor are in rural areas, most of them are daily wagers, self-employed householders, and landless
labourers. Although the Indian economy has grown steadily over the last two decades, its growth has
been uneven when compared with different social groups, economic groups, geographic regions, and
rural and urban areas.

Although the middle class has gained from the recent positive economic developments, India suffers from a substantial
poverty.

Fig ure 11.1 Percentage of Population Below Poverty Line

The wealth distribution in India is fairly uneven, with the top 10 per cent of income groups earning
nearly 33 per cent of the income. Despite a significant economic progress, one-fourth of the nation’s
population earns less than the government-specified poverty threshold of $0.40 per day. The official
figures estimate that 27.5 per cent of Indians lived below the national PL in 2004–2005. A 2007 report
by the State-run National Commission for Enterprises in the Unorganised Sector (NCEUS) found that
25 per cent of Indians, or 236 million people, lived on less than Rs 20 per day with most working in
“informal labour sector with no job or social security, living in abject poverty”. The income
inequality in India is increasing. In addition, India has a higher rate of malnutrition among children
under the age of three (46 per cent in year 2007) than any other country in the world.

The wealth distribution in India is fairly uneven, with the top 10 per cent of income groups earning nearly 33 per cent of the
income. Despite a significant economic progress, one-fourth of the nation’s population earns less than the government-
specified poverty threshold of $0.40 per day.
CAUSES OF POVERTY IN INDIA
There are at least two main schools of thought regarding the causes of poverty in India. They are as
follows:
The Developmentalist View
Colonial Economic Restructuring

Pandit Nehru noted, “A significant fact which stands out is that those parts of India which have been
longest under British rule are the poorest today”. The Indian economy was purposely and severely
deindustrialised (especially in the areas of textiles and metal-working) through colonial
privatisations, regulations, tariffs on manufactured or refined Indian goods, taxes, and direct seizures.
In 1830, India accounted for 17.6 per cent of global industrial production against Britain’s 9.5 per
cent, but by 1900 India’s share was down to 1.7 per cent against Britain’s 18.5 per cent. (The change in
industrial production per capita is even more extreme due to Indian population growth). Not only was
Indian industry losing out, but also consumers who were forced to rely on expensive, (open
monopoly produced), British-manufactured goods, especially as barter, local crafts, and subsistence
agriculture was discouraged by law. The agricultural raw materials exported by Indians were subject
to massive price swings and declining terms of trade.
Mass Hunger: British policies in India exacerbated the weather conditions to lead to mass famines
which, when taken together, led to a range of 30 million to 60 million deaths from starvation, in the
Indian colonies. Community grain banks were forcibly disabled, use of land for foodcrops for local
consumption was converted into cotton, opium, tea, and grain for export, largely for animal feed. In
summary, deindustrialisation, declining terms of trade, and the periodic mass misery of man-made
famines are the major ways in which the colonial government destroyed development in India and
held it back for centuries.

In summary, deindustrialisation, declining terms of trade, and the periodic mass misery of man-made famines are the major
ways in which the colonial government destroyed development in India and held it back for centuries.
The Neoliberal View

1. Unemployment and underemployment, arising in part from protectionist policies and pursued till 1991, prevented high foreign
investment. Poverty also decreased from the early 1980s to 1990s significantly. However, there are some legal and economic
factors like
Lack of property rights: The right to property is not a fundamental right in India.
Over-reliance on agriculture: There is a surplus of labour in agriculture. Farmers are a large vote bank and they use
their votes to resist reallocation of land for higher-income industrial projects. While services and industry have grown at
double-digit figures, the agriculture growth rate has dropped from 4.8 per cent to 2 per cent. Neoliberals tend to view
food security as an unnecessary goal when compared to purely financial, economic growth.
2. There are also varieties of more direct technical factors like
About 60 per cent of the population depends on agriculture whereas the contribution of agriculture to the gross
domestic product (GDP) is about 28 per cent only.
High population growth rate, though demographers generally agree that this is just a symptom rather than a cause of
poverty.
3. And a few cultural ones have been proposed like
The caste system, under which hundreds of millions of Indians were kept away from educational, ownership, and
employment opportunities, and subjected to violence for “getting out of line”. The British rulers encouraged caste
privileges and customs even before the 19 th century.
Despite this, India currently adds 40 million people to its middle class every year. Analysts such as the
founder of “Forecasting International”, Marvin J. Cetron writes that an estimated 300 million Indians
now belong to the middle class; one-third of them have emerged from poverty in the last 10 years. At
the current rate of growth, a majority of Indians will be included in middle-class by 2025. Literacy
rates have risen from 52 per cent to 65 per cent in the same period.

Cetron writes that an estimated 300 million Indians now belong to the middle class; one-third of them have emerged from
poverty in the last 10 years.
HISTORICAL TRENDS IN POVERTY STATISTICS
The proportion of India’s population below the PL has fluctuated widely in the past, but the overall
trend has been downward. However, there have been roughly three periods of trends in income
poverty.
1950 to mid-1970s: Income poverty reduction shows no discernible trend. In 1951, 47 per cent of India’s rural population was
below the PL. Although the proportion went up to 64 per cent in 1954–55 it came down to 45 per cent in 1960–61, but in 1977–
78 it went up again to 51 per cent.
Mid-1970s to 1990: Income poverty declined significantly between the mid-1970s and the end of the 1980s. The decline was
more pronounced between 1977–78 and 1986–87, with rural income poverty declining from 51 per cent to 39 per cent. It went
down further to 34 per cent by 1989–90. The urban income poverty went down from 41 per cent in 1977–78 to 34 per cent in
1986–87, and further to 33 per cent in 1989–90.
After 1991: This post-economic reform period evidenced both setbacks and progress. The rural income poverty increased from
34 per cent in 1989–90 to 43 per cent in 1992 and then fell to 37 per cent in 1993–94. The urban income poverty went up from
33.4 per cent in 1989–90 to 33.7 per cent in 1992 and declined to 32 per cent in 1993–94. Also, NSS data for the period from
1994–95 to 1998 show little or no poverty reduction, so that the evidence till 1999–2000 was that poverty, particularly rural
poverty, had increased post-reform. However, the official estimate of poverty for 1999–2000 was 26.1 per cent, a dramatic
decline that led to much debate and analysis. This was because, for this year, the NSS had adopted a new survey methodology
that led to both higher-estimated mean consumption and also an estimated distribution that was more equal than in the past NSS
surveys. The latest NSS survey for 2004–05 is fully comparable to the surveys before 1999–2000 and shows poverty at 28.3
per cent in rural areas, 25.7 per cent in urban areas, and 27.5 per cent for the country as a whole, using uniform recall period
(URP) consumption. The corresponding figures using the mixed recall period (MRP) consumption method was 21.8 per cent,
21.7 per cent, and 21.8 per cent, respectively. Thus, poverty has declined after 1998, though it is still being debated whether
there was any significant poverty reduction between 1989–90 and 1999–2000. The latest NSS survey was so designed as to
also give estimates roughly, but not fully, comparable to the 1999–2000 survey. These measures suggest that most of the
decline in rural poverty over the period between 1993–94 and 2004–05 actually occurred after 1999–2000.
Poverty has declined after 1998, though it is still being debated whether there was any significant poverty reduction
between 1989–90 and 1999–2000.
The proportion of India’s population below the PL has fluctuated widely in the past, but the overall trend has been
downward.
POVERTY AND INCLUSIVE GROWTH
“Incidence of Poverty” is estimated by the Planning Commission on the basis of quinquennial “large
sample” surveys on household consumer expenditure conducted by the NSSO. The URP consumption
distribution data of NSS 61st Round yields a poverty ratio of 28.3 per cent in rural areas, 25.7 per cent
in urban areas, and 27.5 per cent for the country as a whole in 2004–05. The corresponding poverty
ratios from the MRP consumption distribution data are 21.8 per cent for rural areas, 21.7 per cent for
urban areas, and 21.8 per cent for the country as a whole. While the former consumption data uses a
30-day recall/reference period for all items of consumption, the latter uses a 365-day recall/reference
period for five infrequently purchased non-food items, viz., clothing, footwear, durable goods,
education, and institutional medical expenses, and a 30-day recall/reference period for the remaining
items. The percentage of poor in 2004–05, estimated from the URP consumption distribution of NSS
61st Round of consumer expenditure data, are comparable with the poverty estimates of 1993–94 (50th
round), which was 36 per cent for the country as a whole. The percentage of poor in 2004–05,
estimated from the MRP consumption distribution of NSS 61st Round of consumer expenditure data,
are roughly comparable with the poverty estimates of 1999–2000 (55th round), which was 26.1 per
cent for the country as a whole. In summary the official poverty rates recorded by NSS are given in
Table 11.2.

The percentage of poor in 2004–05, estimated from the MRP consumption distribution of NSS 61 st Round of consumer
expenditure data, are roughly comparable with the poverty estimates of 1999–2000 (55 th round), which was 26.1 per cent
for the country as a whole.
Consumption Patterns Below and Above PL

There are concerns about the vulnerability of people who have crossed the PL and are at present
above it. Vulnerability is a relative term and could be gauged from the consumption patterns (refer to
Table 11.3) (in the absence of a better available alternative). Given meagre resources, the higher share
of expenditure on food items, which is the most basic of all basic needs, would be indicative of
vulnerability to some extent. The average per capita consumption expenditure for rural and urban
population as per 61st Round (2004–05) is Rs 558.78 and Rs 1,052.36, respectively. NSSO data also
reveals that the rural population on an average spends about 55 per cent of its consumption on food
and remaining 45 per cent on non-food items (Table 11.4). The rural population divided on the basis
of their monthly per capita expenditures (MPCEs) exhibit consumption patterns as follows:
Rural poor (below PL) are spending about 31 per cent to 35 per cent of their total consumption expenditure on non-food items
and remaining on food items.
In the group of population between PL and 1.5PL, non-food items take up between 36 per cent and 40 per cent of the total
consumption expenditure.
For rural population between PL and 2PL, non-food items take up between 36 per cent and 46 per cent of the total consumption
expenditure.
The average per capita consumption expenditure for rural and urban population as per 61 st Round (2004–05) is Rs 558.78
and Rs 1,052.36, respectively.

Table 11.2

Table 11.3 Poverty Ratios by URP and MRP (%)
Source: Planning Commission

Table 11.4 Consumption Pattern Across Different MPCE Classes of Population, Rural (%)
MPCE classes of population—rural Food (55.05) Non-Food (44.95)

Poor (roug hly below PL)
0–235 68.45 31.55
235–270 67.16 32.84
270–320 66.35 33.65
320–365 a 64.78 35.22
Roug hly between PL and 2PL

365–410 63.99 36.01
410–455 62.93 37.06
455–510 61.61 38.39
510–580 b 60.11 39.88
580–690 58.02 41.98
690–890 c 53.92 46.08
Roug hly above 2 PL

890–1155 49.80 50.20
Source: NSSO: Estimated from Table 5R of NSS Report No. 508: Level and Pattern of Consumer Expenditure, 2004–05.
Notes:
a MPCE class having PL at Rs 356.30.
b MPCE class having 1.5 times the PL (1.5PL) at Rs 534.45.
c MPCE class having twice the PL (2PL) at Rs 712.60.

A similar classification of urban population indicates a consumption pattern as in Table 11.5. While
about 43 per cent of the total consumption on an average is spent on food items and the remaining 57
per cent is spent on the non-food items, the urban poor (below PL) are spending. About 35 per cent to
43 per cent of their total consumption expenditure on non-food items.
In the group of population between PL and 1.5 PL, non-food items take up between 45 per cent and 50 per cent of the total
consumption expenditure.
However, in the group of population between PL, and 2 PL, non-food items take up between 45 per cent and 53 per cent of the
total consumption expenditure.
It is noticeable that on expected lines, the average consumption pattern of urban population, in general, is more skewed in favour
of non-food items.
Trends in Consumption Growth (Rural–Urban Disparity)
The compound annual growth rate (CAGR) of consumption for the rural as well as urban population
for different percentile groups of population over the period between 1993–94 and 2004–05 based on
NSSO data, on monthly per capita consumption for various rounds at constant prices (Table 11.6)
indicate the following:
While, on an average, the growth in consumption expenditures over this period may not appear too different for rural (CAGR—
1.16 per cent) and urban (CAGR—1.35 per cent) population, the differences are noticeable if different MPCE-based percentile
groups of population are taken into consideration.
For all percentile groups, except top 10 per cent in rural population between 1993–94 and 2004–05, CAGR has been around 1
per cent.
At the same time, the CAGR of the upper 50 percentile group in the urban population is consistently
above 1 per cent and higher when compared with those of the lower 50 percentile urban population. It
is also noticeable that while in urban population, a CAGR of more than 1 per cent is for the entire
upper 50 percentile, only the uppermost 10 percentile group is registering a CAGR of consumption
(MPCE) above 1 per cent for rural population (refer to Table 11.6). Further, the growth in
consumption of the lower 40 percentile urban population is consistently lower than its counterpart
rural population.

Table 11.5 Consumption Pattern Across Different MPCE Classes of Population, Urban (%)
MPCE classes of population—urban Food 42.51 Non-food 57.48

Poor (roug hly below PL)
0–335 64.86 35.14
335–395 63.11 36.89
395–485 60.04 39.96
485–580 a 57.30 42.70
Roug hly between PL and 2PL

580–675 55.35 44.65
675–790 52.37 47.62
790–930 b 49.69 50.31
930–1100 c 46.61 53.39
Roug hly above 2 PL

1100–1380 44.44 55.56
1380–1880 40.17 59.83
Source: NSSO: Estimated from Table 5U of NSS Report No. 508: Level and Pattern of Consumer Expenditure, 2004–05.
Notes:
a MPCE class having PL at Rs 538.60.
b MPCE class having 1.5 times the PL (1.5PL) at Rs 807.90.
c MPCE class having twice the PL (2PL) at Rs 1077.20.

Table 11.6 Growth in MPCEs Between 1993–1994 and 2004–2005
Source: NSSO: Estimated from Table No.P7: Comparison of average MPCE at constant prices over rounds. NSS Report No. 508: Level
and Pattern of Consumer Expenditure, 2004–2005.

Hence, the changes in MPCEs over this period within the urban population may have been less
uniform than in the rural population. (Rural–urban migration may be behind this phenomenon as the
influx of migrant population may be neutralising the rise in the average incomes of the lower half of
the urban population. At the same time, the migrant workers may be sending back funds to support
their poor families back home, thus raising the consumption levels). This also signals the importance
of programmes that improve the supply of public goods and services to the urban poor.
FACTORS RESPONSIBLE FOR POVERTY
Poverty is widespread in India. The main factors responsible for this problem are stated as follows:
Rapidly Rising Population

The population during the last 50 years has increased at the rate of 2.2 per cent per annum. On
average, 17 million people are added every year to its population which raises the demand for
consumption goods considerably.
Low Productivity in Agriculture

The level of productivity in agriculture is low due to subdivided and fragmented holding, lack of
capital, use of traditional methods of cultivation, illiteracy, and so on. This is the main cause of
poverty in the country.
Under-utilised Resources
The existence of underemployment and disguised unemployment of human resources and low
production in the agricultural sector. This brought down a fall in their standard of living.
Low Rate of Economic Development

The rate of economic development in India has been below the required level. Therefore, there
persists a gap between the levels of availability and the requirements of goods and services. The net
result is poverty.
Price Rise
The continuous and steep price rise has added to the miseries of the poor. It has benefitted a few
people in the society, and the persons in the lower-income group find it difficult to get their minimum
needs.
Unemployment
The continuously expanding army of unemployed is another cause of poverty. The job seekers are
increasing in number at a higher rate than the expansion in the employment opportunities.
Shortage of Capital and Able Entrepreneurship

Capital and able entrepreneurship have an important role in accelerating the growth. But these are in
short supply making it difficult to increase the production significantly.
Social Factors
The social set up is still backward and is not conducive to faster development. Laws of inheritance,
caste system, and traditions and customs are putting hindrances in the way of faster development, and
have aggravated the problem of poverty.
Political Factors
The Britishers started a lop-sided development in India and reduced the Indian economy to a colonial
state. They exploited the natural resources to suit their interests and, in turn, weakened the industrial
base of the Indian economy. In independent India, the development plans have been guided by political
interests. Hence, the planning is a failure to tackle the problems of poverty and unemployment.
MEASURES TO REDUCE POVERTY
Pandit Nehru has correctly observed, “In a poor country there is only poverty to redistribute”. The
following measures can go a long way to reduce poverty.
More Employment Opportunities

Poverty can be eliminated by providing more employment opportunities so that people may be able to
meet their basic needs. For this purpose, labour-intensive rather than capital-intensive techniques can
help to solve the problem to a greater extent. During the Sixth and Seventh Five-Year Plan, the
programmes like Integrated Rural Development Programme (IRDP), Jawahar Rozgar Yojana, and
Rural Landless Employment Guarantee Programme, and so on have been started with a view to
eliminate poverty in the rural sector.
Minimum Needs Programme
The programme of minimum needs can help to reduce poverty. This fact was realised in the early
1970s as benefits of growth do not percolate to poor people, and less-developed countries (LDC) are
left with no other choice except to pay a direct attention to the basic needs of the lower strata of the
society. In the Fifth Five-Year Plan, the Minimum Needs Programme was introduced for the first time.
Social Security Programmes

The various social security schemes like Workmen’s Compensation Act, Maternity Benefit Act,
Provident Fund Act, Employees State Insurance Act, and other benefits in case of death, disability, or
disease while on duty can make a frontal attack on poverty.
Establishment of Small-scale Industries

The policy of encouraging cottage and small industries can help to create employment in rural areas,
especially in the backward regions. Moreover, this will transfer resources from surplus areas to
deficit areas, without creating much problem of urbanisation.
Upliftment of Rural Masses

As it is mentioned that India lives in villages, thus, various schemes for upliftment of the rural poor
may be started. The poor living in rural areas, generally, belong to the families of landless
agricultural labourers, small and marginal farmers, village artisans, scheduled castes, and scheduled
tribes. However, it must be remembered that the Government of India has introduced many schemes
from time to time for the upliftment of the poor.
Land Reforms
Land reforms has the motto, “land belongs to the tiller”. Thus, legislature measures were undertaken
to abolish the Zamindari System. Intermediaries and ceiling on holdings were fixed. But it is a bad
luck that these land reforms lack a proper implementation. Even then, it is expected that if these
reforms were implemented seriously, it would yield better results, which will be helpful to reduce the
income of the affluent section.
Spread of Education
Education helps to bring out the best in human body, mind, and spirit. Therefore, it is urgent to
provide education facilities to all. The poor should be given special facilities of stipend, free books,
contingency allowance, and so on. Education will help to bring an awakening among the poor and
raise their mental faculty.
Social and Political Atmosphere

Without the active cooperation of citizens and political leaders, poverty cannot be eradicated from
India. A conducive, social and political atmosphere is a necessary condition for eradicating the
poverty from its root.
To Provide Minimum Requirements
Ensuring the supply of minimum needs to the poor sections of society can help in solving the
problem of poverty. For this, the public procurement and distribution system should be improved and
strengthened.
POVERTY ALLEVIATION PROGRAMMES
After the dawn of freedom, India got wedded to the goal of democratic set-up in the country. Under
the Directive Principles, it has been laid down that the State strives to promote the welfare of the
people by securing and protecting, as effectively as it may, the social order in which justice, social,
economic, and political—shall inform all the institutions of national life. With this motto, the strategy
of direct assault on poverty and inequality through rural development and rural employment
programme has been adopted.

Under the Directive Principles, it has been laid down that the State strives to promote the welfare of the people by securing
and protecting, as effectively as it may, the social order in which justice, social, economic, and political—shall inform all the
institutions of national life.
The launching of the Community Development Programme (CDP) in 1952 was a landmark in the
history of India, which ushered in an era of development with the participation of people. It adopted a
systematic integrated approach to rural development, with a hierarchy of village-level workers and
block-level workers drawn from various fields to enrich the rural life. About 5,000 National
Extension Service (NES) Blocks were created under the CDP by the end of the Second Five-Year Plan.
During the Third Five-Year Plan, the momentum was maintained through a series of development
schemes through allocations under the NES programmes. This was succeeded by the Small Farmer ’s
Development Agencies followed by Marginal Farmer ’s Development Agencies, Crash Schemes for
Rural Employment, Food-for-Work Programme, Drought-Prone Areas Programme (DPAP), and
Desert Development Programme (DDP) in the early 1970s. Panchyati Raj for decentralised
administration was evolved by the Balwant Roy Mehta Committee in 1957. However, employment
generation and poverty alleviation programmes as follows are also implmented:
Jawahar Gram Samridhi Yojana (JGSY): JGSY was introduced in April 1999 by restructuring the Jawaliar Roazgar Yojana and
is being implemented as a Centrally sponsored scheme on a cost-sharing ratio of 75:25 between the Centre and the states. The
programme is implemented by Gram Panchayats, and works which result in creation of durable, productive community assets are
taken up. The secondary, however, is the generation of wage employment for the rural unemployed pool.
Swarnjayanti Gram Swarozgar Yojana (SGSY): SGSY was launched with effect from April 1, 1999, as a result of
amalgamating certain erstwhile programmes, viz., IRDP, Development of Women and Children in Rural areas (DVCRA),
Training of Rural Youth for Self-Employment (TRYSEM), Million Wells Scheme (MWS), and so on, into a single self-
employment programme. It aims at promoting micro-enterprises and helping the rural poor into self-help groups (SHG). This
scheme covers all aspects of self-employment like organisation of rural poor into SHG and their capacity-building, training,
planning of activity clusters, infrastructure development, financial assistance through bank credit, subsidy, and marketing support,
and so on. The scheme is being implemented as a Centrally sponsored scheme on a cost-sharing ratio of 75:25 between the
Centre and the states.
Employment Assurance Scheme (EAS): EAS was started in October 1993 for implementation in 1778-identified, backward
Panchayat Samitis of 257 districts situated in doughtprone areas, desert areas, tribal areas, and hill areas in which the revamped
public distribution system was in operation. It was, subsequently, expanded by 1997–98 to all the 5,448 rural panchayat samitis
of our country. It was restructured in 1999–2000 to make it a single-wage employment programme and implemented as a
Centrally sponsored scheme on a cost-sharing ratio of 75:25.
Sampoorna Grameen Rozgar Yojana (SGRY): Launched with effect from September 2001, the scheme aims at providing wage
employment in rural areas as also food security, along with the creation of durable community, with social and economic assets.
The scheme is being implemented on a cost-sharing ratio of 75:25 between the Centre and the states. The EAS and JGSY have
been integrated within the scheme, with effect from April 1, 2002.
National Social Assistance Programme (NSAP): NSAP was introduced on15 August, 1995 as a 100-per cent Centrally
sponsored scheme for social assistance benefit to poor households that are affected by old age, death of primary bread earner,
and maternity care. The programme has three components, that is, National Old Age Pension Scheme (NOAPS), National
Family Benefit Scheme (NFBS), and National Maternity Benefit Scheme (NMBS).
Pradhan Mantri Gramodaya Yojana (PMGY): PMGY was introduced in 2000–01 with the objective of focusing on village-
level development in five critical areas, that is, Health, primary education, drinking water, housing and rural roads, with the
overall objective of improving the quality of life of people in the rural areas.
Pradhan Mantri Gram Sadak Yojana (PMGSY): PMGSY was launched on December 25, 2000, with the objective of providing
road connectivity through good, all-weather roads to all rural habitations with a population of more than 1,000 persons by the
year 2003 and those with a population of more than 500 persons by the year 2007. An allocation of Rs 2,500 crore has been
provided for the scheme in 2001–02.
Pradhan Mantri Gramodaya Yojana (Gramin Awas): This scheme is to be implemented on the pattern of Indira Awas Yojana
with the objective of a sustainable habitat development at the village level and to meet the growing housing needs of the rural
poor.
Pradhan Mantri Gramodaya Yojana—Rural Drinking Water Project: Under this programme, a minimum 25 per cent of the
total allocation is to be utilised by the respective states/union territories (UTs) on projects/schemes for water conservation, water
harvesting, water recharge, and sustainability of the drinking water sources in respect of areas under DDP and DPAP.
Swarna Jayanti Shahari Rozgar Yojana (SJSRY): The urban self-employment programme and the urban wage-employment
programme are two special schemes of the SJSRY. Initiated in December 1997, it replaced various programmes operated earlier
for urban poverty alleviation. This is funded on a 75:25 basis between the Centre and the states. During 2001–02, an allocation
of Rs 168 crore has been provided for various components of this programme.
Indira Awaas Yojana (IAV): This is a major scheme for construction of houses to be given to the poor, free of cost. An additional
component for conversion of unserviceable kutcha houses to semi-pucca house has also been added. From 1999–2000, the
criteria for allocation of funds to states/UTs have been changed from poverty ratio to equally reflect the poverty ratio and the
housing shortage in the state. Similarly, the criteria for allocation of funds to a district have been changed to equally relied
SC/ST population and the housing shortage.
Samagra Awaas Yojana: This has been launched as a comprehensive housing scheme in 1999–2000 on a pilot-project basis in
one block, in each of 25 districts of 24 states and in one UT, with a view to ensuring integrated provision of shelter, sanitation,
and drinking water. The underlying philosophy is to provide for convergence of the existing housing, sanitation, and water-supply
schemes with a special emphasis on technology transfer, human resource development, and habitat improvement with people’s
participation.
Food-for-Work Programme: This programme was initially launched with effect from February 2001 for live months and was
further extended. The programme aims at augmenting food security through wage employment in the drought-affected rural
areas in eight states, that is Gujarat, Chattisgarh, Himachal Pradesh, Madhya Pradesh, Maharashtra, Orissa, Rajasthan, and
Uttranchal. The Centre makes available appropriate of food grains, free of cost, to each of the drought-affected states as an
additionality under the programme. Wages by the State government can be paid partly in kind (up to 5 kg of food grains per
man-day) and partly in cash. The workers are paid the balance of wages in cash, such that they are assured of the notified
minimum wages. This programme stands extended up to March 31, 2001 in respect of notified “natural calamity-affected
districts”.
Annapurna: This scheme came into effect from April 1, 2000 as a 100-per cent Centrally sponsored one. It aims at providing
food security to meet the requirement of those senior citizens who, though eligible for pensions under theNOAPS, are not getting
the same. Food grains are provided to the beneficiaries at subsidised rates of Rs 2 per kg of wheat and Rs 3 per kg of rice. The
scheme is operational in 25 states and 5 UTs. More than 6.08 lakh families have been identified and the benefits of the scheme
are passing on to them.
Krishi Shramik Samajik Suraksha Yojana: The scheme was launched in July 2001 for giving social security benefit to
agricultural labourers on hire, in the age group of 18–60 years.
Shiksha Sahayog Yojana: The scheme has been finalised for providing an educational allowance of Rs 100 per month to the
children, of parents living below the PL, for their education in classes from 9 th Standard to 12 th standard.
POVERTY ALLEVIATION THROUGH MICRO-CREDIT
All over the world, micro-credit is being recognised as an instrument of poverty alleviation. About
30 years ago, the concept of micro-credit was unknown. Since then, its role in poverty alleviation and
empowerment of the weaker sections has gained recognition in many developing countries and even
in a few developed ones. Today, it is active in more than 100 countries and is said to have helped
more than 100 million people to take steps to reduce poverty.

All over the world, micro-credit is being recognised as an instrument of poverty alleviation. About 30 years ago, the concept
of micro-credit was unknown.
In the recent years, the World Bank and the International Finance Corporation (IFC) have also
participated in the promotion of micro-finance. Of course, the Bank’s role has been much bigger in
this endeavour. It has targeted the firms, financial and social protection sectors, in many developing
countries. The World Bank Group’s portfolio in micro-finance initiatives has risen to over $1 bn in
recent years.

The World Bank Group’s portfolio in micro-finance initiatives has risen to over $1 bn in recent years.
Indian Experience
A significant feature of the micro-finance movement in India is that it has relied heavily on the
existing banking infrastructure, in the process, obviating the need for a new institutional set-up. Most
of the leading practitioners of micro-finance activities follow the Grameen model. Banks lend micro-
credit through SHGs to local micro-finance institutions (MFIs) that have contacts in small villages.

A significant feature of the micro-finance movement in India is that it has relied heavily on the existing banking
infrastructure, in the process, obviating the need for a new institutional set-up.
India’s bank–SHG link programme is now the biggest in the world. According to the RBI Annual
Report 2005–06, the cumulative number of SHGs linked to banks stood at 2.2 million, with total bank
credit to these SHGs at Rs 11,398 crore. The 2006–07 Budget envisages the banking industry to credit
link another 385,000 SHGs in 2006–07. Some 30 million women have reportedly formed 2.2 million
small businesses so far, and another four lakh are expected to be in place by March 2007, according
to the National Bank of Agriculture and Rural Development (NABARD).
Of late, some of the leading commercial banks, such as ICICI Bank, HDFC Bank, UTI Bank, and the
State Bank of India, have begun focusing on this sector, rather aggressively. Even some of the
multinational banks operating in India, such as ABN Amro, Standard Chartered, HSBC, and Citibank,
have moved into the sector. There is a growing realisation among the commercial banks that micro-
finance is a bankable proposition.

Of late, some of the leading commercial banks, such as ICICI Bank, HDFC Bank, UTI Bank, and the State Bank of India,
have begun focusing on this sector, rather aggressively.
The award of the Nobel Peace Prize to Prof. Yunus and Grameen Bank is expected to provide a big
boost to micro-finance activities in India. ICICI Bank, which has emerged as an active and innovative
player in the micro-finance segment, has now joined hands with Grameen Foundations, the United
States and ITCOT Consulting to set up Grameen Capital India (GCI). It has already approached the
Reserve Bank of India, seeking a licence for a non-banking finance company (NBFC).

The award of the Nobel Peace Prize to Prof. Yunus and Grameen Bank is expected to provide a big boost to micro-finance
activities in India.
Suggestions
Clearly, a multi-pronged approach is required to solve the pervasive imbalances in the banking
services.
1. Firstly, banks especially the PSBs, must be constantly encouraged to extend small loans to the poor. Many private and foreign
banks are rapidly increasing their rural banking activities. For instance, ICICI Bank has doubled the size of its rural banking
activities to about Rs 157 crore and has outstanding micro-loans of Rs 2,475 crore. ABN Amro began its micro-finance
operations in September 2003 and has 24 Indian partners and Rs 10.3 crore as outstanding loans in this sector. What is more,
banks view micro-credit operations as a lucrative business opportunity. They believe that the sheer volumes of the micro-loans
market will, in the long term, make up for the low interest charges (9.5 per cent is the lending cap for loans up to Rs 2 lakh).

Firstly, banks especially the PSBs, must be constantly encouraged to extend small loans to the poor.
2. Secondly, banks must also be actively encouraged to lend to the poor through intermediaries such as MFIs and SHGs. This has
been a huge success in neighbouring Bangladesh, and there is no reason why the same would not hold true for India as well.
This approach is all the more important as it entails an average default rate of a mere 3 per cent.

Secondly, banks must also be actively encouraged to lend to the poor through intermediaries such as MFIs and
SHGs.
3. Thirdly, and most importantly, all such measures must be complemented by a large government intervention in the form of land
reforms, provision of irrigation facilities, crop insurance, and better physical infrastructure.

Thirdly, and most importantly, all such measures must be complemented by a large government intervention in the
form of land reforms, provision of irrigation facilities, crop insurance, and better physical infrastructure.
OUTLOOK FOR POVERTY ALLEVIATION
Eradication of poverty in India can only be a long-term goal. Poverty alleviation is expected to make
a better progress in the next 50 years than in the past, as a trickle-down effect of the growing middle
class. Increasing stress on education, reservation of seats in the government jobs, and the increasing
empowerment of women and the economically weaker sections of society, are also expected to
contribute to the alleviation of poverty. It is incorrect to say that all poverty-reduction programmes
have failed. The growth of the middle class (which was virtually non-existent when India became a
free nation in August 1947) indicates that economic prosperity has, indeed, been very impressive in
India, but the distribution of wealth is not at all even.

Increasing stress on education, reservation of seats in the government jobs, and the increasing empowerment of women and
the economically weaker sections of society, are also expected to contribute to the alleviation of poverty.
After the liberalisation process and moving away from the socialist model, India is adding 60
million to 70 million people to its middle class every year. Analysts such as, the founder of
“Forecasting International”, Marvin J. Cetron writes that an estimated 390 million Indians now belong
to the middle class where one-third of them have emerged from poverty in the last 10 years. At the
current rate of growth, a majority of Indians will be middle-class by 2025. Literacy rates have risen
from 52 per cent to 65 per cent during the initial decade of liberalisation (1991–2001).

After the liberalisation process and moving away from the socialist model, India is adding 60 million to 70 million people to
its middle class every year.
CONTROVERSY OVER THE EXTENT OF POVERTY REDUCTION
While the total overall poverty in India has declined, the extent of poverty reduction is often debated.
While there is a consensus that there has not been an increase in poverty between 1993–94 and 2004–
05, the picture is not so clear if one considers other non-pecuniary dimensions (such as health,
education, crime, and access to infrastructure). With the rapid economic growth that India is
experiencing, it is likely that a significant fraction of the rural population will continue to migrate
towards cities, making the issue of urban poverty more significant in the long run.

With the rapid economic growth that India is experiencing, it is likely that a significant fraction of the rural population will
continue to migrate towards cities, making the issue of urban poverty more significant in the long run.
Economist Pravin Visaria has defended the validity of many of the statistics that demonstrated the
reduction in the overall poverty in India, as well as the declaration made by India’s former Finance
Minister Yashwant Sinha that poverty in India has reduced significantly. He insisted that the 1999–
2000 survey was well-designed and supervised and felt that, just because they did not appear to fit the
preconceived notions about poverty in India, they should not be dismissed outright. Nicholas Stern,
the Vice President of the World Bank, has published defenses of the poverty-reduction statistics. He
argues that increasing globalisation and investment opportunities have contributed significantly to the
reduction of poverty in the country. India, together with China, has shown the clearest trends of
globalisation with the accelerated rise in the per-capita income.
A 2007 report by the State-run NCEUS found that 77 per cent of Indians, or 836 million people,
lived on less than Rs 20 per day (US$ 0.50 nominal, US$ 2.0 in PPP), with most working in “informal
labour sector with no job or social security, living in abject poverty”.

A 2007 report by the State-run NCEUS found that 77 per cent of Indians, or 836 million people, lived on less than Rs 20
per day (US$ 0.50 nominal, US$ 2.0 in PPP), with most working in “informal labour sector with no job or social security,
living in abject poverty”.
A study by the McKinsey Global Institute found that in 1985, 93 per cent of the Indian population
lived on a household income of less than Rs 90,000 a year, or about a dollar per person per day; by
2005 that proportion had been cut nearly in half, to about 54 per cent. More than 103 million people
have moved out of desperate poverty in the course of one generation in urban and rural areas as well.
They project that if India can achieve 7.3 per cent annual growth over the next 20 years, 465 million
more people will be spared a life of extreme deprivation. Contrary to popular perceptions, rural India
has benefitted from this growth: extreme rural poverty has declined from 94 per cent in 1985 to 61
per cent in 2005, and they project that it will drop to 26 per cent by 2025. The report concludes that
“India’s economic reforms and the increased growth that has resulted have been the most successful
anti-poverty programmes in the country”.

Contrary to popular perceptions, rural India has benefitted from this growth: extreme rural poverty has declined from 94
per cent in 1985 to 61 per cent in 2005.
CASE
ICT and Rural Poverty Alleviation
Poverty alleviation is not the responsibility of the NGOs alone, as corporate sector also can play a
very important role in it, especially in India. If the corporate is able to link their corporate social
responsibility with poverty alleviation in India, it will really help to a greater extent. But how many
business organisations are aware about their role in poverty alleviation in India? Very few like Tata
Steel spends about 5 per cent to 7 per cent of its profit-after-tax on several CSR initiatives. Tatas have
signed an MoU (memorandum of understanding) with the Jharkhand government in August 2005, to
pay Rs 25 crore every year, for the next 30 years, for medical insurance of people living below the
PL.
JRD Tata, Chairman of the Tata Group from 1938 to 1993, had said: “Let industry established in the
countryside adopt [adopts] the villages in the neighbourhood… it is also clearly in the interests of
industry that surrounding areas should be healthy, prosperous and peaceful”. The House of Tatas has,
in fact, ensured that no stone is left unturned in its endeavour to meet the expectations of the
community and the environment within which it exists. An innovative approach for the poverty
alleviation by Tata is Jamsetji Tata National Virtual Academy for Rural Prosperity (NVA).The NVA
has become the umbrella for MSSRF’s (M.S. Swaminathan Research Foundation) initiatives in ICT-
led development.
From small beginnings as an experimental information village project started in Pondicherry in
1998, MSSRF’s initiative in the use of ICT (information and communication technology) for
information and poverty alleviation in rural areas has evolved and expanded over the years. By
December 2004, 12 VKCs (Village Knowledge Centres) were in operation in Pondicherry. VKC
initiatives are also being attempted at other field sites, and different models are emerging in response
to local needs. As a need was felt for network-linking experts and grassroot-level communities, the
NVA was launched in August 2003, with the generous support of Sir Dorabji Tata Social Welfare
Trust. The State-level hub, located at MSSRF, is the knowledge resource that creates and maintains
websites and databases for the local hubs, in close collaboration with national and international
agencies. It is linked to Village Resource Centres (VRCs), which in turn are linked to VKCs for a
cluster of villages. It is an information system that establishes lab-to-lab, lab-to-land, land-to-lab, and
land-to-land linkages.
The NVA aims to provide information and knowledge related to drought, climate management,
augmentation of water, maximising crop yield (more cropper drop) and markets, and build skills and
capacities of the rural poor, with a view to enhancing livelihood opportunities, and empowering
vulnerable people to make better choices and have better control of their own development.
A State-level hub in Chennai and four block-level hubs in Tamil Nadu at Thiruvaiyaru (Thanjavur
District), Sempatti (Dindigul District), Annavasal (Pudukkottai District), and Thangatchimadam
(Ramanathapuram District) have been set up. In October 2004, ISRO (Indian Space Research
Organisation) provided satellite connectivity for three block-level information centres (Thiruvaiyaru,
Sempatti, and Thangatchimadam) under the VRC programme. The Prime Minister of India
inaugurated this programme through video conferencing in October 2004. In his inaugural speech, he
said, “Community-based vulnerability and risk-related information, provision of timely, early
warning and dissemination of weather related information can lead to reliable disaster management
support at the village level”.
This network provides the services of tele-education, tele-medicine, online decision support,
interactive farmers’ advisory services, tele-fishery, weather services, and water management. This
programme covers both farm and fishing families, based on the motto “food, water, health, literacy,
and work for all and for ever”.
Under the VRC programme, a spatial database for Thiruvaiyaru has been prepared by ISRO. It
reveals the land-use pattern of crops grown, such as paddy, sugarcane, and oil seeds. It also includes
fallow lands, sandy areas, built-up land, water bodies, and a detailed soil survey. The database helps
farmers to plan their activities. TNAU (Tamil Nadu Agricultural University) has developed a software
called DSSIFER (Decision Support System for Integrated Fertilizer Recommendation) which gives a
district-wise cropping pattern. The TN Rice Research Institute has suggested that it could include the
land and water resource plan.
Under the Microsoft Unlimited Potential Programme (MUPP), 100 Community Technology
Learning Centres (CTLC) are to be set up. A series of need-based training programmes was
facilitated through networking with various research centres, NGO, and government agencies. The
hub at MSSRF has a good satellite bandwidth under the ISRO VRC programme. All the centres
regularly hold video conferences between the rural communities and experts, between farmers,
between SHGs and between farmers and manufacturers. They promote lateral learning among rural
families. Interactive programmes were held during the year for diverse groups. About 40 audio
programmes on different topics were created by knowledge workers and relayed every Saturday
through All India Radio (AIR), Pondicherry. This programme produced under the Open Knowledge
Network (OKN) collects and disseminates information in the local language on various matters.
The aim of the NVA in reaching frontier technology to the resource-poor rural women and men,
and enabling them to become masters of their own destiny will help to create large numbers of
knowledge managers in our villages. This cadre of grass-root workers, both men and women, are to
be elected as Fellows of the NVA for “rural prosperity” and trained to be master trainers for
spearheading the knowledge revolution in rural India. In 2004, six Fellows were selected through a
rigorous selection process as the first Fellows of the NVA. About 137 grass-root workers were
inducted as Fellows of the NVA at the Second National Convention of Mission 2007, and the
Convocation of the NVA was inaugurated by the President of India in July 2005.
Case Questions
1. Comment on the application of ICT in poverty alleviation in the rural sector.
2. Do you think so such kind of experiments should be done in all parts of India?
3. What kind of prior planning will be required for using ICT in alleviation of rural poverty?
KEY WORDS
Absolute Standard
Below the Poverty Line
Relative Standard
Cut-off Amount
Substantial Poverty
National Sample Survey Organisation (NSSO)
Wealth Distribution
Malnutrition
Mass Hunger
Deindustrialisation
Declining Terms of Trade
The Periodic Mass Misery
Unemployment and Underemployment
Lack of Property Rights
Over-reliance on Agriculture
Uniform Recall Period (URP)
Mixed Recall Period (MRP)
Shortage of Capital and Able Entrepreneurship
Inheritance
Land Belong to the Tiller
Zamindari System
Community Development Programme
Food-for-Work Programme
Drought-prone Areas
Desert Development Programme (DDP)
Integrated Rural Development Programme (IRDP)
Rural Youth For Self-employment (RYSEM)
Self-help Groups (SHGS)
Micro-finance Institutions (MFIS)
National Bank of Agriculture and Rural Development (NABARD)
Grameen Capital India (GCI)
Non-banking Finance Company
QUESTIONS
1. What do you mean by the term “poverty”? Give its extent.

2. Highlight the factors responsible for poverty?
3. Discuss the phases in poverty reduction?
4. Explain the “Incidence of Poverty” and suggest suitable measures to overcome the situation?
5. Discuss the various poverty alleviation programmes adopted by the Government of India from time to time?
6. Discuss the impact of economic reforms on poverty reduction?
REFERENCES

Ten Five-Year Plan Document, Government of India.
The Economic Times, Pune, October 10, 2006.
The Economic Times, Pune, October 12, 2006.
www.wikipedia.com (the free encyclopedia).
CHAPTER 12
Unemployment in India
CHAPTER OUTLINE
Concept, Meaning, and Types of Unemployment
Nature of Unemployment in India
Magnitude of Unemployment
Factors Responsible for Unemployment
Steps to Reduce Unemployment
Government Policy Measures to Reduce Unemployment
Overview of Unemployment and Underemployment
Case
Key Words
Questions
References
CONCEPT, MEANING, AND TYPES OF UNEMPLOYMENT
Concept of Unemployment
The ugly calamity that can affect the life of a nation is the “problem of unemployment”. The
unemployment in our country is quite different from that of advanced countries of the world. The
well-developed countries like the United States and England usually suffer from a frictional or
cyclical unemployment, but in the case of India it is a permanent feature. In fact, it has become a
multi-dimensional phenomenon and in recent years, it has assumed alarming proportions. In the
opinion of late President V. V. Giri, “unemployment” is the “problem of problems”. Unemployment
has made our youths “nexalites”. Educated youth are deprived of all deserving comforts and their
growing discontent has given scope for the speedy growth of “nexalism”. Unemployment in India is
of a complex nature. In a sense, it is a colossal waste of human resources which further hurdles the
tempo of economic development of a country. It, thus, calls for a remedial action at the earliest
possible.

The ugly calamity that can affect the life of a nation is the “problem of unemployment”. The unemployment in our country is
quite different from that of advanced countries of the world.
Meaning of Unemployment
In a common sense, unemployment is a situation characterised when any one is not gainfully
employed in a productive activity. It means that an unemployed person is the one who is seeking any
work for wages but is unable to find any job suited to his capacity. From this view, one can easily
make an idea of voluntarily and involuntarily unemployed. Obviously, in an economy, there is a
section of working population who are not interested in any gainful job and, still, others who are
interested in employment at wage rates higher than those prevailing in the labour market. Professor
Keynes calls this type of labour force as voluntarily unemployed. According to him, involuntary
unemployment refers to a situation in which though people are ready to accept work at prevailing
wage rate they fail to get the same wage.

In a common sense, unemployment is a situation characterised when any one is not gainfully employed in a productive
activity.
Types of Unemployment
Broadly, unemployment is of many types like (i) cyclical, (ii) frictional, (iii) technological, (iv)
seasonal, (v) structural, (vi) voluntary, (vii) involuntary, (viii) disguised, and (ix) casual. But in most
of the underdeveloped countries, unemployment can be of three main forms. They are (a) open, (b)
disguised, and (c) under.
Let us see each of them in detail as follows:
a. Open Unemployment: Under this category, unemployment refers to a situation wherein a large labour force does not get
employment opportunities that may yield a regular income. In a sense, workers are willing to work and able to work, but they
are not getting any job. This type of unemployment is the result of a lack of complementary resources, especially capital. The
rate of capital accumulation lags behind the rate of population growth. This type of unemployment can be identified as
“structural unemployment”.

Open unemployment refers to a situation wherein a large labour force does not get employment opportunities that
may yield a regular income.
b. Disg uised Unemployment: Basically, disguised unemployment is associated with the agricultural, underdeveloped countries
like India. Still, it is also suitable to industrially developed countries which are hit by cyclical unemployment. However, it
implies to that unemployment that is not open for everyone and remains concealed. In fact, such employment is a work-sharing
device, that is, existing work is shared by a large number of workers. In such a situation, even if many workers are withdrawn
the same work can be continued by few workers. The contribution of such labourers to production is zero or near to zero. In
Indian villages, this form of unemployment is a common feature.

Disguised unemployment is associated with the agricultural, underdeveloped countries like India.
c. Underemployment: This form of unemployment can be defined in two ways. They are (a) a situation in which a labourer does
not get the type of work he is capable of doing though he has the abilities and can yield larger income; but he is denied the
opportunity due to lack of suitable jobs and (b) a situation in which a labourer does not get sufficient work to absorb him for the
total length of working hours a day. Some time, the second form of unemployment is known as “seasonal unemployment”. The
first form of underemployment can be explained with the help of an example. Suppose a degree-holding engineer wants an
appropriate job, but he starts as an operator, then, he may be said as “underemployed”. He may be deemed as working and
earning in a production activity but, in reality, he is not working to his full capability. Thus, he is in the state of underemployment.

A situation in which a labourer does not get the type of work he is capable of doing though he has the abilities and
can yield larger income; but he is denied the opportunity due to lack of suitable jobs.
NATURE OF UNEMPLOYMENT IN INDIA
The Indian experience of the relationship between employment and development is vastly different
from that in the developed countries. The unemployment in those countries is basically temporary and
every one gets the employment in the course of time. This happens due to technological
improvements or cyclical fluctuations. But, here, the tale of unemployment is chronic rather than
temporary, which can be called “structural”. It is mainly due to the slow growth of capital formation
when compared to the increase in labour force. A close analysis explains that there is a negligible
change in the occupational structure of the country. Agriculture and allied occupations were
occupying the same position in 2008 as they did in 1931 or even in 1911. In rural areas, about 70 per
cent of the population are directly or indirectly dependent on the agricultural sector. This situation
leads to the problem of disguised as well as rural unemployment. For convenience, we shall classify
unemployment as
a. Disguised unemployment or Rural unemployment.
b. Industrial unemployment or Urban unemployment.
c. Educated unemployment or White-collar unemployment.
In rural areas, about 70 per cent of the population are directly or indirectly dependent on the agricultural sector. This
situation leads to the problem of disguised as well as rural unemployment.
Disguised Unemployment or Rural Unemployment
Both unemployment and underemployment exist side by side in the rural sector and it is difficult to
make a distinction between the two. In rural areas, it exhibits in seasonal and perennial apart from
chronic and disguised unemployment. It is due to increasing heavy pressure on land, decline of
handicrafts and village and cottage industries, backward nature of cultivation, and absence of
alternative occupations. This has largely contributed to the problem of unutilised labour or disguised
unemployment in the agricultural sector. In the recent years, the introduction of agricultural
machinery has tended to add more rural unemployed force. Moreover, a large number of labourers
accumulate around primary occupations, and inelasticity of the occupational structure prevents any
movement away from that position in the period of slack demand. This further leads to seasonal
unemployment and its incidence varies from region to region and even, within the region over
different seasons, depending on climate, cropping pattern, and socio-economic factors. Therefore,
seasonal unemployment is closely associated with the problem of underemployment of manpower.
This type of unemployment is estimated between 20 per cent and 30 per cent.

Seasonal unemployment is closely associated with the problem of underemployment of manpower. This type of
unemployment is estimated between 20 per cent and 30 per cent.
Industrial Unemployment or Urban Unemployment
Industrial unemployment is largely the offshoot of rural unemployment. In the face of increasing
pressure of population on land, a mass exodus of population from rural areas has migrated to the
urban areas in search of employment. They are uneducated and unskilled. This type of migration
swells the size of labour force in urban areas and, in turn, adds to the number of unemployed army of
labour.

Industrial unemployment is largely the offshoot of rural unemployment.
Educated Unemployment or White-collar Unemployment
In the urban areas, this is the special class that emerged due to mere educational facilities in towns.
The rate of unemployment is higher among the educated than among the uneducated persons. This is
also, perhaps, due to the reason that tertiary sector could not grow speedily to that extent to which the
people are being educated in the urban areas. The educational system is ill-planned which provides
very little scope to cater the needs of the nation. In 1971, the total educated unemployed was recorded
as 22.9 lakh against its number 5.79 lakh in 1961. In August 1983, the number of persons registered
on the employment exchange was 211 lakh and further, on December 31, 1985, its number had
increased to 262 lakh. They all hanker after “white-collar jobs”, which result in a great scramble for
“clerical jobs”.

The educational system is ill-planned which provides very little scope to cater the needs of the nation.
MAGNITUDE OF UNEMPLOYMENT
The Economic Survey 2006–07 had given estimates of employment and unemployment on usual
principal status (UPS) basis from various rounds of NSSO (National Sample Survey Organisation)
survey. In the meantime, the Eleventh Five-Year Plan has largely used the Current Daily status (CDS)
basis of estimation of employment and unemployment in the country. It has also been observed that
the estimates based on daily status are the most inclusive rate of unemployment, giving the average
level of unemployment on a day during the survey year. It captures the unemployed days of the
chronically unemployed; the unemployed days of the usually employed, who become intermittently
unemployed during the reference week; and the unemployed days of those classified as “employed”
according to the criterion of a current weekly status. The estimates presented earlier also need
revisiting so as to be based on population projections released by National Commission on
Population. The estimates on employment and unemployment on CDS basis (refer to Table 12.1)
indicate that employment growth between 1999–2000 and 2004–05 had accelerated significantly when
compared to the growth witnessed between 1993–94 and 1999–2000. During the period from 1999–
2000 to 2004–05, about 47 million work opportunities were created when compared to only 24
million in the period between 1993–94 and 1999–2000. The employment growth accelerated from
1.25 per cent per annum to 2.62 per cent per annum. However, since the labour force grew at a faster
rate of 2.84 per cent than the workforce, the unemployment rate also rose. The incidence of
unemployment on CDS basis increased from 7.31 per cent in 1999–2000 to 8.28 per cent in 2004–05.
Table 12.2 shows sectoral employment shares on CDS basis from a survey by NSSO for the Planning
Commission.

The estimates on employment and unemployment on CDS basis (refer to Table 12.1) indicate that employment growth
between 1999–2000 and 2004–05 had accelerated significantly when compared to the growth witnessed between 1993–94
and 1999–2000.

Table 12.1 Employment and Unemployment in Million/Person/Year (on CDS basis)
Source: Various rounds of NSSO survey on employment and unemployment for Planning Commission.

Table 12.2 Sectoral Employment Shares on Current Daily Status (CDS) Basis

The decline in the overall growth of employment during the period from 1993–94 to 1999–2000 was
largely due to the lower absorption in agriculture. The share of agriculture in the total employment
dropped from 61 per cent to 57 per cent. This trend continued and the share of agriculture in the total
employment further dropped to 52 per cent in 2004–05. While the manufacturing sector ’s share
increased marginally during this period, trade, hotel, and restaurant sector contributed significantly
higher to the overall employment than in the earlier years. The other important sectors whose shares
in employment have increased are transport, storage, and communications apart from financial,
insurance, real estate, business and community, and social and personal services (refer to Table 12.2).
Male participation remained higher both in labour and workforce, throughout the period between
1983 and 2004–05. Female participation per se in rural areas was much higher than in the urban areas.
The urban male participation rates (both labour force and workforce) were higher than the rural male
participation in 1999–2000 and 2004–05 (refer to Table 12.3).
In urban India, in 2004–05, “trade, hotel, and restaurant” sector had engaged about 28 per cent of
the male workers while “manufacturing” and “other services” sectors accounted for nearly 24 per
cent and 21 per cent, respectively, of the usually employed males. On the other hand, for urban
females, “services” sector accounted for the highest proportion (36 per cent) of the total usually
employed, followed by “manufacturing” (28 per cent) and “agriculture” (18 per cent). Work
opportunities for women in urban services and manufacturing sector, probably, exist but there is a
need for facilitating and improving their WPR (work participation rate) through better education,
skill development, and removal of gender-associated hurdles like lack of crèches, and so on.

Table 12.3 Labour-force and Workforce Participation Rates (CDS basis) (%)

Unemployment Rates by Level of Education
The NSSO data indicates that when compared to 1993–94, the unemployment rates for persons of
higher education level has declined in rural areas, both for males and females in 1999–2000, and it
has further declined in 2004–05 when compared to 1999–2000. The unemployment rate of graduate-
and-above female population is much higher in rural areas than in the urban areas, which is indicative
of lack of opportunities in rural India combined with lack of mobility of this population segment.

The unemployment rate of graduate-and-above female population is much higher in rural areas than in the urban areas,
which is indicative of lack of opportunities in rural India combined with lack of mobility of this population segment.
NSS 62nd Round on Employment and Unemployment
Subsequent to the 61st round in 2004–05, which was a quinqennial round, NSSO conducted an All
India Survey (62nd Round) of moderately large sample size on the situation of employment and
unemployment in India during the period from July 2005 to June 2006 as part of the annual series of
rounds. The main findings of this survey are as follows:
The overall unemployment rate for rural areas according to the usual-status approach was around
2 per cent (3 per cent for males and 2 per cent for females). The urban rates were higher than the
rural rates except for the CDS approach in which the unemployment rates for rural and urban areas
were almost equal (nearly 8 per cent).
The unemployment rate, obtained by any of the approaches, was higher for females than that for
males in the urban areas, but it was lower than that for males in the rural areas.

The unemployment rate, obtained by any of the approaches, was higher for females than that for males in the urban areas,
but it was lower than that for males in the rural areas.
Employment in Organised Sector
The employment growth in the organised sector, public and private combined, had declined during
the period between 1994 and 2005. This had primarily happened due to the decline of employment in
the public-organised sector. The employment in establishments covered by Employment Market
Information System of the Ministry of Labour grew at 1.20 per cent per annum during 1983–94, but
decelerated to –0.31 per cent per annum during 1994–2004. However, the latter decline was mainly
due to a decrease in employment in public sector establishments, whereas the private sector had
shown an acceleration in the pace of growth in the employment from 0.44 per cent to 0.58 per cent per
annum (refer to Table 12.4).

The employment growth in the organised sector, public and private combined, had declined during the period between 1994
and 2005.

Table 12.4 Rate of Growth of Employment in Organised Sector (% per annum)
Heads 1983–1994 1994–2005

Public sector 1.53 –0.70
Private sector 0.44 0.58
Total organised 1.20 –0.31
Source: Eleventh Plan Document.

As per the National Commission for Enterprises in the Unorganised Sector (NCEUS), which uses a
different classification of organised/unorganised sector, the organised sector employment had
increased from 54.12 million in 1999–2000 to 62.57 million in 2004–05. However, the increase had
been accounted for by an increase in the unorganised worker in the organised enterprises from 20.46
million in 1999–2000 to 29.14 million in 2004–05. Thus, the increase in employment in the organised
sector had been on account of the informal employment of workers.
Employment in the Eleventh Plan
The Eleventh Plan envisages a rapid growth in employment opportunities while ensuring
improvement in the quality of employment. It recognises the need to increase the share of regular
employees in total employment and a corresponding reduction in the casual employment. The
employment-generation strategy of the Eleventh Plan is also predicated on the reduction of
underemployment and the movement of surplus labour in agriculture sector to higher wage and more
gainful employment in non-agricultural sector. The agriculture sector is projected to generate no
increase in employment during the Eleventh Plan period. The employment in manufacturing is
expected to grow at 4 per cent while construction and transport and communication are expected to
grow at 8.2 per cent and 7.6 per cent, respectively. The projected increase in the total labour force
during the Eleventh Plan is 45 million. As against this, 58 million employment opportunities would be
created in the Eleventh Plan. This would be greater than the projected increase in the labour force
leading to a reduction in the unemployment rate to below 5 per cent.

The Eleventh Plan envisages a rapid growth in employment opportunities while ensuring improvement in the quality of
employment.
FACTORS RESPONSIBLE FOR UNEMPLOYMENT
Apparently, the widespread unemployment in the urban as the well as the rural India is a complex
problem caused by many factors. The major causes can be discussed as follows:
Slow Pace of Growth

The foremost cause of unemployment is the slow pace of growth. The size of employment, generally,
depends on the level of development to a large extent. During the phase of planning, our country has
made tremendous development in all sectors but the rate of growth is comparatively very low than the
targeted rate. Thus, employment in adequate number could not be created.

The foremost cause of unemployment is the slow pace of growth.
Backward Agriculture
The appalling nature of underdevelopment and unemployment in India is the backward agriculture.
Methods of techniques and organisation of agriculture is primitive and outdated. As a result,
agricultural productivity is low per worker and per unit of labour. Nearly, 70 per cent population is
directly or indirectly dependent on agriculture. Land-holding is uneconomic. Further, agriculture is a
seasonal occupation. Absence of supplementary employment opportunities is evident. In mid-1960s,
India witnessed green revolution but it benefitted the rich farmers and widened the gulf between the
poor and rich farmers. The institutional reforms like land reforms, consolidation, and ceiling of
land-holding and tenancy reforms had not been in a true spirit due to political and administrative
inefficiency and further non-cooperative attitude of the farmers.

The appalling nature of underdevelopment and unemployment in India is the backward agriculture. Methods of techniques
and organisation of agriculture is primitive and outdated.
Explosive Population Growth

India is experiencing an explosive population growth since 1951. In fact, the population increased at a
rate of 2.5 per cent annually. Therefore, employment situation has been adversely affected in two
ways. Firstly, increasing the number of labour force and secondly, reducing the available resources
for capital formation. About 90 lakh of new entrants were recorded in the First Plan, 118 lakh in the
Second Plan, 170 lakh in the Third Plan, and 230 lakh in the Fourth Plan. New additions of 650 lakh
and 340 lakh were estimated in the Fifth and Sixth Five-Year Plans, respectively. Again, it was
estimated to add 390 lakh of labour force in the Seventh Plan.

India is experiencing an explosive population growth since 1951. In fact, the population increased at a rate of 2.5 per cent
annually.
Inadequate and Defective Employment Planning

Still, another cause to the higher growth of job opportunities in the country is the inadequate and
defective job planning. Although the planning is in operation since 1951, it has not contributed to the
solution of the problem. It has absolutely neglected the employment problem and the underrating of
human resources. Employment, till recent times, has not become the integral part of the planning
strategy. In fact, very little has been done to utilise the Nurksian variety of surplus labour in the rural
sector.

Although the planning is in operation since 1951, it has not contributed to the solution of the problem.
Poverty
It is a condition where a person is poor. Underdeveloped countries are in the grip of a vicious circle
of poverty, which in turn, greatly influences the pattern of employment opportunities in the country.
Being poor, a person does not make any gainful use of the existing resources.

Underdeveloped countries are in the grip of a vicious circle of poverty, which in turn, greatly influences the pattern of
employment opportunities in the country.
More Emphasis on Capital-intensive Techniques

In India, capital is scarce and labour is available in surplus quantity. Under these circumstances, the
country should adopt labour-intensive techniques of production. But it has been observed that not only
in the industrial sector but also in the agricultural sector, there is a substantial increase of capital
rather than labour. In the case of Western countries, where the capital is in abundant supply, the use of
automatic machines and other sophisticated equipment is justified, whereas in our country the
abundant labour results in a large number of unemployment.

In India, capital is scarce and labour is available in surplus quantity. Under these circumstances, the country should adopt
labour-intensive techniques of production.
Defective Education System

The education system in our country too has failed to respond to the existing inter-generation gap. It
is the same old system, which Macaulay had introduced during the colonial period. It simply imparts
general and literary education, devoid of any practical content, in fact; and no sincere efforts have
been made to develop the educational system in accordance to the manpower requirements of the
economy. India’s education policy merely produces clerks and lower-cadre executives for the
government and private concerns. The open-door policy at the secondary and university level has
increased manifold unemployment among the educated, who are fit only for white-collar jobs.

India’s education policy merely produces clerks and lower-cadre executives for the government and private concerns.
Slow Growth of Tertiary Sector

When the expansion of tertiary sector comprising commerce, trade and transportation, and so on, is
limited, which could not provide employment even to the existing labour force, then the new entrants’
position stands a question. As a result of this, there is a wide scale of unemployment among
engineers, doctors, technically trained persons, and other technocrats.

There is a wide scale of unemployment among engineers, doctors, technically trained persons, and other technocrats.
Decay of Cottage and Small-scale Industries

The traditional handicraft has a glorious past and was the main source of employment, especially to
the village craftsman, artisans, as well as non-agricultural workers. Unfortunately, most of the rural,
traditional crafts have been ruined or faded, partly, due to the unfavourable policy of the foreign
rulers and, partly, due to the tough competition from the machine-made goods. Consequently, these
labourers were out of job. Most of them turned as landless labourers.
Lack of Vocational Guidance and Training Facilities
As, already discussed, our education system is defective as it provides purely academic and bookish
knowledge which is not job oriented. The need of the hour is that there must be a sufficient number of
technical-training institutions and other job-oriented courses at the village level. Most of the students
in rural areas remain ignorant of possible venues of employment and choice of occupation.

The need of the hour is that there must be a sufficient number of technical-training institutions and other job-oriented
courses at the village level.
Less Means for Self-employment

Another hurdle in generation of more employment opportunities is that there are inappropriate means
for self-employment in rural and semi-urban areas of the country. Like other developed countries,
most of our engineers, technocrats, and other well-qualified persons do not possess ample means for
self-employment. They go about in search of paid jobs.

Another hurdle in generation of more employment opportunities is that there are inappropriate means for self-employment
in rural and semi-urban areas of the country.
Defective Social System

The defective social systems of the country also add fuel for the seriousness of the problem. People
are still superstitious and illiterate, who still believe that family planning is a great sin, with the result
—population is increasing at a very high speed. It is equally difficult rather impossible to feed them
with food, clothes, and shelter. Then, where is the question of making a provision of employment?

The defective social systems of the country also add fuel for the seriousness of the problem.
STEPS TO REDUCE UNEMPLOYMENT
The problem of unemployment in the country is alarming. It has adversely affected the social life of
many individuals. Thus, keeping in view the different aspects of the problem, some steps are
suggested which will be helpful to solve the problem of rural unemployment and other types of urban
unemployment, as follows:
Reconstruction of Agriculture
Indian agriculture is a mode of living rather than a profitable occupation. It is a tale of woe to tell.
Therefore, it needs overhauling and reconstruction, making it an economic pursuit. Methods of
cultivation should undergo a radical change according to the condition of local needs. Irrigation
facilities should be improved so that agriculture should not be at the mercy of monsoons. Institutional
framework and agrarian relations should vigorously be adopted to provide social justice and
economic equality.

Indian agriculture is a mode of living rather than a profitable occupation. It is a tale of woe to tell. Therefore, it needs
overhauling and reconstruction, making it an economic pursuit.
Adoption of Labour-intensive Techniques

Despite the usage of the strategy of Prof. Mahalanobis for basic and key industries, which are based
on the capital-intensive techniques, our government should try to adopt labour-intensive techniques
for new fields of production.
Rapid Industrialisation
To solve the problem of industrial unemployment, stepping up of industrial efficiency is the remedy.
It means the expansion of the existing and the development of new industries are urgently required.
Some basic industries like iron and steel industries, defence, chemicals, power generation, atomic,
and so on, should be set up. At the same time, to improve the defective and uneconomic centralisation,
it is a pre-requisite to introduce rationalisation on scientific grounds.

To solve the problem of industrial unemployment, stepping up of industrial efficiency is the remedy.
Population Control
There is no second opinion to say that population in India is rising at a very high speed. Unless this
problem is not checked, the problem of unemployment cannot be solved properly. Efforts should be
made to raise the agricultural and industrial production. Therefore, a special drive should be made to
make the programme of family planning a good success, especially in the rural and backward
regions of the country.

There is no second opinion to say that population in India is rising at a very high speed. Unless this problem is not checked,
the problem of unemployment cannot be solved properly.
Reorientation of Education System

As regards the problem of educated unemployment in urban areas, India should reconstruct the
education system and overhaul according to the changing environment of the country. There must be
vocation-alisation of education. Proper education should be imparted to the younger men, who will
be in a position to start certain cottage and small-scale industries of their own choice, especially at the
village level.

As regards the problem of educated unemployment in urban areas, India should reconstruct the education system and
overhaul according to the changing environment of the country.
Extension of Social Services

India is still lagging behind in the sphere of education, medical science, and other services, when
compared to the advanced countries of the West. Therefore, efforts should be made to extend these
services to rural folks and to the backward regions of the country. It will go a long way to impart
awakening among the common masses.
Decentralisation
Experience shows that lack of gainful opportunities of employment in villages and small towns has
led to the migration of people to metropolitan cities in search of alternative jobs. This has created the
problem of overcrowdedness and urbanisation. Under these circumstances, it is advisable to
encourage industries around small towns, preferably, according to the local endowments.

It is advisable to encourage industries around small towns, preferably, according to the local endowments.
Encouragement of Small Enterprises

To provide the opportunities for self-employment, small-scale industries should be given top priority.
They should be provided with liberal loans, training, facilities of raw material and infrastructures,
and market facilities, and so on. It is fortunate that the Sixth Five-Year Plan (1980–85) had given due
consideration to dispel these facilities under the scheme of self-employment. Similar steps had been
proposed in the Eighth Five-Year Plan and in the successive plans, these steps were carried out and
small-scale industry development has been given encouragement to provide opportunity for self-
employment.

To provide the opportunities for self-employment, small-scale industries should be given top priority.
Guiding Centres and More Employment Exchanges

The economists are of a unanimous view that more employment exchanges should be opened in both
rural as well as urban areas to give guidance to the people to search for employment. They should
also be motivated for self-employment proposals.
Rural Development Schemes
As rural sector is dominated and agriculture is the basic occupation of the people, the urgent need of
the hour is to introduce rural development schemes. It is correctly believed that there is no other
remedy than a massive programme of investment, in rural development and massive injection of
science and technology, into the methods of production followed in the rural areas, in their
agricultural and non-agricultural activities.

As rural sector is dominated and agriculture is the basic occupation of the people, urgent need of the hour is to introduce
rural development schemes.
GOVERNMENT POLICY MEASURES TO REDUCE UNEMPLOYMENT
National Rural Employment Programme

The National Rural Employment Programme was started as a part of the Sixth Plan and remained
continued under the Seventh Five-Year Plan. It envisages to create employment opportunities of the
order of 300 million to 400 million man-days every year. It aims to provide employment in the lean
agricultural season. During the Seventh Plan, the outlay for this programme was targeted at Rs 3,092
crore and it created 1,477 million man-days.

It aims to provide employment in the lean agricultural season.
Rural Landless Employment Guarantee Programme

Rural Landless Employment Guarantee Programme (RLEGP) was started in 1983. The basic
objective of the programme was (a) to improve and expand employment opportunities for rural
landless workers and (b) to strengthen the rural infrastructure. During the Seventh Five-Year Plan,
about 1,154 million man-days of employment were created under this programme.

The basic objective of the programme was to improve and expand employment opportunities for rural landless workers.
Integrated Rural Development Programme

The Integrated Rural Development Programme aims at to raise the poor people above the poverty
line. It was expected to cover 18 million families in all the blocks of the country during the Seventh
Plan. On an average, about 3,000 families in a block were provided assistance through this
programme.

The Integrated Rural Development Programme aims at to raise the poor people above the poverty line.
Food-for-work Programme
This programme was started in 1977. Its objectives were to generate employment, have improvement
in income, create durable community assets, and strengthen the rural infrastructure. This scheme was
directly beneficial to the poor people. According to an estimate, the scheme was to generate an
additional employment of 40 crore man-days in a year.

Its objectives were to generate employment, have improvement in income, create durable community assets, and strengthen
the rural infrastructure.
Training Rural Youth for Self-employment

The TRYSEM or Training Rural Youth for Self-employment was started in 1979 with the objective of
removing unemployment among the rural youth. It aimed to provide training to about two lakh rural
youth every year, so that they may be self-employed. Under this scheme, 40 youths were selected
from each block. In the selection process, selection, members of SC/ST were given preference. Under
the scheme, a minimum of 331/3 per cent of rural youth trained were to be women. During the Seventh
Plan 10 lakh rural youth received training under TRYSEM.

The TRYSEM or Training Rural Youth for Self-employment was started in 1979 with the objective of removing
unemployment among the rural youth.
Operation Flood II
This programme is expected to benefit eight million milk-producing families. The other Dairy
Development Schemes would benefit about five million additional families.
Employment Guarantee Scheme

This scheme was started by the Government of Maharashtra in 1972–73. It provides gainful and
productive employment to the rural unskilled labour by raising durable community assets like roads,
canals, and so on. The scheme provides right to work at a wage of Rs 6 per day. Similar schemes have
been started in Tamil Nadu, Gujarat, Andhra Pradesh, Madhya Pradesh, and Karnataka.

It provides gainful and productive employment to the rural unskilled labour by raising durable community assets like roads,
canals, and so on.
Jawahar Rozgar Yojana
Jawahar Rozgar Yojana (JRY) was started in 1989–90. Its aims are to generate additional employment
by taking up productive works in rural areas. During the Seventh Plan, it had generated 3,497 million
man-days of employment.

Its aims are to generate additional employment by taking up productive works in rural areas.
Nehru Rozgar Yojana

Nehru Rozgar Yojana was started in October 1989. It consists of three sub-schemes, viz., Scheme of
Urban Micro-Entreprises (SUME), Scheme of Urban Wage Employment (SUWE), and Scheme of
Housing and Shelter Upgradation (SHASU). In 1991–92, 1.59 lakh families were assisted under
SUME and 13 million man-day of employment were generated under SUME and SHASU.
Minimum Needs Programme

The various components of the minimum needs programme are meant to create substantial additional
employment in the infrastructure and social services in the rural areas.
OVERVIEW OF UNEMPLOYMENT AND UNDEREMPLOYMENT
Unemployment
The economic reforms may have given a boost to industrial productivity and brought in foreign
investment in the capital-intensive areas. But the boom has not created jobs. This was not unexpected.
According to a report by the Washington-based Institute of Policy Studies (IPS), the combined sales
of the world’s top 200 MNCs is now greater than the combined GDP of all but the world’s nine largest
national economies. Yet, the total direct employment generated by these multinationals is a mere 18.8
million—one-hundredth of one per cent of the global workforce.
India’s Ninth Five-Year Plan projects a generation of 54 million new jobs during the Plan period (1997–2002). But the
performance has always fallen short of the target in the past, and few believe that the current Plan will be able to meet its
target.
India’s labour force is growing at a rate of 2.5 per cent annually, but employment is growing at only 2.3 per cent. Thus, the
country is faced with the challenge of not only absorbing new entrants to the job market (estimated at seven million people
every year), but also clearing the backlog.
About 60 per cent of India’s workforce is self-employed, many of whom remain very poor. Nearly 30 per cent are casual
workers (i.e., they work only when they are able to get jobs and remain unpaid for the rest of the days). Only about 10 per cent
are regular employees, of which two-fifths are employed by the public sector.
More than 90 per cent of the labour force is employed in the “unorganised sector”, that is, sectors which do not provide the
social security and other benefits of employment in the “organised sector”.
In the rural areas, agricultural workers form the bulk of the unorganised sector. In urban India, contract and sub-contract as well
as migratory, agricultural labourers make up for most of the unorganised labour force.
The unorganised sector is made up of jobs in which the Minimum Wage Act is neither, or only marginally, implemented. The
absence of unions in the unorganised sector does not provide any opportunity for collective bargaining.
Over 70 per cent of the labour force in all sector combined (organised and unorganised) is either illiterate or educated below
the primary level.
The Ninth Plan projects a decline in the population growth rate to 1.59 per cent per annum by the end of the Ninth Plan, from
over 2 per cent in the last three decades. However, it expects the growth rate of the labour force to reach a peak level of 2.54
per cent per annum over this period; the highest it has ever been and is ever likely to attain. This is because of the change in age
structure, with the highest growth occurring in the age group of 15–19 years in the Ninth Plan period (refer to Table 12.5).
The addition to the labour force during the Plan period is estimated to be 53 millions on the usual-status concept. The
acceleration in the economy’s growth rate to 7 per cent per annum, with a special emphasis on the agriculture sector, is expected
to help in creating 54 million work opportunities over the period. This would lead to a reduction in the open unemployment rate
from 1.9 per cent in 1996–97 to 1.47 per cent in the Plan’s terminal year, that is, by about a million persons—from 7.5 million to
6.63 million.
In other words, if the economy maintains an annual growth of 7 per cent, it would be just sufficient to absorb the new additions
to the labour force as shown in the following table. If the economy could grow at around 8 per cent per annum during the Plan
period, the incidence of open unemployment could be brought down by two million persons, thus attaining nearly full
employment by the end of the Plan period, according to the Plan. The trends in the labour-force participation rates are shown in
Table 12.6.
However, there appears to be some confusion about the figure of open unemployment. The unemployment figure given in the
executive summary of the Ninth Plan, gives the figure of open unemployment at 7.5 million, while the annual report of the
Labour Ministry, for 1995–96, puts the figure for 1995 at 18.7 million. An internal government paper prepared in 1997 put the
unemployment figure at the beginning of the Eighth Plan at 17 million and at 18.7 million at the end of 1994–95. Perhaps, the
Planning Commission referred to the current figure while the Labour Ministry figure referred to the accumulated unemployment
backlog.
The economic reforms may have given a boost to industrial productivity and brought in foreign investment in the capital-
intensive areas. But the boom has not created jobs.
Sector-wise Absorption of Labour (%)

Agriculture 62
Manufacturing and construction 16
Services 10
Sundry/miscellaneous jobs 12

Table 12.5 Age Structure of Population: 1997–2002
Ag e g roup 1997 (%) 2002(%)

0–14 37.23 33.59
15–59 56.07 59.41
60+ 6.70 7.00

Table 12.6 Trends in Labour-force Participation Rates (per thousand of population)
Notes: Constituent shares in labour force in 1993–94 are rural Male, 0.499; rural female, 0.270; urban male, 0.182; and urban female,
0.049.

Underemployment
Open unemployment is not a true indicator of the gravity of the unemployment problem in an economy such as India,
characterised, as it is, by large-scale underemployment and poor employment quality in the unorganised sector, which accounts
for over 90 per cent of the total employment. The organised sector contributes only about 9 per cent to the total employment.
Underemployment in various segments of the labour force is quite high. For instance, though open unemployment was only 2 per
cent in 1993–94, the incidence of underemployment and unemployment taken together was as much as 10 per cent that year.
This is in spite of the fact that the incidence of underemployment was reduced substantially in the decade ending 1993–94.
According to the Planning Commission, the states which faced the prospect of increased unemployment in the post-Ninth Plan
period (2002–2007) were Bihar, Rajasthan, Uttar Pradesh, Kerala, and Punjab.
For a picture of participation in labour force on the basis of age group and sex, Table 12.7 is evident.
Table 12.8 shows details on labour-force projections by age groups. Whereas Table 12.9 details on
population and labour force between 1997 and 2012, Table 12.10 projects on the work opportunities
between 1997 and 2002. Finally, Table 12.11 explains population, labour force, and employment
between 1978 and 2007.

Table 12.7 Participation in Labour-force by Age Group and Sex: 1997–2012 (per thousand of population)
Note: (a) No change in labour-force participation in the age groups above 20 years.

Table 12.8 Labour-force Projections by Age Groups.

Table 12.9 Population and Labourforce: 1997–2012 (million—April 1)

Table 12.10 Projections of Work Opportunities, 1997–2002

Table 12.11 Population, Labour-force, and Employment (million)
Notes:
1. Estimates of labour force and employment are on usual-status concept and pertain to 15 years and above.
2. Figures in brackets are compound growth rates in the preceding period.
a As on January 1.
b As on July 1.
c Population at the terminal year of the plan.
d Required to attain near full employment.
e Unemployment reduces to negligible level by the year 2007.
f Labour-force, employment, and unemployment are stated as annual averages during the Plan period.
CASE
Literate State with the Highest Unemployment

The state with the highest literacy rate—almost 97 per cent—has the highest unemployment rate too,
when compared to the other states in India. That state is none but our neighbour, Kerala.
Kerala is known for a large-scale migration of skilled labour to other states and countries.
What ails the state that has such a high literacy rate and is also blessed by vast natural resources to
have the highest unemployment rate in the country?
No industrialist wants to set up any industry in Kerala due to labour problems. The state is
bankrupt, besides being corrupt and largely politicised. Trade unionism is still alive in Kerala.
One important feature of the Kerala economy, which makes it different from the rest of the country,
is the net out-migration of the labour force, particularly, to Gulf and the inflow of huge remittances
into the economy. The Centre for Development Studies (CDS) has been doing an interesting work on
emigration and the impact of NRI remittances on Kerala’s economy. Kerala vitally depends on the
transfers only—$5.8 bn in 2007 or 20.2 per cent of net state domestic product—from its Diaspora
overseas. CDS has now scaled up its efforts statewide through its regular Migration Monitoring
Studies (MMS).
The latest MMS 2007 round data indicated stability in Kerala’s migration pattern. The number of
emigrants (18.5 lakh), return emigrants (8.9 lakh), non-resident Keralites (27.3 lakh), and the
proportion of households with a non-resident Keralite (25.8 per cent) has remained virtually the same
since 2003.
Emigration has had a major impact on the labour market of a state that has, perhaps, the highest
unemployment rate (12.2 per cent) in India. If among the unemployed, the emigration rate is as high
as 43.5 per cent, the process of going abroad for work lowers Kerala’s unemployment rate than it
would otherwise have been. Inspite of the fact that a large section of the population has migrated out
to Gulf, and elsewhere, for jobs, the rate of unemployment here is way above the all-India average.
Instead of migrating to other states for jobs, Keralites should use their knowledge and expertise in
establishing new productive activity on their own. Many of them should look at self-employment for
overcoming the serious problem of unemployment.
As on September 30, 2006, there were close to 40 lakh registered job seekers in the Live Register
of Employment Exchanges in Kerala. This constituted about 46 per cent of the state’s population in the
age group of 19–29. Of the total number registered, 58 per cent are females. There are few illiterates
among Kerala’s unemployed, while the largest number of job seekers boasted academic qualification
up to the matriculation level.
Kerala’s unemployment problem is not only a serious problem of educated unemployment but also
a substantial portion of this problem is simple unemployment of low-skilled workers. The population
in the productive age group (15–29 years) in Kerala was 201.83 lakh (2001 Census) and they are the
work seekers. The problem of unemployment in Kerala is very acute and has been worsening over
time. The worsening unemployment situation is obviously related to the inability of the economy of
the state to generate any fresh employment during the last decade or so, particularly, after the advent
of liberalisation in the country. While this phenomenon of “jobless growth” is observable in all the
states in the country, the situation in Kerala appears to be particularly distressing in this regard. The
growth rate in employment during the period 1993–94 and 1999–2000 in Kerala was a meagre
number of 0.07 per cent per annum.
The problem of “simple unemployment” (unemployment of simple, low-skilled labour) is also
quite significant in Kerala. The National Rural Employment Guarantee Scheme, under the NREG Act,
2005, is aimed at enhancing the livelihood security in the rural areas. National Rural Employment
Guarantee Act (NREGA) is being implemented in Wayanad and Pallakad districts of Kerala, which is
a right-based constitutional approach. The Registration of rural unemployed has already begun in
Wayanad and Palakkad districts under the scheme.
It is clear that the problem of unemployment is not just one of unemployment among the educated
youth. The unemployment and underemployment among workers in the traditional sectors like
agriculture and household industries are indeed major concerns. One of the most important groups of
such workers is the traditional agricultural workers. According to the 2001 Census, the number of
agricultural workers in Kerala was around 16.20 lakh and this is more than twice, the number of
cultivators (7.20 lakh) and more than four times, the number in the household industry (3.70 lakh).
About three-fourth of workers in the household industry are in rural areas and close to half of them
are female workers. The unemployment rate among the youth and females is also found to be high.
The Department of Employment operates about 96 institutions and they provide placement service,
vocational guidance, employment-market information, self-employment guidance, unemployment
assistance, and self-employment scheme for the registered unemployed. But these services have been
considered inadequate to tackle the problem of unemployment in the state, since most of the
unemployed do not possess marketable skills, and this reduces their employ-ability. This would call
for a convergent action by the Employment Department and Industrial Training Department.
Internal migration has also made a difference to the overall joblessness. Simultaneously,
employment also had significantly increased by over 3 lakh persons during 2003–2007, with a 100
per cent increase in the private sector employment and a 20 per cent increase in the self-employment.
But the biggest message of MMS 2007 is the shift from remittance-based consumption to
remittance-based investments as the key driver of Kerala’s growth. In the early years of large-scale
emigration, Gulf remittances went into subsistence, children’s education, and housing. The return
emigrants, then, also lacked the educational background or the know-how to start any businesses. But
times are changing, as more than a million emigrants have returned with their accumulated savings
and are ready to invest. Note that only less than 2 per cent of the surveyed households used
remittances for starting a business.
Much, of course, depends on the investment environment in the state, which determines how
productively resources can be used. Unfortunately, Kerala is a laggard on this, in contrast to the
experience of investment-friendly states like Tamil Nadu and Karnataka, which have harnessed
resources from their non-residents and returned emigrants rather well.
Case Questions
1. What are the reasons for unemployment in Kerala inspite of having a 97-per cent literacy?
2. Do you think emigration is a major reason for the unemployment in Kerala?
3. Migration of labour force is the highest in Kerala, to Gulf or any other state of the country. How can this feature of Kerala
economy be used positively for generating employment in Kerala?
KEY WORDS
Cyclical Unemployment
Open Unemployment
Disguised Unemployment
Underemployment
Usual Principal Status (UPS)
Current Daily Status (CDS)
National Commission for Enterprises in the Unorganised Sector (NCEUS)
Organised Sector Employment
Explosive Population Growth
Inadequate and Defective Employment Planning
Capital-intensive Techniques
Labour-intensive Techniques
Population Control
Decentralisation
QUESTIONS
1. Discuss the nature and extent of unemployment in India.

2. Unemployment problem in India is primarily a problem of structural unemployment. Do you agree?
3. What are the causes of unemployment in India? What measures would you recommend to solve the problem?
4. Economic planning has not been able to solve the problem of unemployment. Explain?
5. Unemployment is a chronic problem, which needs structural transformation of the economy. To what extent do economic
reforms help to solve the problem?
REFERENCES

Eleventh Plan Document of Planning Commission of India.
NSS surveys’ various rounds.
www.wikipedia.com (the free encylopedia).
CHAPTER 13
Inflation
CHAPTER OUTLINE
Meaning and Definition of Inflation
Features of Inflationary Economy
Measures of Inflation
Inflation and Developing Economies
Demand-pull vs Cost-push Inflation
Causes of Inflation
Effects of Inflation
Global Inflation and India
Case
Key Words
Questions
References
MEANING AND DEFINITION OF INFLATION
“Inflation” is commonly understood as a situation of substantial and rapid general increase in the
level of prices and consequent deterioration in the value of money over a period of time. The
behaviour of general prices is measured through price indices. The trend of price indices reveals the
course of inflation or deflation in the economy. As Lerner says, “a price rise which is unforeseen and
uncorrected is inflationary”.

“Inflation” is commonly understood as a situation of substantial and rapid general increase in the level of prices and
consequent deterioration in the value of money over a period of time.
Thus, inflation is statistically measured in terms of percentage increase in the price index, as a rate
per cent per unit of time—usually a year or a month. Generally, the wholesale price index (WPI)
numbers are used to measure inflation. Alternatively, the consumer price index (CPI) or the cost of
living index number can be adopted in measuring the rate of inflation.
Inflation is like an elephant to the blind men. Different economists have defined inflation
differently. We may, thus, enlist a few important definitions of inflation as follows, which would give
us a comprehensive idea about this intricate problem.
Harry Johnson defines inflation as a “sustained rise in prices”. Crowther, similarly, defines
inflation as “a state in which the value of money is falling, that is, prices are rising”. The common
feature of inflation is a price rise, the degree of which may be measured by price indices. Edward
Shapiro puts it thus: “Recognising the ambiguities our words contain, we will define inflation simply
as a persistent and appreciable rise in the general level of prices”.

The common feature of inflation is a price rise, the degree of which may be measured by price indices.
Prof. Samuelson puts it thus: “Inflation occurs when the general level of prices and costs is rising”.
Authors like Thorp and Quandt, however, opine that it is of great help to define inflation in terms of
observable phenomenon and, for this reason, the process of rising prices should be considered as
inflation. There are, at least, two distinct views on the concept of inflation. To some economists,
inflation is a pure monetary phenomenon, while to others it is a post-full-employment phenomenon.
FEATURES OF INFLATIONARY ECONOMY
The following are the strategic features of an inflationary economy:
1. There is a continuously rising price trend, whether it is measured through WPI or CPI.
2. The money supply is in excess of the requisite production and exchange needs of the economy. There is an undeserving excess
of monetary liquidity adding fuel to the fire.
3. There is an over-expansion of credit by the banks.
4. A good part of the flow of credit is supplied to unproductive channels, speculative activities, and sick and non-viable units of
production. In many cases, there is no direct relation between the bank loans and the physical capacities of the enterprises.
5. There is a lack of financial discipline on the part of the government. The budget is usually large with huge deficits on the revenue
and capital account.
6. A large number of commodities are in short supply paving ways for the sectoral price disequilibrium.
7. Artificial scarcity is commonly caused by hoarding activities and has become conspicuous for traders, producers, and consumers.
8. The rate of return of speculative hoarding of commodities, precious metals like gold and silver, and investments in immovable
properties—land, buildings, flats, and so on, are much high and fascinating than the rate of returns on the shares and bonds in an
inflationary economy.
9. Interest rates in the unaccounted and unorganised sectors tend to be higher than the organised sectors of the money market.
10. Labour unrest, strikes, lock-outs, and so on, are common. Organised labour force successfully resists any reduction in the real
wages and pushes up the money-wages, thereby, accelerating the process of cost-push inflation.
11. In an inflationary economy, the government is trapped in the cobweb of an ever-increasing public expenditure, larger budgets,
higher taxes, larger public debts, huge deficit financing, and a large number of controls, which, in turn, encourage black money
and dual accounting system, black marketing, smuggling, and other antisocial activities on account of the deterioration of the
community’s morals, in general, caused by the inflationary impact.
In short, an economy is inflationary because it is inflationary. There tends to be a vicious circle of

inflation when it is curbed immediately. In the long period, the state of unchecked inflation becomes a
built-in feature of the economy and people expect the rate of inflation to accelerate further.
MEASURES OF INFLATION
Prices as Measures of Inflation
It is well recognised that inflation in India is a structural as well as a monetary phenomenon. In the
short term, the localised demand—supply imbalances in wage goods, often due to seasonal variations
in production—coupled with market rigidities and regulatory failures have supported inflationary
expectations that have resulted in a more widespread impact, than the initial inflationary impulse, on
the consumers. In the medium to long term, the movement and outcome of monetary aggregates, such
as the money supply and reference interest rates of the financial systems, have influenced aggregate
demand and consequently, changes in the price levels in the economy. The latter considerations and
the influence of global commodity prices on the domestic prices have become more important with
the opening and growing integration of the Indian economy with the rest of the world. Indeed, the
fiscal year (FY) 2007–08 has demonstrated this facet of the economy more than ever before. With a
huge surge in capital inflows, the liquidity management with its underlying implications for inflation
has been a major challenge for the policymakers.
The WPI, which is available on a weekly basis, continues to be the most popular measure of
headline inflation in India. There are, however, four Consumer Price Indices (CPIs) that are specific
to different groups of consumers. The commodity basket for these indices is derived on the basis of
group-specific consumer expenditure surveys, and weights to each commodity are proportionate to
its expenditure. WPI is an economy-wide index covering 435 commodities. Weights of the
commodities are derived based on the value of quantities traded in the domestic market. It is,
therefore, the most comprehensive measure of economy-wide inflation available with high frequency.
The four CPIs are as follows: CPI-IW for industrial workers; CPI-UNME for urban non-manual
employees; CPIAL for agricultural labourers; and, CPI-RL for rural labourers. CPI-IW is the most
well known of these indices as it is used for wage indexation in the government and organised
sectors. CPIs are compiled in terms of general standards and guidelines set by the International
Labour Organization (ILO) for its member countries.

The WPI, which is available on a weekly basis, continues to be the most popular measure of headline inflation in India.
There are, however, four Consumer Price Indices (CPIs) that are specific to different groups of consumers.
Inflation in terms of the wholesale prices started firming up from June 2006. This owed
substantially to an increase in the prices of wheat, pulses, and edible oils in the “primary articles”
group and mineral oils in the group “fuel and power”. The increase in the international price of crude
(Brent) from an average of US$38 bn in 2004 to US$54 bn in 2005, and further to US$70 bn during
April-June 2006, necessitated an upward revision in the prices of petrol and diesel in the domestic
market. The price of petrol and diesel was raised by Rs 4 per litre and Rs 2 per litre, respectively, with
effect from June 6, 2006. However, the pass-through to the consumers was restricted to 12.5 per cent
with the rest being absorbed by the government, the upstream companies, and the oil-marketing
companies. With softening of the international price of crude oil in the later months of 2006 and early
2007, the domestic prices of petrol and diesel were reduced on November 30, 2006, and February 16,
2007 to their pre-June 6, 2006 levels. The increase in the prices of wheat, pulses, and edible oils was
largely because of the shortfall in the domestic supply relative to demand and firm international
prices. The wholesale prices reached a peak of 6.6 per cent in March 2007 and started decelerating
thereafter.
The fiscal, administrative, and monetary measures which were taken in the beginning of June 2006,
together with improved availability of wheat, pulses, and edible oils, started working through in
terms of a decline in the inflation. Headline inflation declined gradually from April 2007 onwards to
reach 3.6 per cent in December 2007. With a decline in the prices of primary articles, deceleration
was also observed in CPI. The decelerating trend in CPIs became apparent from September 2007 and
in the next four months, the decline ranged from 1.3 percentage points (CPI-UNME) to 2.9 percentage
points (CPI-AL). The year-on-year (y-o-y) inflation remained generally high for CPI-AL and CPI-RL,
as food articles have relatively high weights in these indices. But with a deceleration in the inflation
of primary articles, the decline in inflation was manifested in all these indices (refer to Table 13.1 and
Figure 13.1).
WPI—General Trends
WPI recorded an inflation of 3.9 per cent, on January 19, 2008, down sharply from the 6.3 per cent
inflation rate a year ago. Build-up of inflation in the current FY (from end-March 2007 to January
2008) at 3.2 per cent was also significantly lower than the inflationary build-up of 5.9 per cent in the
corresponding period of the previous year (refer to Table 13.2 and Figure 13.2). All the three major
components of the WPI, viz., “primary articles”, “fuel, power, light, and lubricants” and
“manufactured products” showed a deceleration in the annual inflation during 2007–08. There was a
sharp deceleration in the inflation of primary articles to 3.8 per cent on January 19, 2008, when
compared to 10.2 per cent, a year ago. These commodities contributed about 22 per cent to the overall
inflation as against 35.4 per cent in the previous year. For primary articles, the year 2007–08 began
with a y-o-y inflation of 12.2 per cent as on April 7, 2007, but this decelerated gradually to reach the
current levels. Further, the overall build-up of inflation in the first 10 months (42 weeks) of the
current FY was 3.2 per cent, contributing 22.7 per cent to the overall inflation. The corresponding
inflation in 42 weeks of 2006–07 (up to January 20, 2007) was 11 per cent. The primary articles were
the major drivers of inflation in 2006–07 and were also the major contributors to the decline in
inflation in 2007–08.

All the three major components of the WPI, viz., “primary articles”, “fuel, power, light, and lubricants” and “manufactured
products” showed a deceleration in the annual inflation during 2007–08.
The primary articles were the major drivers of inflation in 2006–07 and were also the major contributors to the decline in
inflation in 2007–08.

Table 13.1 Annual Inflation as per Different Price Indices (%)*
Source: Economic Survey 2007–08, Government of India.
*Monthly averages.

Fig ure 13.1 Annual Inflation as per Different Price Indices (%)
Source: Business Line, April 8, 2008.

Fuel, power, light, and lubricants seemed to be emerging as a major contributor of inflation in
2007–08, with a FY inflation rate of 4.5 per cent and a contribution of 30.4 per cent, which is more
than twice its weight of 14.2 per cent in the index (refer to Table 13.2). In the case of fuel and power,
with the prices of petrol and diesel being administratively kept constant at the February 16, 2007 level,
this component of inflation remained low during 2007–08. Annual inflation remained negative from
June 9, 2007 to November 10, 2007. Although the increase in the prices of other commodities in this
group continued to push up the index from 320.1 at end-March 2007 to 326.5 as on November 10,
2007, the base effect kept the inflation negative. Inflation increased in the later months to reach 3.9 per
cent on January 19, 2008, higher than the inflation on the same date in the earlier year. The
contribution of this group to overall inflation also remained negative till November 2007 and started
increasing thereafter. Annual inflation has been on a clear uptrend since October (refer to Figure
13.2) because the sharply rising fuel prices have been passed through the items that are free of
control.

Table 13.2 Inflation as on January 19, 2008, in Major Groups (%)

Fig ure 13.2 Annual Inflation in WPI (major groups)

In the case of “manufactured products”, y-o-y inflation, as on January 19, 2008, was 3.9 per cent
when compared to 5.9 per cent in the corresponding period of 2006–07. The manufactured products,
with a weight of 63.8 per cent in WPI, contributed 55.2 per cent of the y-o-y inflation, which is not
significantly higher than their contribution in the previous year. In the financial year so far, the build-
up of inflation was 2.7 per cent only, as the annual manufactured goods inflation has been
decelerating since it peaked in February 2007 (refer to Figure 13.2).
Wholesale Prices—Primary Articles
Primary articles are further sub-grouped as food articles, non-food articles, and minerals. In the case
of food articles, y-o-y inflation decelerated to 2.1 per cent as on January 19, 2008. Food articles
contributed about 8.5 per cent to the overall inflation and their share in the inflation of primary
articles was 38.4 per cent. The value of the index of the food articles, however, continued to show an
upward trend till September 2007 and a decline thereafter. In the current FY so far, food articles with
an inflation of 2.7 per cent contributed 13.1 per cent to the overall inflation. Within food articles, milk
recorded an inflation of more than 6 per cent. In case of “condiments and spices”, while the annual
inflation as on January 19, 2008, was negative, the build-up of inflation in 42 weeks of the current FY
was 5.1 per cent. The index of “condiments and spices”, after a decline between the period February
2007 and May 2007, witnessed an increase, making what was earlier a negative point-to-point
inflation into a positive build-up in inflation in the current FY. However, both on y-o-y basis and in
terms of build-up, inflation in the current FY remained lower than in the previous year. In the non-
food articles, inflation was significantly higher for fibres, particularly cotton. Oilseeds and other
non-food crops (sugarcane) witnessed a deceleration in inflation. A deceleration in the inflation in
minerals was also significant. The level of prices for minerals, as reflected by the value of the index,
after reaching a level of 453.5 (1993–94=100) on May 19, 2007 declined to 424.7 on September 1,
2007, and remained at that level till January 19, 2008. The build-up of inflation, therefore, remained
moderate (refer to Table 13.3).

The value of the index of the food articles, however, continued to show an upward trend till September 2007 and a decline
thereafter. In the current FY so far, food articles with an inflation of 2.7 per cent contributed 13.1 per cent to the overall
inflation. .
The y-o-y inflation in the primary articles was the highest in April 2007. However, there was a
significant deceleration since July 2007. Between July 28, 2007 (10.5 per cent) and January 19, 2008,
inflation in primary articles declined by 665 basis points. The y-o-y inflation was negative for fruits
and vegetables; eggs, meat and fish; condiments and spices; and other non-food articles. With a
deceleration in the inflation of primary articles, contribution of these articles to overall inflation
declined from 51.8 per cent, as on July 7, 2007, to 22.0 per cent (refer to Table 13.3). All the three
components of primary articles—food, non-food, and minerals—contributed more than
proportionately to acceleration in inflation during 2006–07, and all the three contributed (more or
less in equal proportion) to the decline in the primary articles and overall inflation in 2006–07.

The y-o-y inflation in the primary articles was the highest in April 2007. However, there was a significant deceleration since
July 2007.
Wholesale Prices—Fuel and Power
In the major group “fuel and power”, the index of petrol, diesel, kerosene, and liquefied petroleum
gas (LPG) remained at the February 17, 2007 levels as there was no change in the administered prices
of these products. Stable prices of petroleum products also exerted a significant neutralising influence
on the overall inflation. The other products in the mineral oil group, particularly naphtha, bitumen,
furnace oil, and aviation turbine fuel (ATF), were not covered by the “price freeze”. However, since
these products had a smaller weight in the overall basket of the WPI, an increase in the prices of these
products only moderately affected the level of prices in the fuel and power group. Further, there was
no increase in the prices of coal until December 2007. The WPI of coal, after remaining unchanged
from February 2005 to December 2007, moved upwards in the first week of January 2008 after a
revision in its prices. The index for electricity also remained stationary since May 2007 indicating a
stable price regime. As a result of the upward revision of coal prices and the increase in the prices of
mineral oils, that is, products not covered by the administered prices, inflation of this group increased
to 3.9 per cent as on January 19, 2008. Coal mining had an inflation of 8.8 per cent followed by
mineral oils with an inflation of 5.8 per cent. The contribution of mineral oils to the overall inflation
was 18.8 per cent. The inflation of the subgroup “mineral oils” in the current FY (over end-March
2007) was 6.2 per cent when compared to 1.2 per cent in the previous year. Mineral oils contributed
nearly a quarter to the total build-up of inflation in the current year (refer to Table 13.4).

Stable prices of petroleum products also exerted a significant neutralising influence on the overall inflation.

Table 13.3 Inflation as on January 19, 2008, in Primary Articles (%)

Wholesale Prices—Manufactured Products

In the case of manufactured products, the increase in the prices was generally moderate. The y-o-y
inflation, as on January 19, 2008, continued to show deceleration for many product groups within the
manufacturing sector. An increase in the rate of inflation was observed for food products, beverages
and tobacco, wood products, leather products, chemicals and chemical products, and transport
equipments. In the case of textiles, the level of index declined and inflation turned negative in
September 2007 and remained so in the next four months. In the case of basic metals, inflation
substantially moderated from 13.9 per cent, as on January 20, 2007, to 2.7 per cent. The build-up of
inflation for metal products, over end-March 2007 at 2.4 per cent, was significantly lower.
International prices of metals also witnessed deceleration during this period and deceleration in the
domestic inflation was keeping with the global trend (refer to Table 13.5).

In the case of manufactured products, the increase in the prices was generally moderate. The y-o-y inflation, as on January
19, 2008, continued to show deceleration for many product groups within the manufacturing sector.
It has been observed, generally, that for most of the products the inflation is usually high in the first
and second quarter of the year. Cumulative increase in the prices in the first half of the years 2005–06,
2006–07, and 2007–08 were 4 per cent, 5.5 per cent, and 2.5 per cent, respectively. In the second half
of these years, this increase was only -0.2 per cent, 1 per cent, and 0.4 per cent, respectively. Although
it was hypothetical to say whether this trend would be observed in the last quarter of 2007–08 also, the
indications were that the build-up of inflation in the second half except for the group “fuel and
power” may remain moderate (refer to Table 13.6).

It has been observed, generally, that for most of the products the inflation is usually high in the first and second quarter of
the year.
Broadly, seven commodity groups were the major contributors to inflation. The overall
contribution of these seven commodity groups averaged 82 per cent between April 2006 and
December 2007. The overall contribution increased from 75 per cent in 2006–07 to 92 per cent in
about nine months of the current year. The acceleration in the rate of inflation during January-April
2007 was associated with an increasing contribution of food articles, edible oils (including oilseeds
and oilcake), and metals. A decline in the contributionofmetals (from July2007 onwards), mineral oils
(negative contribution from May 2007 to October 2007), and food articles (October 2007 to
December 2007) to the overall inflation, resulted in deceleration in the inflation rate in the subsequent
months (refer to Table 13.7). The commodity composition of main drivers of inflation in the recent
months indicates that domestic inflation has been affected by global commodity price changes
(metals, mineral oils, edible oils, and food items), domestic supply shortfalls (edible oils and food),
and a buoyant demand (machinery, chemicals, and cement). There are also spillover effects due to
inter-linkages of commodities.

Table 13.4 Inflation as on January 19, 2008, in Fuel Group (%)

Table 13.5 Inflation, as on January 19, 2008, in Manufactured Goods (%)

Table 13.6 Cumulative Movement in WPI (%)

Table 13.7 Inflation as on January 19, 2008, in Essential Commodities (%)

Fig ure 13.3 Essential Commodities Index and Annual Inflation (%)

WPI—Essential Commodities
About 30 commodities within the WPI have been identified as essential commodities. These
commodities are broadly grouped into seven categories: cereals and their products; pulses; edible
oils; vegetables and spices; dairy, fisheries, and animal products; tea, sugar, gur, and salt; and other
essential commodities. Nearly 16 of these 30 commodities are primary articles, 12 are manufactured
products, and 2 belong to fuel-and-power group. These commodities together have a weight of 17.6
per cent in the WPI and also figure in the consumption basket of CPI-IW (refer to Table 13.6 and
Figure 13.3).

About 30 commodities within the WPI have been identified as essential commodities.
Nearly 16 of these 30 commodities are primary articles, 12 are manufactured products, and 2 belong to fuel-and-power
group.
The overall level of prices as reflected in the value of the composite index of the 30 commodities
continued to show a moderate increase from 201.4 as on April 7, 2007 (1st week of 2007–08) to 207
as on January 19, 2008. The y-o-y inflation, however, moderated from 3.4 per cent in the first week of
2007–08 to 2.5 per cent in the 42nd week, indicating a deceleration of 89 basis points. Inflation was
also significantly lower when compared to 4.8 per cent as on January 20, 2007. The rate of inflation,
however, differed across the seven groups by a wide margin. In case of pulses and “tea, sugar, gur,
and salt”, the index witnessed a decline in the current financial year, with inflation measured either on
y-o-y basis or as a build-up during the current FY so far turning negative. The deceleration in
inflation was also significant for cereals (including atta) and edible oils. The fiscal and administrative
measures (reduction in customs duty on edible oils, import of wheat, and pulses through PSUs [public
sector units] to increase the domestic availability and a strict vigil on prices of these products)
contributed to this deceleration in inflation. The value of index for the other essential commodities,
mainly the manufactured products and two products of the fuel group, remained stable throughout
these 10 months. In case of “vegetables and spices”, an increase in index up to October 2007 was
primarily because of an increase in the prices of onions. With a deceleration in the prices of onions in
the later months, there was also a moderation in the index and inflation rates.
A deceleration in the y-o-y inflation for the 30 essential commodities was both on account of base
effect and also because of a decline in the index for pulses and “tea, sugar, gur, and salt”. The
inflation of 30 essential commodities in the current year also remained lower than the overall WPI
inflation. The essential commodities contributed about 11 per cent of the overall inflation, as on
January 19, 2008, when compared to a contribution of 13.3 per cent in the corresponding period of
2006–07.
Essential Commodities—Retail Prices
The Department of Consumer Affairs monitors the prices of 16 essential commodities at selected
centres throughout the country. These commodities witnessed wide fluctuations in y-o-y inflation in
the last five years. In 2007–08 (measured as an increase in prices as on January 16, 2008 over January
17, 2007), however, nine of these commodities witnessed a deceleration in inflation, when compared
to a deceleration in prices of four commodities in the previous year (refer to Table 13.8). Highest
inflation of 28.5 per cent was recorded for tur dal. An increase in the rate of inflation was observed
for rice, groundnut, mustard oil, milk, and salt (both in packets and loose) (refer to Table 13.9).

The Department of Consumer Affairs monitors the prices of 16 essential commodities at selected centres throughout the
country.
CPI and Other Price Indicators
The commodity composition of the CPIs significantly differ from the WPI and also across the other
group-specific CPIs. Because of a different commodity composition and weights assigned to various
commodities and services in the CPIs, inflation measured in terms of CPIs and WPI differs
significantly over the months.

The commodity composition of the CPIs significantly differ from the WPI and also across the other group-specific CPIs.
From a long-term perspective, however, inflation as measured in terms of WPI and CPIs seems to
be converging. Reconstructing the WPI and CPIs, including the GDP consumption deflator with a
common 1999–2000 base, reveal that the cumulative increase in inflation during the years from
1999–2000 to 2006–07 was the highest for the WPI. There, however, were inter-year variations in the
rate of inflation based on these indices. But, over the years, the difference seemed to be narrowing
considerably. The average difference between the monthly rate of inflation, measured in terms of
WPI and CPI-IW, during the period 2001–02 and 2007–08 (up to December), was only 5 basis points,
and between WPI and CPI-UNME was only 3 basis points. While the inflation measured in terms of
WPI remained higher when compared to the CPIs in 2003–04 and 2004–05, it was lower than these
indices during 2006–07. The general converging of overall indices, measuring changes in the prices
notwithstanding their y-o-y variations, indicates a strong association in inflation, both in its
acceleration and deceleration phases, across all these indices (refer to Table 13.10 and Figure 13.4).

Table 13.8 Contribution of Selected Commodity Groups to Inflation (%)

Table 13.9 Average Retail Prices of Essential Commodities

There is, however, no aggregate, broad-based CPI in India. While considering shifting of the
present base of CPI-UNME, the Technical Advisory Committee on Statistics of Prices and Cost of
Living in its 44th meeting decided that (i) the resources proposed to be utilised for the revision of
CPI-UNME may be used for compilation of CPI numbers, separately for rural and urban and (ii)
existing series of CPI-UNME may be continued without revision till CPI (urban) series gets stabilised.
The Central Statistical Organisation has already initiated steps to bring out CPI (urban).
Real Estate/Housing Price Index
Rapid urbanisation and high economic growth experienced by the urban centres in the last few years
has resulted in an upsurge in property values. The importance of facilitating supply of affordable
housing to the people and the necessity of designing a right mix of policy initiatives to encourage
house acquisition, highlight the necessity of tracking the movement of residential house prices.
Moreover, the real-estate assets are a significant component of the wealth of the private sector, and
financial freedom allowed for acquiring this wealth is one of the important financial obligations of
this sector. For the financial intermediaries also, lending for residential houses has been a significant
component of their credit portfolio. The authentic data on the real-estate sector in the country, that is,
development of a credible database on market-driven price trends, and price index of market
segments have, therefore, emerged as crucial elements of market development and for enhancing the
efficiency of market processes. The National Housing Bank (NHB) had earlier set up a Technical
Advisory Group (TAG) to explore the possibility of constructing a real-estate price index. TAG has,
since, submitted its report and has provided an index of housing prices in about five cities for 2000–
05 on a pilot basis.

Rapid urbanisation and high economic growth experienced by the urban centres in the last few years has resulted in an
upsurge in property values.
The authentic data on the real-estate sector in the country, that is, development of a credible database on market-driven
price trends, and price index of market segments have, therefore, emerged as crucial elements of market development and
for enhancing the efficiency of market processes.

Table 13.10 Annual Trends in Various Price Indicators

Fig ure 13.4 Annual Trends in Various Price Indices

The housing prices in the five selected cities have increased between 12.1 per cent (KMA— Kolkata
Metropolitan Region) and 28.8 per cent (Bangalore) (per year on an average basis), over the last five
years, and inter-year and inter-city variations have been quite significant. These results are only
indicative as they are based on a pilot study. NHB, however, is setting up an institutional mechanism
for releasing an economy-wide housing price index on a regular basis (refer to Tables 13.11 and
13.12).

Table 13.11 Housing Price Index for Selected Cities

Table 13.12 Housing Price Inflation in Selected Cities (y-o-y, %)

INFLATION AND DEVELOPING ECONOMIES

Inflation in the developed countries may be regarded as a full-employment phenomenon and it may
be well-linked with a full-employment policies. But what about the underdeveloped or newly
developing economies? To explain the phenomenon of inflation in developing economies,
champions of Development Economics like Myrdal say that underdeveloped countries like India are
structurally backward with a lop-sided development, characterised by sectoral imbalances due to
market imperfections and stagnancy, as may be caused by a dual nature of the economy with a high
fragmentation. As such, scarcity in some sectors may cause underutilisation of the productive
capacity of the economy and create the problem of sectoral inflation, more serious than a general
price rise. Hence, the general aggregate demand-and-supply analyses are not suitable to such types of
situation. It should be replaced by the analyses of sectoral demand-and-supply balances and the
bottlenecks involved to study the true nature of inflation in these economies.

Inflation in the developed countries may be regarded as a full-employment phenomenon and it may be well-linked with a
full-employment policies.
In short, to understand the true nature of inflation in an underdeveloped country, one has to
examine the bottlenecks and gaps of various types, which obstruct the normal growth process,
causing prices to rise with the generation of money income, without an appropriate rise in the real
income. These gaps and bottlenecks may be enlisted as follows:

In short, to understand the true nature of inflation in an underdeveloped country, one has to examine the bottlenecks and
gaps of various types, which obstruct the normal growth process, causing prices to rise with the generation of money
income, without an appropriate rise in the real income.
Market Imperfections
Market imperfections like factor immobility, price rigidity, ignorance of market conditions, rigid
social and institutional structures and lack of specialisation and training in underdeveloped
economies do not allow an optimum allocation and utilisation of resources. Hence, an increase in
money supply and increased money income remain unaccompanied by an increased supply of real
output, causing a net price rise of inflationary nature in these economies.
Capital Bottleneck
On account of a very low rate of capital formation and consequent capital deficiency, a poor country
is caught in a vicious circle of poverty, and any excessive money supply instead of breaking this
vicious circle, tends to create a chronic inflationary spiral. Thus, in a poor country, there is inflation
because, by virtue of its internal backwardness, it is prone to chronic inflation.
Entrepreneurial Bottleneck
Entrepreneurs in the underdeveloped countries lack skill, the spirit of boldness, and adventure. They
prefer trading or safer traditional investments rather than attempting risky innovations. Absence of
adequate industrial capital, prevalence of merchant capital, and a colossal amount of private
investments in such unproductive fields like land, jewellery, gold, and so on, which is a gross socio-
economic waste, starve the developing economy of its much-needed capital resources. Thus, the
increased money supply of savings in terms of money makes a little impact on the real output, and
monetary equilibrium is just obtained through a galloping price rise in various sectors of the
economy.
Food Bottleneck
Due to the slow growth of agriculture, overpressure on land due to the growing population, primitive
methods of cultivation, defective land tenure system, lack of adequate irrigation facilities, and many
other reasons, agricultural output—especially, food supply that constitutes a large part of wage
goods, has failed to keep in pace with the growing demand for it, from the growing population, but
has increased rural employment in the rural industrialisation process in these countries. This food
bottleneck has created the problem of price rise of food grains, and it has become the corner stone in
the whole of price structure in the developing economies.
Infrastructural Bottleneck
This bottleneck refers to power shortages and inadequacies of transport facilities in the
underdeveloped economies. It obviously restricts the growth process in industrial, agricultural, and
commercial sectors and causes underutilised capacity in the economy as a whole. The underutili-
sation of resources does not absorb the full increase in money supply but reflects upon the rising
prices.
Foreign Exchange Bottleneck

The developing economies suffer from a fundamental, structural disequilibrium in the balance of
payments due to high imports and low exports on unfavourable terms of trade; hence, they usually
suffer from foreign-exchange-scarcity problem. In recent years, day by day, the rising import bills
due to high oil prices have aggravated the problem further. This foreign exchange bottleneck comes
in the way of necessary imports to check domestic inflation. Again, the need to boost exports to meet
the growing deficits in the balance of payments, puts an extra pressure on the marketable surplus that
is meant for domestic requirements. This eventually leads to a heavy price rise of exportable
commodity in the domestic market.
Resources Gap
When the public sector is widely expanded for industrial development in the underdeveloped
countries, the government aggravates the problem of “resources gap”. Owing to the backward, socio-
economic-political structure of the less-developed country (LDC), the government always finds it
difficult to raise sufficient resources through taxation, public borrowings, and profit of state
enterprises, to meet the ever-increasing public expenditure in intensive and extensive dimensions. As
such, under the pressure of the resources gap, the government has to resort to a heavy dose of deficit
financing, despite knowing its dangers. This makes the economy inflation-prone. Similarly, the
resource-gap in the private sector, caused by low voluntary savings and high-cost economy, presses
for an over-expansion of money supply through bank credit which, by and large, results in an
acceleration of inflationary spiral in the economy.
DEMAND-PULL VS COST-PUSH INFLATION
Broadly speaking, there are two schools of thought regarding the possible causes of inflation. One
school views the demand-pull element as an important cause of inflation, while the other group of
economists holds that inflation is mainly caused by the cost-push element.
Demand-pull Inflation
According to the demand-pull theory, prices rise in response to an excess of aggregate demand over
the existing supply of goods and services. The demand-pull theorists point out that inflation (demand-
pull) might be caused, in the first place, by an increase in the quantity of money, when the economy is
operating at the full-employment level. As the quantity of money increases, the rate of interest will
fall and, consequently, the investment will increase. This increased investment expenditure will soon
increase the income of the various factors of production. As a result, the aggregate consumption
expenditure will increase leading to an effective increase in the effective demand. With the economy
already operating at the level of full employment, this will immediately raise prices, and inflationary
forces may emerge. Thus, when the general monetary demand rises faster than the general supply, it
pulls up prices (commodity prices as well as factor prices, in general). Demand-pull inflation,
therefore, manifests itself when there is an active cooperation, or passive collusion, or a failure to
take counteracting measures by monetary authorities.

According to the demand-pull theory, prices rise in response to an excess of aggregate demand over the existing supply of
goods and services.
However, the demand-pull inflation can also occur without an increase in the money supply. This
can happen when either the marginal efficiency of capital increases or the marginal propensity to
consume (MPC) rises, so that investment expenditures may rise, thereby leading to a rise in the
aggregate demand, which will exert its influence in the raising prices beyond the level of full
employment that was already attained in the economy.
According to the demand-pull theorists, during the process of demand inflation, the rise in wages
accompanies or follows die-price rise as a natural consequence. Under the condition of rising prices,
when the rate of profit is increasing, producers are inclined, in general, to increase investment and
employment, in that they bid against each other for labour, so that labour-prices (i.e., wages) may rise.
In short, the inflationary process, described by the demand-inflation theory, implies the following
sequences: increasing demand, increasing prices, increasing costs, increasing income, and so on.

In short, the inflationary process, described by the demand-inflation theory, implies the following sequences: increasing
demand, increasing prices, increasing costs, increasing income, and so on.
Causes of Demand-pull Inflation
It should be noted that the concept of demand-pull inflation is associated with a situation of full
employment where an increase in the aggregate demand cannot be met by a corresponding expansion
in the supply of real output. There can be many reasons for such excess monetary demand as follows:
Increase in Public Expenditure

There may be an increase in the public expenditure (G) in excess of public revenue. This might have
been made possible (or rendered necessary) through public borrowings from banks or through
deficit financing, which implies an increase in the money supply.
Increase in Investment
There may be an increase in the autonomous investment (II) in firms, which is in excess of the current
savings in the economy. Hence, the flow of total expenditure tends to rise, causing an excess monetary
demand, leading to an upward pressure on prices.
Increase in MPC
There may be an increase in the MPC, causing an excess monetary demand. This could be due to the
operation of demonstration effect and such other reasons.
Increasing Exports and Surplus Balance of Payments

In an open economy, an increasing surplus in the balance of payments also leads to an excess demand.
The increasing exports also have an inflationary impact because there is a generation of money
income in the home economy due to export earnings but, simultaneously, there is a reduction in the
domestic supply of goods because products are exported. If an export surplus is not balanced by
increased savings, or through taxation, the domestic spending will be in excess of the value of
domestic output, marketed at current prices.
Diversification of Goods
A diversion of resources from die-consumption-goods sector either to the capital-good sector or the
military sector (for producing war goods) will lead to an inflationary pressure because while the
generation of income and expenditure continues, the current flow of the real output decreases on
account of high gestation period involved in these sectors. Again, the opportunity cost of war goods
is quite high in terms of consumption goods meant for the civilian sector. This leads to an excessive
monetary demand for the goods and services against their real supply, causing the prices to move up.
In short, it is said that the demand-pull inflation could be averted through deflationary measures
adopted by the monetary and fiscal authorities. Thus, passive policies are responsible for the demand-
pull inflation.
Cost-push Inflation
A group of economists hold the opposite view that the process of inflation is initiated not by an excess
of general demand but by an increase in costs, as factors of production try to increase their share of
the total product by raising their prices. Thus, it has been viewed that a rise in prices is initiated by
growing factor costs. Therefore, such a price rise is termed as “cost-push” inflation as prices are
being pushed up by the rising factor costs.
Cost-push inflation, or cost inflation, as it is sometimes called, is induced by the wage-inflation
process. It is believed that wages constitute nearly 70 per cent of the total cost of production. This is
especially true for a country like India, where intensive techniques are commonly used. Thus, a rise in
wages leads to a rise in the total cost of production and a consequent rise in the price level, because
fundamentally, the prices are based on costs. It has been said that a rise in wages causing a rise in
prices may, in turn, generate an inflationary spiral because an increase would motivate the workers to
demand higher wages. Indeed, any autonomous increase in costs, such as a rise in the prices of
imported components or an increase in the indirect cost-push inflation may occur either due to wage-
push or profit-push. Cost-push analysis assumes monopoly elements either in the labour market or in
the product market. When there are monopolistic labour organisations, prices may rise due to wage-
push. And, when there are monopolies in the product market, the monopolists may be induced to raise
the prices in order to fetch high profits. Then, there is profit-push in raising the prices.

Cost-push inflation, or cost inflation, as it is sometimes called, is induced by the wage-inflation process. It is believed that
wages constitute nearly 70 per cent of the total cost of production.
However, the cost-push hypothesis rarely considers autonomous attempts to increase profits, as an
important inflationary element. Firstly, because profits are generally a small fraction of the total
price, a rise in profits would have only a slight impact on the prices. Secondly, the monopolists
generally hesitate to raise prices in the absence of obvious demand-pull elements. Finally, the
motivation for profit-push is weak since, at least in corporations, those who make the decision to
raise the prices are not the direct beneficiaries of the price increase.
Hence, cost-push is generally conceived as a synonymous one with wage-push. When wages are
pushed up, the cost of production increases to a considerable extent so that the prices may rise. Since
wages are pushed up by the demand for high wages by the labour unions, wage-push may be equated
with union-push.

Cost-push is generally conceived as a synonymous one with wage-push. When wages are pushed up, the cost of production
increases to a considerable extent so that the prices may rise.
CAUSES OF INFLATION
Inflation is a complex phenomenon which cannot be attributed to a single factor. We may summarise
the major causes of inflation as follows:
Over-expansion of Money Supply

Many a times, a remarkable degree of correlation between the increase in money supply and the rise
in the price level may be observed.
Expansion of Bank Credit

Rapid expansion of bank credit is also responsible for the inflationary trend in a country.
Deficit Financing
The high doses of deficit financing, which may cause reckless spending, may also contribute to the
growth of the inflationary spiral in a country.
Ordinary Monetary Factors

Among other monetary factors influencing the price trend in an economy the major ones are listed as
follows:
Hig h Non-development Expenditure: The continuous increase in public expenditure and, especially, the growth of defence and
non-development expenditure.
Hug e Plan Investment: The huge plan investment and its high rate of growth in every plan may lead to an excess demand in the
capital goods sector, so that the industrial prices may raise.
Black Money: Some economists have condemned black money, which is in the hands of tax evaders and black marketers, as an
important source of inflation in a country. Black money encourages lavish spending, which causes excess demand and a rise in prices.
Hig h Indirect Taxes: Incidence of high commodity taxation. The prices tend to raise on account of high excise duties imposed by
the government on raw materials and essential goods.
Non-monetary Factors
There are various non-monetary and structural factors that may cause a rising-price trend in a
country. They are as follows:
Hig h Population Growth: Undoubtedly, the rising pressure of demand, resulting from growing population and money income, will
cause a high price rise in an over-populated country.
Natural Calamities and Bad Weather Conditions: Vagaries of monsoon, bad weather conditions, droughts, and failure of
agricultural crops have been responsible for the price spurts, from time to time, in many underdeveloped countries. Agricultural
prices are most sensitive to inflationary forces in India. Natural calamities also contribute occasionally to the inflationary boost in a
country. Events such as cyclones and floods, which destroy village economies, also aggravate the inflationary pressure.
Speculation and Hoarding : Hoarding and speculative activities, that is, corruption at every level, in both private and public sectors
and so on, are also responsible to some extent for aggravating inflation in a country.
Hig h Prices of Imports: Inflation has also been inflicted on some countries through the import content used by their industries. The
prices of petroleum products have been increased in many countries due to price hikes by the oil-producing countries.
Monopolies: Monopoly profits and unfair trade practices by big industrial houses are also responsible for the price rise in countries
like India.
Underutilisation of Resources: Non-utilisation of installed capacities in large industries is also a contributory factor to inflation.
Inflation in a country may be regarded as a symptom of a deep-seated malady, born of structural

deficiencies involved in the functioning of its economic system, which is characterised by inherent
weaknesses, wastages, and imbalances.
Gaps and Bottlenecks

To understand the true nature of inflation in an underdeveloped country, one has to examine the
bottlenecks and gaps of various types, which obstruct the normal growth process, causing prices to
raise with the generation of money income, without an appropriate rise in the real income. These
gaps and bottlenecks may be enlisted as follows: market imperfections, capital bottleneck,
entrepreneurial bottleneck, food bottleneck, infrastructural bottleneck, foreign exchange bottleneck,
and resources gap.

To understand the true nature of inflation in an underdeveloped country, one has to examine the bottlenecks and gaps of
various types, which obstruct the normal growth process, causing prices to raise with the generation of money income,
without an appropriate rise in the real income.
EFFECTS OF INFLATION
Inflation has direct socio-economic consequences. As such, inflation has been taken to be a serious
social and economic problem. The US Presidents Ford and Carter have considered inflation as
“public enemy number one”.

Inflation has direct socio-economic consequences. As such, inflation has been taken to be a serious social and economic
problem. The US Presidents Ford and Carter have considered inflation as “public enemy number one”.
Economic Effects of Inflation
The effects of inflation on the economic system may be classified into three kinds as follows: (1)
effects on production, that is, changes in the tempo of economic activity, (2) effects on income
distribution, that is, re-distribution of income and wealth, and (3) effects on consumption and welfare.
Effects on Production
Keynes argues that a moderate rise in prices, that is, a mild inflation, or creeping inflation, as it may
be called, has a favourable effect on production when there are unutilised or underemployed
resources in existence in an economy. The rising prices breed optimistic expectations within the
business community in view of increasing profit margins, because the price level moves up at a faster
rate than the cost of production. Businessmen are induced to invest more, and as a result,
employment, output, and income increase.
The tempo of economic activity starts raising. But, there is a limit to it—this limit is set by the full-
employment ceiling. Once the full-employment stage is reached in an economy, a further rise in
prices will not stimulate production, employment, and real income, due to physical limitations.
Therefore, till the level of full employment is reached, moderately rising prices, though otherwise
harmful, are also beneficial. The benefit effect on production, however, is possible only when an
inflation does not take place at too fast a rate. A state of running of galloping inflation creates
uncertainty, which is inimical to production. Thus, when the inflation has reached an advanced stage,
its brighter aspects disappear and the evil aspects manifest themselves. The disastrous consequences
of inflation on the economic system may be stated briefly as follows:
Maladjustments: Inflation leads to maladjustments in production and disrupts the working of the price system, which is ruinous to
the entire system.
Hindrance to Capital Accumulation: Capital accumulation is hindered by uncontrolled inflation, and the savings potentiality of the
community also declines due to the diminishing purchasing power of money.
Speculation: Since excessive inflation disturbs all economic relationships and leads to uncertainty, the skills and energies of the
business community are concentrated on speculation and on making quick profits rather than on genuine productive activity, as a
result. In short, speculation takes the place of production in the economy.
Hoarding and Black Marketing : During inflation, when prices are rapidly rising, the holding of larger stocks of goods becomes
very profitable. Hoarding is encouraged, which further decreases the available supply of goods in relation to increasing monetary
demand. Eventually, the phenomena of black marketing and spiralling inflation develop.
Distortion of Production Pattern: Inflation not only adversely affects the volume of production but also changes its pattern.
Generally, resources are diverted from the production of essential goods to those of non-essential because the rich people, whose
incomes increase more rapidly, make their demand for luxury goods felt in the market. Production of undesirable lines is, therefore,
stimulated and finally, results in the breakdown of the economic system.
Creation of a Sellers Market: Inflation tends to create a sellers market. As a result, sellers have a command on prices because of
the excessive demand in the market. Anything can be sold in such a market. The sellers do not care for quality as their interest is in
high profits only.
Distortions in Resource Allocation: Inflation will turn away resource allocation from longer-term productive investments and
towards unproductive assets like housing, real estate, inventories, gold, and so on. Such a diversification of savings tends to inhibit
the future capacity to grow.
Disincentive Effect due to Income-tax Bracket Creep: During inflation, with the rise in money incomes of the individuals under
progressive income tax system, the effective tax rate will raise (called “Income-tax Bracket Creep”). This may cause a disincentive
effect on willingness to work, save, and invest, thus, discouraging the productive activity.
Distributional Effects
Inflation redistributes income because prices of all factors do not rise in the same proportion. Since
the effect of inflation on the income of different classes of earners varies, there are serious social
consequences. During inflation, the distributive share accruing to the profiteers increases more than
that of wage earners or fixed-income earners, such as the rentier class. All producers, traders, and
speculators gain during an inflation because of the windfall profits which arise, as prices rise at a
faster and a higher rate than the cost of production; wages, interest, and rent do not increase rapidly,
and are more or less fixed. Moreover, profits increase because there is a lag between the rise in the
prices and the rise in the cost of production. Businessmen always find the money value of their
inventories going up because the general price level raises. Usually, inflation enlarges the money
incomes in the hands of the flexible groups, and adversely affects the people in the fixed-income
groups, such as pensioners, government employees, and salaried classes, such as teachers, clerks,
and, to some extent, labourers or wage earners. Among the wage earners or the labour class, those
who are well organised are hit less than others.

Inflation redistributes income because prices of all factors do not rise in the same proportion. Since the effect of inflation on
the income of different classes of earners varies, there are serious social consequences.
The changes in the value of money also cause redistribution of wealth, partly because (a) during
inflation, there is no uniform price rise as prices of some types of goods alone change more than
others and (b) debts are expressed in terms of money. Inflation is a sort of hidden tax, steeply
regressive in effect. The redistribution of wealth due to inflation is a burden on those groups of
people who are least able to bear it. Let us study the concrete effects of inflation on various economic
groups as follows:
Debtors and Creditors: Generally, debtors gain and creditors lose during an inflation. Gain accrues to a debtor because he repays
loan at a time when the purchasing power of money is lower than when it was borrowed. The creditor, on the other hand, is a loser
during inflation, since he receives, in effect, less in goods and services than he would have received in times of low prices. Thus, the
borrowers who borrowed funds prior to inflation stand to gain by inflation, and creditors who lent funds lose. However, this does
not mean that debtors always welcome inflation because, usually, they are members of one another group of people who are
adversely affected by inflation.
Business Community: Inflation is welcomed by entrepreneurs and businessmen as they stand to profit by raising prices. They find
that the value of the then inventories and stock of goods is rising in money terms. They also find that prices are rising faster than the
costs of production, so that their profit margin is greatly enhanced. The business community, therefore, gets supernormal profits
during the period of inflation, and those profits continue to increase as long as the prices raise. However, the producers of
conventionally priced goods and services, such as electricity and transport services, gain very little or not at all during inflation,
because the prices of their goods are fixed by convention or by law. When the prices in general raise, the cost of production of these
commodities or services also raises but their price remains constant, giving the producer a continuously decreasing margin of profit.
Fixed Income Groups: Inflation hits wage earners and salaried people very hard. Although wage earners, by the grace of trade
unions, can chase the galloping prices, they seldom win the race. Since the wages do not raise at the same rate and at the same time
as the general price level, the cost of living index raises, and the real income of the wage earner decreases. Moreover, in trying to
push up wages to sustain their real income, wage earners bring about a cost-push inflation and, in the process, worsen their position.
Those who depend exclusively on fixed salaries for a living are severely affected by inflation. Among these people are teachers,
clerks, government servants, pensioners, and persons living on past savings. The salaried groups are further handicapped by the fact
that they are less organised than the labour class, to press for higher pay in order to compensate for a fall in the real income.
Investors: Those who invest in debentures and fixed-interest bearing securities, bonds, and so on, lose during inflation. However,
the investors in equities benefit because more dividend is yielded on account of high profits made by the joint-stock companies during
inflation.
Farmers: Farmers usually gain during an inflation, because they can get better prices for their harvest during inflation.
We may conclude that inflation redistributes income and wealth in favour of businessmen, debtors,
and farmers but hits consumers, creditors, small investors, labour class, middle class, and fixed-
income groups very hard. Inflation favours one group at the expense of another. Besides, it is always
regressive in effect, that is, it hits hard all those who cannot protect themselves.
Effects on Consumption and Welfare

Inflation implies an erosion of the consumer ’s value of money. It is a form of taxation. Due to
deteriorating purchasing power, the real consumption of the common people declines. The rising cost
of living during inflation implies falling standard of living and lowering of general economic
welfare of the community at large. A galloping inflation is, therefore, described as the “cruellest tax
of all”. In short, inflation is unfair on the distribution side of economic activity.

Inflation implies an erosion of the consumer’s value of money. It is a form of taxation.
In short, inflation is unfair on the distribution side of economic activity.
Other Economic Effects

Inflation may lead to many adverse consequences as follows:
Deterioration in Saving s: A continuous inflation reduces the real worth of savings in the long run. Savers are also adversely
affected when the annual rate of inflation is exceeding the current rate of interest. During an inflation, the real rates of interest tend to
decline. The capacity to save is also reduced due to the rising cost of living and the consequent rise in money expenditure caused by
the rising prices. Persistent inflation also discourages individual savings.
Distortion of the Budg et and Vicious Circle: The budgetary provision for public spending proves to be inadequate, due to the
rising costs caused by inflation. A vicious circle is thus developed. When deficit financing leads to inflation, more deficit financing
may be needed to fill the resource gap occurring in public spending, which further pushes up the prices, causing further deficit
financing and further inflation and so on, and thus, a vicious circle is developed.
Disturbance in the Planning : Plan programmes and allocation of resources may be grossly disturbed due to resource constraints
caused by a continuous inflation and rising factor costs. The investment allocation based on the current price level at the beginning of
a particular plan obviously proves to be inadequate in the later years of the plan. Thus, a severe resource constraint may be
experienced in the fulfilment of the plan targets.
Lowering of International Competitiveness: If the rate of inflation in a country is higher than in other countries, its international
competitiveness in foreign market is weakened.
Distortion of the Exchang e Rate: A high rate of inflation in a country, when compared to the inflation rates in other countries,
would ultimately lead to a decrease in the external value of its currency, that is, lowering of its exchange rate in terms of foreign
currencies or key currencies such as dollar. Even a key currency like the dollar has lost its real worth and reputation due to the high
inflation rate in the US economy.
Irrationality of Consumption: Inflation enhances money incomes of many. This fosters “consumerism” resulting in distorted
consumption patterns. Consumerism spurts the trend to consider all goods as non-durable. Due to expensive labour, repair gives way
to replacement of parts/products. Modern society is, thus, becoming a “junk” society in which nothing is durable. People fanatically
crave for new models and new things, which is facilitated by the consumer credit given by the banks. Today’s inflation-oriented
prosperity is based on credit-induced consumption in many countries. Thus, to stop credit involves a great risk of unemployment and
recession.
Control of Inflation
Data Management
The price policy since 1973–74 has relied predominantly on fiscal and monetary measures with a
view to check the demand of the general public for goods and services.
Fiscal Measures
Since 1990–91, the government of India has woken up to the importance of reducing fiscal deficit.
The budget of July 1991–92 took the first decisive action to limit the fiscal deficit by bringing it down
from 8.4 per cent of GDP in 1990–91 to 6.2 per cent in 1991–92 and 4.9 per cent in 199293. Since
then, the government has failed to reduce the fiscal deficit which has remained around 7 per cent of
GDP till date.

Since 1990–91, the government of India has woken up to the importance of reducing fiscal deficit.
Monetary Measures
In general, the RBI uses its monetary policy to achieve a judicious balance between the growth of
production and control of the general price level. RBI uses bank rate, CRR (cash reserve ratio), SLR
(statutory liquidity ratio), and open-market operations to increase bank credit and expansion of
business activity (in times of business recession), or to contract bank credit and check business and
speculative activity (in periods of inflation).

In general, the RBI uses its monetary policy to achieve a judicious balance between the growth of production and control of
the general price level.
Supply Management
This is related to the volume of supply and its distribution system. On the commodity front, the
government has generally focused its attention on (a) securing a greater control over the process of
rice, wheat, sugar, oils, and other commodities of mass consumption and (b) to increase in domestic
supplies, that is, large releases from official stocks of food grains, and widening and streamlining of
the network of public distribution. Also the government has taken some measures to prevent an undue
increase in the prices of essential commodities. Some of the important aspects of this policy are given
as follows:
Fixing of maximum prices.
The system of dual prices.
Increase in supplies of food grains.
Problem of oilseeds and edible oils.
Public distribution system.
Even as the government pulls out all stops to douse the fires of inflation, we should not forget that
what we are dealing with is the outcome of years of neglect of agriculture. The oilseeds mission of
the 1980s and later of the pulses were both given a short shrift when it was realised that India has
sufficient foreign exchange reserves (FER) to import edible oils and pulses. But nobody cared to ask
what would happen the if global prices rose. Likewise, in the 1990s the liberalites were keen that India
focuses on “value addition” in agriculture and meets its food security through imports. Again, the
fears expressed about the cost of imports in a tight global market were dismissed as of little
consequence; we are now paying the costs. We can only hope that even if it takes years, may be even a
decade and more, the demands of food security are ultimately addressed by expanding the domestic
production in agriculture through adequate research, investment in infrastructure, and appropriate
mix of price and non-price incentives.
GLOBAL INFLATION AND INDIA
With the annual rate of inflation in India having touched 7 per cent on a point-to-point basis during
the week ending March 22, 2008, the search for policies to combat the price rise has begun. One
factor seen as making that search difficult is the ostensible role of “imported inflation” in driving the
rise in the domestic prices. There is an obvious reason why such an argument arises. Among the
products primarily responsible for the current inflation are food products of different kinds,
including cereals, intermediates like metals, and the universal intermediate, oil.

With the annual rate of inflation in India having touched 7 per cent on a point-to-point basis during the week ending March
22, 2008, the search for policies to combat the price rise has begun. One factor seen as making that search difficult is the
ostensible role of “imported inflation” in driving the rise in the domestic prices.
Of these, the difficulties that high and rising levels of oil prices pose have been known for some
time now. The price movements for the two varieties of crude that enter India’s import basket (refer
to Figure 13.5) show that since May 2003 international prices have, despite fluctuations, been on a
continuous rise. In the event, the prices per barrel of these varieties have moved from less than $25 in
May 2003 to close to or well above $100 today.
This has changed one feature of the oil-price scenario that was held during much of the last two
decades. During those years, despite high nominal prices, the real price of oil (adjusted for increases
in the general price level) was far lower than that which prevailed during the 1970s. As Figure 13.6
shows, when measured by the price-deflated refiner acquisition cost of imported oil in the United
States, in the years since 1974, the real price of oil was higher than that was in 2006, only during a
brief period between 1980 and 1982. Since 2006, the nominal oil prices have risen further at rates
much higher than the average level of prices.
As a result, oil producers are regaining the real price benefits they garnered during the 197981
shock. According to one estimate, in terms of current prices, the period from the late 1970s to early
1980s, which peaked in oil prices, worked out to $100 to $110 a barrel—that is, a figure that we are
fast approaching.

Fig ure 13.5 Movement in International Oil Prices

Fig ure 13.6 Real Price of Oil

Underlying the buoyancy in prices is the closing gap between demand and supply of global
petroleum, at a time when the spare capacity is more or less fully utilised. Much of the increase in
demand is coming from China, but that is affecting stockpiles everywhere. This trend, combined with
the uncertainty in West Asia resulting from the occupation of Iraq and the standoff in Iran, has created
a situation where any destabilising influence—such as political uncertainty and attacks on the oil
supply chain in Nigeria—triggers a sharp rise in prices.
What needs noting, however, is that prices are where they are because speculators have exploited
these fundamentals. It is known that energy markets have attracted substantial financial investor
interest since 2004, but especially after the recent decline in stock markets and in the value of the
dollar. Investors in search of new investment targets have moved into speculative investments, in
commodities, in general, and, oil, in particular. The Organisation of the Petroleum Exporting
Countries (OPEC), which is normally held responsible for all oil price increases, has repeatedly
asserted that oil has crossed the $100-a-barrel mark not because of a shortage of supply but because
of financial speculation.

The Organisation of the Petroleum Exporting Countries (OPEC), which is normally held responsible for all oil price
increases, has repeatedly asserted that oil has crossed the $100-a-barrel mark not because of a shortage of supply but
because of financial speculation.
The views similar to those from OPEC have been expressed by more disinterested sources as well.
As far back as April 29, 2006, The New York Times had reported that: “In the latest round of furious
buying, hedge funds and other investors have helped propel crude oil prices from around $50 a
barrel at the end of 2005 to a record of $75.17 on the New York Mercantile Exchange”.
According to that report, the oil contracts held mostly by hedge funds had risen to twice the amount
that was held five years ago. Such transactions are clearly speculative in nature. Although the
disruption was caused by the United States’ occupation of Iraq, other geopolitical factors and the
speculation that followed have played a role in the case of oil. Whereas the recent increase in other
global commodity prices, especially food articles and metals (based on IMF data), shows that, except
for agricultural raw materials whose prices have increased a very little, all the other commodity
groups have shown a sharp rise in their prices (refer to Figure 13.7).
The rise in price levels for metals was the earliest in the recent surge, with the weighted average of
metals prices increasing sharply from the last quarter of 2005, and almost doubling in the two year
period to February 2008. The coal prices more than doubled last year, thereby showing a faster rise
than even the oil price. Food prices, like agricultural raw materials, had shown only a modest
increase until early 2007. But since then they have zoomed, such that the IMF data show more than 40
per cent increase in the world food prices over 2007.
Food Price Index
The FAO (Food and Agriculture Organisation) food price index, which includes national prices as
well as those in the cross-border trade, suggests that the average index for 2007 was nearly 25 per
cent above the average for 2006. Apart from sugar, nearly every other food crop has shown very
significant increases in price in the world trade over 2007, and the latest evidence suggests that this
trend has continued and even accelerated in the first few months of 2008. The net result is that,
globally, the prices of many basic commodities have been rising faster than they ever did during the
last three decades. It has been argued that these developments are largely demand driven, being the
result of several years of rapid global growth and the voracious demand from some fast-growing
countries such as China. Certainly, there is some element of truth in this. And to the extent that this is
true, it implies that the world economy is heading back to the late 1960s and early 1970s scenario,
wherein rapid and prolonged growth came up against an inflationary barrier. Capitalism’s success
over the last two decades was its ability to prevent such an outcome, that is, the political economy
processes that restrained the wage and income demands of workers and primary producers. But
clearly, there are limits to such a process, and these limits are now being reached.

The FAO (Food and Agriculture Organisation) food price index, which includes national prices as well as those in the cross-
border trade, suggests that the average index for 2007 was nearly 25 per cent above the average for 2006.

Fig ure 13.7 Indices of World Commodity Prices

If this was to be the only cause of the recent commodity price inflation, it would not necessarily be
of such a concern to the policymakers, as it could then be expected that a slowing down of overall
growth would simultaneously reduce inflation. It would also reflect some recovery of the drastically
reduced bargaining power of workers and primary producers. But there are other, more worrying,
tendencies in operation, that suggest that the current global inflationary process has other factors
pushing it, which will not be so easily controlled.
Forces Behind the Rise
To understand this, it is necessary to examine the forces behind the price rises for different
commodities. In the case of food, there are more than just demand forces at work, although it is
certainly true that rising incomes in Asia and other parts of the developing world have led to
increased demand for food. Five major aspects affecting supply conditions have been crucial in
changing the global market conditions for food crops.

In the case of food, there are more than just demand forces at work, although it is certainly true that rising incomes in Asia
and other parts of the developing world have led to increased demand for food. Five major aspects affecting supply
conditions have been crucial in changing the global market conditions for food crops.
Firstly, there is the impact of high oil prices, which affect the agricultural costs directly because of
the significance of energy as an input in the cultivation process itself (through fertilizer and irrigation
costs) as well as in transporting food. Across the world, the governments have reduced protection and
subsidies on agriculture, which means that high costs of energy directly translate into higher costs of
cultivation, and, therefore, the higher prices of output.

Firstly, there is the impact of high oil prices.
Secondly, there is the impact of both oil prices and government policies in the United States,
Europe, Brazil, and elsewhere that have promoted bio-fuels as an alternative to petroleum. This has
led to significant shifts in acreage as well as in the use of certain grains. For example, in 2006 the
United States diverted more than 20 per cent of its maize production to the production of ethanol;
Brazil used half of its sugarcane production to make bio-fuel; and the European Union (EU) used the
greater part of its vegetable oil production as well as the imported vegetable oils, to make bio-fuel.
This has naturally reduced the available land for producing food.

Secondly, there is the impact of both oil prices and government policies.
Policy Neglect
Thirdly, the impact of policy neglect of agriculture over the past two decades is finally being felt. The
prolonged agrarian crisis in many parts of the developing world; the shifts in acreage from food
crops to cash crops relying on the purchased inputs; the excessive use of groundwater and inadequate
attention to preserving or regenerating land and soil quality; the lack of attention to relevant
agricultural research and extension; the overuse of chemical inputs that have long-run implications
for both safety and productivity; the ecological implications of both pollution and climate change,
including desertification and loss of cultivable land: all these are issues that have been highlighted by
analysts but largely ignored by policymakers in most of the countries. Reversing these processes is
possible but will take time and substantial public investment, so until then the global supply conditions
will remain problematic.

Thirdly, the impact of policy neglect of agriculture over the past two decades.
Fourthly, there is the impact of changes in the market structure, which allows for a greater
international speculation in commodities. It is often assumed that rising food prices automatically
benefit farmers, but this is far from the case, especially as the global food trade has become more
concentrated and vertically integrated. A small number of agri-business companies worldwide
increasingly control all aspects of cultivation and distribution, from supplying inputs to farmers, to
buying crops and even in some cases, to retail food distribution. This means that marketing margins
are large and increasing, so that direct producers do not get the benefits of increases except with a
time lag and even then, not to the full extent. This concentration also enables greater speculation in
food, with a more centralised storage.

Fourthly, there is the impact of changes in the market structure, which allows for a greater international speculation in
commodities.
Financial Speculators
Finally, primary commodity markets are also attracting financial speculators. As the global financial
system remains fragile with the continuing implosion of the US housing finance market, commodity
speculation is increasingly emerging as an important alternative investment market. Such speculation
by large banks and financial companies is in both agricultural and non-agricultural commodities, and
explains, at least partly, why the very recent period has seen such sharp hikes in the price. The
commodity speculation has also affected the minerals and metals sector. For these commodities, it is
evident that recent price increases have been largely the result of increased demand, not only from
China and other rapidly growing, developing countries, but also from the United States and EU.

Finally, primary commodity markets are also attracting financial speculators.
A positive fallout of the recent growth in the demand and diversification of sources of the demand
is that it has allowed primary metal-producing countries, especially in Africa, to benefit from the
competition to extract better prices and conditions for their mined products. But there is also the
unfortunate reality that higher mineral prices have rarely, if ever, translated into better incomes and
living conditions of the local people, even if they may benefit the aggregate economy of the country
concerned.
At any rate, metal prices are high and are likely to remain so because of the growing imbalance
between the world supply and demand. A reduction in the global output growth rates would definitely
have some dampening effect on prices from their current highs, but the basic imbalance is likely to
continue for some time. This is also because there has been a neglect of investment in this sector as
well, so that building up of a new capacity will take time, given the long gestation period involved in
investments for the metal production.
Implications for India
So the medium-term outlook for the global commodity prices, while uncertain, is that they are likely
to remain high even if the world economy slows down in terms of the output growth. What does this
mean for India? Until the 1990s, both producers and consumers in India were relatively sheltered
from the impact of such global tendencies because of a complex system of trade restrictions, public
procurement, and distribution and policy emphasis on at least food self-sufficiency.
The liberalising policies that began in the early 1990s have rendered all of that history, since one
explicit aim of the reform strategy was to bring the Indian prices closer in line to the world prices.
The countries like India, seeking to manage this effect of global speculation on the prices of a
universal intermediate like oil, have to decide how important it is to insulate the domestic economy
and the domestic consumer from its effect.

The liberalising policies that began in the early 1990s have rendered all of that history, since one explicit aim of the reform
strategy was to bring the Indian prices closer in line to the world prices. The countries like India, seeking to manage this
effect of global speculation on the prices of a universal intermediate like oil, have to decide how important it is to insulate
the domestic economy and the domestic consumer from its effect.
Given the huge revenues being derived from duties on oil products, one way to get that done is to
forego duty while holding the oil prices. This would require compensating for revenue losses with
taxes in other areas, which a growing economy can contemplate. But the government appears
unwilling to take this route, thereby increasing pressure to hike oil prices further and aggravate an
inflationary tendency that is already proving to be economically and politically damaging.
Ineffective Strategy
This reticence, till recently, to proactively insulate the domestic economy, has meant that both
producers and consumers are now more or less directly affected adversely by the global trends. The
government’s response to the domestic price rise, which is already creating panic in the official
corridors in an election year, has been to reduce or eliminate import duties on several food items
such as edible oils, so as to allow imports to bring the price down.
But that is a short-sighted and probably an ineffective strategy. It provides a direct competition to
Indian farmers producing oilseeds, even as they suffer rapidly rising costs. It sends confused signals
not only to farmers for the next sowing season, but also to consumers, and leaves the field open for
domestic speculators as well, as the imports are not under public supervision but are left to private
traders.
Most of all, given the tendency of international commodity prices noted here, it will not solve the
basic problem of rising inflation in such commodities. Instead, it will make the Indian economy even
more prone to the volatility and inflationary pressure of world markets. In fact, the increases in prices
in India have not been as sharp for some commodities, largely because of the vestiges of the
intervention era.
Thus, the prices of some commodities, like rice for example, have gone up less than world prices
only because exports have been prohibited. This does suggest that the Indian economy cannot hope to
remain insulated from these global trends, without much more proactive policies that rely
substantially on the government intervention in several areas. In the case of food, this essentially
requires a more determined effort to increase the viability of food cultivation, to improve the
productivity of agriculture through public measures, and to expand and strengthen the public system
of procurement and distribution. For other commodities too, it is now evident that a laissez faire
system is simply not good enough and public intervention and regulation of markets is essential.
CASE
Calculating Inflation in India
Some economists assert that India’s method of calculating inflation is wrong, as there are serious
flaws in the methodologies used by the government. So how does India calculate inflation? And how
is it calculated in the developed countries?
India uses the WPI to calculate and then decide the inflation rate in the economy.
Most developed countries use the CPI to calculate inflation.
WPI was first published in 1902, and it was one of the more economic indicators available to
policymakers, until it was replaced by the most developed countries by the CPI in the 1970s.
WPI is the index that is used to measure the change in the average price level of goods traded in the
wholesale market. In India, a total of435 commodities data on price level is tracked through WPI,
which is an indicator of a movement in the prices of commodities in all trade and transactions. It is
also the price index which is available on a weekly basis with the shortest possible time lag of only
two weeks. The Indian government has taken WPI as an indicator of the rate of inflation in the
economy.
The WPI has an All Commodities Index, which consists of three major groups—primary articles;
fuel, power, light, and lubricants; and manufactured products. These are again broken up into smaller
sub-groups. For instance, the primary articles group would have food articles, non-food articles, and
minerals. Each of these sub-groups would have several individual commodities in them.
The current WPI tracks the prices of 435 commodities, of which 98 are primary articles; 19 fall in
the fuel, power, light & lubricants group; and 318 are in the manufactured products group. The WPI
in India has been periodically revised from the time it was first constructed in the 1930s and, for
obvious reasons, the weights have moved progressively in favour of manufactured products. The
current index, which uses 1993–94 as its base year, has weights of 22.025 for primary articles, 14.226
for fuel, and so on, and 63.749 for manufactured products.
CPI is a statistical time-series measure of a weighted average of prices, of a specified set of goods
and services, purchased by consumers. It is a price index that tracks the prices of a specified basket of
consumer goods and services, providing a measure of inflation. CPI is a fixed-quantity price index
and is considered by some as a cost-of-living index. Under CPI, an index is scaled so that it is equal to
100 at a chosen point in time, so that all other values of the index are a percentage relative to this one.
The economists say that it is high time that India abandoned WPI and adopted CPI to calculate
inflation. India is the only major country that uses a WPI to measure inflation. Most countries use the
CPI as a measure of inflation, as this actually measures the increase in price that a consumer will
ultimately have to pay for.
CPI is the official barometer of inflation in many countries such as the United States, the United
Kingdom, Japan, France, Canada, Singapore, and China. The governments functioning there review
the commodity basket of CPI, every four to five years, to factor in changes in the consumption
pattern.
It has pointed out that WPI does not properly measure the exact price rise, an end-consumer will
experience because, as the same suggests, it is at the wholesale level. The main problem with WPI
calculation is that more than 100 out of the 435 commodities included in the Index have ceased to be
important from the consumption point of view. Take, for example, a commodity like coarse grains
that go into the making of a livestock feed. This commodity is insignificant, but it continues to be
considered while measuring inflation.
India constituted the last WPI series of commodities in 1993–94, but has not updated it till now.
Economists argue that the Index has lost relevance and cannot be the barometer to calculate current
inflation (Refer www.rediff.com.money/2008/may/27infla1.htm). WPI is supposed to measure the
impact of prices on business. But it is used to measure the impact on consumers. Many commodities
not consumed by consumers get calculated in the Index. And it does not factor in services that have
assumed so much importance in the economy. But why India is not shifting calculation from WPI to
CPI is a major question. The officials of Finance Ministry point out that there are many intricate
problems in shifting from WPI to CPI model.
First of all, they say, in India, there are four different types of CPI indices, and that makes switching
over to the Index from WPI fairly “risky and unwieldy”. The four CPI series are as follows: CPI
industrial workers, CPI urban non-manual employees, CPI agricultural labourers, and CPI rural
labourers. The different CPIs are needed because the prices facing different consumer groups are
different. Thus, while urban house rents may be of great significance to the first two groups, they
would be of no relevance to the farm labourers. Thus, the composition of each CPI is different, and it
should ideally reflect the actual consumption patterns of the relevant consumer groups.
Secondly, officials say that the CPI cannot be used in India because there is too much of a lag in
reporting the CPI numbers. In fact, as of May 2006, the latest CPI number reported is for March
2006.The WPI is published, on a weekly basis and the CPI, on a monthly basis. And in India, inflation
is calculated on a weekly basis. But then, the question remains how the United States, the United
Kingdom, Japan, France, Canada, Singapore, and China use CPI for inflation calculation.
Case Questions
1. Do you think India’s method of calculating inflation is wrong as there are serious flaws in the methodologies used?
2. Why India is not able to shift WPI to CPI for calculating inflation?
3. Suggest some innovative methods for calculating inflation in India.
KEY WORDS
Wholesale Price Index (WPI)
Consumer Price Index (CPI)
Market Imperfection
Resource Gap
Demand-pull Inflation
Cost-push Inflation
Deficit Financing
The Organisation of The Petroleum Exporting Countries (OPEC)
Food Price Index
QUESTIONS
1. How is “inflation” defined? Can any rise in price be considered as inflation? What is the acceptable or desirable limit of
inflation?
2. What are the methods of measuring inflation? Why is national income deflator considered as a more reliable method of
measuring inflation?
3. Explain the various kinds of inflation? How do they differ from one another?
4. What are the effects of inflation on wage earners, fixed-income people, debtors and creditors, producers, and the government?
Give the reasons for the effects of inflation.
5. In what way does inflation contribute to economic growth? What kind of inflation affects economic growth adversely?
6. Explain the relationship between inflation and employment. Is achieving a high rate of employment by means of inflation always
desirable?
7. What is monetarists’ explanation for inflation? Is inflation always and everywhere a monetary phenomenon?
8. Explain how the demand factors cause demand-pull inflation. What are the major weaknesses of the demand-pull theory of
inflation?
9. What are the factors behind cost-push inflation? Is there any link between cost-push and demand-pull inflation?
10. Distinguish between demand-pull and cost-push inflation. Can the two types of inflation go hand-in-hand? Explain in this regard
the “wage price spiral”.
11. Combating inflation has been one of the most intractable economic problems faced by the developed and the underdeveloped
countries. Comment.
12. What are the traditional monetary measures to control inflation? Explain how these measures work to control inflation.
13. Explain the working of the monetary weapons of inflation control. Which of these weapons is more effective under what
conditions?
14. What are the fiscal measures for controlling inflation? Are they more effective than the monetary measures in controlling
inflation?
REFERENCES
Economic and Political Weekly, 43(14), April 5–11, 2008.

Economic Survey 2007–08, Government of India.
The Hindu Business Line, April 8, 2008.
CHAPTER 14
Human Development
CHAPTER OUTLINE
Concept of Human Development
Meaning and Importance of Human Resource
How to Attain Human Development
Human Development and Gender Situation
Growth of Human Development
Human Development Report (2007–08)
Overview of Human Development
Case
Summary
Key Words
Questions
References
CONCEPT OF HUMAN DEVELOPMENT
The ultimate objective of a planned development is to ensure human well-being through a sustained
improvement in the quality of life of people, particularly the poor and the vulnerable segments of the
population. In terms of policy measures it requires an emphasis on the social sector development and
programmes. The human resource development (HRD) contributes to sustained growth and
productive employment. A healthy, educated, and skilled workforce can contribute more significantly
and effectively to economic development.

The ultimate objective of a planned development is to ensure human well-being through a sustained improvement in the
quality of life of people, particularly the poor and the vulnerable segments of the population.
The concept of human development (HD) is complex and multi-dimensional. It is, however, certain
that HD is much more than mere poverty eradication. It requires a situation where people can freely
identify and select their choices. In this chapter, I have confined to the concept of HD from the vantage
point of policymakers and planners, who believe in intervention of the state and civil society, for a
better social order for the development of all. The present concept of HD has gained currency with
the efforts of the United Nations Development Project (UNDP). Mahbub ul Haq, one of the architects
of UNDP, spells out the concept in the following manner:
The basic purpose of development is to enlarge people’s choices. In principle, these choices can be infinite and can change over time.
People often value achievements that do not show up at all, or not immediately, in income or growth figures: greater access to
knowledge, better nutrition and health services, more secure livelihoods, security against crime and physical violence, satisfying
leisure hours, political and cultural freedoms and a sense of participation in community activities. The objective of development is to
create an enabling environment for people to enjoy long, healthy and creative lives.

The objective of development is to create an enabling environment for people to enjoy long, healthy and creative lives.
MEANING AND IMPORTANCE OF HUMAN RESOURCE
The people of a country constitute its most important resource called “human resource”. Human
resource implies the abilities, skills, and technical know-how of the population of a country. Here,
human resource of the country is not only the size of population but its efficiency, education,
qualities, productivity, and organisational abilities. If the people are educated, skilled, and healthy,
they provide a good quality of human resource to the economy. All developmental efforts of the
government are for the welfare of the people—to raise their standard of living and improve their
quality of life. The human resource of an economy, particularly of an underdeveloped economy, can
be improved by providing education, medical facilities, and other facilities like housing, sanitation,
and so on.

Human resource implies the abilities, skills, and technical know-how of the population of a country.
The human resource of an economy, particularly of an underdeveloped economy, can be improved by providing education,
medical facilities, and other facilities like housing, sanitation, and so on.
Since its launch in 1990, the Human Development Report (HDR) published by UNDP has defined
HD as the process of enlarging people’s choices. The most critical ones are to lead a long and healthy
life, to be educated, and to enjoy a decent standard of living. The additional choices include political
freedom, other guaranteed human rights, and various ingredients of self-respect. These are among
the essential choices, the absence of which can block many other opportunities. HD is thus a process
of widening people’s choices as well as raising the level of well-being that is achieved. Thus, as noted
by Paul Streeten, the concept of HD puts people back at the centre stage, after decades in which a maze
of technical concepts had obscured this fundamental vision.
According to Mahbub ul Haq,
The defining difference between the economic growth and the human development schools is that the first focuses exclusively on the
expansion of only one choice—income—while the second embraces the enlargement of all human choices—whether economic,
social, cultural or political. It is sometimes suggested that the expansion of income can enlarge all other choices as well. This may
happen but generally does not, on account of a variety of reasons. First, income may be unevenly distributed within a society. The
choices of those people who have either no access to income or a very limited access, are very much limited. Thus, economic
growth does not “trickle down”. Second, and more importantly, the national priorities chosen by the society or its rulers and the
political structure prevalent in the society may not allow the income expansion to enlarge human options.
As emphasised by Mahbub ul Haq, “use of income” by a society is just as important as “generation of

income” itself as would be clear from the fact that income expansion leads to much less human
satisfaction in a virtual political prison or cultural void than in a more liberal, political and economic
environment. Accumulation of wealth may not be necessary for the fulfilment of several kinds of
human choices. In fact, many choices do not require any wealth at all. For instance,
A society does not have to be rich to afford democracy. A family does not have to be wealthy to respect the rights of each member.
A nation does not have to be affluent to treat women and men equally. Valuable social and cultural traditions can be and are
maintained at all levels of income.
A society does not have to be rich to afford democracy. A family does not have to be wealthy to respect the rights of each
member. A nation does not have to be affluent to treat women and men equally. Valuable social and cultural traditions can
be and are maintained at all levels of income.
There are many human choices that extend far beyond economic well-being. Knowledge, health, a
clean physical environment, political freedom, and simple pleasures of life are not dependent on
income. Accumulation of wealth can expand people’s choices in the above areas but it is not
necessary. It is the use of wealth and not wealth itself that is decisive. Haq, thus, rightly warns, “unless
societies recognize that their real wealth is their people, an excessive obsession with creating material
wealth can obscure the goal of enriching human lives”.

Haq thus rightly warns “unless societies recognize that their real wealth is their people, an excessive obsession with
creating material wealth can obscure the goal of enriching human lives”.
According to Paul Streeten, HD is necessary on account of the following reasons:

HD is the end, while economic growth is only a means to this end. The ultimate purpose of the entire exercise of development is
to treat men, women, and children—present and future generations—as ends, to improve the human condition, to enlarge
people’s choices.

HD is the end while economic growth is only a means to this end.
HD is a means to higher productivity. A well-nourished, healthy, educated, skilled, and alert labour force is the most important
productive asset. Thus, investments in nutrition, health services, and education are justified on the grounds of productivity.

HD is a means to higher productivity.
HD helps in lowering the family size by slowing the human reproduction. It is the experience of all developed countries that has
seen improvement in education levels (particularly of girls), better health facilities, and reduction in infant mortality rates
(IMRs), leading to a lowering of the birth rates. While improved education facilities make the people aware of the benefits of a
small family (a higher-income level, better standard of living, etc.), reduction in IMRs reduces the incentive of having larger
families as fewer child deaths are now feared.

HD helps in lowering the family size by slowing the human reproduction.

HD is good for physical environment. Deforestation, desertification, and soil erosion decline when poverty declines. How
population growth and population density affect the environment is a subject of controversy. The conventional view is that they
have a detrimental effect. However, Paul Streeten cites a recent research to show that rapid (though not accelerating) population
growth and high population density (particularly if combined with secure land rights) can be good for soil and forest
conservation. Reduced poverty contributes to a healthy civil society, increased democracy, and a greater social stability.

HD is good for physical environment. Deforestation, desertification, and soil erosion decline when poverty
declines.
HD can help in reducing the civil disturbances in a society and in increasing the political stability.

HD can help in reducing the civil disturbances in a society and in increasing the political stability.
The above discussion shows that the HD paradigm embraces the entire society and not just the
economy alone. The political, cultural, and social factors are given as much importance as the
economic factors. What is more, a careful distinction is being maintained between ends and means.
While people are regarded as the end of development, the means are not forgotten. In this context, the
expansion of GNP (gross national product) becomes an essential means for expanding many human
options. However, the character and distribution of economic growth are measured in terms of
enriching the lives of people. People not only remain the instruments for producing commodities but
also acquire the centre stage. The production processes are not treated in an abstract vacuum but are
made to acquire a “human” context.
According to Mahbub ul Haq, there are four essential components in the HD paradigm: equity,
sustainability, productivity, and empowerment.

According to Mahbub ul Haq, there are four essential components in the HD paradigm: equity, sustainability, productivity,
and empowerment.
Equity
If a development is to enlarge people’s choices, people must enjoy an equitable access to

opportunities. Equity in access to opportunities demands a fundamental restructuring of power in
many societies and changes along the following lines: (i) change in the distribution of productive
assets especially through land reforms; (ii) major restructuring in the distribution of income through
a progressive fiscal policy, aimed at transferring income from the rich to the poor; (iii) overhauling
of the credit systems so that the credit requirements of the poor people are satisfactorily met; (iv)
equalisation of political opportunities through voting rights reform, campaign finance reform, and
other actions aimed at limiting the excessive political power of a feudal minority; and (v) undertaking
steps to remove social and legal barriers that limit the access of women or of certain minorities or
ethnic minorities to some of the key economic and political opportunities.

If a development is to enlarge people’s choices, people must enjoy an equitable access to opportunities.
Sustainability
The next generation deserves the opportunity to enjoy the same well-being that we now enjoy and this
right makes sustainability an essential component of the HD paradigm. At times, the concept of
sustainability is confused with the renewal of natural resources, which is just one aspect of sustainable
development. As emphasised by Mahbub ul Haq, “it is the sustaining of human opportunities that must
lie at the centre of our concerns”. This, in turn, requires sustaining all forms of capital—physical,
human, financial, and environmental. Sustainability is a matter of distributional equity—of sharing
development opportunities between present and future generations and ensuring intra-generational
and inter-generational equity in access to opportunities. However, as cautioned by Haq,

The next generation deserves the opportunity to enjoy the same well-being that we now enjoy and this right makes
sustainability an essential component of the HD paradigm.
Sustainability does not mean sustaining present levels of poverty and human deprivation. If the
present is miserable and unacceptable to the majority of the world’s people, it must be changed before
it is sustained. In other words, what must be sustained are worthwhile life opportunities, not human
deprivation. Not only this, sustainability also means that wide disparities in life styles within and
between nations must be re-examined and efforts undertaken to reduce them. This is due to the reason
that an unjust world is inherently unsustainable both politically and economically. It may be
environmentally unsustainable as well.
Productivity
“An essential part of the human development, paradigm is productivity, which requires investments in
people and an enabling macroeconomic environment for them to achieve their maximum potential.
Economic growth is therefore a subset of human development models— an essential part but not the
entire structure”, by Haq. Many East Asian economies like Japan and the Republic of Korea have
accelerated their growth through tremendous investments in human capital. In fact, most of the
development literature has focused on the productivity of human endeavour. Many recent models of
development are based primarily on human capital. However, as correctly pointed out by Haq, this
approach treats people only as a means of development and obscures the centrality of people as the
ultimate end of development. Therefore, it is better to treat productivity only as one part of the HD
paradigm—with equal importance given to equity, sustainability, and empowerment.

An essential part of the human development, paradigm is productivity, which requires investments in people and an
enabling macroeconomic environment for them to achieve their maximum potential.
Empowerment
HD paradigm envisages a full empowerment of the people. Empowerment means that people are in a
position to exercise choices of their own free will.

HD paradigm envisages a full empowerment of the people. Empowerment means that people are in a position to exercise
choices of their own free will.
It implies a political democracy in which people can influence decisions about their lives. It requires economic liberalism so that
people are free from excessive economic controls and regulations. It means decentralisation of power so that real governance is
brought to the doorstep of every person. It means that all members of civil society, particularly non-governmental organisations,
participate fully in making and implementing decisions.
The empowerment of people requires action on various fronts: (i) it requires investing in the
education and health of the people so that they can take advantage of market opportunities; (ii) it
requires ensuring an enabling environment that gives everyone access to credit and productive assets
so that the playing fields of life are more even; and (iii) it implies empowering both women and men
so that they can compete on an equal footing.
HOW TO ATTAIN HUMAN DEVELOPMENT
How to attain HD is a moot question for policymakers. Rule of law, relative equality, and freedom are
important pillars of socio-political system in facilitating the HD. They provide equal opportunities,
irrespective of gender, race, creed, or caste to everyone to “empower” oneself and opt for choices
according to one’s own preferences. Inequality in status and power restricts exercise of choices of
those who are at the lower rung of the hierarchical ladder. In a situation where very wide gap in status
and income prevails between those who are at the higher echelon and at the bottom, the latter are
vulnerable to the dictation of the powerful. Such inequitable system provides better and more
opportunities to the former because of their network and socialisation than to the latter. They also
enjoy hegemony in the form of value system and ideology over the latter. In such a situation,
autonomy of the lower strata in identifying choices is restricted. For instance, people at the lower
strata in Scandinavian countries have relatively more autonomy than those who are in a similar
position in the United States.

How to attain HD is a moot question for policymakers. Rule of law, relative equality, and freedom are important pillars of
socio-political system in facilitating the HD.
It is assumed, almost orchestrated by the institutions of global governance that market-driven
growth is a royal path for HD. Alternative approaches for the development of human civilizations are
believed to have been exhausted with the fall of the Soviet Union. The Western capitalist societies
have invented an ideal path for the development of all. According to some proponents of the path,
human civilization has reached the end of history only with capitalist economy and liberal democracy.
This is the final and inevitable destiny of the civilization (Fukuyama 1992). It is argued that the state
has curbed human freedom and incentives. People are made dependent on the state for their
development. Such a state is antithetical to the well-being of all—including of the poor. Therefore, the
state should roll back and confine to the minimum functions of maintaining law and order. In the
contemporary dominant discourse, the mantra is let the economy flourish and be free from politics.
Market is a dynamic force for self-corrections. Bill Clinton asserted in 2004 before the World
Economic Forum: “We have to reaffirm unambiguously that open markets are the best engine we
know of to lift living standards and build shared prosperity”. The responsibility of the state is to
facilitate market-oriented economic growth. It is required to maintain macro-economic stability and
guarantee property rights. This economic trajectory is sacrosanct. The IMF and the World Bank, the
architects and monitors of neoliberal trajectory, claim that their policies are essentially apolitical in
nature and simply reflect the “value free” principles uncovered by “positive economics” (Thomas
2000).
In this trajectory, what is needed is good management and good governance on the part of the state.
Intervention of the state from the social sphere needs to be minimum. Given this, UNDP defines
governance, “as the exercise of economic, political, and administrative authority to manage a
country’s affairs at all levels. It comprises mechanisms, processes, and institutions through which
citizens and groups articulate their interests, exercise their legal rights, meet their obligations, and
mediate their differences (1997)”. Accountability, transparency, and equality before the law are the
important parameters of good governance. Catch words like “decentralisation”, “empowerment”, and
“participation” of the people are often repeated with a little clarity. Cooperation and accommodation
of “conflicting and diverse interests” are called for.

UNDP defines governance, “as the exercise of economic, political, and administrative authority to manage a country’s
affairs at all levels. It comprises mechanisms, processes, and institutions through which citizens and groups articulate their
interests, exercise their legal rights, meet their obligations, and mediate their differences (1997)”. Accountability,
transparency, and equality before the law are the important parameters of good governance.
Within this neoliberal framework, “good governance” guarantees “property rights” and
maintenance of macro-economic stability. But redistribution of growth—nationally and inter-
nationally—is not even mentioned. Relative equality in income, assets, and opportunities is not on
agenda. Nor it gives importance to social and economic security of the population. Insecurity of job,
income, and health breeds uncertainties, anxiety, and fear of an unknown situation. Inse-cured persons
tend to become vulnerable to the manipulation of power mongers. Without relative equality and social
security, it is agreed that accountability, transparency, decentralisation, and electoral democracy
though very important cannot attain HD. Mere market-driven growth makes the state subservient to
those who control capital and undermines societal networks and human needs. HD is possible with the
shift from market-oriented growth to social-oriented growth. Our plea is that the market needs to be
tamed and brought under the supervision of civil society and state. Therefore, alternative politics, of
course, not of excessive Centralised statism, has to be brought back. This is a political issue.
HUMAN DEVELOPMENT AND GENDER SITUATION
As per the UNDP’s Global HDR 2007, in spite of the absolute value of the human development index
(HDI) for India improving from 0.577 in 2000 to 0.611 in 2004 and further to 0.619 in 2005, the
relative ranking of India has not changed much, even till date. India ranks at 128 among the countries
with medium HD, out of 177 countries of the world, as against 126 in the previous year. In terms of
Gender Development Index (GDI), India ranks 113 out of 157 countries ranked on the basis of their
GDI value (refer to Table 14.1). A zero count for HDI rank minus GDI rank for India is indicative of
almost a similar status of ranking in terms of GD and HD. At the same time, while India’s HDI rank
reflects a low relative achievement in the level of HD, a negative count of (-11) for gross domestic
product (GDP) per capita (PPP US$) rank minus HDI rank is also indicative that the country has done
better in terms of per capita income than in the other components of HD. The other indicators related
to health and education also indicate the same. The situation reinforces the need for a greater focus on
this area in our development planning. It is this concern that is reflected in the Eleventh Plan which
seeks to reduce not only poverty but also the various kinds of disparities across regions and
communities by ensuring a better access to not only the basic physical infrastructure but also the
health and education services to one and all.

India ranks at 128 among the countries with medium HD, out of 177 countries of the world, as against 126 in the previous
year. In terms of Gender Development Index (GDI), India ranks 113 out of 157 countries ranked on the basis of their GDI
value.

Table 14.1 India’s Global Position on Human and Gender Development
Source: UNDP Human Development Reports 2002 and 2007.

Major Initiatives in the Social Sector
In consonance with the commitment to foster a social sector development under the National
Common Minimum Programme (NCMP), the Central government has launched new initiatives for a
social sector development during 2007–08. Substantial progress was also made on the major
initiatives launched in earlier years.

In consonance with the commitment to foster a social sector development under the National Common Minimum
Programme (NCMP), the Central government has launched new initiatives for a social sector development during 2007–08.
Substantial progress was also made on the major initiatives launched in earlier years.
The Central government expenditure on social services and rural development has gone up
consistently over the years (refer to Table 14.2). The share of Central government expenditure on
social services, including rural development in total expenditure (plan and non-plan), has increased
from 11 per cent in 2001–02 to 16.4 per cent in 2007–08 (BE). The Central support for social
programmes has continued to expand in various forms though most of the social sector areas fall
within the purview of the states. A significant amount of programme-specific funding is available to
the states through the Centrally sponsored schemes. The pattern of funding for these schemes varies
depending upon the priority laid on the sector. At the same time, the objective is to make states more
and more self-reliant in supporting these schemes, as is borne out by the funding pattern proposed for
Sarva Shiksha Abhiyan (SSA).
The increasing trend of expenditure on social services by the general government (the Centre and
the states combined) in the recent years as shown in Table 14.3 reflects the high priority attached to
these sectors. The expenditure on social sectors as a proportion of total expenditure, after decreasing
from 20.4 per cent in 2002–03 to 19.5 per cent in 2003–04, increased steadily to 22.3 per cent in 2006–
07 (RE) and 22.5 per cent in 2007–08 (BE).

Table 14.2 Central Government Expenditure (plan and non-plan) on Social Services and Rural Development
Source: Budget Documents and Ministry of Rural Development.

Notes:
aLaunched in 2000–01 as a new initiative for basic rural needs. However, PMGY has been discontinued from 2005–06.
b Includes Rs 4500 crore as loan taken from a separate RIDF window of NABARD.

The expenditure on education as a proportion of total expenditure has increased from 9.8 per cent
in 2004–05 to 10.4 per cent in 2006–07 (RE). The share of health in the total expenditure has also
increased from 4.4 per cent in 2004–05 to 4.9 per cent in 2006–07 (RE).
The inter-state comparisons based upon the important socio-economic indicators bring out the
disparities between the states in the development outcomes. The performance of states across various
sub-sectors, be it poverty, health, or education-related, reinforce each other. To some extent, this
disparity in performance between states may be accounted for by extraneous factors, but largely can
be attributed to governance and delivery of services. This calls for a greater emphasis on the
governance issues. While governance is a broader area to be tackled at various fronts, the use of e-
governance is becoming an important method to ensure better delivery and monitoring of services in
different sectors including the social sectors.

Table 14.3 Trends of Social Sector Expenditure by General Government (Centre and state governments combined)
Source: Budget Documents of Centre and State Governments, RBI.

Education
Primary Education
The 86th Constitutional Amendment of 2002 led to inclusion of a new Article 21-A in Part III of the
Constitution that made free and compulsory education to all children of 6–14 years of age, as a
fundamental right. Due to the pending enactment of a suitable follow-up legislation envisaged in
Article 21-A, the 86th Constitutional Amendment has not yet been enforced. However, it is imperative
to give good-quality elementary education to all children in the age group of 6–14 years. Policies and
programmes in this direction are also necessary for honouring the country’s commitment to the
“Millennium Development Goals” and “Education for All”, as well as commitment under the NCMP,
for increasing the public expenditure on education to 6 per cent of GDP and for universalising the
elementary education at the national level (refer to Box 14.1).

It is imperative to give good-quality elementary education to all children in the age group of 6–14 years. Policies and
programmes in this direction are also necessary for honouring the country’s commitment to the “Millennium Development
Goals”.
Box 14.1 Primary Education Schemes
Sarva Shiksha Abhiyan (SSA)

The Sarva Shiksha Abhiyan (SSA) is being implemented in partnership with states to address the
needs of children in the age group of 6–14 years. The achievements under SSA up to September
30, 2007 include construction of 170,320 school buildings, 713,179 additional classrooms,
172,381 drinking water facilities, and 218,075 toilets; supply of free textbooks to 6.64 crore
children; and appointment of 8.10 lakh teachers besides opening of 186,985 (till March 31, 2007)
new schools. About 35 lakh teachers receive in-service training each year. Central allocation for
SSA in 2007–08 was Rs 10,671. With a significant success in enrolling children in schools, the
SSA’s thrust areas are now on reduction of dropouts and improving quality of student learning.
National Programme for Education of Girls at Elementary Education (NPEGEL)

This programme is aimed at enhancing girls’ education by providing additional support for
development of a “model girl-child friendly school” in every cluster with more intense
community mobilisation and supervision of girls’ enrolment in schools. Under NPEGEL, 35,252
model schools have been opened in addition to supporting 25,537 Early Childhood Care and
Education (ECCE) centres. Besides, 24,387 additional classrooms have been constructed, and 1.85
lakh teachers have been given training on gender sensitisation. Remedial teaching has also been
provided to 9.67 lakh girls, apart from holding bridge courses covering 1.53 lakh girls and
additional incentives like uniforms, and so on, to about 71.46 lakh girls (up to October 31, 2007).
An outlay of Rs 708.44 crore was provided under NPEGEL for 2007–08.
Kasturba Gandhi Balika Vidyalaya (KGBV)

The Kasturba Gandhi Balika Vidyalaya (KGBV) Scheme was launched in July 2004 for setting up
residential schools at upper primary level for girls belonging predominantly to the SC, ST, OBC,
and minority communities. The KGBV ran as a separate scheme for two years but was merged
with SSA with effect from April 1, 2007. About 2,180 KGBVs were sanctioned by the Government
of India up to March 2007. Of these, 270 KGBVs have been sanctioned in the Muslim
concentration blocks, 583 in ST blocks, and 622 in SC blocks. As on October 31, 2007, 1,564
KGBVs are functional (71.74 per cent) and 109,786 girls (26 per cent SC girls, 33 per cent ST
girls, 26 per cent OBC girls, 11 per cent BPL girls, and 5 per cent minority girls) were enrolled in
them.
National Programme of Mid-day Meals in Schools

The National Programme of Mid-day Meals in Schools covers approximately 9.70 crore. The
children studying at the primary stage of education is 9.50 lakh through government (including
local bodies), government-aided schools, and the centres run under Education Guarantee Scheme
(EGS) and Alternative and Innovative Education (AIE) Scheme. The programme was extended,
with effect from October 1, 2007, to children in the upper primary stage of education (classes VI-
VIII) in 3,479 Educationally Backward Blocks (EBBs). Approximately, 1.7 crore additional
children in classes VI-VIII in EBBs are expected to be included. In 2007–08, a provision of Rs
7,324 crore was made under the scheme. The programme provides a mid-day meal of 450
calories and 12 g of protein to children at the primary stage. For children at the upper primary
stage, the nutritional value is fixed at 700 calories and 20 g of protein. Adequate quantities of
micro-nutrients like iron, folic acid, and Vitamin A are also recommended under the programme.
To meet the nutritional norm, the Central government provides food grains @ 100 g per primary
school child/school day and 150 g per upper primary school child/school day. In 2007–08, the
Central government also approved the inclusion of Inflation Adjusted Index (Consumer Price
Index) for calculation of Central assistance towards the cooking cost once in every two years.
This will be applicable from 2008–09 for primary and upper primary stages. The programme has
helped in promoting school participation, preventing classroom hunger, instilling educational
values, and fostering social and gender equality.
Secondary Education
The number of secondary and higher secondary schools has increased from 7,416 in 1950–51 to
152,049 in 2004–05. Total enrolment in secondary and higher secondary stage has increased
correspondingly from 1.5 million in 1950–51 to 37.1 million in 2004–05. The Gross Enrolment Ratio
(GER), which shows the total enrolment in secondary stage (i.e., Classes IX to XII) as a percentage of
total population in the relevant age group has also increased steadily from 19.3 in 1990–91 to 39.91 in
2004–05. GER for Class IX-X (14–16 years) was 51.65 and for Class XI-XII (16–18 years) was 27.82
in 2004–05. With the rapid growth of Indian economy, coupled with the need to improve quality of
life and reduce poverty, skill development is essential at the school level also. It is essential that a
student at the end of the secondary education acquires a particular level of knowledge and skills (refer
to Box 14.2).

With the rapid growth of Indian economy, coupled with the need to improve quality of life and reduce poverty, skill
development is essential at the school level also. It is essential that a student at the end of the secondary education acquires
a particular level of knowledge and skills.
Box 14.2 Scheme for Universalisation of Access to Secondary Education (SUCCESS)
Since universalisation of elementary education has become an important goal, it is also essential
to push this vision forward to move towards universalisation of secondary education, something
which has already been achieved in a large number of developed countries and several developing
countries. Not only universal enrolment, but also universal retention and satisfactory quality of
learning should be a priority. The major challenge before secondary education is that of meeting
the surge in demand due to success of SSA whose target is to ensure that all children of
elementary school-going age enrol by 2010. It has been, therefore, decided to launch a Centrally
sponsored scheme, viz., Scheme for Universalisation of Access to Secondary Education
(SUCCESS) and improvement of quality at secondary stage during the Eleventh Five-Year Plan.
The main objective of the programme is to make secondary education of good quality available,
accessible, and affordable to all young students in the age group of 15–16 years (classes IX and
X). The target of the scheme is (i) universal access of secondary level education to all students in
the age group of 15–16 years by 2015 and (ii) universal retention by 2020. It envisages (i)
provision of necessary infrastructure and resources in the secondary education sector to create a
higher capacity in secondary schools in the country and for improvement in the quality of
learning in the schools (ii) provision for filling the missing gaps in the existing secondary-school
system (iii) provision of extra support for education of girls, rural children, and students
belonging to SC/ST, minority, and other weaker sections of the society, and (iv) a holistic
convergent framework for implementation of various schemes in the secondary education.
Higher and Technical Education

There has been a significant growth in higher education during the academic year 2005–06.
According to the University Grants Commission (UGC), enrolment in various courses at all levels in
universities/colleges and other institutions of higher education in 2005–06 was 11.34 million when
compared to 10.50 million in the previous year. Out of this, the number of women students was 4.58
million constituting 40.39 per cent. There has also been a significant expansion of Central institutions
of higher education in the recent years (refer to Box 14.3). With the increased demand for higher-
quality education, training of teachers has become even more important and out-of-box thinking is
required to ensure an adequate supply of quality teachers.

With the increased demand for higher-quality education, training of teachers has become even more important and out-of-
box thinking is required to ensure an adequate supply of quality teachers.
Health PEQ
There has been some improvement in the quality of health care over the years (refer to Table 14.4),
but wide inter-state, male-female, and rural-urban disparities in the outcomes and the impacts
continue to persist. While population stabilisation is in the Concurrent List, health is a state subject.
The reproductive and child-health services reach community and household levels through the
primary health-care infrastructure. Inadequacies in the existing health infrastructure have led to gaps
in coverage and outreach services in the rural areas. India’s position on health parameters when
compared even to some of its neighbours continues to be unsatisfactory. While India has improved in
respect to some important health indicators, over the years, it compares poorly with China and Sri
Lanka (refer to Table 14.5).

Inadequacies in the existing health infrastructure have led to gaps in coverage and outreach services in the rural areas.
Box 14.3 Recent Expansion of Higher Educational Institutions
Two state universities in Arunachal Pradesh and Tripura were converted into Central universities, and a new Central
university has been established in Sikkim. With this, all the eight states in the north-eastern region have at least one Central
university each.
Central Institute of English and Foreign Languages (CIEFL), which was earlier a deemed university, has been converted
into a Central university.
Two Indian Institutes of Science Education and Research (IISERs) were established during 2005–06 at Kolkata and Pune,
and a third one at Mohali in 2006–07. Two more IISERs have been approved at Bhopal and Thiruva-nanthapuram during
the Eleventh Plan.
The 20 National Institutes of Technology (NITs) were earlier managed by individual registered societies. They were
brought under a common statutory framework during 2007–08 by enacting the NITs Act which came into force on August
15, 2007.
The seventh IIM, viz., the Rajiv Gandhi Indian Institute of Management, has been established at Shilong in 2007–08. It will
admit the first batch of students in 2008.
The Indian Institute of Information Technology, Design, and Manufacturing (IIIT&M) Kanchipuram, has also come into
being during 2007–08.

Table 14.4 Comparative Health-care Parameters
Source: Office of the Registrar General of India.

NA: Not available.

National Rural Health Mission (NRHM)
The NRHM was launched on April 12, 2005, to provide accessible, affordable, and accountable
quality-health services to the poorest households in the remotest rural regions. The thrust of the
Mission was on establishing a fully functional, community-owned, decentralized, health-delivery
system with inter-sectoral convergence at all levels, to ensure a simultaneous action on a wide range
of determinants of health like water, sanitation, education, nutrition, and social and gender equality.
Under the NRHM, the focus was on a functional health system at all levels, from the village to the
district.
NRHM has successfully provided a platform for community health action at all levels. Besides
being a merger of Departments of Health and Family Welfare in all states, NRHM has successfully
moved towards a Single State and District-level Health Society for effective integration and
convergence. Through a concerted effort at a decentralised planning through a preparation of District
Health Action Plans, NRHM has managed to bring about intra-health sector and inter-sectoral
convergence for effectiveness and efficiency. In all the states, the specific health needs of people have
been articulated for local action. With the establishment of public institutions like the Village Health
and Sanitation Committees (VH&SCs), Hospital Development Committees, and PRI-led Committees,
it is the civil society to which the health system is being made increasingly accountable. Through
untied and flexible financing, NRHM is trying to drive reforms that empower local communities to
make their own decisions. It is thus a serious effort at putting people’s health in people’s hands itself
(refer to Box 14.4).

NRHM has successfully provided a platform for community health action at all levels.
Through a concerted effort at a decentralised planning through a preparation of District Health Action Plans, NRHM has
managed to bring about intra-health sector and inter-sectoral convergence for effectiveness and efficiency.

Table 14.5 Some Health Parameters: India and its Neighbours
Source: UNDP, Human Development Report 2007–08.

Notes:
NA: Not available. Figures shown for India are at variance with the official figures of the Office of Registrar General of India (RGI) for
Maternal Mortality Rate and IMR. Data shown in the table are as per the methodology and adjustment made by the UNDP.

Funding for Support Mechanism of ASHA
One of the key strategies under the NRHM is a community health worker, that is, Accredited Social
Health Activist (ASHA) for every village at a norm of 1,000 population. The role of ASHA vis-avis
that of Anganwadi Worker (AWW) and Auxiliary Nurse Mid-wife (ANM) is also clearly laid down.
Under the implementation framework for the NRHM, the scheme of ASHA has now been extended to
all the 18 high-focus states. Besides, the scheme would also be implemented in the tribal districts of
the other states. In the new implementation framework, a provision has been made for an expenditure
of Rs 10,000 per ASHA during a financial year. This ceiling does not include the performance-based
compensation, which the different programme divisions would disburse from their own funds. The
earlier ASHA guidelines had visualised an expenditure of Rs 7,415 per ASHA. The increased outlay
gives a valuable opportunity to further strengthen the support mechanism.

Box 14.4 Broad Achievements Under the Mission
543,315 ASHAs (accredited social health activists)/link workers have been selected so far in the states.
186,606 ASHAs/link workers have drug kits.
In all the states, ASHAs/link workers have facilitated the households’ links with the health facilities.
177,578 VH&SCs are already functional. Many other states have also issued government orders in this regard and are in
the process of activating the Committees.
Of the 141,492 functional sub-health centres, 111,979 have operationalised a joint bank account of ANM and Sarpanch for
united funds.
ANMs are playing an important role in the Organisation of Village Health and Sanitation Days and nearly 4.8 lakh such
days have been organised in the last two years.
25,987 ANMs have been appointed on contract so far. 14,440 sub-centres (SCs) are reporting to two ANMs.
Strengthening of the PHCs for 24×7 services is a priority of NRHM. Of the 22,669 PHCs in the country, only 1,634 of
them were working 24×7 on March 31, 2005 (before the NRHM). The number of 24×7 PHCs today, as reported by the
states, is 8,755, signifying the great leap forward in getting patients to the government system.
2,852 PHCs are having three nurses.
More than 50 lakh women have been brought under the Janani Suraksha Yojana (JSY) for institutional deliveries in the last
two-and-a-half years.
So far, 4,380 other paramedical staff have been appointed on contract.
6,232 doctors, 2,282 specialists, and 11,537 staff nurses have been appointed on contract in the states so far, reducing the
human resource gaps in many institutions.
2,335 Community Health Centres (CHCs) have completed their facility surveys and 441 their physical upgradation so far.
The Indian Public Health Standards (IPHS) have been finalised and a first grant of Rs 20 lakh was made available to all
the district hospitals of the country to improve their basic services, given the increased patient load due to JSY and other
programmes.
State-level societies have been merged in 32 States/UTs and 527 districts so far.
Project management units have been set up in 506 districts and 2,432 blocks of 30 states.
The IPHS developed for eight different levels of public institutions in health, provide a basis for all programmes in the
health sector.
Most states have completed the facility surveys up to CHCs.
319 districts have received funds for mobile medical units.
So far, 188 mobile medical units are operational in the states.
Strengthening of Primary Health Infrastructure and Improving Service Delivery
Although there has been a steady increase in the health-care infrastructure available over the plan
period (refer to Table 14.6) as per the Bulletin on Rural Health Statistics in India 2006—Special
Revised Edition, as in March 2006, there is a shortage of 20,903 SCs, 4,803 Primary Health Centres
(PHCs), and 2,653 Community Health Centres (CHCs), as per the 2001 population norm. Further,
almost 50 per cent of the existing health infrastructure is in rented buildings. Poor upkeep and
maintenance and high absenteeism of manpower in rural areas have also eroded the credibility of the
health-delivery system in the public sector. NRHM seeks to strengthen the public health-delivery
system at all levels. In addition to strengthening the health-delivery system under NRHM, several
other programmes in the area of health are being implemented in the country (refer to Box 14.5).

Table 14.6 Trends in Health-care Infrastructure
1991 2005–06
SC/PHC/CHC (March 2006)a 57,353 171,567
Dispensaries and Hospitals (all) (April 1, 2006)b 23,555 32,156
Nursing Personnel (2005)b 143,887 1,481,270
Doctors (Modern System) (2005)b 268,700 660,801
aRHS: Rural Health Statistics in India, 2006—A special revised edition.

b National Health Profile, 2006.

Box 14.5 Major Public Health Programmes
• Universal Immunisation Programme

The coverage of the programme, first launched in the urban areas in 1985, was progressively extended to cover the entire
country by 1990. Between 1988 and 2006, there has been a decline of 83 per cent in diphtheria, 83 per cent in pertussis, 59 per
cent in measles, 94 per cent in neonatal tetanus, and 97 per cent in poliomyelitis. Hepatitis-B Vaccination Programme, which was
started in 2002 in 33 districts and 15 cities as a pilot, has been expanded to all districts of good-performing states. Vaccination
against Japanese encephalitis (JE) was started in 2006.
• Pulse Polio Immunisation Programme

An outbreak of polio has been witnessed in 2006 with the spread of polio virus. During 2007 (as on December 14, 2007) a
total of 471 cases have been reported. To respond to this, supplementary immunisation activities have been intensified in the
high-risk areas. Initiatives include the use of Monovalent Oral Polio Vaccine (mOPV1 & mOPV3) in the high-risk districts and
high-risk states to enhance immunity against P1 and P3 virus, vaccinating the children in transit, and covering children of
migratory population from Uttar Pradesh and Bihar. Special rounds have been conducted in Haryana, Punjab, Gujarat, and West
Bengal during August, September, October, and November 2007.
• National Vector Borne Disease Control Programme

The National Vector Borne Disease Control Programme (NVBDCP) is being implemented for prevention and control of
vector-borne diseases like malaria, philariasis, kala-azar, JE, dengue, and chikungunya. Most of these diseases are epidemic
prone and have seasonal fluctuations. During 2007 (till October), 0.99 million positive cases, 0.44 million plasmodium
falciparum cases, and 940 deaths have been reported. Currently, about 100 districts are identified as highly malaria endemic
where focused interventions are being undertaken. To achieve NHP-2002 (National Health Policy) goal for Elimination of
Lymphatic Philariasis by 2015, the Government of India initiated Annual Mass Drug Administration (AMDA) with a single dose
of Diethylcarbamazine citrate (DEC) tablets to all individuals living at risk of philariasis excluding pregnant women, children
below two years of age, and seriously ill persons. During 2007, AMDA has been observed in 19 states. The reported coverage
of 19 states is 87.28 per cent. Kala-azar is endemic in four states of the country, viz., Bihar, West Bengal, Jharkhand, and Uttar
Pradesh. However, about 80 per cent of the total cases are reported from Bihar. During 2007 (up to October), 37,525 cases
and 169 deaths have been reported. The NHP (2002) envisages kala-azar elimination by 2010. Under the elimination
programme, the Central government provides 100 per cent operational cost to the state governments, besides anti-kala-azar
medicines, drugs, and insecticides. Acute Encephalitis Syndrome (AES)/ Japanese Encephalitis (JE) has been reported frequently
from 12 states/UTs. During 2007 (till December 28, 2007), 3,887 cases and 910 deaths have been reported. Dengue is
prevalent in different parts of the country but the outbreak of the disease is reported mainly in urban areas. However, in the
recent past, dengue is reported from the rural areas as well. In 2007 (up to December), 5,025 cases and 64 deaths have been
reported. During 2006, chikungunya fever had re-emerged in the country in epidemic proportions after a quiescence of about
three decades. During 2007 (up to December 28, 2007), 56,355 suspected chikungunya fever cases have been reported. The
government has taken various steps to tackle the vector-borne diseases (VBDs), including dengue and chikungunya, which
include the implementation of a strategic action plan for prevention and control of chikun-gunya by the state governments.
• Revised National Tuberculosis Control Programme (RNTCP)

The Revised National Tuberculosis Control Programme (RNTCP) using Directly Observed Treatment, Short-course (DOTS) is
being implemented with the objective of curing at least 85 per cent of the new sputum-positive patients initiated on treatment, and
detecting at least 70 per cent of such cases. Since its inception, RNTCP has initiated more than 8.4 million TB patients on
treatment, thereby saving over 1.4 million additional lives. Deaths have been reduced from over 5 lakh per year at the
beginning of the programme to less than 3.7 lakh per year currently. Good quality-assured anti-TB drugs are provided in the
patient-wise drug boxes, free of cost. Paediatric, patient-wise drug boxes have been introduced in the programme from January
2007. The treatment’s success of new infectious TB cases under RNTCP has consistently exceeded the global benchmark of
85 per cent. RNTCP detected 66 per cent of the estimated new infectious cases in 2006, which is close to the global target of
70 per cent. In the third quarter of 2007, the detection rate was 70 per cent. The national programme has initiated the DOTS plus
services for management of Multi-drug Resistant TB (MDR-TB), The community-based Drug Resistance Surveillance (DRS)
conducted in Gujarat and Maharashtra recently estimated the prevalence of MDR-TB to be around 3 per cent among new
cases; in terms of absolute numbers, the burden is quite significant.
• National AIDS Control Programme

Nearly 20,408 AIDS cases were reported in 2007 (December 2007), out of which, 87.4 per cent of the infections were
transmitted through the sexual route, and pre-natal transmission accounted for 4.7 per cent of infections. About 1.8 per cent and
1.7 per cent of infections were acquired while injecting drugs and through contaminated blood and blood products, respectively.
The HIV prevalence among high-risk groups continues to be nearly six to eight times greater than that among the general
population. Based on the HIV Sentinel Surveillance Data from the last three years (2004–06), the districts have been classified
into four categories. About 156 districts have been identified as category A where the HIV prevalence among ANC clinic
attendees is greater than 1 per cent and 39 districts have been classified as category B where HIV prevalence among high-risk
population has been found to be more than 5 per cent. These districts are being given top-priority attention. National AIDS
Control Organisation has tried to increase access to services and communicate effectively for behavioural change. The
Government of India has launched National AIDS Control Programme Phase III, with the goal to halt and reverse the epidemic
in the country over the next five years, by integrating programmes for prevention, care, support, and treatment. During NACP
III, an investment of Rs 11,585 crore is required. Of this, an amount of Rs 8,023 crore is provided in the budget, the rest being
extra-budgetary funding largely from private donations and direct funding from bilateral and UN organisations. A total
expenditure of Rs 482.94 crore up to January 15, 2008 has been made for implementing various interventions during the
financial year 2007–08. An outlay of Rs 11,585 crore has been approved for the next five years (2007–12).
Integrated Disease Surveillance Project (IDSP)
Integrated Disease Surveillance Project (IDSP) was launched in November 2004. It is a decentralised,
state-based surveillance programme in the country. It is intended to detect early-warning signals of
impending outbreaks and help to initiate an effective response in a timely manner. In Phase-I, 9 states;
in Phase-II, 14 states; and in Phase-III, 12 states; are included. Major components of IDSP are
integration and decentralisation of surveillance activities, strengthening of public health laboratories,
HRD, and use of information technology for collection, collation, compilation, analysis, and
dissemination of data.

Major components of IDSP are integration and decentralisation of surveillance activities, strengthening of public health
laboratories, HRD, and use of information technology for collection, collation, compilation, analysis, and dissemination of
data.
User Charges in Government Health Facilities in India
User charges came to be levied on patients belonging to the families above the poverty line for
diagnostic and curative services offered in the health institutions, while free or highly subsidised
services continued to be provided to the poor and needy patients. A majority of states have introduced
the user charges for services in public health facilities though there are differences in levying,
collecting, and utilising user charges among the states. User charges, as an option of financing health-
care-delivery system, need to be supported by an efficient system of collection, and utility of user
charges, combined with an improvement in the quality of health services and facilities, for patients in
health institutions to be encouraged. At the same time, the access of poor and needy patients to health
care should not suffer.
India has one of the highest out-of-pocket household expenditure for health services. User charges
further augment this expenditure. Hence, it is pertinent that mechanisms of risk pooling are designed
and implemented towards improving access to health services. Under NRHM, Rogi Kalyan Samitis
(RKS)/Hospital Development Committees have been created as legal entities to enable greater
flexibility and retention as well as use of resources that they generate through their services. All the
Samitis have also been provided untied funds to carry out locally relevant action to ensure better
services for the poor households that visit the government facilities. RKS have the mandate to ensure
that the poor and needy receive cashless, hospitalised treatment and to charge for services only from
those who can pay. However, since the state of public health facilities sometimes force the poor and
needy patients also to approach private health-care facilities, which are available at high cost, health
insurance and other innovative schemes in this area are vital.

User charges, as an option of financing health-care-delivery system, need to be supported by an efficient system of
collection, and utility of user charges, combined with an improvement in the quality of health services and facilities, for
patients in health institutions to be encouraged.
Since the state of public health facilities sometimes force the poor and needy patients also to approach private health-care
facilities, which are available at high cost, health insurance and other innovative schemes in this area are vital.
Ayurveda, Yoga and Naturopathy, Unani, Siddha, and Homoeopathy ( AYUSH)

Under AYUSH, there is a network of 3,203 hospitals and 21,351 dispensaries across the country. The
health services provided by this network are largely focused on primary health care. The sector has a
marginal presence in secondary and tertiary health care. In the private and non-profit sector, there are
several thousand AYUSH clinics and around 250 hospitals and nursing homes for in-patient care and
specialised therapies like Panchkarma. The key interventions and strategies in the Eleventh Five-Year
Plan include training for AYUSH personnel, mainstreaming the system of AYUSH in the National
Health-Care-Delivery System, strengthening the regulatory mechanism for ensuring quality control,
R&D, and processing technology involving accredited laboratories in the government and non-
government sector, and establishing centres of excellence.

The health services provided by this network are largely focused on primary health care.
Family Planning Programme
The “Family Planning Programme” is now repositioned as a “Family Planning Programme for
Achieving MDG (Millennium Development Goals)” as this is one of the major means through which
both maternal and child mortality and morbidity can be reduced. Increasing the age of marriage and
spacing between the births are major interventions for achieving both these objectives. Intra-uterine
Device (IUD) services in the country are being given a thrust as this is one of the most effective
spacing methods available in the country. An alternative training methodology in IUD is being
introduced through which expansion of services as well as ensuring their quality is being addressed.
This is expected to increase the demand on IUD, along with scaling-up information, education, and
communication (IEC), which is presently introduced in 12 states as a “pilot project”. Increasing the
“basket of choice” in contraceptives through introduction of newer contraceptives is essential for
increasing contraceptive acceptance. The government has now modified the earlier compensation
scheme for sterilisation and has increased the payment to compensate for loss of wages to those
accepting sterilisation. Quality of care in family planning is one of the major thrust areas and
monitoring of quality of services in family planning is done through quality-assurance committees
set up at state and district levels. The government introduced a National Family Planning Insurance
Scheme which provides a compensation to sterilisation acceptors as well as to provide indemnity
insurance to the provider (qualified doctors) against failures, complications, and deaths following
sterilisations. These measures are introduced as confidence-building mechanisms among the family-
planning clients. The increased availability of infrastructure as a result of the NRHM would assist in
increasing access to the family planning services.

The “Family Planning Programme” is now repositioned as a “Family Planning Programme for Achieving MDG
(Millennium Development Goals)” as this is one of the major means through which both maternal and child mortality and
morbidity can be reduced.
GROWTH OF HUMAN DEVELOPMENT

It is true that economic growth has to some extent contributed in the reduction of destitution. Over the
last five decades more and more poor people, in comparison to the past, have gained some access to
certain public services, such as food, education, modern health services, and “safe” drinking water.
The IMR and longevity have improved. Statistically speaking, HDI of all the South Asian countries
have improved. In the case of India, it has moved 0.174 points, from 0.416 in 1975 to 0.590 in 2001.
Sri Lanka, which is already very high in the scale, has gained only 121 points. Bangladesh and
Pakistan have also improved their position. But all of them are far behind to catch up with the
developed countries. With the present rate of growth and other things remaining constant, India would
require at least 60 years to attain a high position in HDI. Assumption is that growth and HD are not
only related but they also have a linear direction. But the fact remains that many of the Scandinavian
countries attained the present level of HD just not by economic growth alone. Sri Lanka and Kerala,
the state within India, also have better HD than high-growth regions.
The countries, which already have high HD, are also in the race for high economic growth.
Policymakers in these countries emphasise that “Work is more important than income”. The Finance
Minister of the Netherlands asserted that if the country wanted to successfully resolve the problem of
aging they should “learn a lot from the Americans. … USA has a higher rate of economic growth
because the people work longer there….” At the same time, unemployment is increasing and wage
freeze is being introduced. Health and education are increasingly being privatised. There is also more
cut every year on social security provisions such as unemployment benefits and health-care costs. The
cuts in social sectors are not because of the decline rate in the economic growth. But it is because of
the state’s unwillingness to tax profiteers for public goods. Inequality has increased in these countries.
Andre Gorge argues:

The countries, which already have high HD, are also in the race for high economic growth. Policymakers in these countries
emphasise that “Work is more important than income”.
The social security system must be reorganised, and new foundations put in its place. But we must also ask why it seems to have
become impossible to finance this reconstruction. Over the past 20 years, the EU countries have become 50 per cent to 70 per cent
richer. The economy has grown much faster than the population. Yet the EU now has 20 million unemployed, 50 million below the
poverty line, and 5 million homeless. What has happened to the extra wealth? From the case of the United States, we know that
economic growth has enriched only the best of 10 per cent of the population. This 10 per cent has garnered 96 per cent of the
additional wealth. Things are not quite bad in Europe, but they are not much better.
In Germany since 1979 corporate profits have risen by 90 per cent and wages by 6 per cent. But the revenue from income tax has
doubled over the past 10 years, while the revenue from corporate taxes has fallen by a half. It now contributes a mere 13 per cent
of the total tax revenue, down from 25 per cent in 1980 and 35 per cent in 1960. Had the figure remained at 25 per cent, the state
would have annually netted an extra 86 billion marks in recent years, (Beck 2000).
As we have seen in the case of India, the economic growth has not generated employment. It is a
jobless growth. The present development of high technology reduces a requirement for human
labour. It is capital intensive. As a result, “the global employment situation is grim and getting
grimmer”, ILO observes. “Social exclusion of the most vulnerable is intensifying: the old, the young,
the disabled, ethnic minority groups, the less skilled, and across all these groups there is a bias
against women” (Thomas 2000: 31).

As we have seen in the case of India, the economic growth has not generated employment. It is a jobless growth. The
present development of high technology reduces a requirement for human labour. It is capital intensive.
On the other hand, profits of the 95 multinationals among India’s top 900 companies have
increased their share of profits from 7.70 per cent of total profits in 1994–95 to 10.82 per cent in
2002–03. The growth rate of their net profit is 225.05 during the period. Despite their poor sales, their
profits have increased because their share in salaries and wages fell from 11.99 per cent in 1994–95 to
10.70 per cent in 2002–03. The rise in profit is also without taxes. At the global level, the taxes yield
from corporate profits fell by 18.6 per cent between 1989 and 1993. Their proportion of the total
fiscal revenue has gone down nearly by half (Beck 2000: 5). In India, during the last decade the
corporate taxes have not only been reduced but industries also have received several concessions to
boost up production and market. At the same time, “black economy” estimated at around 60 per cent
continues to dominate the Indian economy (Kumar 1999; Harris-White 2003: 7).
The purpose of economic growth in the capitalist mode of production is enhancement of profit. It
provides incentive to capital for the investment and growth. For that, markets have to be expanded and
also invented. Hence, such growth is geared not only to cater to the existing needs of the people but
also to manufacture the needs as well as greed; thereby, consumerism is promoted. It breeds “sense of
envy” among those who cannot possess what the others have; as one advertisement puts “owner ’s
pride is neighbour ’s envy”. In the process, relative deprivation and poverty perpetuate. The
champions of such models of development glorify and legitimise inequality. The former British
Prime Minister Margaret Thatcher advocated, “It is our job to glory in inequality, and see that talents
and abilities are given vent and expression for the benefit of us all” (Thomas 2000: 14). The incentive
for entrepreneurship is, of course, necessary for the growth of wealth and society, provided they are
used for social goods. More important question is: What should be the ratio of inequality? In India, an
agricultural labourer or a casual labourer gets on an average Rs 6,000 a year, not to speak of the
labourer in a draught-prone area, who gets barely Rs 3,000. Whereas, the top chief executive officers
(CEOs) of the corporations, on an average, get Rs 60 lakh; not to speak of the topmost who get above
Rs 90 lakh plus many perks. In India and elsewhere, the gap between poor and rich has glaringly
widened in the last three decades.

The purpose of economic growth in the capitalist mode of production is enhancement of profit.
Such growth is geared not only to cater to the existing needs of the people but also to manufacture the needs as well as
greed; thereby, consumerism is promoted.

In India and elsewhere, the gap between poor and rich has glaringly widened in the last three decades.
Expansion of all kinds of industries and “development” projects like irrigation dams, thermal
power, roads, and so on, take away the livelihood resources such as land, forest, river, and marine of
the poor people. Forest areas are shrinking every year and so is biodiversity. Environmental
degradation continues unabated. Ground and river water, land, as well as crops—vegetables and food-
grains—get contaminated with industrial effluents. According to a survey, seven largest estates of
more than 100 industrial development estates in India produce 220,381 tonnes of hazardous waste a
year. With the growth and consumption, quantum of solid waste too is mounting. With such a rush for
growth, natural resources are not only depleting very fast but also endangering the environment. Such
growth cannot be sustained for a long. According to a recent survey, it is estimated that if the present
rate of climate change continues, thanks to industrial technologies and greenhouses, more than one
million plant and animal species would be extinguished by 2050. The worse sufferers would be the
people from the developing countries.

According to a recent survey, it is estimated that if the present rate of climate change continues, thanks to industrial
technologies and greenhouses, more than one million plant and animal species would be extinguished by 2050. The worse
sufferers would be the people from the developing countries.
In the present uncontrolled market-driven growth only those who have the capacity to produce
more and expand markets can survive, and those who can buy more and more can exist. In order to
increase the buying capacity, people are pushed into a rat race, to compete with each other. Space for
individual choice and autonomy is shrinking. Philosophy of Social Darwinism dominates the lifestyle
of the well-off. The rest are pushed to imitate the rich for their survival or else, they get eliminated.
Oswaldo De Rivero persuasively argues,
The underlying Darwinism of the neoclassical, ultra-liberal message that inspires current capitalist globalisation, turns the economy
into the paramount factor determining all other options, whether political or social and even cultural; nothing could be closer to the
Marxist ideology. However, the archetype is not the robot-like homo sovieticus, but rather the homo economicus, whose sole
motivation is money, the ability to consume more material goods, who is aggressively competitive, a kind of predator lost in the
Darwinian jungle of social and economic de-regulation. In this jungle, not only companies but also individuals—each social group,
each community, must be fittest, the strongest, and the best. Those who are not competitive must be eliminated from the economic
arena, regardless of social, moral, or environmental implications. This is a zero-sum game, where there is no cooperation. You win or
you lose (2001: 80).
Enough historical and contemporary evidences show that uncontrolled market-driven growth is self-
destructive for human civilisation. It is dangerous to the environment. It is unsustainable and
increasingly becoming devoid of ethical values for common goods. Its potentiality for enhancing HD
is questionable. Market is indifferent to the needs of the majority of the people. The corporate sectors
—local or transnational—do not take social responsibilities though they talk about social
commitments. More often than not, many of them even do not take care of the welfare of the workers
who work for them. Managing Director of the IMF, Michel Camdessus, also accepts negative aspects
of free market:

Enough historical and contemporary evidences show that uncontrolled market-driven growth is self-destructive for human
civilisation. It is dangerous to the environment. It is unsustainable and increasingly becoming devoid of ethical values for
common goods.
A new paradigm of development is progressively emerging ... A key feature of this is the progressive humanization of basic economic
concepts. It is now recognized that markets can have major failures and that growth alone is not enough and can even be destructive
of the natural environment and of social and cultural goods. Only the pursuit of high-quality growth is worth the effort ... growth that
has human person in the center ... A second key feature is the convergence between respect for ethical values and the search for
economic efficiency and market competition (Thomas 2000: 93).
HUMAN DEVELOPMENT REPORT (2007–08)
Each year since 1990, the HDR has published the HDI which looks beyond GDP to a broader
definition of well-being. The HDI provides a composite measure of the three dimensions of HD:
living a long and healthy life (measured by life expectancy), being educated (measured by adult
literacy and enrolment at the primary, secondary, and tertiary level), and having a decent standard of
living (measured by purchasing power parity (PPP) income). The index is not in any sense a
comprehensive measure of HD. It does not, for example, include important indicators such as gender
or income inequality and more-difficult-to-measure indicators, like respect for human rights and
political freedoms. What it does provide is a broadened prism for viewing human progress and the
complex relationship between income and well-being. The HDI for India is 0.619, which gives the
country a rank of 128 out of 177 countries with data (refer to Table 14. 7).

The HDI for India is 0.619, which gives the country a rank of 128 out of 177 countries with data.
This year ’s HDI, which refers to 2005, highlights the very large gaps in the well-being and life
chances that continue to divide our increasingly interconnected world. By looking at some of the
most fundamental aspects of people’s lives and opportunities, it provides a much more complete
picture of a country’s development than other indicators, such as GDP per capita. Figure 14.1
illustrates that countries on the same level of HDI as India can have very different levels of income.

Table 14.7 India’s HDI, 2005
Source: World Human Development Report 2007–08.

Fig ure 14.1 The HDI Giving a More Complete Picture than Income

Notes: HDI and GDP data refers to 2005 as reported in the 2007–08 Report

OVERVIEW OF HUMAN DEVELOPMENT
Of the components of the HDI, only income and gross enrolment are somewhat responsive to short-
term policy changes. For that reason, it is important to examine changes in the HDI over time.
The HDI trends tell an important story in that aspect. Since the mid-1970s, almost all regions have
been progressively increasing their HDI score (refer to Figure 14.2). East Asia and South Asia have
accelerated progress since 1990. The Central and the Eastern Europe and the Commonwealth of
Independent States (CIS), following a catastrophic decline in the first half of the 1990s, has also
recovered to the level before the reversal. The major exception is sub-Saharan Africa. Since 1990 it
has stagnated, partly because of economic reversal but principally because of the catastrophic effect
of HIV/AIDS on life expectancy.
Human Poverty in India
Focusing on the most deprived through multiple dimensions of poverty, the HDI measures the
average progress of a country in HD. The Human Poverty Index (HPI) for developing countries (HPI-
1), focuses on the proportion of people below a threshold level in the same dimensions of HD as the
HDI—living a long-and-healthy life, having access to education, and a decent standard of living. By
looking beyond the income deprivation, the HPI-1 represents a multi-dimensional alternative to the $1
a day (PPP US$) poverty measure. The HPI-1 value of 31.3 for India ranks 62nd among 108
developing countries, for which the index has been calculated.

The HPI-1 value of 31.3 for India ranks 62 nd among 108 developing countries, for which the index has been calculated.
The HPI-1 measures the severe deprivation in health by the proportion of people who are not
expected to survive the beyond age of 40. Education is measured by the adult illiteracy rate. And a
decent standard of living is measured by the unweighted average of people, without access to an
improved water source, and the proportion of children under age 5, who are underweight for their
age. Table 14.8 shows the values for these variables for India and compares them with that of the
other countries.
Building the Capabilities of Women
The HDI measures the average achievements in a country, but it does not incorporate the degree of
gender imbalance in these achievements. The Gender-related Development Index (GDI), introduced in
HDR 1995, measures achievements in the same dimensions using the same indicators as the HDI, but
captures inequalities in achievement between women and men. It is simply the HDI-that is adjusted
downward for gender inequality. The greater the gender disparity in the basic HD, the lower is a
country’s GDI relative to its HDI.

Fig ure 14.2 HDI Trends

Table 14.8 Selected Indicators of Human Poverty for India

India’s GDI value, 0.600 should be compared to its HDI value, 0.619. Its GDI value is 96.9 per cent
of its HDI value. Out of the 156 countries with both HDI and GDI values, 137 countries have a better
ratio than India’s. Table 14.9 shows how India’s ratio of GDI to HDI compares to other countries, and
also shows its values for selected underlying values in the calculation of the GDI.
Fighting Climate Change

As a result of the past emissions of carbon dioxide (CO2) and other greenhouse gases (GHGs), the
world is now on course for future climate change. This year ’s HDR identifies 2°C as the threshold
above which irreversible and dangerous climate change will become unavoidable. It also explains
why we have less than a decade to change the course and start living within a sustainable global
carbon budget identified at 14.5 gigatonnes of CO2 (Gt CO2) per annum for the remainder of the 21st
century. Currently, emissions are running at twice this level. If these trends continue, the carbon
budget will be set for expiry during the 2030s, setting in motion processes that can lead to
temperature increases of 5°C or above by the end of this century—roughly similar to temperature
changes since the last ice age, which was about 10,000 years ago. With 17.4 per cent of the world’s
population, India accounts for 4.6 per cent of global emissions—an average of 1.2 tonnes of CO2 per
person. These emission levels are below those of South Asia (refer to Table 14.10).
High-income OECD (Organisation for Economic Cooperation and Development) countries
meanwhile lead the league of “CO2 transgressors”. With just 15 per cent of the world’s population,
they account for almost half of all emissions. If the entire world emitted like high-income OECD
countries—an average of 13.2 tonnes of CO2 per person, we would be emitting six times our
sustainable carbon budget. India has signed and ratified the Kyoto Protocol. As a non-Annex I Party to
the Protocol, India is not bound by any specific target for GHG emissions.

High-income OECD (Organisation for Economic Cooperation and Development) countries meanwhile lead the league of
“CO2 transgressors”. With just 15 per cent of the world’s population, they account for almost half of all emissions. If the
entire world emitted like high-income OECD countries—an average of 13.2 tonnes of CO2 per person, we would be
emitting six times our sustainable carbon budget.

Table 14.9 The GDI Compared to the HDI—A Measure of Gender Disparity

Table 14.10 Carbon dioxide Emissions

CASE
Iceland and India
Iceland, officially the Republic of Iceland, is a country in northern Europe, comprising the island of
Iceland and its outlying islets in the North Atlantic Ocean between the rest of Europe and Greenland. It
is the least populous of the Nordic countries and the second smallest; it has a population of about
316,000 (April 1, 2008 estimate) and a total area of 103,000 sq. km. Its capital and largest city is
Reykjavik.
Located on the Mid-Atlantic Ridge, Iceland is volcanically and geologically active on a large scale;
this defines the landscape in various ways. The interior mainly consists of a plateau characterised by
sand fields, mountains, and glaciers, while many big glacial rivers flow to the sea through the
lowlands. Warmed by the Gulf Stream, Iceland has a temperate climate relative to its latitude and
provides a habitable environment and nature.
The settlement of Iceland began in 874 when, according to Landndmabok, the Norwegian chieftain,
Ingolfur Arnarson became the first permanent Norwegian settler on the island. Others had visited the
island earlier and stayed over winter. Over the next centuries, people of Nordic and Gaelic origin
settled in Iceland. Until the 20th century, the Icelandic population relied on fisheries and agriculture,
and was from 1262 to 1918, a part of the Norwegian and later, the Danish monarchies. In the 20th
century, Iceland’s economy and welfare system developed in a rapid pace.
As of 2007, Iceland is the most developed country in the world, with fellow Nordic country
Norway, according to the HDI; and one of the most egalitarian, according to the calculation provided
by the Gini coefficient. Interestingly, Iceland overtook Norway to top the HD ranking. Norway, which
had held the top position for the last six years, is close to second only.
Based upon a mixed economy where service, finance, fishing, and various industries are the main
sectors, it is also the fourth, most productive country per capita.
India, known as one of the largest and strongest economies, ranks 128th in terms of HD. The HDI
for India is 0.619, which gives the country a rank of 128th out of 177 countries.
The HPI value of 31.3 for India ranks 62nd and Iceland ranks 1st among the 108 developing
countries for which the index has been calculated. HPI focuses on the proportion of people below a
threshold level in the same dimensions of HD as the HDI—living a long and healthy life, having
access to education, and a decent standard of living. By looking beyond income deprivation, the HPI
represents a multi-dimensional alternative to the $1 a day (PPP US$) poverty measure.
No significant difference is seen between the HD policies of India and Iceland if we have a
comparison.
Inspite of having very strong policies and programmes like Swarnajayanthi Gram Swarozgar
Yojana Scheme, which is a holistic approach towards poverty eradication in rural India through
creation of self-employment opportunities to the rural Swarozgaries, Pradhan Mantri Gramodaya
Yojana, Sampoorna Grameen Rozgar Yojana, Food-for-Work Programme, Swarnajayanti Shahari
Rozgar Yojana, Development of Women and Children in Rural, and so on, India is having list of
policies and programmes for HD.
But the difference lies in the strong implementation of these policies. The public awareness is high
in Iceland when compared to India, and the public is indirectly involved in the policy formulation in
Iceland, the reason may be “almost 100 per cent literacy”. Public expenditures have played an
important role in India’s HD. Public expenditure on health and education of India in terms of
percentage of GDP is very less when compared to Iceland. Public expenditure of India on health and
education is just 0.9 per cent and 4 per cent of GDP, respectively, and Iceland spends 8.3 per cent and
8.1 per cent of GDP on health and education, respectively. The Table 14.11 gives the comparison
between Iceland and India in various aspects.
The interesting fact here is that Transparency International has published an annual Corruption
Perceptions Index (CPI), ordering the countries of the world according to “the degree to which
corruption is perceived to exist among public officials and politicians”. Iceland ranked 6th place in the
year 2007 and 72nd place as per CPI. Iceland, the block of sub-Arctic lava to which these statistics
apply, tops the latest table of the UNDP’s HDI rankings, meaning that as a society and as an economy
—in terms of wealth, health, and education—they are the champions of the world. The highhights like
—the only country in NATO with no armed forces (they were banned 700 years ago); the highest
ratio of mobile telephones to population; the fastest-expanding banking system in the world;
rocketing export business; crystal-pure air; hot water delivered to all Icelandic households straight
from the earth’s volcanic bowels; and so on and so forth—add feathers to its crown.

Table 14.11 Customised Indicator Comparison Report of Iceland and India
Case Questions
1. Why Iceland is ranked first in HDI?

2. What are the reasons for low HDI of India when compared to Iceland, inspite of having strong policies and programmes for
human development?
3. Suggest some policies and programmes for human development in India.
4. Collect some more facts and figures and give a complete, detailed comparison of human development in Iceland and India.
SUMMARY
The human resource of an economy, particularly of an underdeveloped economy, can be improved

by providing education, medical facilities, and other facilities like housing, sanitation, and so on.
These facilities help the HRD in an economy. The Government of India gives more importance to the
development of women and children as they are important for the development of an economy.
India, being a developing country, has had to face several economic and political challenges. One of
the most important problems is the population explosion. Some of the reasons for this -population
explosion are poverty, better medical facilities, and immigration from the neighbouring countries of
Bangladesh and Nepal. The population density of India was 325 persons per sq. km in the year 2004.
Several solutions to decrease the rate of population increase have been tried by the government,
though some were successful, some were unsuccessful too. Although the rate of increase has
decreased, the rate has not reached the satisfactory level yet. The population in India continues to
increase at an alarming rate. The effects of this population increase are evident in the increasing
poverty, unemployment, air and water pollution, and shortage of food and health resources.
KEY WORDS
Human Resource Development (HRD)

Life Expectancy
Education
Birth Rate
Death Rate
Population Explosion
Migration
Unemployment
Illiteracy
Indra Mahila Yojana
Health
QUESTIONS
1. What do you mean by human development? What are the essential components of human development?
2. Give the importance of human resource development for a nation, and explain the steps taken by the Government of India for the
development of human resource.
3. Define the term population and explain the scenario of population in India.
4. What are the impacts of population explosion in India?
5. Give the different measures for controlling the population of India.
REFERENCES
Budget Documents of Central and State Governments, Government of India.

Budget Documents of Ministry of Rural Development, Government of India.
Government of India. The Economic Survey 2007–08. New Delhi: Ministry of Finance.
UNDP Report 2007.
World Bank Human Development Report 2007–08.
CHAPTER 15
Rural Development
CHAPTER OUTLINE
Concept, Meaning, and Definition of Rural Development
Integrated Rural Development
Important Features of Rural Economy and Rural Society
Scope of Rural Development
Interdependence Between Rural and Urban Sectors
Strategies for Rural Development
Rural Water Supply and Sanitation
Women and Child Development
Rural Development: A Critical Analysis
Key Words
Questions
References
CONCEPT, MEANING, AND DEFINITION OF RURAL DEVELOPMENT
A vast majority of people in the world live in rural areas and as such, rural development assumes a
global importance in the current scenario. In the early stages of development of the present rich
countries, rural area had played a crucial role in different directions. In the Asian context,
development primarily means rural development, since most of the people still live in rural
communities.
Among the Asian countries, India is primarily a rural country, with 70 per cent of the total
population still living in villages. Indian culture developed and flourished primarily in the rural
communities. Even now, rural people wield an overwhelming influence on social, economic, and
political activities in India. In fact, in the Indian context, development primarily means rural
development only.

Among the Asian countries, India is primarily a rural country, with 70 per cent of the total population still living in villages.
Indian culture developed and flourished primarily in the rural communities.
Rural Development Defined
“Development” may be defined as an activity or process of both qualitative and quantitative change in
the existing systems, aiming at an immediate improvement of the living conditions of the people or
increase the potential for a betterment of living conditions in future. Until recently, the concepts
“economic development” and “economic growth” were used interchangeably. Nowadays, a clear
distinction is made between the two concepts. Development is a broad concept, which also embraces
growth. It covers both quantitative and qualitative aspects.

“Development” may be defined as an activity or process of both qualitative and quantitative change in the existing systems,
aiming at an immediate improvement of the living conditions of the people or increase the potential for a betterment of
living conditions in future.
Economic growth is mainly concerned with the quantitative aspect of development. For example,
producing more farm output by way of extensive cultivation is an indication of growth. Producing
more output by way of increasing yield per hectare through new farm technology is an indication of
development. However, in the latter case, some authors prefer the “economic progress”, implying an
increasing productivity per head. Development has many dimensions and includes qualitative changes
in social, economic, political, cultural, environmental, and such other aspects. It is a continuous and
unending process attempting to improve all aspects of the society.
Development ultimately means development of man and, therefore, it is to be judged by what it
does to him. In the rural areas, a good number of people for over several years lived a life of
dependency or almost a complete slavery. Because of abject poverty and consequent
underdevelopment or social stagnation, people lose faith in themselves and in their potentialities for
development, and remain without active participation in social, economic, cultural, and political life.
It is important to bring them out of this apathy and scepticism and to motivate them to think freely
about progressive ideas. Development should ultimately result in the reduction of dependency on
external resources, increased selfreliance, confidence in their own strength and potentialities for
development, spirit of mutual respect, and collective effort. Rural development, therefore, should be
viewed as a strategy designed to liberate the rural poor from the age-old bondage of degraded life,
and to awaken and activate the entire rural population in the process of achieving and sharing of
higher levels of production.

Development ultimately means development of man and, therefore, it is to be judged by what it does to him. In the rural
areas, a good number of people for over several years lived a life of dependency or almost a complete slavery.
Anker gives the following working definition of the rural development strategies, policies, and
programmes for the development of rural areas and the promotion of activities carried out in such
areas, (agriculture, forestry, fishery, rural crafts and industries, and the building of the social and
economic infrastructure), with the ultimate aim of achieving a fuller utilisation of the available
physical and human resources, and, thus, higher incomes and better living conditions for the rural
population, as a whole, particularly the rural poor, and the effective participation of the latter in the
development process. In this definition, some important elements can be identified, which are as
follows:
There should be a full utilisation of the available physical and human resources in rural areas, with functional linkage;
There should be the development of agriculture and its allied activities;
There should be again the development of rural industries;
There should be an aim for higher incomes and better living conditions of rural population; and
There should be a focus of development on rural poor, with their effective participation in the development process.
The Rural Development Sector Policy Paper of the World Bank Report, 1973, observed that
Rural development is a strategy designed to improve the economic and social life of a specific group of people the rural poor. It
involves extending the benefits of development to the poorest among those who seek a livelihood in the rural areas. The group
includes small-scale farmers, tenants and the landless.
The Rural Development Sector Policy Paper of the World Bank Report, 1973, observed that Rural development is a strategy
designed to improve the economic and social life of a specific group of people the rural poor.
Again, a World Bank publication defines rural development as “improving the living standards of the
masses of the low-income population residing in rural areas making the process of rural
development self sustaining”.

Again, a World Bank publication defines rural development as “improving the living standards of the masses of the low-
income population residing in rural areas making the process of rural development self sustaining”.
The World Bank definition of rural development is based inherently on an operational approach
that is constrained by the practicalities of allocating loan resources over a wide spectrum of
countries, ensuring maximum economic returns to them. In a seminar on approaches to rural
development in Asia, discussions were centred around a definition of “rural development as a process
which leads to a continuous rise in the capacity of the rural people to control their environment
accompanied by a wider distribution of benefits resulting from such control” (World Bank Report).
This definition is composed of three important elements:
1. Rural development should be viewed as a process of raising the capacity of the rural people to control their environment.
“Environment” does not mean only agricultural or economic development. It includes all aspects of rural life—social,
economic, cultural, and political;
2. Rural development as a process should continuously raise the capacity of the rural people to influence their total environment,
enabling them to become initiators and controllers of changes in their environment, rather than being merely the passive objects
of external manipulation and control; and
3. Rural development must result in a wider distribution of benefits accruing from technical developments and the participation of
weaker sections of the rural population in the process of development.
G. Parthasarathy opines that

The critical element in the rural development is improvement of living standards of the poor through opportunities for better
utilisation of their physical and human resources; in the absence of this, utilisation of rural resources has no functional significance.
Making the process of rural development self-sustaining not only implies the mobilisation of capital and use of technology for the
benefit of the poor but their active involvement in the building up of institutions as well as in functioning of these.

The critical element in the rural development is improvement of living standards of the poor through opportunities for better
utilisation of their physical and human resources.
Michael Todaro views that

Rural development encompasses:
1. Improvement in levels of living, including employment, education, health and nutrition, housing and a variety of social services;
2. Decreasing inequality in the distribution of rural incomes and in rural-urban balances in incomes and economic opportunities, and
3. Increasing the capacity of the rural sector to sustain and accelerate the pace of these improvements.
INTEGRATED RURAL DEVELOPMENT
Development is a function of several disciplines; and as per the final analysis, development is an all-
round development of man. Development is always an integrated one. Economic development, though
has been aspired much, cannot be separated from the social, cultural, and such other aspects of
development. R. Krishnaswamy rightly views that rural development involves several categories of
integration, viz., spatial integration, that is, integration between areas; integration of different sectors
of the rural economy—agriculture, off-farm activities, industry, and so on, with forward and
backward linkages; integration of economic development with social development; integration of
total-area approach and target-group approach; integration of credit with technical services;
integration of human resource development with manpower needs by dovetailing education and
training programmes with anticipated manpower needs; and integration of income-generating
schemes with the Minimum Needs Programme of education, rural health, water supply, nutrition, and
so on.

Development is a function of several disciplines; and as per the final analysis, development is an all-round development of
man.
Rural development has been an integral part of India’s development from the very beginning. In a
nutshell, rural development may be viewed as a programme intended for the all-round development
of the entire rural society with a focus on the rural poor. Different schemes have been initiated to
develop agriculture, small-scale and village industries, rural transport and communication, education,
health, and so on. Rural development has assumed a considerable significance throughout the
planning era. The early development schemes such as Community Development Programme,
Intensive Agricultural District Programme, Intensive Agricultural Area Programme, Drought-Prone
Area Programme (DPAP), Command Area Development Programme, and so on, have all aimed at
rural development. Considerable amounts have been spent over these different schemes.

Rural development has been an integral part of India’s development from the very beginning. In a nutshell, rural
development may be viewed as a programme intended for the all-round development of the entire rural society with a focus
on the rural poor.
No doubt, to some extent, development has taken place in the rural areas because of these different
schemes. However, these schemes have not helped significantly all sections of the rural society. It is
noticed that rural poor with meagre or no assets of any type, like small and marginal farmers, village
artisans, tenant cultivators, agricultural landless labourers, and so on, have almost been bypassed by
these different development schemes. Rural development, therefore, is now rightly viewed as a
strategy designed to improve the socio-economic conditions of the rural poor.

Rural development, therefore, is now rightly viewed as a strategy designed to improve the socio-economic conditions of the
rural poor.
IMPORTANT FEATURES OF RURAL ECONOMY AND RURAL SOCIETY
Rural areas are described as underdeveloped or backward as the per capita real income is low in the
rural areas when compared to the same in the urban areas. This definition is an indicator of one
aspect of underdevelopment that is based on income alone. The Indian Planning Commission defined
underdevelopment as one “which is characterised by the co-existence, in greater or lesser degree, of
unutilised and underutilised manpower, on the one hand, and of unexploited natural resources, on the
other”. It is a well-known fact that many natural resources like industrial raw materials, water
resources, forest resources, and so on, remain unexploited while there is plenty of manpower
remaining idle in rural areas.

The Indian Planning Commission defined underdevelopment as one “which is characterised by the co-existence, in greater
or lesser degree, of unutilised and underutilised manpower, on the one hand, and of unexploited natural resources, on the
other”.
Owing to inadequate capital resources and lack of skill and technology, different resources in the
rural areas remain unutilised or underutilised leading to backwardness of rural areas. There is quite
visible “poverty in the midst of plenty” in the rural areas. It is appropriate to examine the important
features of the rural sector before we discuss in detail the nature and scope of the rural development.
The main features of the rural sector or the rural economy in India are as follows:
i. Greater Dependence on Agriculture: Agriculture is the main economic activity in rural areas supporting nearly 70 per cent of the
population. Yet, even agriculture remains backward, as can be seen from the low level of average productivity or yield per
hectare of different crops. Low productivity leads to low level of incomes, which, in turn, results in poor living conditions. Due
to the law of inheritance, land is divided and subdivided from generation to generation, creating tiny and fragmented holdings. In
many cases, cultivation of a very small holding of say, less than an acre or two and that too located in more than one place,
becomes quite uneconomical, yielding not even subsistence wages for the family labour. In such type of cultivation, adoption of
new farm technology is almost absent and the farm operator in such a situation is no better than a landless labourer.

Agriculture is the main economic activity in rural areas supporting nearly 70 per cent of the population.
ii. Large-scale Underemployment and Unemployment: A vast majority of people live in rural areas; and with faster growth of
population and in the absence of a considerable increase in the non-agricultural occupation, there is growing pressure on land.
Irrigation expansion has been quite inadequate and hence, additional population cannot be gainfully employed on land. This has
resulted in disguised unemployment with low or zero marginal productivity of labour: even if some people leave the agricultural
families, farm output is not going to decline. As there are no alternatives for gainful employment opportunities for the surplus
rural labour, many continue to depend on land for their living. Rural employment, again, is seasonal, particularly where
agricultural operations take place under the rain-fed conditions. In many villages of drought-prone areas, a large number of
rural people remain idle for a long period in a year. Rural unemployment is more in the nature of underemployment of varying
degrees.

In many villages of drought-prone areas, a large number of rural people remain idle for a long period in a year.
Rural unemployment is more in the nature of underemployment of varying degrees.
iii. Poor Incomes and Indebtedness: In many cases, what is produced is not sufficient to meet even their consumption requirements.
They resort to “distress sales” of limited grain reserves, even ignoring the requirement for seed purposes. They are forced to
borrow to meet the basic necessities of life like food, clothing, and so on. A considerable number of rural poor are born in debt,
inherit huge debt from ancestors, and find it impossible to pay even the interest amount for the huge, accumulated past debt.
Borrowing from different sources to repay the accumulated debt is still a common feature in rural areas. There is no wonder that
rural indebtedness continues to be a major problem.

A considerable number of rural poor are born in debt, inherit huge debt from ancestors, and find it impossible to
pay even the interest amount for the huge, accumulated past debt.
iv. Capital Deficiency: For the development of any sector, adequate investment is necessary. Under the conditions of poor incomes,
the saving capacity of rural poor, with very few exceptions, is very low. With low level of savings, investment capacity is at a
low level. The institutional credit made available in the recent years, it is reported, is often used for consumption purposes,
thereby denying the minimum investment for farming operations.

With low level of savings, investment capacity is at a low level.
v. Low Level of Technology and Poor Extension Facilities: In the rural sector, both in agricultural operations and in on-
agricultural enterprises, the application of new technology is at a very low level. It is a well-known fact that new farm
technology leading to the Green Revolution is confined mostly to the large-size farmers in areas with assured irrigation facilities.
Lack of adequate capital, coupled with a lack of provision of a proper guidance in the application of technical know-how, result
in an inadequate utilisation of even the known technology for development.

Lack of adequate capital, coupled with a lack of provision of a proper guidance in the application of technical
know-how, result in an inadequate utilisation of even the known technology for development.
vi. Low Level of Productivity: An important feature of rural economy is the low level of farm productivity and a low level of
labour productivity, both in the agricultural and non-agricultural enterprises. With the average yield per hectare remaining
deplorably low, the marketable surplus is either almost nil in many cases or is very limited. Often, many farmers resort to
distress sales to meet the immediate cash requirements and once again, they purchase the same grain, paying even higher price,
leading to indebtedness.

An important feature of rural economy is the low level of farm productivity and a low level of labour productivity,
both in the agricultural and non-agricultural enterprises.
vii. Lack of Infrastructure: Rural India severely suffers from lack of adequate, economic and social overheads such as power,
transportation, and communication. Although India has made impressive gains in creating a social and economic infrastructure, the
above overheads are mostly concentrated in urban and semi-urban areas. The infrastructural facilities in the context of different
developmental schemes are quite inadequate in the rural areas.

The infrastructural facilities in the context of different developmental schemes are quite inadequate in the rural
areas.
viii. Lack of Basic Amenities of Life: Many villages in India suffer for want of basic necessities of life like drinking water, health
services, sanitation, and so on. In India, during 1990–96, the population without access to (a) safe drinking water was 19 per
cent; (b) health services was 15 per cent, and (c) sanitation was 71 per cent. It is also estimated that during 1990–97, 53 per cent
of children below five years were found to be underweight. The children not reaching Grade 5 was found to 5 per cent.
According to the study of an expert group for 1993–94, the per capita monthly expenditure of Rs 205.84 in the rural areas and
Rs 281.35 in the urban areas would be necessary to ensure the minimum level of living. On that basis, about 37.27 per cent of
India’s population in the rural areas and 32.36 per cent in the urban areas were living below the poverty line. It is estimated that
nearly two-thirds of expectant mothers belonging to the poorer sections of the community suffer from a serious malnutrition.

37.27 per cent of India’s population in the rural areas and 32.36 per cent in the urban areas were living below the
poverty line.
ix. Averse to Population Limitation: In rural areas, the “small family norms” is not well received, particularly by the rural poor
without any assets. The agricultural labourer, for example, who has no assets, thinks that his children, particularly male children,
are dependable assets to rely upon during his old age. Under these conditions, family planning is not well adopted and fertility
rate is recorded to be relatively higher in the rural areas when compared to that in the urban areas. Under poor dietary conditions
of the mothers, unhealthy children are born. The maternity facilities in rural areas are quite inadequate and hence, the infant
mortality rate is higher.

Family planning is not well adopted and fertility rate is recorded to be relatively higher in the rural areas when
compared to that in the urban areas.
x. Social and Cultural Factors: The backwardness of rural society is not attributable to economic factors alone. Many non-
economic factors too account for the miserable rural life. Men in the rural areas remain illiterate and the illiteracy of women is
still, of a higher degree. It is more disturbing to note a wide gulf in the enrolment of boys and girls. It is estimated that among
girls, about 55 per cent at the primary level, about 75 per cent at the middle level, and about 85 per cent at the secondary level
are out of school. The corresponding figures for boys are said to be about 20 per cent at the primary level, about 57 per cent at
the middle level, and 71 per cent at the secondary level. The enrolment positions of girls and children of scheduled castes
(SCs) and scheduled tribes (STs), particularly in the rural areas, are found to be quite unsatisfactory. The rural people are still
under the predominant influence of caste and religious customs and beliefs, resulting in extravagant expenses on avoidable
social and religious functions, and these expenses would adversely affect the family budget and the normal development
activities of the family. Huge amounts are borrowed and spent on unproductive items leading to heavy debt burden. The rigid
caste system still followed in certain remote rural areas prevents freedom of occupation and mobility of labour. Women in
certain rural communities are considered inferior and do not have equal status in the society. In spite of the different
developmental schemes in operation in the rural areas, rural masses do not have adequate motivation for development, and they
are still guided by superstitious beliefs and age-old rigid religious customs without a modern outlook.

Men in the rural areas remain illiterate and the illiteracy of women is still, of a higher degree.
In spite of the different developmental schemes in operation in the rural areas, rural masses do not have adequate
motivation for development, and they are still guided by superstitious beliefs and age-old rigid religious customs
without a modern outlook.
SCOPE OF RURAL DEVELOPMENT
The need for rural development in India is apparent. The critical areas of development and the
interlinkages among the different elements or dimensions of development have to be carefully
identified and an appropriate strategy has to be evolved. An attempt is made here to indicate some of
the broad areas of rural development, which need an integrated approach.
i. Developing Social Consciousness: The first step in rural development is the one of a development of social consciousness
among people about the different hindrances to their development, the ways and means of overcoming them, their rights and
duties in the community in which they live, progressive aspects of their traditions, and their own strengths and potentialities to
develop themselves. This type of consciousness about the social reality would pave the way for an awareness of many
possibilities for the development. Formal and non-formal education would help to create social consciousness. Apart from it,
certain effective, short-term measures are to be taken to create social consciousness and awareness. Among others, mass media
like slide shows on specific programmes, films with social development themes, and cultural programmes with relevant themes
can be used. The rural people must be educated to think for themselves the ways and means of their own development, thus
paving the way for a collective decision-making and a collective action.

The rural people must be educated to think for themselves the ways and means of their own development, thus
paving the way for a collective decision making and a collective action.
ii. Collective Decision-making and Collective Action: When people in the rural areas face problems and begin to discuss them and
take action jointly, the movement towards development has well begun. However, collective decision-making depends upon the
sympathy towards others, helping attitude, collaborative attitude of sharing the gains of collective work, and the ability to face
problems and explore the means of solving them. For an effective, collective decision and action, certain norms have to be
developed to govern the general behaviour. Individuals who do not follow the norms must be made answerable to groups. In
other words, there must be some mechanism of implementing the collective decisions and the norms established in the groups
and the communities. This calls for a dedicated village leadership.

There must be some mechanism of implementing the collective decisions and the norms established in the groups
and the communities. This calls for a dedicated village leadership.
iii. Dedicated Village Leadership: Rural development cannot be achieved by allocation of funds and by the role of government
officials alone. It is a process that should come from within and it cannot be imposed. It is only through the honest and dedicated
leaders of the village that villagers can be motivated and a proper direction can be given. Rural and community development
programmes should not be tools for political parties for propaganda and promotion of their political interests. There should be a
separate cadre of dedicated and honest, rural leadership with a genuine interest in the development of rural India with democratic
ideals.

There should be a separate cadre of dedicated and honest, rural leadership with a genuine interest in the
development of rural India with democratic ideals.
iv. Use of Science: Use of science and scientific knowledge is essential for the rural development in several ways. Through science
and scientific reasoning, the illiterate and ignorant rural poor can be convinced of the causal relationship between events; and
their knowledge and awareness helps in a better understanding of social relationships and reduces the hold of prejudices and
superstitious beliefs. With scientific knowledge, one can improve work skills and reduce the drudgery of human muscles. Science
helps to devise the appropriate technology for rural development and higher levels of productivity from all sectors. Further,
science has helped people, wherever it is used constructively, to solve a wide range of problems from fighting diseases and
increasing the longevity of life to improvement of living conditions, through higher levels of production of various necessities of
life. It is necessary for the scientists to communicate through appropriate media, the relevant discoveries that are made in various
sciences to the people in rural areas.

It is necessary for the scientists to communicate through appropriate media, the relevant discoveries that are made
in various sciences to the people in rural areas.
v. Development of Agriculture and Allied Sectors: Even though rural development is not synonymous with agricultural
development, yet agricultural development is critical for meeting the growing demand for food and raw material and for
creating more employment opportunities in the rural sector. Therefore, agriculture and allied activities should be developed as
more rewarding pursuits with a focus on higher productivity. The average yield per hectare of most of the crops all over India is
lower than the yield achieved in some states and also in a few areas within a particular state. This disparity between high and low
yields is an indication of both backwardness as well as potentiality for achieving higher productivity. There is a pressing need not
only for a substantial increase in the agricultural growth, but also for a sustainable growth. Proper and prudent use of land by
small and marginal farmers by a committed effort is of utmost importance. Japan could produce from her small holdings
significantly higher levels of productivity or yield per hectare. It should not, therefore, be difficult to raise productivity levels by
the small farmers too. This calls for
a. An acceleration in the land development programmes,
b. Land reforms, particularly tenancy reform,
c. An assured availability of water with proper water management,
d. A better access to institutional credit at a reasonable interest rate,
e. An improvement of agricultural work skills through intensive extension services, backed by intensified area-specific
agricultural research,
f. An efficient delivery system, leading to easy supply of modern inputs to all,
g. An efficient marketing system with an assured remunerative price, and
h. An effective administering of the different development schemes so as to remove structural bottlenecks, if any, and tap
the potential for a higher productivity among the poor.

Agriculture and allied activities should be developed as more rewarding pursuits with a focus on higher
productivity.
vi. Provision of Subsidiary Occupations and Incomes: The small and marginal farmers, the landless poor, and similar such rural
poor without any asset must be helped to have a gainful employment through dairy farming and other subsidiary occupations.
Dairying may be developed as the main occupation for some, apart from serving as a supplementary occupation. The
development of dairying calls for
a. An adequate fodder supply,
b. A marketing facility with a remunerative price for milk and milk products,
c. A more intensive, veterinary facilities in rural areas by following the policy, “clinic to the cow” in remote villages and
thereby, improving the milch yield and genetic make-up of local cows and buffaloes.
Through adequate institutional credit, weaker sections must be helped to earn through dairying, poultry, sericulture, and so on.

Through adequate institutional credit, weaker sections must be helped to earn through dairying, poultry,
sericulture, and so on.
vii. Development of Cottage and Village Industries: The unemployed and underemployed masses in rural areas must be gainfully
employed through the development of village industries and other non-farm enterprises. The local resources in terms of raw
material, capital, and so on, must be identified and suitable village industries must be started. This measure should receive an
immediate attention so that there would be no further pressure on the land and the rural poor are, thus, helped to secure gainful
employment.

Several programmes of rural development have stressed the development of non-agricultural skills in rural areas.
It calls for technical and mechanical skills which are essential for the development of rural industries and for
evolving appropriate technologies for rural areas.
This would require the development of various skills and setting up of industries in rural areas.
Several programmes of rural development have stressed the development of non-agricultural skills
in rural areas. It calls for technical and mechanical skills which are essential for the development of
rural industries and for evolving appropriate technologies for rural areas.
INTERDEPENDENCE BETWEEN RURAL AND URBAN SECTORS
Rural development cannot be planned and achieved in isolation. For the overall development of India,
both rural development and urban development become necessary. The development of these two
sectors is interlinked. We cannot conceive of rural development without the urban development. They
are interdependent, one supporting the other and in the process, both are being benefitted. Rural
development is a comprehensive programme of activities which include agricultural growth;
development of village industries; development of housing for the poor; planning for public health,
family planning and child care, and health care for livestock; education, like provision of adult
education—including functional literacy; development of rural transport and communication; and so
on.

We cannot conceive of rural development without the urban development. They are interdependent, one supporting the
other and in the process, both are being benefitted.
In each of these different aspects of the rural development, the urban support in terms of goods and
services is required. Modern agricultural inputs like chemical fertilizers, pesticides, pump-sets,
tractors, and so on, that are required for agricultural development, have to be supplied by the urban
sector. Again, the urban people have to supply different types of improved tools and implements for
the development of rural industries, rural transport, and communication. Many urban-based goods
and services are required for rural house construction and rural electrification. Further, tools and
implements for digging of wells, construction of irrigation canals, and so on, are drawn from the
urban centres. Education, health and medical, and other professional services needed for rural
development are to be provided by the urban-based people. Certain food items are processed and
supplied by the urban people to the rural consumers also. The demand for different rural products is
generated by urban consumers, apart from providing marketing services.

In each of these different aspects of the rural development, the urban support in terms of goods and services is required.
The rural sector, as discussed earlier, plays a very crucial role in the process of the economic
development of a country. It supplies food for a fast-growing population, including urban population.
The raw material required for the urban manufacturing sector is provided by the rural sector. Rural
people are the major source of demand for several urban products. Rural people significantly
contribute to capital formation that is needed for the industrial development. Through export of rural
products a considerable amount of foreign exchange is earned in India.
The interdependence between rural and urban sectors clearly shows that the development of both is
necessary for the mutual good as well as the overall development of the country. It is such
interdependent relationship that will culminate in the fusion of the two sectors and formation of an
integrated modern society. However, it should be noted that there is a category of poor people both in
the rural and urban areas who are normally bypassed by the development programmes in both the
sectors. The urban-or rural bias in the development strategies should not ignore the interests of the
poor classes. The policies suggested for rural development, among others, are
a. A shift in terms of trade in favour of agriculture,
b. Resource allocation in favour of agriculture, village industries, and so on, through institutional credit and public investment,
c. Protecting the small producer from unhealthy competition of large-scale industry through quotas and reservation, and
d. Application of science and technology, thereby, meeting the production requirements of small units, and so on.
The interdependence between rural and urban sectors clearly shows that the development of both is necessary for the
mutual good as well as the overall development of the country.
In all these measures, the rural poor are not the direct beneficiaries with a significant increase in
their incomes. For example, while there is a case for a shift in the terms of trade in favour of the rural
communities, on equity grounds, this may not help the rural poor at all. Many rural people live on the
sale of labour power and not on the sale of any products of their household or farms. It is, therefore,
argued that certain radical measures in the redistribution of wealth in the unorganised sector and
socialisation in the organised sector is relevantly required . After a clear analysis of different policies
of rural development and real obstructions in a fair distribution of the gain of development, it is
concluded that “the contradictions between the objectives of integrated rural development and the
existing structure of production relationship are too strong to be ignored” Therefore, there is a
strong case for a development strategy, with a thrust on equity and social justice.

“The contradictions between the objectives of integrated rural development and the existing structure of production
relationship are too strong to be ignored”. Therefore, there is a strong case for a development strategy, with a thrust on
equity and social justice.
STRATEGIES FOR RURAL DEVELOPMENT

After the dawn of freedom, India got wedded to the goal of democratic set up in the country. Under
the Directive Principles, it has been laid down that the “state shall strive to promote the welfare of the
people by securing and protecting, as effectively as it may, social order in which social justice,
economic and political, freedom shall inform all the institutions of national life”. With this motto, the
strategy of direct assault on poverty and inequality through rural development and rural employment
programme has been adopted in different five-year plan periods. The beginning of Community
Development Programme in 1952 had been the landmark in the history to establish a network of basic
extension and development services in the rural areas. This had created a sense of awareness among
the rural masses about the potentials and means of development.

The beginning of Community Development Programme in 1952 had been the landmark in the history to establish a network
of basic extension and development services in the rural areas.
The investments in various five-year plans have led to the creation of necessary physical and
institutional infrastructure of socio-economic development in many areas. Later on it was felt that the
benefits of the development are being pocketed by those who are better endowed. Therefore, in the
early 1970s, special programmes were designed for the upliftment of small and marginal farmers.
The establishment of Drought-Prone Area Programme (DPAP) and Development of Desert Areas
(DDA) in 1970 are some leading examples for the development of small and marginal fanners.
Similarly, the Food-for-Work Programme was launched in 1977 to provide opportunities of work for
the rural poor especially during the slack employment periods of the year. Moreover, irrigation
facilities in the rural areas have been expanded to a large extent. In order to remove the regional
disparities, special sub-plans of development were also introduced.

The establishment of Drought-Prone Area Programme (DPAP) and Development of Desert Areas (DDA) in 1970 are some
leading examples for the development of small- and marginal fanners.
Some Important Strategies of Rural Development
During the last, more than five decades of planning, several significant strategies have been adopted
for the development of rural poor. The most important rural development strategies are discussed as
follows:
1. Small Farmers Development Agency

2. Marginal Farmers and Agricultural Labour Development Agency
3. Cash Scheme for Rural Development
4. Drought-Prone Area Programme (DPAP)
5. Development of Tribal Areas
6. Minimum Needs Programme
7. Twenty-point Economic Programme
8. Development of Desert Areas (DDA) Programme
9. Village Development Programme
10. Training of Rural Youth for Self-employment
11. National Rural Development Programme (NRDP)
12. Rural Landless Employment Guarantee Programme
13. Development of Women and Children
14. Council for Advancement of People’s Action and Rural Technology
15. AntodayaYojana
16. Jawahar Rozgar Yojana
17. Tribal Sub-plan (TSP)
18. Scheme for Rural Artisan
19. Employment Insurance Scheme
20. National Social Assistance Programme
21. Rural Group Life Insurance Scheme
22. Swarna Jayanti Shahari Rozgar Yojana
23. Swarnajayanti Gram Swarozgar Yojana
24. Jawahar Gram Samridhi Yojana
25. Pradhan Mantri Gramodaya Yojana
RURAL WATER SUPPLY AND SANITATION
“Water supply and sanitation” is a critical determinant of public health outcomes, particularly in low
and lower middle-income countries. Drinking-water supply schemes are implemented by the states.
The Government of India supplements the efforts of the states by providing financial assistance under
the Accelerated Rural Water Supply Programme (ARWSP). Additional assistance is also available to
states for Rural Water Supply Programme under various externally aided projects.

The Government of India supplements the efforts of the states by providing financial assistance under the Accelerated Rural
Water Supply Programme (ARWSP).
The entire programme (ARWSP) was given a mission approach when the technology mission on
drinking water management, called the National Drinking Water Mission (NDWM) was introduced as
one of the five societal missions in 1986. NDWM was renamed as Rajiv Gandhi National Drinking
Water Mission (RGNDWM) in 1991. ARWSP is currently being implemented through the Rajiv
Gandhi National Drinking Water Mission. The prime objectives of the Mission are
a. To ensure coverage of all rural habitations, especially to reach the unreached with an access to safe drinking water;
b. To ensure sustainability of the systems and sources; and
c. To tackle the water-quality problems in the affected habitations.
With an investment of over Rs 76,000 crore, a considerable success had been achieved in meeting the
drinking-water needs of the rural population. The status of the state-wise uncovered habitations (refer
to Table 15.1) under Bharat Nirman indicates the need for an accelerated implementation in the
lagging states. The problem of water quality on account of contamination due to arsenic, salinity,
fluoride, iron, nitrate, and so on, in a large amount in the habitations, also needs to be addressed on a
priority basis.

The problem of water quality on account of contamination due to arsenic, salinity, fluoride, iron, nitrate, and so on, in a
large amount in the habitations, also needs to be addressed on a priority basis.
Large incidence of slippage from “fully covered” to “partially/not covered” categories is due to a
number of factors such as sources going dry, lowering of the ground-water table, systems outliving
their lifespan, and an increase in population resulting in lower per capita availability. The Central
allocation of funds for Rural Water Supply (ARWSP) had been stepped up from Rs 5,200 crore in
2006–07 to Rs 6,500 crore in 2007–08.

Table 15.1 Number of Habitations to be Covered/Addressed Under Bharat Nirman— Rural Water Supply (as on April 1, 2007)
Note: UC: uncovered; SB: slipped back; QA: quality affected.

Drinking Water Supply Under Bharat Nirman
Drinking water supply is one of the six components of Bharat Nirman, which had been conceived as a
plan to be implemented in four years from 2005–06 to 2008–09, for building rural infrastructure.
During the Bharat Nirman period, around 55,067 uncovered habitations and about 3.31 lakh slipped-
back habitations were to be covered, and 2.17 lakh quality-affected habitations were to be addressed.
Tackling arsenic and fluoride contamination had been given priority. Under the Bharat Nirman, in the
first two years, impressive achievements had been made. In 2006–07, against the target to cover
73,120 habitations, about 107,350 habitations had been covered. As on April 1, 2007, there are 29,534
uncovered habitations, 174,782 slipped-back habitations, and 159,348 quality-affected habitations.
These habitations are proposed to be covered/addressed during the Bharat Nirman period, which may
definitely be fruitful.

Drinking-water supply is one of the six components of Bharat Nirman, which had been conceived as a plan to be
implemented in four years from 2005–06 to 2008–09, for building rural infrastructure.
Rural Sanitation
The Centrally sponsored scheme of Central Rural Sanitation Programme (CRSP), remodelled as the
Total Sanitation Campaign (TSC), has the main objectives of bringing about an improvement in the
general quality of life in rural areas, accelerate sanitation coverage, generate demand through
awareness and health education, cover all schools and anganwadis in the rural areas with sanitation
facilities, and promote hygienic behaviour among students and teachers, encourage cost-effective and
appropriate technology development and application, and endeavour to reduce the water and
sanitation-related diseases.
TSC is currently, operational in 578 districts with an outlay of Rs 13,426 crore. The entrusted goals
for TSC are construction of individual household latrines, coverage of rural schools, and solid waste
management, provision of revolving fund for Self-Help Groups (SHGs) and Cooperative Societies;
School Sanitation & Hygiene Education (SSHE); and coordination with other departments. The
sanitation coverage in 1981 was only 1 per cent which increased to 11 per cent in 1991. By the year
2001, the access to toilets improved to 21.9 per cent of the rural population. However, in the last few
years, with the launch of the demand-based TSC, there has been tremendous improvement in rural
sanitation coverage in the country, which has reached 50 per cent. In the success of TSC, Panchayati
Raj Institutions (PRIs) have played a key role in the further acceleration of sanitation coverage.
However, in a few states, there is a need to improve the implementation so that the goal of total
sanitation by the year 2012 is achieved.

In the success of TSC, Panchayati Raj Institutions (PRIs) have played a key role in the further acceleration of sanitation
coverage. However, in a few states, there is a need to improve the implementation so that the goal of total sanitation by the
year 2012 is achieved.
WOMEN AND CHILD DEVELOPMENT
As women and children constitute roughly 72 per cent of the population of this country, the Ministry
of Women and Child Development was carved out as a separate ministry in 2006 to further accelerate
their development. Two schemes are being implemented for the development of adolescent girls, viz.,
Kishori Shakti Yojana (KSY) and Nutrition Programme for Adolescent Girls (NPAG). KSY aims at
addressing the needs of self-development, nutrition and health status, literacy and numerical skills,
and vocational skills of adolescent girls in the age group of 11–18 years. The scheme is currently
operational in 6,118 Integrated Child Development Services (ICDS) scheme projects. NPAG is being
implemented in 51 identified districts across the country to provide free food grain @ 6 kg per
beneficiary per month to undernourished adolescent girls (11–19 years), irrespective of the financial
status of the family to which they belong. Both the schemes are being implemented through the
infrastructure of ICDS.

As women and children constitute roughly 72 per cent of the population of this country, the Ministry of Women and Child
Development was carved out as a separate ministry in 2006 to further accelerate their development.
The Support to Training and Employment Programme (STEP) seeks to provide updated skills and
new knowledge to poor assetless women in 10 traditional sectors, viz., agriculture, animal husbandry,
dairying, fisheries, handlooms, handicrafts, khadi and village industries, sericulture, social forestry,
and wasteland development, through mobilising them into cohesive groups. About 13 new projects
had been sanctioned during 2007–08 (up to November 30, 2007). To facilitate employment of women
away from their homes/towns, schemes such as Working Women’s Hostels with day-care centres or
crèches continue. Provision of care and protection for women in distress is a focused area for
attention and is provided through Swadhar Homes and Short-Stay Homes. A comprehensive scheme
for prevention of trafficking and rescue, rehabilitation and reintegration of victims of trafficking and
commercial sexual exploitation—”Ujjawala”—has been launched recently. The scheme has five
components—prevention, rescue, rehabilitation, reintegration, and repatriation.
The National Commission for Women (NCW) safeguards the interests of women with a mandate to
cover all aspects of women’s rights. The Protection of Women from Domestic Violence Act, 2005,
which came into force on October 26, 2006, seeks to provide immediate relief to women who are
facing situations of violence in their homes. Gender Budgeting, as an application of gender-
mainstreaming in the budgetary process, has also been adopted. It encompasses incorporating a
gender perspective at all levels and all stages of the budgetary process, and paves the way to
translating gender commitments of the government to budgetary commitments.
A rights-based approach has been continued in the Eleventh Plan for promoting survival,
protection, and development of children. The National Commission for Protection of Child Rights
(NCPCR) was set up on March 5, 2007, for an effective implementation of child rights in the country.
Initiated in 1975, ICDS is one of the largest child intervention programmes in the world with a
holistic package of six basic services for children, up to six years of age, and for pregnant and
nursing mothers. These services are health checkup, immunisation, referral services, supplementary
feeding, preschool education, and health and nutrition education through one platform, that is,
Anganwadi Centre (AWC). Starting with a modest 33 blocks/projects, it had gradually expanded to
6,284 projects with 1,052,638 AWCs, of which 5,885 projects with 863,472 AWCs became operational
as on June 30, 2007. ICDS covers 736.96 lakh beneficiaries consisting of 606.50 lakh children below
six years of age and 130.46 lakh pregnant women and lactating mothers as on June 30, 2007.

A rights-based approach has been continued in the Eleventh Plan for promoting survival, protection, and development of
children. The National Commission for Protection of Child Rights (NCPCR) was set up on March 5, 2007, for an effective
implementation of child rights in the country.
To fulfil the NCMP commitment of providing a functional AWC in every settlement and ensuring a
full coverage of all children, and also to comply with the Supreme Court’s directives, the government
had sanctioned 466 additional ICDS projects and 188,168 AWCs, during 2005–06; and 166 additional
ICDS projects, 106,833 AWCs, and 25,961 mini-AWCs, during 2006–07. A number of new initiatives
have been taken to improve the impact of the programme, which includes a sharing of one-half of the
cost of supplementary nutrition with the states under ICDS, as per the latest updation. The scheme of
Rajiv Gandhi National Creche Scheme for Children of Working Mothers provides its services to the
children of age group 0–6 years, which includes supplementary nutrition, emergency medicines, and
contingencies. At present, about 28,000 creches are functioning under the scheme benefitting about 7
lakh children.
The Juvenile Justice (Care and Protection of Children) Act, 2000 is the primary law relating to
juveniles in conflict with law as well as children in need of care and protection. This Act provides for
proper care, protection, and treatment for juveniles, by adopting a child-friendly approach in the
adjudication and disposition of matters in the best interest of children and for their ultimate
rehabilitation through various institutions established under the Act. The Juvenile Justice (Care and
Protection of Children) Amendment Act, 2006 came into effect from August 23, 2006 and had made
the law more child friendly.
Under the scheme “A Programme for Juvenile Justice”, about 50 per cent expenditure requirements
of states/UTs (union territories) are being provided for the establishment and maintenance of various
homes under the Juvenile Justice (Care and Protection of Children) Act, 2000. The Integrated
Programme for Street Children provides basic facilities like shelter, nutrition, health care, education,
and recreation facilities, and also seeks to protect street children from abuse and exploitation.
Childline with a dedicated telephone number 1098, a 24-hour toll-free telephone service for all
children in distress, is also available in 76 cities under the scheme. The implementation of “Scheme
for Welfare of Working Children in Need of Care and Protection” commenced in January 2005 to
provide non-formal education and vocational training to working children, to facilitate their entry/re-
entry into the mainstream education.

The Intergrated Programme for Street Children provides basic facilities like shelter, nutrition, health care, education, and
recreation facilities, and also seeks to protect street children from abuse and exploitation.
The Central Adoption Resource Agency (CARA), an autonomous organisation of the Ministry of
Women and Child Development is functioning with the goal to promote domestic adoption and
regulate inter-country adoption as provided under the guidelines of the Government of India. CARA
is also implementing the Shishu Greh Scheme for providing institutional care to children up to the
age of six years and their rehabilitation through an in-country adoption.
The bias against the girl child is reflected in the fall in child sex ratio (0–6 yrs), which had declined
drastically from 945 in 1991 to 927 per 1,000 males in 2001. Female Foeticide is found more in the
urban-educated prosperous classes and in the states of Punjab, Haryana, and Gujarat with low sex
ratios. Efforts are, therefore, being made to ensure the survival of the girl child and her right to be
born, and nurture her so that she grows up to be an informed, secure, and productive, participating
member of the community and society. A multi-dimensional strategy has been adopted with
legislative, preventive advocacy and programmatic inputs for the welfare and development of SCs,
STs, Other Backward Classes (OBCs), and other weaker sections.

A multi-dimensional strategy has been adopted with legislative, preventive advocacy and programmatic inputs for the
welfare and development of SCs, STs, Other Backward Classes (OBCs), and other weaker sections.
The programmes for educational development and economic and social empowerment of socially
disadvantaged groups and marginalised sections of the society are implemented through the close
participation of state governments, UT administrations, and non-governmental organisations
(NGOs). Public-Private Partnership (PPP) approach is also one of the strategies for attaining
objectives of development of the targeted groups. National-level Finance and Development
Corporations for SCs, Safaikaramcharis, STs, OBCs, and the disabled are working towards the
economic empowerment of the beneficiaries. Allocation for schemes exclusively for the welfare and
development of SCs and STs had been enhanced to Rs 3,271 crore in 2007–08.
Scheduled Castes Development
A number of schemes are being implemented to encourage SC students for continuing their education
from school level to higher education. During the financial year up to November 2007, Rs 3.09 crore
had been released under the scheme of Pre-Matric Scholarships to the children of those engaged in
unclean occupation and Rs 458.98 crore had been released under the scheme of Post-Matric
Scholarships (PMS) to an estimated number of over 33.86 lakh SC students. A sum of Rs 3.94 crore
had been released for construction of eight hostels for 610 boys and 117 girls belonging to the SCs.
For upgrading the merit of SC students, Rs 0.95 crore had been released for benefitting 706 students.
For free coaching to 2,230 students belonging to SCs and OBCs, Rs 1.57 crore had been released. An
allocation of Rs 88 crore had been made under Rajiv Gandhi National Fellowship for SC students for
pursuing M.Phil and Ph.D courses. During the current year, 1,333 fresh students will be given
fellowship.

A number of schemes are being implemented to encourage SC students for continuing their education from school level to
higher education.
The scheme of Top Class Education for SCs aims at promoting quality education among students
belonging to SCs by providing full financial support for pursuing education at graduate and post-
graduate levels in identified, reputed institutions. Under this scheme, Rs 0.96 crore had been released
up to November 2007 out of a budget allocation of Rs 16 crore. The scheme of National Overseas
Scholarships for SC candidates provides financial assistance to the finally selected candidates, for
pursuing higher studies abroad in the specified fields of master level courses and Ph.D in the field of
engineering, technology, and sciences. Of 30 awards given every year, about 27 are given to SCs, two
to denotified, nomadic, and semi-nomadic tribes, and one to landless agricultural labourers and
traditional artisans. An amount of Rs 1.70 crore had been released to selected students up to
November 2007 out of the budget allocation of Rs 4 crore.

The scheme of Top Class Education for SCs aims at promoting quality education among students belonging to SCs by
providing full financial support for pursuing education at graduate and post-graduate levels in identified, reputed
institutions.
Special Central Assistance (SCA) to SC Sub-plan is a major scheme for economic advancement of
persons belonging to SCs. During 2007–08, an allocation of Rs 470 crore had been made under this
scheme. Up to November 30, 2007, Rs 252.70 crore had been released to states/ UT administrations
for the overall socio-economic development of SC persons. The formulation and implementation of
SC Sub-plan for the welfare of SCs by the state governments is being monitored intensively. National
Scheduled Castes Finance and Development Corporation (NSCFDC) provides credit facilities to the
beneficiaries who are living below double the poverty line.

Special Central Assistance (SCA) to SC Sub-plan is a major scheme for economic advancement of persons belonging to
SCs.
Under the schemes of National Safaikaramcharis Finance and Development Corporation
(NSKFDC), there is no income criteria. NSCFDC had disbursed Rs 21.64 crore benefitting 4,445
persons up to November 2007 and had disbursed Rs 38.06 crore benefitting 6,806 persons. A sum of
Rs 20 crore had been released as an equity support to NSCFDC up to November 2007 and Rs 15 crore
had been released to NSKFDC. Under Self-Employment Scheme for Rehabilitation of Manual
Scavengers, Rs 25 crore had been released out of budget allocation of Rs 50 crore up to November
2007. The scheme, launched in January 2007, is being implemented through NSKFDC and other apex
corporations of the Ministry. To abolish the practice of untouchability and curb the high incidence of
crimes and atrocities against SCs, efforts are being made through effective implementation of the
Protection of Civil Rights (PCR) Act, 1955 and the Scheduled Castes and the Scheduled Tribes
(Prevention of Atrocities) Act, 1989.

To abolish the practice of untouchability and curb the high incidence of crimes and atrocities against SCs, efforts are being
made through effective implementation of the Protection of Civil Rights (PCR) Act, 1955 and the Scheduled Castes and the
Scheduled Tribes (Prevention of Atrocities) Act, 1989.
Scheduled Tribes Development
According to the 2001 Census, Scheduled Tribes (STs) accounted for 84.32 million, corresponding to
8.2 per cent of the country’s total population. The objective of the Tenth Plan was to empower the STs
through their educational, economic, and social development. For the welfare and development of the
STs, an outlay of Rs 1,719.71 crore had been provided in the Annual Plan for 2007–08, which is 3.79
per cent higher than the outlay of Rs 1,656.90 crore for the year 2006–07 (RE). The outlay of 2007–08
includes Rs 816.71 crore provided as SCA to Tribal-Sub plan (TSP), which includes Rs 220.00 crore
for the development of forest villages and Rs 150 crore for the minor irrigation of tribal lands.
SCA to TSP is a 100 per cent grant extended to states as an additional funding to undertake a
number of developmental schemes on family-oriented income-generating schemes, creation of
critical infrastructure, extending financial assistance to SHGs for community-based activities, and
development of Primitive Tribal Groups (PTGs), and forest villages. Grant-in-aid under Article
275(1) is also being provided to the states with an objective to promote the welfare of the STs and
improve administration in the states to bring them at par with the rest of the states, and to take up such
special welfare and development programmes, which are otherwise not included in the Plan
programmes. Under the scheme of PMS, all eligible ST students are provided with a stipend to pursue
their education beyond matric, including professional and graduate and post-graduate courses in the
recognised institutions. The scheme of Rajiv Gandhi National Fellowship for ST students to pursue
higher education was launched during the year 2005–06 and had been entrusted to UGC (University
Grants Commission) for implementation.

Under the scheme of PMS, all eligible ST students are provided with a stipend to pursue their education beyond matric,
including professional and graduate and post-graduate courses in the recognised institutions.
A new Central Sector Scholarship Scheme of Top Class Education for ST students was launched
during the year 2007–08, with the objective of encouraging meritorious ST students to pursue studies
at degree and post-degree level in any of the identified institutes. There are 127 institutes identified
under the scheme in both the government and private sectors covering the fields of management,
medicine, engineering, law, and commercial courses. Each institute had been allocated five awards,
with a ceiling of 635 scholarships per year. The family income of the ST students from all the sources
shall not exceed Rs 2 lakh per annum.
Economic empowerment of the STs continued through extension of financial support to National
Scheduled Tribes Finance and Development Corporation (NSTFDC). Financial support is being
extended to ST beneficiaries/entrepreneurs in the form of term loans and micro-credit at
concessional rate of interests from income-generating activities. Tribal Cooperative Marketing
Federation of India Limted (TRIFED) is engaged in the marketing development of tribal products and
their retail marketing through its sales outlets.

Economic empowerment of the STs continued through extension of financial support to National Scheduled Tribes Finance
and Development Corporation (NSTFDC).
In order to address the problems of tribal communities, who are dependent on forests, and to undo
the historical injustice done to them, the Scheduled Tribes and Other Traditional Forest Dwellers
(Recognition of Forest Rights) Bill, 2006 was passed by the Parliament in 2006. This Act recognises
the forest rights of forest dwelling STs and other traditional forest dwellers over the forest land under
their occupation for self-cultivation, rights over minor forest produce, and traditional rights. There is
a great emphasis on the education of ST girls, especially in the low literacy areas. From 2007–08,
keeping in view the habitat/hamlet development approach and also to give a boost to the socio-
economic development of the most marginalised community among STs, that is, PTGs, the long-term
Conservation-cum-Development (CCD) plans have been formulated on the basis of results of the
baseline surveys conducted by the various state governments and the UT of Andaman and Nicobar
Islands.

In order to address the problems of tribal communities, who are dependent on forests, and to undo the historical injustice
done to them, the Scheduled Tribes and Other Traditional Forest Dwellers (Recognition of Forest Rights) Bill, 2006 was
passed by the Parliament in 2006.
Minorities Development
Five communities, viz., Muslims, Christians, Sikhs, Buddhists, and Parsis were notified by the
government as minority communities under Section 2(c) of the National Commission for Minorities
Act, 1992. As per the 2001 Census, the minority communities constitute 18.42 per cent of the total
population. A new Ministry of Minority Affairs was created in January 2006, to ensure a focused
approach to issues relating to the minorities and to play a pivotal role in the overall policy, planning,
coordination, evaluation, and review of the regulatory and development programmes for the benefit
of the minority communities.

Five communities, viz., Muslims, Christians, Sikhs, Buddhists, and Parsis were notified by the government as minority
communities under Section 2(c) of the National Commission for Minorities Act, 1992.
The Prime Minister ’s new 15-Point Programme for the welfare of minorities was announced in
June 2006. An important aim of this programme is to ensure that the benefits of various government
schemes for the underprivileged reach the disadvantaged sections of the minority communities. It
provides that, wherever possible, 15 per cent of the targets and outlays under various schemes,
included in the programme, should be earmarked for minorities. The targets for 200708 had been
fixed and efforts had been made to refine the method of targeting, to ensure that the targets are as
close as possible to the earmarked 15 per cent. A high-level committee under the chairmanship of
Justice Rajindar Sachar was set up to look into the social, economic, and educational status of the
Muslim community of India. The Committee submitted its report in November 2006. A total of 76
recommendations and suggestions contained in the report were examined. A statement on the
“Follow-up Action on the Recommendations of the Sachar Committee” was laid in both the Houses of
Parliament on August 31, 2007.

The Prime Minister’s new 15-Point Programme for the welfare of minorities was announced in June 2006.
A high-level committee under the chairmanship of Justice Rajindar Sachar was set up to look into the social, economic, and
educational status of the Muslim community of India. The Committee submitted its report in November 2006.
Maulana Azad Education Foundation provides financial assistance to implement educational

schemes for the benefit of the educationally backward minorities. The National Minorities
Development & Finance Corporation (NMDFC) is engaged in promoting self-employment and other
ventures among the backward sections of the minority communities through term loans and micro-
finance. For the development of OBCs, the government provides central assistance to state
governments/UT administrations for the educational development of OBCs. Till November 2007, Rs
59.16 crore had been released to states/UT administrations against an allocation of Rs 100 crore
under PMS for OBCs, and Rs 9.46 crore had been released under Pre-Matric Scholarships against an
allocation of Rs 25 crore.

Maulana Azad Education Foundation provides financial assistance to implement educational schemes for the benefit of the
educationally backward minorities.
For construction of hostels for OBC boys and girls, state governments/UT administrations/NGOs
had been released Rs 5.92 crore against an allocation of Rs 21 crore up to November 2007. The
National Backward Classes Finance & Development Corporation (NBCFDC) extends credit facilities
to persons living below double the poverty line, for undertaking various income-generating
activities. During the year 2007–08, the Corporation had disbursed Rs 73.23 crore till November 2007
to benefit 82,955 persons. NBCFDC had released Rs 25 crore as equity support against an allocation
of Rs 28 crore up to November 2007.

The National Backward Classes Finance & Development Corporation (NBCFDC) extends credit facilities to persons living
below double the poverty line, for undertaking various income-generating activities.
Welfare and Development of Persons with Disabilities
During 2007–08, an allocation of Rs 221 crore had been made for the welfare and development of
persons with disabilities. An expenditure of Rs 63.9 crore had been incurred up to November 2007.
The programmes are implemented through national and apex institutes dealing with various
categories of disabilities. These institutes conduct short and long-term courses for various categories
of personnel for providing rehabilitation services to those needing them. Till November 2007, Rs
20.20 crore (plan) had been released to these institutes.

During 2007–08, an allocation of Rs 221 crore had been made for the welfare and development of persons with disabilities.
The Persons with Disabilities (equal opportunities, protection of rights, and full participation) Act,
1995 is under implementation. Five Composite Rehabilitation Centres (CRCs) at Srinagar, Lucknow,
Bhopal, Guwahati, and Sundernagar provide facilities for manpower development and ensuring
availability of rehabilitation services for all categories of persons with disabilities. Four Regional
Rehabilitation Centres (RRCs) provide services to persons with spinal injuries at Chandigarh,
Cuttack, Jabalpur, and Bareilly. About 199 District Disability Rehabilitation Centres (DDRCs) had
been sanctioned in the country for providing comprehensive rehabilitation services at the grass-root
level.

About 199 District Disability Rehabilitation Centres (DDRCs) had been sanctioned in the country for providing
comprehensive rehabilitation services at the grass-root level.
Under the scheme of Assistance to the Disabled for Purchase/Fitting of Aids and Appliances
(ADIP), Rs 10.31 crore had been released during 2007–08 up to November 2007. Deen Dayal
Disabled Rehabilitation Scheme provides financial assistance to voluntary organisations for running
special schools for children with hearing, visual, and mental disability; rehabilitation centres for
persons with various disabilities, including leprosy-cured persons; and manpower development in the
field of mental retardation and cerebral palsy. Under this scheme, organisations are given grant-in-
aid for both recurring and non-recurring expenditure to the extent of 90 per cent of the total approved
cost of the project. During the year 2007–08, Rs 22.30 crore had been released up to November 2007
to voluntary organisations. The National Handicapped Finance & Development Corporation provides
credit facilities to persons with disability for their economic empowerment and Rs 7 crore had been
released to the Corporation till the end of November 2007.
Social Defence Sector
Older persons who, in the wake of declining family support systems and other socio-economic
circumstances, are left helpless, also require the support and protection of the state. To fulfil the
commitments of the National Policy on Older Persons for providing health, shelter, vocational
training, recreation, protection of life, and so on, for the aged, a special emphasis is being placed on
expanding the on-going programmes of old-age homes, day-care centres, and mobile medicare units,
under the scheme of Integrated Programme for Older Persons. During 2007–08, Rs 4.80 crore had
been released under this scheme till the end of November 2007. The Maintenance and Welfare of
Parents and Senior Citizens Bill, 2007 had been passed by both the Houses of Parliament. The Bill
contains provisions for the maintenance and welfare of parents and senior citizens guaranteed and
recognised under the Constitution.

The Maintenance and Welfare of Parents and Senior Citizens Bill, 2007 had been passed by both the Houses of Parliament.
The Bill contains provisions for the maintenance and welfare of parents and senior citizens guaranteed and recognised
under the Constitution.
Rigorous efforts are being made to tackle the growing problem of drug abuse and alcoholism
through an integrated and comprehensive, community-based approach in the country. The
programme is implemented through voluntary organisations running Treatment-Cum-Rehabilitation
Centres and Awareness and Counselling Centres. An amount of Rs 6.62 crore had been released to
voluntary organisations under the scheme of Prevention of Alcoholism and Substance (Drugs) Abuse
up to November 2007, during the year 2007–08. For an effective implementation of the social defence
programmes, personnel engaged in the delivery of services in this area are being trained under
various training programmes being organised by the National Institute of Social Defence.
CHALLENGES AND OUTLOOK
With the objective of inclusive growth taking the centre stage, the government has strengthened its
efforts for the social sector development in the recent years. The expenditures of the Government of
India on social services and rural development have more than doubled over the last four years.
Impressive outlays on education, health, water supply, and housing indicate the emphasis which the
government places on these sectors. These expenditures have supplemented and sustained a high level
of economic growth in achieving a better social sector performance and improvement in the quality
of life. Several initiatives have been launched, especially for the poor. Programmes like the National
Rural Employment Guarantee Scheme, Pradhan Mantri Gram Sadak Yojana, Aam Admi Bima Yojana,
and Rashtriya Swasthya Bima Yojana can go a long way in improving the living conditions of the
common men in the remotest part of the country. Proper implementation of these programmes is
essential. Consequently, the role of states and district administrations responsible for the
implementation of the welfare schemes too is vital.

With the objective of inclusive growth taking the centre stage, the government has strengthened its efforts for the social
sector development in the recent years. The expenditures of the Government of India on social services and rural
development have more than doubled over the last four years.
Along with higher economic growth and poverty reduction, there has been an improvement in
many important social indicators like life expectancy, infant mortality rate, and gross enrolment
ratios at the primary level of education. However, disparities continue at the state and regional level.
Better governance and improved service delivery are essential to ensure that the leakages are
plugged, and also to rest assured that the funds under the welfare schemes reach the intended
beneficiaries to the maximum extent. Local governments and PRIs, as well as social and non-
government organisations, can play an important role in this area. It is essential that these higher
outlays result in better outcomes. To achieve this objective, the government has taken the initiative of
introducing outcome budgets.
The Eleventh Five-Year Plan also aims at reducing poverty and the disparities that are found across
regions and communities. The pattern of funding also has the objective of making states more self-
reliant. Proper monitoring and evaluation against the laid-down benchmarks, along with the use of
modern technology like e-governance, can help in ensuring that higher outlays result in better
outcomes and more inclusive growth.

The Eleventh Five-Year Plan also aims at reducing poverty and the disparities that are found across regions and
communities.
RURAL DEVELOPMENT: A CRITICAL ANALYSIS
Despite making a spectacular progress in various fields, India still faces poverty, unemployment,
ignorance, and socio-economic inequality. New economic forces are bringing with them new
opportunities for development and for contributing to nation-building. It is, however, important to
ensure that our growth is inclusive and that we do not leave anyone behind, and that the benefits of
development reach everyone, particularly the rural masses who have not been effectively touched by
the efforts of six decades of freedom. The policies and programmes formulated to augment
economic growth should also contribute towards improving the lives of the poor and the vulnerable.

Despite making a spectacular progress in various fields, India still faces poverty, unemployment, ignorance, and socio-
economic inequality.
More than 70 per cent of our people live in villages and 80 per cent of our poor live in rural areas.
The benefits of economic growth are not percolating to more than two-thirds of our population. The
divide between the rural and the urban areas in terms of economic infrastructure is widening day by
day. Crop failures due to unpredictable climatic variations, inability to meet the rising cost of
cultivation, and the increasing debt burden are among the factors that lead our farmers to growing
frustration that is being expressed in the most extreme ways. In the recent years, agricultural growth
in India has fallen. So have investment in, and profitability of, agriculture, the net sown area under
crops, and the area under irrigation. It is apprehended that the Indian peasantry is facing a serious
crisis. According to the Economic Survey 2006–07, low yield per unit area across almost all crops has
become a regular feature.

More than 70 per cent of our people live in villages and 80 per cent of our poor live in rural areas. The benefits of
economic growth are not percolating to more than two-thirds of our population.
Agriculture is the backbone of our economy. Although the share of agriculture in the gross
domestic product (GDP) had seen a steady decline from 36.4 per cent in 1982–83 to 18.5 per cent in
2006–07, the sector continues to sustain more than half a billion people, providing employment to 52
per cent of the workforce. It is an important source of raw material and absorbs many industrial
products, particularly fertilizers, pesticides, agricultural implements, and consumer goods. The very
fact that over a period, the growth in agriculture had remained much lower than the growth in the
non-agricultural sectors will explain the unpleasant plight of the rural people. Today, there is a
greater need than ever before to critically analyse and address the problems facing this sector.
Initiatives on the part of the media will have a positive impact on policy formulation for the rural
economic sector and on their effective implementation.

Agriculture is the backbone of our economy. Although the share of agriculture in the gross domestic product (GDP) had
seen a steady decline from 36.4 per cent in 1982–83 to 18.5 per cent in 2006–07, the sector continues to sustain more than
half a billion people, providing employment to 52 per cent of the workforce.
Poverty, hunger, and health care represent some of the major challenges before rural India. The
unenviable plight of the landless labourers and small and marginalised farmers can be attributed to
factors such as natural calamities, crop failures, exploitation by moneylenders, lack of adequate
supplementary income, and low level of education, besides lack of effective intervention by the state
in the form of measures like land reforms. It is a socio-economic phenomenon rooted in structural
inequalities and an unjust and inegalitarian social and economic order. Acute poverty, indebtedness,
and illiteracy are among the factors that have combined to compel many farmers to take their own
lives. This is a blot on the nation’s collective conscience.

Poverty, hunger, and health care represent some of the major challenges before rural India.
Addressing unemployment in the rural areas is crucial to improving the economic conditions of
the people. Governments, at the Centre and the states, have adopted a multi-pronged approach, and
several initiatives have been launched in the recent years to address the challenges in our rural
economy. Some of the developmental programmes launched by the Union government, if
implemented sincerely, can mitigate the misery of the rural poor, substantially. The political
leadership, the bureaucracy, and the media have vital roles in this. The honest implementation of such
well-meaning programmes and their effective monitoring should be ensured. No one should be
permitted to misuse the resources or benefit from the distress of the rural poor.

Addressing unemployment in the rural areas is crucial to improving the economic conditions of the people.
In order to increase productivity and employment generation in the agricultural sector, structural
changes are needed. Land reforms are the primary need; support prices and provision of cheap credit
do not help beyond a point. The experience in West Bengal and Kerala has shown that providing the
poor with access to land through the honest implementation of land reform legislation always acts as
a major catalyst for growth, and helps to address rural poverty as the peasants get an identity of their
own. Such institutional reforms in the ownership of agricultural land can unleash the peasantry’s
productive forces, increasing the food-grain production and helping to address poverty and distress.

In order to increase productivity and employment generation in the agricultural sector, structural changes are needed.
KEY WORDS
Green Revolution
Qualitative and Quantitative Aspects of Rural Development
Betterment of Living Conditions
Economic Development
Economic Growth
Abject Poverty
Underdevelopment
Social Stagnation
Reduction of Dependency
Increased Self-reliance
Unexploited Natural Resources
Inadequate Capital Resources
Poor Incomes and Indebtedness
Capital Deficiency
Low Level of Technology and Poor Extension Facilities
Low Level of Productivity
Lack of Infrastructure
Social and Cultural Factors
Developing Social Consciousness
Collective Decision-making and Collective Action
Dedicated Village Leadership
QUESTIONS
1. What do you mean by rural development? Discuss its nature and scope.
2. State the important features of rural economy and rural society?
3. Discuss the strategy of rural development after independence.
4. Discuss the poverty alleviation programmes introduced in the country since 1995.
5. Discuss the integrated rural development programmes adopted by the government since 1952.
6. Discuss the important economic reforms of rural development.
7. What are the measures adopted by the government in the Union Budget 2008–09 for rural development.
a. Agriculture Finance Corporation (AFC).
b. Rural Infrastructure Development Fund (RIDF).
c. National Rural Development Programme (NRDP).
d. Small Farmers Development Agency.
e. Rural development during Eleventh Five-Year Plan.
REFERENCES

The Hindu, May 12, 2008.
Finance Minister’s Budget Speech 2008–09
World Bank Report 1973.
CHAPTER 16
Problems of Growth
CHAPTER OUTLINE
Parallel Economy
Regional Imbalances
Social Injustice
Case
Key Words
Questions
References
PARALLEL ECONOMY
Parallel economy connotes the functioning of an unsanctioned sector in the economy, whose
objectives run parallel, rather in contradiction with the avowed social objectives. This is variously
referred to as black economy, unaccounted economy, illegal economy, subterranean economy, or
unsanctioned economy. The term “parallel economy” emphasises a confrontation between the
objectives of the legitimate and illegitimate sectors.

This is variously referred to as black economy, unaccounted economy, illegal economy, subterranean economy, or
unsanctioned economy.
Review of the Various Estimates of Black Income
IMF Staff Survey, on the unaccounted sector of the economy, has estimated black money in India at 50
per cent of gross national product (GNP), which was Rs145,141 crore in 1982–83 at current prices.
On this computation, India’s unaccounted sector is of the order of Rs 72,000 crore. The main findings
of the various studies on black income are as follows:
The amount of black money has not only been rowing in absolute terms, but also in relative terms as a percentage of GNP.
In 1994–95, as per the estimate of the Parliament Standing Committee on Finance, black money in circulation at current prices
was Rs 1,100,000 crore against the GNP estimate of Rs 843,294 crore, that is, 130 per cent of GNP. Obviously, black money
operators are running a parallel economy.
The rate of growth of black income generation is faster than the rate of growth of GNP.
Higher rate of taxation motivated businessmen and industrialists to go for massive tax evasion.
The political system winked at the growth of black income but did not take effective measures to curb the growth of
unaccounted income.
IMF Staff Survey, on the unaccounted sector of the economy, has estimated black money in India at 50 per cent of gross
national product (GNP).
Impact of Black Income on the Economic and Social System
The creation of a parallel economy, as a consequence of the growing proliferation of black money in every sector of the
economy, has a very serious and, in a number of ways, pernicious influences on the working of the Indian economy.

The creation of a parallel economy, as a consequence of the growing proliferation of black money in every sector
of the economy, has a very serious and, in a number of ways.
First of all, the direct effect of black income is the loss of revenue to the state exchequer as a consequence of tax evasion, both
from direct and indirect taxes. Moreover, tax evasion does not include loss of revenue resulting from unreported production or
illegal economic activity. Since the government is not able to plug the leakage of tax evasion, it has to resort to other avenues of
raising funds. So it imposes more taxes on commodities or raises the existing rates of taxation on commodities. As a consequence,
India has developed a regressive tax structure. It is the salaried person (who cannot escape taxation) who suffers and the
dishonest tax-payer is able to get away and then, use the evaded income in luxurious and ostentatious consumption.

First of all, the direct effect of black income is the loss of revenue to the state exchequer as a consequence of tax
evasion, both from direct and indirect taxes.
Secondly, the availability of black income with businessmen and capitalists and the consequent inequalities of income place a
large amount of funds at their disposal. As a result, the consumption pattern is tilted in favour of the rich and the elite classes, at
the cost of encouraging the production of articles of mass consumption.

The consumption pattern is tilted in favour of the rich and the elite classes, at the cost of encouraging the
production of articles of mass consumption.
Thirdly, black money encourages investment in precious stones, jewellery, bullion, and so on. This has an adverse effect on
growth via its demonstration effect.
Fourthly, black money has encouraged diversion of resources in the purchase of real estate and investment in luxury housing.
There is large-scale under-valuation of property and, in this way, lots of black money is made white.
As most of these buildings are registered at under-value prices, the government loses by way of tax revenues when
these buildings are transferred as gifts or are bequeathed.

Black money has encouraged diversion of resources in the purchase of real estate and investment in luxury
housing.
Fifthly, a part of the black income is held in cash and, as a consequence, there is an abundance of liquidity which becomes
available through the accumulation of savings held in the form of cash, bullion, gold, silver, and so on. This is popularly termed
as “black liquidity”. Thus, whenever the government attempts to control the excess demand with the help of measures like credit
control or rationing, such attempts are frustrated by the huge liquidity provided by black money. Since this liquidity results in
heavy inventory build-up, it becomes a threat to price stability.

Whenever the government attempts to control the excess demand with the help of measures like credit control or
rationing, such attempts are frustrated by the huge liquidity provided by black money.
Sixthly, black money results in transfer of funds from India to foreign countries through clandestine channels. Such transfers are
made possible by violations of foreign exchange regulations, through the device of under-invoicing of exports and over-
invoicing of imports.

Black money results in transfer of funds from India to foreign countries through clandestine channels.
Last but not the least, black money has corrupted our political system in the most vicious manner. At various levels, MLAs,
MPs, ministers, and party functionaries openly and shamelessly go on collecting funds.

Black money has corrupted our political system in a most vicious manner.
Corruption
There is, perhaps, not even a single person who does not rail against corruption and its baneful
impact on both the country’s economy, as well as on its social fabric. The governments pledge to stop
and eradicate it, middle-class drawing rooms discuss the ways in which corruption has a baneful
influence on the national life, the press continues to expose its prevalence, religious leaders and
moralists preach against it, while courts of law and the police express their inability to stamp it out.
From the helper in a government office to some of the top functionaries of our governments, almost
everyone seems implicated. Paul Wolfowitz, the soon-to-be past president of the World Bank, has
surely helped to underline the universality of this scourge across country and ethnicity.
It was, in fact, a World Bank study that put the value of all the bribes paid all over the world in 2003
at over $1,000 bn (or 1 tn). Some experts consider this a gross underestimation. A study of corruption
in India by a noted economist Prof. Arun Kumar, some years ago, noted that this “black economy”
accounted for about 50 per cent of the national gross domestic product (GDP). At today’s figures, this
proportion would mean that India’s black economy is approximately $500 bn a year. According to the
report of Transparency International, the foremost corruption-monitoring body internationally, most
South Asian countries fall far below the watershed 5-point mark on their 10-point scale. India is at 3.3
points while Pakistan is at 2.2. This means that, if anything, corruption is deeper and more widespread
in Pakistan. So if we take Prof. Kumar ’s estimate of the “black economy” in India as a representative
of South Asian economies, it would imply that the size of Pakistan’s black economy is at least $62 bn,
given that its GDP for 2006 is estimated at $124 bn.

A World Bank study that put the value of all the bribes paid all over the world in 2003 at over $1,000 bn (or 1 tn).
The mind boggles at the size of corruption and, perhaps, it is this widespread and deeply
entrenched nature of corruption that gets bigger with each passing year, while everyone seems to rant
and rage against it. Unfortunately, solutions to corruption have fallen into two broad categories. They
are
The first strategy has been of moral strictures and ethical exhortations by religious heads, those with moral authority in our
society, and by the State functionaries.
The second strategy has been of enacting laws, establishing rules, and framing policies by the governments and the public
authorities to curb corruption. While the first has been a spectacular failure, the latter too has floundered in most cases.
The reason for the relative failure of all measures to fight corruption has to be found, as with all
successes and failures in our societies, in a class analysis of the situation, by discovering which class
is placed where in relation to corruption and who benefits in what manner.

The reason for the relative failure of all measures to fight corruption has to be found, as with all successes and failures in
our societies, in a class analysis of the situation, by discovering which class is placed where in relation to corruption and
who benefits in what manner.
Prof. Kumar in his study of India estimates that black money is concentrated in the top few per cent
of the population, based on income (refer to Figure 16.1). India’s top 10 per cent of households earn
33.5 per cent of its income, while the top 20 per cent of its households earn 46.1 per cent of the total
income. The bottom 40 per cent of the household earned less than 20 per cent of the total income. If
we combine the figures of this study with Prof. Kumar ’s, it would suggest that the top 10 per cent of
the households, apart from earning a third of the legal income, also controls an extra-legal economy
with a GDP of $500 bn a year! For Pakistan, assuming the proportion of those involved in the black
economy to be similar, this would mean that the top decile of the population controls an extra-legal
economy larger than $60 bn.
Very little of this money is actually kept hidden, as most of it is poured back into profitable
economic activities. The main difference of the black economy from the legal one is that there is no
legal control over this money and no public scrutiny. No taxes are paid for this and it is not part of the
larger wealth that society can use for public purposes. It is truly a “private” capital outside of all
public control and other than that, this money is as much a capital as any other legal wealth.

Fig ure 16.1 Real Income of Top One Per cent of Income Earners as a Share of Total Income
Source Banerjee and Piketty (2001).

There are mainly two ways in which this black money is generated. They are as follows:
One is by siphoning off money from government schemes and payments. Former Indian Prime Minister Rajiv Gandhi once
famously said: “Out of every rupee that the government spends on welfare schemes, only 14 paisas reach the actual
beneficiary”. While specifics may differ, it seems that this figure is similar for all South Asian countries. Even in the other
government expenditure, whether it is infrastructure or defence, money is siphoned off . This is a veritable open secret of all our
countries, even though no government would accept this.

Former Indian Prime Minister Rajiv Gandhi once famously said: “Out of every rupee that the government spends
on welfare schemes, only 14 paisas reach the actual beneficiary”.
Government expenditure on welfare is a direct concession to the demands of the poor. It is the
“subsidy” that our governments purportedly give to the poor to keep them quiet. These allocations are
made in our budget, but much of the money does not reach the poor. So while the poor are pacified by
the announcement of huge schemes with massive financial outlays, the income redistribution they are
meant to effect never happens. This money, siphoned off by government officials, contractors, and
other middlemen, who form the bulk of our middle classes, is nothing but a financial transfer from
the state to those classes on whose ideological and professional services the state survives. They
provide the legal, religious, educational, media, and other services that sustain the hegemony of the
state among the working classes and peasantry.
The second way in which black money is generated is through tax evasion and keeping goods and services out of the ambit of
legal transactions. One, it reduces the amount of revenues generated by the state that could be used for public purposes, and
two, it reduces public control over a very large part of the economy. Therefore, it has been suggested that black economy is
truly a “private” capital without any state control.

The South Asian states, whether democracies or tyrannies, have had to make large populist
concessions to the poor and marginalised, who live within their national boundaries. The specific
form of that populism has varied greatly, but some form of populism has been invariant in all our
countries. On the other hand, again despite a great variation, the ruling classes have been, as ruling
classes often are, loathe to give up their power, position, and share of national wealth.
Corruption, or the siphoning off of public money and keeping a large part of the economy outside
of public scrutiny, has been one of the most effective tools of our ruling classes to, one, reduce
income distribution to the minimum necessary level and two, keep a significant part of their capital as
a “private” one. Unless a significant transformation of social and political power is effected in our
societies, it would be impossible to make a dent in corruption, as it has entrenched itself as one of the
most important ways in which our ruling classes effect the accumulation of capital.

Unless a significant transformation of social and political power is effected in our societies, it would be impossible to make
a dent in corruption, as it has entrenched itself as one of the most important ways in which our ruling classes effect the
accumulation of capital.
Factors Responsible for the Generation of Black Money
There are several factors responsible for the generation of black money. It would be relevant to
discuss those factors so that a correct understanding about the genesis, growth, and expansion of
black money can be made. The principal factors are
Divergence Between the Acceptable, Net Rate of Return, and Legally Permissible Rate of return
There is a school of thought which believes that the chief factor responsible for generation of black
income is that individuals expect a higher net rate of return than the legally permissible rate of return.
In this connection, the higher marginal rates of taxes assume special importance.
Black Money Generation as a Consequence of Controls and Licensing System

There is another school of thought which firmly believes that the system of controls, permits, quotas,
and licences, which are associated with maldistribution of the commodities in short supply, results in
the generation of black money.
Donation to Political Parties

Ever since the government decided to ban donations to political parties in 1968, it prompted the
businessmen to fund political parties, especially the ruling party, with the help of black money.
Ostensibly, this decision was taken to reduce the influence of big business on the electoral process
but, in practice, what happened was precisely the opposite.
Ineffective Enforcement of Tax Laws

Whereas the government has an armoury of tax laws pertaining to income tax, sales tax, stamp duties,
excise duty, and so on, their enforcement is very weak due to widespread corruption in these
departments. The high rates of these taxes induce businessmen to avoid recoding of these transactions.
The soft attitude to tax compliance by the government can be seen from the fact that according to the
Finance Ministry, an amount of Rs 224 crore was outstanding by way of arrears towards 20
monopoly houses on February 28, 1990, with Modis at the top accounting for an arrear of Rs 70.17
crore. Followed by J.K. Singhania, Rs 45.90 crore; Tata, Rs 36.73 crore; Mafatlal, Rs 19.49 crore;
Birla, Rs 12.84 crore; Hindustan Lever, Rs 9.65 crore; Shri Ram, Rs 6.76 crore; Thapar, Rs 5.85
crore; Walchand, Rs 5.02 crore; M.A. Chidambaram, Rs 3.51 crore; Reliance, Rs 3.17 crore; Bangor,
Rs 1.74 crore; and Kirloskar, Rs 1.1 crore.

Whereas the government has an armoury of tax laws pertaining to income tax, sales tax, stamp duties, excise duty, and so
on, their enforcement is very weak due to widespread corruption in these departments.
Generation of Black Money in the Public Sector

Every successive Five-Year Plan planned for a large size of investment in the public sector. The
projects undertaken by the public sector have to be monitored by the bureaucrats in the government
departments and public sector undertakings. Tenders are invited for various works, and these tenders
are awarded by the bureaucracy in consultation with the political bosses. Thus, a symbiotic
relationship develops between the contractors, bureaucracy, and the politicians and, by a large
number of devices, costs are artificially escalated and black money is generated by underhand deals.

A symbiotic relationship develops between the contractors, bureaucracy, and the politicians and, by a large number of
devices, costs are artificially escalated and black money is generated by underhand deals.
A Survey of Measures Undertaken to Unearth Black Money
Measures to Check Tax Evasion

One of the basic causes of black income generation and, then, its conversion into either white money
by various measures or into black wealth is “tax evasion”. Therefore, plugging the loopholes that are
found in tax evasion by a large number of legal and administrative measures becomes mandatory.
Demonetisation
In 1946, demonetisation was resorted but the Direct Taxes Enquiry Committee in its interim report
admitted: “Demonetization was not successful then, because only a very small proportion of total
notes in circulation was demonetized. Notes demonetized in 1946 were of the value of Rs 143.97
crore as against the total notes issued of the value of Rs 1,235.93 crore”. Demonetisation assumes that
all black income are held in the form of cash balances, but the matter of fact is that it is only a small
part of the total black income which is held in liquid form. The rest are in circulation. Secondly,
businessmen invent a number of clandestine ways to circumvent demonetisation. So, the net effect of
this limited and partial measure to destroy black income becomes too insignificant.
Voluntary Disclosure Schemes
From time to time, various voluntary disclosure schemes were floated by the government. These
schemes were nothing but a camouflaged version of reduction in the tax rates at higher income levels.
Special Bearer Bonds Scheme

Special Bearer Bonds Scheme (1981) was intended for canalising unaccounted money for productive
purposes. The Special Bearer Bonds Scheme, that was found in 1981, with the face value of Rs 10,000
each, was issued at par with a maturity period of 10 years. The holders of these bonds were to be
entitled to receive Rs 12,000 on maturity. In other words, they carry an interest of 2 per cent per
annum. Complete immunity has been granted to the original subscriber or possessor of the bonds
from being questioned about the possession of bonds or about the sources of money from which the
same have been acquired.
Voluntary Disclosure Scheme (1997)

Finance Minister M.P. Chidambaram while presenting 1997–98 budget announced a Voluntary
Disclosure Scheme (VDS). After balancing the economic and ethical arguments for harnessing black
money, his conclusion was that that period was the most favourable one to introduce VDS. The
scheme is very simple. Irrespective of the year or nature of the source of funds, the amount disclosed
either as cash, securities, or assets, whether held in India or abroad, would be charged to tax at 30 per
cent for individuals and 35 per cent for corporations. Total immunity would be granted for any action
under the scheme under the Income Tax Acts, Wealth Tax Acts, and Foreign Exchange Regulation Act
(FERA).
REGIONAL IMBALANCES
Balanced regional growth is necessary for the harmonious development of a federal state such as
India. India, however, presents a picture of extreme regional variations, in terms of such indicators of
economic growth as per capita income, the proportion of population living below the poverty line,
working population in agriculture, the percentage of the urban population’s manufacturing industries,
and so on. Relatively speaking, some states are economically advanced while others are relatively
backward. The coexistence of relatively developed and economically depressed states, and even
regions within each state, is known as “regional imbalance”. Economic backwardness of a region is
indicated by symptoms like high pressure of population on land, excessive dependence on agriculture
leading to high incidence of rural employment, absence of large-scale urbanisation, low productivity
in agriculture and cottage industries, and so on.

Relatively speaking, some states are economically advanced while others are relatively backward.
Indicators of Regional Imbalance

To study regional imbalance, the 15 major states of India have been classified into two major groups:
forward states and backward states. Among the forward states are included: Punjab, Gujarat, West
Bengal, Karnataka, Kerala, Tamil Nadu, and Andhra Pradesh. Among the backward states are
included: Madhya Pradesh, Assam, Uttar Pradesh, Rajasthan, Orissa, and Bihar (refer to Box 16.1).

Box 16.1 Socio-economic Profile of States
Poverty
The percentage of population below the poverty line is the highest in Orissa, followed by Bihar,
Chhattisgarh, Jharkhand, and Madhya Pradesh. Apart from them, Punjab followed by Himachal
Pradesh, Haryana, Kerala, and Andhra Pradesh have low poverty.
Consumption
During 2004–05, when compared to 30 per cent at the all-India level, 57 per cent of the rural
population in Orissa followed by Chhattisgarh (55 per cent), Madhya Pradesh (47 per cent), Bihar
and Jharkhand (46 per cent each) were living below the monthly per capita expen diture (MPCE)
level of Rs 365 or about Rs 12 per day. As against this, 57 per cent of the rural population in
Kerala, 51 per cent of Punjab, and 47 per cent in Haryana had MPCE of at least Rs 690. At the all-
India level, this corresponds to the top 20 percentile of the MPCE distribution.
During 2004–05, as compared to 30 per cent at the all-India level, 55 per cent of Bihar and 50 per
cent of Orissa’s urban population were below the MPCE level of Rs 580 or Rs 19 per day. As
against the top 20 per cent at the all-India level, 28 per cent of Kerala’s and 27 per cent of Punjab’s
urban population were having an MPCE level of at least Rs 1,380.
Inequality
In the urban areas, inequality in consumption, as mea-sured by Lorenz Ratio, is the highest in
Chhattisgarh, followed by Kerala, Madhya Pradesh, Punjab, and West Bengal. It is low in urban
Gujarat, followed by Assam and Himachal Pradesh. It is also lower in rural India than urban India
in all major states. In rural India, it is the highest in Kerala, followed by Haryana, Tamil Nadu, and
Maharashtra. Assam has the lowest inequality followed by Bihar, Jharkhand, and Rajasthan
amongst the states in rural India.
Employment
Regular employment is the major engagement of working urban households in most of the major
states. About (48 per cent) of urban households in Maharashtra, fol-lowed by Haryana (47 per
cent), Chhattisgarh (46 per cent), Gujarat (45 per cent), and Punjab and Assam (44 per cent each),
depend on regular employment. Percentage of self-employed households in the urban areas is
higher in Uttar Pradesh (49 per cent) and Bihar (47 per cent). The proportion of casual-labour
households was higher in the urban areas for Kerala (25 per cent) and Himachal Pradesh (24 per
cent) than in the other major states.
In the rural areas, self-employment was more important in many of the major states. The
proportion was high in Uttar Pradesh (68 per cent), followed by Rajasthan and Assam (66 per cent
each), Himachal Pradesh (57 per cent), and Madhya Pradesh (56 per cent).
Health
Life expectancy is highest in Kerala, followed by Punjab, Maharashtra, Himachal Pradesh, and
Tamil Nadu. It was found least in Madhya Pradesh, followed by Assam, Orissa, Uttar Pradesh, and
Bihar.
As in March 2006, 100 per cent of Primary Health Centres (PHCs) had labour room in Andhra
Pradesh, Karnataka, and Tamil Nadu, while it was low in Uttar Pradesh, Bihar, Kerala, and
Madhya Pradesh.
As in March 2006, the proportion of PHCs with operation theatres was 87 per cent in Andhra
Pradesh, followed by Rajasthan (83 per cent), Maharashtra (74 per cent), Haryana (71 per cent),
and Gujarat (67 per cent). It was low in Uttar Pradesh, West Bengal, Chhattisgarh, Kerala, and
Bihar.
Hunger and Inadequate Food

Prevalence of hunger as measured in months in which any member of the household had
inadequate food is unusually high in West Bengal. It is also high in Orissa, Assam, and Bihar, but
lower in Himachal Pradesh, Rajas-than, Haryana, Gujarat, Karnataka, and Tamil Nadu.
Education
In 2004–05, the gross enrolment ratios (GER) for elemen-tary education, that is, Classes I–VIII
(6–14 years), was high-est in Madhya Pradesh (114.1 per cent), followed by Tamil Nadu (114 per
cent) and Chhattisgarh (112.6 per cent). It was found lowest in Bihar (65.2 per cent), followed by
Punjab (72.6 per cent) and Jharkhand (75.8 per cent).
GER for Secondary Education (Classes IX-X) was high in Himachal Pradesh (134.9 per cent),
followed by Kerala (93 per cent) and Tamil Nadu (80.7 per cent). It was lowest in Bihar (22.5 per
cent), Jharkhand (26.5 per cent), and West Bengal (41.5 per cent). For Senior- Secondary level
(Classes XI-XII), GER was least at 2.5 per cent in Jharkhand, followed by 9.8 per cent in Bihar;
and highest at 127.7 per cent for Himachal Pradesh, followed by 43.9 per cent in Tamil Nadu.
Basic Amenities
Himachal Pradesh, Punjab, Haryana, Kerala, Karnataka, Gujarat, Tamil Nadu, and Andhra Pradesh
have much larger percentage of households having electricity than is the case in Bihar, Assam,
Jharkhand, Uttar Pradesh and Orissa. Households having access to toilet facilities are high in
Kerala, Assam, and Punjab and are low in Chhattisgarh, Jharkhand, Bihar, and Madhya Pradesh.

Net State Domestic Product (NSDP) as the Indicator of Regional Imbalance

An important indicator of regional disparity is the growth rate of net state domestic product (NSDP)
observed during the last two decades. In 1980–81, out of a total net domestic income of Rs 110,340
crore of the whole country, the nine forward states accounted for 55 per cent, while the six backward
sates accounted for nearly 39 per cent.
NSDP in forward states indicated an annual average growth rate of 5.2 per cent between 1980–81
and 1990–91, that is, the pre-reform period. However, the situation showed a marked improvement in
these states, and the states, in turn, showed a higher annual average growth rate of 6.3 per cent during
the period from 1990–91 to 1997–98.
As against them, the backward states indicated a growth rate of 4.9 per cent during the pre-reform
period, but this growth rate decelerated in the post-reform period. The planning process, by helping
the backward regions, made an effort to reduce regional disparities, but the force of liberalisation and
globalisation strengthened the investment in forward states much more than in the backward states.

The planning process, by helping the backward regions, made an effort to reduce regional disparities, but the force of
liberalisation and globalisation strengthened the investment in forward states much more than in the backward states.
Trends in Investment and Financial Assistance

A study indicated that more than two-third of investment proposals (69.2 per cent) in the post-reform
period were concentrated in the forward states and a similar situation prevailed in terms of financial
assistance distributed by All India Financial Institutions as well as State Financial Corporations. The
All India Financial Institutions, viz., IDBI, IFCI, ICICI, UTI, LIC, GIC, IRBI, and SIDBI disbursed 67.3
per cent of total financial assistance to forward states up to March 31, 1997. Even among the nine
forward states, four states, viz., Maharashtra, Gujarat, Tamil Nadu, and Andhra Pradesh were able to
appropriate about 51 per cent of the total assistance. Even in the case of State Financial Corporations,
70 per cent of total assistance was received by the forward states. This analysis underlines the fact that
the reform process has favoured the forward states in terms of approval of investment proposals as
well as financial assistance.

The reform process has favoured the forward states in terms of approval of investment proposals as well as financial
assistance.
Infrastructure Disparities
Consumption of power per capita is an indicator of the level of energy consumption.The upshot of
analysis of indicators of regional imbalances is that even though during the planning process, there is
some evidence of the growth of regional disparities but, still, the state made a conscious effort to
reduce them. But the reform process, which strengthened the market forces within the country,
coupled with globalisation, favoured the forward states and neglected the backward states. As a result,
regional disparities were aggravated.

The reform process, which strengthened the market forces within the country, coupled with globalisation, favoured the
forward states and neglected the backward states.
Regional Inequality
There was a sharp increase in the regional inequality in India during the 1990s. In 2002–03, the per
capita NSDP of the richest state, Punjab, was about 4.7 times that of the poorest state, Bihar (refer to
Figure 16.2a). This ratio had increased from 4.2 per cent in 1993–94. A time-series graph of this ratio
shows that the disparity between the richest and poorest state shot up remarkably during the 1990s
(refer to Figure 16.2a). This has been highlighted by Ghosh and Chandrasekhar (2003), who showed
that inter-state inequality increased sharply in India during the reform period. As the authors pointed
out, based on the per capita SDP, the basic hierarchy of the Indian states remained the same during the
reform period, with Punjab, Haryana, and Gujarat, at the top, and Bihar and Orissa, at the bottom.
They also noted that the gap between the richest and poorest states opened up considerably after
1990–1991. To illustrate this, the authors benchmarked the average per capita net SDP of the three
richest states (Punjab, Haryana, and Gujarat) against the average per capita net SDP of the two poorest
states (Bihar and Orissa) as seen in Figure 16.2b.

The gap between the richest and poorest states opened up considerably after 1990–1991.
Ahluwalia (2002) also highlighted the trend of increasing inequality among the states by using the
per capita state GDP data for the period between 1980–81 and 1998–99. The trend of the Gini
coefficient indicating inter-state inequality is shown in Table 16.1, which confirms that inter-state
inequality grew steadily in India with liberalisation. More evidence on the increasing inter-state
inequality came from Singh and others (2003), who used regressions to check convergence in the per
capita consumption expenditures across states. The study found absolute divergence of inter-state per
capita consumption expenditures for the periods between 1983 and 1999–2000, and 1993–94 and
1999–04. A convergence exercise by Jha (2004) indicated that the ranking of states with respect to
inequality had not changed in the reform period. According to his findings, inter-state convergence of
the level of inequality was weak.

Fig ure 16.2 Widening Disparity Between the Richest and the Poorest States

Table 16.1 Gini Coefficientsa
Source: Sen and Himanshu (2005).

aUsing comparable estimates for the 50 th and 55 th Round of NSS Surveys.
Causes of Economic Backwardness and Regional Imbalances
There can be certain deterrent factors, which come in the way of rapid development of a region; most
important of these are the geographical isolation and inadequacy of economic overheads like
transport, labour, technology, and so on. Historically, the existence of backward regions started from
the British rule in India. The British helped the development of only those regions, which possessed
facilities for prosperous manufacturing and trading activities. Maharashtra and West Bengal were the
states preferred by the British industrialists. The three metropolitan cities—Calcutta, Bombay, and
Madras—attracted all the industries and the rest of the country was neglected and remained backward.

Historically, the existence of backward regions started from the British rule in India. The British helped the development of
only those regions, which possessed facilities for prosperous manufacturing and trading activities.
Further, under that land system of the British, the rural areas were continuously pauperised, and the
farmers remained the most oppressed class; the zamindars and the moneylenders were, of course, the
only prosperous persons on the rural scene. The absence of effective land reforms allowed the
structure in most of the rural India to remain inimical to economic growth. The uneven investment in
irrigation during the British period helped some areas become prosperous under the British rule.
In the developing countries, the developed regions are generally confined to urban centres and
urban areas. This is mainly because physical geography controls the economic growth in a greater
degree in developing countries and in developed countries. For example, Japan and Switzerland have
overcome the handicaps of mountain terrain but our Himalayan states, viz., Northern Kashmir,
Himachal Pradesh, the hill districts of Uttar Pradesh, Bihar, and NEFA (Arunachal Pradesh), have
remained backwards and underdeveloped mainly because of inaccessibility. Climate too plays an
important role in the low economic development of many regions in India as reflected in the low
agricultural output and in the absence of a large-scale industry.

In the developing countries, the developed regions are generally confined to urban centres and urban areas. This is mainly
because physical geography controls the economic growth in a greater degree in developing countries and in developed
countries.
Some regions are preferred because of certain locational advantages. The location of iron and steel
factories or oil refineries will have to be only in those technically defined areas, which are optimal
from all the standpoints considered together. Naturally, as the process of development gains
momentum, they attract feed from the developing regions. New investment, more so, in the private
sector has a tendency to concentrate in an already well-developed area, thus reaping the benefit of
external economies. This is but natural from the private sector point of view, since well-developed
area offers private investors certain basic advantages, viz., labour, infrastructure facilities, transport,
and the market.

New investment, more so, in the private sector has a tendency to concentrate in an already well-developed area, thus
reaping the benefit of external economies.
Nature of Development During the Planning Era
Serious regional imbalances resulted during the period of planned economic development since
1950–51. Even though a balanced development was strongly endorsed by the Industrial Policy
Resolution of 1956 and was accepted as one of the principal objectives of economic planning from
the Second Plan onwards, it was almost completely ignored by our planners and the licensing
authorities.
Since 1951, considerable investments have been concentrated at a few places like Bombay,
Ahmedabad, Dehi, Kanpur, Calcutta, Bangalore, and so on, on “efficiency criteria”. These areas have
outgrown their capacities and are faced with serious problems of congestion, slums, transport, public
health, and so on. At the same time, they are causing serious brain-and-resource drain from the
adjoining areas. They act as “suction pumps”, pulling in more dynamic elements from the more static
regions. While the growth centres experience rapid, sustained, and cumulative economic growth, the
neighbouring regions have experienced an outflow of people, capital, and resources.

Since 1951, considerable investments have been concentrated at a few places like Bombay, Ahmedabad, Dehi, Kanpur,
Calcutta, Bangalore, and so on, on “efficiency criteria”.
The adoption of new technologies in agriculture during the 1960s has also aggravated the regional
economic disparities. Working on the assumption of using the scarce resources in the most
productive ways and maximising the food-grain production to solve the problem of food shortage,
the government has concentrated its resources on farmers of heavily irrigated tracts in different parts
of the country. These farmers were already well-off and they are made still better-off. On the other
hand, the dry-land farmers and non-farming population of the countyside have been left out. This has
led to a widening of the gap of income disparities between the irrigated areas and the dry areas, and
between the large farmers and the small farmers in every state.
The government did make an attempt towards decentralisation and development of backward
regions through public sector investment programmes in such areas as Rourkela, Bhilai, Barauni, and
so on. But as the ancillary industries did not come up fast enough, these areas have continued to
remain backward despite the heavy investment by the Centre. Finally, there was an additional factor
for the growing regional imbalance after independence. While some state governments like Punjab,
Haryana, Gujarat, Maharashtra, and Tamil Nadu (at one time), devoted much attention to the industrial
development of their regions, others were more interested in political intrigues and manipulation than
in the rapid and balanced economic growth of their areas.

The government did make an attempt towards decentralisation and development of backward regions through public sector
investment programmes in such areas as Rourkela, Bhilai, Barauni, and so on. But as the ancillary industries did not come
up fast enough, these areas have continued to remain backward despite the heavy investment by the Centre.
Criteria for Industrial Backwardness
Balanced development of all regions and all states in a country is necessary to draw the available
human and material resources throughout the country into the development process and to enable
people in all regions to share the benefits of development. According to the Planning Commission,
Balanced regional development has always been an essential component of the Indian development strategy in order to ensure the
unity and integrity of the nation. Since not all parts of the country are equally well-endowed to take advantage of growth
opportunities, and since historical inequalities have not been eliminated, planned intervention is required to ensure that large regional
imbalances do not recur.
Economic Plans and Regional Planning

The First Plan did not refer to the problem of regional disparities. The Second Plan clearly admitted
that “in any comprehensive plan of development, it is axiomatic that the special needs of the less
developed areas should receive due attention. The pattern of investment must be so devised as to lead
to balanced regional development”. The Second and Third Plans mentioned the necessity to locate
basic industries in the less-developed areas, subject, of course, to technical and economic limitations,
as means to achieving regional development.
Identification of Industrially Backward Areas

In 1968, the National Development Council (NDC) considered the problem of industrial
backwardness among states and recommended the following five cities for the purpose of
identification of industrially backward states and union territories (UTs):
Total per capita income together with the contribution of industry and mining;
Number of workers in factories per lakh of population;
Per capita annual consumption of electricity;
Length of surfaced road in relation to population and area of the state; and
Railway mileage in relation to the population and the areas of the state.
In 1968, the National Development Council (NDC) considered the problem of industrial backwardness among states and
recommended the following five cities for the purpose of identification of industrially backward states and union territories
(UTs).
The NDC appointed the following two working groups: (a) identify industrially backward states and
UTs (using the above criteria); and (b) the Wanchoo Working Group to recommend fiscal and
financial incentives for starting industries in the backward areas.
Selection of Backward States

On the basis of the five criteria given by the NDC, the Pande Working Group identified the
following states and UTs as industrially backward and, hence, qualified to receive a special treatment
for industrial development.
a. Andhra Pradesh, Assam, Bihar, Himachal Pradesh, Jammu & Kashmir, Madhya Pradesh, Nagaland, Orissa, Rajasthan, and
Uttar Pradesh and
b. All UTs except Chandigarh, Delhi, and Pondicherry.
Accordingly, the Planning Commission evolved the following criteria to identify the backward
districts in all states:
i. The per capita food grains/commercial crop production;
ii. Ratio of agriculture labour to the total number of factory employees per lakh of population;
iii. Per capita industrial output;
iv. Number of factory employees per lakh of populations;
v. Number of persons engaged in secondary and tertiary activities per lakh of population;
vi. Per capita consumption of electricity; and
vii. Length of surfaced roads in relation to population or railway mileage in relation to population.
The Planning Commission in consultation with national financial institutions constructed a

composite weighted index for all the districts in each state. The territories as backward districts are
eligible for concessional finance and other facilities.
Wanchoo Working Group
The Wanchoo Working Group studied the fiscal and financial incentives that are to be provided for
starting industries in backward areas and the following measures are recommended:
Grant of higher-development rebate to industries located in the backward areas;
Grant of exemption from corporate income tax for a period of five years;
Exemption from import duty on plant and machinery and components imported by a unit located in a backward district;
Exemption from excise duties for a period of five years;
Exemption from sales tax for a period of five years; and
Provision of transport subsidy.
These recommendations were broadly accepted by the government and were implemented, with
some modifications.
Conclusion
In India, although there are claims that inequality has decreased in the post-liberalisation period, a
careful analysis of the available data shows that these views are mostly unsubstantiated. The
comparable estimates of the 50th (1993–94) and 55th (1999–2000) rounds of the National Sample
Survey (NSS) data reveal that inequality increased in both rural and urban India. Several authors have
also pointed out that though the richer sections of the population benefitted in the post-liberalisation
period, there has been a stagnation of income for the majority, with the bottom rung of the population
severely affected negatively by this process. There is also evidence that, both at the National and the
State levels, the income disparities between the rural and the urban sectors increased during this
period. State-level data also showed that not only had the income gap between the poorest and the
richest states increased during the 1990s, but the urban inequality also had increased for all the 15
major states in India. Inequality also has alarmingly increased in the north-eastern part of the country,
where all the states experienced an increased rural and urban poverty during this same period.

In India, although there are claims that inequality has decreased in the post-liberalisation period, a careful analysis of the
available data shows that these views are mostly unsubstantiated.
One of the reasons behind the increased income inequality observed in India in the post-reform
period has been the stagnation of employment generation in both the rural and urban areas across the
states. Open unemployment increased in most parts of the country, and the rate of growth of rural
employment hit an all-time low. The declining employment elasticity in several sectors, including
agriculture, was one of the main reasons behind this decline. Low employment generation in the
agriculture sector has also been associated with a steady, but a significant increase in casualisation of
the labour force in India. Due to the large-scale downsizing and the privatisation of public sector units
(PSUs), the employment generation in the organised sector too has suffered. However, the services
sector performed relatively better during this period. The employment growth rate in this sector was
higher than in the other sectors of the economy. Particularly in some sub-sectors like information
technology, communication, and entertainment, employment generation and wages increased
substantially in this period. However, these sectors employed only a very small section of the labour
force, and their impact on the overall employment scenario has been minimal. One countervailing
force to the lower employment generation has been increased economic migration, typically to other
countries in Asia and the Middle East.

One of the reasons behind the increased income inequality observed in India in the postreform period has been the
stagnation of employment generation in both the rural and urban areas across the states.
This has been important especially in certain regions and has provided an important alternative
source of transfer income to local residents through remittances. However, these flows have had little
to do with domestic policies and more to do with international economic processes. The discussion of
health and education-related indicators shows that though there has been some progress in India in
these areas, this progress has been unsatisfactory, even when compared to other developing countries.
Huge inter-state disparities in health and education-related indicators remain across the country. State
involvement and investment in these sectors have historically remained very low and declined even
further during the 1990s. Gradual withdrawal of the state from these sectors and increased reliance on
the private sector are likely to further exacerbate the already inequitable distribution of health and
education services in India.

The discussion of health and education-related indicators shows that though there has been some progress in India in these
areas, this progress has been unsatisfactory, even when compared to other developing countries.
A number of policies adopted during the reform period essentially increased the level of inequality
in India. Liberalisation of trade helped some sectors where India was internationally competitive, but
it also negatively affected the other sectors. The agriculture sector, as well as small and medium
enterprises (SMEs), which account for the bulk of employment, were the worst hit by the trade
liberalisation undertaken by the policymakers since the mid-1990s. The inflow of FDI into India has
only marginally improved GDCF, but its incidence has been confined to some very small pockets,
both geographically and sectorally. This has increased inter-state and intersectoral inequalities in the
country.

A number of policies adopted during the reform period essentially increased the level of inequality in India.
An emphasis on the reduction of the fiscal deficit also increased inequality in India during the
reform period. Due to pressures from powerful lobbies, direct and indirect tax rates declined in India.
The government’s failure to reduce current expenditure implied that most of the adjustment to reduce
the fiscal deficit was carried out by reducing capital expenditure and rural expenditure generally, as
well as by selling PSUs to generate a one-time revenue. Reduction of capital expenditure reduced the
public investment in key infrastructural areas and social welfare schemes. In a country like India,
where the level of infrastructure development is poor, public investment in infrastructure is critical,
not only for its direct developmental effects, but also for its bringing in the private investment
through its crowding effects.

An emphasis on the reduction of the fiscal deficit also increased inequality in India during the reform period.
Attempts to reduce the government expenditure on food subsidies and social welfare schemes have
also had serious negative effects on the inequality in the country. In their zeal to adopt market-
oriented reform measures, Indian policymakers have tended to overlook the fact that not only the so-
called “market economies” of Europe and America, but also the industrialisation success stories of
East Asia, spend a very high percentage of their GDP on health, education, and social security.
Notwithstanding the free-market rhetoric, these countries have steadily increased their public
expenditure on social services since the 1980s.

Attempts to reduce the government expenditure on food subsidies and social welfare schemes have also had serious
negative effects on the inequality in the country.
Other market-oriented reform measures, like closure of non-profit-making PSUs, have seriously
undermined the social objectives of the PSUs and have negatively affected the employment and the
economic development in some parts of the country. The closure of non-profit-making PSUs hurt the
backward regions of the country more severely as the profit-maximising private sector often does not
find these areas economically attractive.
Opening up of the economy and the financial sector liberalisation too had major negative
consequences for the weaker sections of the population. The introduction of prudential norms for
private and public sector banks and the Basle NPA benchmark made wary banks avoid lending to
borrowers in agriculture and to small enterprises. As a result, credit flows to agriculture and SMEs
went down drastically in the recent years. This reinforced the problems faced by these sectors due to
trade liberalisation and the complete removal of quantitative restrictions on imports.

Opening up of the economy and the financial sector liberalisation too had major negative consequences for the weaker
sections of the population.
All the above factors points to conclusions with implications for a government policy. The first is
the crucial importance of a continued and increased public expenditure for productive investments in
the infrastructure as well as social expenditures, and ensuring food access. Both aggregate
expenditure and the pattern of public expenditure are important. In addition, fiscal federalism—
relations between the Central and Provincial governments—are very significant in large countries
like India. Methods of raising resources for government expenditure, such as the pattern of taxation,
also impact this connection. The relationships between the growth patterns and the extent and type of
employment generated have been extremely important as well. Trade liberalisation has had
disequalising effects while it provided more opportunities for some export activities. There were
adverse effects for those employed in import-competing sectors, especially in the small-scale
activities. FDI patterns have tended to reinforce the existing inequalities, possibly even more than the
domestic investment.

FDI patterns have tended to reinforce the existing inequalities, possibly even more than the domestic investment.
SOCIAL INJUSTICE
Researchers have advanced a hypothesis of compression of public sector outlay on education and
health during the reform period. The government expenditures on social services and education have
registered an increase in the absolute terms over the period of time, illustrating, as it were, Wanger ’s
Law of increasing state activity. Thus, during the six-year period before the intensive reform process
of 1991, the State government expenditures on social services aggregated to Rs 10,491 crore, which
increased to Rs 13,438 crore, during the six-year period after 1991–92. Similarly, expenditures on
education, medical and public health, housing, urban development, and so on, also registered
significant increases during the same period.
But, what is worth noting is the decline in the share of expenditures of some of the crucial
components of the social sector during the reform period. Thus, before the reform period, the social
services constituted about 39.4 per cent of the total government expenditures. This percentage
declined to 6 per cent during the period between 1991–92 and 1996–97. Similar trends are seen in the
case of education, sports, art and culture, medical and public health, water supply and sanitation,
housing, labour and labour welfare, social security and welfare relief on account of natural
calamities, and so on. Table 16.2 presents the percentage share of some of these crucial components
of the social sector.
Thus, in most of the components of the social sector, the percentage share of the state government
expenditures has declined during the reform period. This is worth noting. The share of plan
expenditures has also declined in the case of a number of components of the social sector. From this
point of view, it appears that the reforms are not associated with fresh initiatives (i.e., plan
programmes) of the government with regard to the social sector.

In most of the components of the social sector, the percentage share of the state government expenditures has declined
during the reform period.

Table 16.2 Expenditure of All States on Social Sector (% to Total Government Expenditure)
Source: RBI Bulletins 1985–99.

CASE
In India, the per capita income of Punjab is Rs 25,048 and Bihar is Rs 5,460. In 1965, Punjab’s per
capita income at Rs 562 was just 1.7 times that of Bihar ’s Rs 332. Since then, Punjab’s per capita
income has grown 45 times and is now almost five times that of Bihar ’s. The latter state’s per capita
income in contrast, grew by just 16 times. In the same period, the national per capita grew from Rs
490 to Rs 16,707 or by 34 times.
Quite clearly, Bihar has been growing at a much slower pace than the rest of the country, while
Punjab has been growing faster. Compounding this extremely unhappy situation is the fact that the
intra-state inequality too is much greater in Bihar than that is in Punjab. One obvious thing is that the
State has been the main engine of economic growth in India; and Planning Commission, as it decided
the priorities and apportions resources, is the driver of this engine.
Although the achievements of a greater equalisation of people and regions in India were not
explicitly stated in the constitution, the very notion of a socialistic society and democracy implies a
determined thrust towards just that. Unfortunately from all the available data, it is obvious that it did
not happen.
The relative prosperity of Punjab is due to the hardworking and innovative peasant, while the
poverty of Bihar is due to the deep divisions in its society, corruption, and lawlessness. Like the most
generalisation, these too are seriously flawed. Clearly Punjab prospered as India made huge
investments in it. These investments were often at the cost of other regions. In 1955, the total national
outlay for irrigation was Rs 29,106.30 lakh, of this Punjab got Rs 10,952.10 lakh or 37.62 per cent.
In contrast, Bihar got only Rs, 1,323.30 lakh, a meagre 4.54 per cent. The Bhakra Nangal Dam—
one of Nehru’s grandest temples of Modern India, planned at an outlay of Rs 7,750 lakh—alone
irrigates 14.41 lakh ha. Even after excluding this from Punjab’s irrigation plan, its outlay is almost 2.5
times that of Bihar. Punjab extends over 50.36 lakh ha, of which 42.88 lakh ha is arable. Of this 89.72
per cent or 38.47 lakh ha is irrigated; in other words, 76.38 per cent of all land in Punjab is irrigated,
thanks to the magnificence of the government.
In contrast, only 40.86 per cent or 71 lakh ha, of Bihar ’s total area of 173.80 lakh ha is under
cultivation. Of this, only 36.42 lakh ha or 51.30 per cent is irrigated. Thus, Bihar, which is almost 3.5
times larger than Punjab, has less irrigated land than the latter. Even after accommodating for the
differences in terrains in both states, the sheer difference in the irrigated acreage and the percentage
of irrigated acreage, the direct result of public spending on irrigation in Punjab is telling. That Punjab
grew faster than Bihar because of higher investment is easily discerned from the per capita plan
allocation from the First Plan onwards. In the current plan of 2003–04. Bihar has a per capita outlay
of Rs 2,536.23 while Punjab is more than three times than that of Rs 7,681.10.
Higher public investment in a state has other long-term effects. Higher investment results in greater
tax collections giving rise to an ever-increasing entitlement to Central funds. In this manner, the
original injustice leads to perennial flow of rightful funds. There is no need to stress that the bulk of
the plan funds are provided by the Centre. This is well known, but what needs to be stressed is that
there are many other less-obvious benefits; for instance, almost 50 per cent of the food grains
procurement by the Food Corporation of India (FCI) is from Punjab, which means about half the food
subsidy of Rs 25,160 crore too flows to that State’s farmers; likewise, as Punjab consumes 8.01 per
cent of the total fertilizers, it benefitted by Rs 1,060.85 crore on this account. As subsidies rise
constantly, in the years to come Punjab will only benefit more.
In the recent years, a new trend of magazines and other publications are ranking states ostensibly
on the basis of performance. As they command considerable resources and are politically influential,
sure awards are public occasions with constitutional functionaries present lending an area of
authencity to the awards. If there was one for the most subsidised state, will that too go to Punjab?
As we have seen in the case of Punjab and Bihar, unequal public spending has created an unequal
economic situation. But this does not automatically establish that Punjab is better administered, as
these publications would like us to believe. Punjab’s financial position is not very much better than
that of Bihar. Probably, the best measure of how well a state is being administered is to look at its
debt-service ratio. Punjab is not better than Bihar in this regard. While both Punjab and Bihar live
beyond their means, the latter is doing on this account with much smaller revenue expenditure to
revenue gap.
In 2002–03, this gap for Bihar was Rs 1,517 crore, whereas it was Rs 3,018 crore for Punjab. Both
states have almost the same revenue levels. Bihar has a superior improving record than Punjab when
it comes to the proportion of disbursement, out of capital budgets. If one has to go by the charges
made by the present Chief Minister of Punjab against his immediate predecessor, the corruption in
Punjab is a more serious matter. There is no evidence to suggest that the incidence of subordinate
corruption is any less in the state than Bihar.
Clearly, being better-off does not make a State better, especially when doing better just means
getting more than others from the Centre. This now leaves us with the question as to how much more
did Punjab get on account of Central planning and how much less did Bihar get? The record since the
First Plan onwards shows that Punjab consistently got more than the national per capita average and
Bihar, progressively, got less in each Plan.
When these are added, the amount is quite huge. Even without factoring in the benefits due to The
Bhakra Nangal Project and border roads and canal networks, Punjab got Rs 9,742.19 crore more and
Bihar a huge Rs 77,161.50 crore less. Furthermore, on account of just salaries and pensions from the
armed forces, food, and fertilizer subsides, Punjab has benefitted by over Rs 100,000 crore in just the
past years alone.
Case Question
What are the reasons for the regional imbalance in the above Case, where Punjab is ahead than Bihar?
KEY WORDS
Black Money
Recession
Supply Management
Parallel Economy
Black Income
Black Money
Regional Imbalances
Social Sector
Economic Backwardness
Infrastructure
QUESTIONS
1. What do you mean by regional imbalance? Discuss the measures taken by the government to remove the regional imbalance.
2. Discuss the measures adopted by the government to eradicate social injustice.
3. What do you mean by parallel economy? Discuss the factors governing black money.
4. Discuss measures adopted by the government to control parallel economy
REFERENCES
Agarwal, A. N. (2000). Indian Economy: Problems of Development and Planning. New Delhi: Wishwa Prakashan.
India (2004): A Reference, Annual Publications Division, Ministry of Information and Broadcasting, Government of India.
CHAPTER 17
Direct and Indirect Taxes
CHAPTER OUTLINE
Introduction
Income Tax
Corporate Tax
Wealth Tax
Excise Duties
Customs Tariff
Central Sales Tax (CST)
Modified Value Added Tax (MODVAT)
Central Value Added Tax (CENVAT)
Value Added Tax (VAT)
Case
Summary
Key Words
Questions
References
INTRODUCTION
A tax which is paid by the person on whom it is legally imposed and the burden of which cannot be
shifted to any other person is called a “Direct Tax”. J.S. Mill defines a direct tax as “one which is
demanded from the very persons who, it is intended or desired, should pay it”. The person from
whom it is collected cannot shift its burden to somebody else. Thus, we have the impact, that is, the
initial, as the first burden and the incidence, the ultimate burden of the direct tax.
An indirect tax, on the other hand, is a tax, the burden of which can be shifted to others. Thus, the
impact and the incidence of in direct taxes are on different persons. An indirect tax is levied on and
collected from a person who manages to pass it on to some other person or persons on whom the real
burden of the tax falls. Hence, in the case of in+direct taxes, the tax-payer is not the tax-bearer.
Commodity taxes are generally indirect taxes, as they are imposed on the producers or sellers, but
their incidence falls upon the consumers as such taxes are wrapped up in the prices.
Table 17.1 gives a list of the major direct and indirect tax laws and the authorities who are
responsible for administering these laws. A system of advance ruling has recently been introduced by
the tax authorities. At present, non-residents can apply for advance rulings on the income tax law.
Under the Indian Income Tax (IT) Act, 1961, the income earned during a tax year, that is, April 1–
March 31 is subject to income tax. Box 17.1 gives a list of direct and indirect taxes, under that
category.

Table 17.1 Direct and Indirect Tax Laws
Nature of Tax Government Act Authority
Direct Tax
Income Tax Income Tax Act, 1961 Central Board of Direct Tax
Wealth Tax Wealth Tax Act, 1957 Central Board of Direct Tax
Gift Tax Gift Tax Act, 1958 Central Board of Direct Tax
Indirect Tax
Central Excise Central Excise & Salt Act, 1944 Central Board of Excise and Customs (CBEC)
Customs Customs Act, 1962 CBEC
Central Sales Tax Central Sales Tax Act, 1956 Union Government
State Sale Tax Respective State Sales Tax Acts Respective State Governments
Box 17.1 Taxes
Direct Taxes
1. Personal Income Tax

2. Corporation Tax
3. Inheritance Tax
4. Wealth Tax
Indirect Taxes
1. Excise Duty
2. Value Added Tax (VAT)
3. Custom Duty
4. Sales Tax
INCOME TAX
Income tax was introduced in India in 1860 but was discontinued after a few years in 1873. It was
reintroduced in 1886, and since then it has been an integral part of the Indian tax system. In 1939, the
rate structure was shifted to a slab system. Since then, the rates, exemptions, and other dimensions of
this tax have undergone endless revisions.
In the Indian constitution, taxation of agricultural income is reserved for the states, while the
Central government can tax non-agricultural incomes only. Furthermore, the net proceeds of the
income tax used to be shared with the states. The percentage share going to states, as also the shares
of individual states vis-à-vis each other, were decided on the recommendations of the Finance
Commission. Now, divisible income tax proceeds from a part of the Centre’s entire divisible tax
revenue. In India, in addition to the income tax proper, some surcharges in one form or the other have
usually been in existence. The income tax which is imposed on corporate incomes is also known as
“super tax” or “corporation tax”. Till the 80th amendment of the Constitution, it was not shareable
with the states.
The Indian IT Act, 1992 which was in force up to and including the assessment year 1961–62 was
repealed with effect from April 1, 1962 and in its place, a new Act called the IT Act, 1961 was
introduced which is the operative Act for and from the assessment year 1962–63. Since its
introduction, various new provisions were and are being included that it is difficult to keep track of
the frequent changes that were made and make them understandable in relation to the assessment year
2001–02 and subsequent years.
Assessment
The IT Act is a machinery for computing the total income of the previous year from various sources
as classified in Section 14. Such computation or assessment is made after allowing various
exclusions, exemptions, and deductions as provided in the Act. The IT Act does not, however,
prescribe the rates at which the tax is to be charged. Section 4 of the IT Act lies down the fact that
income tax shall be charged for any assessment year in respect of the total income of the previous
year that was computed under the IT Act at the rates prescribed by the Finance Act, which is passed
every year by the Parliament. Thus, while the total income is computed under the IT Act, which is a
permanent enactment, the tax payable on such income has to be worked out at the rates laid down in
the Finance Act which is an annual enactment. An assessment, therefore, comprises of two stages: (1)
computation of total income and (2) determination of the tax payable thereon. When both these stages
are completed, an assessment is said to have been made.

Assessment of the total income is a two staged process namely- (a) computation of total income and (b) determination of the
tax payable thereon.
Assessment Year [Section 2 (9)]
The question then arises as to what an assessment year is? In the IT Act, the “income tax year” is
described as an assessment year, that is, the year in which the income of the previous year which
ended before the commencement of the assessment year is to be assessed. The “assessment year”
comprises of a period of 12 months corresponding to a financial year, commencing from April 1 and
ending on March 31. Thus, the assessment year 2004–05 commenced from April 1, 2004 and ended
on March 31, 2005.

Assessment Year or the income tax year, refers to the year, in which the income of the previous year which ended before the
commencement of the assessment year, is to be assessed.
Previous Year [Section 3]
There will be only one previous year for all assessees ending on March 31 for all sources of income.
In other words, the financial year immediately preceding the assessment year shall be the uniform
previous year. In the case of a newly set-up business or a profession during the financial year, the
previous year will end on March 31, even though the period comprised in the previous year may be
less than 12 months. For example, an assessee has started a new business on July 1, 2003, his previous
year for the assessment year 2004–05 would be of nine months beginning from July 1, 2003 and
ending on March 31, 2004 and for the subsequent assessment years, his previous year will consist of
12 months beginning with April 1 and ending on March 31 [Proviso to Section 3].

The financial year that precedes the assessment year is the uniform previous year.
Assessee [Section 2(7)]
The assessee is a person by whom any tax or any other sum of money (such as interest, penalty) is
payable under the IT Act or in respect of whom any proceeding under the Act has been taken for the
assessment of his income or loss or of the income or loss, of any other person in respect of which he
is assessable, or of the amount of refund due to him or to such other person. Under Section 2(31) of
the IT Act, persons (i.e., assessees) are divided into the following categories:
i. Individual.
ii. Hindu undivided family (HUF) which consists of all persons lineally descended from a common male ancestor and is
assessable in respect of the income that is derived from the joint family corpus, and not being the income that is earned by its
individual members in their individual and personal capacity.
iii. Company. (As defined under Section 2[17] of the IT Act [e.g., any Indian company].)
iv. Firm. (A partnership of two or more persons [but not exceeding 20 persons] carrying on a business or a profession constituted
under the Indian Partnership Act, 1932.)
v. Association of persons or a body of individuals (i.e., a combination of persons formed for promoting a joint venture or a joint
enterprise, executors of an estate, trustees of a trust, etc.).
vi. Local authority (e.g., municipality, local boards, etc.).
vii. Every artificial juridical person, not falling in any of the preceding categories (i.e., a Hindu deity).
From the assessment year 2002–03 onwards, “person” includes an association of persons or a body
of individuals or a local authority or an artificial juridical person, whether or not such person or
body or authority or juridical person was formed or established or incorporated with the object of
deriving income, profits, or gains. (An explanation to Section 2[31].)
Residential Status of an Assessee

The income liable to tax in the hand of an assessee is determined on the basis of residential status. For
this purpose, the assessees are divided into the following two categories:
i. Resident in India and
ii. Non-resident in India.
Individuals and HUFs, who are resident in India, are again classified as:
a. Ordinarily resident and
b. Not ordinarily resident.
Resident in India
In respect of “Individuals”: Taxation of individuals is determined by their residential status. An
individual is “resident” if he stays in India in the fiscal year (April 1–March 31) either
for 182 days or more, or
for 60 days or more (182 days or more for NRIs), and has been in India in aggregate for 365 days or more in the previous four
years.
In respect of “HUF, Firm, and Other Association of Persons”: A HUF, firm, or other association of
persons is said to be a resident in India in any previous year, except during that year when the control
and management of its affairs is situated wholly outside India [Section 6(2)].
In respect of a “Company”: A company is said to be a resident in India in any previous year, if it
satisfies any of the following two conditions:
i. it is an Indian company, or
ii. during that year, the control and management of its affairs is situated wholly in India [Section 6(3)].
Non-resident in India
An individual who does not satisfy either of these requirements is a “non-resident”. A resident
individual is considered to be “ordinarily resident” in any fiscal year if he has been a resident in India
for nine out of the previous 10 years and, in addition, has been in India for a total of 730 days or
more in the previous seven years. The residents who do not satisfy these conditions are called the “not
ordinarily resident” individuals. Taxability of individuals is summarised in Table 17.2.
The remuneration for work done in India is taxable irrespective of the place of receipt.
Remuneration includes salaries and wages, pension, fees, commissions, profits in lieu of or in
addition to salary, advance salary, and perquisites. Allowances, deferred compensation, and tax
equalisation are also taxable. Perquisites are taxed beneficially.
Heads of Income [Section 14 of IT Act]
Save as otherwise provided by the IT Act, 1961, that all income shall, for the purposes of charge of
income tax and computation of total income, be classified under the following heads of income:
Salaries
Income from house property
Profits and gains of business or profession
Capital gains
Income from other sources

Table 17.2 Taxability of Individuals
Status Indian Income Foreig n Income

Resident and ordinarily resident Taxable Taxable
Resident but not ordinarily resident Taxable Not taxable
Non-resident Taxable Not taxable
Individual Tax Rates

Income tax is a tax levied on the financial income of a person, corporation, or other legal entities.
The individual income tax rate is applicable to those whose income exceeds Rs 150,000 for the
financial year. The slabs and rates of income tax for individual and corporation are given below
according to the Indian IT Act for AY 2008–09 or FY 2007–08.
Income tax for an individual other than women and senior citizens: Finance Minister P.
Chidambaram has brought cheer to the individual tax-payer by raising the basic income tax
exemption limit from Rs 110,000 to Rs 150,000. The move will see the individual save at least Rs
4,000 in taxes in the financial year 2008–09.
Beyond Rs 150,001 and up to Rs 300,000, a tax rate of 10 per cent is applicable. The 20 per cent tax
rate is applicable in the Rs 300,001–500,000 slabs and anything beyond Rs 500,000 will be taxed at 30
per cent. The 3 per cent surcharge on tax, at all levels, remains.
Up to Rs 150,000—NIL.
From Rs 150,001 to Rs 300,000—10 per cent.
Above Rs 500,001—30 per cent.
The table of income tax rates in India for an individual in the year 2008–09 is as follows:

Tax (%) Income (INR)

0 1–150,000
10 150,001–300,000
20 300,001–500,000
30 500,001 and above

The table of tax liability in India in the year 2008–09 is as follows:

Income Past Tax Present Tax
150,000 4,000 NIL
200,000 14,000 5,000
300,000 39,000 15,000
400,000 69,000 35,000
500,000 99,000 55,000
1,000,000 249,000 205,000
Notes:
1. Figures in rupees.
2. Tax liability does not include any surcharge.

Table 17.3 explains the tax liabilities in the pre-budget and post-budget for men, women, and senior
citizens. And all classes of assessees are entitled to an additional relief under Section 80D. If the
medical premium expenses incurred under that Section are for the benefit of the tax-payer ’s parents,
the maximum exemption under that Section will be Rs 50, 000 instead of the earlier Rs 15, 000. Bad
news, though, for those who earn their living playing on the stock market. The FM has raised the rate
of short-term capital gains tax on the sale of listed shares from 10 per cent to 15 per cent.

Table 17.3 Comparison of Tax Liabilities—Pre-budget and Post-budget for Men/Women/Senior Citizens

For women other than senior citizens: The exemption for women assessees has been raised from
Rs 145,000 to Rs 180,000.
The table of income tax rates in India for women other than senior citizens in the year 2008–09 is as
follows:


0 1–180,000
10 180,001–300,000
20 300,001–500,000

For senior citizens: As far as the exemptions are concerned, the senior citizens get a further reprieve.
The Senior Citizens Savings Scheme and some other post office products have been brought under
the ambit of Section 80C, and any investment made in these instruments will qualify as a deduction
from the senior citizens’ total income.
The table of income tax rates in India for senior citizens in the year 2008–09 is as follows:


0 1–225,000
20 225,001–300,000

For other individuals—HUF (Hindu Undivided Families), AoP (Association of Persons), BoI
(Body of Individuals): For such individuals, tax slabs are the same as individuals other than women
and senior citizens. That is,
The table of income tax rates in India for an individual in the year 2008–09 is as follows:


0 1–150,000
10 150,001–300,000
20 300,001–500,000

There are no significant changes in the Indian tax rates in 2008. The tax in India on an individual’s
income is progressive. For the financial year 2008–09, an individual’s income is taxed progressively
at 10 per cent to 30 per cent. A 10 per cent surcharge is imposed on the tax, subject to legally specified
limits, and an education tax (CESS) of 3 per cent too imposed.
Spouses are treated separately for tax purposes and their income is not normally clubbed. However,
income of all minors, except handicapped minors, is clubbed with the income of their parents unless
the income is derived from manual work or an activity involving skill, specialised knowledge, and
experience. The Finance Act, 1994 increased the income tax exemption limit and has abolished
surcharge on income tax for individuals.
To widen the tax base, the Union Budget for 1995 made a new provision in the IT Act subjecting the
sums payable by way of fees for professional or technical services to the requirement of deduction of
income tax at source, at the rate of 10 per cent. There will be no deduction of tax at source where the
aggregate of payments or credits during the financial year is below Rs 22,000 or where payments are
made by individuals and HUFs.
Special provisions relating to the income of non-resident Indian individuals: When the income
of an NRI consists only of investment income or income from long-term capital gains, the tax
payable is at the rate of 20 per cent. The capital gains on transfer of assets that are acquired in foreign
exchange are not taxable in certain cases.
Non-resident Indians are not required to file a tax return if their income consists of only interests
and dividends, provided the taxes due on such income are deducted at source. The tax rate on such
income is 20 per cent. It is possible for non-resident Indians to avail of these special provisions even
after becoming residents by following certain procedures that have been laid down by the IT Act.
Agricultural Income
a. Any rent or revenue derived from land, which is situated in India and is used for agricultural purposes;
b. Any income derived from such land by—
i. Agriculture; or
ii. The performance by a cultivator or receiver of rent-in-kind of any process ordinarily employed by a cultivator or
receiver of rent-in-kind to render the produce raised or received by him, fit to be taken to market; or
iii. The sale by a cultivator or receiver of rent-in-kind of the produce raised or received by him, in respect of which no
process has been performed other than a process of the nature described in paragraph (ii) of this sub-clause;
c. Any income derived from any building owned and occupied by the receiver of the rent or revenue of any such land, or occupied
by the cultivator or the receiver of rent-in-kind, of any land with respect to which, or the produce of which, any process
mentioned in the paragraphs (ii) and (iii) of sub-clause (b) is carried on
Provided that—
i. The building is on or in the immediate vicinity of the land, and is a building which the receiver of the rent or revenue or
the cultivator, or the receiver of rent-in-kind, by reason of his connection with the land, requires as a dwelling house, or
as a storehouse, or other out-building, and
ii. The land is either assessed for land revenue in India or is subject to a local rate, assessed and collected by the officers
of the government as such or where the land is not so assessed to land revenue or subject to a local rate, it is not
situated—
A. in any area which is comprised within the jurisdiction of a municipality (whether known as a municipality, municipal corporation,
notified area committee, town area committee, town committee, or by any other name) or a cantonment board and which has a
population of not less than 10,000 according to the last preceding census of which the relevant figures have been published
before the first day of the previous year; or
B. in any area within such distance, not being more than 8 km, from the local limits of any municipality or cantonment board
referred to in item (A), as the Central government may, having regard to the extent of, and scope for, urbanisation of that area
and other relevant considerations, specify in this behalf by a Notification in the Official Gazette.
Explanation: For the removal of doubts, it is hereby declared that the revenue derived from land shall not include and shall be
deemed never to have included any income arising from the transfer of any land referred to in item (a) or item (b) of sub-clause
(iii) of Clause (14) of this Section.
Highlights of the Union Budget 2008–09 on Agriculture

Loan waiver and debt relief for farmers having land up to 2 hectares
Marginal and small farmers to get complete loan waiver; all loans up to March 2007 under the scheme
Other farmers to get one-time relief settlement by paying 75 per cent debt
Implementation of relief of farmers scheme with effect from June 2008
Total relief package for farmers to cost Rs 60,000 crore
Agricultural growth estimated at 2.6 per cent
Rashtriya Krishi Vikas Yojna launched
National Agriculture Insurance Scheme to continue in the present format
Agricultural credit to reach Rs 2.4 lakh crore by the year-end
Haryana and Chandigarh to develop a smart-card facility for food-subsidy distribution
Rs 40,000 crore allocated for Special Purpose Tea Fund
Fertilizer subsidy to continue in the current form
Amalgamation [Section 2(1B) of IT Act]
“Amalgamation”, in relation to companies, means the merger of one or more companies with
another company or the merger of two or more companies to form one company (the company or
companies which so merge being referred to as the amalgamating company or companies and the
company with which they merge or which is formed as a result of the merger, as the amalgamated
company) in such a manner that—
i. All the properties of the amalgamating company or companies immediately before the amalgamation become the properties of
the amalgamated company by virtue of the amalgamation;
ii. All the liabilities of the amalgamating company or companies immediately before the amalgamation become the liabilities of the
amalgamated company by virtue of the amalgamation;
iii. Shareholders holding not less than nine-tenths in value of the shares in the amalgamating company or companies (other than
shares already held therein immediately before the amalgamation by, or by a nominee for, the amalgamated company or its
subsidiary) become the shareholders of the amalgamated company by virtue of the amalgamation, other-wise than as a result of
the acquisition of the property of one company by another company, pursuant to the purchase of such property by the other
company or as a result of the distribution of such property to the other company after the winding up of the first-mentioned
company.
Amalgamation of companies means the merging of one or more companies (amalgamating company/ies) with another
company or the merger of two or more companies to form one company (amalgamated company).
Assessing Officer [Section 2(7A) of IT Act]
This means the Assistant Commissioner or the Deputy Commissioner or the Assistant Director or the
Deputy Director of Income Tax or the Income Tax Officer who is vested with the relevant jurisdiction
by virtue of directions or orders issued under sub-section (1) or sub-section (2) of Section 120 or any
other provision of this Act, and the Joint Commissioner or Joint Director who is directed under
Clause (b) of sub-section (4) of that Section to exercise or perform all or any of the powers and
functions conferred on, or assigned to, an Assessing Officer (AO) under this Act.
Average Rate of Income Tax [Section 2(10) of IT Act]
This means the rate arrived at by dividing the amount of income tax calculated on the total income, by
such total income.
Capital Asset [Section 2(14) of IT Act]
This means property of any kind held by an assessee, whether or not connected with his business or
profession, but does not include—
i. Any stock-in-trade, consumable stores or raw materials held for the purposes of his business or profession;
ii. Personal effects, that is to say, movable property (including wearing apparel and furniture, but excluding jewellery) held for
personal use by the assessee or any member of his family dependent on him.
Explanation: For the purposes of this sub-clause, “jewellery” includes—
a. Ornaments made of gold, silver, platinum, or any other precious metal or any alloy containing one or more of such
precious metals, whether or not containing any precious or semi-precious stone, and whether or not worked or sewn into
any wearing apparel;
b. Precious or semi-precious stones, whether or not set in any furniture, utensil, or other article; or worked or sewn into
any wearing apparel;
iii. Agricultural land in India, not being land situated—
a. in any area which is comprised within the jurisdiction of a municipality (whether known as a municipality, municipal
corporation, notified area committee, town area committee, town committee, or by any other name) or a cantonment
board, and which has a population of not less than 10,000, according to the last preceding census of which the relevant
figures have been published before the first day of the previous year; or
b. in any area within such distance, not being more than 8 km, from the local limits of any municipality or cantonment
board referred to in Item (a), as the Central government may, having regard to the extent of, and scope for, urbanisation
of that area and other relevant considerations, specify in this behalf by a Notification in the Official Gazette.
Charitable Purpose [Section 2(15) of IT Act]
This includes a relief of the poor, education, medicine, and the advancement of any other object of
general public utility.
Maximum Marginal Rate [Section 2(29C) of IT Act]
This means that the rate of income tax (including surcharge on income tax, if any) applicable in
relation to the highest slab of income in the case of an individual, association of persons, or as the
case may be, body of individuals as specified in the Finance Act of the relevant year.
Income Deemed to Be Received [Section 7 of IT Act]
The following incomes shall be deemed to be received in the previous year:

i. The annual accretion in the previous year to the balance at the credit of an employee who participates in a recognised provident
fund, to the extent provided in Rule 6 of Part A of the Fourth Schedule; and
ii. The transferred balance in a recognised provident fund, to the extent provided in sub-rule (4) of Rule 11 of Part A of the Fourth
Schedule.
Income Deemed to Accrue or Arise in India [Section 9 of IT Act]
The following incomes shall be deemed to accrue or arise in India:

i. All income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or
from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset
situated in India.
Explanation: For the purposes of this Clause—
a. In the case of a business of which all the operations are not carried out in India, the income of the business deemed
under this Clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the
operations carried out in India;
b. In the case of a non-resident, no income shall be deemed to accrue or arise in India to him through or from operations
which are confined to the purchase of goods in India for the purpose of export;
c. In the case of a non-resident, being a person engaged in the business of running a news agency or of publishing
newspapers, magazines, or journals, no income shall be deemed to accrue or arise in India to him through or from
activities which are confined to the collection of news and views in India for a transmission out of India;
d. In the case of a non-resident, being—
1. An individual who is not a citizen of India; or
2. A firm which does not have any partner who is a citizen of India or who is a resident in India; or
3. A company, which does not have any shareholder who is a citizen of India or who is a resident in India, no
income shall be deemed to accrue or arise in India to such individual, firm, or company through or from
operations, which are confined to the shooting of any cinematograph film in India;
ii. An income, which falls under the head “Salaries”, if it is earned in India.
Explanation: For the removal of doubts, it is hereby declared that the income of the nature referred to in this Clause payable
for a service rendered in India shall be regarded as the income that is earned in India;
iii. An income that is chargeable under the head “Salaries” that is payable by the government to a citizen of India for a service
outside India;
iv. A dividend paid by an Indian company that is outside India;
v. An income by way of interest payable by—
a. The government; or
b. A person who is a resident, except where the interest is payable in respect of any debt incurred or money borrowed and
used, for the purposes of a business or a profession carried on by such person outside India, or for the purposes of
making or earning any income from any source outside India; or
c. A person who is a non-resident, where the interest is payable in respect of any debt incurred, or money borrowed and
used, for the purposes of a business or a profession carried on by such person in India;
vi. Income by way of royalty payable by—
b. A person who is a resident, except where the royalty is payable in respect of any right, property, or information used or
services utilised for the purposes of a business or a profession carried on by such person outside India or for the
purposes of making or earning any income from any source outside India; or
c. A person who is a non-resident, where the royalty is payable in respect of any right, property, or information used or
services utilised for the purposes of a business or a profession carried on by such person in India or for the purposes of
making or earning any income from any source in India:
1. Provided that nothing contained in this Clause shall apply in relation to so much of the income by way of
royalty as consists of a lump-sum consideration for the transfer outside India of, or the imparting of
information outside India in respect of, any data, documentation, drawing, or specification relating to any
patent, invention, model, design, secret formula, or process, or trade mark, or similar property, if such income
is payable in pursuance of an Agreement made before the April 1, 1976, and the Agreement is approved by
the Central government:
2. Provided further that nothing contained in this Clause shall apply in relation to so much of the income by way
of royalty as consists of lump-sum payment made by a person, who is a resident, for the transfer of all or any
right (including the granting of a licence) in respect of a computer software that is supplied by a non-resident
manufacturer, along with a computer or a computer-based equipment under any scheme approved under the
Policy on Computer Software Export, of the Software Development, and Training, 1986, of the Government
of India.
Explanation 1: For the purposes of the first proviso, an Agreement made on or after April 1, 1976, shall be
deemed to have been made before that date if the Agreement is made in accordance with the proposals
approved by the Central government before that date; however, where the recipient of the income by way of a
royalty is a foreign company, the Agreement shall not be deemed to have been made before that date unless,
before the expiry of the time allowed under sub-section (1) or sub-section (2) of Section 139 (whether fixed
originally or on extension) for furnishing the return of income for the assessment year commencing on April 1,
1977, or the assessment year in respect of which such income first becomes chargeable to a tax under this Act,
whichever assessment year is later, the company exercises an option by furnishing a declaration in writing to
the AO (such option being final for that assessment year and for every subsequent assessment year) that the
Agreement may be regarded as an Agreement made before April 1, 1976.
Explanation 2: For the purposes of this Clause, “royalty” means a consideration (including any lump-sum
consideration but excluding any consideration which would be the income of the recipient that is chargeable
under the head “capital gains”) for—
i. The transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret
formula, or process, or trade mark, or similar property;
ii. The imparting of any information concerning the working of, or the use of, a patent, invention, model, design, secret formula, or
process, or trade mark, or similar property;
iii. The use of any patent, invention, model, design, secret formula, or process, or trademark, or similar property;
iv. The imparting of any information concerning technical, industrial, commercial, or scientific knowledge, experience, or skill;
v. The transfer of all or any right (including the granting of a licence) in respect of any copyright; literary, artistic or scientific work
including films or video tapes for any use in connection with a television or tape or with a radio broadcasting, but not including
any consideration for the sale, distribution, or exhibition of cinematographic films; or
vi. The rendering of any services in connection with the activities referred to in sub-clauses (i)–(v).
Explanation 3: For the purposes of this Clause, the expression “computer software” shall have the meaning assigned to it in
Clause (b) of the Explanation to Section 80HHE;
vii. Any income by way of fees for technical services payable by—
b. A person who is a resident, except where the fees are payable in respect of services that are utilised in a business or a
profession that is carried on by such person outside India or for the purposes of making or earning any income from any
source outside India; or
c. A person who is a non-resident, where the fees are payable in respect of services utilised in a business or a profession
carried on by such person in India or for the purposes of making or earning any income from any service in India:
Provided that nothing contained in this clause shall apply in relation to any income by way of fees for technical
services that are payable in pursuance of an Agreement that is made before April 1, 1976, and approved by the Central
government.
Explanation 1: For the purposes of the foregoing proviso, an Agreement made on or after April 1, 1976, shall be
deemed to have been made before that date if the Agreement is made in accordance with proposals approved by the
Central government before that date.
Explanation 2: For the purposes of this Clause, “fees for technical services” means any consideration (including any
lump-sum consideration) for the rendering of any managerial, technical, or consultancy services (including the provision
of services of technical or other personnel) but does not include a consideration for any construction, assembly, mining,
or a like project that is undertaken by the recipient, or a consideration which would be the income of the recipient that is
chargeable under the head “Salaries”.
Transfer [Section 2(47) of IT Act]
“Transfer” in relation to a capital asset includes—

i. The sale, exchange, or relinquishment of the asset; or
ii. The extinguishment of any rights therein; or
iii. The compulsory acquisition thereof under any law; or
iv. In a case where the asset is converted by the owner thereof into, or is treated by him as, a stock-in-trade of a business carried on
by him, such conversion or treatment; or
v. Any transaction involving the allowing of the possession of any immovable property to be taken or retained in part performance
of a contract of the nature referred to in Section 53A of the Transfer of Property Act, 1882 (4 of 1882); or (vi) any transaction
(whether by way of becoming a member of, or acquiring shares in, a cooperative society, company, or other association of
persons; or by way of an agreement or any arrangement or in any other manner whatsoever) which has the effect of transferring,
or enabling the enjoyment of any immovable property.
Explanation: For the purposes of sub-clauses (v) and (vi) “immovable property” shall have the same meaning as in clause (d)
of Section 269UA.
Transactions Not Regarded as Transfer [Section 47 of IT Act]
Nothing contained in Section 45 shall apply to the following transfers:

i. any distribution of capital assets on the total or partial partition of a HUF;
ii. any transfer of a capital asset under a gift or will or an irrevocable trust;
iii. any transfer of a capital asset by a company to its subsidiary company, if—
a. the parent company or its nominees hold the whole of the share capital of the subsidiary company, and
b. the subsidiary company is an Indian company;
iv. any transfer of a capital asset by a subsidiary company to the holding company, if—
a. the whole of the share capital of the subsidiary company is held by the holding company, and
b. the holding company is an Indian company:
Provided that nothing contained in Clause (iv) or Clause (v) shall apply to the transfer of a capital asset made after February 29,
1988, as stock-in-trade;
v. any transfer, in a scheme of amalgamation, of a capital asset by the amalgamating company to the amalgamated company, if the
amalgamated company is an Indian company;
v(a) any transfer, in a scheme of amalgamation, of a capital asset being a share or shares held in an Indian company, by the
amalgamating foreign company to the amalgamated foreign company, if—
a. at least 25 per cent of the shareholders of the amalgamating foreign company continue to remain shareholders of the
amalgamated foreign company, and
b. such transfer does not attract a tax on the capital gains in the country in which the amalgamating company is
incorporated;
vi. any transfer by a shareholder, in a scheme of amalgamation, of a capital asset being a share or shares held by him in the
amalgamating company, if—
a. the transfer is made in consideration of the allotment to him of any share or the shares in the amalgamated company,
and
b. the amalgamated company is an Indian company:
vi(a) any transfer of a capital asset being bonds or shares referred to in sub-section (1) of Section 115AC, made outside India
by a non-resident to another non-resident;
vii. any transfer of agricultural land in India effected before March 1, 1970;
viii. any transfer of a capital asset, being any work of art—archaeological, scientific, or art collection; book, manuscript, drawing,
painting, photograph, or print; to the government or a university or the national museum, national art gallery, national archives, or
any such other public museum or institution as may be notified by the Central government in the Official Gazette to be of national
importance or to be of renown throughout any state or states.
Explanation: For the purposes of this Clause, “University” means a University established or incorporated by or under a
Central, State, or Provincial Act, and includes an institution declared under Section 3 of the University Grants Commission Act,
1956 (3 of 1956), to be a University for the purposes of that Act;
ix. any transfer by way of conversion of bonds or debentures, debenture-stock, or deposit certificates in any form of a company,
into shares or debentures of that company.
x. any transfer made on or before December 31, 1998 by a person (not being a company) of a capital asset, being membership of
a recognised stock exchange, to a company in exchange of shares allotted by that company to the transferor.
Explanation: For the purposes of this Clause, the expression “membership of a recognised stock exchange” means the
membership of a stock exchange in India which is recognised under the provisions of the Securities Contract (Regulation) Act,
1956 (42 of 1956);
xi. any transfer of a capital asset, being the land of a sick industrial company, made under a Scheme prepared and sanctioned under
Section 18 of the Sick Industrial Companies (Special Provisions) Act, 1985(1 of 1986) where such sick industrial company is
being managed by its workers’ cooperative:
a. Provided that such transfer is made during the period commencing from the previous year in which the said company has
become a sick industrial company under subsection (1) of Section 17 of that Act and ending with the previous year
during which the entire net worth of such company becomes equal to or exceeds the accumulated losses.
Explanation: For the purposes of this Clause, “net worth” shall have the meaning assigned to it in Clause (ga) of
sub-section (1) of Section 3 of the Sick Industrial Companies (Special Provisions) Act, 1985(1 of 1986).
Recognised Provident Fund [Section 2(38) of IT Act]
This means a provident fund which has been and continues to be recognised by the Chief
Commissioner or Commissioner in accordance with the rules contained in Part A of the Fourth
Schedule, and includes a provident fund established under a Scheme framed under the Employees’
Provident Funds Act, 1952 (19 of 1952).
Permanent Account Number (PAN)
Permanent Account Number (PAN) is a number by which the AO can identify any person. Presently,
the income tax department is allotting PAN under the “new series” to all assessees that consist of 10
alpha-numeric characters and is issued in the form of a laminated card. The PAN is ultimately meant
to supplant the General Index Register Number, which is currently in use. The General Index Register
Number is a number given by an AO to the assessees in the General Index Register maintained by
him, which also contains the designation and the particulars of the AO. As per Section 139A of the
Act, obtaining PAN is a must for the following persons:
1. Any person whose total income or the total income of any other person in respect of which he is assessable under the Act
exceeds the maximum amount which is not chargeable to tax.
2. Any person who is carrying on any business or profession whose total sales, turnover, or gross receipts are or is likely to
exceed Rs 5 lakh in any previous year.
3. Any person who is required to furnish a return of income under Section 139(4) of the Act.
The requirement for applying for allotment of PAN under the new series has now been extended to the whole of India.
PAN is required to be quoted in all the transactions mentioned below—
In all returns and in all correspondence with the department.
In all challans for payment of any tax or sum due to the department.
In certain notified transaction. (See the sub-module on notified transactions where PAN has to be quoted.)
How to Obtain PAN

(Form No. 49A has been prescribed for making an application for allotment of the PAN. The existing assessees who have already
filed their returns of income and who have not been allotted the PAN can attach Form No. 49A (duly filled in), along with the return
of income, while filing their return of income with their respective AOs. However, new assessees whose income is likely to exceed
Rs 50,000 (the maximum amount not chargeable to tax for AY 1998–99) can fill up the form and submit it to the “new assessee”
circle or ward, which has jurisdiction over them. In the cases of persons carrying on a business or a profession, if the turnover is
likely to exceed Rs 500,000 (Rs five hundred thousand) in any previous year, the Form No. 49A should be filled up and presented
to the range/circle/ward where the new returns are required to be filed.
Permanent Account Number (PAN) refers to a number of ten alphanumeric characters by which a person can be identified
by the Assessing Officer and ultimately supplants the General Index Register Number.
Tips for Filling Form 4 (No. 49A)
The form should be filled in carefully and completely as it may not be possible for the department to
allot PAN if all the details are not filled in. In any case, the following information must necessarily be
given:
In the case of companies, the information that is necessarily required is as follows:

Date of incorporation
Registration number
Date of commencement of the business
Full and complete names of at least two directors of the company
Branch addresses and branch names of the company
Unless the Form No. 49A contains all the above information, it would not be possible to allot the PAN
to a company assessee.
In the case of individuals, the information that is necessarily required is as follows:

Full and complete name of the assessee
Full and complete name of his/her father
Date of birth
Sources of income
Unless the Form No. 49A contains all the above information, it would not be possible to allot the PAN
to an individual assessee.
Usefulness of PAN
If PAN is quoted in all documents, it would be very convenient to locate the AO holding jurisdiction over the person concerned.
If PAN is quoted in all challans, the credit for payment of taxes can be quickly granted to the tax-payer.
If PAN is quoted in all specified transactions, the department can exercise a greater control over unregulated and undisclosed
transactions.
Notified Transactions Where PAN Has to be Quoted

Provisions of Section 139A(5): Every person shall quote his PAN or General Index Register Number
in all documents pertaining to the transactions specified as follows:
a. Sale or purchase of any immovable property valued at Rs 500,000 or more;
b. Sale or purchase of a motor vehicle or vehicles, which requires registration by a registering authority;
c. A time deposit, exceeding Rs 50,000, with a banking company to which the Banking Regulation Act, 1949 applies (including
any bank or banking institution referred to in Section 51 of that Act);
d. A deposit, exceeding Rs 50,000, in any account with Post Office Savings Bank;
e. A contract of a value exceeding Rs 1,000,000 for sale or purchase of securities as defined in Clause (h) of Section 2 of the
Securities Contracts (Regulation) Act, 1956(42 of 1956);
f. Opening an account with a banking company to which the Banking Regulation Act, 1949 applies (including any bank or banking
institution referred to in Section 51 of that Act);
g. Making an application for installation of a telephone connection (including a cellular telephone connection);
h. Payment to hotels and restaurants against their bills for an amount exceeding Rs 25,000 at any one time—
A person shall quote General Index Register Number in the documents pertaining to transactions specified in the above
Clauses (a)–(h), till such time the PAN is allotted to him.
A person, being a minor and who does not have any income chargeable to income tax, making an application for
opening an account referred to in the Clause (f) of this Rule, shall quote the PAN or General Index Register Number of
his father or mother or guardian, as the case may be.
Any person, who has not been allotted a PAN or who does not have a General Index Register Number and who
makes payment in cash or otherwise, than by a crossed cheque drawn on a bank or by a crossed-bank draft in respect
of any transaction specified in Clauses (a)–(h), shall have to make a declaration in Form No. 60, giving therein the
particulars of such transaction.
In simple terms, it is mandatory to quote Pan in

Applications for opening an account with a bank
Applications for installation of a telephone connection (including a cellular telephone)
Documents pertaining to sale or purchase of a motor vehicle
Documents pertaining to sale or purchase of immovable property valued at Rs 5 lakh or more
Documents pertaining to deposits exceeding Rs 50,000 in an account with a Post Office Savings Bank
Documents pertaining to a contract of a value exceeding Rs 10 lakh for sale or purchase of securities (shares, debentures, etc.)
Payment to hotels and restaurants against their bills for an amount exceeding Rs 25,000 at any one time
Returns of income
Challans for payment of direct taxes
All correspondence with the Income Tax Department
If you have applied for allotment of PAN under the new series and have received a letter asking for
further information, then please send your reply immediately with details as follows:
Individuals should give their, as well as their father’s full name (expand initials).
Married ladies should give their father’s name in full (and not husband’s name).
Exact date of birth/incorporation (not merely month or year) should be specified.
Give pin code in all the addresses.
Failure to comply with the provisions of Section 139A of the IT Act attracts a penalty of Rs 500
(minimum) to Rs 10,000 (maximum) for each default or failure.
Persons to whom provisions of Section 139A shall not apply: The provisions of Section 139A shall
not apply to following class or classes of persons, viz.,
a. The persons who have agricultural income and are not in receipt of any other income chargeable to income tax. Such persons
shall instead be required to make a declaration in Form No. 61 in respect of transactions referred to in Clauses (a)–(h) of Rule
114B of the Income Tax Rules.
b. Non-residents referred to in Clause (30) of Section 2 of IT Act, 1961.
c. A non-resident, who enters into any transaction referred to in Clauses (a)–(h) of Rule 114B, shall have to furnish a copy of his
passport.
Obligation of the authorities:

Any authority on receiving any document for purchase or sale of any immovable property or a motor vehicle and on receiving
any document relating to a transaction specified under Clauses (a)–(h) of sub-rule (i) of Rule 114B of Income Tax Rules shall
ensure that the PAN or the General Index Register Number has been duly quoted in the document or the declaration in Form
No. 60 or Form No. 61, as the case may be. The specified authorities are—
A registering officer appointed under the Registration Act, 1908 (16 of 1908);
A registering authority referred to in Clause (b) of sub-rule (1);
Any manager or officer of a banking company referred to in Clause (c) of sub rule (1);
Post Master;
Stockbroker, sub-broker, share transfer agent, banker to an issue, trustee of a trust deed, registrar to an issue, merchant
banker, underwriter, portfolio manager, investment advisor, and such other intermediaries registered under Section 12 of
the Securities and Exchange Board of India Act, 1992(15 of 1992);
Any authority or company receiving application for installation of a telephone by it;
Any person raising bills referred to in Clause (h) of sub-rule (i).
Such authority shall intimate the details of transactions to the Director of Income Tax (Investigation) and shall forward the
following documents:
a. A statement indicating therein the details of all the documents pertaining to any transaction referred to in Clauses (a)–(h)
of Rule 114B of Income Tax Rules wherein the PAN General Index Register Number is quoted.
b. The statement referred to in Clause (a) shall contain
Name and address of the person entering into the transactions,
Nature and date of the transaction,
Amount of each transaction,
PAN or General Index Register Number quoted in the documents pertaining to any transaction.
c. Copies of declaration in Form No. 60.
d. Copies of declaration in Form No. 61.
e. Copies of passport.
The statement, declaration, and copies of passports shall be forwarded to the concerned Director of
Income Tax (Investigation) by every person, within a month of receipt of the same by that person.
Highlights of the Union Budget 2008–09 on Income Tax

Income Tax exemption (general) increased to Rs 1.5 lakh
Income Tax exemption for women increased to Rs 1.8 lakh
Income Tax exemption for senior citizens raised to Rs 2.25 lakh
Tax slab for an income group between Rs 1.5 lakh to 3 lakh fixed at 10 per cent
Tax slab for an income group between Rs 3 lakh to 5 lakh slated at 20 per cent
Tax slab for an income group exceeding Rs 5 lakh have been modified at 30 per cent
Waiver on insurance premium up to Rs 35,000

Section Consequential Effect
In case of a person resident outside India or a person
permitted by RBI to maintain non-resident (External)
account: Any income by way of interest on the credit
10(4)
standing in non-resident (External) account in any
bank in India was previously not included in the total
income but now this section is omitted
Standard deduction available to salaried employees
16(i)
will not be available.
Rs 1 lakh consolidated exemption limit will be
allowed to all individual/HUF before computing
taxable income. The concept of 20 per cent/15 per cent
rebate on investment under Section 88 is no longer
applicable. Now, investment that is made will be
80C
directly reduced from the income of the assessee
under Section 80C. Previously, the benefit of Section
88 was not available to persons having income above
Rs 5.0 lakh, but they can now enjoy a deduction under
Section 80C.
Investment in small-saving schemes, Equity-Linked
Saving Schemes (ELSSs), contributions to insurance
policies and pension plans, and so on, have all been
made a part of the eligible Rs 1 lakh. This amount will
be reduced from the taxable income of the assessee.
This means that now the tax benefits will no longer
dictate an investor ’s investment decisions because
there is no limit on any particular saving/investment,
that is, investment/saving can be done of any mix to
get deduction under Section 80C up to a maximum of
Rs 1 lakh.
To clarify, the deductions in certain areas like
interest payment towards home loans, contribution
towards medical insurance premium, interest on loan
taken for higher education, and so on, have been left
unchanged. Investors are free to claim benefits from
the same over and above the stipulated Rs 1 lakh
investment.
Same as before, subject to limitations as per Section
80CCC
80CCE.
Same as before, subject to limitations as per Section
80CCD
80CCE.
As per Section 80CCE, the aggregate amount of
80CCE
deduction.
Deduction will only be available on the interest
80E portion and not on the repayment of the principal
amount.
Omitted (The interest income from bank and on
securities as specified in Section 80L will now be
80L
taxable and no deduction will be available in this
regard.)
88 No deductions available.
Omitted (However, no tax on income up to Rs 1.5 lakh
88B
for senior citizens.)
Omitted (However, no tax on income up to Rs 1.25
88C
lakh for women assessees below 65 years.)
Omitted (No relevance as no tax on income up to Rs 1
88D
lakh.)

CORPORATE TAX
The tax levied on the taxable income of a company is called “corporate tax” (also named “super tax”).
The income tax liability of a shareholder does not reduce on account of the company having paid a
tax on its own income. Of course, a company may deduct tax at source from the dividend payments
and deposit the same with the authorities on behalf of its shareholders. This payment is adjusted
against tax liability of the shareholders. Corporate tax is levied at a flat rate but may be subject to a
number of rebates, exemptions, and so on. Inter-corporate dividends are distinguished from the other
corporate profits, and companies are also classified on the basis of size, ownership (widely or
closely held), and nationality (Indian and foreign). The taxability of a company’s income depends on
its domicile:
Indian companies are taxable in India on their worldwide income.
Foreign companies are taxable on income that arises out of their Indian operations, or, in certain cases, income that is deemed to
arise in India. Royalty, interest, gains from the sale of capital assets that are located in India (including gains from sale of shares
in an Indian company), dividends from Indian companies, and fees for techincal services are all treated as income arising in India.
For companies, income is taxed at a flat rate of 30 per cent for Indian companies, with a 10 per cent
surcharge applied on the tax paid by companies with a gross turnover over Rs 1 crore (10 mn).
Foreign companies pay 40 per cent. An education cess of 3 per cent (on both the tax and the
surcharge) is payable, yielding effective tax rates of 33.99 per cent for domestic companies (refer to
Table 17.4) and 41.2 per cent for foreign companies (refer to Table 17.5).
Taxable Income
The main source of income of a company is generally from “business”. A company would also earn
income from under the following heads:
income from house property
income from capital gains
income from other sources

Table 17.4 Domestic Corporate Income Tax Rates
Status Tax Rate (%) Effective Tax Rate with Surcharg e (%)
Domestic corporations 30 33 1
Notes:
1 A surcharge of 10% of the income tax is levied, if the taxable income exceeds Rs 1 mn.
2 All companies incorporated in India are deemed as domestic Indian companies for tax purposes, even if owned by foreign companies.

Table 17.5 Foreign Companies Tax Rates
Withholding Tax Rate for Non-treaty Withholding Tax Rate for the US Companies Doing
Status
Foreig n Companies (%) Business in India Under the India–US Tax Treaty (%)
Dividends 20 15 1
Interest income 20 15 2
Royalties 30 20 2
Technical services 30 20 2
Other income 55 55
Notes:
1 Inter-corporate rates where there is a minimum holding. These tax rates are applicable under the India–US Tax Treaty. For other
countries, the tax rates are different under the tax treaties between India and other countries.
2 10% or 15% in some cases.
3 Withholding tax is charged on the estimated income, as approved by the tax authorities.
4 There are other favourable tax rates under various tax treaties between India and other countries.

Taxable income is calculated according to the rules for each class of income and then aggregated to
determine the total taxable income.
Deductibility of Expenses
While calculating income from a business or a profession, the expenses incurred wholly and
exclusively for business purposes are generally deductible. These include depreciation on fixed
assets, interest paid on borrowings in the financial year, and so on. Certain expenses are specifically
disallowed or the amount of deduction is restricted. These expenses include
Entertainment expenses
Interest or other amounts paid to a non-resident without deducting tax
Corporate taxes paid
Indirect general and administrative costs of a foreign head office
Set-off and Carry-forward of Losses
Business losses incurred in a tax year can be set off against any other income earned during that year,
except the capital gains. Unabsorbed business losses can be carried forward and set off against the
business profits of subsequent years for a period of eight years; the unabsorbed depreciation element
in the loss can, however, be carried forward indefinitely. However, this carryforward benefit is not
available to closely held (private) companies in which there has been no continuity of business or
shareholding pattern. Also, any change in the beneficial interest in the shares of the company that is
exceeding 51 per cent disqualifies the private company from the carry-forward benefit. Box 17.2
gives a list of IT-enabled products of services that are exempted from income tax when exported.

Box 17.2 List of IT-enabled Products
The Government of India (Central Board of Direct Taxes—CBDT) allowed total income tax
exemption on the export of information technology (IT)-enabled outsourcing services under
Section 10A/10B of the Income Tax Act, 1961. The IT-enabled products of services are as follows:
1. Back office operations
2. Call centres
3. Content development of animation
4. Data processing
5. Engineering and design services
6. Geographic information system services
7. Human resource services
Highlights of the Union Budget 2008–09 on Corporate Tax

Rs 5,000-crore fund for enhancing re-finance operations
No change in corporate tax
Excise duty on Pharma products down to 8 per cent from last year’s 16 per cent
Excise duty on two and three wheelers down to 12 per cent
Excise duty on hybrid cars reduced to 14 per cent from 24 per cent
Excise duty on buses and their chassis reduced to 12 per cent
Special exemptions and reductions for paper, fertilizers, and auto industries
Four new services (asset management service provided under ULIP, services provided by stock/commodity exchanges and
clearing houses, right to use goods in the cases where VAT is not payable, and customised software) brought under tax net
Custom duty on project import have been reduced from 7.5 per cent to 5 per cent
Public Sector Units (PSUs)to get Rs 16,436 crore in 2008–09
Export taxes on the key raw materials of steel to be increased
Bulk cement to attract excise duty of Rs 400 per metric tonne
Excise duty on packaged software increased from 8 per cent to 12 per cent
Change in Security Transaction Tax (STT)
Short-term capital gains to increase to 15 per cent
Banking Transaction Tax (BTT) withdrawn
Commodity Transaction Tax (CTT) introduced
No double deduction of Dividend Distribution Tax (DDT)

Section Consequential Effect
In case a company that is engaged in the
business of manufacture or production of any
drugs, pharmaceuticals, electronic equipment,
computers, telecom, and chemicals incurs an
35(2AB) Clause expenditure on scientific research (not being
(5) experienced in nature of cost of land or
building) before April 1, then deduction will be
allowed under Section 35 (previosuly, no
deduction was available for expenditure after
March 31, 2005).
Where a deduction is claimed under this Section
in respect of specified securities, then no
54 EC
deduction in respect of such securities will be
allowed under Section 80 C.
Where a deduction is claimed under this Section
in respect of specified securities, then no
54 ED
deduction in respect of such securities will be
allowed under Section 80 C.
Losses from speculation business can only be
carried forward for four assessment years
73 (previously eight years) immediately
succeeding the assessment year for which the
loss was first computed.
In case where the total income of a foreign
company includes an income by way of royalty
or fees for technical services received from the
government or an Indian concern in pursuance
of an agreement made by the foreign company,
115 A
the tax rate will be 30 per cent for an agreement
made on or before March 31, 1997, and 20 per
cent for an agreement made after March 31,
1997, but before June 01, 2005, and 10 per cent
for an agreement on or after June 01, 2005.
Where an amount is paid by an assessee under
115 JB(1), being a company for the financial
year commencing April 1, 2005 and subsequent
years, then the credit in respect of tax so paid
shall be allowed to him in accordance with
provision for this Section. The method of
115 JAA calculation is given in Section 115 JAA(2)
where the words 115 JA(1) will be substituted by
115 JB(1), that is, the difference between the tax
paid as per 115 JB(1) and tax computed in
accordance with the other provision of this Act.
The other Clauses of Section 115 JAA will
remain as it is.
Fringe Benefit Tax—It is a Commonwealth tax
that is levied on a non-salary type benefit that is
provided by the employer to employees as a
collective benefit. The tax rate would be 30 per
115 WA
cent on the benefit calculated on the basis of a
criterion mentioned as follows and would be
levied on the employer. It is essentially a tax
paid on non-cash remuneration that is provided
to employees or associates. This tax is based on
a self-assessment system (described in detail
below).

There are various sources of income of any company- house property, capital gains or other sources, but the chief source of
income is generally ‘business’.
Fringe Benefit Tax (FBT)
It is a tax payable by companies against benefits that are seen by employees but cannot be attributed to
them individually. This tax is paid as 33.99 per cent of the benefit, which is only a percentage of the
actual amount paid. Some fringe benefits and their taxable rates are mentioned as follows:

Fring e Benefits Taxable (%) Effective Tax Rate (%)

Medical reimbursements 20 6.8
Telephone bills 20 6.8
Employee stock options (difference between
100 33.99
market value and purchase price on vesting date)

From April 1, 2007, Employees Stock Option Plan (ESOP) or Sweat Equity has also been brought
within the ambit of FBT. Section 115WB(1)(d) specifies that any ESOP will attract FBT, and the
benefit is equal to the difference between the price paid and the fair market value of the share, as
determined by the Board. The tax is levied on the date of vesting of such options. “Fair Market Value”
is not yet defined by the Income Tax Department.
Criterion for Calculation of FBT

1. The FBT will be payable by an employer even if no tax is payable by the employer on his income.
2. “Fringe Benefit” means
a. Any privilege, service, facility of amenity, directly or indirectly provided by an employer to his employees (including
former employees) by reason of their employment; or
b. Any reimbursement directly or indirectly made by the employer to his employees for any purpose;
c. Any free or concessional ticket provided by the employer for a private journey of the employees and their family
members; and
d. Any contribution by the employer to an approved superannuation fund.
In the case of expenditure incurred by an employer under (c) above, the amount on which the tax will
be charged will be reduced by the amount, if any provided by an employee and in the case of
expenditure incurred by an employer under (d) above, the tax will be charged on an amount actually
contributed to the fund.
Section 115WC: The fringe benefit shall be deemed to have been provided if an employer in the
course of his business or profession (whether for profit or not) incurred any expense on or made any
payment for the following purposes:

Nature of Faculty Amount on Which Tax will be Paid
Entertainment 50% of the amount.
Festival celebrations 50% of the amount.
Gifts 50% of the amount.
Use of club facilities 50% of the amount.
Provision of hospitability of every kind of
50% of the amount except in the case of an
employer (including food or beverages, except
employer engaged in a business of hotel where the
food and beverages provided by an employer in
tax will be charged on 50% of the amount.
an office or factory)
Maintenance of accommodation by nature of a
50% of the amount.
guest house
Conference 50% of the amount.
Employee welfare 50% of the amount.
Use of health, clubs, sports, and similar facilities 50% of the amount.
Sales promotion including publicity 50% of the amount.
Conveyance, tour, and travel, including foreign
20% of the amount.
travel
Hotel, boarding, and lodging 20% of the amount.
employer engaged in a business of carriage of
passengers or goods, either by motorcar or
aircraft where the tax will be charged on 5% of the
Repair, running, and maintenance of motorcars
amount. Also, for calculating the amount of
expenditure on the fringe benefits, the
depreciation on motorcar or aircraft will also be
included.
employer engaged in a business of carriage of
Repair, running, and maintenance of aircrafts passengers or goods, either by motorcar or
aircraft where the tax will be charged on 5% of the
amount.
Use of telephone 10% of the amount.
Scholarship of children of employee Actual amount incurred.

However, no tax will be payable by the employer in case of facilities which has been taxed as
perquisites in the hands of the employees.
Filing of Return for Fringe Benefit

a. In case of a company, October 30 of assessment year
b. In case of a person (other than company) whose October 30 of assessment year accounts are required to be audited
c. In case of any other employer other than (a) and (b), July 31 of the assessment year
A revised return can be filed at any time before the expiry of one year from the end of relevant
assessment year or before the completion of assessment, whichever is earlier.
Payment of Advance Tax in Respect of Fringe Benefit
An employer is liable to deposit an advance tax that is equal to 30 per cent of the value of fringe
benefits (as per Section 115WC) given in each quarter tax by the 15th of the end of the quarter.
However, for the quarter ending March 31, the tax will be deposited on or before March 15 of that
financial year. And at that can be interpreted from the wordings of the Section, that the advance tax is
30 per cent of the value of fringe benefits and not the 30 per cent of the tax due on fringe benefits. If
the employer fails to deposit the above-said amount, then a simple interest rate at the rate of 1 per cent
on the amount, which falls short on the said 30 per cent for every month or part thereof for which the
shortfall continues.
Where employer makes default in the filing of return, then the interest at the rate of 1 per cent will be charged for every month
or part thereof for which the default continues or completion of assessment, whichever is earlier.
Highlights of the Union Budget 2008–09 on Service Tax
There is no change in the service tax rate. It remains at 12 per cent. However, certain services have
been brought in the service tax coverage. Also, the scope of levy of service tax has also been
specified and expanded for certain services. Accordingly, the service tax will now be leviable for the
following services:
Banking and other financial services [Section 65(12)], so as to levy a service tax on the purchase or sale of foreign currency,
including money changing by an authorised dealer and authorised money changer;
Foreign exchange broker services provided by an individual [Section 65(105)(zzk)], so as to levy a service tax on the purchase
or sale of foreign currency, including money changing by an authorised dealer and authorised money changer; and
Cargo-handling services [Section 65(23)], so as to include specifically the services of packing, together with a transportation of
cargo or goods, with or without one or more other services like loading, unloading, and unpacking;
Service Tax Exemption for Small-service Providers

The annual threshold limit of service tax exemption for small-service providers has been increased
from the present level of Rs 8 lakh to Rs 10 lakh, with effect from April 1, 2008, provided that the
aggregate value of taxable services rendered by such provider of taxable service from one or more
premises, does not exceed Rs 10 lakh in the preceding financial year. The Department of Revenue,
Ministry of Finance has issued Notification No. 8/2008-Service Tax, dated March 1, 2008 in this
regard.
Consequent upon an increase in the threshold limit of exemption from Rs 8 lakh to Rs 10 lakh,
Notification No.26/2005-Service Tax, dated June 7, 2005, and Notification No.27/2005-Service Tax,
dated June 7, 2005, have been amended to raise the limit for obtaining a service tax registration from
Rs 7 lakh to Rs 9 lakh. The Department of Revenue, Ministry of Finance has issued the following
Notifications: No. 9/2008-Service Tax, No. 10/2008-Service Tax, and No.11/2008-Service Tax—all
dated March 1, 2008 in this regard. These changes will come into effect from April 1, 2008.
Service Tax Exemption for Goods Transport Agency (GTA)

An exemption from service tax is being provided to the extent of 75 per cent of the gross amount that
is charged as freight for services, provided by a goods transport agency (GTA) in relation to
transport of goods by road in a goods carriage, unconditionally. The Department of Revenue,
Ministry of Finance has issued the following Notifications: No. 13/2008- Service Tax, No. 10/2008-
Central Excise (NT), and No. 12/2008-Service Tax—all dated March 1, 2008 in this regard. This
exemption will come into effect from March 1, 2008.
WEALTH TAX
Wealth tax is levied on non-productive assets whose value exceeds Rs 1.5 mn. Productive assets like
shares, debentures, bank deposits, and investments in mutual funds are exempt from wealth tax.
However, the government levies wealth tax on non-productive assets like residential houses,
jewellery, bullion, motor cars, aircrafts, urban land, and so on. Foreign nationals are exempt from
wealth tax on non-Indian assets. Net wealth up to Rs 1.5 mn is exempt from wealth tax and any amount
in excess of this is taxed at a flat rate of 1 per cent. In arriving at the net taxable wealth, any debt
incurred in acquiring specified assets is deductible.

Wealth Tax
Net Taxable Wealth Tax Rate (%)
Over Not Over
0 Rs 1,500,000 0
Rs 1,500,000 above 1
Wealth tax is levied on non-productive assets whose value exceeds Rs 1.5 mn. Productive assets like shares, debentures, bank deposits,
and investments in mutual funds are exempt from wealth tax. The non-productive assets include residential houses, jewellery, bullion,
motor cars, aircraft, urban land, and so on. Foreign nationals are exempt from wealth tax on non-Indian assets. In arriving at the net
taxable wealth, any debt incurred in acquiring specified assets is deductible.

The wealth tax is an annual levy by the Central government on the net value of a non-agricultural
property of an assessee. The taxable wealth is estimated as the initial wealth plus appreciation and net
addition to it during the year under consideration. The factor of inflationary price appreciation makes
this tax highly irrational and unjustified. It is nothing short of expropriation. Although it may be
possible to identify some arguments in its favour, it is a very bad tax from the viewpoint of capital
formation. By itself, it amounts to taxing the savings of the assessee. Rising prices do no increase real
wealth of the tax-payer, but his tax liability goes up all the same. This tax becomes still more
burdensome when the taxed assets do not yield any income. It, therefore, encourages current
consumption at the cost of saving and capital formation.

Wealth Tax refers to the annual levy by the Central government on the net value of non-agricultural properties of an
assessee.
There is also an incentive to convert savings into those assets which are not taxed, or the ownership
of which can be concealed. This tendency distorts the resource use of the economy in favour of low-
priority uses and generates unaccounted transactions and black money. Quite often, wealth tax is
defended on grounds of checking evasion of income tax and reducing economic inequalities.
Experience tells us that in India both these objectives have been frustrated. Ideally, there should be no
wealth tax at all.
EXCISE DUTIES
Excise duty is a tax on the manufacture of goods within the country. Excise duties are levied under the
Central Excise and Salt Act, 1944, the Excise Tariff Act, 1985, and the Modified Value Added Tax
(MODVAT) scheme. The rates of excise duty leviable vary depending inter alia on the nature of the
item manufactured, the nature of the manufacturing concern, and the place of ultimate sale.
Central excise revenue is the biggest single source of revenue for the Government of India. The
Union government tries to achieve different socio-economic objectives by making suitable
adjustments in the scope and quantum of levy of central excise duty. The scheme of Central Excise
Levy is suitably adapted and modified to serve different purposes of price control, sufficient supply
of essential commodities, industrial growth, and promotion of small-scale industries (SSIs); and it is
like an authority for collecting the “central excise duty”.
Article 265 of the Constitution of India has laid down that both levy and collection of taxes shall be
under the authority of law. The excise duty is levied in pursuance of Entry 45 of the Central List in the
Government of India Act, 1935 as adopted by the Entry 84 of List I of the Seventh Schedule of the
Constitution of India. The charging Section is Section 3 of the Central Excise and Salt Act, 1944. The
duty rates are either ad valorem (i.e., a fixed percentage of the cost of production), specified (a fixed
rate depending on the nature of the manufactured item), or a combination of both. In the Finance Act,
1994, there has been a shift in the basis of taxation from specific to ad valorem rates, with a reduction
in excise duty proposed on a large number of items.
The MODVAT scheme, introduced in 1986, applies to certain specific items. The objective of this
scheme is to limit the cascading effect of duty incidence on a number of goods, subject to excise,
which are further used as inputs for other excisable goods. The Finance Act, 1994 had extended the
MODVAT scheme to capital goods and petroleum products. The Finance Bill of 1995 has further
extended the MODVAT scheme to cover woollen fabrics and industrial fabrics. Under the scheme,
MODVAT credit can be claimed on the purchase of raw materials on which the excise has been paid.
This MODVAT credit can be used to set off excise duty payable on subsequent manufacture of goods.
In addition, countervaling duty (CVD) paid on imports can be used to claim a MODVAT credit. All the
manufacturers of excisable goods are required to register under the Central Excise Rules, 1944. The
registration is valid as long as the production activity continues and no renewals are necessary.
Liability to Pay Central Excise Duty

Section 3 of the Central Excise and Salt Act, 1944 provides that there shall be levied and collected in
such manner, as may be prescribed, duties of excise on all excisable goods other than salt, which are
produced or manufactured in India at the rates set forth in the Schedule to the Central Excise Tariff
Act, 1985. It is, therefore, clear that as soon as the goods in question are produced or manufactured,
they will be liable to payment of Excise Duty. However, for convenience, duty is collected at the time
of removal of the goods. While Section 3 of the Central Excise and Salt Act, 1944 lays down the
taxable event, Rules 9 and 49 of the Central Excise Rules, 1944 provides for the collection of duty.
Highlights of the Union Budget 2008–09 on Central Excise

Step down of excise on paper and its products
Reduction of excise duties on buses and their chassis
Excise on small cars stepped to 14 per cent
Reduction of excise duties on anti-AIDS drugs
Excise duty reduced to 8 per cent on water purification items
Excise duty of Rs 1.35/litre applied on unbranded petrol
Excise duty of Rs 4.6/litre applicable on unbranded diesel
Excise duty may not change: 16 per cent
Excise duty reduced to 8 per cent on water purification items
Excise on pharma goods reduced to 14 per cent
CUSTOMS TARIFF
The Customs Act was formulated in 1962 to prevent illegal imports and exports of goods. Besides, all
imports are sought to be subject to a duty with a view to affording protection to indigenous industries
as well as to keep the imports to the minimum in the interests of securing the exchange rate of Indian
currency.
The duties of customs are levied on goods that are imported or exported from India, at the rate
specified under the Customs Tariff Act, 1975, as amended from time to time, or by any other law for
the time being in force. For the purpose of exercising proper surveillance over imports and exports,
the Central government has the power to notify the ports and airports for the unloading of the
imported goods and loading of the exported goods, the places for clearance of goods imported or to
be exported, the routes by which the above goods may pass by land or inland water into or out of
India, and the ports which alone shall be coastal ports.
In order to give a broad guide as to classification of goods for the purpose of duty liability, the
Central Board of Excise Customs (CBEC) brings out periodically a book called the “Indian Customs
Tariff Guide” which contains various tariff rulings issued by the CBEC. The Act also contains
detailed provisions for warehousing of the imported goods, and manufacture of goods is also
possible in the warehouses.
The customs duties are levied on imports at rates specified in the Annual Budget. The maximum
rate of customs duty for 1994–95 is 65 per cent, except on baggage. The Finance Act, 1994 has
witnessed a general reduction in the duty on capital goods, steel, chemicals, drugs, pesticides, and
project imports. For a person who does not actually import or export goods, customs has relevance
in so far as they bring any baggage from abroad.
Types of Duties
Export duties are levied occasionally to mop up the excess profitability in the international prices of
goods in respect of which domestic prices may be low at the given time. But the sweep of import
duties is quite wide. Import duties are generally of the following types :
Basic Duty: It may be at the standard rate or, in the case of import from some other countries, at the
preferential rate:
Additional Customs Duty: It is equal to central excise duty that is leviable on like goods that are
produced or manufactured in India. The additional duty is commonly referred to as the countervailing
duty or CVD. It is payable only if the imported article is such as, if produced in India, that its process
of production would amount to “manufacture” as per the definition in the Central Excise Act, 1944.
Exemption from excise duty has the effect of exempting an additional duty of customs.
Additional duty is calculated on a value based on the aggregate value of the goods, including
landing charges and basic customs duty. Other duties like anti-dumping duty, safeguard duty, and so
on, are not taken into account. In case of goods, covered by provisions of the Standards of Weights
and Measures Act, 1976, the value base would be the retail sale price declared on the package of
goods less the rebate as notified under the Central Excise Act, 1944 for such goods.
True Countervailing Duty or Additional Duty of Customs: It is levied to off set the disadvantage
to like Indian goods due to high excise duty on their inputs. It is levied to provide a level-playing field
to indigenous goods that have to bear various internal taxes. Value base for this additional duty would
be as in the case of CVD, under Customs Tariff Act, 1975 minus the retail sales price provision. This
additional duty will not be included in the assessable value for levy of education cess on imported
goods. Manufacturers will be able to take credit of this additional duty for payment of excise duty on
their finished products.
Anti-dumping Duty/ Safeguard Duty: It is levied for import of specified goods with a view to
protecting the domestic industry from an unfair injury. It would not apply to goods that are imported
by a 100 per cent EOU (Export Oriented Units) and units in FTZ (Free Trade Zones) and SEZ (Special
Economic Zones). On the export of goods, anti-dumping duty is rebatable only by way of a special
brand rate of drawback. Safeguard duties do not require the finding of an unfair trade practice such as
dumping or subsidy on the part of exporting countries but they must not discriminate between imports
from different countries. Safeguard action is resorted to only if it has been established that a sudden
increase in the imports has caused or threatens to cause a serious injury to the domestic industry.
Education cess: It is levied at the prescribed rate as a percentage of aggregate duties of customs. If
goods are fully exempted from duty or are chargeable to nill duty or are cleared without any payment
of duty under a prescribed procedure, such as clearance under bond, no cess would be levied.
(Refer to http://business.gov.in/taxation/types_customsduties.php).
Highlights of the Union Budget 2008–09 on Custom Tariff

Export taxes on the key raw materials of steel to be increased
Export duty on Iron ore decreased by 15 per cent at Rs 300 per tonne
Exercise duty on the finished steel products reduced to 8 per cent
Customs duty on the imports of scrap metal to be scrapped
Customs duty on natural rubber and basic raw materials to be reduced
Customs duty on some bulk drugs out by 5 per cent
Customs duty being reduced on specified machinery from 7.5 per cent to 5 per cent, to provide fillip to the manufacture of sports
goods; duty also being exempted on the specified raw materials for sports goods
Customs duty to be exempted on rough cubic zirconia and to be reduced on polished cubic zirconia from 10 per cent to 5 per
cent, in order to encourage value addition and exports by gem and jewellery industry
Customs duty on rough coral being reduced from 10 per cent to 5 per cent.
About 10 salient points of Kelkar Committee Recommendations are given in Box 17.3.

Box 17.3 Kelkar Committee Recommendations
Kelkar Committee (2002) recommended some of the future changes foreseen in the tax
environment (Indirect Tax) in the country, as follows:
1. Shift to a two-slab custom duty structure at the rate of 20 per cent on finished goods and 10 per cent on raw materials by
2004–05.
2. Application of CENVAT at the rate of 16 per cent for all non-food and 8 per cent on all food products.
3. Implementation of VAT.
4. Extension of public utilities from service tax.
5. Tax relief of export-oriented units (EOUs) and units in the Special Economic Zones (SEZs) for all products.
6. Drastic reduction in the multiplicity of tax rate structures.
7. Custom tariff rate of 150 per cent on selected form of products and demerit goods.
8. Phased withdrawal of special addition duty (SAD) of 8 per cent and 16 per cent, over and above the 16 per cent CENVAT.
9. Avoiding an increase in the import tariff—may be imposed only up to 5 per cent.
10. Simplification of tax procedure to promote tax coverage and improve tax compliance.
CENTRAL SALES TAX (CST)
“Sales tax” is a tax, levied on the sale or purchase of goods. There are two kinds of sales tax, that is,
central sales tax (CST), imposed by the Centre, and sales tax, imposed by each State. Sales tax is
levied on the sale of a commodity which is produced or imported and sold for the first time. If the
product is sold subsequently without being processed further, it is exempt from sales tax.

Central Sales Tax, levied by either Central or the State government, is a tax levied on the sale of a commodity which is
produced or imported and sold for the first time.
While sales tax is levied by either the Central or the State government, Central sales tax or 4 per
cent is generally levied on all inter-state sales. The State sales taxes, which apply on sales made within
a state, have rates that range from 4 per cent to 15 per cent. The sales tax is also charged on work
contracts in most states, and the value of contracts is subject to tax and the tax rate varies from state to
state. However, exports and services are exempt from sales tax.
When is Sales Tax Payable

Central sales tax is generally payable on the sale of all goods by a dealer in the course of inter-state
trade or commerce or, outside a state or, in the course of import into or, export from India.
Inter-state Trade or Commerce
According to Section 3, a sale or purchase shall be deemed to take place in the course of inter-state
trade or commerce in the following cases:
when the sale or purchase occasions the movement of goods from one state to another, and
when the sale is effected by a transfer of documents of title to the goods during their movement from one state to another.
Where the goods are delivered to a carrier or other bailee for transmission, the movement of the
goods for the purpose of Clause (b) above, is deemed to start at the time of such delivery and
terminate at the time when the delivery is taken from such carrier or bailee. Also, when the movement
of goods starts and terminates in the same state, it shall not be deemed to be a movement of goods
from one state to another. A sale or purchase of goods is said to take place outside a state under the
following conditions:
1. Subject to the provisions contained in Section 3, when a sale or purchase of goods is determined in accordance with sub-section
(2) to take place inside a state, such sale or purchase shall be deemed to have taken place outside all other states.
2. A sale or purchase of goods shall be deemed to take place inside a state, if the goods are within the state—
a. in the case of specific or ascertained goods, at the time the contract of sale is made, and
b. in the case of unascertained or future goods, at the time of their appropriation to the contract of sale by the seller or by
the buyer, whether assent of the other party is prior or subsequent to such appropriation.
Where there is a single contract of sale or purchase of goods situated at more places than one, the
provisions of this sub-section shall apply as if there were separate contracts in respect of the goods at
each of such places. A sale or purchase of goods is said to take place in the course of import or
export under the following conditions:
A sale or purchase of goods shall be deemed to take place in the course of the export of goods out of the territory of India,
only if the sale or purchase either occasions such export or is effected by a transfer of documents of title to the goods after the
goods have crossed the customs frontiers of India.
A sale or purchase of goods shall be deemed to take place in the course of the import of the goods into the territory of India
only if the sale or purchase either occasions such import, or is effected by a transfer of documents of title to the goods before
the goods have crossed the customs frontiers of India.
Notwithstanding anything contained in sub-section (1), the last sale or purchase of any goods preceding the sale or purchase
occasioning the export of those goods out of the territory of India, shall also be deemed to be in the course of such export, if
such last sale or purchase took place after, and was for the purpose of complying with the agreement or order for or in relation
to such export.To make a sale as one in the course of inter-state trade, there must be an obligation to transport the goods outside
the state. The obligation may be of the seller or the buyer. It may arise by a reason of statute or contract between the parties or
from mutual understanding or agreement between them or, even from the nature of the transaction, which linked the sale to such
transaction. There must be a contract between the seller and the buyer. According to the terms of the contract, the goods must be
moved from one state to another. If there is no contract, then there is no inter-state sale. There can be an inter-state sale even if
the buyer and the seller belong to the same state; even if the goods move from one state to another as a result of a contract of
sale; or, the goods are sold while they are in transit by transfer of documents.
To Whom is Sales Tax Payable and by Whom

Sales tax is payable to the sales tax authority in the State from which the movement of goods
commences. It is to be paid by every dealer on the sale of any goods affected by him in the course of
inter-state trade or commerce, notwithstanding that no liability to tax on the sale of goods arises
under the tax laws of the appropriate State.
Central Sales Tax Act, 1956
Central Sales Tax Act is an Act to formulate principles for determining when a sale or purchase of
goods takes place in the course of inter-state trade or commerce or outside a State or in the course of
import into or export from India, to provide for the levy, collection, and distribution of taxes on sales
of goods in the course of inter-State trade or commerce, and to declare certain goods to be of special
importance of inter-State trade or commerce, and specify the restrictions and conditions to which
State laws imposing taxes on the sale or purchase of such goods of special importance (GSI) shall be
subject.
Central Sales Tax (CST) Reduced

On the basis of the discussions between the Empowered Committee (EC) of State Finance Ministers
and the Union Finance Minister regarding the compensation package, the Department of Revenue, of
the Ministry of Finance, of the Givernment of India, has issued a Notification on May 30, 2008 to
bring into effect from June 1, 2008 the newly reduced rate of Central Sales Tax (CST) of 2 per cent
on inter-State sales of goods. The notification of new CST rate of 2 per cent in the place of earlier 3
per cent is in accordance with the announcement made by the Union Finance Minister in his Budget
speech in the Parliament in February 2008 that the rate of CST would be reduced.
The rate of CST on the inter-State sale of goods to registered dealers (against Form-C) shall now
be the lowest of about 2 per cent, and the rate of VAT or State Sales Tax is applicable. This reduction
forms a part of the roadmap for phasing out CST completely by March 31, 2010 in the preparation of
introducing Goods & Services Tax (GST), the roadmap for which is being worked out by the EC of
State Finance Ministers together with the Union Finance Ministry. The Central government and the EC
of State Finance Ministers have further agreed that the compensation for revenue loss to the states in
any year arising from the lowering of CST will be limited to the proportionate loss, based on the
actual collection of CST in the relevant year.
MODIFIED VALUE ADDED TAX (MODVAT)
MODVAT is the abbreviated form of “Modified Value Added Tax”. The MODVAT scheme was
introduced with effect from April 1, 1986, as an improvement over the Proforma Credit Scheme,
which was in operation prior to that date. The scheme primarily aims at avoiding the “cascading
effect” of duty-on-duty, and at ensuring that duty is paid only on the “value added” at each stage of
production, instead of on the gross value including the duty paid in the earlier stages. This is achieved
by allowing the manufacturer to avail credit on the duty paid in the earlier stages and to utilise the
credit towards the payment of duty on the goods cleared by him, provided the conditions and
requirements laid down in the scheme are satisfied. To start with, the scheme applied only to inputs,
but later, with effect from March 1, 1994, the scheme was extended to capital goods also.

MODVAT scheme ensures that duty is paid only on the value added at each stage of production, thereby avoiding the
“cascading effect” of duty-on-duty, by allowing the manufacturer to avail credit on the duty paid in earlier stages and
utilise the credit towards payment of duty on the goods cleared by him.
Background of MODVAT
Prior to the introduction of MODVAT, the Proforma Credit Scheme as specified under Rule 56A of
the Central Excise Act, 1944 was in operation. The scheme was narrow in scope and could be applied
to some specific situations only.
Introduction
In the Union Budget of 1986 was introduced the new system of MODVAT. It is a tax on the “Value
Addition”. Value Addition means the value of the output as reduced by the total cost of bought-out
inputs. The MODVAT scheme at present allows a set-off of the excise duties and additional duties of
custom on inputs against the duty liability on final products and capital goods.
Purpose
It was introduced in order to avoid a double taxation on the inputs as well as the finished goods.
MODVAT Credit [Rule 57A]
On Inputs
It is governed in terms of Rules 57A–57J of Central Excise Rules. The manufacturer of the final
products shall be allowed to take the credit of the specified duty paid on the goods, used in or in
relation to the manufacture of the final products, whether directly or indirectly and whether contained
in the product or not. Therefore, the inputs should be such that they participate in the process of
manufacture without which the end-product cannot be manufactured. Also, it covers not only the
goods which are used in the manufacture but which are also used in the stages once removed from the
process.
MODVAT Credit on Consumable Stores

In general, it is to be noted that which ever items are in the nature of consumables are eligible for
MODVAT credits as their usage would qualify them as inputs, as per the broad definition of Rule 57A
of the Central Excise Rules.
MODVAT Credit on Packing Materials

MODVAT credit is available on packing materials that are used to pack finished products, which are
chargeable to specific rates of duty.
MODVAT Credit on Inputs

It is used as fuels.
MODVAT Credit on Accessories
It is applicable if the cost of accessories is included in the assessable value.
MODVAT Credit on Capital Goods

New set of Rules 57Q–57U have been inserted in Chapter V of the Central Excise Rules for granting
MODVAT credit on capital goods. These provisions were inserted with effect from March 1, 1994.
Pre-conditions to Be Fulfilled
1. Final Product must be dutiable.
2. Both final product and capital goods must be specified for eligibility under the Table of Rule 57Q.
3. Capital goods should be duty paid with an evidence of payment.
Salient Features of MODVAT

No prior permission is required, but a 57G declaration is a must
No need of filing Form D-3 for an intimation of receipt of input
It is available for both basic excise duty and special excise duty
Removal of inputs for home consumption or export under Rule 57F(3)
Also, the adjustment of credit is allowed; that is, for obtaining a refund on credit if goods get exported and the credit could not
be adjusted in the domestic sale
Manufacturer availing the MODVAT facility should maintain the following registers apart from filing the return:
a. RG-23A Part I to show input received/used/lying as stock
b. G-23A Part II to show details of credit availed/utilised/balance
From MODVAT to CENVAT
After MODVAT now its time for CENVAT (Central Value Added Taxes) introduced in this year ’s
Budget which is similar to the industrialised nations who have implemented VAT (Value Added Tax).
This marks a fundamental change in the government’s revenue collections policy as 86 per cent of the
excise collections during 2000–01 would be under the new levy, and since a single rate is introduced
this year the changes that take place in the rate of duties would be eliminated. CENVAT covers
practically all the items in the Central Excise Tariff, though a few items like automobiles, pan masala,
aerated water, tobacco products, cosmetics, tyres, and air-conditioners have been placed under the
special excise duty regime, totalling to only 14 per cent of the estimated excise collection during the
year, and would be under the special excise duty which has been spread over three slabs of 8 per cent,
16 per cent, and 24 per cent. Only 1 per cent of the total collections of ad valorem excise duty would
be from the 8 per cent slab of additional customs duty. About 9 per cent would come from the 16 per
cent slab while 4 per cent would be from the 24 per cent levy. Further, this would also eliminate the
classification disputes totally.
Inspite of the above, the opinion of most of the industries and the middle-class people is not very
positive towards this single rate of duty as they will have to now pay more for quite a few items like
culinary products, toiletries, ice-cream, squashes, cosmetics, perfumes, talcum powders, jams, and
confectionery for which the rate of duty has been raised from 8 per cent to 16 per cent, which is quite
a lot. Moreover, the new slab will have a cascading effect on the overall prices. The industry had
hoped that the Budget would lower the excise duties, thereby enabling the companies to tread the
growth path and improve the market penetration, especially in the rural areas. In fact it would increase
the inflation level.
Another step is towards procedural simplification, which is supposed to benefit the industry in a
big way as maintenance of statutory records has been done away with. The revenue department would
rely on the account that is maintained by the assessee. Random checks would be done to check any
evasion it persists while a detailed examination on a regular basis would be discontinued. A move is
made towards a regime of transaction cost where documents produced by the assessee would be
accepted.
Although the above is supposed to be a procedural simplification, now the revenue department,
instead of relying only on the excise statutory records, can check any records they wish to and,
therefore, the onus is now more on the assessee on how to maintain the records and how perfect and
careful he needs to be.
The amendment of Section 4 of the Central Excise relating to valuation is made. Instead of the
assessment based on the normal price, a transaction value assessment would be made. This means that
there is a total new change in the valuation norms. The transaction value would now include the
amount charged for servicing, financing, warranty, commission, and advertising. The changes are in
line with customs valuation rules, which are in line with GATT norms. In simplified terms, the new
valuation norms for goods attracting ad volrem duty would mean that the cost of servicing, providing
warranty, or extending credit to the buyer would be included in the cost of the items for the purpose
of imposing excise duty. As of now, manufacturers pay an excise duty only on the goods and not on
the add-ons. The new norms have also tightened the rules that are governing the transfer of goods to a
related person. Even here, now the onus remains with the assessee to prove that the goods are sold at a
fair market price or there would be a demand of a differential duty by the excise department; and this
would certainly lead to more litigations as in the case of related persons where the definition has been
enlarged with more inclusions like an employee being added to the list of related persons, which
would lead to more interpretations; and more interpretations means more litigations.
About 4 per cent SAD on imports were to be paid by the manufacturers alone in the last year, but
this year it has been introduced even to the importers and dealers, which is a welcome move. The
changes in SAD are set to push up the premiums on advance licence and freely transferable credits in
the duty-free entitlement passbook scheme (DEPB). The introduction of CENVAT almost puts to rest
all the initiatives taken for the introduction of mini-VAT for exporters, under which all State and
Central levies would be reimbursed to them—a sort of expanded-duty drawback scheme. Non-
reimbursed levies such as state sales tax, electricity duty, and the like constitute about 13 per cent of
the cost of export production.
Further, in case of mandatory penalty, it would be reduced to 25 per cent of the duty amount along
with 24 per cent interest if 25 per cent penalty is paid within 30 days of the date of communication of
the order. This is a relief to the assessee in certain cases, while otherwise the time limit to issue a
show-cause notice is increased from six months to one year, which means that now there is a larger
scope for the department to issue show-cause notices. It can thus be concluded that as usual the
changes in the indirect taxes would make some goods more expensive and some hopefully cheaper.
The single slab rate and fortnightly payments of excise duty will reduce the procedural delays but
may not improve the demand.
CENTRAL VALUE ADDED TAX (CENVAT)
Today in India, taxation of inputs, like raw materials, components, and other intermediaries, had a
number of limitations. In a production process, the raw material passes through various process
stages till a final product emerges. Thus, the output of the first manufacturer becomes an input for the
second manufacturer and so on.
For example, when the inputs are used in the manufacture of a product A, the cost of the final
product increases not only on account of the cost of the inputs, but also on account of the duty paid on
such inputs. As the duty on the final product is on an ad valorem basis and the final cost of product A
includes the cost of inputs, inclusive of the duty paid, the duty charged on product A meant doubly
taxing the raw materials. In other words, the tax burden goes on increasing as the raw material and
final product passes from one stage to the other because, each subsequent purchaser has to pay a tax
again and again on an the material which has already suffered tax. This is called “cascading effect” or
“double taxation”. This process very often distorted the production structure and did not allow the
correct assessment of the tax incidence. Therefore, the government tried to remove these defects of
the Central Excise System by progressively relieving inputs from excise and countervailing duties.
An ideal system to realise this objective would have been to adopt Value Added Taxation (VAT).
However, on account of some practical difficulties it was not possible to fully adopt VAT. Hence, the
government evolved a new scheme, MODVAT (Modified Value Added Tax). The MODVAT scheme
which essentially follows VAT scheme of taxation, that is, if a manufacturer A purchases certain
components (raw materials) from another manufacturer B for some use in its product. Then, B would
have paid an excise duty on the components that were manufactured by it and would have recovered
that excise duty in its sales price from A. Now, A has to pay an excise duty on the product
manufactured by it as well as bear the excise duty paid by the supplier of raw material B. Under the
MODVAT scheme, a manufacturer can take credit of excise duty paid on raw materials and
components used by him in his manufacture. It amounts to excise duty only on additions in value by
each manufacturer at each stage. The MODVAT scheme is regulated by Rules 57A–57U of the Central
Excise Rules and the notifications issued there under The Central Excise Rules, 2002, and Section 143
of the Finance Act, 2002. The Modvat scheme ensures the revenue of the same order and, at the same
time, the price of the final product could be lower too. Apart from reducing the costs through
elimination of cascade effect, and bringing in a greater rationalization in tax structure and a certainty
in the amount of tax leviable on the final product, this scheme will help the consumer to understand
precisely, the impact of taxation on the cost of any product and will, therefore, enable the consumer
resistance to unethical attempts on the part of the manufacturers to raise the prices of the final
products, attributing the same to higher taxes.
Subsequently, MODVAT scheme was restructured into CENVAT( Central Value Added Tax) scheme.
A new set of rules 57AA–57AK, under The CENVAT Credit Rules, 2004, were framed and whatever
restrictions were there in MODVAT Scheme were put to an end and comparatively, a free hand was
given to the assesses. Under the CENVAT scheme, a manufacturer of the final product or a provider
of the taxable service shall be allowed to take credit of the excise duty as well as of the service tax that
are paid on any input that is received in the factory or any input service received by a manufacturer of
the final product.
Background of CENVAT
CENVAT provisions are used in Central Excise to implement the concept of VAT at the manufacturing
stage by giving credit of the duty that is paid on inputs. CENVAT was known as MODVAT up to March
31, 2000. CENVAT has its origin in the system of VAT, which is common in West European Countries.
Generally, any tax is related to the selling price of a product. In modern production technology, any
raw material passes through various stages and processes till it reaches the ultimate stage, for
example, steel ingots made in a steel mill. These are rolled into plates by a re-rolling unit, while a
third manufacturer makes furniture from these plates. Thus, the output of the first manufacturer
becomes the input for the second manufacturer, who carries out further processing and then, supply it
to a third manufacturer.
This process continues till the final product emerges. This product then goes to a distributor/
wholesaler, who sells it to a retailer and then, it reaches the ultimate consumer. If a tax is based on the
selling price of a product, the tax burden goes on increasing as raw material and final product passes
from one stage to the other. A tax purely based on the selling price of a product has a cascading
effect, which has the following disadvantages:
Computation of exact tax content difficult: It becomes very difficult to know the real tax content
in the price of a product, as it passes through various stages and tax too is levied at each stage. This is,
particularly, important for granting export incentives or for fixing regulatory prices.
Varying tax burden: The tax burden on any commodity will vary widely depending on the number
of stages through which it passes in the chain from the first producer to the ultimate consumer.
Discourages ancillarisation: Ancillarisation means getting most of the parts/components
manufactured from outside and making a final assembly. It is common for large manufacturers (like
automobile, machinery, and so on) to get the parts manufactured from outside and make a final
assembly in their plant. If a component is purchased from outside, tax is payable. However, if the
same component is manufactured inside the factory, no tax is payable. Thus, the manufacturers are
tempted to manufacture parts themselves instead of developing ancillary units for supply of the same.
This is against the national policy, because it discourages the growth of SSI and increases the
concentration of economic power.
Increases cost of production: If a manufacturer decides to reduce ancillarisation, it increases the
cost of production and wastage of scarce national resources, as the large manufacturer may not be in
a position to fully utilise the production capacity of the machinery.
Concessions on the basis of use are not possible: Some articles may be used for various
purposes. For example, copper may be used for utensils, electric cables, or air conditioners. The
government would naturally like to vary the tax burden depending on the use. However, this is not
possible as when copper is cleared from the factory, its final use cannot be known.
Exports cannot be made tax free: Although the final products which are exported are exempt
from tax, there is no mechanism to grant rebate of tax that was paid at the earlier stages on the inputs.
Highlights of CENVAT Scheme
Highlights of the scheme are as follows:

Credit of duty paid on input: The CENVAT scheme is principally based on the system of granting
credit of the duty that is paid on inputs. Under CENVAT, a manufacturer has to pay duty as per the
normal procedure on the basis of “assessable value” (which is mainly based on selling price).
However, he gets the credit of duty paid on inputs. The example we saw above can be recalculated as
follows:
B will purchase goods from A @ Rs 110, which is inclusive of a duty of Rs 10. Since B is going to
get a credit of duty of Rs 10, he will not consider this amount for his costing. He will charge
conversion charges of Rs 40.00 and will sell his goods at Rs 140. He will charge 10 per cent tax and
raise an invoice of Rs 154.00 to “C” (140 plus tax @ 10 per cent). In the invoice prepared by B, the
duty shown will be Rs 14. However, B will get the credit of Rs 10 that was paid on the raw material
purchased by him from A. Thus, the effective duty paid by B will be only Rs 4. C will get the goods at
Rs 154 and not at Rs 165, which he would have got in the absence of CENVAT. Thus, in effect, B has
to pay duty only on the value added by him. (See illustration given in a later para.)
Meaning of “value added”: In the above illustration, the “value” of inputs is Rs 110, while the
“value” of outputs is Rs 150. Thus, the manufacturer has made a “value addition” of Rs 40 to the
product. Simply put, “value added” is the difference between the selling price and the purchasing
price.
Inputs eligible for CENVAT: Credit will be available for a duty paid on (a) raw materials
(excluding few items), (b) materials that are used in relation to manufacturing of items like
consumables, and so on, (c) Packaging materials, and (d) Paints [Rule 2(g)].
Inputs should be used in or in relation to manufacture: CENVAT credit is available only on
inputs used in or in relation to the manufacture of a final product.
Input may be used directly or indirectly: The input may be used directly or indirectly in or in
relation to manufacture. The input need not be present in the final product.
No credit on HSD, LDO, and petrol: The duty paid on high-speed diesel (HSD) oil, Light diesel
oil (LDO), and motor spirit (petrol) is not available as CENVAT credit, even if these are used as raw
materials.
No credit if final product is exempt from duty: No credit is available if the final product is
exempt from duty—Rule 6(1) of CENVAT Credit Rules. If a manufacturer manufactures more than
one product, it may happen that some of the products are exempt from duty. In such cases, the duty
paid on inputs that are used for the manufacture of exempted products cannot be used for a payment
of duty on other products which are not exempt from duty. However, if the manufacturer uses
common inputs both for exempted as well as unexempted goods, he should maintain separate records
for inputs that are used for manufacture of exempted final products and should not avail CENVAT on
such inputs. However, if he does not maintain separate records and inventories of inputs that are used
in exempted final products, he has to pay an “amount” of 8 per cent of the price of the exempted
goods. As no credit is available if the final product is exempt, an SSI unit availing an exemption
cannot avail CENVAT credit and pay 8 per cent amount under Rule 6—CBE&C Circular No.
624/15/2002-CX.8, dated February 28, 2002.
Credit on the basis of specified documents: Credit is to be availed only on the basis of specified
documents, as proof of payment of duty on inputs.
Credit available instantly: Credit of duty on inputs can be taken up instantly, that is, as soon as the
inputs reach the factory. In the case of capital goods, up to 50 per cent credit is available in the current
year and the balance in the subsequent financial year.
No cash refund: In some cases, it may happen that the duty paid on inputs may be more than the
duty payable on final products. In such cases, though the CENVAT credit will be available to the
manufacturer, he cannot use the same and the same will lapse. There is no provision for refund of the
excess CENVAT credit. However, the only exception is in the case of exports where the duty paid on
input material used for exported goods is refundable. One other exception is that the Tribunal can
order a refund when CENVAT credit could not be availed due to a fault/wrong action of the
department.
CENVAT on capital goods: Credit of duty paid on machinery, plant, spare parts of machinery,
tools, dies, and so on, is available. However, up to 50 per cent credit is available in the current year
and the balance in the subsequent financial year or years.
CENVAT available only if there is “manufacture”: CENVAT on inputs is available only if the
process amounts to “manufacture”. Otherwise, CENVAT is not available. (In fact, in such cases, no
duty is payable on the final product and the question of CENVAT does not arise at all.)
Eligibility of CENVAT Credit
Rule 3(1) of CENVAT Credit Rules states that a manufacturer or producer of final products shall be
allowed to take credit (termed as CENVAT credit) of specified duties (basic, special, AED [Additional
Excise Duty], NCCD, and so on, as discussed later) that are paid on inputs or capital goods that are
received in the factory.
Manufacturer can avail CENVAT credit: CENVAT credit can be availed by a manufacturer or
producer of final products. We have already seen that a manufacturer or producer is the person who
actually brings the final product into existence.
Final products eligible under the CENVAT scheme: Recently, CENVAT has been extended to all
items included in CETA, except matches (Heading 36.05). Rule 2(e) of CENVAT Credit Rules states
that “final products” means excisable goods that are manufactured or produced from inputs, except
matches. CENVAT scheme has been extended to all the manufactured final products. These goods
cover food products, chemicals, plastics and rubber products, tobacco products, leather and wood
articles, paper, metals, engineering goods, textile products, electrical and electronic goods, and
automobile sector.
Waste and scrap is the final product for CENVAT: As per CENVAT provisions, waste or scrap is
treated as the final product within the definition of Rule 57AA(c) [Now new Rule 2(e)] and its
clearance is as if it is a final product—MFDR TRU No. 345/2/2000-TRU, dated August 29, 2000.
Inputs Eligible for CENVAT
Rule 2(g) of CENVAT Credit Rules [earlier Rule 57AA(d)] defines “input”. The definition covers the
following:
All goods (except HSD, LDO, and petrol) used in, or in relation to, the manufacture of the final products. The input may be used
directly or indirectly in or in relation to the manufacture of final product. The input need not be present in the final product.
Input includes (a) accessories of final products cleared along with the final product, (b) goods used as paint, (c) packing
material, (d) fuel, and (e) goods that are used for generation of electricity or steam that is used for manufacture of final products
or for any purpose.
Input also includes lubricating oils, greases, cutting oils, and coolants.
Input includes goods that are used in the manufacture of capital goods which are further used in the factory of the manufacturer.
Inputs Not Eligible for CENVAT
Motor spirit (petrol), LDO, and HSD is not eligible as inputs. The following is the broad summary of
inputs and outputs that are eligible:
Most of the goods are eligible under CENVAT both as final products and inputs. These chapters cover food products,
chemicals, plastics and rubber products, tobacco products, leather and wood articles, textile products, paper, metals,
engineering goods, electrical and electronic goods, and automobile sector.
Matches are not eligible as final products, though eligible as input.
Motor spirit (petrol), LDO, and HSD oil are eligible as final products but not as inputs.
No time limit for utilisation of inputs: It was held that there is no time limit for consumption of
inputs. (In this case, it was held that when goods are lying in stock in factory premises, CENVAT
credit is not to be reversed even though the value has been written off in accounts).
CENVAT credit of capital goods that are used in the factory: CENVAT credit is available in
respect of duty that is paid on “capital goods” also. It may be noted that “capital goods” can also be
covered in the definition of “inputs” as these are obviously used “in or in relation to the
manufacture”. Some provisions are common in respect of CENVAT on inputs and capital goods.
However, there are some differences too. These are discussed later.
Capital goods that are manufactured within the factory: As per Explanation 2 to Rule 2(g)
[earlier Rule 57AA(d)], “input” includes goods that are used in the manufacture of capital goods
which are further used in the factory of a manufacturer. Thus, if a manufacturer manufactures some
capital goods within the factory, goods that are used to manufacture such capital goods will be
eligible as “inputs”. (i.e., 100 per cent CENVAT credit will be available in the same financial year).
In or in relation to the manufacture of a final product: Mere inclusion of an input in the list of
goods that are eligible as CENVAT input is not enough. The input must be used in or in relation to the
manufacture of the final product. Thus, if an input is used “in the manufacture” or “in relation to the
manufacture”, it is eligible for claiming CENVAT credit. “In the manufacture” means the input is
actually used in the manufacture of a finished product, either directly or indirectly. It may be present
in the “final product” in the same or similar or an identifiable form, or it might have got converted
during the process and may not be seen or identified in the final product. “In relation to the
manufacture” means, the input has been used during a process while manufacturing the product like a
consumable. The input need not form a part of the final product. Thus, the term “in relation to
manufacture” is a very wide term and covers all inputs which have a direct nexus with the
manufacturing process. “Manufacture” includes all processes that are incidental or ancillary to the
manufacture. Thus, the term “inputs” is much wider than the mere “raw materials”.
For example, while manufacturing a wooden table, wood, nails and paints are used “in the
manufacture” of a table, while sandpaper for polishing the table may be said to be used “in relation to
manufacture” of the product. The carpenter ’s instruments are “capital goods”. While cooking food,
the vegetables, oil, wheat flour, and so on, are used “in the manufacture”. Cooking gas and kerosene
can also be said to be “used in manufacture”. However, electricity used in a mixer or refrigerator can
be said to be used “in relation to manufacture”. The electricity for tubelight in the kitchen may
facilitate cooking, but it cannot be said to be “used in or in relation to manufacture” of food.
Inputs should be “used”: A mere intention to use is not sufficient—Rule 2(g) which defines
“inputs” states that the following should be “used in the factory”. Thus, mere intention to use is not
sufficient to avail the CENVAT credit.
Credit if goods lost/destroyed in the process but no credit if inputs are lost or destroyed in a
store room or pilfered: Since credit on inputs is available only for inputs that are used in or in
relation to the manufacture of final products, if the inputs are lost or destroyed in the store room,
credit of duty that is paid on such inputs will not be available, as it cannot be said that they are used “in
or in relation to manufacture”.
Use must be within the factory: Definition of “input” in Rule 2(g) of CENVAT Credit Rules and of
“capital goods” in Rule 2(b) of CENVAT Credit Rules specifies that the inputs/capital goods must be
used within the factory of production. Factory has been defined in Section 2(e) of CEA and it covers
any premises, including precincts thereof, where the manufacturing process is ordinarily carried out.
Credit on any input can be used for any final product: Credit of input can be used in any of the
final product. An illustration will clarify. Assume that there are two inputs I-1 and I-2, used in two
final products F-1 and F-2, respectively. Excise duty paid on inputs is Rs 350 on I-1 and Rs 150 on I-2.
The manufacturer can avail credit for this duty paid. Duty payable on the final product is Rs 200 on F-
1 and Rs 400 on F-2. Thus, CENVAT credit on I-1 is Rs 350 while the duty payable on F-1 is Rs 200
only. Thus, even after utilising the full CENVAT credit, a balance of Rs 150 is left to the credit of the
manufacturer. Normally, this credit would lapse as there is no provision in CENVAT to grant a refund
of such excess credit. However, Rule 3(3) of CENVAT Credit Rules provides that CENVAT credit can
be utilised for payment of duty of excise on any final product that is manufactured by the
manufacturer. Thus, the balance left on payment of duty on F-1 can be used while paying the duty on
F-2. On F-2, the duty payable is Rs 400, while the credit available on I-2 is only Rs 150. Thus,
normally, the manufacturer will have to pay a balance amount of Rs 250 by cash (through PLA). Of
course, both F-1 and F-2 must be manufactured in the same factory. Further, this provision is not
available if the final product is exempt from duty, that is, cleared from the factory without any
payment of duty.
Inputs that are used in the exempted products are not eligible: If a manufacturer manufactures
more than one product, it may happen that some of the products are exempt from duty. In such cases,
the duty paid on inputs used for the manufacture of the exempted products cannot be used for payment
of duty on other products which are not exempt from duty—Rule 6(1) of CENVAT Credit Rules.
Thus, this is an exception to the above rule. As per the Rule 6 of CENVAT Credit Rules, if the
manufacturer is engaged in the manufacture of both dutiable and exempted final products, he should
maintain separate accounts of these inputs. However, if this is not possible, an “amount” equal to 8 per
cent of “price” of “such exempted products” should be paid.
CENVAT available on packaging material: CENVAT is available on packing material as per
definition of input contained in Rule 2(g) of CENVAT Credit Rules.
Quantum and Mode of Availment of CENVAT Credit
CENVAT credit is available only on specified duties. CENVAT is available on the basis of proof of
specified documents. Provisions are also made for availing additional credit if the differential duty is
paid later.
Duties eligible for credit: The following duties paid on inputs are eligible for CENVAT credit—
Rule 3(1) of CENVAT Credit Rules.
1. Basic excise duty on indigenous inputs (paid on goods specified in the First Schedule to CETA).
2. Special excise duty (paid on goods specified in the Second Schedule to CETA).
3. Additional duty (CVD) (paid on imported inputs).
4. If the inputs are obtained from EOU/STP (Software Technology Park)/EHTP (Electronics Hardware Technology Park)/SEZ, the
credit will be as per the prescribed formula. See note as follows.
5. AED paid under Additional Duties of Excise (goods of special importance) [AED(GSI)] Act. If these are imported, the credit of
corresponding CVD on imported goods can be availed.
6. AED that is paid on textile and textile articles [AED(TTA)]. If these articles are imported, the corresponding CVD paid is also
eligible. The credit of additional duty under Additional Duties (textiles and textile articles) [AED(TTA)] and the corresponding
CVD that is paid on imported goods should be utilised only for the payment of duty under that Act and not for other duties like
basic excise duty, and so on.
7. National Calamity Contingent Duty (NCCD) that is leviable under Section 136 of Finance Act, 2001, and the corresponding
CVD that is paid on imported goods; and NCD (and corresponding CVD on imported goods) on inputs. This credit can be used
for the payment of NCD on outputs alone and not for any other duty.
8. AED (tea and tea waste) that is levied under Section 157 of Finance Act, 2003. This credit can be used for the payment of
AED(TTW) on outputs alone the and not for any other duty.
The credit of AED(GSI) and special excise duty can be utilised for the payment of basic excise duty
on the final products and vice versa. Thus, basic duty, SED, and AED(GSI) are interchangeable, that
is, the credit of duty paid under one head can be utilised for payment of duty under another head.
Taking and utilisation of credit: The credit of the duty that is paid on eligible inputs that is
received in the factory can be taken by the manufacturer immediately on receipt of inputs, according
to Rule 4(1) of CENVAT Credit Rules. In the case of capital goods, up to 50 per cent credit only can
be taken at any point of time in a financial year and in any succeeding year or years—Rule 4(2) of
CENVAT Credit Rules. The payment of duty through CENVAT credit is almost as good as the payment
of duty through PLA and a refund is permissible (if otherwise eligible), even if the duty was paid
through the CENVAT credit. [For case law, see under “refunds”].
Credit can be taken as the soon as goods are received in the factory. It is not necessary to wait till
the inputs/capital goods are actually utilised in the production. In the case of textile and textile articles,
the duty liability is of the raw material supplier. They can avail CENVAT credit as soon as the inputs
are received in the premises of the raw material supplier. [Rule 4(1) of CENVAT Credit Rules.]
The manufacturer should maintain a record of CENVAT credit availed and of credit utilised. (The
record should be similar to PLA where the credit is taken of duty paid by a challan in a bank and when
finished goods are cleared, debit entry is made in PLA). As soon as an input is received in a factory,
the duty paid on the input is credited in the CENVAT records. This credit can be utilised for a payment
of any excise duty as follows:
Any final product manufactured by the manufacturer [Rule 3(3)(a)]
Payment of “amount” if inputs are removed as such or after partial processing [Rule 3(3)(b)]
Payment of “amount” if capital goods are removed as such [Rule 3(3)(c)]
Payment of “amount” if goods are cleared after repairs under Rule 16(2) [Rule 3(3)(d)]
Payment under CENVAT Credit Rule 6 of 8 per cent “amount” on exempted goods or a reversal of credit on inputs when
common inputs are used for exempted as well as dutiable final products—Explanation I to CENVAT Credit Rule 6(3)
Reversal of CENVAT credit if assessee opts out of CENVAT—Rule 9(2)
Payment of “amount” if goods sent for job work are not returned within 180 days—Rule 4(5)(a)
Since the by-product, scrap, or waste is dutiable in most of the cases, duty will be payable on these as
if they are “final products”. Any duty that is paid on inputs can be utilised for a payment of any duty
on the outputs. Thus, the special excise duty that is paid on inputs can be utilised for a payment of
basic or special excise duty that is paid on final products and vice versa., as is clear from the
wordings of the new Rule 3(6) [earlier Rule 57AB(b)].
CENVAT credit is only to inputs that are received up to the end of month, even if duty is to be paid
by the fifth or 15th of the following month. Excise duty is presently payable on a monthly basis. Duty
for clearances during the month is payable by fifth of the following month. In the case of SSI units,
the duty for the whole month is payable by 15th of the following month. Proviso to CENVAT Credit
Rule 3(3) states that only CENVAT credit that is available as on the last day of the month can be
utilised for payment of duty even if the duty is payable by the fifth of the following month (15th of the
following month in case of SSI). Thus, CENVAT credit in respect of inputs/capital goods received
after the end of month cannot be utilised while paying duty on the fifth or 15th, as the case may be. The
credit can be utilised in the subsequent month only.
Duty-paying documents for inputs: As soon as a manufacturer receives an input, he can avail the
CENVAT credit of the duty paid on the inputs. Documentary evidence is required regarding payment
of duty on inputs. Rule 7(1) of CENVAT Credit Rules prescribes that credit can be taken on the basis
of (i) invoice of manufacturer, (ii) invoice issued by registered importer, (iii) invoice by registered
importer from his depot or premises of consignment agent, (iv) invoice issued by registered, first-
stage or second-stage dealer, (v) bill of entry, and (vi) a certificate issued by an appraiser of customs
in respect of goods that are imported through a foreign post office.
Credit on the basis of original documents only: Earlier, CENVAT credit was allowable only on
the basis of an invoice copy marked “Duplicate for Transport”. However, now there is no such copy
specified. The CENVAT Credit Rules states that CENVAT credit can be availed on the basis of an
“Invoice issued by a manufacturer”. Thus, whether the invoice is marked as “Original for Buyer” or
“Duplicate for Transport”, it is still an “invoice issued”. However, a certified copy is not an “invoice
issued by a manufacturer”. Thus, it is doubtful if a credit can be availed on the certified copy of the
invoice. In the opinion of the author, it should be possible to avail CENVAT credit on the basis of a
“triplicate copy of invoice”, as it is also an “invoice issued by manufacturer”.
No CENVAT if inputs are used for the exempted final products: As per the basic principle of
VAT, credit of duty can be availed only for a payment of duty on the final product. As a natural
corollary, if no duty is payable on the final product, then the credit of duty paid on inputs cannot be
availed.
As per Rule 6 of CENVAT Credit Rules, CENVAT credit is not admissible if the final product is
exempt from duty. However, as per Rule 6(5), a manufacturer can avail CENVAT credit on inputs
when the final product is despatched without any payment of duty, in the following cases: When a (a)
final product is despatched to SEZ, EOU, EHTP, or STP; (b) When a final product is supplied to
United Nations or an international organisation for their official use or supplied to projects funded by
them, which are exempt from duty; and (c) When a final product is exported under bond without any
payment of duty.
In other cases, the manufacturer is not entitled to avail CENVAT credit on inputs when the final
product is cleared without any payment of duty. It may happen that same inputs are used partly for the
manufacture of dutiable goods and partly for the exempted products. In such cases, the manufacturer
has two options which are as follows:
Maintain separate inventories with accounts of receipt and use of inputs that are used for exempted final products. In such cases,
he should not avail CENVAT of credit of such inputs at all—Rule 6(2) of CENVAT Credit Rules [earlier Rule 57AD(2)—prior
Rule 57CC(9)]. However, it is not necessary to maintain separate accounts in respect of “fuel” used as inputs. [In CCE v. Padmini
Polymers 2003(151) ELT 358 (CEGAT), it was held that there is no requirement that these must be stored separately].
If the manufacturer is unable to maintain such separate accounts, he has to pay an amount equal to 8 per cent of the “price” of
such exempted final products. Such payment can be made by debit to CENVAT credit account or PLA.
Meaning of “exempted goods”: As per Rule 2(d) of CENVAT Credit Rules, “exempted goods”
means goods which are exempt from the whole of duty of excise that is leviable thereon and includes
goods which are chargeable to “nil” rate of duty. Thus, the “exempted goods” for the purpose of
CENVAT cover (a) goods chargeable to nil duty as per tariff and (b) goods which are exempt by a
notification issued under Section 5A.
When to pay the 8 per cent “amount”: The rules do not state on when the “amount” should be
paid. It is an established principle that if the statute does not provide any time limit, the thing should be
done in a “reasonable time”. “Paying it on a monthly basis” a can be considered as a “reasonable
time” as that time is permitted for the payment of duty. Payment before clearance cannot be insisted
upon, in the absence of any statutory provision. Moreover, no interest can be charged for delayed
payment, as no time limit has been prescribed.
Procedure for CENVAT
Procedures, records, and returns: The records and returns that are prescribed under CENVAT are
discussed here. The main procedures are as follows:
Maintaining records of inputs
Maintaining records of credit received and utilised
Submit monthly/quarterly return in the prescribed form
Record of inputs and capital goods: The manufacturer shall maintain proper records for the receipt,
disposal, consumption, and inventory of the inputs and capital goods. The record should contain
relevant information regarding value, duty paid, and the person from whom inputs/capital goods have
been procured. The burden of proof regarding admissibility of CENVAT credit is on the
manufacturer taking the credit—Rule 7(4) of CENVAT Credit Rules. Another record is CENVAT
Credit Record, which is similar to PLA. It is a current account of CENVAT credit that is received and
utilised, and also the credit balance. This should give details of (a) credit that was availed against each
input/capital goods; (b) credit that was utilised against clearance of final products or removal of
inputs as such, or after processing, or removal of capital goods as such; and (c) balance credit
available.
Periodical return: The manufacturer has to submit within 10 days to close of month, a monthly
return giving details in the prescribed Form No. 1 [Rule 7(5)]. The SSI units and certain units in
textile sector have to submit return on a quarterly basis. The form has been prescribed vide Annexure
to CENVAT Credit Rules.
CENVAT on stock on the date of opting for CENVAT: A manufacturer is entitled to avail credit
for all inputs that are used in or in relation to manufacture. Thus, when he opts to avail CENVAT
credit, he will be entitled to avail credit of all inputs lying in his stock, on the date when he decides to
opt for CENVAT—Rule 3(2) of CENVAT Credit Rules. The stock may be (a) lying in stores or (b)
contained in the finished product which is lying in the factory. The assessee should quantify the
amount of admissible credit on the basis of documentary evidence and records that are maintained for
this purpose.
Other Provisions of CENVAT
Export of final products: As far as the excise is concerned, two major export incentives are
available to a manufacturer. They are (a) no duty is payable on the finished products that are exported
and (b) duty paid on inputs is refunded—called “duty drawback”. Provisions have been made for these
incentives in the CENVAT rules. As an export incentive, no excise duty is payable on the products
exported. Similarly, goods can be supplied to units in SEZ, EOU, EHTP, or STP without payment of
duty (these are “deemed exports”). As per normal CENVAT rules, CENVAT is available only if duty is
payable on final products. Hence, CENVAT credit on inputs that are used for manufacture of final
products which are exported will lapse because final products are exempt from duty.
However, as an incentive to export, it has been provided that CENVAT credit will be available on
such inputs which can be used for clearance of any of the final products—Rule 6(5) of CENVAT
Credit Rules. (However, the manufacturer will not be entitled to duty drawback, or claim a rebate of
duty). If the credit cannot be used for a clearance of any of the exported final goods, the manufacturer
can get a cash refund of the same—Rule 5 of CENVAT Credit Rules. (This is only for exports and not
for home clearances.) The refund of AED(GSI) is also permissible, even prior to February 28, 2003
—CBE&C Circular No. 701/17/2003-CX, dated March 12, 2003.
The reversal of CENVAT is not necessary if an intermediate product is cleared as an input to
another manufacturer and the final product exported from the place of the final manufacturer. Excise
rules permit the removal of intermediate products under a bond for export. These are used as inputs
by another manufacturer. The final product is then exported [Notification No. 43/2001CE(NT), dated
June 26, 2001, issued under Rule 19 of Central Excise Rules]. In such cases, it was argued by the
department that the intermediate products were exempt from duty and removed without any payment
of duty and hence, CENVAT on inputs should be reversed as per Rule 57C. It has been held that the
removal without any payment of duty under a bond does not mean that the goods are wholly exempt
from duty or chargeable to nil rate of duty.
No reversal if goods removed under a bond without a payment of duty for export: CENVAT
credit has to be reversed if the final products are exempted from duty or are chargeable to nil rate of
duty. If the goods are removed under bond (e.g., export bond), the goods are assessed to normal rate
of duty and the only concession given is that the goods are allowed to be removed without payment of
a duty. These products are neither exempt from duty or are chargeable to nil rate of duty. Hence, if
such goods are cleared without a payment of duty, CENVAT on inputs used for such products need not
be reversed—Ministry of Law Advice dated October 29, 1974, reiterated in CBE&C Circular No
278/112/96-CX, dated December 11, 1996.
No reversal if a supplier gives reduction in price after clearance: Excise duty is payable on the
basis of price at the time of clearance. Thus, the assessable value does not change if the supplier gives
credit of duty after removal of goods. In view of this, credit is not to be reversed only because the
supplier of inputs has given some reduction in the prices after removal of goods. In CCE v. Kinetic
Engg 1997 (95) ELT 396 (CEGAT), it was held that the classification of goods made at the supplier ’s
end cannot be altered at the manufacturer ’s end. The same principle will apply to valuation also. In
MRF Ltd. v. CCE 1997(92) ELT 309 (SC), it was held that any fluctuation in price, subsequent to
removal of goods, has no relevance whatsoever to the liability of the excise duty.
Wrongful/irregular availment of credit: If the CENVAT credit has been taken or utilised wrongly,
the same shall be payable along with interest, and provisions of Sections 11A and 11AB shall apply
mutatis mutandis for effecting the recovery—Rule 12 of CENVAT Credit Rules. If the 8 per cent
“amount” which is payable under Rule 6 of CENVAT Credit Rules is not paid, the same can also be
recovered along with interest.
CENVAT credit if demand is made on the final products for the past period: It may happen that
an assessee may not follow CENVAT procedures assuming that the product is exempt from duty. If,
subsequently, a demand is raised on him for the past period, he cannot obviously comply with the
procedures prescribed in respect of the past period. In such cases, CENVAT credit has to be allowed
for the past period even if CENVAT declaration is not filed or the prescribed records not maintained.
Special provisions in respect of SSI: A SSI is exempt from duty up to a limit (presently Rs 100
lakh). The SSI unit is permitted to avail an exemption up to the exemption limit and then pay a duty.
The SSI unit can avail CENVAT credit when it starts paying duty in the middle of the year. The SSI
unit can also avail CENVAT credit in respect of inputs lying in stock, in WIP, and in final products,
when it starts availing the CENVAT credit. This has been specifically provided in Rule 3(2) of
CENVAT Credit Rules.
The department has confirmed that SSI unit can avail CENVAT credit of duty on stock of raw
materials, WIP, and finished goods, when it starts the payment of duty after crossing the exemption
limit. For this purpose, the assessee should quantify the amount of admissible credit on the basis of
documentary evidence and records maintained for this purpose—MFDR TRU No. 345/2/2000-TRU,
dated August 29, 2000—similar to CCE, Madurai TN 104/2000, dated August 22, 2000, where it is
stated that the SSI unit should file an intimation to the Range Superintendent with a copy to
jurisdictional AC/DC, 24 hours in advance, along with the details of stock held by them on that date.
The SSI unit can opt out of CENVAT on March 31 and then avail SSI exemption from April 1
onwards. However, it will have to pay an amount equivalent to CENVAT credit in respect of stock of
inputs, WIP, and the final products that are lying with him on March 31, and the balance in CENVAT
credit on March 31 will lapse—Rule 9(2) of CENVAT Credit Rules.

The main procedures for CENVAT are maintaining proper records of the inputs and capital goods, maintaining CENVAT
Credit record, and submitting monthly returns.
No cash refund: In some cases, it may happen that the duty paid on inputs may be more than the
duty payable on the final products. In such cases, though the CENVAT credit will be available to the
manufacturer, he cannot use the same and the same will lapse. There is no provision for the refund of
the excess CENVAT credit. However, the only exception is in the case of exports where the duty paid
on inputs that are used for exported goods is refundable.
The other exception is when the CENVAT credit could not be availed due to a fault/wrong action of
the department. In such cases, the Tribunal has ordered a cash refund/credit in PLA in many cases. If
the assessee is in a position to avail the CENVAT credit, then the refund should be given only by
means of CENVAT credit, if duty was paid through CENVAT credit. [Case law discussed under
“Refunds”.]
Transfer/merger/shifting of undertaking: If a factory is transferred on account of change in
ownership or on account of sale, merger, amalgamation, lease, or transfer of factory to a joint
venture, the manufacturer can transfer unutilised CENVAT credit to the transferred/sold/merged/
leased/amalgamated factory—Rule 8 of CENVAT Credit Rules. The transfer of credit is subject to the
following: (a) there should be a specific provision for transfer of liabilities of such factory and (b)
the transfer is allowed only if a stock of inputs as such, or in process, or the capital goods, are also
transferred along with the factory to the new site or ownership, and the inputs or capital goods on
which the credit has been availed of are duly accounted for to the satisfaction of Assistant/Deputy
Commissioner. Thus, the transfer is possible only with the permission of Assistant/ Deputy
Commissioner of CE.
Note that in most of the cases, the permission of High Court is obtained much later than the
“effective date” as specified in the scheme. However, till the permission of High Court is obtained, the
two units work independently. Hence, the approval of Assistant/Deputy Commissioner can be obtained
only as on the date of application to him and not the “effective date” as mentioned in the scheme.
Storage of inputs outside the factory: Inputs should be stored within the factory. However, if the
manufacturer is unable to store the inputs inside the factory for want of space, hazardous nature of
goods, and so on, he can store the inputs outside the premises. The storage point will be treated as an
extension of the factory. Permission from Assistant/Deputy Commissioner is necessary [Rule 6A of
CENVAT Credit Rules].
CENVAT on Capital Goods
CENVAT credit is available on inputs as well as capital goods. Some provisions are common while
there are some specific provisions in respect of CENVAT on capital goods. The specific provisions in
respect of capital goods are discussed here.
Capital goods that are eligible: Following are the “capital goods”, if used within the factory of the
manufacturer of the final product, vide Rule 2(b) of CENVAT Credit Rules:
1. Tools, hand tools, knives, and so on, falling under Chapter 82:
Machinery covered under Chapter 84
Electrical machinery under Chapter 85
Measuring, checking, and testing machines and so on, falling under Chapter 90
Grinding wheels and like goods falling under sub-heading No. 6801.10
Abrasive powder or grain on a base of textile material, falling under 68.02
2. Pollution control equipment
3. Components, spares, and accessories of the goods specified above.
4. Moulds and dies
5. Refractories and refractory material
6. Tubes, pipes, and fittings thereof, used in the factory
7. Storage Tank
Spares, components, and so on, of Sr Nos. iii–vii: Item No (iii) covers only components, spares, and
accessories of Sr Nos. (i) and (ii). In the opinion of author, components, spares, and so on, of Sr Nos
(iv)–(vii) will be eligible as “inputs”, as these are obviously used “in or in relation to manufacture”.
Capital goods that do not cover any equipment or appliances that are used in office: Rule 2(b)
[Earlier Explanation to Rule 57AA(a)] clarifies that equipment or appliances that are used in an office
will not be eligible as “capital goods”. What is “office” is not defined, and hence the word has to be
understood in commercial parlance. Of course, some litigation seems possible; for example, whether
an air conditioner/computer that is used in the cabin of production managers/ officers are eligible if
their offices are within the factory itself? Whether a computer that is used for maintaining production
records or cupboard/storage system to keep production records will be eligible? In the opinion of
author, as per commercial parlance, these are understood as office equipment/appliances. However,
note that “office equipment and appliances” and “equipment or appliances used in an office” are not
the same thing. As per Section 2(f) of CE Act, “factory” means any premises, including the precincts
thereof, wherein or in any part of which any manufacturing process is carried out. Thus, the office of
a factory manager or plant manager, located within the plant, will be the “factory” and not “office”.
Thus, any equipment or appliance used within such “office”, which is located within the plant should
be eligible if it falls within the specified chapter headings.
It is clarified that air conditioners, refrigerating equipment, and computers will be eligible for
CENVAT credit of capital goods if they are used in the manufacture of the final product. An air
conditioner that is used in office premises or a computer that is used in the office premises of a
factory shall not be eligible to CENVAT credit. (As per rules, the capital goods should be “used” in
the factory; while as per a department, it will be eligible only if it is “used in the manufacture of a
final product in the factory”. As is well known, the departmental circular cannot override the
provisions of Acts or Rules.)
Capital goods that are not covered in the above definition: Any “capital goods” that are not
covered in the above definition will be covered as “input” if it is used in or in relation to manufacture.
Distinction between accounting principles and excise definition: The definition of “capital
goods” as per Rule 2(b) of CENVAT Credit Rules is entirely different from “capital goods” as
understood in the accounting principles or for income tax purposes. Items like spare parts, tools, dies,
tubes, fittings and so on, are never capitalised in accounts or for income tax purposes but are defined
as “capital goods” for CENVAT.
Capital goods should be used in the factory: The only requirement is that the eligible capital
goods should be “used” in the factory for manufacture of eligible final products. The purpose for
which these capital goods are used is not relevant. The same view was held in Ghatampur Sugar v.
CCE 1998(104) ELT 415 (CEGAT). Thus, capital goods will be eligible even if they are used for
processing, quality control, testing, material handling, or any other purpose.
Using elsewhere is not permitted: CENVAT credit is available only if capital goods are installed in
the very factory of manufacturer of final products. The credit on capital goods is not available if it is
used in another factory—even if it is subsidiary. The capital goods that are used at a job worker ’s
premises for work on inputs are not eligible.
The exception is moulds, dies, jigs, and fixtures, which can be sent to a job worker for production
of goods on behalf of and according to specifications of the manufacturer sending the moulds, dies,
jigs, and fixtures—Rule 4(5)(b) of CENVAT Credit Rules. However, these cannot be sent directly to
the place of a job worker. These have to be brought to the factory (or manufactured in factory) and
then sent, as Rule 3(1) of CENVAT Credit Rules permits a direct despatch of only inputs to a job
worker.
Capital goods that are used outside the factory premises are not permitted: Capital goods used
away from the factory (e.g., equipment in mines away from the factory or a pump house situated away
from the factory) are not eligible for CENVAT credit. The same provision holds good for CENVAT
on inputs also.
Capital goods that are received in the initial stages: During the initial setting up of a factory,
machinery is received but the factory has not yet come into existence as the production is yet to
commence. The credit will be available when the factory is registered and production starts—CBE&C
Circular No. 88/88/94, dated December 26, 1994. [The trade notice stated that the manufacturer should
go on filing a declaration under Rule 57Q, even if the factory has not come into existence and is not
registered. Now that the provision in respect of CENVAT (that time MODVAT) has been dropped, the
declaration is not required. However, it is advisable to keep the department informed.]
Conditions for availing credit on capital goods: The conditions for eligibility of credit are as
follows:
Duty-paying documents that are eligible are the same for CENVAT on inputs
Depreciation under Section 32 of IT Act should not be claimed on the excise portion of the Capital Goods—Rule 4(4) of
CENVAT Credit Rules. (Otherwise, the manufacturer will get a double deduction for Income Tax—one credit as CENVAT and
another credit as depreciation.)
Depreciation cannot be availed on CENVAT portion: Rule 4(4) of CENVAT Credit Rules clarifies
that a manufacturer cannot avail a depreciation in respect of the excise portion, for example, if the
cost of “capital goods” is Rs 1.15 lakh, out of which Rs 0.15 lakh is duty paid, the assessee can claim a
depreciation under Income Tax only on Rs 1 lakh, if he has availed a CENVAT credit of Rs 0.15 lakh.
The requirement gets satisfied only if the assessee follows accounting procedures, which are
specified in guidelines issued by the Institute of Chartered Accountants of India. A corresponding
provision has been made in Income Tax, vide Section 43(1) to the effect that the actual cost of asset
will be reduced by any duty paid, if CENVAT credit is availed on the asset. This amendment to IT Act
has been made with a retrospective effect from the assessment year 1994–95.
Credit on capital goods has to be availed in two stages: CENVAT credit on capital goods is
required to be availed in more than a year, viz., up to 50 per cent credit can be availed when these are
received and the balance only in subsequent financial year/s. The condition for taking balance credit
is that the capital goods should be in possession and use of final products in the subsequent years—
Rule 4(2)(a) of CENVAT Credit Rules. (The word used is “subsequent years” and not “subsequent
year”). The exception is that in the case of consumables like spare parts, components, refractories,
and grinding wheels, the balance credit can be availed in a subsequent year, even if they are not in
possession and use. (The obvious reason is that these may not be available in the next year or in the
subsequent years at all; and even if they are available, it will be practically impossible to locate them
and prove their possession and use.) However, the condition is that these should have been consumed
in the factory. The balance 50 per cent credit cannot be taken if these are sold as such in the first year
itself—Rule 4(2)(b) of CENVAT Credit Rules.
Provision if capital goods are cleared “as it is” in the first year itself: If the assessee clears
capital goods “as such” in the first year itself, full 100 per cent CENVAT credit will be available.
[Proviso to Rule 4(2)(a) to CENVAT Credit Rules]. (This provision has been made with effect from
March 1, 2002. Earlier, there was no such provision, which had created problem for the assessee if he
had to clear goods in the first year itself. In such cases, he was entitled to only up to 50 per cent credit,
while he had to pay a full normal duty while clearing these capital goods. However, in the next year,
the balance 50 per cent credit cannot be availed, as the “capital goods” will not be in use and
possession of the manufacturer. Thus, he was entitled to avail only up to 50 per cent credit while
paying a full 100 per cent duty while clearing the capital goods in the first year itself. This was unjust
and hence, the anomaly has been removed).
Requirements of a dealer’s invoice for CENVAT: An invoice raised by the manufacturer of inputs
will contain details of excise duty that is paid on total quantity. The wholesaler or distributor may
supply the goods that are received from the manufacturer to more than one buyer, dealers, or sub-
dealers. In a normal commercial invoice raised by the wholesaler, distributor, or dealer, the excise
duty will not be charged separately. In fact, the dealer cannot charge excise duty in his invoice
separately as he has not paid the same.
Excise duty should not be charged separately to a buyer in invoice: A dealer is required to
indicate in his invoice the excise duty that is paid on goods by the buyer. However, this should not be
separately charged to the buyer. The details of excise duty paid by the manufacturer should only be
shown separately in the invoice. The amount of excise should not be recovered from buyer separately
showing it as an “excise duty”.
Dealer can have another series of invoice called “Private Invoices” for Non-CENVAT goods: A
dealer is permitted to have another series of invoice for non-excisable goods or goods chargeable to
nil rate of duty. An RG23D register need not be maintained in respect of such goods.
Records and returns by Dealer: As per Rule 7(3) of CENVAT Credit Rules, the CENVAT credit in
respect of inputs and capital goods that are purchased from a first-stage or second-stage dealer shall
be allowed only if the dealer maintains records indicating the fact that the inputs or capital goods
were supplied from the stock on which the duty was paid by the manufacturer/producer of such
goods. Thus, the dealer issuing the invoice should maintain a record of goods received and sold. The
records of dealer can be inspected by the excise authorities on obtaining permission from
Assistant/Deputy Commissioner, Central Excise. All records must be preserved for a period of the
five years. The dealer is required to file a quarterly return to Superintendent of Central Excise, in the
prescribed Form No. 2, within 15 days from close of each quarter [Rule 7(6) of CENVAT Credit
Rules].
VALUE ADDED TAX (VAT)
It has become a common practice around the world to adopt Value Added Tax (VAT) in place of
excise duties and sales taxes. With the two-tier VAT regime that debuted on April 1, 2005, the
consumers can expect a major bonanza. VAT is prevalent in over 120 countries (refer Table 17.6). In
India, the introduction of VAT would be a historic reform of the domestic trade system. Since 1991, a
momentum was gathering in favour of implementation of VAT all over the country. The Central
government, as a policy, decided to implement VAT. However, sales tax can be levied only by any
State government and not by the Central government. The role of Central government is only to
convince and guide the states to implement VAT.
VAT is essentially a form of sales tax. It is a multi-point and multi-stage tax, levied only on the
value addition to a product, at each stage of production and distribution chain. There will be a
deduction from taxes that were paid earlier in the chain. At present, sales tax is levied at a single point
either at the hands of a producer, distributor, or a wholesaler.

Value Added Tax (VAT), levied only by the States, it is a multipoint, multi-stage sales tax, levied only on the value addition to
a product, at each stage of production and distribution chain.
VAT has been defined as a tax on the sale of a commodity at every point in the series of sales by the
registered dealers, with the provision of credit of input tax paid at the previous point of purchase,
there of. As such, the VAT paid by the registered dealer would be deducted and the balance be paid. As
said by the Chairman of Madras School of Economics that in a country with a federal constitution, the
constituent states have to adopt a consumption (or destination) type of indirect tax if a common
market is to be precluded, and inter-state tax exportation is to be minimised.
The implementation of VAT in the month of April is a very important step as all major states are
going to adopt it at the same time and have agreed on several common features. It will be a landmark
in the economic history of India. Once this is done, there will be two VAT systems, one at the centre—
the CENVAT, and the other at the state level. They will exist side by side and efforts will be made to
harmonise the two. CENVAT is applicable only at the manufacturing stage whereas the state VAT is
levied on the domestic trade transactions. The adoption of VAT as the major system of domestic trade
transaction is extremely important—the VAT system enables the government to levy a tax on the
principle of destination and only on the value of consumption.

Table 17.6 Tax Rates Around the World
Source: http://www.worldwide-tax.com/index.asp#partthree

The constitutional position in India is that the Central government can tax goods at the
manufacturing stage and services, where as the states can tax goods at all stages but only a few
services mentioned in the constitution (such as entertainment, transport of goods by road). The states
now claim that they should be given the power to levy taxes on services.
Background and Justification of VAT
In the existing sales tax structure, there are problems of double taxation of commodities and
multiplicity of taxes, resulting in a cascading tax burden. For instance, in the existing structure, before
a commodity is produced, inputs are first taxed; and then after the commodity is produced with the
input tax load, the output is taxed again. This causes an unfair double taxation with cascading effects.
In the VAT, a set-off is given for input tax as well as tax paid on previous purchases. In the prevailing
sales tax structure, there are in several states also a multiplicity of taxes, such as turnover tax,
surcharge on sales tax, additional surcharge, and so on. With introduction of VAT, these other taxes
will be abolished. In addition, CST is also going to be phased out. As a result, the overall tax burden
will be rationalised, and prices in general will also fall. Moreover, VAT will replace the existing
system of inspection by a system of built-in self-assessment by the dealers and auditing. The tax
structure will become simple and more transparent. That will improve tax compliance and will also
augment the revenue growth (refer to Table 17.7).

Table 17.7 Sales Tax Structure of States
States Rang e of Sales Tax Rates (%)
Delhi 0–20.0
Haryana 0–20.0
Andhra Pradesh 0–20.0
Gujarat 0–54.0
Maharashtra 0–33.0
Tamil Nadu 0–70.0
Uttar Pradesh 0–32.5
West Bengal 0–20.0
Rajasthan 0.5–47
Source: The Journal of Indian Management & Strategy (JIMS), 9(2) (April–June 2004).
Note: Central Sales Tax rate being reduced from 3% to 2% from April 1, 2008.

Thus, to repeat, with the introduction of VAT, benefits will be as follows:
1. A set-off will be given for the input tax as well as the tax paid on previous purchases.
2. Other taxes, such as turnover tax, surcharge, additional surcharge, and so on, will be abolished.
3. The overall tax burden will be rationalised.
4. The prices will in general, fall.
5. There will be a self-assessment by dealers.
6. The transparency will increase.
7. There will be a higher revenue growth. The VAT will, therefore, help common people, traders, industrialists, and also the
government. It is, indeed, a move towards more efficiency, equal competition, and fairness in the taxation system.
For these beneficial effects, a full-fledged VAT was initiated first in Brazil in the mid-1960s, then in
European countries in 1970s, and subsequently introduced in about 130 countries, including several
federal countries. In Asia, it has been introduced by a large number of countries from China to Sri
Lanka. Even in India, there has been a VAT system introduced by the Government of India for the last
10 years in respect of central excise duties. At the state-level, the VAT system as decided by the State
governments, would now be introduced in terms of Entry 54 of the State List of the Constitution.
The first preliminary discussion on the state-level VAT took place in a meeting of chief ministers
convened by Dr. Manmohan Singh, the then Union Finance Minister, in 1995. In this meeting, the basic
issues on VAT were discussed in general terms and this was followed up by periodic interactions of
the State Finance Ministers. Thereafter, in a significant meeting of all chief ministers, convened on
November 16, 1999 by Mr. Yashwant Sinha, the then Union Finance Minister, three important
decisions were taken. Firstly, before the introduction of the state-level VAT, the unhealthy sales tax
rate “war” among the states would have to end and the sales tax rates would need to be harmonised by
implementing uniform floor rates of sales tax for different categories of commodities, with effect
from January 1, 2000. Secondly, in the interest again of harmonisation of incidence of sales tax, the
sales tax-related industrial incentive schemes would also have to be discontinued, with effect from
January 1, 2000. Thirdly, on the basis of achievement of the first two objectives, steps would be taken
by the states for the introduction of state-level VAT after adequate preparation. For implementing
these decisions, an EC of the State Finance Ministers was set up.

The introduction of the Statelevel VAT was possible only when firstly, the unhealthy sales tax rate “war” among the states
ended and secondly, the sales tax-related industrial incentive schemes discontinued. For the implementation of the above,
an Empowered Committee of State Finance Ministers was set up.
Thereafter, this EC has met regularly, attended by the State Finance Ministers, and also by the
Finance Secretaries and the Commissioners of Commercial Taxes of the State Governments, as well
as the senior officials of the Revenue Department of the Ministry of Finance, Government of India.
Through repeated discussions and collective efforts in the EC, it was possible within a period of
about a year and a half to achieve nearly 98 per cent success in the first two objectives on the
harmonisation of sales tax structure, through implementation of uniform floor rates of sales tax and
discontinuation of sales tax-related incentive schemes. As a part of regular monitoring, whenever any
deviation is reported from the uniform floor rates of sales tax, or from the decision on incentives, the
EC takes up the matter with the concerned state and also the Government of India for a necessary
rectification.
After reaching this stage, steps were initiated for a systematic preparation for the introduction of a
state-level VAT. In order to avoid again any unhealthy competition among the states which may lead to
distortions in the manufacturing and trade, attempts have been made from the very beginning to
harmonise the VAT design in the states, keeping also in view the distinctive features of each state and
the need for a federal flexibility. This has been done by the states by collectively agreeing, through
repeated discussions in the EC, to certain common points of convergence regarding VAT, and
allowing at the same time a certain flexibility for the local characteristics of the states. Along with
these measures at ensuring a convergence on the basic issues on VAT, steps have also been taken for
necessary training, computerisation, and interaction with trade and industry, particularly at the state
levels. This interaction with trade and industry is being specially emphasised.
It may be noted that while such preparation was going on, the chief ministers of all the states in an
important meeting on a state-level VAT convened by the Prime Minister on October 18, 2002, when
Mr. Jaswant Singh, the then Union Finance Minister was present, clearly stated their intention of
introducing VAT from April 1, 2003. About 29 states and Union Territories (UTs) had expeditiously
sent their bills to the Ministry of Finance, Government of India for prior vetting. The Union Ministry
of Finance had considered these bills of states and UTs, and sent their comments/suggestions to the
states and UTs in line with the decisions of the EC of the State Finance Ministers for incorporating the
same in VAT bills that are to be placed in the State legislatures and subsequent transmission to the
Government of India for the presidential assent. At this stage, there were certain developments that
delayed the introduction of VAT. Despite these developments, most of the states remained positively
interested in the implementation of VAT. Madhya Pradesh VAT Bill had already been accorded the
presidential assent in November 2002. One state, viz., Haryana, has already introduced VAT on its
own with good results in the revenue growth. It is important to note that in the meeting of EC on June
18, 2004, when Mr. P. Chidambaram, the Union Finance Minister, was invited and was kindly present,
all the states, excepting one, once again categorically renewed their commitment to the introduction
of VAT from April 1, 2005. Even for this particular state with certain problems, a positive interaction
has recently been organised with that state to resolve certain genuine ground-level problems. Now,
nearly all the states have either finalised their VAT bills and are in the process of obtaining
presidential assent, or will reach that stage very soon.
Design of State-level VAT
As already mentioned, the design of state-level VAT has been worked out by the EC through several
rounds of discussion, and by striking a federal balance between the common points of convergence
regarding VAT and flexibility for the local characteristics of the states. Since the state-level VAT is
centred around the basic concept of “set-off ” for the tax paid earlier, the needed common points of
convergence also relate to this concept of set-off/input tax credit, its coverage, and related issues,
which are elaborated as follows:
Concept of VAT and set-off /input tax credit: The essence of VAT is in providing a set-off for
the tax paid earlier, and this is given an effect through the concept of input tax credit/rebate. This input
tax credit in relation to any period means the setting off of the amount of input tax by a registered
dealer against the amount of his output tax. The VAT is based on the value addition to the goods, and
the related VAT liability of the dealer is calculated by deducting the input tax credit from the tax
collected on sales during the payment period (say, a month). If, for example, an input worth Rs
100,000 is purchased and sales are worth Rs 200,000 in a month, and the input and output tax rate are
4 per cent and 10 per cent, respectively, then the input tax credit/set-off and the calculation of VAT will
be as shown as follows:
a. Input purchased within the month: Rs 100,000
b. Output sold in the month: Rs 200,000
c. Input tax paid: Rs 4,000
d. Output tax payable: Rs 20,000
e. VAT payable during the month: Rs 16,000 after set-off/input tax credit [(d)–(c)]
Vat provides set-off for the tax paid earlier and this is given effect through the concept of input tax credit /rebate.
Coverage of set-off/input tax credit: This input tax credit will be given to both manufacturers and
traders for purchase of inputs/supplies that are meant for both sales within the state as well as to other
states, irrespective of when those items will be utilised/sold. This also reduces the immediate tax
liability. Even for stock transfer/consignment sale of goods out of the state, the input tax paid in
excess of 4 per cent will be eligible for the tax credit.
Carrying over of tax credit: If the tax credit exceeds the tax that is payable on sales in a month, the
excess credit will be carried over to the end of next financial year. If there is any excess unadjusted
input tax credit at the end of second year, then the same will be eligible for a refund. Input tax credit
on capital goods will also be available for traders and manufacturers. Tax credit on capital goods
may be adjusted over a maximum of 36 equal monthly instalments. The states may at their option
reduce this number of instalments. There will be a negative list for capital goods (on the basis of
principles already decided by the EC) the are not eligible for input tax credit.
Treatment of exports: For all exports made out of the country, the tax paid within the state will be
refunded in full, and this refund will be made within three months. The units located in SEZ and EOU
will be granted either an exemption from the payment of an input tax or a refund of the input tax that
is paid within three months.
Inputs procured from other states: The tax paid on inputs procured from other states through
inter-state sale and stock transfer will not be eligible for credit. However, a decision has been taken
for duly phasing out of inter-state sales tax or CST. As a preparation for that, a comprehensive inter-
state tax information exchange system is also being set up.
Treatment of opening stock: All tax-paid goods purchased on or after April 1, 2004 and still in
stock as on April 1, 2005 will be eligible to receive an input tax credit, subject to submission of
requisite documents. The resellers holding tax-paid goods on April 1, 2005 will also be eligible. VAT
will be levied on the goods when sold on and after April 1, 2005, and the input tax credit will be given
for the sales tax that was already paid in the previous year. This tax credit will be available over a
period of six months after an interval of three months a needed for that is verification.
Compulsory issue of tax invoice, cash memo, or bill: This entire design of VAT with an input tax
credit is crucially based on a documentation of tax invoice, cash memo, or bill. Every registered
dealer, having a turnover of sales above an amount specified, shall issue to the purchaser, serially
numbered tax invoice with the prescribed particulars. This tax invoice will be signed and dated by the
dealer or his regular employee, showing the required particulars. The dealer shall keep a counterfoil
or duplicate of such tax invoice duly signed and dated. In case of failure to comply with the above will
attract a penalty.
Particulars to be specified in the Tax Invoice.
Tax Invoice shall contain all the particulars on the original, as well as, on all the copies:
i. The words Tax Invoice to be given in bold letters on the top or at any prominent place
ii. Name, address, and the registration certificate number of the selling dealer as well as the name and address of the
purchasing dealer
iii. The date and serial number of the Tax Invoice
iv. Description, quantity/number, and price of the goods sold
v. The amount of tax charged separately
vi. Space for signature of the selling dealer, employee, manager, or agent duly authorised
vii. The certificate to be specified by a registered dealer is as follows:
“I/we hereby certify that my/our registration certificate under the Maharashtra Value Added Tax Act,
2002 is in force on the date on which the sale of the goods specified in this tax invoice is made by
me/us and that the transaction of sale covered by this tax invoice has been effected by me/us”.
If the selling dealer is older of an Entitlement Certificate in place of the aforesaid certificate, he is
required to issue an invoice containing the following certificate:
“I/we hereby declare that sale of goods evidenced by this invoice is exempt from the whole of sale
tax in my/our hands on account of the Certificate of Entitlement bearing No. _____________ duly
granted to us and as such the purchaser shall not be entitled to claim any set off in respect of this
transaction under any provision of Maharashtra Value Added Tax Act, 2002 or the rules framed
hereunder.”
Registration, small dealers, and composition scheme: The registration of dealers with a gross
annual turnover of above Rs 5 lakh will be compulsory. There will be a provision for voluntary
registration. All the existing dealers will be automatically registered under the VAT Act. A new dealer
will be allowed a 30-day time from the date of liability to get registered. Small dealers with a gross
annual turnover not exceeding Rs 5 lakh will not be liable to pay VAT. The states will have flexibility
to fix a threshold limit within Rs 5 lakh. The small dealers with an annual gross turnover not
exceeding Rs 50 lakh, who are otherwise liable to pay VAT, shall, however, have the option for a
composition scheme with a payment of tax at a small percentage of gross turnover. The dealers
opting for this composition scheme will not be entitled to input tax credit. For the purpose of
registration, the limits of turnover are as follows:

Categ ory Limit of Total Turnover (Rs) Limit of Turnover of Taxable Goods (Rs)
Importer 100,000 10,000
Any other dealer 500,000 10,000

Tax-payer’s identification number (TIN): The Tax-Payer ’s Identification Number (TIN) will consist
of 11 digit numerals throughout the country. First two characters will represent the state code as used
by the Union Ministry of Home Affairs. The set-up of the next nine characters may, however, be
different in different states.
Return: Under VAT, simplified form of returns will be notified. The returns are to be filed
monthly/quarterly as specified in the State Acts/Rules, and will be accompanied with payment
challans. Every return furnished by dealers will be scrutinised expeditiously within the prescribed
time limit from the date of filing the return. If any technical mistake is detected on scrutiny, the dealer
will be required to pay the deficit appropriately.
Procedure of self-assessment of VAT liability: The basic simplification in VAT is that VAT
liability will be self-assessed by the dealers themselves in terms of submission of returns upon setting
off the tax credit. Return forms as well as other procedures will be simple in all states. There will no
longer be a compulsory assessment at the end of each year, as exists now. If no specific notice is
issued proposing a departmental audit of the books of accounts of the dealer within the time limit
specified in the Act, the dealer will be deemed to have been self-assessed on the basis of returns
submitted by him. Because of the importance of the concept of self-assessment in VAT, the provision
for “self-assessment” will be stated in the VAT bills of the states.

The self-assessment of the VAT liability, by the dealers themselves, in terms of submission of returns upon setting off the tax
credit, has led to basic simplification in Vat Further, the correctness of the self assessment can be checked through a system
of departmental audit.
Audit: Correctness of self-assessment will be checked through a system of departmental audit. A

certain percentage of the dealers will be taken up for an audit every year on a scientific basis. If,
however, any evasion is detected on the audit, the concerned dealer may be taken up for audit for the
previous periods. This audit wing will remain delinked from the tax collection wing to remove any
bias. The audit team will conduct its work in a time-bound manner, and the audit will be completed
within six months. The audit report will be transparently sent to the dealer also.
Simultaneously, for cross-checking, a computerised system is being worked out on the basis of
coordination between the tax authorities of the State governments and the authorities of the Central
Excise and Income Tax to compare constantly the tax returns and the set-off documents of the VAT
system of the States and those of the Central Excise and Income Tax. This comprehensive, cross-
checking system will help to reduce tax evasion and will also lead to a significant growth in tax
revenue. At the same time, by protecting transparently the interests of tax-complying dealers against
the unfair practices of tax-evaders, the system will also bring in more equal competition in the sphere
of trade and industry.
Declaration form: There will be no need for any provision for a concessional sale under the VAT
Act as the provision for set-off makes the input zero-rated. Hence, there will be no need for a
declaration form, which will be a further relief for dealers.
Incentives: Under the VAT system, the existing incentive schemes may be continued in the manner
that mey be deemed appropriate by the states after ensuring that the VAT chain is not affected.
Other taxes: As mentioned earlier, all other existing taxes such as turnover tax, surcharge,
additional surcharge, and Special Additional Tax (SAT) would be abolished. There will not be any
reference to these taxes in the VAT bills. The states that have already introduced entry tax and intend to
continue with this tax should make it VAT-able. If not made VAT-able, the entry tax will need to be
abolished. However, this will not apply to the entry tax that may be levied in lieu of octroi.
Penal provisions: The penal provisions in the VAT bills should not be more stringent than in the
existing Sales Tax Act.
Coverage of goods under VAT: In general, all the goods, including the declared goods, will be
covered under VAT and will get the benefit of input tax credit. The only few goods which will be
outside VAT will be liquor, lottery tickets, petrol, diesel, aviation turbine fuel, and other motor spirits
as their prices are not fully market determined. These will continue to be taxed under the Sales Tax
Act or any other State Act or even by making special provisions in the VAT Act itself, and with
uniform floor rates decided by the EC.
VAT rates and classification of commodities: Under the VAT system covering about 550 goods,
there will be only two basic VAT rates of 4 per cent and 12.5 per cent, plus a specific category of tax-
exempted goods and a special VAT rate of 1 per cent only for gold and silver ornaments, and so on.
Thus, the multiplicity of rates in the existing structure will be done away with under the VAT system.
Under the exempted category, there will be about 46 commodities comprising of natural and
unprocessed products in the unorganised sector, items which are legally barred from taxation, and
items which have social implications. Included in this exempted category is a set of maximum of 10
commodities that are flexibly chosen by individual states from a list of goods (finalised by the EC),
which are of local social importance for the individual states without having any inter-state
implication. The rest of the commodities in the list will be common for all the states. Under the 4 per
cent VAT rate category, there will be the largest number of goods (about 270), common for all the
states, comprising of items of basic necessities such as medicines and drugs, all agricultural and
industrial inputs, capital goods, and declared goods. The schedule of commodities will be attached to
the VAT bill of every state. The remaining commodities, common for all the states, will fall under the
general VAT rate of 12.5 per cent. In terms of decision of the EC, VAT on AED items that are relating
to sugar, textile, and tobacco, because of initial organisational difficulties, will not be imposed for
one year after the introduction of VAT, and till then the existing arrangement will continue. The
position will be reviewed after ane year.
Effects of the VAT system: This design of the state-level VAT has been carefully worked out by
the EC after repeated interactions with the states and others concerned and by striking a balance
between the needed convergence and federal flexibility as well as the ground-level reality. If all the
components of the VAT design are taken together now, then it will be seen that the total effect of this
VAT system will be to rationalise the tax burden and bring down, in general, the price level. This will
also stop the unhealthy tax-rate “war” and trade diversion among the states, which had adversely
affected the interests of all the states in the past. Moreover, this VAT design will also significantly
bring in simplicity and transparency in the tax structure, thereby improving the tax-compliance and
eventually, the revenue growth too, as mentioned in the beginning.
Steps Taken by the States
It is now of significance to note that most of the states, after a collective interaction in the EC, have
either already modified or agreed to modify their VAT bills by incorporating the above common
points of convergence including flexibility as mentioned in the VAT design above, and are also taking
other preparatory steps towards the introduction of VAT from April 1, 2005. As a part of the
preparatory steps, the states have started the process of preparing the draft of VAT Rules, including
Books of Accounts to be maintained. The objective will be to keep these as simple as possible so that
it becomes easy for a small trader to comply with the requirements.
Moreover, the states have initiated; and in many cases, have also completed, the steps for
computerisation up to the levels of AOs and also at the check posts. This process will continue as this
is extremely important for a document-based verification and an integration with Taxation
Information Exchange System as well as with the information of the Central Excise and Income Tax
Systems as indicated earlier. It may be mentioned here that appropriate Central funds for VAT-related
computerisation in the north-eastern states are also being released by the Government of India.
Related Issues
While the states have thus taken several steps towards introduction of VAT, certain supporting
decisions were critically needed at the national level for a more effective implementation of VAT
from April 1, 2005. It needs to be carefully noted that although the introduction of VAT may, after a
few years, lead to revenue growth, there may be a loss of revenue in some states in the initial years of
transition. It is with this in view that the Government of India had agreed to compensate for 100 per
cent of the loss in the first year, 75 per cent of the loss in the second year, and 50 per cent of the loss
in the third year of introduction of VAT; and the loss would be computed on the basis of an agreed
formula. This position has not only been reaffirmed by the Union Finance Minister in his Budget
Speech of 2004–05, but a concrete formula for this compensation has also now been worked out after
an interaction between the Union Finance Minister and the EC.
As mentioned earlier, there is also a need, after the introduction of VAT, for phasing out the CST.
However, the states are now collecting nearly Rs 15,000 crore every year from CST. There is
accordingly a need of compensation from the Government of India for this loss of revenue as CST is
phased out. Moreover, while CST is phased out, there is also a critical need for putting in place a
regulatory framework in terms of the Taxation Information Exchange System to give a
comprehensive picture of the inter-state trade of all commodities. As already mentioned, this process
of setting up of Taxation Information Exchange System has already been started by the EC, and is
expected to be completed within a year. The position regarding CST will be reviewed by the EC
during 2005–06, and a suitable decision on the phasing out of CST will be taken.
It is also essential to bring imports into the VAT chain. Because of the set-off, this will not result in
any tax-cascading effect, but will only improve tax compliance. A proposal for VAT on imports,
including the collection mechanism with adequate safeguards for the protection of interest of land-
locked states, is being discussed with the Government of India. Similarly, the discussion between the
EC and the Government of India is going on for an early decision on the question of collection and
appropriation of service tax by the Centre and the states. If decisions on VAT on imports and service
tax are taken expeditiously at the national level, then these two important spheres of taxation can be
integrated, along with the AED items as mentioned earlier, into the VAT system of the states from the
second year of introduction of VAT.
It may be noted that this VAT design has been worked out carefully by the EC to strike a balance not
only between the common points of convergence and federal flexibility, but also a balance between
what can be done to begin with and what should be incorporated subsequently for a further perfection
of the VAT system. For a successful implementation of the state-level VAT, a close interaction with
trade and industry is especially important. The EC has, therefore, also set up a Consultative
Committee with one representative from each of the national-level trade organisations and national-
level chambers of commerce and industry. This Committee has already started interacting with the
EC. This process of interaction will continue regularly to discuss issues and sort out the problems of
implementation of VAT. Such Consultative Committees will also be set up at the level of each state,
and interaction with the State government will take place in a similarly regular manner.
In the course of discussion with the representatives of trade and industry, reference has often been
made to the earlier VAT bills of some of the states. It should be clearly noted, as already mentioned
before, that all the states have agreed to amend their earlier VAT bills so as to conform broadly to the
common design as elaborated in this White Paper. This process of amendment has also already
started. The point of reference on VAT should, therefore, be this design of VAT as explained in this
White Paper. It should also be mentioned that there are some important points on the ground-level
implementation of VAT, which have been raised by the representatives of trade and industry. Many of
the points will be taken care of in the VAT rules of the states, with changes wherever necessary.
Finally, a comprehensive campaign on the state-level will be launched to communicate in a simple
and transparent manner the benefit of VAT for common people, traders, industrialists, and also the
State governments. This campaign will then be launched first at the national level on the basis of a
necessary coordination between the states and the Centre. This will then be simultaneously followed
up at the level of every state and also in districts of the states. This campaign will be based on the
written materials as well as publicity through all forms of media. The purpose of this campaign will
be a two-way interaction between the government and the trade and industry as well as the common
people. We have been looking forward to the introduction of state-level VAT by all the states and UTs
from April 1, 2005. We seek cooperation of all sections of people in the country.
Computation of VAT
Suppose a prime producer supplies sugarcane and the final consumer buys sugar. In this process, the
sugarcane passes through various processes, requiring a payment of VAT at the rate of 10 per cent. In
this supply chain, the payment of VAT would be as in Table 17.8. The Central government has agreed
to compensate the states for a 100 per cent loss in the first year, 75 per cent loss in the second year,
and 50 per cent loss in the third year of the introduction of VAT. The VAT tax rate from April, 1, 2005
as proposed by the Ministry of Finance is given in Table 17.9.

Table 17.8 Computation of VAT
Source: http://www.tn.gov.in/misc.

Table 17.9 Proposed VAT Rate
Source: A White Paper on a state-level VAT by the EC of State Finance Ministers (Constituted by the Ministry of Finance, Government of
India).

CASE
Whenever the government companies or financial institutions fight tax cases more often than not, the
issue is not only interesting but also sets important principles for other assessees to follow. The stakes
are naturally high in such cases and sufficient legal points emerge from these battles. Recently, the
Bank of India had to fight out its own case of getting an exemption under Section 54-E of the IT Act,
1961, when the section was in force. This case is peculiar as the Bank availed itself of the exemption
in accordance with the Scheme which was floated by it. This pointed issue came up before the
Mumbai Bench of the Tribunal in the concerneded bank vs DCIT.
The assessee, the Bank, framed a bond scheme and issued three-year capital bond. The institution
while computing a chargeable income under the long-term capital gain claimed a deduction under the
Section 54 E(1) of the amount invested in purchasing the said bonds. The AO opined that the plain and
simple meaning of an investment or deposit was the withdrawal of fund from one person and transfer
of the same to another person; and that a person cannot invest or deposit with himself.
The AO held that the assessee had merely transferred the amount from one of its own accounts to
another, and such a book entry could not be treated as an investment even if a certificate/bond was
issued in respect thereof. On appeal, the Commissioner (Appeals) upheld the impugned order. The
matter reached the Tribunal, and the issue here in simple term was: Could a Bank avail itself of a tax
exemption in accordance with a scheme that is floated by itself?
The Bombay Tribunal held that the Bank was entitled to the exemption under the Section 54 E(1)
though the scheme was floated by itself. An analysis of the Section provides that where the gain the
aroses from the transfer of a long-term capital asset, and an assessee invests or deposits the whole or
any part of the net consideration in any specified assets within six months after the date of such
transfer, that assessee is entitled to an exemption.
The explanation below Section 54 E(1) had stated that an investment can be made in any of the
assets that are specified in Clause (c) of such bonds that are issued by any public sector company, as
the Central government may by a notification specify in that behalf. Through a Notification dated
April 13, 1987, the government specified the three-year capital bonds that were issued by the bank for
the purpose of the said clause (c). In pursuance of that Notification, the assessee had framed a bond
scheme.
The Tribunal reasoned, “The scheme was available to all tax-payer residents in India, other than the
minors and persons of unsound mind. The assessee was not precluded from opting the scheme.
However, overtly it seems that the legislative intent in not providing for a distinct bar against an
acroses investing in its own scheme, so as to entitle itself to claim exemption under Section 54-E,
would allow such a legal infeasibility”.
At the first sight, the request of the assessee under the Section 54 E and the intent of the legislature
in enacting that Section appeared to be mutually contradictory. It was not so. The Tribunal also
disregarded the promise that a person cannot invest in himself on the reasoning that “It was not a case
where there was no parting with funds. The funds in which the investment had been made did not
remain or continue with the assesee”. The assessee undeniably had no control over that fund. So it was
wrong to say that the assessee was bound to use that fund of its own, in its own business, or for other
development activities and that, therefore, the purpose of Section 54 E was defeated, as the assessee
has no control over or access to the fund.
It was not possible for the assessee to utilise it in its own business. That being so, even though the
depositor, the investor or transferor, and the transferee remained one and the same, that is, the
assessee itself, the fund was safely out of the reach of the assessee. That presented a simulated setting
where in spite of the assessee transferring the amount to its own fund, it had no power over the fund;
thereby, bringing its case at par with that of an assessee other than the Bank itself. Hence, the purpose
of Section 54-E was fully served, the assessee having complied with the terms of the bond scheme,
and there being no prohibition in the law against the assessee investing in the scheme in the obtaining
scenario.
The Tribunal held that the Bank was entitled to the exemption under the Law. In the Case discussed
above, it was a similar situation of trying to get an exemption through one’s own scheme. But then,
the funds earmarked for the investment were distinct and separate, the Tribunal came to the
conclusion that the assessee was an independent entity and the scheme floated by the assessee was
distinct and separate.
Case Questions
1. Suggest your views on this case.

2. Do you support the decision taken by the Tribunal?
SUMMARY
India has a well-developed tax structure with the authority to levy taxes that are divided between the
Union and the State governments. The union government levies direct taxes such as personal income
tax and corporate tax, and indirect taxes like custom duties, excise duties, and CST. The states are
empowered to levy state sales tax apart from various other local taxes like entry tax, octroi, and so
on. Taxation has always played an important role in the formulation of the government’s industrial
policy. One of the objectives of the recent economic reforms is the rationalisation of the tax structure
in the country.
In 1991, the government set up a special committee, the Raja Chelliah Committee on tax reforms, to
review the country’s tax system. Its mandate was to make recommendations to make the tax system
more elastic and broad based, and to suggest means that are required for simplifying the existing laws
and regulations to facilitate a better enforcement and compliance. The recommendations made by this
Committee envisaged simplified procedures and a rationalised rate structure. The government has
implemented a large number of recommendations such as:
drastic reduction in customs and excise duties
lowering of corporate tax rates
removing the distinction between widely held and closely held companies
extending MODVAT to more industries
simplifying income tax return-filing procedures
levying taxes on services like insurance, stockbroking, and telephones
The government intends to substantially implement the Committee’s recommendations in the next
few years. Other recommendations yet to be implemented include the introduction of VAT and
streamlining tax administration, appellate procedures, and procedures for searches and raids. Tax
revenue as percentage of GNP (gross national product) has been consistently increasing with the
lion’s share of the revenues that are increasingly attributable to indirect taxes—particularly, customs
and excise.
The report given by the EC of State Finance Ministers in the form of White Paper, is a result of
collective efforts of all the states in formulating the basic design of the state-level VAT through
repeated and candid discussions in the EC of the State Finance Ministers. The state-level VAT, as
elaborated in this White Paper, has certain distinct advantages over the existing sales tax structure.
The VAT will not only provide a full set-off for an input tax as well as tax on previous purchases, but
will also abolish the burden of several of the existing taxes, such as turnover tax, surcharge on sales
tax, additional surcharge, SAT, and so on. In addition, CST is also going to be phased out.
As a result, the overall tax burden will be rationalised, and the prices, in general, will fall.
Moreover, VAT will replace the existing system of inspection by a system of built-in self-assessment
by traders and manufacturers. The tax structure will become simple and more transparent. This will
significantly improve tax compliance and will also help increase revenue growth. While this state-
level VAT has all these advantages, it is a state subject derived from Entry 54 of the State List, for
which the states are sovereign in taking decisions. On these decisions on VAT, the states, through
discussion in the EC, have found it in their interests, to avoid unhealthy competition and have certain
features of VAT to be common for all the states. These features will constitute the basic design of
VAT. At the same time, the states will have freedom for appropriate variations that are consistent with
this basic design. This White Paper is a collective attempt of the states to strike a balance between this
needed commonality and the desired, federal flexibility in the VAT structure.
The White Paper also strikes a balance between what is possible in the VAT design to begin with
and what can be improved upon in the subsequent years as we gather more experience. The White
Paper further mentions how after working out a consensus on this VAT design, nearly all the states
either have finalised their VAT bills by now and are in the process of obtaining presidential assent, or
will reach that stage very soon. Even for one major state where there are some ground-level
problems, a positive interaction with the EC has recently opened up the possibility of resolving most
of these problems.
These efforts of the states towards formulation of VAT design and its implementation have received
the full cooperation of the Finance Ministry, Government of India. At the same time, the Finance
Ministry has never imposed their views on us. We, therefore, remain thankful to the former Union
Finance Ministers—Dr. Manmohan Singh, Mr. Yashwant Sinha, and Mr. Jaswant Singh. We are
specially grateful to Mr. P. Chidambaram, the present Union Finance Minister, for his active support
over the last eight months, when he not only helped to formulate the modality of Central financial
support to the states for a possible loss of revenue in the transitional years of implementation of VAT,
but also took time off his busy schedule to participate with us in the campaign for VAT in the states.
It has always been fruitful to have an interaction with Dr. Parthasarathi Shome, the Advisor to the
Union Finance Minister, for his insightful observations on the analytical structure of VAT as well as
his references due to his vast experience in the implementation of VAT. The Secretary, Revenue; the
Additional Secretary, Revenue; and all the concerned officials of the Revenue Department of the
Finance Ministry have helped us by participating in the discussions whenever we requested them, and
also by assisting in various procedural matters. An interaction with Dr. Govinda Rao, the Chairman of
the Technical Experts Committee on VAT, and other members of the Committee has also been useful.
We take this opportunity to thank all of them.
Discussions with the representatives of trade organisations and chambers of commerce and
industry at the national level as well as in the state level have been relevant in assessing the ground-
level difficulties. Together with them, we are determined to overcome these difficulties in
implementing VAT in the states. We remain thankful to them, and our mutual interaction will take
place regularly.
Finally, this White Paper could be written only on the basis of a lively support of the Finance
Ministers of the states, and with a constant help from the Finance Secretaries and the Commissioners
of Commercial Taxes of the states. The Commissioners of Commercial Taxes have often burnt their
mid-night oil, and their contribution should be particularly recorded. Mr. Ramesh Chandra, the
Member-Secretary of the EC had to carry on the difficult administrative task in the functioning of the
EC. We appreciate the efforts of Mr. Chandra and the staff of the EC.
Even after all these efforts, there may be some unavoidable shortcomings in this White Paper,
which we will try to overcome as we learn more from the actual experience in implementing the VAT.
With this background and the attitude, this White Paper is an expression of the genuine commitment
of the states to the implementation of VAT from April 1, 2005.
KEY WORDS
Direct Tax
Indirect Tax
Assessment Year
Previous Year
Assessee
Amalgamation
Capital Asset
Permanent Account Number (PAN)
Corporate Tax
Set-off
Fringe Benefits
Wealth Tax
Excise Duties
Customs Tariff
MODVAT
CENVAT
Capital Goods
VAT
TIN
Resident of India
HUF
Individual Tax Rates
Agricultural Income
Average Rate of Income Tax
Assessing Officer (AO)
QUESTIONS
1. Define income tax. Discuss its assessment procedure and income exempted from tax rates.
2. Explain how CENVAT is charged on capital goods.
3. List down the provisions of CENVAT.
4. List down the highlights of the Union Budget, 2008 on custom tariff and income tax.
5. Explain how VAT is computed?
6. What do you mean by corporate tax? Discuss the provisions of corporate tax in respect of set-off and carryforward loss.
a. Wealth Tax
b. Excise Duties
c. Custom Tariffs
d. Central Sales Tax Act, 1956
REFERENCES
Balchandani, K. R. (2001). Business Law for Management, 2nd revised ed. Hyderabad: Himalaya Publishing House.
CBDT Department of India, www.surfindia.com
Central Board of Direct Taxes (CBDT), http://finmin.nic.in
Datey, V. S. (2001). Indirect Taxes. New Delhi: Taxmann Publications.
Directorate General of Foreign Trade, http://dgft.delhi.nic.in
Government of India, http://indiabudget.nic.in
Gulshan, S. S. and G. K. Kapoor (2006). Business Law Including Company, 10th ed. New Delhi: New Age International Pub.
Income Tax Department, www.incometaxindia.gov.in
Ministry of Finance, http://finmin.nic.in
Pagare, D. (2001). Indirect Taxes. New Delhi: Sultan Chand.
Pagare, D. (2005). Law and Practice of Income Tax, 27th revised ed. New Delhi: Sultan Chand.
Pagare, D. (2005). Tax Law, 13th ed. New Delhi: Sultan Chand.
Pagare, D. (2006). Business Taxation, 7th ed. New Delhi: Sultan Chand.
Shanbhag, A. N. (2001). In the Wonderland of Investment, 14th revised ed. Mumbai: Focus Popular Prakashan.
Singhania, V. K. (2001 and 2002). Direct Taxes. New Delhi: Taxmann Publications.
CHAPTER 18
MRTP Act, FERA, and FEMA
CHAPTER OUTLINE
Monopolies and Restrictive Trade Practices Act (MRTP), 1969
Foreign Exchange Regulation Act (FERA), 1973
Foreign Exchange Management Act (FEMA), 1999
Case
Key Words
Questions
References
MONOPOLIES AND RESTRICTIVE TRADE PRACTICES ACT (MRTP), 1969
This Act was enacted to prevent the concentration of economic power to common detriment, control
of monopolies, and prohibition of monopolistic and restrictive trade practices (MRTP) and matters
connected therewith.

This Act was enacted to prevent the concentration of economic power to common detriment, control of monopolies, and
prohibition of monopolistic and restrictive trade practices (MRTP) and matters connected therewith.
Prevention of Concentration of Economic Power
Under this enactment, any undertaking producing one-fourth or more of any type of goods and
having assets of more than Rs 1 crore, is required to obtain clearance for any scheme of expansion.
Initially, for the purpose of computing, the total goods produced by the undertaking, including goods
that were exported, were also taken into account. By an amendment in 1980, goods which are
exported are no longer taken into account while computing the total goods produced. The amendment
was in view of the objective of the enactment to control such practices within India.
Monopolistic Trade Practices
Section 2(i) of the Act defines monopolistic trade practice while Section 31 provides for investigation
into such practices by the MRTP Commission, either on reference by the Central government or on
receipt of an information about the carrying on of such activities by any such undertaking.
Monopolistic trade practices such as maintenance of prices and profits at unreasonable levels,
arbitrary price increases, high expenditure on advertisement, and high power salesmanship to
maintain the undertaking in a monopoly situation, limiting technical detriment to common detriment
or allowing quality of goods to deteriorate, are some of the situations which would call for
investigation and action under this enactment. Under Section 32 of the Act, such monopolistic trade
practices are deemed to be prejudicial to public interest.
Permitted Monopolistic Trade Practices
The Central government may permit monopolistic practices if satisfied that it would be necessary for
defence purposes, to ensure maintenance of supply of essential goods/services, or to give effect to
any terms of an agreement to which the Central government is a party.
Restrictive Trade Practices (RTPs)
Section 2(O) defines restrictive trade practices (RTPs), which may be investigated by the MRTP
Commission under Section 37 of the Act. RTPs include differential or discriminatory incentives
based on quantities, stipulation in agreement as to the prices that should be charged on resale,
territorial restrictions and restricting terms of guarantee, bumper prize contests wherein the prices of
goods are increased to cover the cost of prizes, announcing loan facilities without a guarantor while
charging guarantor ’s commission, sale of goods for a particular price and issue of cash memos for a
lesser sum, display of price lists indicating maximum recommended rates, and absence of indication
that a lower price could be charged thus encouraging the consumer.
MRTP and New Industrial Policy, 1991
The MRTP Act became effective in June 1970. With the emphasis placed on productivity in the Sixth
Plan, major amendments to the MRTP Act were carried out in 1982 and 1984 in order to remove the
impediments to industrial growth and expansion. This process of change was given a new momentum
in 1985 by an increase of the threshold limit of assets.

The MRTP Act became effective in June 1970. With the emphasis placed on productivity in the Sixth Plan, major
amendments to the MRTP Act were carried out in 1982 and 1984 in order to remove the impediments to industrial growth
and expansion.
With the growing complexity of industrial structure and the need for achieving economies of scale
for ensuring higher productivity and competitive advantage in the international market, the
interference of the government through the MRTP Act in investment decisions of large companies has
become deleterious in its effects on the Indian industrial growth. The pre-entry scrutiny of investment
decisions by the so-called MRTP companies will no longer be required. Instead, the emphasis will be
on controlling and regulating monopolistic, restrictive, and unfair trade practices (UTPs) rather than
making it necessary for the monopoly houses to obtain prior approval of the Central government for
expansions; establishment of new undertakings; merger, amalgamation, and take-over, and
appointment of certain directors. The thrust of policy will be more on controlling UTPs or RTPs.
The MRTP Act will be restructured by eliminating the legal requirement for prior governmental
approval for expansion of present undertakings and establishment of new undertakings. The
provisions relating to merger, amalgamation, and take-over will also be repealed. Similarly, the
provision regarding restrictions on acquisition of and transfer of shares will be appropriately
incorporated in the Companies Act.
Simultaneously, the provisions of the MRTP Act will be strengthened in order to enable the MRTP
Commission to take appropriate action in respect of the monopolistic, restrictive, and UTPs. The
newly empowered MRTP Commission will be encouraged to require investigation suo moto or on
complaints received from individual consumers or classes of consumers. Box 18.1 gives an overview
of the MRTP Act.

Box 18.1 An Overview of the MRTP Act
Section Provision
2(0) Defines an RTP
2(g) Defines interconnect undertakings
3 Provides exemptions from MRTP provision
5 Relates to formation of MRTPs by Central government
10(a) & (k), 10(b), 36B Relates to formation of MRTPs by Central government
11 Relates to power of the DGIR regarding preliminary investigation
12(2 Confers power of civil court to MRTP Commission
Relates to power of Central government for division of
27(2)
undertaking
31(2) Specifies power of Central government in respect of MRTPs
33(1) Gives “deemed” RTPs
33(1)(f) Defines resale price maintenance
35(1)(j) Defines price control arrangement
35(h) Provides for registration requirement of RTPs
36(a) Defines Unfair Trade Practices (UTPs)
38 Provides “gateways” to RTPs
FOREIGN EXCHANGE REGULATION ACT (FERA), 1973
This Act consolidates and amends the law regulating certain payments, dealings in foreign exchange
and securities, transactions indirectly affecting foreign exchange and the import and export of
currency for the conservation of foreign exchange resources of the country, and the proper utilisation
thereof in the interests of the economic development of the country.

FERA applies to all citizens within and outside of India and to branches and agencies of companies/corporate bodies
registered or incorporated in India. Its main objective is to consolidate and amend the law regulating certain payments,
dealings in foreign exchange and securities, transactions indirectly affecting foreign exchange and the import and export of
currency for the conservation of the foreign exchange resources of the country, and the proper utilisation thereof in the
interests of the economic development of the country.
This Act extends to the whole of India. It also applies to all citizens of India, outside India, to
branches and agencies outside India and of companies or bodies corporate, registered, or
incorporated in India. It shall come into force on such date as the Central government may, by
notification in the Official Gazette, appoint in this behalf, provided that different dates may be
appointed for different provisions of this Act and any reference in any such provision to the
commencement of this Act shall be construed as a reference to the coming into force of that
provision.
Definitions
In this Act, unless the context otherwise requires

i. “Appellate Board” means the Foreign Exchange Regulation Appellate Board, constituted by the Central government under sub-
section (1) of Section 52.
ii. “Authorised dealer” means a person for the time being authorised under Section 6 to deal in foreign exchange.
iii. “Bearer certificate” means a “certificate of title to securities” by the delivery of which (with or without endorsement), the title to
the securities is transferrable.
iv. “Certificate of title to a security” means any document used in the ordinary course of business as a proof of the possession or
control of the security, or authorising or purporting to authorise, either by an endorsement or by delivery, the possessor of the
document to transfer or receive the security thereby represented.
v. “Currency” includes all coins, currency notes, bank notes, postal notes, postal orders, money orders, cheques, drafts,
travellers’ cheques, letters of credit, bills of exchange, and promissory notes.
vi. “Foreign currency” means any currency other than Indian currency.
vii. “Foreign exchange” means foreign currency and includes all deposits, credits, and balances payable in any foreign currency,
and any drafts, travellers’ cheques, letters of credit, and bills of exchange—expressed or drawn in Indian currency but payable
in any foreign currency; and any instrument payable, at the option of the drawee or holder thereof or any other party thereto,
either in Indian currency or in foreign currency, or partly in one and partly in the other.
viii. “Foreign security” means any security created or issued elsewhere than in India, and any security, the principal of or interest on,
which is payable in any foreign currency, elsewhere than in India.
ix. “Indian currency” means currency which is expressed or drawn in Indian rupees but does not include special bank notes and
special one-rupee notes issued under Section 28A of the Reserve Bank of India Act, 1934.
x. “Indian custom waters” means the waters extending into the sea to a distance of 12 nautical miles measured from the appropriate
base line on the coast of India and includes any bay, gulf, harbour, creek, or tidal river.
xi. “Money-changer” means a person for the time being authorised under Section 7 to deal in foreign currency.
xii. “Overseas market”, in relation to any goods, means the market in a country outside India and in which such goods are intended
to be sold.
xiii. “Owner”, in relation to any security, includes any person who has the power to sell or transfer the security, or who has the
custody thereof or who receives, whether on his own behalf or on behalf of any other person, dividends or interest thereon, and
who has any interest therein, and in a case where any security is held on any trust or dividends or interest thereon, are paid into a
trust fund, also includes any trustee or any person entitled to enforce the performance of the trust, or to revoke or vary, with or
without the consent of any other person, the trust, or any terms thereof, or to control the investment of the trust’s money.
xiv. “Person resident in India (PRI)” means a citizen of India, who has, at any time after March 25, 1947, been staying in India but
does not include a citizen of India who has gone out of, or stays outside India, in either case
a. for or on taking up employment outside India, or
b. for carrying on outside India a business or vocation outside India, or
c. for any other purpose, in such circumstances as would indicate his intention to stay outside India for an uncertain period;
or a citizen of India, who having ceased by virtue of paragraph (a) or paragraph (b) or paragraph (c) of sub-clause (I)
to be a resident in India, returns to, or stays in, India, in either case
a. for or on taking up employment in India, or
b. for carrying on in India a business or vocation in India, or
c. for any other purpose, in such circumstances as would indicate his intention to stay in India for an uncertain
period;
or a person, not being a citizen of India, who has come to, or stays in, India, in either case:
c. for staying with his or her spouse, such spouse being a PRI, or
d. for any other purpose, in such circumstances as would indicate his intention to stay in India for an uncertain
period;
or acitizen of India, who, not having stayed in India at any time after March 25, 1947, comes to India for any
of the purposes referred to in paragraphs (a), (b), and (c) of sub-clause (iii), or for the purpose and in the
circumstances referred to in paragraph (d) of that sub-clause, or having come to India stays in India for any
such purpose and in such circumstances.
A person, who has, by reason only of paragraph (a) or paragraph (b) or paragraph (d) of sub-clause (iii),
been a resident in India, shall, during any period in which he is outside India, be deemed to be not a resident in
India.
xv. “Person resident outside India (PROI)” means a person who is not a resident in India.
xvi. “Precious stones” includes pearls and semi-precious stones and such other stones or gems as the Central government may for
the purposes of this Act, notify in this behalf in the Official Gazette.
xvii. “Prescribed” means prescribed by rules made under this Act.
xviii. “Reserve Bank” means the Reserve Bank of India (RBI).
xix. “Security” means shares; stocks; bonds; debentures; debenture stock; government securities as defined in the Public Debt Act,
1944; savings certificates to which the Government Savings Certificates Act, 1959 applies; deposit receipts in respect of deposits
of securities, and units or sub-units of unit trusts, and includes certificates of title to securities, but does not include bills of
exchange or promissory notes other than government promissory notes.
Moneychangers
The Reserve Bank may, on an application made to it in this behalf, authorise any person to deal in
foreign currency. An authorisation under this Section shall be in writing and
i. may authorise dealings in all foreign currencies or may be restricted to authorising dealings in specified foreign currencies only;
ii. may authorise transactions of all descriptions in foreign currencies or may be restricted to authorising specified transactions only;
iii. may be granted with respect to a particular place where alone the moneychanger shall carry on his business;
iv. may be granted to be effective for a specified period, or within specified amounts;
v. may be granted subject to such conditions as may be specified therein.
Any authorisation granted under sub-section (1) may be revoked by the Reserve Bank at any time if it
is satisfied that
i. it is in the public interest to do so; or
ii. the money-changer has not complied with the conditions subject to which the authorisation was granted or has contravened any
of the provisions of this Act or of any rule, notification, direction, or order made there under, provided that no such authorisation
shall be revoked on the ground specified in Clause (ii) unless the moneychanger has been given a reasonable opportunity for
making a representation in the matter.
The provisions of sub-sections (4) and (5) of Section 6 shall, in so far as they are applicable, apply in
relation to a moneychanger as they apply in relation to an authorised dealer. According to the Act,
“foreign currency” means foreign currency in the form of notes, coins, or travellers’ cheques and
“dealing” means purchasing foreign currency in the form of notes, coins, or travellers’ cheques or
selling foreign currency in the form of notes or coins.

A moneychanger is any person authorised by RBI in writing, to deal in foreign currency where “foreign currency” can be in
the form of notes, coins, or travellers’ cheques; and “dealing” means purchasing foreign currency in the form of notes,
coins, or travellers’ cheques, or selling the same.
Authorised Dealers in Foreign Exchange
The Reserve Bank may, on an application made to it in this behalf, authorise any person to deal in
foreign exchange. An authorisation under this section shall be in writing and
i. may authorise transactions of all descriptions in foreign currencies or may be restricted to authorising dealings in specified
foreign currencies only;
ii. may authorise dealings in all foreign currencies or may be restricted to authorising specified transactions only;
iii. may be granted to be effective for a specified period, or within specified amounts;
iv. may be granted subject to such conditions as may be specified therein.
Any authorisation granted under sub-section (1) may be revoked by the Reserve Bank at any time if it
is satisfied that
i. it is in the public interest to do so; or
ii. the authorised dealer has not complied with the conditions subject to which the authorisation was granted or has contravened any
of the provisions of this Act or of any rule, notification, direction, or order made thereunder, provided that no such authorisation
shall be revoked on the ground specified in Clause (ii) unless the authorised dealer has been given a reasonable opportunity for
making a representation in the matter.
Any authorised dealer shall, in all his dealings in foreign exchange and in the exercise and discharge
of the powers and of the functions delegated to him under Section 74, comply with such general or
special directions or instructions as the Reserve Bank may, from time to time, think fit to give, and,
except with the previous permission of the Reserve Bank, an authorised dealer shall not engage in any
transaction involving any foreign exchange, which is not in conformity with the terms of his
authorisation under this Section.
An authorised dealer shall, before undertaking any transaction in foreign exchange on behalf of
any person, requires that person to make such declarations and to give such information as will
reasonably satisfy him that the transaction will not involve, and is not designed for the purpose of,
any contravention or evasion of the provisions of this Act or of any rule, notification, direction, or
order made thereunder, and where the said person refuses to comply with any such requirement or
makes only unsatisfactory compliance therewith, the authorised dealer shall refuse to undertake the
transaction and shall, if he has a reason to believe that any such contravention or evasion as aforesaid
is contemplated by the person, report the matter to the Reserve Bank.

An authorised dealer before undertaking any transaction in foreign exchange needs to ensure that the transaction is not
designed for the purpose of any contravention or evasion of the provisions of this Act.
Restrictions on Dealing in Foreign Exchange
Except with the previous general or special permission of the Reserve Bank, no person other than an
authorised dealer shall in India, and no PRI other than an authorised dealer shall outside India,
purchase or otherwise acquire or borrow from, or sell, or otherwise transfer or lend to or exchange
with, any person not being an authorised dealer, any foreign exchange, provided that nothing in this
sub-section shall apply to any purchase or sale of foreign currency effected in India between any
person and a moneychanger. For the purposes of this subsection, a person, who deposits foreign
exchange with another person or opens an account in foreign exchange with another person, shall be
deemed to lend foreign exchange to such other person.
Except with the previous general or special permission of the Reserve Bank, no person, whether an
authorised dealer or a moneychanger or otherwise, shall enter into any transaction which provides
for the conversion of Indian currency into foreign currency or foreign currency into Indian currency
at rates of exchange other than the rates for the time being authorised by the Reserve Bank.
Where any foreign exchange is acquired by any person, other than an authorised dealer or a
moneychanger, for any particular purpose, or where any person has been permitted conditionally to
acquire foreign exchange, the said person shall not use the foreign exchange so acquired otherwise
than for that purpose or, as the case may be, fail to comply with any condition to which the
permission granted to him is subject, and where any foreign exchange so acquired cannot be so used
or the conditions cannot be complied with, the said person shall, within a period of 30 days from the
date on which he comes to know that such foreign exchange cannot be so used or the conditions
cannot be complied with, sell the foreign exchange to an authorised dealer or to a moneychanger.

A person who has been permitted conditionally to buy foreign exchange and if he/she is not able to use it for the specified
purpose, then the said person shall sell the foreign exchange to an authorised dealer or money-changer within 30 days.
For the avoidance of doubt, it is hereby declared that where a person acquires foreign exchange for
sending or bringing into India any goods but sends or brings no such goods or does not send or
bring goods of a value representing the foreign exchange acquired, within a reasonable time or sends
or brings any goods of a kind, quality, or quantity different from that specified by him at the time of
acquisition of the foreign exchange, such person shall, unless the contrary is proved, be presumed not
to have been able to use the foreign exchange for the purpose for which he acquired it or, as the case
may be, to have used the foreign exchange so acquired otherwise than for the purposes for which it
was acquired. Nothing in this Section shall be deemed to prevent a person from buying from any post
office, in accordance with any law or rules made thereunder for the time being in force, any foreign
exchange in the form of postal orders or money orders.
Restrictions on Payments
1. Save as may be provided in and in accordance with any general or special exemption from the provisions of this sub-section,
which may be granted conditionally or unconditionally\by the Reserve Bank, no person in, or a resident in, India shall
a. make any payment to or for the credit of any PROI;
b. receive, otherwise than through an authorised dealer, any payment by order or on behalf of any person who is a
resident outside in India. For the purposes of this Clause, where any person in, or a resident in, India receives any
payment by order or on behalf of any PROI through any other person (including an authorised dealer), without a
corresponding inward remittance from any place outside India, then, such person shall be deemed to have received
such payment otherwise than through an authorised dealer;
c. draw, issue, or negotiate any bill of exchange or promissory note or acknowledge any debt, so that a right (whether
actual or contingent) to receive a payment is created or transferred in favour of any PROI;
d. make any payment to, or for the credit of, any person by order or on behalf of any PROI;
e. place any sum to the credit of any PROI;
f. make any payment to, or for the credit of, any person or receive any payment for, or by order or on behalf of, any
person as consideration for or in association with (i) the receipt by any person of a payment or the acquisition by any
person of property outside India and (ii) the creation or transfer in favour of any person of a right (whether actual or
contingent) to receive payment or acquire property outside India; and
g. draw, issue, or negotiate any bill of exchange or promissory note, transfer any security or acknowledge any debt, so
that a right (whether actual or contingent) to receive a payment is created or transferred in favour of any person as
consideration for or in association with any matter referred to in Clause (f).
2. Nothing in sub-section (1) shall render unlawful
a. the making of any payment already authorised either with foreign exchange obtained from an authorised dealer or a
moneychanger under Section 8 or with foreign exchange retained by a person in pursuance of an authorisation granted
by the Reserve Bank;
b. the making of any payment with foreign exchange received by way of salary or payment for services not arising from
any business in, or anything done while in, India.
3. Save as may be provided in, and in accordance with, any general or special exemption from the provisions of this sub-section,
which may be granted conditionally or unconditionally by the Reserve Bank, no person shall remit or cause to be remitted any
amount from any foreign country into India except in such a way that the remittance is received in India only through an
authorised dealer.
4. Nothing in this section shall restrict the doing by any person of anything within the scope of any authorisation or exemption
granted under this Act.
5. For the purposes of this Section and Section 19, “security” includes coupons or warrants representing dividends or interest and
life or endowment insurance policies.
Blocked Accounts
1. Where an exemption from the provisions of Section 9 is granted by the Reserve Bank in respect of payment of any sum to any
PROI and the exemption is made subject to the condition that the payment is made to a blocked account
a. the payment shall be made to a blocked account in the name of that person in such manner as the Reserve Bank may,
by general or special order, direct;
b. the crediting of that sum to that account shall, to the extent of the sum credited, be a good discharge to the person
making the payment.
2. No sum standing at the credit of a blocked account shall be drawn on except in accordance with any general or special
permission which may be granted conditionally or otherwise by the Reserve Bank.
3. In this section, “blocked account” means an account opened, whether before or after the commencement of this Act, as a
blocked account at any office or branch in India of a bank authorised in this behalf by the Reserve Bank, or an account
blocked, whether before or after such commencement, by order of the Reserve Bank.
From FERA to FEMA
In the wake of an acute shortage of foreign exchange in the country, the Government of India enacted
the Foreign Exchange Regulation Act (FERA) in 1973. Under this controversial piece of legislation,
foreign exchange law violators (which sometimes included big names in the Indian industry) were
treated as criminals and dealt with sternly.
Realising that FERA was not in tune with the economic reforms initiated since 1991, the
government replaced it with a new legislation—Foreign Exchange Management Act (FEMA), 1999,
which came into effect from June 1, 2000. FERA remained a nightmare for 27 years for the Indian
corporate world. FEMA set out its objectives as “facilitating external trade and payment” and
“promoting the orderly development and maintenance of foreign exchange market in India”.

FERA (1973) categorised foreign exchange law violators as criminals, and actions against them were very strict. It was
replaced by FEMA (1999) which aimed at facilitating external trade and payment and law rotators were treated as civil
offenders rather than as criminals.
Under FEMA, foreign exchange law violators are treated as civil offenders rather than as criminals
as was the case under FERA. Contravention of the provisions of FEMA invites monetary penalties.
Moreover, FEMA provides for a number of appellate authorities which can be approached by the
aggrieved party against whom penalties have been levied. Box 18.2 details the salient features of
FERA and FEMA.

Box 18.2 FERA and FEMA
FERA
FERA came into force on January 1, 1974.
It laid emphasis on exchange regulation and exchange control.
It was necessary to obtain Reserve Bank’s permission, either special or general, in respect of most regulations thereunder.
The draconian provisions of FERA gave unbridled power to the Enforcement Directorate to arrest any person, search any
premises, seize documents, and start proceedings against any person for contravention of FERA. A contravention under
FERA was treated as a criminal offence.
FEMA
FEMA was introduced by the Government of India in the Parliament on August 4, 1998.
It lays emphasis on exchange management and facilitates external trade and payments.
With the exception of Section(3), which relates to dealings in foreign exchange and so on, no other provision of FEMA
stipulates obtaining Reserve Bank’s permission.
Unlike FERA, violation of FEMA will not attract criminal proceedings. The contravention will be treated as a civil offence.

FOREIGN EXCHANGE MANAGEMENT ACT (FEMA), 1999
This Act consolidates and amends the law relating to foreign exchange with the objective of
facilitating external trade and payments and for promoting the orderly development and maintenance
of the foreign exchange market in India.
This Act extends to the whole of India. It shall also apply to all branches, offices, and agencies
outside India, owned or controlled by a PRI, and also to any contravention thereunder committed
outside India by any person to whom this Act applies. It shall come into force on such date as the
Central government may, by notification in the Official Gazette, appoint, provided that different dates
may be appointed for different provisions of this Act, and any reference in any such provision to the
commencement of this Act shall be construed as a reference to the coming into force of that
provision.

This Act extends to the whole of India. It shall also apply to all branches, offices, and agencies outside India, owned or
controlled by a PRI, and also to any contravention thereunder committed outside India by any person to whom this Act
applies.
Definitions
In this Act, unless the context otherwise requires

a. “Adjudicating Authority” means an officer authorised under sub-section (1) of Section 16.
b. “Appellate Tribunal” means the Appellate Tribunal for Foreign Exchange established under Section 18.
c. “Authorised person” means an authorised dealer, moneychanger, off-shore banking unit, or any other person for the time being
authorised under sub-section (1) of Section 10 to deal in foreign exchange or foreign securities.
d. “Bench” means a Bench of the Appellate Tribunal.
e. “Capital account transaction” means a transaction which alters the assets or liabilities, including contingent liabilities, outside
India of persons who are resident in India or assets or liabilities in India of persons who are resident outside India, and includes
transactions referred to in sub-section (3) of Section 6.
f. “Chairperson” means the Chairperson of the Appellate Tribunal.
g. “Chartered accountant” shall have the meaning assigned to it in Clause (b) of sub-section (1) of Section 2 of the Chartered
Accountants Act, 1949 (38 of 1949).
h. “Currency” includes all currency notes, postal notes, postal orders, money orders, cheques, drafts, travellers’ cheques, letters
of credit, bills of exchange and promissory notes, and credit cards or such other similar instruments, as may be notified by the
Reserve Bank.
i. “Currency notes” means cash in the form of coins and bank notes.
j. “Current account transaction” means a transaction other than a capital account transaction and without prejudice to the generality
of the foregoing, such transaction includes
i. payments due in connection with foreign trade, other current business, services, and short-term banking and credit
facilities in the ordinary course of business,
ii. payments due as interest on loans and as net income from investments,
iii. remittances for expenses of living parents, spouse, and children residing abroad, and
iv. expenses in connection with foreign travel, education, and medical care of parents, spouse, and children.
k. “Director of Enforcement” means the Director of Enforcement appointed under subsection (1) of Section 36.
l. “Export”, with its grammatical variations and cognate expressions, means
i. the taking out of India to a place outside India any goods and
ii. provision of services from India to any person outside India.
m. “Foreign currency” means any currency other than Indian currency;
n. “Foreign exchange” means foreign currency and includes
i. deposits, credits, and balances payable in any foreign currency,
ii. drafts, travellers’ cheques, letters of credit, or bills of exchange, expressed or drawn in Indian currency but payable in
any foreign currency, and
iii. drafts, travellers’ cheques, letters of credit, or bills of exchange drawn by banks, institutions, or persons outside India,
but payable in Indian currency.
o. “Foreign security” means any security, in the form of shares, stocks, bonds, debentures, or any other instrument denominated or
expressed in foreign currency, and includes securities expressed in foreign currency, but where redemption or any form of return,
such as interest or dividends, is payable in Indian currency.
p. “Import”, with its grammatical variations and cognate expressions, means bringing into India any goods or services.
q. “Indian currency” means currency which is expressed or drawn in Indian rupees but does not include special bank notes and
special one-rupee notes issued under Section 28A of the Reserve Bank of India Act, 1934 (2 of 1934).
r. “Legal practitioner” shall have the meaning assigned to it in Clause (i) of sub-section (1) of Section 2 of the Advocates Act,
1961 (25 of 1961).
s. “Member” means a Member of the Appellate Tribunal and includes the Chairperson thereof.
t. “Notify” means to notify in the Official Gazette and the expression “notification” shall be construed accordingly.
u. “Person” includes—an individual, a Hindu undivided family (HUF), a company, a firm, an association of persons (AOP) or a
body of individuals (BOI), whether incorporated or not, every artificial juridical person, not falling within any of the preceding
sub-clauses, and any agency, office, or branch owned or controlled by such person.
v. “Person resident in India (PRI)” means
i. a person residing in India for more than 182 days during the course of the preceding financial year but does not include
a. a person who has gone out of India or who stays outside India, in either case— for or on taking up
employment outside India, or for carrying on outside India a business or vocation outside India, or for any
other purpose, in such circumstances as would indicate his intention to stay outside India for an uncertain
period.
b. a person who has come to or stays in India, in either case, other than—for or on taking up employment in India,
or for carrying on in India a business or vocation in India, or for any other purpose, in such circumstances as
would indicate his intention to stay in India for an uncertain period; any person or body corporate registered or
incorporated in India: an office, branch, or agency in India—owned or controlled by a PROI; an office, branch
or agency outside—India; owned or controlled by a PRI.
w. “Person resident outside India (PROI)” means a person who is not a resident in India.
x. “Prescribed” means prescribed by rules made under this Act.
y. “Repatriate to India” means bringing into India the realised foreign exchange and the selling of such foreign exchange to an
authorised person in India in exchange for rupees, or the holding of realised amount in an account with an authorised person in
India to the extent notified by the Reserve Bank, and includes use of the realised amount for discharge of a debt or liability
denominated in foreign exchange, and the expression “repatriation” shall be construed accordingly.
z. “Reserve Bank” means the Reserve Bank of India constituted under sub-section (1) of Section 3 of the Reserve Bank of India
Act, 1934 (2 of 1934). In this Section,
i. “Security” means shares, stocks, bonds and debentures, government securities as defined in the Public Debt Act, 1944
(18 of 1944), savings certificates to which the Government Savings Certificates Act, 1959 (46 of 1959) applies, deposit
receipts in respect of deposits of securities and units of the Unit Trust of India established under sub-section (1) of
Section 3 of the Unit Trust of India Act, 1963, (52 of 1963) or of any mutual fund and includes certificates of title to
securities, but does not include bills of exchange or promissory notes other than government promissory notes or any
other instruments which may be notified by the Reserve Bank as security for the purposes of this Act.
ii. “Service” means service of any description which is made available to potential users and includes the provision of
facilities in connection with banking, financing, insurance, medical assistance, legal assistance, chit fund, real estate,
transport, processing, supply of electrical or other energy, boarding or lodging or both, entertainment, amusement or
the purveying of news or other information, but does not include the rendering of any service free of charge or under a
contract of personal service.
iii. “Special Director (Appeals)” means an officer appointed under Section 18.
iv. “Specify” means to specify by regulations made under this Act and the expression “specified” shall be construed
accordingly.
v. “Transfer” includes sale, purchase, exchange, mortgage, pledge, gift, loan, or any other form of transfer of right, title,
possession, or lien.
Authorised Person
The Reserve Bank may, on an application made to it in this behalf, authorise any person to be known
as the authorised person to deal in foreign exchange or in foreign securities, as an authorised dealer,
moneychanger or off-shore banking unit, or in any other manner as it deems fit. An authorisation
under this Section shall be in writing and shall be subject to the conditions laid down therein. An
authorisation granted under sub-section (1) may be revoked by the Reserve Bank at any time if the
Reserve Bank is satisfied that it is in public interest it does so; or the authorised person has failed to
comply with the condition subject to which the authorisation was granted or has contravened any of
the provisions of the Act or any rule, regulation, notification, direction, or order made thereunder,
provided that no such authorisation shall be revoked on any ground referred to in Clause (b) unless
the authorised person has been given a reasonable opportunity of making a representation in the
matter.

The Reserve Bank may, on an application made to it in this behalf, authorise any person to be known as the authorised
person to deal in foreign exchange or in foreign securities, as an authorised dealer, moneychanger or off-shore banking
unit, or in any other manner as it deems fit.
An authorised person shall, in all his dealings in foreign exchange or foreign security, comply
with such general or special directions or orders as the Reserve Bank may, from time to time, think
fit to give, and, except with the previous permission of the Reserve Bank, an authorised person shall
not engage in any transaction involving any foreign exchange or foreign security, which is not in
conformity with the terms of his authorisation under this section. An authorised person shall, before
undertaking any transaction in foreign exchange on behalf of any person, require that person to make
such declaration and to give such information as will reasonably satisfy him that the transaction will
not involve, and is not designed for the purpose of any contravention or evasion of the provisions of
this Act or of any rule, regulation, notification, direction, or order made thereunder, and where the
said person refuses to comply with any such requirement or makes only unsatisfactory compliance
therewith, the authorised person shall refuse in writing to undertake the transaction and shall, if he has
reason to believe that any such contravention or evasion as aforesaid is contemplated by the person,
report the matter to the Reserve Bank.
Any person, other than an authorised person, who has acquired or purchased foreign exchange for
any purpose mentioned in the declaration made by him to the authorised person under subsection (5),
does not use it for such purpose or does not surrender it to the authorised person within the specified
period or uses the foreign exchange so acquired or purchased for any other purpose for which the
purchase or acquisition of foreign exchange is not permissible under the provisions of the Act or the
rules or regulations or direction or order made thereunder shall be deemed to have committed
contravention of the provisions of the Act for the purpose of this Section.
Important Concepts Under FEMA

FEMA, 1999 replaced Foreign Exchange Regulation Act, 1973 (FERA) with effect from June 1, 2000.
The replacement was a great sigh of relief for the people as FERA was unduly stringent in its
criminal provisions. FEMA is a civil law and proactive in its outlook compared to FERA. The thrust
of FEMA is to “manage” the scarce foreign exchange resources of the country rather than to
“control” them as was prevalent under FERA. FEMA met the need of the day in the changed economic
scenario of India, especially since 1991.

FEMA, 1999 replaced Foreign Exchange Regulation Act, 1973 (FERA) with effect from June 1, 2000. The replacement was
a great sigh of relief for the people as FERA was unduly stringent in its criminal provisions.
Applicability of FEMA
FEMA is applicable to the whole of India. The expression “whole of India” would indicate that the
provisions of the Act are applicable to all transactions that are taking place in India. Thus, any person
who is present in India at the time of transaction has to comply with the provisions of FEMA. FEMA
is applicable to all branches, offices, and agencies outside India that are owned or controlled by a PRI.
Thus, FEMA has retained its extra-territorial jurisdiction, as under FERA.
Illustration: If an Indian company opens a branch in New York, the United States, that branch will
become a resident of India and, therefore, all restrictions applicable to Indian residents for overseas
transactions are equally applicable to such a branch. Then, right from opening of a bank account to
entering into any transaction of capital nature (e.g., acquisition of premises), it will need prior
approval from RBI (subject to exemptions/general permissions granted by RBI under various
Notifications).
Residential Status
One of the important changes in FEMA relates to the “Residential Status of a Person”. The terms
“person” and “person resident in India (PRI)” are defined under Sections 2(u) and 2(v) of FEMA,
respectively. Ironically, like FERA, FEMA, too, does not define the term “Non-resident”. Section 2(w)
defines “person resident outside India (PROI)” as a person who is not a resident in India. (For all
practical purposes, the term “person resident outside India” is synonymous with the term “non-
resident” and these terms are used interchangeably in this book.) Let us look closely at these two
important definitions under FEMA, which are as follows:
Definition of “Person”
Section 2(u): The term “Person” includes
i. an individual,
ii. a Hindu Undivided Family (HUF),
iii. a company,
iv. a firm,
v. an association of persons (AOP) or a body of individuals (BOI), whether incorporated or not,
vi. every artificial juridical person, not falling within any of the preceding sub-clauses, and
vii. any agency, office, or branch owned or controlled by such person.
Explanation: The above definition is similar to the definition of “person” under Section 2(31) of the
Income Tax Act, with some minor differences like exclusion of local authority and inclusion of
category (vii) above. This definition is unique to FEMA, not found under FERA. The idea obviously
is to provide clarity about its applicability and extend its coverage.
Person Resident in India (PRI)

Section 2 (v): The term “person resident in India” means
i. a person residing in India for more than 182 days during the course of the preceding financial year (FY) but does not include
A. a person who has gone out of India or who stays outside India, in either case
a. for or on taking up employment outside India, or
b. for carrying on outside India a business or vocation outside India, or
c. for any other purpose, in such circumstances as would indicate his intention to stay outside India for an
uncertain period;
B. a person who has come to, or stays in, India, in either case, otherwise than—
c. for any other purpose, in such circumstances as would indicate his intention to stay in India for an uncertain
period;
ii. any person or body corporate registered or incorporated in India;
iii. an office, branch, or agency in India owned or controlled by a PROI; and
iv. an office, branch, or agency outside India owned or controlled by a PRI.
Explanation: An attempt has been made to link the definition of the PRI under FEMA with the
definition of that term under the Income Tax Act, 1961, by providing the criteria of physical stay of
183 days or more in India, in so far as the individuals are concerned.
Practical Aspects
i. First of all, “Financial Year (FY)” is not defined under FEMA.
For the sake of understanding, we assume it to be from April 1 to March 31, being the official year of the Government of India.
Secondly, the Income Tax Act requires a physical presence of 182 days or more, whereas FEMA requires 183 days or more.
Thirdly, the term “ residing in India” is not defined. We may assume that it is equivalent to physical presence in India. Under
FERA, a person’s residential status was determined based on his intention alone, rather than his physical presence in India. FEMA
has attempted to blend the two different definitions as prevailed under FEMA and the Income Tax Act, 1961, resulting in
confusion.
ii. The Income Tax Act considers the physical presence of a person in the current FY for determining his tax liabilities of the current
year, whereas FEMA considers physical presence of a person in the preceding FY, with the result that a person might have to
wait for one-and-a-half year to become a resident in India.
Illustration: Mr. Sangwan comes to India after a continuous stay abroad for two years. During the FY 2003–04, that is from
April 1, 2003 to March 31, 2004 his stay was less than 183 days. Assuming that he stays in India throughout the FY 2004–
2005, he would be a non-resident under FEMA for the FY 2004–05 notwithstanding the fact that he was in India for more than
182 days, as his presence in India during the preceding FY, that is, 2003–04 was for a period of less than 183 days. In order to
avoid this anomaly, the definition of a PRI needs to be interpreted in a manner that leads to a logical conclusion.
Determination of the Residential Status Under FEMA

Individuals
In order to make a definition of a PRI workable, one has to look first at the exceptions given in
Clauses (A) and (B) and if the person is not falling under either of them, then look at his physical
presence in India during the preceding FY. Thus, in effect, the criteria, for determination of
residential status of a person under FERA based on “facts and intentions”, are retained under FEMA,
too, as it is evident from the examples given herein as follows:
Mr Mishra leaves India on December 1, 2004 for taking up employment outside India for the first time. What will be his
residential status?
Mr Mishra will be considered as a non-resident, with effect from December 1, 2004, irrespective of the fact that he was residing
in India for more than 182 days in the preceding FY (i.e., 2003–04), for the reason that he is covered by exception (A)(a) of the
definition.
Mrs Katrina, a foreign citizen of non-Indian origin, sets up a proprietary concern in India on June 1, 2004 for carrying on
business. What was her residential status for the FY 2004–05?
The situation is covered by exception B (b). Mrs Katrina will be considered as a resident in India, with effect from June 1, 2004,
as she came to India for carrying on business, irrespective of the fact that she had not at all stayed in India during the preceding
FY (i.e., 2003–04).
Mr Singh, who is staying in Dubai for more than 10 years, had come to India on July 1, 2003 for medical treatment. He had not
visited India during the preceding FY 2002–03. He planned to return to Dubai after his medical treatment was over. The doctors
had advised him to stay in India up to October 31, 2004. What was his residential status under FEMA?
Mr Singh was not covered by any of the exceptions laid down under Clause (B) as his intention to stay in India was for a specific
period only. He would be considered as a non-resident in the FY 2003–04, notwithstanding his stay exceeding 182 days in that
current year, as in the preceding FY (i.e., 2002–03), he was not in India for 183 days or more. As far as the FY 2004–05 was
concerned, he would be considered as a resident from April 1, 2004 till October 31, 2004 (as his stay in the FY 2003–04 had
exceeded 182 days). Mr Singh would be considered as a non-resident, with effect from October 31, 2004, as he was leaving
India for an uncertain period, covered by an exception mentioned in Clause A(c).
Residential Status of a Student Leaving for Overseas for the Purpose of Education
A student leaving India for the purpose of further education was treated as a resident by the Reserve
Bank unless he takes up employment overseas even though his stay in India was less than 183 days.
Based on a review of the situation, Reserve Bank has liberalised the provisions as follows:
A student leaving abroad for the purpose of further education would be treated as a nonresident
Indian (NRI) on the grounds that his stay abroad is for more than 182 days in the preceding FY and
that his intention is to stay abroad for an uncertain period. As a non-resident, the student would be
eligible for receiving the following remittances from India (Circular No. 45, dated December 8,
2003):
1. up to US$100,000 from close relatives from India on self-declaration towards maintenance and studies;
2. up to US$1 mn out-of-sale proceeds/balances in his account maintained with an authorised dealer in India;
3. all other facilities available to NRIs under FEMA; and
4. educational and other loans availed of by students as “resident in India”, can be allowed to continue.
Residential Status of Other Entities

The Clauses (ii)–(iv) of sub-section (v) of Section 2 of FEMA deal with the determination of
residential status of entities other than individuals.
Clause (ii): This Clause provides that any person or a corporate body (say, HUF, FIRM, AOP, BOI,
companies, etc.), registered or incorporated in to India would be considered as PRI. Here, the
emphasis is on the registration or incorporation. A question arises as to what about an unregistered
FIRM, or AOP, or BOI, or say HUF that requires no registration? Whether it would be out of the
purview of FEMA, though it is included in the definition of “person”, or? Here, too, the outcome
seems to be unintended. In order to make FEMA workable, it is advisable to consider that FEMA is
applicable to such entities.
Clause (iii): This Clause provides that an office, branch, or an agency in India owned or controlled
by a PROI is considered as a “resident in India”. Even though such entities are treated as residents in
India, under Section 6(6) of the Act, RBI is empowered to prohibit, restrict, or regulate their
establishment as well as their activities in India. Notification No. FEMA/22/RB-2000 deals with the
regulations that are pertaining to establishment of such entities in India. One difficulty here is that the
terms “ agency”, “ownership”, and “control” are not defined.
Clause (iv): As per this Clause, an office, branch, or an agency outside India owned or controlled
by a PRI would be considered as a “resident in India”. This is a significant departure from FERA
where under such entities were considered as “non-resident”. The consequences of this change are
far-reaching. Under the scheme of FEMA, transactions are divided into two distinct categories, viz.,
Current Account and Capital Account Transactions. While current account transactions are by and
large freely permitted, a lot of restrictions are placed on capital account transactions, to be entered
into by the Indian residents. Therefore, treating such entities as residents in India would pose several
unforeseen difficulties.
Illustrations:
An Indian company sets up a branch in the United States. Such a branch cannot carry out the following
transactions without RBI’s prior approval (the list is just illustrative):
i. Purchase of any premises (although US laws may be permitting it freely);
ii. Purchase of any capital assets;
(Vide Notification No. 47/2001-RB, dated December 5, 2001, RBI has clarified that purchase or acquisition of office
equipments and other assets that are required for normal business operations of an overseas branch/office/representative will not
be deemed to be capital account transactions.)
iii. Borrow or lend money; and (Vide Notification No. 67/2002-RB, dated August 20, 2002, RBI has permitted Indian companies to
grant rupee loans to their employees, who are NRIs or PIOs.)
iv. Placement or acceptance of deposits.
It will, thus, be observed that this particular change in FEMA would result in an undue hardship as such entities will have to
comply with legal requirements of two countries, viz., the “host country” (i.e., where they are operating) as well as the “home
country” (i.e., India). Many a time, requirements in either country may be conflicting with each other.
Non-resident Indian (NRI)
Section 2 of the FEMA deals with various definitions. It defines a PRI and a PROI. However, it does
not define the term “non-resident” nor it defines the term NRI. However, Notification No. 5/2000-RB
(dealing with various kinds of bank accounts) defines the term “Non-resident Indian (NRI)” to mean a
person resident outside India (PROI), who is either a citizen of India or is a “Person of Indian Origin”
(PIO). The term PIO has been defined differently in different Notifications; and therefore, the term
NRI, in turn, will have a different meaning. In short, one should bear in mind that the definitions of
NRI and PIO are contextual.
Person of Indian Origin (PIO)
The term “Person of Indian Origin” (PIO) is defined differently in different Notifications and,
therefore, the term NRI will have a different meaning depending upon the Notification one applies.
Therefore, when applying provisions of FEMA, one must be careful about the reference and context
of such application.
Different Definitions of the Term PIO
1. The term PIO as defined under Notification No. 5 (dealing with various kinds of bank accounts), Notification No. 13 (dealing
with Remittance of Assets), and Notification No. 20 (dealing with Inbound Investments including Foreign Direct Investments
(FDIs), is as follows:
Person of Indian origin (PIO) means a citizen of any country other than Bangladesh or Pakistan, if
i. he at any time held Indian passport; or
ii. he or either of his parents or any of his grandparents were a citizen of India by virtue of the of the Constitution of India
or the Citizenship Act, 1955 (57 of 1955).
2. The term is defined almost identically as above under the Notification No. 24 (dealing with investment in a Firm or Proprietary
Concern in India) except that the citizens of Sri Lanka are also excluded from the definition in addition to the citizens of
Bangladesh or Pakistan as mentioned above.
3. The term is defined in the following manner in the Notification No. 21 (dealing with the Acquisition and Transfer of Immovable
Property in India):
“PIO” means an individual (not being a citizen of Afghanistan, Bangladesh, Bhutan, China, Iran, Nepal, Pakistan, or Sri Lanka)
who
i. at any time held Indian passport; or
ii. who or either of whose father or whose grandfather was a citizen of India by virtue of the Constitution of India or the
Citizenship Act, 1955 (57 of 1955).
It will, thus, be seen that for the purposes of acquisition or transfer of immovable property in India,
the PIOs, who are citizens of Afghanistan, Bangladesh, Bhutan, China, Iran, Nepal, Pakistan, or Sri
Lanka, are excluded from the definition of PIO.
Overseas Corporate Body (OCB)

Like the term NRI, the term “Overseas Corporate Body (OCB)” is also not defined in the Section
2,which deals with definitions of various words/terms in general. Notification No. 5 (dealing with
Bank Accounts) and Notification No. 20 (dealing with Inbound Investments) define the term OCB in
following manner: Overseas Corporate Body (OCB) means a company, partnership firm, society, and
other corporate body wholly owned, directly or indirectly, to the extent of at least 60 per cent by non-
resident Indians and includes overseas trust in which, not less than 60 per cent beneficial interest is
held by NRIs, directly or indirectly but irrevocably.
In order to establish that a particular entity is an OCB, the investor has to furnish a certificate in
following forms from the Certified Public Accountant and/or Chartered Accountant of the country to
which such entity belongs. However, RBI has issued Notification No. 101/2003-RB, dated October 3,
2003, whereby the OCBs holding investments/interests in India as on September 16, 2003 are de-
recognised as an eligible “class of investors”. Now, OCBs, which did not have any
investments/interests in India prior to September 16, 2003, would be treated on par with foreign
companies. (Refer Annexure V for Circular No. 44, dated December 8, 2003, on De-recognition of
OCBs.
Current Account and Capital Account Transactions
Under the FERA regime, the thrust was on regulation and control of the scarce foreign exchange,
whereas under the FEMA, the emphasis is on the management of foreign exchange resources. Thus,
there is a clear shift in focus from control to management. Therefore, under FERA it was safe to
presume that any transaction in foreign exchange or with a non-resident was prohibited unless it was
generally or specially permitted. FEMA has formally recognised the distinction between current
account and capital account transactions. Two golden rules or principles in FEMA are mentioned as
follows:
all current account transactions are permitted unless otherwise prohibited, and
all capital account transactions are prohibited unless otherwise permitted.
Current Account Transactions
India is signatory to the WTO (World Trade Organization) Agreement. As a part of its obligation
under the WTO Agreement, India has relaxed (not removed) its exchange control regulations on
current account transactions. The term “current account transaction” is defined under Section 2(j) to
mean “a transaction other than a capital account transaction and without prejudice to the generality of
the foregoing, such transaction includes
1. payments due in connection with foreign trade, other current business, services, and other short-term banking credit facilities in
the ordinary course of business,
2. payments due as interest on loans and as net income from investments,
3. remittances for living expenses of parents, spouse, and children residing abroad,
4. expenses in connection with foreign travel, education, and medical care of parents, spouse, and children”.
Explanation: As discussed earlier, this concept is unique to FEMA and was not found in FERA. When
it is said that current account transactions are free from controls in India, it does not imply that any
amount of remittance is permitted for a single transaction. Section 5 authorises the Central
government to impose restrictions on the above transactions. Exercising this authority, the Central
government has issued Notification No. GSR 381(E) entitled as the FEM (current account
transactions) Rules, 2000, dated May 3, 2000, according to which drawal of foreign exchange is
prohibited for:
1. transactions specified in Schedule I, or
2. travel to Nepal and/or Bhutan, or
3. transactions with a person who is a resident in Nepal or Bhutan.
As far as the above categories (b) and (c) are concerned, it may be noted that Indian rupee is a widely
accepted currency in these countries and hence, drawal of foreign exchange is not permitted for travel
to and transactions with these countries. Schedule II of the said Notification lists transactions, which
require prior approval of the Government of India, except when the exchange is drawn from
RFC/EEFC accounts. Schedule III of the said Notification lists transactions, which require prior
approval of the RBI. In some cases, prior permission is required only if the transaction value exceeds
the limits specified therein except where the exchange is drawn from RFC/RFC(D) accounts. (Refer
Annexure I of this Chapter for the items covered by Schedule I, II, and III.)
RBI has liberalised the remittances permissible under the current account transactions vide Circular
No. 76, dated February 24, 2004. Following transactions are permissible under the automatic route
without any monetary ceiling:
1. Remittance by Artistes, for example, wrestler, dancer, entertainer, and so on.

2. Remittance for securing Insurance for Health from a company abroad.
3. Short-term credit to overseas offices of Indian companies.
4. Remittance for Advertisement on Foreign Television Channels.
5. Remittance of Royalty and Payment of Lump-sum Fee, provided the payments are in conformity with the norms as per Item No.
8 of Schedule II, that is, royalty does not exceed 5 per cent on local sales and 8 per cent on exports, and lump-sum payment
does not exceed US$2 mn.
6. Remittance for use of Trademark/franchise in India.
It may be noted from the above that interest and other income on investments are only covered as
current account transactions. Therefore, the principal amount of investment can be remitted abroad,
only if it has been invested on repatriation basis. Any current account transaction that is not regulated
or prohibited is permitted by an implication.
Capital Account Transactions
Section 2(e) defines “capital account transactions” to mean “a transaction which alters the assets or
liabilities, including contingent liabilities, outside India of a PRI, or assets or liabilities in India of
persons who are residents outside India, and includes transactions referred to in sub-section (3) of
Section 6”. (Refer Annexure 2 for Capital Account Transactions specified in Section 6[3].)

Section 2(e) defines “capital account transactions” to mean “a transaction which alters the assets or liabilities, including
contingent liabilities, outside India of a PRI.
Section 6(3) contains 10 sub-clauses covering a wide range of transactions, viz., FDIs in India,
Overseas Direct Investments (ODIs) from India, borrowing or lending in Foreign Exchange and in
Indian rupees, various kinds of bank accounts, immovable property in India and abroad, guarantees,
and so on. For each category, the RBI has issued separate Notifications.
Distinction Between Capital Account and Current Account Transactions
The distinction between the two types of transactions needs to be understood from the viewpoint of
“balance of payments” of the country. There is a difference between our normal understanding of a
“capital asset” or a “capital expenditure” and a “capital account transaction” per se. For example,
import of machinery on payment of cash or on normal credit terms of the vendor will be regarded as
the current account transaction. The importer may capitalise it in his account books and claim
depreciation, thereon. As far as the country is concerned, it is a “trade transaction”. However, if the
same machinery is imported on deferred credit basis or is funded out of ECB, and so on, the credit
beyond 12 months (as less than 12 months again would fall within the definition of “current account
transactions”) would result in the creation of the long-term liability outside India and, therefore, be
termed as a “capital account transaction”. A word of caution here is that, the meaning of “alteration of
assets or liabilities” is not properly defined and, therefore, leads to different interpretations. In order
to be in the right side of the law, it is advised that, in case of doubt, the matter may be referred to the
Reserve Bank of India.

Table 18.1 Illustrative List of Current and Capital Account Transactions
Nature of Transaction Current a/c Capital a/c
If imported on suppliers’ credit or
Import of machinery If imported on COD basis funded out of Transactions foreign
loans.
Import and export of
goods on credit Yes –
Payment for Web-hosting Yes –
Payment for consultancy Yes –
Remittance of
(a) interest on loans/
investments Yes –
(b) dividend Yes –
(c) rental from immovable property – –
(d) capital gains on
(i) movable assets – Yes
(ii) immovable property – Yes
Loans/borrowings other than from banks (whether short term or
– –
long term)
Short-term working capital
from bank Yes –
Term loan from bank/F1
(Formula 1) – Yes
Living expenses of parents,
spouse, & children Yes –
Expenses in connection
with foreign-travel education
and medical care of parents,
spouse, & children Yes –
Investments in securities
(whether in India by a non-resident
or outside India by a resident) – Yes
Investments in immovable
property (whether in India
by a non-resident or outside
India by a resident) – Yes
List of Current Account Transactions for which drawal of Foreign Exchange is not permitted
1. Remittance out of lottery winnings.

2. Remittance of income from racing/riding, and so on, or any other hobby.
3. Remittance for purchase of lottery tickets, banned/prescribed magazines, football pools, sweepstakes, and so on.
4. Payment of commission on exports made towards equity investment in joint ventures/ wholly owned subsidiaries abroad of
Indian companies.
5. Remittance of dividend by any company to which the requirement of dividend balancing is applicable. (The condition of dividend
balancing is not applicable presently.)
6. Payment of commission on exports under Rupee State Credit Route, except commission up to 10 per cent of invoice value of
exports of tea and coffee.
7. Payment related to “Call Back Services” of telephones.
8. Remittance of interest income on funds held in Non-resident Special Rupee Scheme account.
9. Travel to Nepal and/or Bhutan.
10. Transaction with a person who is a resident in Nepal and/or Bhutan. (RBI has the power to relax this prohibition.)
11. Remittance towards participation in lottery schemes involving money circulation or for securing prize money/awards, and so on.

Table 18.2 List of Current Account Transactions for Which Prior Approval of the Government is Required
Ministry/Department of Government of India Whose

Purpose of Remittance
Approval is Required
Ministry of Human Resources Development (Department of
Cultural tours
Education and Culture)
Advertisement in foreign print media abroad by any PSU/State and
Central Government Department other than promotion of tourism,
Ministry of Finance (Department of Economic Affairs)
foreign investments, and international bidding (exceeding
US$10,000)
Remittance of freight of vessel charted by a PSU Ministry of Shipping (Chartering Wing)
Payment of import by a Government Department or a PSU in CIF
(cost, insurance, and freight) basis (i.e., other than FOB [free on Ministry of Shipping (Chartering Wing)
board], and FAS [free alongside ship] basis)
Multi-modal transport operators making remittance of their agents
Registration Certificate from the Director General of Shipping
abroad
Remittance of hiring charges of transponders by
Ministry of Information & Broadcasting Ministry of
a. TV channels
Communication & Information Technology
b. Internet service providers
Remittance of container detention charges exceeding the rate

Ministry of Shipping (Director General of Shipping)
prescribed by Director General of Shipping
Remittances under technical collaboration agreements where
payment of royalty exceeds 5% on local sales and 8% on Ministry of Industry And Commerce
exports, and lump-sum payment exceeds US$2 mn
Remittance of prize money/ sponsorship of sports activity abroad
Ministry of Human Resource Development (Department of Youth
by a person other than international/national/State-level sports
Affairs and Sports)
bodies, if the amount involved exceeds US$100,000
Remittance for membership of P&I Club (remittances from other
Ministry of Finance (Insurance Division)
than RFC account)

(No permission is required if payment is made out of RFC. (Domestic account for all types of
payments listed in Item Nos. 1–10, whereas for payments out of EEFC account, no permission is
required for transactions listed in Item Nos. 1–9.)
List of Current Account Transactions for which prior approval of RBI is required
1. Release of exchange exceeding US$10,000, or its equivalent in one FY (April to March), for one or more private visits to any
country (except Nepal and Bhutan).
2. Gift remittance exceeding US$50,000 per remitter/donor per annum.
3. Donation exceeding US$50,000 per remitter/donor per annum.
4. Exchange facilities exceeding US$100,000 per persons going abroad for employment.
5. Exchange facilities for emigration exceeding US$100,000 or the amount prescribed by the country of emigration.
6.
a. Remittance for maintenance of close relatives abroad exceeding net salary (after deduction of taxes, contribution to
provident fund, and other deductions) of a person, who is a resident but not a permanent resident in India and is a citizen
of a foreign state other than Pakistan or is a citizen of India, who is on deputation to the office or branch or subsidiary or
joint venture in India of such foreign company.
b. Exceeding US$100,000 per year, per recipient, in all other cases.
Explanation: For the purpose of this term, a PRI on account of his employment or deputation of a specified duration
(irrespective of length thereof) or for a specific job or assignment; the duration of which does not exceed three years, is
a resident but not a permanent resident.
7. Release of foreign exchange, exceeding US$25,000 to a person, irrespective of period of stay, for business travel, or attending
a conference or specialised training or for maintenance expenses of a patient going abroad for medical treatment or check-up
abroad, or for accompanying a patient as an attendant in going abroad for medical treatment/check-up.
8. Release of exchange for meeting expenses for medical treatment abroad, exceeding the estimate from the doctor in India.
9. Release of exchange for studies abroad, exceeding the estimates from the institution abroad, or US$100,000 per academic year,
whichever is higher.
10. Release of exchange for commission to agents abroad, for sale of residential flats / commercial plots in India, exceeding 5 per
cent of the inward remittance per transaction, or US$25,000, whichever is higher.
11. Remittances exceeding US$1mn per project for consultancy services procured from abroad, subject to the applicant submitting
documents to the satisfaction of the authorised dealer.
12. Remittance exceeding US$100,000 for reimbursement of incorporation expenses.
13. Remittance exceeding US$5,000, or its equivalent, for small-value remittances.
Note: The above restrictions shall not apply on the use of International Credit Card for making any payment by a person towards
meeting expenses while such person is on a visit outside India.
Regulation and Management of Foreign Exchange
Dealing in Foreign Exchange

According to the Clause as otherwise provided in this Act, rules or regulations made thereunder, or
with the general or special permission of the Reserve Bank, no person shall deal in or transfer any
foreign exchange or foreign security to any person not being an authorised person; or make any
payment to or for the credit of any PROI in any manner; or receive otherwise through an authorised
person, any payment by order or on behalf of any PROI in any manner. For the purpose of this
Clause, where any person in, or a resident in, India receives any payment by order or on behalf of any
PROI through any other person (including an authorised person), without a corresponding inward
remittance from any place outside India, then, such person shall be deemed to have received such
payment otherwise than through an authorised person.
According to another Clause for those who enter into any financial transaction in India, as
consideration for or in association with acquisition or creation or transfer of a right to acquire, any
asset outside India by any person. For the purpose of this Clause, “financial transaction” means
making any payment to, or for the credit of any person, or receiving any payment for, by order or on
behalf of any person, or drawing, issuing, or negotiating any bill of exchange or promissory note, or
transferring any security or acknowledging any debt.

“Financial transaction” means making any payment to, or for the credit of any person, or receiving any payment for, by
order or on behalf of any person, or drawing, issuing, or negotiating any bill of exchange or promissory note, or
transferring any security or acknowledging any debt.
Holding of Foreign Exchange

According to the Clause as otherwise provided in this Act, no PRI shall acquire, hold, own, possess,
or transfer any foreign exchange, foreign security, or any immovable property situated outside India.
Current Account Transactions

Any person may sell or draw foreign exchange to or from an authorised person if such sale or
drawal is a current account transaction, provided that the Central government may, in public interest
and in consultation with the Reserve Bank, impose such reasonable restrictions for current account
transactions, as may be prescribed.
Capital Account Transactions
1. As per the Act, that is, subject to the provisions of sub-section, any person may sell or draw foreign exchange to or from an
authorised person for a capital account transaction.
2. The Reserve Bank may, in consultation with the Central government, specify any class or classes of capital account transactions
which are permissible; and the limit up to which the foreign exchange shall be admissible for such transactions, provided that the
Reserve Bank shall not impose any restriction on the drawal of foreign exchange for payments that are due on account of
amortisation of loans or for depreciation of direct investments in the ordinary course of business.
3. Without prejudice to the generality of the provisions of sub-section, the Reserve Bank may, by regulations, prohibit, restrict, or
regulate the following:
i. transfer or issue of any foreign security by a PRI;
ii. transfer or issue of any security by a PRI;
iii. transfer or issue of any security or foreign security by any branch, office, or an agency in India of a PROI;
iv. any borrowing or lending in foreign exchange in whatever form or by whatever name called;
v. any borrowing or lending in rupees in whatever form or by whatever name called between a PRI and a PROI;
vi. deposits between persons who are resident in India and persons who are resident outside India;
vii. export, import, or holding of currency or currency notes;
viii. transfer of immovable property outside India, other than a lease not exceeding five years, by a PRI;
ix. acquisition or transfer of immovable property in India, other than a lease not exceeding five years, by a PROI;
x. giving of a guarantee or surety in respect of any debt, obligation, or other liability incurred
i. by a PRI and owed to a PROI or
ii. by a PROI.
4. A PRI may hold, own, transfer, or invest in foreign currency, foreign security, or any immovable property situated outside India
if such currency, security, or property was acquired, held, or owned by such person when he was a resident outside India or
inherited from a person who was a resident outside India.
5. A PROI may hold, own, transfer, or invest in Indian currency, security, or any immovable property situated in India, if such
currency, security, or property was acquired, held, or owned by such person when he was a resident in India or inherited from a
person who was a resident in India.
6. Without any prejudice to the provisions of this section, the Reserve Bank may, by regulation, prohibit, restrict, or regulate
establishment in India of a branch, office, or other place of business by a PROI for carrying on any activity relating to such
branch, office, or other place of business.
Export of Goods and Services
1. Every exporter of goods shall
i. furnish to the Reserve Bank or to such other authority a declaration in such form and in such manner as may be
specified, containing true and correct material particulars, including the amount representing the full export value or, if
the full export value of the goods is not ascertainable at the time of export, the value which the exporter, having regard
to the prevailing market conditions, expects to receive on the sale of the goods in a market outside India;
ii. furnish to the Reserve Bank such other information as may be required by the Reserve Bank for the purpose of ensuring
the realisation of the export proceeds by such exporter.
2. The Reserve Bank may, for the purpose of ensuring that the full export value of the goods or such reduced value of the goods
as the Reserve Bank determines, having regard to the prevailing market conditions, is received without any delay, direct any
exporter to comply with such requirements as it deems fit.
3. Every exporter of services shall furnish to the Reserve Bank or to such other authorities a declaration in such form and in such
manner as may be specified, containing the true and correct material particulars in relation to payment for such services.
Realisation and Repatriation of Foreign Exchange
Unless otherwise provided in this Act, where any amount of foreign exchange is due or has accrued
to any PRI, such person shall take all reasonable steps to realise and repatriate to India such foreign
exchange within such period and in such manner as may be specified by the Reserve Bank.
Exemption from Realisation and Repatriation in Certain Cases
The provisions of Sections 4 and 8 shall not apply to the following, viz.
i. possession of foreign currency or foreign coins by any person up to such limit as the Reserve Bank may specify;

Exemption from realisation and repatriation is granted in certain cases where RBI sets up the limits and the
transactions are compliant with the same.
ii. foreign currency account held or operated by such person or class of persons and the limit up to which the Reserve Bank may
specify;
iii. foreign exchange acquired or received before July 8, 1947, or any income arising or accruing thereon which is held outside
India by any person in pursuance of a general or special permission granted by the Reserve Bank;
iv. foreign exchange held by a PRI up to such limit as the Reserve Bank may specify, if such foreign exchange was acquired by
way of a gift or inheritance from a person referred to in Clause (c), including any income arising therefrom;
v. foreign exchange acquired from employment, business, trade, vocation, services, honorarium, gifts, inheritance, or any other
legitimate means up to such limit as the Reserve Bank may specify; and
vi. such other receipts in foreign exchange as the Reserve Bank may specify.
CASE
Mr. Alex and Mr. Murthy are planning to start a business in Mumbai. Mr. Alex wants to invest Rs 3
crore and Mr. Murthy Rs 2 crore in the business. While Mr. Murthy is a resident of India, Mr. Alex is a
resident of the United States. They want to start the business in partnership, but Mr. Alex wants to buy
his own land for the business purpose in Mumbai. For this he is ready to invest more than Rs 50 lakh.
Mr. Murthy suggests to Mr. Alex that it is not easy to buy land in Mumbai in the latter ’s name.
It would be better to buy the land and all assets required for the business in his, Mr. Murthy’s, name
because Reserve Bank may prohibit any borrowing or lending in rupees between a PRI and PROI and
under Section 6 of FEMA. Reserve Bank may by regulation, prohibit, restrict, or regulate the
establishment in India of a branch office, or other place of business by a PROI, for carrying on any
activity relating to such branch, office, or other place of business. There fore, Mr. Murthy suggests,
that Mr. Alex, should just invest the money alone. Whatever assets they buy will be owned by Mr.
Murthy alone. Mr. Alex does not agree with this suggestion of Mr. Murthy. He says, “We will buy all
assets in partnership as we are starting a business in partnership”.
Case Questions
1. Do you support the suggestion of Mr. Murthy?

2. Do you think that the suggestion of Mr. Murthy is correct?
3. Give correct suggestions to Mr. Alex for starting a business in India.
KEY WORDS
Monopoly
Monopolistic and Restrictive Trade
Practices (MRTPs)
Restrictive Trade Practices (RTPs)
Authorised Dealer
Bearer Certificate MRTP
Foreign Exchange
Foreign Security
Currency
Overseas Market
Moneychangers
Blocked Accounts
Security
Authorised Person
Repatriation
Appellate Board
Indian Custom Waters
FEMA
FERA
MRTP
Goods
QUESTIONS
1. What were the objectives of the MRTP Act, 1969?

2. Describe the recent amendments made in the MRTP Act.
3. “After the 1991 amendment, the MRTP Act has become toothless to control the concentration of economic power”. Discuss.
4. Discuss the provisions and objectives of the Foreign Exchange Regulation Act (FERA), 1973.
5. Discuss the provisions of the Foreign Exchange Management Act (FEMA), 1999.
6. Describe the important concepts under FEMA?
7. How is residential status determined under FEMA?
8. List down the different transactions that come under current account and capital account?
a. Applicability of FEMA
b. Residential Status
REFERENCES
Bretty, J. F. and S. Samuelson (2000). Business Law for a New Century, 2nd ed. Mason, OH, US: Thomson/South-Western
Publishing.
Bulchandani, K. R. (2002). Business Law for Management. Mumbai: Himalaya Publishing House.
Datt, R. and K. P. M. Sundharam (2004). Indian Economy. Delhi: Sultan Chand.
http://exim.indianart.com
Kapoor, N. D. (2002). Elements of Mercantile Law, 25th revised ed. New Delhi: Sultan Chand.
Maheshwari, S. N. (2004). Business Regulatory Framework, 2nd ed. Himalaya Publishing House.
Mann, R. A. and B. S. Robert (2004). Business Law and the Regulation of Business, 7th ed. Mason, OH, US: Thomson/ South-
Western Publishing.
Miller, R. L. and G. A. Jentz (2005). Business Law Today, 6th ed. Mason, OH, US: Thomson/South-Western Publishing.
Prasad, M. (2002). Principles of Business Law and Management, 2nd ed. Hyderabad: Himalaya Publishing House.
Saravanvel, P. and S. Sumathi (2004). Business Law for Management. Mumbai: Himalaya Publishing House.
——— Legal Aspects of Business, 1st ed. Hyderabad: Himalaya Publishing House.
Savilson, D. V., B. Knowles, and L. Forsytte (2003). Business Law: Principles and Cases in the Legal Environment, 7 th ed.
Mason, OH, US: Thomson/South-Western Publishing.
Sen, A. K. (2001). Commercial Law and Industrial Law. Kolkata: World Press.
Tuteja, S. K. (1998). Business Law for Managers, 5th ed. New Delhi: Sultan Chand.
www.fema.gov/help
www.fema.gov/emergency/reports/2008
CHAPTER 19
Business Ethics
CHAPTER OUTLINE
Ethics and Values
Relevance of Ethics in Business
Benefits of Ethical Business
Importance of Business Ethics
Values in Business
Inculcating Values in Management
Categories of Business Values
Need for Ethics in Global Change
Managing Ethics
Impact of Globalisation on Business Ethics
Business Ethics as Competitive Advantage
Business Ethics in India
Case
Summary
Key Words
Questions
References
ETHICS AND VALUES
Some say “Knowledge is Power”. I believe that actual power lies in the character of a person. Human
and ethical values constitute the “wealth” of a character. Ethics is nothing but the degree of faith that
one bestows upon oneself. Ethics involves learning what is right or wrong. According to Wayne
Mondy, “Ethics is the discipline dealing with what is good and bad, or right and wrong, or with moral
duty and obligation”. Ethics is concerned with right and wrong, good and bad, and virtue and vice.

Ethics is nothing but the degree of faith that one bestows upon oneself. Ethics involves learning what is right or wrong.
Ethics, “ethicus” in Latin, is derived from the word “ethos”, meaning character and manners. Ethics
is thus a science of morals and principles. Moral principles are actions that carry the best
consequence for everyone concerned. For instance, “Never break a promise”, “Treat everyone
fairly”, and “Always tell the truth”. Ethics refer to the code of conduct that guides an individual in
dealing with a situation. It relates to the social rules that influence people to be honest in dealing with
the other people.
The objectives of ethics are to study human behaviours and make evaluative assessments about
them as moral or immoral, and establish moral standards and norms of behaviour. Values that guide
us of how we ought to behave are considered as moral values, for example, values such as respect,
honesty, fairness, and responsibility. Statements about how these values are applied are sometimes
called “moral or ethical principles”.
Values are general beliefs concerning what is good or bad and desirable or not desirable, which
are shared by individuals and organisations in societies. They are not directed towards any specific
elements but are used to access a broad range of objects and situations. For example, someone who
believes that honesty is important will likely to act honestly in most situations (a cashier being honest
while dealing with money). An employee who values a sense of accomplishment will generally, try to
do his best in each task for which he is responsible.
Values are important characteristics that influence individual and organisational behaviours. The
way an individual’s cognitive structure (a person’s mind) works is by values that influence his beliefs.
These beliefs form a person’s attitude and subsequently, the person’s attitude heavily influences his
behaviour. Values are sometimes also confused with “code of conduct”, but these two are different
entities. Codes merely represent rules and regulations of what to do and what not to do. Values go
beyond stating the dos and don’ts. Values are what underline codes; values are the foundation of
codes.

Values are important characteristics that influence individual and organisational behaviours.
Values not only enhance the quality of life of the individuals of society, but they also make the
society, and thereby the world, a better place to live. Value-based actions and decisions ensure the
welfare of all people belonging to the society. Various social institutions like family, school, other
extra-curricular bodies like sports club, debating, painting, singing, religion, and society or
community play an important role in inculcating values in individuals. Some common
personal/organisational values include the following:
Honesty and truth
Respect
Self-fulfilment
Sense of accomplishment
Social responsibility
Security/stability
Courage
Generosity
Creativity
Patience
Humility
Loyalty
Simplicity
Values not only enhance the quality of life of the individuals of society, but they also make the society, and thereby the
world, a better place to live. Value-based actions and decisions ensure the welfare of all people belonging to the society.
A person with all these values has equanimity. Such a person can mobilise his own and other ’s energy
and can help to accomplish wonders.
RELEVANCE OF ETHICS IN BUSINESS
Business ethics has come to be considered as a management discipline, especially since the birth of
the social responsibility movement in the 1960s. In that decade, the social awareness movement
caused businesses to use their massive financial and social influence to address issues such as
poverty, crime, environmental protection, rights, public health, and education. Commerce became
more complicated and dynamic over time. Organisations realised that they needed more guidance to
ensure that their dealings supported the common good and did not harm others. Thus, the concept of
business ethics was born. The concept has come to mean various things to various people, but
generally it has come to mean what is right or wrong in business and doing only what is right. This is
with regard to the effect of products/services and the relationship with stockholders.
Business Ethics is Nothing but Application of Ethics in Business

Since business exists and operates within a society and is a part of the subsystem of the society, its
functioning must contribute to the welfare of the society. Arguments against business ethics say that
since business is an economic entity, it should have nothing to do with morals or with ethics. This
view has changed drastically over the years, and more and more companies are resorting to ethical
means of conducting themselves and doing business.

The need for business ethics springs from the philosophy that since business operates and exists within the society and is a
part of the subsystem of society, its functioning must contribute to the welfare of the society.
The Tata group of companies is an example of a company that follows ethical business practice. In
India the credit of following business ethics goes to J.R.D Tata. Ethics for the Tata group means
conducting business in a manner which is fair and just to employees, suppliers, and shareholders, and
with a concern for the community in which it operates. However, often profits and social
responsibilities are at cross-purposes. Organisational growth can be hastened by unethical practices,
but it reduces the long-term frame of work to short-term. Subsequently, the organisation may lose its
face in society and its existence may be questioned by the actions it upholds.

Ethics for the Tata group means conducting business in a manner which is fair and just to employees, suppliers, and
shareholders, and with a concern for the community in which it operates.
BENEFITS OF ETHICAL BUSINESS
1. Maintains a moral cause in turbulent times.

2. Cultivates strong teamwork and productivity .
3. Supports employee growth and meaning.
4. Helps to ensure that policies are legal.
5. Helps to avoid criminal acts of “omission” and can lower fines.
6. Helps to manage values associated with quality management and strategic planning.
7. Promotes a strong public image.
8. Improves trust in relationships.
9. Legitimises managerial actions.
10. Strengthens the coherence and balance of the organisation’s culture.
11. Cultivates a greater sensitivity towards the impact of the enterprise’s values and messages.
12. Every significant management decision has an ethical value dimension.
13. There exists a clear vision and picture of integrity throughout the organisation.
Thus, only the ethical companies that discharge their social responsibilities have survived
competition and turbulent changes all through the years. They have contributed to social welfare and
have continued to flourish undiminished. If business ethics form a part of the corporate culture,
ultimately the customer would be called upon to bear the cost of the ethical practices of the
organisation. Moreover, employees, executives, and stockholders will feel proud to belong to an
ethical organisation. That feeling generates goodwill, loyalty, pride, and peace of mind—all of which
cannot be calculated accurately in terms of money.
A business needs to remain ethical for its own good. Unethical actions and decisions may yield
results only in the very short run. For a long existence and sustained profitability, a business is
required to conduct itself ethically and run its activities on ethical lines. All over the world, there is a
growing realisation that ethics is important for any type of business and for achieving the growth of
any society. Ethics give rise to an efficient economy. It is not the government or the law which will
protect society; ethics alone has the power to protect it. Today, a mass awareness has been built about
the desirability and, indeed, the necessity of incorporating ethical practices in business conduct. In
future, this is bound to be more necessary than ever before.

A business needs to remain ethical for its own good. Unethical actions and decisions may yield results only in the very short
run. For a long existence and sustained profitability, a business is required to conduct itself ethically and run its activities
on ethical lines. Ethics give rise to an efficient economy. It is not the government or the law which will protect society; ethics
alone has the power to protect it.
IMPORTANCE OF BUSINESS ETHICS
1. The power and influence of business in society is greater than ever before. Evidence suggests that many members of the public
are uneasy with such developments. Business ethics helps us to understand why some things happen strangely, what their
implications might be, and how we should address such situations.
2. Business has the potential to provide a major contribution to our society, in terms of producing the products and services that we
want, providing employment, paying taxes, and acting as an engine for the economic development, which are just a few
examples. How, or indeed whether, this contribution is made raises significant ethical issues that go to the heart of the social role
in business in the contemporary society.
3. Business malpractices have the potential to inflict an enormous harm on individuals, on communities, and on the environment
itself ultimately. By helping us to understand more about the causes and consequences of these malpractices, Business Ethics
seeks, as the Founding Editor of the Journal of Business Ethics has suggested, “to improve the human condition”.
4. The demands being placed on business that it should be ethical, by its various stakeholders, are constantly becoming more and
more complex and challenging. Business ethics provides the means to appreciate and understand these challenges more clearly,
so that the firms can meet these ethical expectations more effectively.
5. Few business people have received formal business ethics education or training. Business ethics can help to improve ethical
decision making by providing managers with the appropriate knowledge and tools that allow them to correctly identify,
diagnose, analyse, and provide solutions to the ethical problems and dilemmas they are confronted with.
6. Ethical infractions continue to occur in business. For example, in a recent UK survey of ethics at work, one in four employees
said that they had felt the pressure to compromise their own or their organisation’s ethical standards, and one in five employees
had noticed that the behaviour by their colleagues had violated the law or did not accord with the expected ethical standards.
7. Business ethics can provide us with the ability to assess the benefits and the problems that are associated with different ways of
managing ethics in organisations.
8. Finally, business ethics is also extremely interesting in that it provides us with knowledge that transcends the traditional
framework of business studies and confronts us with some of the most important questions that are faced by the society. The
subject can, therefore, be richly rewarding to study as it provides us with knowledge and skills, which are not simply helpful for
doing business; but rather, by helping us to understand the modern societies in a more systematic way, and advance our ability to
address life situations far beyond the classroom or the office desk.
VALUES IN BUSINESS
The CEO of a large back-office software company in the United States was indicted. The primary
crime was that he personally backdated contracts to make the quarterly figures look good and meet
market expectations in regard to the company performance. In another case, a star employee of an
investment-banking firm managed stock offerings, and was considered powerful enough to make
both markets and companies. Those were the heady days of the technology-market bubbles. He was
charged with giving stocks, not in initial public offerings, to the personal accounts of executives of
potential client firms in the hope that his firm would get their business in return. The executives who
received these chunks of stock made large sums of money when the company went public and the
stock price rose.
Without the sophistication of financial engineering, we would call this as “corruption”. Business
news reporting relates to corruption, sabotage, bribery, and so on. Businesses also face other
problems like depression at workplace, restless and bankrupt minds of employees, increase in
absenteeism, workplace violence, and so on. To tackle such problems, every effort must be made by
the top management to inculcate values in the employees. Values are the best means in routine life for
purification of the mind and heart. Today’s business requires value-driven management combined
with the requisite skills. The effectiveness in the performance of managers and workers is a function
of values and skills. Human values support the established business values such as service,
communication, excellence, innovation, creativity, and coordination. Human values help to create
good interactions. They reduce conflicts and disputes at workplace. The following are some
organisational or business values for a group of service executives:
1. Contribute to society and humanity.

2. Be fair; do not discriminate on the basis of race, sex, religion, and other parameters.
3. Do not suppress the voice of conscience even if it means sacrificing achievements.
4. Honour human proprietary rights.
5. Work selflessly to the extent possible for a healthy psychological approach to work life.
Values are the best means in routine life for purification of the mind and heart. Today’s business requires value-driven
management combined with the requisite skills.
INCULCATING VALUES IN MANAGEMENT
“Values should be an integral part of corporate mission and objectives. Else, there should be a
separate statement for values. They should be expressively mentioned in the strategic intent”. An
organisational mission statement that truly reflects the vision and values shared by everyone within
the organisation. It not only creates tremendous commitment from the employees but also creates a
great bond of unity among them. Employees themselves create a frame of reference, a set of criteria,
or guidelines, by which they govern themselves. If that kind of situation is truly created, then there is
no need for others to direct, control, or criticise employees, for they create the ultimate corporate
excellence, where the employees govern their own activities, performance, and behaviour. Take, for
instance, the mission and value statement of Bharat Heavy Electricals Limited (BHEL). Box 19.1 gives
instances of Arthur Anderson and many other US firms, which neglected the basic ethical values.

“Values should be an integral part of corporate mission and objectives. Else, there should be a separate statement for
values. They should be expressively mentioned in the strategic intent”.
Mission
To be a leading Indian engineering enterprise providing quality products, systems, and services in the
fields of energy, transportation, industry, infrastructure, and other potential areas.
Values
Meeting commitment that was made to external and internal customers.
Foster bearing, creativity, and speed of response.
Respect for dignity and potential of individuals.
Loyalty and pride for the company.
Team playing.
Zeal to excel.
Integration and fairness in all matters.
Box 19.1 Lesson from America
In the United States, Arthur Anderson, a well-respected and venerable auditing firm with an
international presence, which was considered responsible for non-disclosure of vital financial
information relating to Enron, faced serious criminal charges from the government for
obstruction of justice; and a large number of shareholder suits, has been closed. Several high-
profile executives from Enron and Worldcom who are responsible for Enron’s collapse are in
jail. Many of the technical analysts of the dot-com era have lost their jobs and are likely to face
prosecution for selling shares, with a rosy picture, to ordinary investors. A number of leading
Wall Street bankers have paid out tonnes of money as their research ana-lysts wrote biased
company research reports to induce ordi-nary investors to subscribe for such shares. Many
established auditing firms in the United States are facing legal action from their clients for
professional negligence and improper and wrong advice.

The members of the management team and the union leaders must be regularly exposed to
spiritualisation seminars and workshops, meditations, introspections, common prayers, and so on.
The organisation should inculcate the sprit of giving rather than taking. Individuals should be
encouraged to subdue their ego, overcome to some extent their selfishness, anger, jealousy, greed,
hatred, partiality, and such other negative aspects. Organisations must strive for the internal growth of
their employees rather than concentrating only on their skills and proficiency to bring about a radical
change in thought, speech, and actions of employees, which needs discipline and conscious and well-
directed effort.

Individuals should be encouraged to subdue their ego, overcome to some extent their selfishness, anger, jealousy, greed,
hatred, partiality, and such other negative aspects.
CATEGORIES OF BUSINESS VALUES
Managerial Values
These are values that are important for personal and organisational life. Examples of managerial
values include honesty, loyalty, truth, and gentleness. Any management decision and strategy must be
based on these values.
Leadership Values
These values form the very basis of the company. Examples include transparency, truth, friendliness,
fairness, and equality. These values characterise a true leader.
Organisational Values
Social responsibility, nondiscrimination, satisfaction of the customer, and quality product/services
are some examples of organisational values. Much importance is also given to the voice of the
conscience and selfless work.
NEED FOR ETHICS IN GLOBAL CHANGE
Science and technology set us on the path of development and liberated us from servitude to nature.
But science and technology also brought about phenomenal industrialisation at the cost of
indiscriminate and ruthless exploitation of nature. Liberalisation of economy resulted in cutthroat
competition in business. Today’s market situation has become very dynamic. A business earns more
profit in a short period, resulting in increased exploitation of customers, employees, and nature.
Misleading and false advertisements; defective and contaminated products; price war; delay in
paying corporate taxes, duties, and other dues like electricity bills; bribing public servants; and
corrupting the democratic structure of the country—thus, business has no responsibility towards
society. Take the example of cosmetic companies. Many cosmetic companies manufacture products
that contain a cocktail of chemicals, which cause irreversible damage to the skin, nails, hair, and eyes.
Badly researched and poor-quality cosmetics and toiletries cause unimaginable damage, sometimes
even causing skin diseases and cancers.

The need for ethics has become even more pertinent with the advancement in science and technology, and the industries
have benefitted from such development, like that of in the cosmetic industries, soft-drink companies, and medicine
companies, as a lot of these products can be harmful to the body, on the whole.
The alleged presence of fluoride in toothpaste is another instance. Internationally reputed soft
drinks have been found to contain pesticides. Deodorants contain aluminium, zinc and zirconium
salts, antiseptics, perfume, propellant, alcohol, and formaldehyde that cause irritations to sensitive
skin. Paracetamol is yet another example. If taken regularly for headaches, can aggravate the
headache and even lead to liver or kidney damage, but this information is not written on the product.
Some pediatric multivitamins deteriorate even during the period of their use, which speaks of their
quality. Many cosmetic and medical products are put in the market without any kind of testing.
Businesses today exist only to maximise their profits. These profits can be earned in numerous
ways, even through black marketing, hoardings, and adulteration. But no business can exist without
the acceptance and the sanction of the society in which it carries out its activities. And to get a sanction
from the society, a business should be ethical and socially responsible. A business can, thus, maximise
its profits and do good for the society in which it operates.

No business can exist without the acceptance and the sanction of the society in which it carries out its activities.
An example of a group of industries that has rendered important social service and believes in the
Indian ethos is the Hero group. BHEL has implemented a number of welfare schemes not only for its
employees, but also for the people living in the places it is located in. Other examples of such
companies are the Aditya group, Choksh’s Asian Paints, NDDB, and TVS. These companies practise
business ethics in all their dealings with customers and the public at large.
MANAGING ETHICS
Leaders and managers require more practical information about managing ethics. Managing ethics in
the workplace holds tremendous benefit for both leaders and managers, as it benefit both of them,
morally and practically. This is particularly true today, when it is critical to understand and manage
highly diverse values in the workplace. Organisations can manage ethics in their workplaces by
establishing an ethics management programme. Brian Schrag, the Executive Secretary of the
Association for Practical and Professional Ethics, clarifies, “Typically, ethics programs convey
corporate values, often using codes and policies to guide decisions and behaviour, and can include
extensive training and evaluating, depending on the organisation”.

Organisations can manage ethics in their workplaces by establishing an ethics management programme.
“Typically, ethics programs convey corporate values, often using codes and policies to guide decisions and behaviour, and
can include extensive training and evaluating, depending on the organisation”.
Benefits of Managing Ethics as a Programme
There are numerous benefits in formally managing ethics as a programme rather than as a one-shot
effort when it appears to be needed. Generally, ethics programmes
Establish organisational roles to manage ethics.
Schedule the ongoing assessment of ethics requirements.
Establish the required operating values and behaviours.
Align the organisational behaviours with operating values.
Develop an awareness and sensitivity to ethical issues.
Integrate ethical guidelines and decision making.
Structure mechanisms to resolving ethical dilemmas.
Facilitate the ongoing evaluation and updates to the programme.
Help to convince employees that attention to ethics is not just a knee-jerk reaction to get out of trouble but to improve public
image.
Guidelines for Managing Ethics in the Workplace
The following guidelines ensure that the ethics management programme is operated in a meaningful
fashion:
1. Recognise that managing ethics is a process. Ethics is a matter of values and associated behaviours. Values are discerned through
the process of ongoing reflection. Therefore, ethics programmes may seem more process-oriented than most of the management
practices. Managers tend to be sceptical of process-oriented activities, preferring instead the processes that are focused on
deliverables with measurements. However, experienced managers realise that the deliverables of standard management
practices (planning, organising, motivating, controlling) are only tangible representations of the very process-oriented practices.
For example, the process of strategic planning is much more important than the plan produced by the process. The same is true
for ethics management. Ethics programmes do produce deliverables, for example, codes, policies, and procedures; budget items,
meeting minutes, authorisation forms, newsletters; and so on. However, the most important aspect from an ethics management
programme is the process of reflection and dialogue that produces these deliverables.

Recognise that managing ethics is a process. Ethics is a matter of values and associated behaviours. Values are
discerned through the process of ongoing reflection.
2. The bottom line of an ethics programme is accomplishing preferred behaviours in the workplace. As with any management
practice, the most important outcome is behaviours preferred by the organisation. The best of ethical values and intentions are
relatively meaningless unless they generate fair and just behaviours in the workplace. That is why, practices that generate lists of
ethical values, or codes of ethics, must also generate policies, procedures, and training that translate those values to appropriate
behaviours.
3. The best way to handle ethical dilemmas is to avoid their occurrence in the first place. That is why, practices such as developing
codes of ethics and codes of conduct are so important. Their development sensitises employees to ethical considerations and
minimises the chances of unethical behaviour occurring in the first place.
The best way to handle ethical dilemmas is to avoid their occurrence in the first place. That is why, practices such
as developing codes of ethics and codes of conduct are so important. Their development sensitises employees to
ethical considerations and minimises the chances of unethical behaviour occurring in the first place.
4. Make ethics decisions in groups, and make the decisions public, as appropriate. This usually produces better-quality decisions by
including diverse interests and perspectives, and increases the credibility of the decision process and outcome by reducing
suspicion of unfair bias.
5. Integrate ethics management with the other management practices. When developing the statement of values during strategic
planning, include ethical values preferred in the workplace. When developing personnel policies, reflect on what ethical values
should be most prominent in the organisation’s culture and then design policies to produce these behaviours.
6. Use cross-functional teams when developing and implementing the ethics management programme. It is vital that the
organisation’s employees feel a sense of participation and ownership in the programme if they are to adhere to its ethical values.
Therefore, include employees in developing and operating the programme.
7. Value forgiveness. This may sound rather religious or preachy; but it is probably, the most important component of any
management practice. An ethics management programme may at first actually increase the number of ethical issues to be dealt
with, because people are more sensitive to their occurrence. Consequently, there may be more occasions to address people’s
unethical behaviour. The most important ingredient for remaining ethical is trying to be ethical. Therefore, help people to
recognise and address their mistakes and then, support them to continue to try operating ethically.
8. Note that trying to operate ethically and making a few mistakes is better than not trying at all. Some organisations have become
widely known for operating in a highly ethical manner, for example, Johnson and Johnson and Hewlett-Packard (HP), to name
two. Unfortunately, it seems that when an organisation achieves this strong public image, some business ethics writers place it on
a pedestal. All organisations comprise of people, and people are not perfect. However, when a mistake is made by any of these
organisations, they have a long way to fall. In our increasingly critical society, these organisations are accused of being
hypocritical and social critics soon pillory them. Consequently, some leaders may fear sticking their necks out publicly to
announce an ethics management programme. Box 19.2 gives the key factors that contribute to the best ethical environment.
Note that trying to operate ethically and making a few mistakes is better than not trying at all.
Box 19.2 Ethical Environment
The following factors may influence the ethical environment in an organisation:

The ethical vision of the management which may need a review
The holistic human values the organisation has developed
The ethical code acquired within the organisation
The individual inspiration source
The managerial character and ethical deduction
The workplace environment and the compulsion to follow the ethical norms

Key Roles and Responsibilities in Ethics Management
Depending on the size of the organisation, certain roles may prove useful in managing ethics in the
workplace. These can be full-time roles or part-time functions, which could be assumed by someone
already in the organisation. Small organisations certainly will not have the resources to implement
each of the following roles, using different people in the organisation. However, the following
functions point out responsibilities that should be included somewhere in the organisation:
1. The organisation’s CEO (Chief Executive Officer) must fully support the programme. If he/she is not fully behind the
programme, employees will certainly notice—and this apparent hypocrisy may cause such cynicism that the organisation may be
worse off than having no formal ethics programme at all. Therefore, the CEO should announce the programme, and also should
champion its development and implementation. Most important, he/she should consistently aspire to lead in an ethical manner. If a
mistake is made, he/she should admit it.
2. Consider establishing an Ethics Committee at the board level. The Committee would be charged to oversee the development
and operation of the Ethics Management Programme.
3. Consider establishing an Ethics Management Committee. It would be charged with implementing and administrating an Ethics
Management Programme, including administering and training of policies and procedures, and resolving ethical dilemmas. The
committee should comprise senior officers.
4. Consider assigning/developing an Ethics Officer. This role is becoming more common, particularly in larger and more
progressive organisations. The ethics officer is usually trained about matters of ethics in the workplace, particularly about
resolving ethical dilemmas.
5. Consider establishing an Ombudsperson. The ombudsperson is responsible for coordinating the development of the policies and
procedures to institutionalise moral values in the workplace. This position usually is directly responsible for resolving ethical
dilemmas by interpreting the existing policies and procedures.
6. Note that one person must ultimately be responsible for managing the ethics management programme.
Depending on the size of the organisation, certain roles may prove useful in managing ethics in the workplace. These can
be full-time roles or part-time functions assumed by someone already in the organisation. Small organisations certainly will
not have the resources to implement each the following roles, using different people in the organisation.
Ethics Tools
Code of Ethics
A code of ethics specifies the ethical rules of operation. It is the “thou shalt not’s”. In the later 1980s,
the Conference Board in New Delhi, a leading business membership organisation, found that 76 per
cent of corporations that were surveyed had codes of ethics. Some business ethicists disagree that
codes have any value. Their general opinion is that too much focus is put on the codes themselves,
and that the codes themselves are not influential in managing the ethics in the workplace. Many
ethicists note that it is the developing and continuing dialogue around the code’s values that is most
important.

A code of ethics specifies the ethical rules of operation. It is the “thou shalt not’s”.
Developing Codes of Ethics
Note that if your organisation is quite large, for example, if it includes several large programmes or
departments, you may want to develop an overall corporate code of ethics and then a separate code to
guide each of your programmes or departments. Also note that the codes should not be developed by
the Department of Human Resources or the Legal Department alone, as is done too often. Codes are
insufficient if they are intended only to ensure that policies are legal. All the staff must see the ethics
programme being driven by the top management. Note that the codes of ethics and codes of conduct
may be the same in some organisations, depending on the organisation’s culture and operations and
on the ultimate level of specificity in the code(s).

Codes are insufficient if they are intended only to ensure that policies are legal. All the staff must see the ethics programme
being driven by the top management.
Guidelines for Developing Codes of Ethics

Review if any values need to adhere to relevant laws and regulations; this ensures your organisation
is not (or is not near) breaking any of them. If you are breaking any of them, you may be far better
off to report this violation than to try hiding the problem. Often, a reported violation generates more
leniency than an outside detection of an unreported violation. Increase priority on values that will help
your organisation operate to avoid breaking these laws and to follow necessary regulations. Review
which values produce the top three or four traits of a highly ethical and successful product or service
in your area, for example, for accountants: objectivity, confidentiality, accuracy, and so on. Identify
which values produce behaviours that exhibit these traits.
Identify values that are needed to address the current issues in your workplace. Appoint one or two
key people to interview key staff to collect descriptions of all major issues in the workplace. Collect
descriptions of behaviours that produce the issues. Consider which of these issues is ethical in nature,
for example, issues pertaining to respect, fairness, and honesty. Identify the behaviours needed to
resolve these issues. Identify which values would generate those preferred behaviours. There may be
values included here that some people would not deem as moral or ethical values, for example, team-
building and promptness; but for managers, these practical values may add more relevance and utility
to a code of ethics.
Identify any values needed, based on the findings during a strategic planning. Review information
from your SWOT analysis (identifying the organisation’s strengths, weaknesses, opportunities, and
threats). What behaviours are needed to build on strengths, shore up weaknesses, take advantage of
opportunities, and guard against threats? Consider any top ethical values that might be prised by
stakeholders. For example, consider expectations of employees, clients/customers, suppliers,
founders, members of the local community, and others. Collect from the above steps, the top 5 to 10
ethical values that are high priorities in your organisation. Examples of ethical values might include
the following list of “Six Pillars of Character” developed by the Josephson Institute of Ethics, the
United States:
a. Trustworthiness: honesty, integrity, promise-keeping, loyalty.
b. Respect: autonomy, privacy, dignity, courtesy, tolerance, acceptance.
c. Responsibility: accountability, pursuit of excellence.
d. Caring: compassion, consideration, giving, sharing, kindness, loving.
e. Justice and fairness: procedural fairness, impartiality, consistency, equity, equality.
f. Civic virtue and citizenship: law abiding, community service, protection of environment.
There is a need for constant review of values and identification of values needed to address issues at more places, also
keeping in mind the findings of such values, during strategic planning.
Codes of Conduct
“Codes of conduct specify actions in the workplace and codes of ethics are general guides to
decisions about those actions”, explains Craig Nordlund, the Associate General Counsel and
Secretary at HP. He suggests that codes of conduct contain examples of appropriate behaviour to be
meaningful.

“Codes of conduct specify actions in the workplace and codes of ethics are general guides to decisions about those
actions”,
Developing a Code of Conduct

Note that if your organisation is quite large, for example, includes several large programmes or
departments, you may want to develop an overall corporate code of conduct, and then a separate code
to guide each of your programmes or departments. Consider the following guidelines when
developing codes of conduct:
1. Compose your own code of ethics; attempt to associate with each value, two example behaviours that may reflect each value.
Generally, the critics of codes of ethics assert that the compositions appear vacuous as many people list only the ethical values
and do not clarify or supplement these values by associating examples of related behaviours.
2. Identify the key behaviours that are needed to adhere to the ethical values proclaimed in your code of ethics, including the
ethical values that are derived from the review of key laws and regulations, ethical behaviours needed in your product or
service area, behaviours to address current issues in your workplace, and behaviours needed to reach the strategic goals.
3. Include wordings that indicate that all the employees are expected to conform to the behaviours specified in the code of conduct.
Add wordings that will indicate the respective people, whom the employees can approach if they have any questions.
4. Obtain reviews from the key members of the organisation. Be sure that your legal department reviews the drafted code of
conduct.
5. Announce and distribute the new code of conduct (unless you are waiting to announce it along with any associated policies and
procedures). Ensure that each employee has a copy and the list or index of postcodes in each employee’s bay or office.
6. Update the code at least once in a year. The most important aspect of codes is developing them and not the code itself. The
continued dialogue and reflection around ethical values produces ethical sensitivity and consensus. Therefore, revisit your codes
at least once a year—preferably, two or three times a year.
7. Note that you cannot include preferred behaviours for every possible ethical dilemma that might arise.
8. Examples of topics typically addressed by codes of conduct include preferred style of dress, avoiding illegal drugs, following
instructions of superiors, being reliable and prompt, maintaining confidentiality, not accepting personal gifts from stakeholders as
a result of the company rule, avoiding racial or sexual discrimination, avoiding conflict of interest, complying with laws and
regulations, not using organisation’s property for personal use, not discriminating against race or age or sexual orientation, and
reporting illegal or questionable activity. Try to go beyond these traditional legalistic expectations in your codes—adhere to
what is ethically sensitive in your organisation as well.
Note that, as with the codes of ethics, you may be better off generating your own code of conduct
from scratch, rather than reviewing examples from other organisations. All ethical values are
attractive to be included in a code; however, you are most interested in those that provoke behaviours
needed in your organisation during the corresponding period of time. You may like to include quite
different ethical values in the succeeding years.

You may be better off generating your own code of ethics from scratch, rather than reviewing examples from other
organisations. All ethical values are attractive to include in a code; however, you are most interested in those that provoke
behaviours needed in your organisation at this time. You may want to include quite different ethical values next year.
Note that, as with the codes of ethics, you may be better off generating your own code of conduct from scratch, rather than
reviewing examples from other organisations.
Policies and Procedures

1. Update the policies and procedures to produce behaviours that are preferred from the code of conduct, including, for example,
personnel, job descriptions, performance appraisal forms, management-by-objectives (MBO) expectations, standard forms,
checklists, budget-report formats, and other relevant control instruments to ensure conformance to the code of conduct. In doing
so, try to avoid creating ethical dilemmas such as conflicts of interest or infringing on the employees’ individual rights.
2. There are numerous examples of how organisations manage values through use of policies and procedures. For example, we are
most familiar with the value of social responsibility. To produce behaviour aligned with this value, organisations often institute
policies such as recycling the waste, donating to local charities, or paying employees to participate in the community events. In
another example, a high value on responsiveness to customers might be implemented by instituting policies to return phone calls
or to repair any defective equipment within a certain period of time. Consider the role of job descriptions and performance
appraisals. For example, an advanced technology business will highly value technical knowledge, creativity, and systems
thinking. They use job descriptions and performance appraisals to encourage behaviours aligned with these values, such as
rewarding advanced degrees, patents, and analysis and design skills.
3. Include policies and procedures to address ethical dilemmas, like to select a method, which is the most appropriate one to your
organisation’s culture and operations.
4. Include policies and procedures to ensure training of employees on the ethics management programme. Refer the following
section “Training”.
5. Include policies and procedures to reward ethical behaviour and impose consequences on unethical behaviour.
6. Include a “grievance policy” for the employees in order to use that to resolve the disagreements they face with the supervisors
and staff.
7. Consider establishing an ethics “hotline”. This function might best be provided by an outside consultant, for example, a lawyer.
Or, provide an anonymous “tip” box in which the personnel can report suspected unethical activities, and can do so safely on an
anonymous basis.
8. Once in a year, review all the personnel policies and procedures. If yours is a small organisation, consider including all the staff
during this review. Allot a whole day for all the staff to review the policies and procedures, and suggest their opinions and
changes too.
Training
1. The ethics programme is essentially useless unless all the staff members are trained about what it is, how it works, and their
roles in it. The nature of the system may invite suspicion if not handled openly and honestly. In addition, no matter how fair and
up-to-date is, a set of policies, the legal system will often interpret the same (rather than written policies) as “de facto policy”.
Therefore, all the staff members must be aware of and act in full accordance with policies and procedures (this is true, whether
policies and procedures are for ethics programmes or personnel management). This full accordance requires training about
policies and procedures. Orient new employees to the organisation’s ethics programme during new-employee orientation.

All staff must be aware of and act in full accordance with policies and procedures (this is true, whether policies and
procedures are for ethics programmes or personnel management). This full accordance requires training about
policies and procedures. Orient new employees to the organisation’s ethics programme during newemployee
orientation.
2. Review the ethics management programme in management-training experiences.

3. Involving the staff in review of codes is strong ethics training.
4. Involving the staff in review of policies (ethics and personnel policies) is strong ethics training.
5. One of the strongest forms of ethics training is practised in resolving complex ethical dilemmas. We should see to it that all the
staff use any of the three ethical-dilemma-resolution methods and apply them to any of the real-to-life ethical dilemmas.
6. Include ethical performance as a dimension in the performance appraisals.
IMPACT OF GLOBALISATION ON BUSINESS ETHICS
Globalisation has brought about a greater involvement with ethical considerations and most
importantly, achieving a competitive advantage through business ethics. Globalisation and business
ethics are inter-linked as they affect a company’s ability to commit to its shareholders, in particular to
external investors, and preserve the trust needed for further investment and growth.

Globalisation has brought about a greater involvement with ethical considerations and most importantly, achieving a
competitive advantage through business ethics.
It is increasingly important for companies to deal with ethics as a “corporate strategy” that, if
uniquely implemented, could achieve competitive advantage for the company rather than waiting to
react to possible ethical issues of importance to the targeted stakeholders. It is the necessity of being
an ethically proactive company rather than being an ethically reactive company. As the speed of
comparable, tangible assets acquisition accelerates and the pace of imitation quickens, firms that want
to sustain distinctive global competitive advantages need to protect, exploit, and enhance their unique
intangible assets, particularly integrity.
Globalisation, as defined in terms of the deterritorialisation of economic activities, is particularly
relevant for business ethics, and this is evident in three main areas—culture, law, and accountability.
In the context of business ethics, this controversy over localisation plays a crucial role. After all,
corporations—most notably multinational corporations (MNCs)—are at the centre of the public’s
criticism on globalisation. They are accused for exploiting workers in the developing countries and
destroying their environment and, for abusing their economic power by engaging the developing
countries in a so-called “race to the bottom”. This term describes a process whereby the MNCs pitch
the developing countries against each other by allocating foreign direct investment (FDI) to those
countries that can oar them the most favourable conditions in terms of low tax rates, low levels of
environmental regulation, and restricted workers’ rights. However true these accusations are in
practice, there is no doubt that globalisation is the most current and demanding arena in which
corporations have to define and legitimate the “right or wrong” of their behaviour. Box 19.3 lists the
impact of globalisation on business ethics.

Box 19.3 Impact of Globalisation on Business Ethics
Heads Ethical Impacts of Globalisation

Globalisation provides potential not only for greater profitability, but
Shareholders also for greater risks. Lack of regulation of global capital markets
leading to additional financial risks and instability.
Corporations outsource production to the developing countries in order
to reduce costs in the global marketplace—this not only provides jobs
Employees
but also raises the potential for exploitation of employees through poor
working conditions.
Global products not only provide social benefits to consumers across the
globe but may also meet protests against cultural imperialism and
Consumers Westernisation. Globalisation can bring cheaper prices to customers, but
vulnerable consumers in the developing countries may also face the
possibility of exploitation by MNCs.
Suppliers in the developing countries face regulations from MNCs
Suppliers and
through supply-chain management. Small-scale indigenous competitors
competitors
are exposed to powerful global players.
Global business activities bring the company in direct interaction with
Civil society (pressure local communities, with a possibility for erosion of traditional
groups, NGOs, local community life; globally active pressure groups emerge with an aim to
communities) “police” the corporation in countries where governments are weak and
tolerant.
Globalisation weakens the governments and increases the corporate
responsibility for jobs, welfare, maintenance of ethical standards, etc.
Government and
Globalisation also confronts governments with corporations having
regulation
different cultural expectation about issues such as bribery, corruption,
taxation, and philanthropy.

BUSINESS ETHICS AS COMPETITIVE ADVANTAGE
Business ethics as a competitive advantage involves effective building of relationships with a

company’s stakeholders, based on its integrity that maintains such relationships. An integral approach
to business can yield strengthened competitiveness: it facilitates the delivery of quality products in an
honest, reliable way. This approach can enhance work life by making the workplace more fun and
challenging. It can improve relationships with stakeholders and can instil a more positive mindset that
fosters creativity and innovations among the stakeholders.

Business ethics as a competitive advantage involves effective building of relationships with a company’s stakeholders, based
on its integrity that maintains such relationships.
The purpose of ethics is to enhance our lives and relationships, both inside and outside of the
organisation. As the competitive environment with globalisation could be characterised by the “game
metaphor” rather than the “war metaphor”, it is increasingly important to include ethics in the
corporation’s strategy and potentially implement it in a way that achieves a competitive advantage for
the company and adds value to the stakeholders. The game metaphor sees competition in business as
an exciting game, in which each competitor strives to achieve excellence, satisfy customers, and
succeed, as a result. The motive in this type of game is not to drive out the competition, but to work
hard, play by the rules of the game, and do one’s best in order to succeed.
BUSINESS ETHICS IN INDIA
Business in the Indian context has changed drastically in the 1990s when globalisation and FDI
inflows have created immense prosperity in some segments, while many areas are underdeveloped
with hunger, starvation, and marginalisation of the most vulnerable segments of our society. The gap
continues to widen both in urban and rural India. What then are the practical steps forward? Business
cannot work in isolation of the country context nor can they be islands of excellence where there are
starvation deaths, homelessness, and farmers’ suicides; and lack of livelihoods and access to services.
Corporate India must respond much more effectively and work for a more inclusive work
environment and society.

Business in the Indian context has changed drastically in the 1990s when globalisation and FDI inflows have created
immense prosperity in some segments, while many areas are underdeveloped with hunger, starvation, and marginalisation
of the most vulnerable segments of our society.
Companies are normally expected to invest 3 per cent to 5 per cent of their profits into corporate
responsibility (CR) programmes. The present scenario ranges from 0.1 per cent to 2 per cent, and an
exceptional 14 per cent by Tata Steel. However, companies can give and, as such, have given their
skills and expertise—“giving” need not always be measured in just financial terms, as can be seen in
the Tsunami last year. Emergencies and Disaster Relief seems to be an area where corporate India
also responds. Contributions in cash and kind flowed into nonprofit organisations (NPOs), to the
PM’s relief fund, and some directly. The role of the private sector was seen as positive and
encouraging, and this could be enhanced by a sharing of core competency and expertise by the
corporate sector. Just one large garment exporter in Chennai, Ambattur Clothing Limited (ACL) is
quietly rebuilding the Government Hospital (GH) at Nagapattinum, with a contribution of few crore,
while providing a State-of-the-Art Health Centre to its employees and their families. Given the context
of outsourcing, the attention of small- and medium enterprises (SMEs) and supply/assembly chains to
labour norms, employee welfare, health, safety and quality standards, and internal governance and
disclosures, need to be emphasised as much as CR.
In India, CR is not merely a function of wealth or size of a company. Although India has the lowest
level of per capita income among the seven Asian countries when compared to South Korea,
Thailand, Singapore, Malaysia, Philippines, and Indonesia, it has the highest level of CR practices.
Education, health, and community development are some of the most popular areas of CR
engagement followed by natural resource management, information technology (IT), and livelihood-
based activities. Many companies cite constraints and challenges in practising CR, such as the overall
absence of policy and the linkage between CR and financial success, lack of capacity and
comprehension to implement CR, and mechanisms to measure, monitor, and evaluate in discharging
their responsibility. These are some of the areas where non-profits and foundations working in CR
today have a significant role to play. A number of corporates have set up their own in-house
foundations, for example, Infosys, Nandy, and so on. The corporates are created by the society and,
therefore, must have a vision beyond profits; and immediate stakeholders and more companies need
to take a stand on issues such as communal violence, female foeticide, misuse of technology, human
rights, and so on. Presently, only eight Indian companies report on the Global Reporting Initiative. It
has been stated that a KPMG survey in India found that about 35 per cent of rupee losses due to
fraudulence take place because of inflated expense accounts. Managerial hostility to whistle-blowing
is a barrier to corporate governance. Business ethics has been a much-talked about term in the recent
days, and attempts have been made to even include it in the syllabus of business administration
courses.

In India, CR is not merely a function of wealth or size of a c ompany.
The corporates are created by the society and, therefore, must have a vision beyond profits; and immediate stakeholders
and more companies need to take a stand on issues such as communal violence, female foeticide, misuse of technology,
human rights, and so on.
CASE
Mr. Vaidya is the owner of an advertising agency. He is a person who always believes in business
ethics. He always designs an advertising campaign on genuine market analysis, based on the whole
scientific truth of the product. But suddenly, he has been suffering financial losses due to his decision
to stick to the truth. He has lost his regular customers because he always puts in his advertisement
design, the ethics that he follow. In the cases of cosmetics and pharmaceuticals, he always checks the
contents and laboratory reports, or some times the reports from the quality control department itself.
However, now when he needs finance desperately and the agency is on the verge of closure, an
internationally reputed cosmetic company is willing to give him their advertisement contract. This
contract has created hope among the employees of his advertisement agency.
Mr. Vaidya asked the company to submit a report about all its products, in which they have to give
information about the content and its significance. Mr. Vaidya found that nail polishes are based on
nitrocellulose, which is a highly inflammable synthetic substance, chemically related to guncotton, an
explosive. Nail polish solvents are narcotic if inhaled in high concentration and can act on the
nervous system.
As soon as he came to know of the side effects of the contents of nail polishes, Mr. Vaidya
cancelled the contract. He desperately needed money, but it would mean compromising on the ethical
standards of his past reputation. Even then, his managers forced him to accept the contract because if
the agency closes down there is no meaning in being ethical. The company also has a responsibility
towards its employees. Now, Mr. Vaidya is fixed in a moral dilemma.
Case Questions
1. Is it ethical to play with the goodwill and, more importantly, the health of the public?
2. Is it ethical to play with the financial health of the company, go bankrupt, and force the employees on the street? Discuss.
SUMMARY
Ethics is an area dealing with a moral judgement regarding voluntary human conduct. Today, there is
a great interest in the application of ethical practices in business. No business, however great or
strong or wealthy it may be at present, can exist by unethical means, or in total disregard of its social
concern for a very long. Thus, the business needs, in their own interest, should remain ethically and
socially responsible.
Ethics and values must be an integral part of management and work culture to reduce exploitation
of customers, society, shareholders, and nature. Modern businesses are large and complex, catering
to national and even global markets, and problems like cut-throat competition, price war, corruption
at workplace, and so on. Thus, in such a dynamic situation, today’s businesses require a value-based
management. Any management should carefully inculcate values and ethics in its practices.
Some tools are available for managing ethics at the workplace, such as code of ethics, code of
conduct, and training.
Today, mass awareness has been built into the desirability and, indeed, the necessity of
incorporating ethical practices in business conduct. In future, this is bound to be more necessary than
ever before.
KEY WORDS
Ethics
Business Ethics
Values
Codes of Ethics
Codes of Conduct
Ethics Tools
Cross-functional Teams
Trustworthiness
Ethics Training
Ethical Dilemma
Ethics Management
Ethics Officer
Ethics Committee
Organisational Values
Leadership Values
Managerial Values
QUESTIONS
1. Describe what do you understand by business ethics. Are ethics necessary in the present context?
2. Explain the importance of values in business.
3. What tools are available to manage ethics at the work place? Explain.
4. List some personal and organisational values, and suggest some strategies to inculcate values in the management.
5. Why do you need value-based management in global societies?
REFERENCES
Avadhani, V. A. (2004). Global Business, 2nd ed. Mumbai: Himalaya Publishing House.
Bandyopadhyay, P. (2007). “Business Ethics and Profits”, March 10, 2007, http://www.indianmba.com
Bhatia, S. K. and A. Ahmed (2004). Business Ethics and Corporate Governance. New Delhi: B.R. World Books.
Boatright, J. R. (2004). Ethics and the Conduct of Business, 4th ed. New Delhi: Pearson Education.
Caroselli, M. (2003). Ethics of Business Professional Development Sources. Singapore: Thomson.
Crane, A. and D. Maattern (2007). Business Ethics, Online edition, http://www.bookgoogle.co.in
McNamara, C. Complete Guide to Ethics Management; An Ethic Tool kit for Managers, http://www.managementhelp.org
Mondy, W. (2007). Human Resource Management, 10th ed. Prentice-Hall.
Radhakrishnan, S. (2008). “Putting Ethics on the Business Agenda”, Business Line, April 14, 2008, Online edition,
http://www.thehindubusinessline.com
Subramanyan, S. (2002). “Business Ethics: Precept Easier than Practice”, Business Line, October 8, 2002, Online edition,
Velasquez, M. G. (2004). Business Ethics: Concept and Cases, 5th ed. New Delhi: Pearson Education.
Wolfe, J. (2003). The Global Business Game: A Simulation in Strategic Management and Internal Business, 2 nd ed. New
Delhi: Thomson.
Woodrad, N. (2008). “Managing Ethics is a Continuous Process”, The Financial Express, June 7, 2008, Online edition,
http://www.financialexpress.com
CHAPTER 20
Corporate Governance
CHAPTER OUTLINE
Definition
The Need and Importance of Corporate Governance
Problems of Corporate Governance
Best Practices in Corporate Governance: An Indian and International Position Review
The Board—Key to Good Corporate Governance
Disclosure and Transparency: Partners of Good Governance
Executive and Non-executive Directors
Brief Review of Overseas Development on Governance Issues
The Search for a New Approach to Corporate Governance
Code of Conduct for Corporate Governance
Measures to Improve Corporate Conduct
Corporate Governance and India
Challenges Before Managers
Corporate Governance and Some Indian Organisations
Regulatory Framework of Corporate Governance in India
Case
Summary
Key Words
Questions
References
The economic and financial crises, which began in 1998 in certain Asian countries and spread to
other regions of the world, as well as the recent spectacular bankruptcy cases all over the world,
underline the need for a reliable and transparent management system. A system of checks and
balances needs to be put in place among shareholders, directors, auditors, and management. There is
now an increasing realisation among the modern and progressive companies that only ethics and
corporate social responsibility make a good business sense. An ethical and socially responsible
company generally conforms to the standards of good corporate governance. Good governance is
essential for building goodwill and credibility, managing companies efficiently and transparently, and
preventing a variety of corporate crimes like embezzlement, money laundering, kickbacks, expense-
account pending, and price-bid rigging.

The economic and financial crises, which began in 1998 in certain Asian countries and spread to other regions of the
world, as well as the recent spectacular bankruptcy cases all over the world, underline the need for a reliable and
transparent management system.
The sound corporate governance practices have become critical to worldwide efforts to stabilise
and strengthen global capital markets and protect investors. Corporate governance enables
corporations to realise their corporate objectives, protect shareholder rights, meet legal
requirements, and demonstrate to a wider public how they are conducting their business. Researches
show that investors from all over the world indicate that they will pay a large premium for companies
with an effective corporate governance. One such study conducted by the McKinsey Quarterly found
that institutional investors in emerging market companies would be willing to pay as much as 30 per
cent more for shares in companies with good governance. Furthermore, it showed that companies
with better corporate governance had higher price to book ratios, demonstrating that investors do,
indeed, reward good performance.
DEFINITION
1. Corporate governance is concerned with holding the balance between economic and social goals and between individual and
communal goals. The corporate governance framework is there to encourage the efficient use of resources equally, for
accountability, for the stewardship of those resources. The aim is to align as nearly as possible the interests of individuals,
corporations, and the society.
2. This is a system by which companies are run, and the means by which they are responsive to their shareholders, employees, and
the society.
3. The system by which companies are directed and controlled; boards of directors are responsible for the governance of
companies.

Corporate governance is the system by which companies are directed and controlled.
4. Corporate governance is also concerned with the ethics, values, and morals of a company and its directors.
5. The role of corporate governance is to ensure that the directors of a company are subject to their duties, obligations, and
responsibilities to act in the best interest of their company, to give direction, and to remain accountable to their shareholders and
other beneficiaries for their actions.
6. Corporate governance is the relationship among corporate managers, directors, and providers of equity, people, and institutions
who save and invest their capital to earn a return.
THE NEED AND IMPORTANCE OF CORPORATE GOVERNANCE
It is the increasing role of foreign institutional investors (FIIs) in the emerging economies that has
made the concept of corporate governance a relevant issue today. In fact, the expression was hardly in
the public domain. In the increasingly close interaction of the economies of different countries lies
the process of globalisation. The increasing concern of FIIs is that the enterprise in which they invest
should not only be effectively managed but should also observe the principles of corporate
governance. In other words, the enterprises will not do anything illegal or unethical. This need for
reassurance is felt by the FIIs due to the fact that there have been cases of dramatic collapse of
enterprises which were apparently doing well but which were not observing the principles of
corporate governance.

The increasing concern of FIIs is that the enterprise in which they invest should not only be effectively managed but should
also observe the principles of corporate governance.
In India, corruption is an all-embracing phenomenon. In this, if the respective players in the field
were to adopt healthy principles of good corporate governance and avoid corruption in their
transactions, India could really take a step forward to becoming a less-corrupt country and improving
its rank in the Corruption Perception Index listed by the Transparency International. Therefore, there
is a need of corporate governance because of the following factors:
Liberalisation and deregulation all over the world have given greater freedom in management. This would imply greater
responsibilities.
Players in the field are many. Competition brings in its weakness in standards of reporting and accountability.
The market conditions are increasingly becoming complex in the light of global developments like World Trade Organization
(WTO) and removal of barriers/reduction in duties.
The failure of corporates due to lack of transparency, disclosures, and instances of falsification of accounts/embezzlement, and
the effect of such undesirable practices in other companies.
Corporate governance is important for the following reasons:

It lays down the framework for creating a long-term trust between companies and the external providers of capital.
It improves strategic thinking at the top level by inducting independent directors, who bring in a wealth of experience and a host
of new ideas.
It rationalises the management and monitoring of risk that a firm faces globally.
It limits the liability of top management and directors, by carefully articulating the decision-making process.
It has long-term reputation effects among key stakeholders, both internally (employees) and externally (clients, communities,
political/regulatory agents).
PROBLEMS OF CORPORATE GOVERNANCE
Supply of accounting information: The financial accounts form a crucial link in enabling the
providers of finance to monitor directors. Imperfections in the financial reporting process will cause
imperfections in the effectiveness of corporate governance. This should, ideally, be corrected by the
working of the external auditing process.
Demand for information: A barrier to shareholders using good information is the cost of processing
it, especially to a small shareholder. The traditional answer to this problem is the efficient market
hypothesis (EMH) (In finance, the EMH asserts that financial markets are efficient.), which suggests
that the shareholder will have a free ride on the judgements of larger professional investors.
Monitoring costs: In order to influence the directors, the shareholders must combine with others to
form a significant voting group which can pose a real threat of carrying resolutions or appointing
directors at a general meeting.
BEST PRACTICES IN CORPORATE GOVERNANCE : AN INDIAN AND INTERNATIONAL POSITION REVIEW
The best practices in the field of corporate governance may broadly be grouped under four
categories: those relating to corporate boards and directors, those concerning operational
management and control, those dealing with credibility and transparency of reporting, and those
bearing upon shareholder democracy and minority protection. The current position as recommended
by industry bodies, mandated by regulators, and legislated by the existing law is reviewed in this part,
suitably drawing upon the international experience wherever appropriate, pointing to the potential
areas for further improvement.

Best practices in the field of corporate governance are corporate boards and directors, operational management and
control, credibility and transparency of reporting, shareholders democracy, and protection of minority interests.
Corporate Boards and Directors
Reference has been already made to the critical positioning of the board of directors in the corporate
form of organisation. In the United Kingdom, the Cadbury Report placed the corporate board at the
centre stage of the governance system which it described as the one by which companies are directed
and governed. Given the fiduciary relationships that corporate directors are subject to, there is an
overwhelming need to ensure that they discharge their responsibilities to the best of their abilities to
protect and promote the interests of all shareholders. At the same time, there is also a pressing need to
delineate the directing and managing aspects of governance. It is in this perspective that the role,
responsibility and accountability, constitution, structure, independence, competence, remuneration,
empowerment, and evaluation of corporate boards and their directors need to be considered.

Corporate board is at the centre stage of the governance system which it described as the one by which companies are
directed and governed.
Operational Management and Control
While a competent and independent board of directors is a prerequisite to ensure that created wealth is
applied for the benefit of all shareholders, the board and the executive management of the company
have to address in the first place, the all-important task of creating and protecting such wealth and
wealth-creating assets and resources. The policy-making structures and managerial and operational
processes that help achieve these objectives are, indeed, the key constituents of good corporate
governance.

The policy-making structures and managerial and operational processes that help achieve these objectives are, indeed, the
key constituents of good corporate governance.
Reporting and Disclosure

1. The company law in India requires a company’s board to provide an annual report to its shareholders. The minimum contents of
the report and matters requiring disclosure have been prescribed, as have been the formats in which the company’s financials are
to be prepared, audited, and submitted to the shareholders. The auditors’ report is a significantly detailed document and is
required to be actually read out at the annual general meetings of the shareholders. Considering the less-than-satisfactory
attendance and even worse levels of participation by the shareholders at such meetings, there is a case for removing this
requirement altogether.
2. The shareholders are required to decide on a number of matters and it is important that the company provides its shareholders
adequate information to enable them to exercise their votes. The company law again provides for explanatory statements to be
provided to shareholders on certain key matters that require approval by a special resolution.
Shareholder Democracy and Protection of Minority Interests
1. Corporations are owned in a legal sense by shareholders who subscribe to their equity capital on the basis of a public offer or a
private placement, in either case relying upon the stated objectives of the company in the offer document. They exercise their
rights in the general meetings of the shareholders of the company. Usually (and in India, actually), their voting rights are
proportional to their shareholding. The current company law requirements mandate a 75 per cent majority in certain matters and a
simple majority in other cases, of those present and voting (personally or through duly recorded proxies) in the meeting. A
“show of hands” is usually enough for the Chair to determine if a resolution has the required majority. There is, of course, a
provision for poll in case of any doubts or when demanded by eligible shareholders.

Corporations are owned in a legal sense by shareholders who subscribe to their equity capital on the basis of a
public offer or a private placement, in either case relying upon the stated objectives of the company in the offer
document.
2. Owing to their initial and ongoing reliance on information provided by the company and those responsible for its governance, the
shareholders seek and are entitled to some protection from being deceived or unfairly treated by those in the operational
control. Reporting and disclosure requirements and best practices are developed to meet this need. More importance is also
attached to protecting the interests of minority shareholders on the basis that by themselves, individually, they may not have the
resources to do so. But what is important to note in this context is that no protection is justified or to be expected by any
shareholder, including the minority shareholder, in respect of the equity risk that he/she takes, when investing in risky instruments
like the company shares. Securities and Exchange Board of India (SEBI) requirements for highlighting risk factors in equity
offers is an example of how potential investors should be made aware of the nature and extent of the risks involved in investing.
Protection of shareholder interests should, therefore, be applicable to matters relating to transparency in accounting and
reporting, majority oppression, biased management, non-conforming to obligatory requirements, and so on, but certainly not to
issues arising from a normal business risk that equity investments are subject to.
Protection of shareholder interests should, therefore, be applicable to matters relating to transparency in

accounting and reporting, majority oppression, biased management, non-conforming to obligatory requirements,
and so on, but certainly not to issues arising from a normal business risk that equity investments are subject to.
THE BOARD—KEY TO GOOD CORPORATE GOVERNANCE
An effective board of directors is the linchpin of good corporate governance. The “board of
directors” constitute the representatives of the shareholders and are expected to provide corporate
leadership and strategic and competent guidance, independent of the management of the company. In
India, the board of directors generally comprise promoters, directors, professional directors, and
institutionally nominated directors.

In India, a board of directors generally comprise promoters, directors, professional directors, and institutionally nominated
directors.
Board Constitution
1. The board should be composed of qualified individuals of integrity with diversity of experience. At a minimum, qualified means a
good working knowledge of corporate finance.
2. Each board member should be able to devote sufficient time to his/her duties and responsibilities.
3. The boards should be composed of a substantial number of independent directors. The boards should disclose their criteria for
independence to their shareholders and stakeholders.
4. The board committees on compensation, audit, and nomination should consist only of independent directors. The executive
session of the board should also comprise only independent directors.
5. For family-owned business, outside directors are essential to “ask the hard questions” to family owners, where the relationship
between the business and family may be blurred.
Board Responsibility
1. Approve a core philosophy and mission
2. Monitor and evaluate the corporate performance

Core responsibility of the board of directors is to monitor and evaluate corporate performance.
3. Monitor and evaluate the corporate strategy

4. Review and approve material transactions not in the course of ordinary business
5. Determine the executive compensation
6. Evaluate the senior management performance
7. Manage the Executive Director/CEO succession
8. Communicate with the shareholders
9. Evaluate the board’s performance
DISCLOSURE AND TRANSPARENCY: PARTNERS OF GOOD GOVERNANCE
Disclosure and transparency are the partners of good governance; they demonstrate the quality and
reliability of information—financial and non-financial, provided by management to lenders,
shareholders, and public. The two factors enable the investor to take informed decisions; it is
essential that all the relevant information is made available to the shareholders.

Disclosure and transparency of financial and non-financial information of a company is required for good corporate
governance.
In developed countries like the United States, all the information that companies are required to
share with shareholders/investors/public is available at the click of a mouse. The US EDGAR
(Electronic Data Gathering and Retrieval) systems allow the issuer companies to file all the relevant
information in a secured manner electronically.

In developed countries like the United States, all the information that companies are required to share with
shareholders/investors/ public is available at the click of a mouse.
It is mandatory for US companies to file information electronically through EDGAR.
Investors/shareholders can retrieve the information simply by accessing the system on the Internet. A
similar facility has been made available to Indian investors through the EDIFAR (Electronic Data
Information Filing and Retrieval) system. However, a wide range of information filed by companies
with exchanges is still not available on EDIFAR in a structured, user-friendly manner.
Why Disclosure and Transparency Matter?
1. Empirical evidence indicates that high standards of transparency and disclosure can have a material impact on the cost of capital.
2. Reliable and timely information increases confidence among decisionmakers within the organisation and enables them to make
good business decisions, thereby directly affecting growth and profitability.
3. Information also affects decisionmakers outside the entity-shareholders, investors, and lenders who must decide where and at
what risk to place their money.
4. The information a company provides should show decisionmakers and outside interests, whether and to what extent corporations
meet legal requirements.
5. Disclosure helps public understanding of a company’s activities, policies, and performance with regard to environmental and
ethical standards, as well as its relationship with the communities where the company operates.
6. Disclosure and transparency, as well as proper auditing, serve as a deterrent to fraud and corruption, allowing firms to compete
on the basis of their best offering and to differentiate themselves from firms which do not practise good governance.
7. Research has demonstrated that disclosure and transparency also enhance stock market liquidity.
Essential Features
Disclosure should include material information, that is, information whose omission or misstate-
ment could influence the economic decisions taken by the users on factors as follows:
1. Company objectives;
2. Major share ownership and voting rights;
3. Members of the board and key executives;
4. Governance structure—in particular, the division of authority among shareholders, management, and board members;
5. The company’s financial and operating results. The audits should be conducted by an independent auditor in order to provide an
objective assurance that the financial statements have been properly prepared and presented;
6. Material issues affecting employees and other stakeholders;
7. Managerial compensation;
8. Related party transactions; and
9. Foreseeable risk factors.
Disclosure should include material information, information whose omission or misstatement could influence the economic
decisions taken by the shareholders.
EXECUTIVE AND NON-EXECUTIVE DIRECTORS
A board can have both executive and non-executive directors. Executive directors are those who are
in whole-time appointment or are entrusted with the day-to-day operations of a company. Non-
executive directors are from outside the company and work on a part-time basis, after periodic
intervals, when required and attend the board meetings. Such directors are retained because of their
professional advice, external contacts, or for their objective and independent opinion in board
meetings.

The board of directors comprise executive and non-executive directors. Executive directors are those who are in whole time
appointed, and non-executive directors are from outside the company.
The liabilities of non-executive directors are the same as that of executive directors in the “eyes of
law”. A person cannot be a director in more than 20 companies (excluding private limited companies
which are subsidiaries of a public limited company, and unlimited companies or nonprofit
organisations). The whole-time (executive) directors, like the employees of a company, get a monthly
remuneration. The part-time (non-executive) directors get a sitting fee (per meeting) for attending
board meetings and remuneration as a small percentage of the net profits of the company (if its
articles so provide).
BRIEF REVIEW OF OVERSEAS DEVELOPMENT ON GOVERNANCE ISSUES
The United States
The corporate governance in the United States is the Anglo-Saxon system, which is based on the
individual and short-term market orientation. Historically speaking, the US ownership and
governance structure, by and large, is dominated by large public corporations, most of which have
dispersed shareholders with small percentage holdings and relatively little, or no voice, in corporate
governance. It is interesting to note how such a fragmented corporate ownership structure came up in
the United States. The primary reason for the prevailing form of American business is a matter of
international, historical economic revolution. Initially, the American corporations raised money from
the small investors and over a period, these corporations witnessed a shift in the ownership pattern
from the fragmented one to the ownership of domestically located institutions. A 100 years of latent
American financial history is a witness to these developments. However, ownership concentration of
power in the hands of institutions has become a matter of challenge to corporate governance.

The corporate governance in the US is the Anglo-Saxon system, which is based on the individual and short-term market
orientation.
It is difficult to evolve any panacea which could cure the ailments of American corporate
governance. An increased institutional power could lead to political pressure for more government
intervention, which has tended not to work poorly elsewhere. The United States being the focus of
investments and international trade is capable of absorbing multiple governance system. The policy
prescription for the United States, therefore, by researchers has been that they should be thrown open
to more competition and the resulting forces will provide a direction for good governance.
The development of the US securities markets suggests that they developed to a remarkable degree
during the 19th century. While the origin of the New York Stock Exchange (NYSE) dates back to 1792,
it was not until after the Civil War that the market grew significantly, with railroads constituting a
significant portion of the early listings. By 1880, the trading volume reached sufficient levels for a
continuous auction market system to be instituted, and securities of the growing industrial sector
began to be listed.
The NYSE rules required annual financial reports, and encouraged quarterly reports as well, all
before adoption of the securities laws. Offering disclosures of new issues were roughly similar to the
current S-1, S-2, and S-3 registration statement standards though they lacked the overlay of trivial
detail that the Stock Exchange Commission (SEC) has since mandated. Even at this early date the
NYSE was competing on a “quality margin”, as evidenced by the fact that its best practices in the
prospectus area were used as the basis for the mandatory regulation that followed. Even so if these
markets had been left unregulated, we would have expected a competition on quality margins to have
continued, and these standards would have embraced thousands of new issuers who sought public
capital over the decades.

The NYSE rules required annual financial reports, and encouraged quarterly reports as well, all before adoption of the
securities laws.
The accounting standards that are employed today have been left largely in the hands of the private
sector, with only a minimal interference from the SEC. With the onset of regulation, these essentially
private standards were mandated and refined through SEC regulation to provide for the most detailed
disclosure and financial reporting requirements in the world. If they are to be faulted, it is because too
much, rather than too little, information is required to be disclosed.

The accounting standards that are employed today have been left largely in the hands of the private sector, with only a
minimal interference from the SEC.
The US capital markets rise in excess of $1 tn per year, which has been estimated to be more than
the combined total of all other capital markets. In 1980, the market capitalisation of the NYSE
exceeded the combined capitalisation of the exchanges in Tokyo, London, Montreal, Frankfurt,
Toronto, and Paris. While the American markets are less dominant today, this comparison
demonstrates the lead that the United States had in the development of an efficient capital market for
many decades. In short, the US capital market is an efficient capital market. Liquidity in these markets
is relatively high, even for smaller companies, when compared to liquidity and transparency that
attracted large foreign investors to the US markets.
The United Kingdom

The corporate governance system in the United Kingdom (UK) is also based on individualism,
competition, short-termism, and a belief in the market-oriented capitalism. The key players in this
model are the institutional investors, particularly the big insurance companies and pension funds.
Until recently, these owners of the British industry have played merely a passive role in the
companies they own.

The corporate governance system in the United Kingdom is also on individualism, competition, short-termism, and a belief
in the market-oriented capitalism.
This passive role started to change in the late 1980s when the extent of merger and acquisition
activity removed the executive management further from any effective shareholder control. This
undermined to an even greater extent any concept of shareholder democracy that still existed,
alienating shareholders from the decision-making process. This, along with management buyouts,
leveraged buy-outs, and general capital restructuring, has obliged the institutional investors to play a
more active role in their involvement in the corporate matters. Indeed, institutional shareholders are
increasingly seen as having the capacity to decide whether power remains with the executive
management. Stratford Sherman sees power slowly shifting back to shareholders again. Hence, there
is clearly a new willingness in institutional investors to influence actively the management of the
companies they own. This has shown itself in investment protection committees and institutional
shareholder committees, which have also helped to increase the shareholder protection.
In the United Kingdom, over 2,000 companies are quoted on the stock exchange out of a total
population of around 500,000 firms. Almost 80 per cent of the largest 700 companies are quoted on
the stock exchange, and the value of companies quoted on the stock exchange is around 81 per cent of
the gross domestic product (GDP). Approximately, two-thirds of the equity of quoted UK companies
is held by institutions.
However, this pattern of ownership is by no means universal; on the contrary, it appears to be an
exception rather than a rule. Although the United States has more quoted companies than the United
Kingdom, in most other countries, particularly in Europe, the number of quoted companies is far less.
In Germany, for example, there are fewer than 700 quoted companies and in France less than 500. In
both the countries, the value of quoted companies amounts to only 25 per cent of GDP. In short, the
quoted companies in Germany and France account for a much smaller fraction of total corporate
activity than those in the United Kingdom and the United States.
In the United Kingdom and the United States, moreover, ownership is widely dispersed among a
large number of institutions or individuals. Most of the equity of the quoted UK companies is held by
institutions, but no one institution owns a substantial share of equity of any one company. In the
United States, the largest category of corporate shareholders is individual.

In the United Kingdom and the United States, moreover, ownership is widely dispersed among a large number of institutions
or individuals.
In most of the continental Europe, however, ownership is much more concentrated. The takeover
market in the United Kingdom is very active. During the merger wave in the beginning of the 1970s
and in the end of the 1980s, as much as 4 per cent of the total UK capital stock was acquired by a
takeover or merger in one year. Furthermore, it has been estimated that about 25 per cent of takeover
in the 1980s were “hostile”.
Germany
Germany has 171 large quoted companies dominated by different groups of investors—banks,
investment institutions, companies, government, and others. Although the bank holdings aggregate
only 5.8 per cent, yet their role in controlling the corporate activities is significant when compared to
the control exercised by the direct equity holders. The ownership indicators of new firms reveal that
investments have been generally made in quoted companies and other corporate owners are generally
not treated as partners; banks and insurance companies often have substantial interests. Institutional
investors play a vital role in the corporate decision making. The German system of corporate
governance, therefore, can be described as an insider system.
The German capital market developed into an efficient security market primarily because of the
role played by the big German banks. The banks retarded the development of the security markets by
exercising control over corporate proxy machinery. Further, the German banks held shares of their
clients in their own name and held them for saving tax. Whenever a shareholder wishes to sell his
share, he prefers to sell to another customer of the same bank as it would be treated as an intra-bank
transaction and will not result into a taxable affair. High transaction cost gave further boost to such
transactions.

The German capital market developed into an efficient security market primarily because of the role played by the big
German banks. The banks retarded the development of the security markets by exercising control over corporate proxy
machinery.
Barriers to entry to capital markets were first created in 1884 when the German law restricted
corporate access to the stock exchanges. This was accomplished by increasing the minimum size of a
public offering and the length of time a company had to be in existence before it could list its shares
on an exchange. Such restrictions on listing, by forcing smaller companies to deal with the banks,
ensured that only debt would become the dominant form of financing in Germany, and not equity, as
in the case of the United States.
At the same time, the big banks which are both the relevant markets as well as the underwriters,
appear to use their market power over secondary trading activity to dominate the primary markets for
new issues and the underwriting process in most instances. The banks are said to underprice new
issues to assure “success”, and also charge relatively high underwriting fees. And their combined
positions as major stock holders, creditors, and underwriters provided them with an opportunity for
insider trading, which was not legally prohibited until 1994.
Disclosure standards in Germany are also not up to the US standards. The German Accounting
System appears to provide far less information than the US system. A wide variety of accounting
methods are available to German firms that make comparisons difficult if not impossible. The
German corporations can freely create reserves that can be used to mask earnings dips in bad years. It
is hard to believe that accounting standards that permit huge reserves to be declared as current profits
at the management’s discretion can provide the same transparency as German Accounting system
Assessment Programmes (GAAP) reports.

Disclosure standards in Germany are also not up to the US standards. The German Accounting System appears to provide
far less information than the US system.
German stock markets remain relatively small and illiquid when compared to American markets.
Only about 2,800 German corporations are stock corporations (AGs), while the vast majority,
approximately 220,000 are limited liability companies without tradable shares (GmbHs). Only a small
number of firms, approximately 650, have shares traded on the exchanges. Even many of those
companies are not actively traded, and they have floats that are less than one-half of their outstanding
shares. Only 100 firms are widely held.
As a result of big bank dominance and weak capital markets, the frequency with which the German
companies resort to public capital markets is much lower than that of in the United States. The
German corporations are forced to borrow from banks to a far greater extent than their American
counterparts, with two obvious consequences. Firstly, the debt-equity ratios in Germany are much
higher than in the United States. Secondly, it has been suggested that banks have charged German
corporations excessive rates for borrowing, thus restricting the growth of the German industry.
These characteristics hardly describe a mature and developed capital market by the US standards.
Finally, no market for corporate control exists in Germany to cure even the most extreme monitoring
problems.

As a result of big bank dominance and weak capital markets, the frequency with which the German companies resort to
public capital markets is much lower than that of in the United States.
The German system of corporate governance is based on a two-tier management structure,

comprising the Vorstrand, or the management board, which is entrusted with the day-to-day running
of the company; and the Aufsichtsrat, or the supervisory board, whose job is to supervise the
management board, when necessary, and to participate in the long-term strategic decisions. This helps
to prevent the abuses of the management-dominated boards in the unitary board system of the Anglo-
Saxon model. On the supervisory board, there are both shareholder and employee representatives,
controlling the managing board, increasing accountability to a greater range of stakeholders,
reducing institutional pressures upon the board of directors towards short-term decisions, and
allowing for a longer-term strategic planning.

The German system of corporate governance is based on a two-tier management structure, comprising the Vorstand and the
Aufsichtsrat.
Vorstrand is also called “management board”, which is entrusted with the day to day running of the company.
Aufsichtsrat, or the supervisory board, whose job is to supervise the management board.
This system of corporate governance has the longer-term interests of the company at heart. The
longer-term interests of the company are demonstrated in greater investment in plant, equipment, and
intangible assets. As a result, less emphasis is placed on the share dividend. This low return on
shareholdings is not seen as a problem by the major shareholders in the German industry, the banks,
which have other business relationships with the companies they invest in. Apart from their
shareholdings, the German banks are also creditors and help the debt-finance industry. However, this
acceptance of a low return on the stock market may be about to change with the rising influence of the
international institutional investor.
In conclusion, while the German corporate governance system with its supervisory board, with
both shareholder and employee representatives on it, is in many ways a superior governance system
to that in the Anglo-Saxon model, it has some inherent problems too. Such a system ignores the
interests of small shareholders, is over-secretive, and is ill-designed to cope with the pressures of
international investment or the global market for companies. The biggest influence will be
international force; in other words, the shaping of corporate governance by the globalisation of the
financial and corporate markets. Despite these problems, which are solvable, the advantages of the
German system of corporate governance, like that of the Japanese system, can be seen in its use of
industrial groupings, implicit contracting, and extensive cross-shareholding, which are all
relationship-oriented, and finally in the financial sector ’s close links with the industry.
Two-tier Board in Industries

1. Supervisory board—supervises the management board
Representatives of shareholders
Representatives of employees
Paradox: Wider accountability releases short-term pressures and allows more strategic thinking
2. Management board—runs company
3. Longer-term orientation
4. Stable investment
Plant
Equipment
Training
5. Lower return to shareholders
6. Close relationships to banks (80 per cent of votes)
7. Low reliance on capital markets
8. Shareholders’ activism or hostile takeovers, rare
Briefly speaking, Germany lags behind the United States and the United Kingdom in terms of
corporate disclosure. The following matters will be or are being addressed by a regulatory or
legislative action:
1. Accounting standards will be tightened.
2. Insider dealing is being made a criminal offence.
3. Restrictive voting structure will be dismantled.
4. Proper takeover legislation will be introduced; in particular, extending the requirement to report holdings in other companies.
Briefly speaking, Germany lags behind the United States and the United Kingdom in terms of corporate disclosure.
The cumulative effect of these changes will be to weaken the board’s influence and increase the power
of the institutional investors.
There are many signs that elements of the German system will change over the coming years. As
Germany struggles under a severe recession (exacerbated by the costs of integrating East Germany
into the Republic), there is an increasing criticism of Germany’s closed-door system of management,
and an even more urgent need to look beyond Germany for new capital. These forces are likely to
have a far-reaching effect on the German corporate governance:
1. German banks are reconsidering their stakes in the German companies.

2. German and foreign shareholders are challenging the German practice of voting rights restrictions.
3. The generally lenient financial disclosure requirements in Germany may about to be changed. In order to bolster Frankfurt as an
“international financial centre”, for example, the German federal government proposed a legislation that was debated in the
Bundestag in the autumn of 1992, which is more implemented. Included in the “finanzplatz Deutschland” package is a proposal
for a new federal supervisory agency for the securities industry and proposed legislation that outlaws insider trading.
German institutions are likely to improve their standards of financial disclosure.
Japan
The system of corporate governance in Japan is, perhaps, the most remote and exotic when compared
with any of the developed country. This is primarily because this system heavily relies on trust and on
the relationship-oriented approach to corporate governance. Japanese corporations conduct their
business without building defences and, that is why, they concentrate on the long-term interests of the
company and invest in research and development, capital, employee training, and skills development.
While hostile takeovers are unusual, particularly foreign ones, mergers are more common. They tend
to be with business in the same industry and often within the same group. This is, particularly, likely
to occur if a group member is in financial difficulties, resulting in a merger with another company in
the group. However, recently, Japanese companies have started diversifying into unrelated areas,
often resulting in conflicts of interest among the different stakeholders. Another important feature of
the Japanese corporate governance is the reliance on the cross-shareholdings. Nearly, 200 tn yen of
stock is held under reciprocal shareholding agreements. The governance shows that the influence of
such a mechanism is decreasing and corporate governance in Japan is in transition. The growing
competition in the capital market is also likely to change the Japanese corporate governance. The big
institutions have started realising their obligations to maximise the shareholders’ value. Thus, the
long-term institutional shareholdings and cross-shareholdings of shares by several groups of
companies, which used to guarantee the management of a reliability-based control of a company, may
no longer be as reliable as before. It is worth noting that now corporate governance issues have
become conspicuous in Japan, which is becoming fully integrated with the international financial
world, and the country has to learn to adopt both social and regulatory system. How it handles these
changes and improves the aspirations of the investing communities will be a matter of interest and
importance for the international investing community.

Reliance of Japanese Corporate Governance is on crossshareholding and institutional shareholding.
The salient features of the corporate governance in Japan are as follows:
1. Heavy reliance on trust and implicit contracting

2. Relationship-oriented approach
3. Close ties to banks
4. Web of cross-shareholdings (200 tn yen)
5. Long-term investment orientation
Research and development
Capital investment
Employee skills
6. Many stakeholders—long-term interests
7. Transition
Mergers
Speculations
Recession
It is worth noting that following the excesses of 1980 and financial scams that were witnessed in the
political system, several amendments were made in the Japanese Commercial Code permitting
shareholders to have an access to the company books. Shareholders have also been given the right of
filing suits. These changes were introduced in October 1993. From a corporate governance
perspective, these developments are likely to have profound effects on the corporate behaviour. The
supremacy of the role of internal auditors in Japan has also been questioned, particularly after
noticing the disbursement of large sums of money to politicians and bureaucrats. In 2000–02, the
research studies on the working of the corporates have also revealed that there is an external pressure
on managements to enhance financial returns to the shareholders. Further, the slowdown in the
economy is compelling Japanese corporations to raise money from international players, and this is
likely to bring about a change, in the rules of the corporate governance.

It is worth noting that following the excesses of 1980 and financial scams that were witnessed in the political system, several
amendments were made in the Japanese Commercial Code permitting shareholders to have an access to the company
books.
THE SEARCH FOR A NEW APPROACH TO CORPORATE GOVERNANCE
The search for a new approach to corporate governance resulted in the setting up of the Teadway
Commission (US), Cadbury Committee (UK), King Committee (South Africa), National Task Force
on Corporate Governance (India), and Naresh Chandra Committee (India).
Teadway Commission (US)
The National Commission on Fraudulent Financial Reporting (NCFFR), or Teadway Commission,

placed a great emphasis on the composition and functioning of boards to ensure fairness in financial
reporting to protect the interests of the investors in a company. While the audit committees were first
suggested as channels of communication between the external auditors and the board of directors in
the 1930s, in its October 1987 report, the Teadway Commission recommended that the SEC mandates
all public companies to form audit committees, composed exclusively of independent directors.

Teadway Commission (US) placed a great emphasis on the composition and functioning of the board of directors.
Cadbury Committee (UK)
The Cadbury Committee on the financial aspects of corporate governance examined the issue of
corporate governance primarily from the point of view of the shareholders of a company. The
Cadbury Committee Report, published in December 1992, emphasised good practice concerning the
responsibilities of executive and non-executive directors, the role of auditors, and links among
shareholders, boards, and auditors. In addition to highlighting the need for and the role of audit
committees, the report emphasised the need for institutional investors to play a more active role in
ensuring a better corporate governance. It called upon institutions to take greater interest in the
composition of boards, and to use their voting rights to develop a more constructive relationship
between the managers and the owners of companies.
King Committee (South Africa)
The King Committee was set up to develop a code of ethics for business enterprises in the context of
South Africa. Unlike the Cadbury Committee, its terms of reference were wide and included
consideration for the disadvantaged communities. The report of the committee published in
November 1994, in addition to highlighting the role of the boards, auditors, and audit committees, on
lines similar to the Cadbury Committee, contained recommendations on ensuring an effective worker
participation in decision making, adopting affirmative action programmes as part of the business
plans, and respecting the interests of the constituents with no contractual links with the company. The
last would specially require a company to recognise its accountability and responsibility towards
environmental matters.

The King Committee (South Africa) was set up to develop a code of ethics for business enterprises.
National Task Force on Corporate Governance (India)
The National Task Force on Corporate Governance was set up by the Confederation of Indian
Industries (CII), under the chairmanship of Rahul Bajaj, to evolve a code for a desirable corporate
governance in India. The report of the task force was published in April 1996. Using the argument
that shareholders are residual claimants, the task force accepted maximising the long-term
shareholder value as the objective of a “good” corporate governance. The recommendations of the
task force pertained to the composition and functioning of the board of directors, corporate
disclosure (both financial and non-financial norms) facilitating the corporate takeover by allowing
the capital market to play its due role in improving the corporate governance, and the role of
creditors and financers.
Naresh Chandra Committee Report, 2002
The Committee was appointed by the SEBI to make recommendations on the representation of
independent directors on company boards and the composition of audit committees. The Committee
in its report that was submitted in December 2002, has taken forward some of the recommendations
of the Kumar Mangalam Birla Committee. The major highlights and recommendations of the
committee report are as follows:
It makes no distinction between a board with an executive chairman and a board with a non-executive chairman.
It is sufficient to have a compulsory rotation of audit partners in every five years.
Independent directors should play a larger role to ensure that corporate governance practices are improved and that the interest
of stockholders other than promoters are protected.
There should be an increased level of disclosure by a company and its auditors. The disciplinary mechanism for audit and
related professionals should be overhauled.
At least 50 per cent of the directors on the board of any listed company and unlisted public limited company with paid up share
capital and free reserve of Rs 10 crore or more or turnover of Rs 50 crore or more should be independent. The boards of these
companies should have at least four independent directors. The audit committees of these companies should be entirely made up
of independent directors.
The Naresh Chandra Committee (India) was appointed to make recommendation on the representation of independent
directors and composition of audit committees.
Narayana Murthy Committee (India)
Another committee on corporate governance was constituted by SEBI, under the chairmanship of N.
R. Narayana Murthy in the year 2003 to suggest how best to further improve the corporate
government practices. The suggestions of the committee are as follows:
1. Defying the regulatory push, that is, detailed requirements have been laid down in these reports to ensure a good corporate
governance. This includes requirements regarding composition of the board of directors, minimum number of independent
directors on the board, minimum number of meetings of the board in a year, and setting up of audit committees.
2. Need more disclosures.
3. Genuinely independent directors.
4. The corporate governance code is supposed to be enforced through the listing agreement with exchanges.
Recommendations of Narayana Murthy Committee

SEBI constituted a committee on corporate governance under the chairmanship of N. R. Narayana
Murthy. The Committee included representatives from stock exchanges, chambers of commerce and
industry, investor associations, and professional bodies, and it debated on key issues and made
recommendations. The mandatory recommendations of the Committee are as follows:
1. Audit committees of publicly listed companies should be required to review the following information mandatorily:
i. Financial statements and draft audit report including quarterly/half-early financial information
ii. Management discussion and analysis of financial condition results of operations
iii. Reports relating to compliance with laws and to management
iv. Management letters of internal control weaknesses issued by statutory/internal auditors
v. Records of related pay transactions
2. Disclosure of accounting treatment: In case a company has followed a treatment different from the one prescribed in an
accounting standard, companies should be given a reasonable period of time within which to cure the qualifications raised by
SEBI/Stock Exchanges. Mere explanations from companies will not be sufficient.
3. Audit qualification: Companies should be encouraged to move towards a regime of unqualified financial statement. Non-
mandatory recommendations should be reviewed at an appropriate juncture to determine whether the financial reporting climate is
conducive to a system of filing only unqualified financial statements.
4. Risk manag ement—board disclosure: A procedure should be in place to inform the board members about risk assessment
and minimisation procedures. These procedures should be periodically reviewed to ensure that the executive management
controls risk by means of a properly defined framework. The management should place a report before the entire board of
directors in every quarter by documenting the business risks that are faced by the company, measures to address and minimise
such risks, and any limitations to the risk-taking capacity of the corporation. These documents should be formally approved by
the board.
5. Training of board members: Companies should be encouraged to train their board members in the business model of the
company as well as the risk profile of the business parameters of the company, their responsibilities as directors, and the best
way to discharge them.
6. Use of proceeds of IPO: Companies raising money through initial public offerings (IPOs) should disclose to the audit
committee, the uses/applications of funds by major capital (capital expenditure, sales and marketing, working capital, and so on)
on a quarterly basis. On an annual basis, the company should prepare a statement of funds that are utilised for purposes other
than those stated in the offer document/prospectus. The statement should be certified by independent auditors of the company.
The audit committee should make appropriate recommendations to the board to take steps in this matter.

The recommendations of Narayana Murthy Committees are emphasised on audit committee audit qualification, and
code of conduct.
7. Written code of conduct for the executive manag ement: It should be obligatory for the board of the company to lay down
the code of conduct for all board members and the senior management of a company. The code of conduct shall be posted on
the Website of the company. All board members and the senior management personnel shall affirm compliance with the code on
an annual basis. The annual report of the company shall contain a declaration to this effect signed by the CEO and COO.
8. Nominee directors—exclusive of nominee directors from the definition of independent directors: The committee
recommends that there shall be no nominee directors. Where an institute wishes to appoint a director on the board, such
appointment should be made by the shareholders. An institutional director so appointed shall be subject to the same liabilities as
any other director. Similarly, a nominee of the government on public sector companies should be elected and shall be subject to
the same responsibilities and liabilities as the director.
9. Internal policy on access to audit committees: The personnel who observe an unethical or improper practice (not necessarily
a violation of law) should be able to approach the audit committee without necessarily informing their supervisors. The
companies should take measures to ensure that this right of access is communicated to all employees through internal circulars
and so on. The employment and other personnel policies of the company shall contain provisions protecting “whistle blowers”
from unfair termination and other prejudicial employment practices.
10. Whistle blower policy: Companies should annually affirm that they have not denied any personnel an access to the audit
committee of the company and that they have provided protection to the “whistle blower” from unfair termination and other
unfair or prejudicial employment practices. The appointment, removal, and terms of remuneration of the chief internal auditor
must be subject to review by the audit committee. Such affirmation shall form a part of the board’s report on corporate
governance that is required to be prepared and submitted together with the annual report.
CODE OF CONDUCT FOR CORPORATE GOVERNANCE
SEBI prescribes that there should be a conduct for the board of director. It shall be obligatory for the
board of a company to lay down the code of conduct for all board members and the senior
management of a company. This code of conduct shall be posted on the Website of the company. All
board members and the senior management personnel shall affirm compliance with the code of
conduct. The annual report of the company shall contain a declaration to this effect signed by the CEO
and COO. While drafting the code of conduct for corporate governance for the entire corporate
sector, the following aspects can be kept in view:
Prescribing of ethical values which are universally acceptable
Providing for highest standards of functioning as board of directors in an impartial and objective manner
Ensuring transparency in functioning
How requisite care and diligence has to be ensured in functioning
Encouraging discipline
Avoiding conflict of interests
Ensuring confidentiality
Providing of requisite incentives for efficient and effective functioning
Respecting one another
Loyalty to the organisation
Providing motivation
Code of conduct are guidelines for all board members and the senior management of a company, which are obligatory on
them.
In this context, a reference can be made to the Organisation for Economic Co-operation and
Development (OECD), which has prepared guidelines for multinational enterprises. These guidelines
provide principles and standards for good practice consistent with applicable laws. The general
policies of the OECD lay down that enterprises should contribute to economic, social, and
environmental progress with the view to achieving sustainable development and respect for human
rights of those affected by their activities, consistent with the host government’s international
obligations and commitments. Something on these lines can be thought of for the corporate
governance code. In short, the code of conduct must enthuse the board of directors and the executives
of the company to set goals to arrive at the most right decisions in the interest of the company and
ultimately of the country.
MEASURES TO IMPROVE CORPORATE CONDUCT
The paradigm shift in the approach to corporate governance is quite evident in the recommendations
by committees on the issue in the context of four different countries. Some of the measures that were
suggested for improving corporate conduct are as follows:
1. Improving financial disclosure norms;

2. Making relevant non-financial disclosures mandatory;
3. Making the management more accountable towards fulfilling its responsibility to society at large;
4. Changing the composition and functioning of company boards, with greater proportion of competent non-executive directors;

Financial and non-financial disclosure norms, composition, and functioning of company boards are measures to
improve corporate conduct.
5. Formation of audit committees consisting exclusively of non-executive independent directors;

6. Suggesting ways of effective involvement of institutional investors in the management and conduct of the affair of a company;
and
7. Facilitating a free play of market forces in securing a change of management.
CORPORATE GOVERNANCE AND INDIA
India is a vast, vibrant economy. It has a wide array of corporate structures including independent
firms and those owned by business groups, families, and multinationals. Given this special mix of
corporate entities, how can “corporate governance best practices” possibly apply to such a diverse
universe of corporate structures, with such a wide range of ownership patterns? Since 1991, instances
of hostile takeovers, insider trading, issue of duplicate shares (Reliance), Harshad Mehta Scam
(rigging of prices), and Ketan Parikh (KP) Scam have emaciated the credibility of the stock market in
India. Every disaster was a good learning experience followed by new regulations.

Since 1991, instances of hostile takeovers, insider trading, issue of duplicate shares (Reliance), Harshad Mehta Scam
(rigging of prices), and Ketan Parikh (KP) Scam have emaciated the credibility of the stock market in India. Every disaster
was a good learning experience followed by new regulations.
Despite having rules and regulations, a doubt arises as to the reliability of the regulations.
Undoubtedly, corporate governance is more a matter of heart (commitment) than that of the mind
(compliance). Private interests, however, digress from the social good and continue to produce, using
polluting technology, unfair means, and ignoring the cost to society. The liberalisation of Indian
capital markets enabled the Indian companies to invest abroad, and thus, opened up the country to
foreign investments. During the 1990s, the corporate governance in India grew by leaps and bounds.
Pratip Kar, Executive Director, SEBI, describes several reasons for the dramatic increase in corporate
governance in India.
Economic reforms that allowed the growth of free enterprise and free private investment opportunities.
Exposure of domestic private and public sector companies to greater domestic and foreign competition, which has multiplied
choices for consumers and compelled increases in efficiency.
The growing reliance placed by private and public sector companies on capital markets, underpinning the need for better
disclosure and better investor services.

In India, the growing reliance placed by private and public sector companies on capital markets, underpinning the
need of corporate governance.
The consequential changes in the shareholding pattern of private and public sector companies.
The growing awareness of investors and investor groups of their rights.
The growing importance of institutional investors and public financial institutions, gradually asserting and transforming
themselves in their new role as “active shareholders” rather than as “lenders”.
The stock exchanges becoming increasingly conscious of their roles as self-regulatory organisations and exploring the
possibility of using the listing agreement as a tool for raising the standards of corporate governance.
The establishment of a comprehensive regulatory framework for the securities markets, with the setting up of SEBI as the
statutory regulatory body for the securities markets to protect the rights of investors and to regulate the markets.
While India suffered a spate of stock market “scams” in 2001 which shook the investors’ confidence,
the United States had no shortage of its own variety of fraud and mismanagement cases. Companies
like Enron, Arthur Anderson, and Worldcom have fallen under the weight of poor corporate
governance. This should open our eyes to the fact that Indian companies, however big, need to follow
good corporate governance practices to stay afloat.
Issues of corporate governance have been hotly debated in the United States and Europe over the
last decade or two. In India, these issues have come to the force only in the last couple of years. For
example, the corporate governance code proposed by the CII is modelled on the lines of the Cadbury
Committee (Cadbury, 1992) in the United Kingdom. On account of the interest generated by the
Cadbury Committee Report, the CII, the Associated Chambers of Commerce and Industry
(ASSOCHAM) and, the SEBI constituted committees to recommend initiatives in the corporate
governance. The main objective of it was to develop and promote a code for corporate governance to
be adopted and followed by Indian companies, be they in the private sector, the public sector, banks or
financial institutions, all of which are corporate entities. The CII published India’s first
comprehensive code on corporate governance (Desirable Corporate Governance: A Code) in 1998.
This Code was well received by Indian corporates and many of its recommendations became part of
the subsequent regulations.

Issues of corporate governance have been hotly debated in the United States and Europe over the last decade or two. In
India, these issues have come to the force only in the last couple of years.
The corporate governance represents the value framework, the ethical framework, and the moral
framework under which business decisions are taken. In other words, when investments take place
across national borders, the investors want to be sure that not only is their capital handled effectively
and adds to the creation of wealth, but the business decisions are also taken in a manner which is not
illegal or involving any moral hazard.

The corporate governance represents the value framework, the ethical framework, and the moral framework under which
business decisions are taken.
In the Indian context, the need for corporate governance has been highlighted because of the scams
occurring frequently since the emergence of the concept of liberalisation from 1991. We had the
Harshad Mehta Scam, KP Scam, UTI Scam, Vanishing Company Scam, Bhansali Scam, and so on. In
the Indian corporate scene, there is a need to induct global standards so that at least while the scope
for scams may still exist, it can be at least reduced to the minimum. Following are the two steps that
have been implemented so far in this regard:
Kumar Mangalam Birla Committee
First Step in the Intended Direction

A committee was set up by SEBI under the Chairmanship of Kumar Mangalam Birla to promote and
raise standards of corporate governance. The Committee in its report observed that
The strong Corporate Governance is indispensable to resilient and vibrant capital markets and is an important instrument of investor
protection. It is the blood that fills the veins of transparent corporate disclosure and high quality accounting practices. It is the muscle
that moves a viable and accessible financial reporting structure.
The recommendations of the Kumar Mangalam Birla Committee led to the inclusion of Clause 49 in
the Listing Agreement in the year 2000.

The recommendations of the Kumar Mangalam Birla Committee led to the inclusion of Clause 49 in the Listing Agreement
in the year 2000.
National Foundation for Corporate Governance (NFCG)
Second Step in the Intended Direction

The Ministry of Company Affairs has recently set up National Foundation for Corporate Governance
(NFCG) in partnership with CII, Institute of Company Secretaries of India (ICSI), and Institute of
Chartered Accountants of India (ICAI). Functions of NFCG are mainly creating an awareness
regarding benefits of implementation of good corporate governance practices and providing key
inputs for developing laws and regulations.
After many initiatives that were taken for a good corporate governance like Naresh Chandra
Committee 2002, Narayan Murthy Committee 2003, and the very recent SEBI, the J.J. Irani Committee
on company law has recommended that one-third of the board of a listed company should comprise
independent directors in the year 2005 and should give full liberty to the shareholders and owners of
the company to operate in a transparent manner. SEBI revised Clause 49, on the basis of the
recommendations of the J.J. Irani Committee, which is in effect from January 1, 2006.

After many initiatives that were taken for a good corporate governance like Naresh Chandra Committee 2002, Narayan
Murthy Committee 2003, and the very recent SEBI, the J.J. Irani Committee on company law has recommended that one-
third of the board of a listed company should comprise independent directors in the year 2005 and should give full liberty
to the shareholders and owners of the company to operate in a transparent manner.
CHALLENGES BEFORE MANAGERS
It would help a great deal if the advocates of corporate governance were to appreciate the challenges
that stand before managers. The current business environment calls for a much stronger leadership
and speedier decisions than at any time in the past. While globalisation offers new opportunities, it
has enormously raised risks and uncertainties too. Coping with these has brought all CEOs to the
centre stage and often have encouraged the centralisation of key decisions. Although several
managers have built great organisations and rewarded the shareholders, many have fallen victim to
glorification. Even a cursory study of managerial excellence models would show that these are far
from the durable than that are made out by the management gurus, who are keen to produce books.
In addition to glorification of the individual manager, what has aggravated the problem is
performance-based reward. Financial recognition is, indeed, an important motivation for managerial
excellence but it has gone overboard. At some point in this process, the value base of manager has
changed and financial compensation is the “sole motivator”. What has created enormous
psychological stress is measurement of “performance” by investors and securities analysts on the
basis of quarterly results. These developments constitute the principal explanation of a widespread
dishonesty in the form of fudging of financials and creative accounting. Seldom can a business create
“shareholder value” quarter after quarter. Excessive risk, expensive and exciting mergers, and
ruthless restructuring (downsizing) have all emerged as measures of managerial excellence, and
basis of limitless rewards, without, as passage of time has revealed, creating any lasting value for
businesses, stakeholders, and the society at large.

Financial recognition is, indeed, an important motivation for managerial excellence but it has gone overboard.
CORPORATE GOVERNANCE AND SOME INDIAN ORGANISATIONS
Tata Chemicals
The foundations of corporate governance at Tata Chemicals are rooted in transparent disclosure
norms, which enable the company to adopt best practices initiatives. Tata Chemicals ensures that the
company’s corporate business and financial developments are communicated in a timely and unbiased
manner to its shareholders and other stakeholders, complying with regulatory requirements and
international best practices. The members of the board of the Tata Chemicals meet regularly during
the financial year. Tata Chemicals has constituted three board committees, which are as follows:

Tata Chemicals (India) has constituted three board committees, i.e., audit committee, remuneration committee, and
grievance committee.
Audit Committee: The committee reviews internal audit reports and makes recommendations to
the board. Its terms of reference includes meeting auditors regularly to obtain their reviews, seek
clarifications, identify the weaknesses, and act as a link between the board and the auditors.
Remuneration Committee: Its broad duties are to determine and recommend to the board, the
compensation payable to executive directors, appraisal of the performance of the managing director,
and to determine and advise the board about the payment of annual commission/compensation to the
non-executive directors.
Shareholders/investor Grievance Committee: It was set up to look into the redressal of requests
and complaints from the investors/shareholders, such as delay in transfer of shares/ debentures, non-
receipt of dividend, annual report, and so on. The Chairman of the Tata Group, Ratan Tata, bagged
the “Corporate Governance Award” for the year 2001–02 instituted by the Government of India. The
award is given to individuals with an exemplary performance in the field of corporate governance,
with a strong code of ethics and excellence in performance.
Infosys
Infosys Foundation, the philanthropic arm of Infosys Technologies Limited, came into existence on
December 4, 1996, with the objective of fulfilling the social responsibility of the company by
supporting and encouraging the underprivileged sections of the society. In a short span of time, the
foundation has implemented numerous projects in its chosen areas. By the late 1990s, Infosys
Technologies Limited clearly emerged as one of the best managed companies in India. Its corporate
governance practices seemed to be better than those of many other companies in India. Because of its
good-governance practices, Infosys has been the recipient of many awards.

By the late 1990s, Infosys Technologies Limited clearly emerged as one of the best managed companies in India.
Wipro
Wipro started its operations in 1946 as a solvent oil extraction and vanaspati manufacturer and
remained focused on the traditional business till mid-1970s. During the 1970s, Wipro initiated efforts
to diversify from the commoditised and price-sensitive solvent oil/vanaspati market. The company’s
entry into hydraulic engineering marked its first attempt at diversification; its foray into the IT
segment in the early 1980s proved to be more successful. Thus, Wipro’s IT business (software
services and hardware) has grown to be the largest contributor to its revenue and profits. In FY 2003,
the IT business accounted for close to 90 per cent of Wipro’s total revenue and 95 per cent of its
profit before interest and taxes. As on March 31, 2003, Wipro had investments in 15 joint-venture
subsidiaries, covering a range of business, including business process outsourcing (BPO) and
hydraulic and medical equipment. Investment Information and Credit Rating Agency (ICRA) assigned
an SVG1 (Scalable Vector Graphics Format) rating to the stakeholders value creation and governance
practices of Wipro in 2004. The SVG1 rating implies that in ICRA’s current opinion, the rated
company belongs to the highest category on the composite parameters of stakeholder value creation
and management. It is, however, not a certificate of statutory compliance or a comment on the rated
company’s future financial performance, credit rating, or stock price. Wipro is the first and currently,
the only company to be assigned the highest SVG1 rating by ICRA.
The rating reflects Wipro’s sound corporate governance practices as is evident from the
composition of its board of directors (with independent directors forming the majority), the
increasing and active involvement of the board in strategic issues, and the company’s improving
transparency and disclosure standards. Besides, the rating also reflects Wipro’s emphasis on and
adherence to ethical practices.

Wipro’s sound corporate governance practices is evident from the company’s improving transparency and disclosure
standards.
The success of Wipro lies in its approach to corporate governance. It is based on practising the
highest degree of transparency and sharing relevant information with stakeholders quickly and in a
format that is easy to understand and act upon. Examples of this approach include publishing the
consolidation of results and segment-wise reporting from mid-1980s and constitution of an Audit
Committee many years before it became mandatory. Shouldering its social responsibility, Wipro has
focused on bringing about many positive changes in the area of quality through its initiatives. As the
first software services company in India which is ISO 1400 certified, it has practised environmental
management to ensure an optimal use of natural resources such as water, power, and paper.

Wipro has practised environmental management to ensure an optimal use of natural resourcessuch as water, power, and
paper.
REGULATORY FRAMEWORK OF CORPORATE GOVERNANCE IN INDIA

In India, company law, security law, financial institutions, and credit-rating agencies play an
important role in controlling the corporate governance.
Company Law
The Companies Act, 1956 was enacted on the recommendations of the Bhaba Committee that was set
up in 1950 with the object to consolidate the existing corporate laws and to provide a new basis for
the corporate operation in independent India. With enactment of this legislation in 1956, the
Companies Act, 1913 was repealed. The Companies Act, 1956 has since then provided the legal
framework for corporate entities in India. Important amendments introduced in the year 2000 to
Sections 217 and 292 of the Companies Act, 1956 (made applicable from December 13, 2000) set the
tone for corporate governance in the country. The changes made are related to the following:
1. The Directors’ responsibility statement.

2. Formation of audit committee.
3. Guidelines from the Department of Public Enterprises on the corporate governance of Central public sector enterprises.
4. SEBI’s guidelines on corporate governance for listed companies.
5. Independent directors on the board of listed government companies.
6. Constitution and composition of audit committee in listed government companies.
7. Non-official directors on the board of unlisted government companies.
8. Corporate governance in statutory corporations.
Securities Law
Historically, most matters relating to the rights of shareholders were governed by the company law.
Over the last few decades, in many countries, the responsibility for protection of investors has shifted
to the securities law and the securities regulators at least in case of large listed companies. In India,
the SEBI was set up as a statutory authority in 1992, and it has taken a number of initiatives in the area
of investor protection.
SEBI Initiatives for Strengthening Corporate Governance
As a regulator, SEBI has initiated several measures through amendments in the listing agreement.
Some of these are as follows:
1. Strengthening of disclosure norms for IPO following the recommendation of Kumar Mangalam Birla Committee.
2. Providing information in the Director’s Report for utilisation/end use of funds and variation between projected and actual use of
funds.
3. Declaration of unaudited quarterly results.
4. Mandatory appointment of a Compliance Officer for monitoring the share-transfer process and ensuring the compliance with
rules and regulations.
5. Dispatch of a copy of complete balance sheet to every investor household and arbitrage copy of balance sheet to all
shareholders.
Under the SEBI Act, 1992, SEBI has extensive powers to issue directions to market participants on a
wide range of subjects, many of which relate to corporate governance.
Corporate Governance Through Listing Agreement
With the introduction of Clause 49 in the Listing Agreement, the issue of corporate governance has
acquired centre stage. In its constant endeavour to improve the standards of corporate governance in
India, SEBI, in October 2002, constituted a Committee on Corporate Governance under the
Chairmanship of N. R. Narayana Murthy. Based on the recommendations of the said Committee and
public comments received thereof, SEBI issued a circular on August 26, 2003 revising Clause 49 of
the Listing Agreement, to review the progress of the corporate sector in meeting the norms of
corporate governance and to determine the role of companies in responding to rumour and other
price-sensitive information circulating in the market, in order to enhance the transparency and
integrity of the market players and participants.

With the introduction of Clause 49 in the Listing Agreement, the issue of corporate governance has acquired centre stage.
Major changes have been made to the definition of “independent directors”, strengthening the
responsibilities of Audit Committee, improving the quality of financial disclosures, and finally, the
board as a whole has been tasked with the adoption of a formal code of conduct for the senior
management and the certification of financial statements issued by the CEO or the CFO. SEBI in the
revised Clause 49 of the Listing Agreement had mandated that at least 50 per cent of the board of a
listed company comprise independent directors. The capital market regulator had made it clear that
corporate India should comply with the revised Clause 49 by December 31, 2005. Accordingly,
companies are now required to form various committees like a “nomination committee”,
“compensation committee”, “governance committee”, and other committees to adhere to corporate
governance.

Accordingly, companies are now required to form various committees like a “nomination committee”, “compensation
committee”, “governance committee”, and other committees to adhere to corporate governance.
Similarly, the law requires the Nomination Committee of the board to be composed entirely of
independent directors, who will be responsible for the evaluation and nomination of board members.
In India, the responsibilities of Audit Committee include scrutiny of the company’s annually audited
financial statements, appointment of external auditors, interacting with internal auditors, and issues
relating to internal controls that are existing in the company.
Governance by Financial Institutions
The Financial Institutions have also taken responsibility in enforcing corporate governance in the
companies where they have substantial stakes. They insist companies on the following factors:
1. Making adequate disclosures,
2. Moving towards internationally accepted accounting standards,
3. Maintaining distinction between the CEO and Chairman, wherever applicable, and
4. Holding regular meetings with proper recording and dissemination of proceedings.
The financial institutions have also implemented new norms for appointment of Nominee Directors,
which have drastically cut down the total number of such directors on the company’s board.
Role Played by Credit-rating Agencies
Two of the leading credit-rating agencies—Credit Rating Information Services of India Limited
(CRISIL) and ICRA have prepared a comprehensive instrument for rating the good corporate
governance practices of the listed companies. The instrument will enable the securities market
regulator to judge the compliance status of the corporate on parameters such as effective creation,
management, and distribution of investors’ wealth.

Two of the leading credit-rating agencies—Credit Rating Information Services of India Limited (CRISIL) and ICRA have
prepared a comprehensive instrument for rating the good corporate governance practices of the listed companies.
CASE
Reliance Industries Ltd (RIL)
Reliance Industries Ltd. (RIL) is India’s largest private sector company. The Reliance Group was
founded by Dhirubhai H. Ambani. He set up the Reliance Textile Industries in 1967. Mukesh Ambani
and Anil Ambani are the two sons of Dhirubhai Ambani.
The group’s activities span over exploration and production of oil and gas, refining and marketing,
petrochemicals, textiles, financial services, insurance, power, telecom, and infocom services. The
group exports its products to more than 100 countries all over the world. RIL emerged as India’s most
admired business house, for the fourth successive year in a TNS (Taylor Nelson Sofres) mode survey
for 2004.
RIL was one of the pioneers in the country in implementing the best international practices of
corporate governance. In recognition of this pioneering effort, the ICSI bestowed on the company the
National Award for Excellence in Corporate Governance for 2003. In July 2002, Dhirubhai Ambani
passed away. In September 2004, the board decided to give all the financial decision-making power to
Mukesh. Anil allegedly protested.
On November 18, 2004, Mukesh hinted at the ownership issues, which was in the private domain,
and the markets reacted strongly. RIL share prices dropped from Rs 572 to Rs 454, and Rs 3,400 crore
of market capitalisation was shared off. Anil Ambani criticised the corporate governance practices of
RIL. The battle between Mukesh and Anil Ambani over serious corporate governance issues affecting
RIL shifted from the media to the RIL boardroom.
The Anil Ambani Camp said a 500-page note detailing huge corporate failures by RIL had been
sent to the RIL board three days before its meeting on January 18, 2005. Finally, RIL decided to buy
back the equity shares to solve this conflict. On January 11, 2005, a Joint Director in the Finance
Ministry’s Department of Economic Affairs wrote a letter to SEBI asking it to “look into the matter”
of a “note received from Shri Anil D. Ambani regarding the buyback of equity shares of up to Rs
3,000 crore by Reliance Industries Ltd”.
The Ministry wanted to be kept informed about the SEBI findings. Anil Abani’s note was written on
a plain sheet of paper instead of his official letterhead or under his insignia as a Member of
Parliament. He had also publicly voiced his objection to the share buyback just before the board
meeting that decided the issue. In the meeting itself which was the appropriate forum for raising
objections, he did not file a formal dissent note; instead, he made a presentation to the board and
merely abstained from voting. The other charges that Anil Ambani listed in his letter to the Finance
Ministry were “leaked” to the media by what was euphemistically referred to as the “Anil Ambani
Camp”. This was probably the first time in the Indian corporate history that a Vice-Chairman and
Managing Director (MD) has written to the government demanding an investigation against a
company while he continued to hold important fiduciary positions in the top management.
The action raises important issues about corporate governance and the responsibility of senior
management towards the company as well as its shareholders. Before going into these issues, here is
a gist of concerns that Anil Ambani wants the Finance Ministry to investigate through SEBI,
ostensibly in order to protect the “integrity of the capital market and the interests of RIL’s 30 lakh
investors”. Firstly, he alleged that RIL’s statutory public announcement of the share buyback on
December 29, 2004, failed to reveal that SEBI was investigating the insider trading and price
manipulation of RIL shares before the buyback and that the two major stock exchanges were
investigating its compliance with listing norms. (For the record, SEBI did force RIL to make
additional disclosures, but not necessarily all those that Anil Ambani had demanded.)
Secondly, he alleged that RIL had failed to reveal the fact the SEBI was investigating a complaint by
Mr. S. Gurumurthy into the ownership and financing of a web of 400 companies which own RIL
shares. Interestingly, Anil Ambani claimed that these “investigations are in progress”. In fact, he first
reported Mr. Gurumurthy’s allegation about a “gigantic fraud” by RIL in February 2002 and SEBI did
not even bother to initiate an investigation into those charges. Instead, SEBI went on to exonerate RIL
of all charges of manipulation and insider trading in its controversial sale of its 10 per cent stake in
Larsen & Toubro (L&T) of which nearly 6 per cent was acquired through open-market purchase just
two weeks before the Block Deal with Grasim.
A third issue raised by Anil Ambani was that “two unknown individuals” were reported to be in
control of the 20 per cent promoter stake in RIL valued at Rs 20,000 crore. He further said that the
buyback would increase the RIL promoter holding by a further 2 per cent using Rs 3,000 crore of
shareholders’ funds, and that there was a major public controversy over the classification of a 12 per
cent stake in RIL valued at Rs 10,000 crore, which actually belonged to RIL’s 30 lakh investors and
not the promoters.
Ambani’s final point was that the “major issues of ownership, management, corporate governance,
transparency, and disclosures in RIL have publicly surfaced in relation to transactions between
Reliance and Reliance infocom”, which were not disclosed in the advertisement. All these charges
indeed merit investigation. Newer revelations about a series of friends and corporate entities who
seemed to have RIL Infocom shares at Re 1 each, also raised serious questions about why the publicly
listed company ended up paying a high price for its Rs 12,000 crore investment and whether RIL
shareholders have been badly shortchanged in the process.
But RIL had never been a stranger to serious controversy, and until the end of July 2004 (when
many of his powers were curtailed through a board resolution), Anil Ambani was part of the top
management, privy to all confidential information, and, in fact, the group’s public face. He presented
its financial results to the media and analysts, and even collected a clutch of good governance awards
on its behalf. That is why his sudden activism on behalf of the shareholders did not ring true, although
it was in the public interest. Anil Ambani was clearly at liberty to wage a war against his brother over
his share of the RIL family holding and to fight for the management control if he believed that he had
been unfairly ousted. But the governance issue raised by his damaging revelations and many
allegations are clearly at conflict with his role as the Vice-Chairman and MD of Reliance. If these
charges are true, regulatory action can only damage RIL’s valuation and destroy the shareholders’
wealth instead of protecting their interests. If RIL had been a professionally managed company instead
of a family-controlled group, would Anil Ambani had been allowed to remain a Director when he
was fighting a war against several people in the top management? Also, if a company is a distinct and
separate legal entity in the eyes of the law, can a Board Director, or in this case the Vice-Chairman
and MD, retain his official status while working against its interest? And can he continue to get hefty
salary from the company?
There are some governance issues too that were raised by Anil Ambani’s action and allegations,
and they need to be openly debated by peer-group industry bodies and corporate governance experts.
But what can one really expect when injuries of these very peer groups have showered the group with
“corporate excellence” (award ICSI in 2003) and “corporate social responsibility” award (Golden
Peacock by the Institute of Directors in 2004)?
Case Question
Do you think this issue had happened in RIL because of lack of corporate governance?
SUMMARY
Corporate Governance is a system of structuring, operating, and controlling a company with a view
to achieving long-term objectives to satisfy shareholders, creditors, employees, customers, and
suppliers with the legal and regulatory requirements apart from meeting the environmental and social
obligations. Good governance is the primary duty of the board. It is responsible for setting standards
and ensuring that the company achieves them.
There have been many cases of excessive debt financing laced with fraud, generosity with which they
reward their leading executives, disproportionate pay increases for executives, and procedures which
have been less than transparent. In the train of these and many a scandal, there have been increasing
and violent demand for greater transparency and good corporate governance.
In India, the interest in corporate governance was revived with the onset of the process of economic
reforms in 1991. Deregulation, privatisation, marketisation, and globalisation trends unleashed in the
process of reforms led to a renewed interest and a need for good governance in the country’s
corporate sector.
There is a widely held belief that the standards of corporate governance must match with the spirit of
the new economic policy and reforms so that the interests of the various stakeholder groups,
particularly the shareholders and lenders, are adequately protected. Some of the major efforts in the
direction of prescribing codes of good governance are as follows:
1. Teadway Commission (US)

2. Cadbury Committee (UK)
3. King Committee (South Africa)
4. National Task Force on Corporate Governance (India)
5. Naresh Chandra Committee (India)
6. Narayana Murthy Committee (India)
KEY WORDS
Corporate Governance
Board of Directors
Executive Directors
Non-executive Directors
Recession
Capital Market
Shareholders
Grievance
Remuneration
Audit Committee
Whistle Blower Policy
Initial Public Offering (IPO)
Two-tier Board
Risk Management
Stock Exchanges
Nominee Directors
Money Laundering
Takeover
QUESTIONS
1. Comment upon the state of corporate governance in India.

2. What are the measures of good governance?
3. What is the role of the board of directors in corporate governance?
4. What are the central concerns of the different committees formed for corporate code?
5. Why is it important for a modern corporate organisation to follow the prevailing governance code?
REFERENCES
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http://www.business-standard.com
Balasubramanian, N. (2005). “Corporate Governance in India Traditional and Scriptural Perspective”, Chartered Secretary,
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Mittal Pub.
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Online edition, http://www.financialexpress.com
Machraja, H. R. (2004). Corporate Governance. Mumbai: Himalaya Publishing House.
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http://www.sebi.gov.in
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CHAPTER 21
Social Responsibility of Business
CHAPTER OUTLINE
Origin and Growth of Concept
Definition Through Various Dimensions
The Need for Social Responsibility of Business
Social Responsibilities of Business Towards Different Groups
Barriers to Social Responsibility
Corporate Accountability vis-à-vis Social Responsibility
Challenges for Social Responsibility of Business
Emerging Perspectives for Corporate Social Responsibility
Social Responsibility of Business in India
Case
Summary
Key Words
Questions
References
ORIGIN AND GROWTH OF CONCEPT
Although the subject “social responsibilities of business” in its present form and content has gained
popular attention only in the recent years, its origin can be traced back to the evolution of the concept
of a welfare state. As the pace of industrialisation quickened, employers became more and more
concerned with the loss of productive efficiency due to avoidable sickness or accident or stoppages
of work due to bad personal relationships. This gave rise to the idea of a welfare state, which was
further strengthened by the growth of democracy and of respect for human dignity during the last 150
years.

Although the subject “social responsibilities of business” in its present form and content has gained popular attention only
in the recent years, its origin can be traced back to the evolution of the concept of a welfare state.
Any extension of democracy has always produced an extension of popular education. As soon as
the newly enfranchised are in a position to make their demands effectively felt, what they ask of their
governments is social security, protection against the cruel hazards of life, and help for the destitute.
Accordingly, as the electorate widens, so the rulers have to provide as a political necessity, provisions
for the aged, compensation for the disablement at work, relief during sickness and unemployment,
and wage legislation. The framework of a welfare state and with it the concept of social responsibility
have thus come to stay in many countries of the world.
The changing image of business in the recent years has lent further support to the idea of social
responsibility. Some public opinion polls of the 1960s and 1970s in the United States have left the
businessmen disenchanted. These polls have revealed that a businessman is viewed as an individual
who does not care for others, who ignores social problems, who preys upon the population, who
exploits labour, and who is a selfish money grabber.

The changing image of business in the recent years has lent further support to the idea of social responsibility. Some public
opinion polls of the 1960s and 1970s in the United States have left the businessmen disenchanted.
On the other hand, until these opinions were unveiled, a businessman in America believed that
others viewed him as he viewed himself, as a practical, down-to-earth, hard-working, broadminded,
progressive, interesting, and a competitive, free enterpriser. He believed that the society looked up at
him as a self-sacrificing community leader, pillar of society, generous to a fault, great supporter of
education, and patron of the arts—in short, the salt of the earth. Indeed, the businessman in the pre-
poll days thought of himself as a happy mix of Plato, Gandhi, and Churchill.
In India too, the businessman has been under incessant attack both by the government and the
public. Many reports of the Indian Government, such as the P.C. Mahalanobis Committee Report on
the Distribution of Income and Levels of Living (1964), K.C. Dasgupta Report on Monopolies (1965),
Prof. Hazari’s Report on the Industrial Licensing System (1966), and the Dutta Committee Report on
Industrial Licensing Policy (1969) are very critical of the unethical role of an Indian businessman
today.
MEANING AND DEFINITION
The real meaning of social responsibility with reference to business enterprises has to be understood
first to see the correlation of business with the social responsibility. “Business” is an economic
activity to earn profit for the owner, and “social responsibility” means serving community without
any expectation. Now the question that arises is, why is there a need for a business to serve the
community? Business is expected to create wealth, create markets, generate employment, innovate
and produce sufficient surplus to sustain its activities, and improve its competitiveness. Society is
expected to provide an environment in which a business can develop and prosper, allowing investors
to earn returns. Business depends for its survival and long-term prosperity on the society to provide
the resources—people, raw materials, services, and infrastructure. These inputs from the society help
to convert raw materials into profitable goods/services. While the society provides the means of
exchange, trained manpower, legal and banking system, infrastructure like roads, schools, hospitals,
and so on, business provides products and services, direct and indirect employment, and income
generation in terms of wages, dividend, taxes, interest, and the like.

Business is an economic activity to earn profit for the owner, and social responsibility means serving community without any
expectation.
The long-term sustainability of any business requires business-society connection. In addition to
the above, with the advent of the joint stock company, society grants to business two special rights to
assist it in performing its role. The first is “potential immorality” and the second is “limited liability”.
In return for these special privileges, business has a responsibility to fulfil to the society/community
at large. Acharya Vinoba Bhave said
Business was considered to be next to King. The King was known as Shahenshah while business was known as Shah as common
word, first Shah has a duty towards public as King, that is, government and the other Shah has also a duty towards society being part
of Shahenshah.
In the age of globalisation, corporations and business enterprises have crossed the national
boundaries to become international. Business enterprises have been using natural resources in a big
way of maximisation of their profits. Business enterprises intervene in so many areas of social life,
and hence their responsibility towards society and environment has emerged. In India and elsewhere,
there is a growing realisation that business enterprises are, after all, created by society and must,
therefore, serve it and not merely profit from it. Thus, the role of business in a society has been put
under “corporate social responsibility (CSR)”.

In India and elsewhere, there is a growing realisation that business enterprises are, after all, created by society and must,
therefore, serve it and not merely profit from it. Thus, the role of business in a society has been put under “corporate social
responsibility (CSR)”.
India is a democratic welfare state. It wants to achieve welfare through democratic means. Business
organisations which fit in with such a specification would have a better scope to survive and grow
here. In order to make themselves suitable for such a business environment, they should foster a
corporate objective of maximising the social benefit. This must be considered as the social
responsibility of business. It means that every business enterprise has a responsibility to take care of
the society’s interests.
Every business organisation must be sensitive to social needs. The society provides the basis,
scope, and demand for the business organisation and appreciates the responsiveness of the
organisation to the problems that it faces. The problems can either be social, economic, or political;
natural calamities; poverty; or unemployment. The government organisations, social institutions like
nongovernmental organisations (NGOs), and socially conscious individuals cater to the social needs.
Unlimited resources, manpower, and greater vision would be required to tackle the problems that face
every society. Business organisations, which form an important part of the society, and control a
conspicuous share of the resources of the society must, therefore, be responsive to the social needs.
While a domestic company has a primary responsibility towards the local society, a multinational
company (MNC) or a foreign company too needs to have some responsibility towards the social
needs of its host country.

Business organisations, which form an important part of the society and control a conspicuous share of the resources of the
society must, therefore, be responsive to the social needs.
Social responsibility, therefore, is the company’s mission to be responsive to social needs by
earmarking a part of its resources so that they may be allocated for achieving social goals and
tackling social problems. This is particularly so because of the societal approach of business that
influences the business philosophy and vision of the organisation. In the context of globalisation of
business, every company must shape itself to be socially oriented in a global perspective. This is,
perhaps, the reason for the success of Japanese companies.
Social responsibility of a business house enables it to establish a good corporate image. Social
responsibility need not always mean patronising a social project; there are many other areas where
social responsibility can be fulfilled. If an organisation takes up a project for distributing sweets to
slum-dwellers during the festival of Diwali, after amassing substantial wealth over the years through
black market, hoarding, and other unfair means, it cannot be reckoned as a social responsibility. On
the contrary, providing proper products at proper prices in proper places to the proper customer is a
social responsibility.
DEFINITION THROUGH VARIOUS DIMENSIONS
Social responsibility is a nebulous idea and hence, it is defined in various ways. Adolph Berle defined
social responsibility as the manager ’s responsiveness to public consensus. This means that there
cannot be the same set of social responsibilities applicable to all countries at all times. These would
be determined in each case by the customs, religions, traditions, level of industrialisation, and a host
of other norms and standards about which there is a public consensus at any given time in a given
society.

Social responsibility is the manager’s responsiveness to public consensus.
According to Keith Davis, the term “social responsibility” refers to two types of business
obligations: (a) the socio-economic obligation and (b) the socio-human obligation. The
socioeconomic obligation of every business is to see that the economic consequences of its actions
do not adversely affect the public welfare. This includes obligations to promote employment
opportunities, to maintain competition, to curb inflation, and the like. The socio-human obligation of
every business is to nurture and develop human values (such as morale, cooperation, motivation, and
self-realisation in work).

The socio-economic obligation of every business is to see that the economic consequences of its actions do not adversely
affect the public welfare.
Every business firm is part of a total economic and political system and not an island, without
foreign relations. It is at the centre of a network of relationships to persons, groups, and things. The
businessman should, therefore, consider the impact of his actions on all to which he is related. He
should operate his business as a trustee for the benefit of his employees, investors, consumers, the
government, and the general public. His task is to mediate among these interests, to ensure that each
gets a square deal, and that nobody’s interests are unduly sacrificed to those of others.
By the term CSR, what is generally understood is that a business enterprise has an obligation to the
society that extends beyond its narrow obligation to its owner or shareholders. Although CSR as a
concept is appreciated by corporates and the civic world, there is no universally accepted definition
for CSR. Most definitions of CSR focus towards a company’s overall impact on the society and
stakeholders.
According to the London Benchmarking Group Model, “Business Basics”, in the context of CSR,
related as to how the company does its business and whether it is sensitive about the impact of its
business on the society and the plane. That is, societal and environmental returns apart from financial
returns—the so-called “tripple bottom line reporting”—are socio-economic obligation and the socio-
human obligation. The other factors are as follows:
Philanthropy: Intermittent support; wide range of causes; in response to needs and appeals of
charitable and community organisations; in partnership with companies, customers, and suppliers.
Social investment: Long-term and strategic involvement in community partnership; limited range
of social issues chosen by the company; to protect long-term corporate interest and enhance its
reputation.
Commercial: Compliance with law; ethical business practices: concern for the environment and
consideration of the interest of various stakeholders such as customers, supply chain, employees, and
the community at large. According to him, CSR is a culture and should be integrated with all the
phases of a corporation.

CSR is a culture and should be integrated with all the phases of a corporation.
If one goes into the depth of the above definition, under CSR culture, the business has to be run not
only for economic profits that is, financial returns for shareholders, but also considering the actual
and the potential impact on the community where it operates and on the society as a whole to have
long-term sustainable development of the business. So, the company has to consider the varied
interest of the other stakeholders.
THE NEED FOR SOCIAL RESPONSIBILITY OF BUSINESS
There are many situations where the social responsibility of business becomes necessary, as follows:
1. A societal approach to business is the contemporary business philosophy, which demands business organisations to be responsive
to social problems.
2. As a result of the globalisation of business, global companies and MNCs operate in a big way in their host countries. In order to
establish a good corporate image, they include social responsibility as a corporate objective. Indigenous companies are forced to
follow suit for maintaining their corporate identity.

In order to establish good corporate image, business organisations should include social responsibility as a
corporate objective.
3. In the terms and conditions of collaboration agreements, very often, social welfare terms are included which necessitates the
collaborating company to take up the social responsibility of business.
4. On the basis of legal provisions, companies have to concentrate on social problems. For example, an industrial organisation in
India must obtain a certification from the Pollution Control Board.
5. Corporate donations to social welfare projects of approved NGOs are exempted from income tax in India.
6. An organisation’s commitment to social responsibility creates a good corporate image, and thereby, a better business
environment.
7. Social responsibility of business enables the organisation to improve its product positioning, and thereby, improve its market
share.
8. Very often, when a situation demands due to natural calamities, accidents and so on, for example, gas leak at the Union Carbide
plant in Bhopal, wherein the company had to monetarily compensate through medical treatment.
9. For extraneous considerations, some organisations are sometimes forced to take up social responsibility.
10. The organisational culture of certain organisations makes it necessary for them to take up the social cause as their moral
responsibility.
Box 21.1 details the “Virtue Matrix”.

Box 21.1 The “Virtue Matrix”
The virtue matrix depicts the forces that generate CSR. The bottom two quadrants of the matrix
are the civil foundation, which consist of norms, customers, and laws that govern corporate
practice. Companies engage in these practices either by choice or in compliance with the
government.

Frontier (Intrinsic)
Strategic Structural
Choice Compliance

Civil Foundation (Instruments)
Behaviour in the civil foundation does no more than meet the society’s baseline expectations.
Because it explicitly serves the cause of maintaining or enhancing the shareholders’ value, this
behaviour can be described as instrumental. Corporate innovations in the socially responsible
behaviour occur in the frontier, the matrix’s upper two quadrants.
The motivation for these innovative practices, at least initially, tends to be intrinsic; corporate
managers engage in such conduct for its own sake, rather than to enhance the shareholders’ value.

SOCIAL RESPONSIBILITIES OF BUSINESS TOWARDS DIFFERENT GROUPS
Responsibility Towards the Customers
In a competitive market, the customer is the “king” and is the company’s first priority as the company
exists for the customers only. Earlier, the product-selling approach was the basic approach of the
managers who were considered capable when they were able to create a demand. When a salesperson
was able to sell refrigerators even to Eskimos, he was considered very successful. Although the
demand creation is not totally out of the scope of a sales person even today, the manager ’s real job
now is to identify the actual demand and target customers, and to project a product that would provide
maximum satisfaction to the customer needs. The Toyota management’s “customer-first philosophy”
has paid them rich dividends.

In a competitive market, the customer is the “king” and is the company’s first priority as the company exists for the
customers only.
There are many Japanese corporations which strive towards customer satisfaction. On the contrary,
developments in many Indian organisations indicate customer exploitation. For example, the Air
Traffic Controllers (ATC) of Indian airports, who are very highly paid employees, went on strike
four times in 1997 during the United Front regime. The ATC Guild was successful in putting out-of-
gear the control operations. Another interesting aspect about the ATC agitation was that the Indian
Airlines made a claim of crore of rupees as compensation of losses during the ATC strike between
November 1–19, 1997, from the Airport Authority of India. (Both organisations fall under the Civil
Aviation Ministry of the Government of India). To be precise, social responsibility of an organisation
must primarily be accepted and felt by the employees of an organisation.
Talking of the Japanese people’s commitment to customer satisfaction, the customer-first
philosophy is widely fostered by the employers of Japanese corporations, and they take up the
responsibility of customer satisfaction. The Kyoto-based electronic and ceramic company, Kyocera is
developing a new production process to produce and market products, which fit in perfectly with
today’s consumer lifestyle. Their workers fully cooperate with the management for improving
production methods constantly with a view to maximising the customer satisfaction. With such a work
culture, it is no wonder that the Japanese corporations have emerged successful in fulfilling and
maximising the customer satisfaction. Their workforce stands by them to take up any challenge
without grumbling. Naturally, customer-oriented products such as high-definition TVs, solar-
powered appliances, fuel-efficient automobiles, latest consumer electronics, recyclable cars, and the
like which have been introduced by the Japanese corporations, at affordable prices for customers,
have been the result of the success of Japanese employees also.

Talking of the Japanese people’s commitment to customer satisfaction, the customer-first philosophy is widely fostered by
the employers of Japanese corporations, and they take up the responsibility of customer satisfaction.
In order to satisfy the customers, a proper quality product needs to be designed and produced using
proper quality materials, appropriate technology, and well-trained, motivated, and committed human
resources, and sold too at a fair price. Among all the factors, human resource is the most crucial one.
This is the reason why global corporations and multinationals give top priority to human resources
development and management.

Responsibility of business towards the customer is to provide proper quality product at a fair price.
Social Responsibility to Prospects
“Prospects” are the possible or probable customers, that is, “expected customers”. It is always safer
on the part of a company to identify its existing customers, and make a forecast about the expected
customers. Welfare programmes which benefit the prospective customers may convert potential
customers to actual customers. At the product-planning stage, every company thinks in terms of the
existing market and then, the expected market. Taking into account the needs, wants, tastes, and
preferences of the existing market and the expected market, would enable the product to offer
maximum satisfaction to the buyers.

Prospects are the possible or probable customers.
When a company opts to take up a social welfare project, it may think in terms of priorities.
Although the customers and the prospects are in the mind of the project planner, priorities must be
chiefly taken into account. An organisation may not be able to do all that it wants to do on account of
various constraints and changing situations. On the contrary, it is always better to do one or a few
most important things. It means that the most urgent things must be given first priority. As there is
often a danger of fixing wrong priorities, the project planner must take extreme care to choose
appropriate priorities. Unless the priorities are proper, accomplishments cannot be proper.
Setting up wrong priorities may mean that the most appropriate task is abandoned. The most urgent
tasks must, therefore, be taken up first within the stipulated time frame, with the available resources,
capabilities, and manpower. Very often, there is a possibility of neglecting difficult tasks and
choosing the easier ones. This may result in assigning priorities to comparatively unimportant tasks
at the cost of urgent ones. It is very important for any company to decide what needs to be tackled
first, what next, what last, and what never at all. This is more true in respect of social welfare projects.

It is very important for any company to decide what needs to be tackled first, what next, what last, and what never at all.
This is more true in respect of social welfare projects.
Social Responsibility to Community
A company is a part of the community or the immediate society where it exists. Hence, it has a great
responsibility to be conscious and concerned with the community welfare. A community is a part of
the society at large which provides the immediate social environment to the company. The company
must, therefore, be committed to the welfare of the environment, since it has an important social role
to play in the community.

Responsibility of a company towards the community lies in community welfare and environmental welfare.
There are two important aspects of such a social role. One, that the company should lend a positive
assistance to community objectives and secondly, it should not be instrumental to environment
degradation. This calls for initiating a pollution-free and environment-friendly technology,
conservation of the surrounding ecological environment, social afforestation, preventing emission of
fumes and effluents, and so on; not only to satisfy the government or legal provisions, but because of
a commitment to the community welfare and environmental protection. Making extra efforts for
industrial safety is another way of protecting the community. When the gas tragedy at the Union
Carbide plant in Bhopal resulted in loss of human lives and permanent invalidation of many people
from around the factory, the importance of improving industrial safety and reducing occupational
and industrial hazards came to attention. Protecting the community and preventing it from the
industrial hazards is the greatest responsibility of the industrial establishments.

Protecting the community and preventing it from the industrial hazards is the greatest responsibility of the industrial
establishments.
Box 21.2 The MMC Family
The Marsh and McLennan Companies (MMC) is a global professional services firm with annual
revenues of $10 bn and approximately, 58,000 employees are serving clients in more than 100
countries.
On September 11, 2001, MMC had 1,908 people working in or visiting offices in the twin towers
of the World Trade Center (WTC). In the aftermath of the terrorist attacks on September 11, 2001,
victims’ families had faced a variety of immediate needs and long-term ones. MMC worked
quickly to provide a responsive set of benefits and services. They include
1. Family relationship management programme
2. Psychological and emotional counselling
3. Enhanced benefits
4. Financial assistance
5. Financial counselling
6. Family advocacy
7. Remembrances
Fumes and effluents emitted from the factories result in environmental pollution and pollution of
the nearby rivers which supply human beings and cattle with water. This leads to health hazards in the
community. The Supreme Court of India recently ordered the closure of a number of industrial units
on these grounds. It is not only a social responsibility, but also the bounden duty on the part of every
industrial enterprise to follow rigid policies and implement practices to prevent health hazards to the
employees of the organisation, on the one hand, and to the community and society at large, on the
other. A meeting of the Occupational Health and Safety Centre (OHS Centre), Delhi in 1999 expressed
a great concern and anxiety in the increasing occupational hazards. Every industrial unit must make
provisions to prevent safety hazards before it starts its operations. There must be an inbuilt
arrangement to ensure occupational and environmental safety.
When people from around the Ion Exchange plant at Ambernath (near Mumbai) felt suffocated in
the evenings, not much thought was given to it. When Mr. B. N. Shetty, a worker at the plant, died on
January 5, 1990, from cancer, it raised the eyebrows of at least some people in the community around
the factory. In the same factory, nine cancer deaths had occurred in the past. Hence the community
raised an alarm, with 130 workers going on strike on January 5, 1990. Obviously, there was a valid
reason for raising an alarm about the safety hazards in the company’s vicinity.
Industrial units need to gear up to help the community to solve the unemployment and other socio-
economic problems. If an industrial unit is able to provide employment to the people of its immediate
society, it would be a useful step towards solving unemployment, poverty, underdevelopment, social
backwardness, and so on. However, it is not appropriate to uphold a policy of “sons of the soil” in the
interest of the company’s efficiency. A good business enterprise can do its best to assist its community
in solving various socio-economic problems. Successful business houses can set up educational
institutions, social service institutions, technical education centres, hospitals, and health programmes
in its community. They can also assist people during natural calamities like earthquakes and floods in
their communities, making social responsibility substantially conspicuous. Many business
organisations are instrumental in providing assistance to the community indirectly, by creating
indirect employment opportunities for the people—putting up shops, townships, transport
development, housing colonies, new social and religious institutions, cultural developments, markets,
and so on. For example, the once-remote village of Jamshedpur has attained a place of pride in the
world map of today with the headquarters of Tata Iron and Steel Company (TISCO) there.

Industrial units need to gear up to help the community to solve unemployment and other socioeconomic problems.
Business houses can set up educational institutions, social service institutions, technical education centres, hospitals, and
also assist the people during natural calamities.
It is imperative to note here that “community development” has been an important area where the
corporate sector has made invaluable contributions in the past, not only in India but also throughout
the world. All the economically developed nations today once lagged behind in terms of development.
The contribution of the corporate sector has played a tremendous role in developing the respective
communities in all these economies. The corporate sector in India is also very conscious about its
social responsibility. The Confederation of Indian Industries (CII) conducted a seminar on “Corporate
Social Performance” and an exhibition of NGOs in Mumbai in February 1998, clearly highlighting
its concern for the community development. Along with globalisation, there is an added awakening in
the corporate circles to initiate industries’ contribution for community development.
Responsibility to Human Resources
An organisation’s social responsibility is first visible in its approach to its internal environment. The
internal environment of an organisation primarily consists of its human resources. A company’s
policy which does not care for the welfare of its people may not be able to care for its external
environment—the society. The primary responsibility of a business firm is to look after the welfare
of its people. It means that a business enterprise must be willing to maintain the dignity of every
employee as a human being, provide adequate opportunities for every individual to develop to his
maximum potential, and match the organisational objectives with individual development needs. It
should enable every employee to satisfy his needs and aspirations.

The primary responsibility of a business firm is to look after the welfare of its employees.
Responsibility to employees stems from a proper organisational philosophy and human resource
policy. Fair wages, proper organisational climate, conducive working conditions, good career
prospects, proper human resource development facilities, a proper environment for need satisfaction
including self-actualisation needs, are essential. All such aspects enable an organisation’s workforce
to gain a sense of belonging and confidence. Jamshedji Tata’s vision of management as early as 1907
was almost identical.

Fair wages, proper organisational climate, and good career prospects—all such aspects enable an organisation’s workforce
to gain a sense of belonging and confidence.
The TISCO which started its operation in 1911, is one of the largest single private sector
enterprises in India and a leading producer of steel. It has fostered the philosophy of “managing
human resources with human considerations” as a prerequisite to managing business well from its
very inception. Human considerations at TISCO are reflected in their policies and programmes. Some
of their welfare schemes read as follows:
1. An eight-hour shift was first introduced in India in 1912 while it was not practised even in the home of scientific management.
2. Free medical aid for employees and their family members was started in 1915, while the ESI Act itself was passed in India only
in 1948.
3. A welfare department was established and welfare activities were introduced in 1917, while statutory welfare provisions were
introduced in the Factories’ Act only in 1948.
4. A school for the children of TISCO workers was established in 1917, though such a provision is not statutorily enforced even
till date.
5. Workers’ provident fund, leave with pay, and accident compensation were introduced in 1920, though the Employees’ Provident
Fund Act itself was passed only in 1952.
6. A technical training institute was established in 1921 for providing adequate training for its workers.
7. Maternity Benefit Scheme has been operative at TISCO from 1928, though a Maternity Benefit Act was passed by the
government only in 1961.
8. Bonus was introduced in 1934, while a uniform bonus condition was introduced by the government itself only in the Payment of
Bonus Act in 1965.
9. A retirement gratuity was introduced by TISCO in 1937, while the Payment of Gratuity Act itself was passed by the government
only in 1972.
10. An ex-gratia payment for road accidents was introduced by the company in 1979.
Companies like Cadbury Brothers and Unilever are well known among the global organisations that
are operating in India, for their employee welfare policies. Housing schemes, transport facility,
recreation, games and sports facility, workers’ education, counselling and career guidance, career
development, proper organisational climate and culture. . . . So goes the list of items which an
organisation can include in its employee welfare programmes in addition to the statutory welfare
programmes.
First of all, recognising the worth and contribution of an organisation’s people must be accepted as
an important task to provide justice to its people. Social responsibility of a business can be primarily
expressed through responsibility to its own people, on the one hand and to its customers, on the other;
without which no organisation can make claims of social responsibility.

Social responsibility of a business can be primarily expressed through responsibility to its own people, on the one hand and
to its customers, on the other; without which no organisation can make claims of social responsibility.
Responsibility to Society and Ecological Environment
An organisation owes social responsibility not only to the immediate social framework called
community but to the society at large and the ecological environment itself. In a global business
environment, the whole globe can be the society for an organisation. The countries or the cities
wherever a company operates (its products move), or is expected to operate—all such places or
people may come under the company’s society. It can also include its suppliers, dealers, wholesalers,
and retailers. The company has social responsibility to all such constituents of its society. While it can
be a good paymaster to its suppliers, it can maintain a proper supply line and terms and conditions
with its dealers, wholesalers, and others. It can also help the society to tackle its social problems.
MNCs which operate in India, for example, make their contribution for socio-economic development
of the economically weaker sections, participate in the natural problem-solving, and even adopt
villages for concentrated development activities. Almost all MNCs which operate in countries other
than their own countries of origin make a tremendous contribution to the socioeconomic
development of their host countries, which is really commendable.
Responsibility to Government
Social responsibility of a business may include a business firm’s responsibility to the government
also. A business enterprise has a responsibility to the government. It can pay its taxes, duties, and so
on, to the government, honestly taking into consideration the organisation’s commitment to the
government, especially on the social projects. Moreover, business firms constructively cooperate
with the government in their social policies and programmes. For example, corporate contribution to
the Prime Minister ’s Relief Fund is tremendous.

Responsibility of a business enterprise towards the government is to pay taxes and duties in time, cooperate with the
government in their social policies, and to follow all laws laid down by the government.
Business organisations that are good taxpayers and wholeheartedly participate in the government
social welfare projects, gain better corporate image indicating that this responsibility can be
considered as a social responsibility of business. There are some firms which are tax evaders. Firms
which break laws cannot be called as socially conscious firms. There are various categories of law—
industrial law, trade law, labour law, anti-pollution law—which have to be abided by the business
enterprises. Law-abiding corporate entities are bound to fulfil their responsibility to the government.
Social Responsibility to Global Business Environment
Globalisation of business has become an essential condition of business in the contemporary business
environment. Global markets, global operation and technology, global corporate citizenship, and
global policies and strategies—all make a global business environment. Every business organisation
has a responsibility to adhere to the conditions of such a global environment. Global business
environment provides for a free-market operation with a perfect competition. A firm that operates
globally has to appreciate the mechanisms of a global business environment. Even an indigeneous
firm operating indigeneously has to adhere to the global business environment. That is why every
firm, whether operating globally or indigeneously, has its social responsibility to the global
environment.
The global customer needs a globally approved quality, a globally competitive pricing, a globally
approved technology, and so on, which may be related to a global social responsibility. Even a
company which operates, indigeneously has to maintain global quality standards if it wants to remain
in the global market environment. For example, an indigeneously operating foundry which
manufactures castings (gear boxes) for an automobile, which operates in the global market, must
maintain the global quality and precision. There is a possibility that the units may fail and become
sick if they are not able to maintain global quality standards and global social responsibility.

The global social responsibility of a business enterprise is to fulfil global customer needs with a globally approved quality
at a globally competitive price.
Due to globalisation, a larger, faster, and greater growth of industrialisation is expected in the
future resulting in a greater social responsibility being demanded from the business enterprises.
There would exist a possibility for more takeovers, acquisitions, and mergers, resulting in the
emergence of giant enterprises, which may make larger allocations for social welfare projects with
the objective of gaining a greater corporate image and penetration. Companies with low social
responsibility investment may even become unpopular in the eyes of the society in the future years.
As a result of the entry of large business houses and multinationals in the social arena, a number of
innovative projects for the social development are bound to be introduced in the future. Particularly,
on account of the entry of many large industrial enterprises and extensive industrial operations, there
would be a possibility of greater pollution and environmental degradation.
Companies are, therefore, expected to gain a greater social consciousness. On the contrary, greater
government regulations are also expected to be introduced for ensuring the social responsibility of
business. As a result, there would emerge a greater social awakening in the industrial circles towards
this end.
BARRIERS TO SOCIAL RESPONSIBILITY
Although social responsibility of business is the globally accepted task of every business
organisation, there are some obstacles which hinder the effective fusion of the social welfare
objective with the corporate policy. These obstacles can be considered as “barriers” to social
responsibility. A business organisation is a social entity, and it has a responsibility to its society which
consists of its customers, its own human resources, its community and environment, and the society at
large. Certain organisations accept their social responsibility, but certain others pay only a lip service
to it. Some are of the opinion that it is the responsibility of the government to care for the social
welfare of its citizens.

Every business organisation has some obstacles which hinder the effective fusion of the social welfare objective in the
corporate policy.
Business organisations are heavily taxed for social projects. Some of the barriers to the social
responsibility of business include an urge for profiteering, desire for an excessive accumulation of
wealth, low profitability, collective exploitation problems, frequently changing government
mechanism, important commitments by trade unions, and the need for tackling other important
internal issues, which prevent from allocation of funds, extortion and corruption, recession,
depression, and so on. Profitability is important for any business to survive. But profiteering at the
cost of customers and the community is not good. Temptation for profiteering encourages
businessmen to exploit the customers by reducing quality, hiking prices, black marketing, hoarding,
no investment on social responsibility, and so on.
The desire for profitability and excessive wealth motivates businessmen to amass wealth by all
means, resulting in an exploitation of even their own workforce and customers. Social responsibility
is never a necessary proposition for them. The only objective of their business is to multiply the
profit and gather wealth at any cost, which is a great barrier to the social responsibility of business.
Low profitability or a no-profitability situation in business prevents any business firm from
concentrating its attention on social responsibility. It may even pose a question mark on its very
survival. In such a situation, no business firm would be in a position to concentrate on the social
responsibility, even if it has the inclination to do so. Such situations are not rare in businesses.

The desire for profitability and excessive wealth motivates businessmen to exploit the workforce and customers.
Collective exploitation by the trade unions often compels a business organisation to drain out its
profit, and even eat up the capital. This is a very normal phenomenon in the Indian businesses. Trade
unions, by virtue of their collective strength, hold the entire organisation at ransom to realise their
exorbitant claims. Many industrial units turn sick in this process, affecting the social responsibility.
The need for tackling other internal problems may very often become the priority of some
organisations. They are forced to postpone the social responsibility needs. Capital problems, low
cash flow, commitments to financial institutions, financial strain, fresh investment and modernisation
needs, and so on, sometimes affect the company’s capability to divert its funds towards the social
welfare projects.

The need for tackling internal problems, frequently changing governments, and law profitability in business are some
important barriers in the social responsibility.
Box 21.3 UN Panel to Monitor MNCs on Human Rights Issue

The United Nations Human Rights Panel has urged a concern that the UN members, transnational
corporations, and other business enterprises that violate international human rights law should be
investigated and censured.
In a resolution passed in August 2003, the 26-member UN sub-commission on the promotion and
protection of human rights unveiled its draft norms on the responsibilities of transnational
corporations and other business enterprises, which called the United Nations to monitor all
business compliances with international treaties governing human rights, labour environment,
consumer protection, and anti-corruption laws. The norms also provide guidelines for companies
operating in the conflict zones like Iraq.

The frequently changing governments lead to instability and inconsistency in policies, resulting in
uncertainties in the realm of business. The situation in India during 1996–98 is an example, during
which period three governments (under Mr. Atal Bihari Vajpayee, Mr. Deve Gowda, and Mr. Inder
Kumar Gujral) failed, resulting in instability in the nation and in the business environment. Industrial
production went down, GNP declined, share markets crashed, inflation increased, and an economic
turmoil prevailed everywhere. The social welfare investment by Indian business was the lowest
during this period when compared to the last 25 years. When uncertainty prevails in a business, any
firm would think twice before making any commitment towards an additional investment on the
social responsibility.

The frequently changing governments lead to instability and inconsistency in policies, resulting in uncertainties in the realm
of business.
Business firms may face important commitments other than social projects very often, while their
resources are always limited. For example, on account of globalisation, modernisation needs have
become indispensable in many industrial units, while their resources have remained the same. While
their existing commitments including commitments to their financial institutions remain unchanged,
additional commitments have to be made for additional investments on modernisation. Financial
institutions, at times, do not hesitate even to pressurise the industrial units. In such situations, it is
natural that the industrial organisations may hesitate to divert their funds to any other project
including social projects.
On many occasions, industrial and business organisations become the target of extortion and
corruption from many quarters, including political pressures, unscrupulous social elements, and even
corrupt government officials and politicians. While the resources are limited, business organisations
are compelled to oblige to such elements for their very existence. Such extra commitments can be
adjusted only against the social welfare funds, a regular feature in the Indian businesses today.
A couple of giant organisations have suggested setting up of special funds to meet the demands
from politicians. The small- and medium enterprises (SMEs) find it practically difficult to survive
after meeting the exorbitant demands from extortionist and corrupt elements in administration and
politics. Problems like recession and depression, which adversely affect economic activities, affect
the resource mobilisation ability of business enterprises considerably. They have, therefore, to be
very prudent in their economic behaviour and expenditure decisions. This again affects the social
investment decision.

Problems like recession and depression, which affect the behaviour and expenditure, affects the social welfare programme
of business organisations.
CORPORATE ACCOUNTABILITY VIS-À-VIS SOCIAL RESPONSIBILITY
We have discussed about the responsibility of business to its society, since a business firm is a part of
the latter. The social aspect of business demands that the business should not adversely affect the
living conditions of the members of the society, on the one hand but should facilitate good living
standards by providing whatever is possible within its purview, on the other. This is the “social
responsibility” of business. Corporate accountability, on the other hand, is the accountability of
business to its various constituents—owners (shareholders), financiers (financial institutions),
employees, government, and customers. Business has a sort of legal obligation to all these
constituents; and hence, accountability can be considered as a compulsory state of responsibility to
the constituents of a business.

Corporate Accountability is the accountability of business to its various constituents like shareholders, financers,
employees, and customers.
Every organisation is answerable to its owners and financiers, on the one hand and to its employees
and workforce, on the other; for its performance and social contribution. It is accountable to the
government since the latter has a regulatory role, while its accountability to the consumers comes
into play because the goods and services are produced for the sake of the consumers and customers.
A contractor who builds a housing complex is accountable to his buyers and users because they would
be the first victims in case of any untoward incident. Thus, social responsibility and corporate
accountability are not identical terms. They represent two different aspects of the company’s
responsibility. Primarily, a business is accountable to its constituents, on the one hand and
responsibility to itself, on the other.

Business is accountable to its constituents, on the one hand and responsibility to itself, on the other.
The social responsibility of a business primarily goes with the company’s very operation itself, for
maintaining proper product quality, proper product pricing, timely distribution, and after-sales
service; proper advertising and extending information; proper customer education, and so on. The
company should also make it a point not to misguide any customer during the course of advertising,
information giving, and demand creation.

The company should also make it a point not to misguide any customer during the course of advertising, information
giving, and demand creation.
The social responsibility of a business can also be explicit in specific social welfare projects taken
up by the company. Many companies extend financial investments towards these projects. Some of the
social welfare projects of TISCO have already been mentioned earlier. Apeejay Group operates
educational institutions for the welfare of the society, while Hindustan Lever Ltd. (HLL) has adopted
many villages. ITC has sponsored sports and games. Indian Petrochemical Corporation Ltd. (IPCL)
Gujarat Refinery, and Gujarat State Fertilizer Company have jointly constructed a 56-km-long,
effluent disposal channel in Baroda at a cost of about Rs 13 crore. There are many such examples of
corporate, social welfare projects.
As a part of the global movement on environmental protection, there is an awakening in India also.
As a result of the globalisation process, there would be a greater thrust on the social responsibility of
business and environmental protection in the years to come. Social performance of every
organisation can be evaluated with the help of a social audit.

As a result of the globalisation process, there would be a greater thrust on the social responsibility of business and
environmental protection in the years to come.
CHALLENGES FOR SOCIAL RESPONSIBILITY OF BUSINESS
The challenges to a further awareness, dissemination, and adoption of social responsibility practices
among enterprises stem from insufficient factors, as follows:
Knowledge about the relationship between social responsibility and business performance (the “business case”);
Consensus between the various parties involved in an adequate concept, taking into account the global dimension of social
responsibility; in particular, the diversity in domestic policy frameworks in the world;
Teaching and training about the role of social responsibility, especially in commercial and management schools;
Awareness and resources among SMEs;
Transparency, which stems from lack of generally accepted instruments to design, manage, and communicate social
responsibility policies;
Consumers’ and investors’ recognition and endorsement of social responsibility behaviours; and
Coherence in public policies.
EMERGING PERSPECTIVES FOR CORPORATE SOCIAL RESPONSIBILITY
There are three emerging perspectives that inform CSR. They are as follows:
One, a business perspective that recognises the importance of “reputation capital” for capturing and
sustaining markets. Seen thus, CSR is basically a new business strategy to reduce the investment risks
and maximise the profits by taking all the key stakeholders into confidence. The proponents of this
perspective often include CSR in their advertising and social marketing initiatives.
The second is an eco-social perspective. The proponents of this perspective are the new generation
of corporations and the new-economy entrepreneurs who created a tremendous amount of wealth in a
relatively short span of time. They recognise the fact that social and environmental stability and
sustainability are two important prerequisites for the sustainability of a market in the long run. They
also recognise the fact that increasing poverty can lead to social and political instability. Such socio-
political instability can, in turn, be detrimental to business, which operates from a variety of socio-
political and socio-cultural backgrounds. Seen from the eco-social perspective, CSR is both a value
and a strategy to ensure the sustainability of a business. It is a value because it stresses the fact that
business and markets are essentially aimed at the well-being of the society. It is a strategy because it
helps to reduce social tensions and facilitate the markets.
For the new generation of corporate leaders, optimisation of profits is the key, rather than the
maximisation of profit. Hence, there is a shift from accountability to “shareholders” to accountability
to “stakeholders” (including employees, consumers, and affected communities). There is a growing
realisation that long-term business success can only be achieved by companies that recognise that the
economy is an “open subsystem of the earth’s ecosystem, which is finite, non-growing, and
materially closed”.
There is a third and growing perspective that shapes the new principles and practice of CSR. This is
a rights-based perspective of the corporate responsibility. This perspective stresses that consumers,
employees, affected communities, and shareholders have a right to know about corporations and their
businesses. Corporations are private initiatives, true, but increasingly they are becoming public
institutions whose survival depends on the consumers, who buy their products and shareholders, who
invest in their stocks. This perspective stresses accountability, transparency, and social and
environmental investment as the key aspects of CSR.
CSR is qualitatively different from the traditional concept of corporate philanthropy. It
acknowledges the debt that a corporation owes to the community within which it operates, as a
stakeholder in the corporate activity.

CSR is qualitatively different from the traditional concept of corporate philanthropy. It acknowledges the debt that a
corporation owes to the community within which it operates, as a stakeholder in the corporate activity.
SOCIAL RESPONSIBILITY OF BUSINESS IN INDIA
Today, CSR goes far beyond the old philanthropy of the past—donating money to good causes at the
end of the financial year—and is, instead, an all-year-round responsibility that companies accept for
the environment around them, for the best working practices, for their engagement in their local
communities, and for their recognition that brand names depend not only on quality, price, and
uniqueness but on how cumulatively they interact with the companies’ workforce, community, and
environment. Now businesses need to move towards a challenging measure of corporate
responsibility, where we judge results not just by the input but by its outcomes.
In India, CSR has evolved to encompass employees, customers, stakeholders, and sustainable
development or corporate citizenship. The spectrum of CSR includes a number of areas such as
human rights, safety at work, consumer protection, climate protection and caring for the
environment, and sustainable management of natural resources. From the perspective of employees,
CSR activities include providing health and safety measures, preserving employee rights, and
discouraging discrimination at the workplace. This helps in fostering a healthy environment within
the company.
Looking at the strategy adopted by the companies for social responsibility, it is interesting to note
that Hindustan Unilever Limited has dovetailed the CSR strategy into their overall business strategy;
thereby, it achieves the twin objectives of business as well as social responsibility. The philosophy of
this company is its commitment to all the stakeholders—consumers, employees, the environment, and
the society. The initiatives, that are accorded priority, are sustainable, have long-term benefits and an
ongoing business purpose. An example in this regard is the “Shakti” programme, which aims at
empowering rural women through a critically needed additional income by equipping and training
them to become an extended arm of the company’s operation. On the other hand, Godrej Industries
views CSR initiatives as a philanthropy that was started by their founders and continues even today.
Even its competitor Procter and Gamble (P&G) has a different view regarding CSR. P&G believes in
building the community in which it lives and operates by supporting the ongoing development of the
community. Social projects are based on its motto “Business with a Purpose”.
There are also groups like Reliance ADAG, which emphasised the need to be socially responsible,
and further stated that they evaluate and assess each critical business decision or choice from the point
of view of diverse stakeholders’ interest, driven by the need to minimise risk; and to proactively
address long-term social, economic, and environmental costs and concerns. CSR is not an occasional
act of charity or contribution to a school, hospital, or an environmental NGO, but an ongoing
commitment that is integrated into the objectives and strategy of the core business. Even though they
have not spelled out the initiatives, the approach is similar to Hindustan Unilever Ltd.
In case of Tata Steel, the CSR is based on the principle of its founder Jamestji Tata, who said that
the progress of an enterprise, the welfare of the people, and the health of the enterprise were
inextricably linked. The wealth and the generation of wealth have never been ends in themselves, but a
means to an end, for the increased prosperity of India. Companies are taking initiatives for
developing the infrastructure in the rural areas, for example, TATA Motors provides desks, benches,
chairs, tables, cupboards, electrical fittings, and educational and sports material to various primary
schools in Singur. The company has also planned similar programmes to upgrade the school
infrastructure and is also planning to set up a computer laboratory in one of the high schools.
Similarly, TVS Electronics was involved in CSR during the Tsunami to provide relief measures to the
victims. They have also participated with the government to improve sanitation in a village called
Tiruvidenthai. Such initiatives will help in improving the conditions of rural people. Satyam
Foundation of Satyam Computer Services Ltd., Infosys Foundation of Infosys Technologies Ltd., and
GE Foundation of the General Electric Company are exemplary instances of the philanthropic
commitment of the corporate sector in India. Irrespective of the profits they make, these foundations
are aiming at uplifting of the poor and enhancing the standard of life in the rural sector.

In case of Tata Steel, the CSR is based on the principle of its founder Jamestji Tata, who said, that the progress of an
enterprise, the welfare of the people, and the health of the enterprise were inextricably linked.
CSR offers manifold benefits both internally and externally to the companies involved in various
projects. Externally, it creates a positive image among the people for its company and earns a special
respect among its peers. It creates short-term employment opportunities by taking various projects
like construction of parks, schools, and so on. Keeping in view the interests of the local community,
the work brings a wide range of business benefits.

CSR offers manifold benefits both internally and externally to the companies involved in various projects.
CASE
Envopeace vs Suns Pvt. Ltd.
White unfurling banners said “Suns Stop Poisoning Our Food”, the activists said they were
determined to stay chained till the senior-level management answered their questions. This was the
situation at the front door of Suns Pvt. Ltd. on a Thursday. And the war between the activists of the
environmental NGO, Envopeace and Suns Pvt. Ltd. began.
Envopeace was protesting the alleged field trials by Suns Agro (a wholly owned subsidiary of Suns
Pvt. Ltd.) of the genetically modified organism, AAA, as well as the company’s refusal to answer
critical questions repeatedly posed by the NGO. Envopeace says it has asked the company in India to
clarify certain issues including why the Suns was using the same gene, which was proved fit only for
animal feed, to feed people in the country. Envopeace also asked what biosafety and health-safety
assessments have been conducted so far and what were their results too. What did Suns do with the
genetically modified plants, seeds, and produce from the fields, and whether the firm can provide an
assurance that the genetically modified organism has not already entered the food chain. Envopeace
says the matter is not an issue limited to agroscience, but one that is crucial to public health safety as
the gene protein is suspected of being a human allergen.
In the United States, the field trials were abandoned when AAA-laced corn found its way into talco
shells and other items meant for human consumption. This AAA corn was owned by a subsidiary of
Suns Pvt. Ltd., Stars, and was marked under the name LINKS. AAA had made an appearance in the
Indian scene in March 2003, when a food-aid shipment from two US-based aid agencies was
suspected of being contaminated with LINKS corn. At that time, the Genetic Engineering Approval
Committee demanded that the United States and the aid agencies provide a certification stating that the
consignment did not contain any LINKS corn. The Indian government rejected the shipment when no
certificate was forthcoming on this issue.
A press release from Suns Pvt. Ltd called the allegation by Envopeace as “baseless”. The head of
corporate communication at Suns said, “I can categorically say we have never done any trials
involving AAA”. But the campaigners of Envopeace India said, “There is documentary evidence in
the form of article in one of the newspapers in which the Department of Biotechnology of Suns Agro
had conducted field trials of cabbage and cauliflower with AAA”.
It was evening when the company issued a statement to Envopeace which was similar to the press
release calling the statement “lies”. Envopeace says that the matter has not ended and they will
confront the company with the Department of Biotechnology Report at an agreed-on meeting on
Wednesday. Is Suns Pvt. Ltd’s sole responsibility is only to maximise the profit? Or, must they
consider the social and ethical implications of their decisions?
Case Analysis
Yes, business management must consider the social and ethical implications of its decisions. The
business enterprise is a total system within itself. At the same time, it is a subsystem within the social
superstructure and the universe. CSR is seriously considering the impact of the company’s decisions
and actions on the environment and the society. The dependence of any business on its social and
ecological environment is so complete that the very existence, survival, and growth of any enterprise
depends upon its acceptance by the society and the environment. Then, automatically, they can
maximise their profit by using their goodwill in the society.
So, Suns Pvt. Ltd. should stop their alleged trial of the genetically modified organism, AAA, which
is actually fit for animal feed only, for it is a human allergen. The company should conduct biosafety
and health-safety assessments and also disclose the results to the public. Here the management should
remember that they also have some responsibility towards the society, because there may be a chance
that this genetically modified organism has entered the food chain, which is really harmful for the
health of the general public.
Here Envopeace’s stand is right. Not only should businesses to be socially responsible but such
type of social organisations should be socially aware as well. The government, in its turn, should
support the social organisations by revising laws and corporate codes. Therefore, Suns Pvt. Ltd.
should stop their alleged field trials of the AAA, if it is really harmful for the health of the society.
SUMMARY
The term “social responsibility of business” refers to two types of business obligations. Firstly, a
business should see that the economic consequences of its actions do not adversely affect the public
welfare. Secondly, it should develop human values such as morals, cooperation, motivation, and self-
actualisation at work.
There are four views about a businessman’s responsibility to the community. According to the first
view (communist), a businessman can never voluntarily act in a socially responsible manner. Hence,
social responsibilities should be imposed on him through force or legislation. According to the
second view (capitalist), a businessman should not be asked to discharge social responsibility, as it is
not his business. His business is to make profits only. According to the third view (pragmatic), a
businessman should no doubt earn his profits, but should also voluntarily assume some social
responsibility. According to the fourth view (trusteeship), a businessman should hold everything in
trust, and carry on his business as a trustee, for the benefit of the community.
A businessman’s social responsibilities are towards his consumers, workers, shareholders, and the
State, ultimately. There are a number of ways in which he can discharge these responsibilities. His
social performance can be evaluated by means of social audits. Many business organisations in India
have contributed greatly in the area of social responsibility.
A business organisation operates within the precincts of the society. While its immediate society,
where it operates, provides it the environment, material, manpower, market, and so on; the whole
global society provides for it the global corporate citizenship, and ensures its facilities in terms of
environment and market perspective, and exposure to technology and integration with priorities in the
global business scenario. The social responsibility of a business organisation consists of its
responsibility to its consumers and customers, its immediate society (community), its human
resources (people), its society at large, the ecological environment, the government, and its global
business environment.
Globalisation has come to stay; community-socialist set up which divided the globe in the past has
become irrelevant now. Every nation on the globe is striving to integrate its economy with the global
economy. India is also on the threshold of globalising its economy. Many global corporations are
now operating in India, and many others are on the road to Indian market, while many Indian
companies prepare themselves to go abroad. Those who are still satisfied to continue their operation
in India alone are too in a global market, as India itself has become a part of the global market. Thus,
every business activity, either Indian or foreign, should have identical objectives and scope; and
social responsibility of business must be an important objective of all business enterprises.
KEY WORDS
Corporate Social Responsibility (CSR)

Philanthropy
Human Resources
Nongovernmental Organisation (NGO)
Ecological Environment
Globalisation
Hoarding
Corporate Accountability
Community
Organisational Climate
Depression
Social Audit
Employee Welfare Programmes
QUESTIONS
1. Explain what you understand by the concept of “social responsibility of business”. Why should businesses develop a sense of
social responsibility? Discuss.
2. Describe in detail the social performance of business in India.
REFERENCES
(2007) “India Inc on Global CSR Drive”, Business Standard, August 31, 2007, Online edition,
http://www.businessstandard.com
Agarwal, R. (2003), “Corporate Social Responsibility: A Critical Perspective from India”, http://www.toxicslink.org/
Archana, V. (2007), “CSR as a Core Competence”, Business Line, June 4, 2007, Online edition,
Bhatia, S. K. (2002). Business Ethics and Managerial Values: Concepts, Issues and Dilemmas in Shaping Ethical Culture for
Competitive Advantage of Organisations. New Delhi: Deep and Deep Publications.
Bureau (2004), “CSM Releases Guide on Corporate Social Responsibility”, Business Line, October 09, 2004, Online edition,
Chidambaram, K. and V. Alagappan (2003). Business Environment. Delhi: Vikas Publishers.
Giri, A. K. (2005). Reflections and Mobilisations: Dialogues with Movements and Voluntary Organisations. New Delhi: Sage.
Gupta, S. K. (July 2004). “Creating Shareholders Value Through Corporate Social Responsibility”, Executive Chartered
Secretary, The Journal for Corporate Professionals by the Institute of Company Secretaries of India.
Gupta, S. K. (2005). “Creating Shareholders Value Through Corporate Social Responsibility”. New Delhi: Consultancy
Development Center, Vol. 9, March 3, 2005, Online edition, http://www.dsir.gov.in
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House.
Mohanty, J. (2005). Teaching of Ethics: New Trends and Innovations. New Delhi: Deep and Deep Publications.
Prakasham, S. (2001). Essentials of Social Ethics: Concept, Issues and Challenges. New Delhi: Rajat Pub.
Raghavan, B. S. (2007), “Measuring CSR of India’s Corporates”, Business Line, June 18, 2007, Online edition,
Sareen, S. (2001). Ethics Management. New Delhi: Sarup.
Sengupta, S. S. (2004). Business–Social Partnership: An International Perspective. Jaipur: Aalekh Pub.
Sharma, S. P. (2004). Basic Principles of Education. New Delhi: Kanishka.
Verma, S. B. (2004). Environmental Law, Pollution and Management. Jaipur: University Book House.
CHAPTER 22
Liberalisation
CHAPTER OUTLINE
Background
Policy Changes
Meaning of Liberalisation
The Path of Liberalisation
Reform Achievements
Industrial Growth
Future Expectations
Liberalisation—An Assessment
Liberalisation and the Growth of Indian Economy
Issues and Challenges
Case
Key Words
Questions
References
BACKGROUND
The emergence of independent India on August 15, 1947, was the beginning of a new, glorious era in
the history of our country. The Government of India set up the Planning Commission in 1950 to
assess the country’s needs of material capital and human resources in order to formulate plans for
their more balanced and effective utilisation. Since 1950–51, India has passed through 10 five-year
plans and several annual plans, and is now in the Eleventh Five-Year Plan. The role of the private
sector was fairly significant in the plan frame up to the Third Five-Year Plan, but became somewhat
eclipsed during the 1960s and 1970s as a result of the increasing dominance of populist and socialist
postures. The Sixth Plan was marked by the return of the private sector into the plan frame on a low
key. This trend continued during the Seventh Plan. This plan registered an unprecedented high growth
rate of 5.6 per cent of the gross domestic product (GDP), and much of it was accounted for by the
private sector strides in the manufacturing and services. The financial and balance of payments (BoP)
crises, which the nation faced from the beginning of the 1990s, compelled the acceptance of
deregulation; a reduced role for public sector, making the public sector efficient and surplus
generating; and much greater reliance, in general, on the private sector, for industrial and
infrastructure development.

The financial and balance of payments (BoP) crises, which the nation faced from the beginning of the 1990s, compelled the
acceptance of deregulation; a reduced role for public sector, making the public sector efficient and surplus generating; and
much greater reliance, in general, on the private sector, for industrial and infrastructure development.
Meanwhile, despite the impressive growth performance of the 1980s serious budgetary and fiscal
deficits of the government and severe pressure on the country’s BoP position led to a critical
economic and financial situation by 1991, further aggravated by political uncertainty. By the time
there was a new government at the Centre in June 1991, there was no other alternative but to introduce
a new deregulatory and liberal economic regime, thereby drastically reducing the government’s
licensing and regulatory functions. This was the rationale behind the sweeping changes in industrial
and trade policies brought about by the Narasimha Rao government in 1991 and 1992.
POLICY CHANGES
The first Industrial Policy Resolution of 1948 was inspired by the vision of building India rapidly into
a modern industrial economy, generating employment, removing socio-economic disparities, and
attaining self-reliance. The Industrial Policy Resolution of 1956 focused more sharply on achieving
rapid growth by according a due place to the small industry.
The subsequent policy changes of 1973, 1980, and 1985 emphasised the need for promoting
competition in the domestic market and technological upgradation. The public sector was given a
leading role in the First and Second Five-Year Plan for setting up basic industries and infrastructure
facilities. Because of the scarcity of capital, the private sector was not assigned a substantive role in
the development of infrastructure facilities such as power, railways, steel, and other core sectors. For
the first time, in 1973, an attempt was made in the industrial policy statement to allow investment from
large industrial houses and foreign companies in high-priority industries. Small-scale, tiny, and
cottage industries were also encouraged and were given a bigger role in the development of industry.
It was in 1980 that the need was felt for promoting competition in the Indian industry by permitting
import of technology and facilitating modernisation. Again it was during this period that emphasis on
export promotion got a big boost. By the end of the Sixth Plan, the Indian industry had gained
considerable competence and was able to meet the emerging challenges in the world economy.
Recognising the need for consolidating Indian industry’s strength in the Seventh Plan (1985–90), a
number of policy and procedural changes were brought about with a view to increasing productivity,
reducing costs, and improving quality. A beginning was made to open up the economy to competition.
Attempts were also made during this period to give autonomy to the public sector by removing policy
constraints.

In India, during the period 1985–90, attempts were made to give autonomy to the public sector by removing policy
constraints.
ECONOMIC LIBERALISATION
India has been facing grave economic crises and external pressure for foreign exchange (forex).
There was an internal debt trap from 1986. There were severel liquidity crises. India was almost on
the brink of defaulting on international payments which would have tarnished our image in the
international market. Its monetary system, particularly the forex situation, was in a precarious
position when the Narasimha Rao government took over in June 1991. Dr. Manmohan Singh, the then
Union Finance Minister, had the great task of introducing ways and means for the recovery of the
ailing monetary system. Changing the exchange rate structure was, therefore, the first weapon in his
hand.

Narasimha Rao government took over in June 1991, and initiated the liberalisation process which some people call as
Raonomics, some as Manmohanomics, and some others as Rao-Mohanomics.
The foreign exchange reserves (FER) were not sufficient even for a few weeks’ import of essential
goods. Any import cuts would have crippled the economy. The country had, therefore, to attract
forex, on the one hand and increase exports, backed by decreased imports, on the other hand.
Liberalisation was thought to be the only weapon for this purpose. In view of the above situation, the
government initiated the liberalisation process. Some people call it as “Manmohanomics”, some as
“Raonomics”, and some others as “Rao-Mohanomics”.
MEANING OF LIBERALISATION
The term “economic liberalisation” means and includes mainly the following:
1. Dismantling of industrial licensing system built over the previous four decades,
2. Reduction in physical restrictions on imports and also in the rate of import duties,
3. Reduction in controls on forex—both current and capital account,
4. Reform of the financial system,
5. Reduction in the levels of personal and corporate taxation,
6. Reduction in restrictions on foreign investments (direct and portfolios),
7. Opening up of areas hitherto reserved for public sector (basic industries, power, transport, banking, etc.),
8. Partial privatisation of public sector units (PSUs) (with or without passing on majority control to private shareholders),
9. Softening of MRTP (Monopolies and Restrictive Trade Practices ACT) regulations, and
10. Making various sectors of the Indian economy competitive on the global economic platform by making them produce quality
goods in a cost-effective manner.
Liberalisation does not mean simply inviting a number of foreign companies or multinational
corporations (MNCs) on whatever terms with whatever objectives in mind and in whatever sector,
indiscriminately. By implication, economic liberalisation suggests that the entire opening up of the
economy should ultimately be for building up strength of our own. Hence, inviting foreign
companies/MNCs should be a means and not an end. Liberalisation means removal of control and not
of regulations. Liberalisation does not imply any secret deals behind the curtain. On the contrary, it
does mean the elements of transparency and accountability in the functioning and procedures relating
to the various sectors of the economy.
THE PATH OF LIBERALISATION
The path of liberalisation accepted to dismantle the walls of restrictions in India, which has been
multi-pronged. First of all, the government had to release the economy from the restrictive rules and
regulations framed by the bureaucrats in the garb of the socialistic pattern of society, which had
retarded economic growth for the last four decades. Then, India needed to establish a very different
image, that of a market-oriented economy, in the eyes of the foreign governments and investors,
besides sustaining a private sector-friendly image within the country. On the other hand, the
Government of India needed to be successful in effectively checking the twin problems of
unemployment and inflation.

Liberalisation means dismantling of industrial licensing, by softening MRTP regulation, and reduction in restrictions of
foreign investment.
The real task before the government has been two-fold: firstly, to win the confidence of the foreign
investor; and secondly, to allay the fears of the Indian public about the entry of foreign investors into
India in a big way and the government’s capability (rather willingness) to effectively check the
problems of inflation and unemployment. When globalisation became the order of the day, nations
adopted the path of liberalisation. India could not isolate itself from this trend. It was, therefore,
appropriate on the part of the Government of India to institute and implement a strategy for economic
liberalisation. Some of the measures adopted in connection with the liberalisation strategy include the
following:
1. Relief to foreign investors,

2. Devaluation of the Indian rupee,
3. New Industrial Policy,
4. New Trade Policy,
5. Removal of import restrictions,
6. Budgetary policy,
7. Liberalised Exchange Rate Management Systems (LERMS),
8. Memorandum to International Monetary Fund (IMF),
9. Liberalisation of NRI remittances,
10. Encouraging foreign tie-ups,
11. Narasimhan Committee Report,
12. FERA and MRTP relaxation,
13. Decontrol of steel,
14. Redefining SEBI’s role,
15. Privatisation of public sector,
16. Simplification of industrial licensing,
17. Banking and financial sectors reforms, and
18. GATT Agreement.
Liberalisation strategy of India include devaluation of Indian rupee, new industrial and trade policy, relief to foreign
investors, and LERMS.
Relief to Foreign Investors

As a part of the liberalisation process initiated in the New Industrial Policy of 1991, the Indian
government wanted to attract more foreign investments. Hence in place of majority of Indian equity
holdings, foreign investments were allowed to the tune of 51 per cent, in July 1992. In its notification
of June 30, 1992, the Department of Industrial Development prescribed that an existing company that
wishes to raise the foreign equity up to 51 per cent may do so as a part of an expansion plan, provided
such a plan is in high-priority industries shown in Annexure III to the statement on industrial policy.
The increase in the equity level must result from the expansion of the equity base of the existing
company, and the increased equity money must be remitted in forex.

Foreign investments were allowed to the extent of 51 per cent in July 1992.
Although the proposed expansion must be in the high-priority industries, the company need not be
exclusively engaged in the items listed in Annexure III. Companies are allowed to expand the equity
base of the existing company by raising foreign equity up to 51 per cent without an expansion
programme. The foreign equity must be remitted in forex. Before the company passes a special
resolution proposing a preferential allocation of the required volume of equity to the foreign
investor, the approval of the Reserve Bank of India (RBI) must be obtained. Financial institutions
holding equity in such companies should obtain the Finance Ministry’s advice to support such
proposals. On the basis of the guidelines of the Securities and Exchange Board of India (SEBI), a
company should make issues at a price determined by the shareholders in a special resolution.
The government is still stressing the social goals enshrined in the Constitution, which are to be
achieved through the dynamic methods and techniques available today, for which foreign investment,
collaboration, and technological partnership with the developed world, are necessary. In order to
tackle the problems like retrenchment emerging out of the New Industrial Policy, the government
proposed in the 1991–92 Budget a National Renewal Fund for the setting up of which Rs 200 crore
was earmarked. The state governments and the Industry are also expected to contribute to this fund.
This is expected to develop into a “mighty social safety net”.
The policy of liberalising foreign investment paid off tremendously. During the period from
August 1991 to December 1992, foreign investments to the tune of Rs 42.9 bn were approved
according to the annual report of the Union Ministry of Industry for the year 1992–93. During 1992
as many as 1,520 foreign collaboration agreements were approved, which included 692 foreign
equity approvals amounting to Rs 39.9 bn, as against the foreign investment approvals of merely Rs
1.2 bn in 1990 and Rs 5.3 bn in 1991. Under the automatic approval, the RBI approved a foreign
investment of Rs 9.2 bn between September 16, 1991 and December 31, 1992. An important aspect of
these foreign investments was that more than 80 per cent of the foreign direct investment (FDI) were
the priority sector.

During 1992, as many as 1,520 foreign collaboration agreements were approved in India.
Under the automatic approval, the RBI approved a foreign investment of Rs 9.2 bn between September 16, 1991 and
December 31, 1992.
Another important source offoreign investment is the Non-Resident Indian (NRI). Remittances of
NRIs from other countries are provided protection. This even amounted to immunity on black money
being laundered overseas and brought back home as gift via the NRI conduit. The Commerce
Minister ’s visit to the UAE (United Arab Emirates) in November 1991 also convinced the gulf Indians
about remittances to India. The inflow of gulf money to the tune of about US$6 mn to US$7 mn a day,
turned to be a bonanza for the Indian economy. The deadline announced by the Finance Minister, that
is, November 30, 1991, resulted in a tremendous inflow of forex. The import of gold by NRIs by
paying nominal import duties in forex was also important in respect of the inflow of forex. Thus,
liberalisation of foreign investment helped India to tide over the difficulties for forex.
Devaluation of Indian Rupee
In order to pave the way for liberalisation, Indian currency was devalued by 22.5 per cent at two
stages in short intervals. It was expected to improve exports substantially while curtailing imports.
However, exports have not gone up substantially as expected. On the contrary, inflation went up by
about 3 per cent, while revenue from import duty declined. However, positive effects are expected in
the long run.

In 1992, Indian currency was devalued by 22.5 per cent at two stages in short intervals.
New Industrial Policy
As a part of liberalisation, the Government of India announced a new industrial policy in two parts,
on July 24, 1991, and August 6, 1991, respectively. Box 22.1 explains the objectives of the same. And
some of the major aspects of the policy are given as follows:
1. Industrial licensing is dispensed with except in 18 items including coal, petroleum, sugar, motor cars, cigarettes, hazardous
chemicals, drugs and pharmaceuticals, and some luxury items.

In 1991, industrial licensing is dispensed with except in 18 items.
2. DFI up to 51 per cent of equity is allowed in high-priority industries, departing from the 40 per cent limit of foreign equity
participation prescribed in the FERA (Foreign Exchange Regulation Act).
3. The threshold limits of the assets of MRTP companies and dominant undertakings have been removed. Emphasis is to be placed
on controlling and regulating monopolistic, restrictive, and unfair trade practices. Newly empowered MRTP Commission is
authorised to initiate investigations suo moto or on complaints received from individual consumers or classes.
4. Automatic clearance introduced for import of capital goods, provided forex requirement for such import are met through foreign
equity.
5. Automatic permission for foreign technology agreements in high-priority industries up to Rs 1 crore was granted.

In the New Industrial Policy, 1991, automatic permission for foreign technology agreements in high priority
industries up to Rs 1 crore was granted.
6. Foreign equity proposals need not be accompanied by foreign technology agreement.

7. Existing and new industrial units are provided with broadbanding facility to produce any article, so long as no additional
investment in plant and machinery is involved. Exemption from licensing will apply to all substantial expansion of existing units.
Box 22.2 describes the broadbanding facility in detail.
8. Pre-eminent role of public sector in eight core areas including arms and ammunitions, mineral oils, rail transport, and mining of
coal and minerals will continue.
9. Part of government’s shareholding in public sector is proposed to be disinvested, which will be offered to mutual funds,
financial institutions, general public, and workers.
10. Chronically loss-making PSUs to be referred to the Board for Industrial and Financial Reconstruction (BIFR) for formulation of
revival schemes.
11. A simplified procedure for new projects was introduced to manufacture goods not covered by the compulsory licensing. Even a
substantial expansion of a project needs to submit a memorandum in the prescribed form to the secretariat for industrial
approvals.
12. Decisive contribution was expected from foreign investments including foreign corporate bodies, foreign individuals, and NRIs.
13. Industrial policy for the small-scale sector announced on of August 6, 1991, provided a four-point scheme to provide financial
support to this sector.
New Trade Policy
The Government of India enunciated a new trade policy in support of its liberalisation policy in 1991.
The trade regime was liberalised by streamlining and strengthening the advance licensing system and
decanalising 16 export and 20 import items. A new package of incentives was also provided for 100
per cent export processing zones (EPZs). Some important aspects of the trade policy statement made
by Mr. P. Chidambaram, the then Union Commerce Minister in the Lok Sabha are given as follows:
1. As a whole, promotion of export, moderation of growth of imports, and simplification of procedures are the general objectives
of the 1991 trade policy.
2. Advance licensing system was strengthened. (Provision of substantial manufacturing activity as a basic requirement for advance
licence was dispensed with. Procedures have been streamlined and the number of documents has been reduced.)
3. A “transferrable advance licence” scheme for general area has been introduced in the items like textiles, engineering goods, and
leather goods.

In the new trade policy, a transferable advance licence scheme for general area has been introduced.
4. Exporters are allowed to dispose the materials imported against advance licences by way of replenishment (REP) without prior
approval in cases where no MODVAT (modified value added tax) facility was availed of on the domestic material that was used
in exports.
5. Considerable reduction in licensing and in the number and types of licenses has been outlined.
6. Supplementary licences for import of items in Appendices 3, 4, and 9 of the Import Export Policy (1990–93) have been
abolished.
7. Additional licences issued to export houses and trading firms as an incentive earlier have been abolished with effect from April
1, 1992.
8. Procedure for obtaining bank guarantees and legal undertakings from different categories of exporters has been liberalised.
9. It was decided to appoint a high-level committee to outline modalities for eliminating restrictions and licensing.
10. Sixteen items of exports including castor oil, coal and coke, polyethylene (ID) colour, picture tubes and assemblies of colour
TV containing colour TV picture tubes, khandsari, molasses, sugar, iron, ore-grade bauxite, and exposed cinematographic films,
video tape, and cinema films are reanalysed.
11. Sixteen import items are decanalised and placed under REP for import against exim scrips, and another six import items are
decanalised and put under Open General Licence (OGL).

Six import items are decanalised and put under OGL in India in 1991.
12. Export houses, trading houses, and star trading houses are given leeway to import a wide range of items against additional
licences.
Trade policy is an important arm of the liberalisation policy, since trade among various countries is
the crux of global business. Import restrictions practised in India were required to be removed for
making liberalisation more meaningful. The government, therefore, acted in this direction also. Box
22.3 clearly gives a list of industrial clusters or locations to enhance all the plans of the government.
Removal of Import Restrictions
While encouraging exports, the Government of India made efforts to facilitate and streamline imports
too. Globalisation of business necessitated countries to liberalise their economies to freely import
goods and services from other countries. Numerous developing countries have already come out of
their trade wars, regionalism, and protectionism. Korea, Mexico, Indonesia, Malaysia, Morocco,
Thailand, and Turkey are some examples. East European countries have dramatically opened up their
economies while the republics of the former Soviet Union have already followed suit. Countries like
Argentina, Vietnam, Pakistan, and Peru have initiated the reform process. Capitalist market
economies (though they practice some kind of trade barriers) have provided opportunities for many
countries like Japan and Korea. Obviously, countries like India could not, therefore, remain in their
cocoon of protectionism any more.
Import restrictions were, therefore, partially withdrawn in India in accordance with the global
trends in the New Trade Policy of July 1991. The margin requirement for imports was reduced and
the need for a prior clearance by the RBI waived. These measures, however, did not encourage
imports considerably. Hence, further relaxations were demanded by importers. Imports of capital
goods up to Rs 50 lakh is allowed against free forex as per the RBI import relaxation order of
November 15, 1991. Similarly, if the importer is able to arrange for the supplier ’s credit for 360
days, import of capital goods upto a value of Rs 1 crore will be permissible, according to the new
policy. Import of capital goods of value beyond Rs 1 crore will be permissible if the supplier ’s long-
term credit for two years or more is availed or if the importer is a 100 per cent export-oriented unit
(EOU) or a unit assuming export obligations.

If the importer is able to arrange for the supplier’s credit for 360 days, the import of capital goods up to a value of Rs 1
crore will be permissible according to new trade policy.
The government further decided in January 1992 to do away with licensing on import of capital
goods under the scheme of DFI upto 51 per cent of foreign equity in high-priority areas. When forex
for import of capital goods would be fully covered by foreign equity, import of OGL capital goods,
non-OGL capital goods, and restricted capital goods, would be allowed without a specific licence. A
clearance for this purpose will be issued by the RBI.
In the transparent Export–Import (EXIM) Policy announced by the Government of India in March
1992, the Central government made the trade free from control, barring a small negative list. Import
of capital goods and raw materials were further liberalised. This EXIM policy envisaged limited
number of restrictions and fewer administrative control measures, while a greater freedom of trade
was provided. One notable aspect of this EXIM policy is that consumer goods imports were still
under restrictions. Import of three items (tallow, animal rennet, and ivory) were banned, eight items
canalised, and 68 items restricted. Import facilities were provided for the tourism industry, sports
organisations, and hotels. While conspicuous liberalisation of trade was introduced, the most notable
aspect of this policy was a “five year term” fixed for the new policy, which would help the
liberalisation to be consistent for some time to come. Despite the commendable effort for
liberalisation of imports and exports, consumer goods were kept under control, a move widely
criticised by the exponents of free trade.

In the transparent EXIM announced by the Government of India in March 1992, the Central government made the trade
free from control, barring a small negative list.
There emerged a widespread feeling in the trade circles that the government plans to liberalise the
import of consumer goods too in a course of time. On the eve of the General Agreement on Tariffs
and Trade (GATT, December 16, 1993), concluded in Geneva, the Government of India reduced the
import duties of 17 textile products from 85 per cent to 40 per cent, perhaps, as a token of its intention
to liberalise consumer products also.

The government of India reduced the import duties of 17 textile products from 85 per cent to 40 per cent in 1993.
Budgetary Policy
The Central Budget for 1991–92, which was initiated in the face of deteriorating economic condition
and increasing forex crises, started a moderate process primarily to solve impending problems,
restore the economy on a strong footing, and to initiate a liberalisation process. A spending discipline
was introduced, import duties were reduced, and measures were adopted to achieve structural
changes. On account of a subsidy cut and additional tax proposals, the prices of fertilisers and
consumer products increased. Licensing was scrapped in the industrial policy declared along with the
1991–92 budget, except in 18 items including coal, sugar, petroleum, motor cars, cigarettes,
hazardous chemicals, drugs, pharmaceuticals, and luxury goods. MRTP and FERA liberalisations
were also initiated.
The liberalisation process initiated in the 1991–92 budget continued in the following budgets.
Partial convertibility of the rupee was introduced in place of the exim scrip in the budget of 1992–93,
which acted as an important initiative in liberalisation. Full convertibility on current account, which
was announced in the budget of 1994–95, can be considered as a clear improvement on the partial
convertibility announced on February 29, 1992. While gold bonds were floated, NRIs and Indians
returning from abroad were allowed to import a maximum of 5 kg of gold if the cost of gold and
import duty were paid by forex earnings. Another important measure towards liberalisation in the
1992–93 budget was the abolition of government control over capital issues, while a flat rate of 40
per cent tax was fixed on firms. In fact the budgets of 1992–93 and 1993–94 were investment-oriented
budgets, while the 1994–95 budget aimed at boosting the industrial activities. A new fund for
technology development and application was proposed in the 1994–95 budget, while modernisation
of capital market backed by the establishment of a model National Stock Exchange (NSE) was
proposed. In order to stimulate investment, the minimum lending rate was reduced by 1 per cent.
Full convertibility on current account also facilitated the strategies chalked out by the Indian
government to fulfil the forex requirements. Meanwhile, the forex earners and exporters stood
permitted to retain upto 25 per cent of their forex receipts in the forex accounts in place of the earlier
15 per cent. As a special incentive for the ones that are fully EOUs and units in EPZs, as well as the
electronic hardware and software technology parks, 50 per cent retention was permitted in the 1994–
95 budget. An amendment to the Companies’ Act was also proposed in accordance with the
liberalisation envisaged.
Liberalised Exchange Rate Management System (LERMS)
Another important milestone on the path of liberalisation is the Liberalised Exchange Rate
Management System (LERMS) announced by the RBI on February 29, 1992. The exchange control
regulations were liberalised, and the rupee became convertible for all approved external transactions
with effect from March 1, 1992. Under LERMS, exporters and those who receive remittances from
abroad will be able to sell the bulk of their forex receipts at market-determined rates. Similarly, those
who needed to import goods and services or undertake travel abroad will be able to buy forex at
market-determined rates from the authorised dealers, subject to the transactions being eligible under
the liberalised trade and exchange control regime. However, in respect of certain specified priority
imports and transactions, a provision has been made in the scheme for making available the forex at
the official rate.

LERMS was announced by the RBI on February 29, 1992, and the rupee became convertible for all approved external
transactions.
Under LERMS, exporters and those who receive remittance from abroad will be able to sell the bulk of their forex receipts at
market-determined rates.
According to LERMS, all receipts under current account transactions (merchandise export and
invisible receipts) should be surrendered to authorised dealers, 60 per cent of which will be
exchanged at free market rate and 40 per cent at the RBI’s official rate. In place of partial
convertibility, full convertibility on current account was introduced in the budget of 1994–95, which
came into effect on August 20, 1994. In respect of the travellers proceeding abroad, the entitlement in
currency notes was raised from US$100 to US$500 and later to US$2,000 in August 1994. Exporters
are eligible for forex that is not exceeding 12.5 per cent of the invoice value by way of agency
commission. They are also entitled to settlement of quality claims not exceeding 15 per cent of the
invoice value, and for sundry personal- and commercial remittances not exceeding US$100 for any
purpose. Thus, the liberalisation process has been backed by liberalised forex regulations.
Memorandum to IMF
To tide over the forex problem that arose due to India’s adverse BoP position, repayment of IMF
loan, and to opt for an emergency loan from IMF, India wanted to have a safety net arrangement with
the IMF. IMF wanted the Government of India to reduce its budgetary and fiscal deficit, as well as the
rate of inflation, which may affect the recovery of loans. The reform programme initiated by the
Government of India was, therefore, viewed by the IMF with a great interest, particularly in the
context of India’s request for an immediate Compensatory Contingency Finance Facility (CCFF) of
US$220 mn.
Hence, a memorandum was sent to IMF, with detailed targets for reducing fiscal deficit and
inflation, as well as for raising FER over a period of three years. A reorganisation in the financial
sector was indispensable for this purpose. This required legislative measures to reform the tax and
fiscal reign, lowering of tariff barriers, phasing out of subsidies, and reforming the SEBI.

The objectives of a memorandum to IMF were to reduce fiscal deficit and inflation, as well as to raise FER over a period of
three years.
Box 22.1 Objectives of Industrial Policy, 1991
1. To regulate the economy in a substantial manner,

2. To remove weaknesses or distortions of the earlier policies,
3. To maintain sustained growth in productivity and employment,
4. To encourage the growth of entrepreneurship, and
5. To upgrade technology to match the standards of international competitors.

Although the opposition criticised the measures as a “sellout” to IMF, the measures had almost a
magical effect of tiding over the forex crises faced by India. It helped to ease forex tension and
improve India’s position from an “over drawn” country to an “under drawn” nation. In 1993, India’s
SDR (Special Drawing Right) was under drawn by about half a billion US dollars. India’s image
improved in the global business canvas, and its liberalisation programme began to be viewed as a
positive sign of economic advancement. Globalisation has become reality in India also. IMF has again
acted as the “Lender of the last resort”.
NRI Remittances
As a result of the improvement of India’s position, NRI remittances also improved. Moreover, the
government pinned much hopes on NRIs for forex remittances. Hence, as a part of the liberalisation
process, incentives were offered to the NRIs to improve their forex remittances. NRI forex bank
accounts, convertibility of forex in market rates, forex gift schemes, gold import policy, and so on,
facilitated an inflow of forex through NRIs. NRI investment schemes announced by the government
aimed at increasing the inflow of foreign capital through them.

NRI investment schemes in India like NRI forex bank accounts, convertibility of forex in market rates, forex gift schemes,
gold import policy, etc.
Liberalised NRI investment policy announced by the government on October 28, 1991, also
permitted NRIs and Overseas Corporate Bodies (OCBs) to invest up to 100 per cent foreign equity in
high-priority industries including hotels, tourism-related industry, shipping, hospitals, and so on. The
government assured the NRIs and OCBs full benefits of repatriation of capital invested and income
accrued in such proposals. Imports of capital goods also included foreign equity. NRIs are allowed
special privileges in the foreign investment policy.
Existing schemes like 100 per cent investment by the NRIs in 100 per cent EOUs, and investment
for the revival of sick units still continue. In addition, NRI equity holding up to 100 per cent is
allowed in export-oriented deep-sea fishing industry, oil exploration services, and advanced
diagnostic centres, with full repatriation benefits. Automatic approvals are allowed for NRI and OCB
proposals for investment, provided the foreign equity covers the forex requirements for import of
capital goods. The plant and machinery proposed to be imported must be new and not second-hand.
For the import of such capital goods, no indigenous clearance will be required.

Automatic approvals are allowed for NRI and OCB proposals for investment, provided the foreign equity covers the forex
requirements for import of capital goods. The plant and machinery proposed to be imported must be new and not second-
hand. For the import of such capital goods, no indigenous clearance will be required.
Repatriation based on the dividend payments must be balanced by export earnings over a period of
seven years from the start of commercial production. However, such balancing will not be required
after seven years. The proposed projects must be located beyond an area of 25 kms from the
periphery of the standard urban area limits of a city with a million population. NRI and OCB
investments according to this scheme will be exempted from Sections 26 (7), 28, 29, and 31 of FERA.
In the industries requiring compulsory licensing and certain items reserved for the small-scale sector,
as well as other industries excepting those reserved for public sector, NRIs and OCBs are permitted to
make a 100 per cent equity participation with full repatriation benefits.
NRIs and OCBs are allowed to make investments on items reserved for the small-scale sector,
provided the export obligation condition is satisfied. Similarly, in order to encourage NRIs to make
investments, they are allowed to import capital goods financed by their own resources abroad without
any indigenous clearance, provided they are not covered under Appendix I of Part A of the EXIM
policy, 1990–93. In accordance with the EXIM policy, even second-hand capital goods will be allowed
on a case-by-case basis. The government’s NRI Investment Policy has paid off considerable dividends
since NRI and OCB investments have gone up by unprecedented amounts, thus speeding up the pace
of globalisation.
Encouraging Foreign Tie-ups
Among the various measures adopted by the government to facilitate the liberalisation process,
liberal policies adopted for foreign tie-ups are also worth mentioning. Foreign technical and
financial collaboration agreements are substantially liberalised by the government. Single-window
clearance facility was introduced by the government through the RBI in September 1991 to facititate
collaboration between Indian and foreign companies. Single-window clearance is applicable to
proposals for foreign investment, authorisation for issue of shares under the FERA, 1973, exemption
from the operation of FERA, and confirmation of import of capital goods covered by the foreign
equity.

Single-window clearance is applicable to proposals for foreign investment and authorisation for issue of shares under the
FERA, 1973.
This liberal approach was complementary to the simplified procedures for the new projects, for the
manufacture of articles that are not covered by compulsory licensing launched by the Union Ministry
of Industry in August 1991. The effect was spectacular. The Annual Report of the Ministry of Industry
for the year 1992–93 revealed that as many as 1,520 foreign collaboration agreements were approved
in 1992, more than 32 times the foreign collaboration approvals of 1990 and more than seven times
the foreign investment approvals in 1991. Collaboration also became a common phenomenon in India
with even government projects opting for collaboration with foreign organisations.

This liberal approach was complementary to the simplified procedures for the new projects, for the manufacture of articles
that are not covered by compulsory licensing launched by the Union Ministry of Industry in August 1991.
Take the proposal for setting up the communication highway, the nationwide high-speed datacom
network to transmit voice and data across the country. A combination of satellite communication
facilities, optics, and microwave repeaters to get the trade details transmitted quickly all over the
country, was proposed to be set up. Once the communication highway is established, the
communication set-up will be highly useful for stock-trading settlements of the NSE. The
Stockholding Corporation of India Ltd. can use the system for its depository network, while
infrastructure leasing and financial services and inter-bank associations can also make use of it
extensively.
This telecommunication facility via satellite is proposed to be established as an independent
company—as a joint venture with a foreign collaborator, who can provide an international level of
communication through fail-safe technology. The sponsors of the NSE were appointed the promoters
of the communication highway company. Proposals were also studied for collaboration with AT&T
of the United States, or Australian Telecom (Telestral), or US Vent of Denver (Colorado). It was also
considered to set up an independent, private satellite in collaboration with a foreign company. Thus,
foreign collaboration has become a common phenomenon in India.
In consonance with the liberal norms of tie-ups, the industrial approval procedure was simplified.
The Union Ministry of Industry has introduced simplified procedures for new projects to
manufacture articles, not covered by compulsory licensing. Such new projects or even the substantial
expansion of a project required only a memorandum to be submitted in the prescribed form to the
Secretariat for industrial approvals. This scheme has considerably facilitated and supported India’s
liberalisation process.
Narasimhan Committee Report
In accordance with the liberalisation process, the banking system also had to undergo liberalisation.
The Narasimhan Committee Report must be considered in this context. The report recommended a
reorganisation of the public sector banks, solving the problem of bad debts and freedom of operation
of foreign banks. It also recommended the setting up of a supervisory board to monitor the
functioning of the nationalised banks, while they were given autonomy. Partial privatisation of
financial institutions was also viewed as a necessity. Providing greater freedom for the operation of
foreign banks was an important recommendation to facilitate foreign investment in India.

Narasimhan Committee report recommended a reorganisation of the public sector banks, solving the problem of bad debts
and freedom of operation of foreign banks.
FERA and MRTP Relaxation
As a part of the liberalisation announced in 1991, industrial policy measures were initiated by the
government to liberalise the MRTP and FERA regulations. The most important aspect of the
liberalisation of MRTP regulations is the removal of threshold limits of assets of MRTP companies
and dominant undertakings. At the same time, in order to regulate MRTP companies and to check
restrictive and unfair trade practices, the MRTP Commission is authorised to initiate investigations
suo moto or on complaints received from consumers or classes of people. The MRTP Act was
amended to totally remove the pre-entry restrictions on the establishment of new undertakings and
expansion of the existing firms.

Industrial policy measures in 1991 were initiated by the Government of India to liberalise the MRTP and FERA regulations.
Important changes were also made in FERA, 1973, in order to encourage foreign investments in
India. FERA companies are allowed to have foreign equity holdings upto 51 per cent in high-priority
areas. OCBs and NRIs are allowed even 100 per cent foreign equity in high-priority industries
including hotels, tourism-related industry, shipping, hospitals, and so on, with full benefit of
repatriation in addition to the existing 100 per cent foreign equity on EOUs, and investment for the
revival of sick units. While MRTP amendments were brought in through an ordinance in September
1991, changes in FERA were announced by the RBI in January 1992. (These measures have been
examined in detail elsewhere.)

Important changes were also made in FERA, 1973, in order to encourage foreign investments in India. FERA companies are
allowed to have foreign equity holdings upto 51 per cent in high-priority areas.
FERA companies are granted greater freedom to operate in India, since restrictions on internal
operations have been removed. They are allowed to acquire property, raise fixed deposits internally,
and to have stakes in other companies. Even foreign brands and logos are permitted. It means that
FERA companies are now treated almost at par with Indian companies. It is a great motivation for
foreign corporate giants to operate freely in India. This is a conspicuous milestone in the
liberalisation process that facilitates globalisation in India. (MRTP and FERA too are examined in
detail elsewhere.)
Decontrol of Steel
Steel decontrol can also be considered a measure on the part of the government in the liberalisation
package. Price control on steel imposed in India, in the past, has been removed while distribution
control in favour of the priority sector, small-scale industries, and exports stands retained. The
removal of price control may affect the prices in a competitive market. But the immediate price
increase was checked by the government, by asking the integrated steel plants in India not to raise the
price till the budget of 1992–93. Freight charges were also not immediately affected. The Steel
Authority of India (SAIL), a public sector giant and one of the most important players in the steel
market of India, was asked by the Prime Minister not to increase prices even after the budget so as to
retain the price level despite the decontrol.

Steel decontrol can also be considered a measure on the part of the government in the liberalisation package.
Redefining SEBI’S Role
By an ordinance, SEBI was given legal powers but not autonomy. The Union Finance Ministry and the
Department of Company Affairs play a more prominent role now. On account of the huge security
scandal, stock exchanges in the country suffered a great setback. The index rose only 700 points
during the year 1993, though there was a large inflow of foreign capital to the tune of US$750 mn.
SEBI, therefore, introduced certain regulatory measures as follows:
1. Capital adequacy norms for brokers.

2. In the benami share scandal unearthed by the Income Tax Department, SEBI supported the brokers.
3. Huge reforms package in the primary market. SEBI allowed merchant-banking fees to be negotiated, issued a code of conduct,
and announced a set of penalty points against erring merchant bankers. It also freed issue prices.
4. It forced more transparency on the part of promoters.
5. Forward trading was banned.
6. A system of limited carry-forward transactions.
7. It called for a greater degree of diligence, competence, and responsibility on the part of lead managers and underwriters. It
insisted that failure to meet underwriting or sub-underwriting liability should invite penal provisions by the regulatory body.
(Contractual obligations for financial liability between issuers and underwriters should be legally settled.)
8. Unit Trust of India (UTI) was brought under the regulatory supervision of SEBI.

UTI was brought under the SEBI in 1993.
SEBI introduced regulatory measures like capital adequacy norms for brokers, and forward trading was banned.
In spite of all such measures, it is still felt that SEBI is not very effective.
Privatisation of Public Sector
As a part of the liberalisation process, the government had to review the role of the public sector and
the government’s investment in it, particularly in the context of exorbitant losses accumulated by
many of the PSUs. It was observed that 54 PSUs had accumulated a loss of Rs 8,494.04 crore as on
March 31, 1991. These chronically sick PSUs were asked to approach the BIFR for a review. It was in
this context that the Planning Commission had called for a re-examination and reorientation of the
government’s role in the public sector. The paper on “Financial Dimensions and Macro Para-meters
of the Eighth Plan” (1992–97) suggested that the role of the public sector should be very selective.

As a part of the liberalisation process, the government had to review the role of the public sector and the government’s
investment in it, particularly in the context of exorbitant losses accumulated by many of the PSUs.
Simplification of Industrial Licensing
In pursuance of the liberalisation process initiated by the Government of India, liberalisation was
announced in industrial licensing vide the industrial policy tabled in both the houses of Parliament on
July 24, 1991. Various types of industrial approvals have been substantially liberalised, and a
Notification to this effect (Notification No. 477 [E] of July 25, 1991) was issued by the Department of
Industrial Development under the Industries (Development and Regulation) Act, 1951.

In pursuance of the liberalisation process initiated by the Government of India, liberalisation was announced in industrial
licensing vide the industrial policy tabled in both the houses of Parliament on July 24, 1991.
Industrial licensing was done away with, except in respect of 18 items. It was mentioned in the
Notification that “industrial undertakings have been exempted from the operation of Section 10, 11,
11A, and 13 of the I (D&R) Act, 1951, subject to fulfillment of certain conditions”. Section 10 refers
to the requirement of registration of the existing industrial units. Section 11 refers to the requirement
of licensing new industrial undertakings. Section 11A deals with licences for the production of new
articles. Section 13 refers, inter alia, to the requirement of licensing for effecting a substantial
expansion.
Banking and Financial Sector Reforms
In order to facilitate liberalisation and to establish a positive rapport with the World Bank in the
context of the grave forex crises, banking and financial sector reforms were also initiated.
Regulations in India’s financial sector and directions to banks for greater financial discipline were
issued. Private sector banks including foreign banks were encouraged to operate in India. Permission
was also granted by RBI to set up new private banks, and foreign financial institutions were allowed
to acquire up to 20 per cent stake in the equity of private sector banks while NRIs were permitted up to
40 per cent stake. Certain principles and policy parameters were communicated by the World Bank to
guide the decisions on the Financial Sector Adjustment Loan (FSAL). The World Bank also expected
an action on the part of the government on the recommendations of the Narasimhan Committee and
Malhotra Committee about liberalisation of the financial sector before the completion of the Uruguay
Round of GATT negotiations.

India allowed private banks and foreign financial institutions to acquire up to 20 per cent stake in the private sector and
NRIs up to 40 per cent.
Restructuring of the bank management systems, giving greater operational autonomy to the
nationalised and private banks, including foreign banks and financial institutions, is in consonance
with the interests of the World Bank. A market-based interest-rate regime and a reduction of rate
would also be appreciated by the World Bank. The statutory liquidity ratio (SLR) and cash reserve
ratio (CRR) were also expected to be reduced, while greater autonomy was to be given to nationalised
banks. Stringent action would also be taken against the chronically loss-making nationalised banks.
The RBI also initiated steps to reduce lending by sick banks, and to set up an asset reconstruction fund
for the weakest banks. Thus, the liberalisation process initiated by the Government of India has been
supported by manifold measures to speed up the globalisation of business in the country.
REFORM ACHIEVEMENTS
It is said that every crisis situation provides us with an equally challenging opportunity. The decision
to grab the opportunity offered by the BoP crisis in 1991 immediately began to yield results, as
certain fundamental changes in the approach to the strategy for economic development were made.
The foreign sector was specifically targeted by the early reforms and the forex policies were
gradually liberalised; the foreign trade was encouraged by introducing a series of reforms; the
customs duty regime was rationalised to match the global scenario; the industrial policy was
revamped; and the PSUs were specifically chosen to vanguard the process of industrial sector
reforms. When we take stock of the achievement of the economy over the past few years, it appears
that the achievements in terms of growth of the GDP are not to the extent expected. The following
facts and figures refer to the performance of the economy and achievements of reform.

Box 22.2 Broad Banding
Broad banding refers to an increase in the number of items that a licensed industry can produce
within the licensed range of products. This facility is provided by specifying a broad or a generic
product group rather than specific products within a general category.
An industrial licence for the manufacture of motorcycles, when broad banded as two-wheelers,
would include scooters and mopeds as well.

GDP Growth Trend
In 1991, the country was told that the process of liberalisation would help India achieve higher growth
targets. Table 22.1 shows no significant improvement in the 1990s over the 1980s. This is true for the
economy as a whole and for major sectors as well. Table 22.2 details on the annual average growth
rate of industrial production. In sharp contrast to this, the Indian policy structure has been altered
drastically. The growth rates in various crops in the post-reform period have been slowing down as
against the pre-reform period. The growth rate of the index of agricultural production in the post-
reform period is just half of what it was in the pre-reform period.
The share of public sector investment in agriculture has been falling in the post-reform period.
“This has happened mainly because a large proportion of public expenditure has been going into
current expenditure in the form of increased level of subsidy for food, irrigation, fertilizer,
electricity, credit, and other inputs rather than creation of assets”. The annual growth rates of
production of various development programmes in the post-reform period slowed down in
comparison to the pre-reform period. Table 22.3 gives a clear picture to support the fact.

Table 22.1 Annual Average Growth Rate of Industrial Production
Sector 1981–82 to 1990–91 1993–94 to 2001–02

General index 78 6.6
a. Manufacturing 7.6 7.0
b. Electricity 9.0 6.0
c. Mining and quarrying 8.3 3.5
Source: Handbook of Statistics on Indian Economy, 2002–03, RBI.

Table 22.2 Annual Average Growth Rate of Industrial Production—USE-based Classification
Sector 1981–82 to 1990–91 1993–94 to 2001–02

a. Basic goods 7.0 5.4
b. Capital goods 11.5 6.1
c. Intermediate goods 5.9 7.6
d. Consumer goods 6.7 7.3
i. Durables 13.9 12.4
ii. Non-durables 5.5 5.8
General index 7.8 6.6
Source: Handbook of Statistics on Indian Economy, 2002–03, RBI.

Table 22.3 GDP Growth (at Factor Cost) at 1993–94 Prices
Year GDP Growth Rate
1981–82 6.2
1990–91 5.2
1991–92 1.5
1992–93 4.5
1993–94 6.0
1994–95 7.0
1995–96 7.3
1996–97 7.5
1997–98 4.8
1998–99 6.5
1999–2000 6.1
2000–01 4.4
2001–02 (Quick) 5.6
2002–03 4.3
(Revised advance)
Annual Average GDP Growth Rate
1980–81 to 1990–91 5.6
1990–91 to 2000–01 5.6
Source: Handbook of Statistics on Indian Economy, 2000, RBI, and National Accounts Statistics, 2003.

Declining Savings and Investment
Investment (Gross Capital Formation [GCF]) and savings as a percentage of GDP declined or were
stagnant as reflected in Table 22.4.
Taxes and Subsidies—Reduced Role of State
While under SAP (Structural Adjustment Programme), developing countries are being advised to
reduce subsidies and the role of government in the economy, more than half of the total expenditure
of the developed countries goes towards subsides. In the case of United Kingdom, the share increased
from 52 per cent to 58 per cent. On the other hand, during the same period, India reduced its subsidies
from 43 per cent to 40 per cent. (See Table 22.5.)
Poverty and Inequality
According to the Planning Commission of India, the incidence of poverty climbed down from 30.51
per cent in 1993–94 to 26.1 per cent in 1999–2000, a fall of 4.41 percentage points in a six-year
period. It cannot be looked upon as a great success of reforms because the decline of percentage point
in poverty incidence from 36.20 per cent in 1987–88 to 30.51 per cent in 1993–94, exactly a six-year
period, was 5.69. The total number of people below poverty line remained almost the same in 1999–
2000 as it was in 1993–94.

The total number of people below poverty line remained almost the same in 1999–2000 as it was in 1993–94.

Table 22.4 Saving and Investment Rates
Gross Domestic Saving s (as % of

Year Gross Domestic Capital Formation (as % of GDP)
GDP)
1990–91 23.1 26.3
1991–92 22.0 22.5
1993–94 22.5 23.1
1995–96 25.1 26.8
1996–97 23.2 24.5
1997–98 21.5 25.0
1998–99 22.0 23.0
1999–2000 22.3 23.3
2000–01 22.4 23.4
2001–02 23.1 24.2
2002–03 23.5 24.7
Source: Economic Survey, 2002–03, Government of India.

Contrary to the statistical jugglery by the Planning Commission, the estimates of National Sample
Survey Organisation (NSSO) show that the incidence of rural poverty increased from 37.27 per cent
in 1993–94 to 42.25 per cent in 1998, and that of urban poverty increased from 32.36 per cent to 34.58
per cent, in the same period. According to Tendulkar and Sen, the incidence of rural poverty
increased from 39.7 per cent in 1993–94 to 44.9 per cent in 1998, and that of urban poverty went up
from 30.9 per cent in 1993–94 to 31 per cent in 1997–98. Keeping in view the decline in employment
growth rate in the economy, in general and that in agriculture and allied activities and rural
employment, in particular, the NSSO estimates seem more near reality.

The rural poverty in India increased from 39.7 per cent in 1993–94 to 44.9 per cent in 1998, whereas the urban poverty
increased from 30.9 per cent to 31.0 per cent in 1997–98.
The incidence of non-income poverty (deprivations other than the fulfilment of the basic
necessities of life—minimum of food, clothing, shelter, and water—such as in relation to health,
education, sanitation, insurance against mishaps, etc.), if taken into account, perhaps, would be much
higher in India. Argentina and Mexico also experienced a higher incidence of poverty after the
reforms.

Box 22.3 Industrial Clusters
The Government of India initially identified 19 industrial clusters/locations under the Industrial
Infrastructure Upgradation Scheme of the Department of Industrial Policy and Promotions, to
enhance the competition of domestic industries by providing quality infrastructure.
The list of industrial clusters is as follows:

1. Auto components cluster: Vijaywada, AP
2. Pharmaceutical cluster: Hyderabad, AP
3. Chemical cluster: Vapi, Gujarat
4. Auto components cluster: Pune, Maharashtra
5. Gems and jewellery cluster: Surat, Gujarat
6. Steel and metallurgy cluster: Jaipur, Rajasthan
7. Textile cluster: Ludhiana, Punjab
8. Wool and woollen garments cluster: Amritsar, Punjab
9. Store cluster: Kishangarh, Rajasthan
10. Textiles cluster: Tirupur, Tamil Nadu.
11. Pump, motor and foundry cluster: Coimbatore, Tamil Nadu
12. Ceramic pottery cluster: Khurja, Uttar Pradesh
13. Glass cluster: Ferozabad, Uttar Pradesh
14. Food-processing cluster: Arunachal Pradesh
15. Food-processing cluster: Guwahati, Assam
16. Textile cluster: Panipat, Haryana
17. Wood-based cluster: Srinagar, Jammu & Kashmir
18. Pharma/auto cluster: Pritampura, Madhya Pradesh
19. Engineering cluster: Kolkata, West Bengal

Table 22.5 Share of Subsidies and Other Transfer in Total Current Expenditure
(Percentag es)
Country 1990 1997
United States 50 60
United Kingdom 52 58
Australia 56 61
Belgium 56 60
France 63 65
India 43 40
Source: World Development Report, 2000–01, World Bank.

The phenomenal increase in the wheat and rice stock in India, from 13.2 mn tonnes in January 1993
to 45 million tonnes in January 2001 is another crude indicator of the rising incidence of poverty. The
inequality has also increased during the reform period as is clear from the Gini index distribution of
consumption, which rose from 33.8 in 1992 to 37.8 in 1997. The consumption of the lowest 20 per
cent population declined from 8.5 per cent in 1992 to 8.1 per cent in 1997. On the contrary,
consumption of the highest 20 per cent population increased from 42.6 per cent in 1992 to 46.1 per
cent in 1997.
Employment Concerns
The crux of any development strategy lies in the number and nature of jobs created each year. The
Indian population has grown from 84.63 crore in 1991 to 102.70 crore in 2001, with an increase of
21.34 per cent. The growth rate in employment has not only been slow, but had actually started turning
negative in the recent years. Point to point, the increase in employment during the nine years, viz.,
1989–90 and 1998–99 was only 6.68 per cent. The corresponding increase in the registered job
seekers was 22.56 per cent. The estimated number of employed in the organised, private and public
sector and persons on the live registers of employment exchanges are given in Table 22.6.

Table 22.6 Estimates of Employment in Organised Private and Public Sectors, and Persons on Live Registers of Employment
Exchanges
(Fig ures in Lakh)

At the End of March Persons Employed Reg istered Job Seekers
1990 263.53 328
1991 267.53 346
1992 270.56 366
1993 271.77 363
1994 273.75 360
1995 275.25 365
1996 279.41 369
1997 282.45 376
1998 281.66 392
1999 281.13 402
2000 281.06 406
2001 280.90 409
2002 280.50 412
2003 280.40 415

Table 22.7 Pre- and Post-reform Employment Position in India
Source: Economic Census, 1980, 1990, and 1998, CSO as given by G.E. Chadha (2001), Govrnment of India.

Table 22.8 Pre- and Post-reform Employment Position in India
(Percentag es)
Activities 1981–82 1 to 1991–92 1993–94 to 1999–2000 2

General index 7.8 6.6
(a) Manufacturing 7.6 7.0
(b) Electricity 9.0 6.0
(c) Mining and quarrying 8.3 3.5
Source: Report on Currency and Finance, 1998–99, Handbook of Statistics on Indian Economy, 2000, RBI.
Notes:
1 With 1981–82 as base.
2 With 1993–94 as base.

The comparison of employment situation between the pre-reform decade and the post-reform
decade depicts a dismal picture. It is clear from Table 22.7 that the annual compound growth rate of
urban employment in the Indian economy dwindled from 2.99 per cent during 1980–90 to –1.27 per
cent during 1990–98. The annual compound growth rate of rural employment decreased from 3.13
per cent during 1980–90 to –1.58 per cent during 1990–98. The growth rates of employment in rural-
allied agricultural activities during the corresponding periods were 1.80 per cent and 5.62 per cent,
whereas in the non-agricultural activities the corres-ponding growth rates were –2.15 per cent and
2.81 per cent, respectively. The annual compound growth rates of urban employment were 2.88 per
cent and –1.01 per cent, respectively. The employment growth rates in urban-allied agricultural
activities during the corresponding periods were 2.93 per cent and 3.15 per cent; whereas in the non-
agricultural activities, 2.88 per cent and –1.08 per cent, respectively. The employment in the rural and
urban areas grew at 2.03 per cent and 3.99 per cent between 1987–88 and 1993–94, whereas the
corresponding growth rates between 1993–94 and 1990–2000 were 0.67 per cent and 1.34 per cent,
respectively.

The annual compound growth rate of urban employment in India was 2.99 per cent in 1990 which declined to 1.27 per cent
in 1998.
INDUSTRIAL GROWTH
Delicensing to Free Industry from Licence and Permit Raj
Despite all this, the rate of growth of industrial production during the period from 1981–82 to 1990–
91 was higher than that in the post-reform period from 1993–94 to 1999–2000. Table 22.8 gives a
clear picture of the same. For saleable steel and cement, the growth rates in the post-reform period
were higher than in the pre-reform period. In the case of petroleum refinery products, the situation
has improved only in 1999–2000, but for the period from 1993–94 to 1998–99, the growth rate was
only 3.9 per cent. In the case of coal, electricity, and petroleum, the growth rates in the post-reform
period did not fare well, due to being lower than those of the pre-reform period.
Deteriorating Balance of Trade
The balance of trade (imports less exports) was expected to improve with decontrol of imports of raw
material, machinery, and equipment besides offering a healthy global competition to force the Indian
industry to adopt modernisation and achieve a higher productivity. With an improvement in the health
of Indian industry, the SAP of liberalisation was meant to help India to achieve a higher growth in its
exports. The facts are revealed in Table 22.9.
Declining Rupee Value
Adoption of SAP would, it was asserted, stabilise Indian currency after two initial devaluations. A
dollar could be bought for less than Rs 20 at the end of 1990–91. In April 2001, a US$ was worth
nearly Rs 47, and currently, it is Rs 48. The value of Indian currency had been consistently falling
during 1995–01. See Table 22.10.
Mounting External Debt and Liabilities
In spite of relying on non-debt creating, and capital flows like FDI and portfolio capital, India’s
external debt went up from Rs 163,001 crore at the end of 1990–91 to Rs 429,271 crore by March
2000, an increase of Rs 266,270 crore. Refer Table 22.11 for vivid details. Even this rise does not
fully reflect the reality because the total external liabilities shot up phenomenally. For instance, the
latest available data indicate that India’s foreign liabilities rose by Rs 244,546 crore within six years
of liberalisation, that is, between March 1991 and March 1997. Out of this, as much as Rs 191,561
crore, or about two-thirds, was on account of the private sector.
Disastrous Consequences of the Entry of MNCs
It was argued that FDI was needed to build industrial infrastructure and achieve higher manufacturing
capabilities. For enabling this to happen, FERA was revised and in all aspects, FERA has no validity
any longer. Foreign investors are welcome irrespective of the economic activity proposed to be
undertaken. It could be trade or non-priority production; no insistence on having a local partner or
any expectation of locating industry in a backward state; nor any conditions like export obligation or
net contribution to India’s forex. The invesment proposals are cleared for the asking. The result can
be seen in Table 22.12. In practice, a significant part of the FDI inflows were directed at consumer
items. Very little has gone into infrastructure development. There is a wide gap between the reported
approvals and the actual inflows. While the amount of FDI approved since the opening up of the
economy is Rs 246,800 crore, the actual inflow is reported to be Rs 89,000 crore, or a little over the
one-third of the approvals, as can be seen from Table 22.13.

Table 22.9 India’s Exports, Imports, and Trade Balance
Source: BoP statistics.

Table 22.10 Declining Value of Rupee During the Post-liberalisation Period
Year Rs per US$
1990–91 19.64
1991–92 31.23
1992–93 31.23
1993–94 31.37
1994–95 31.50
1995–96 34.35
1996–97 35.92
1997–98 39.50
1998–99 42.44
1999–2000 43.61
April 30, 2001 46.86
Source: Handbook of Statistics on Indian Economy, RBI.

Table 22.11 India’s External Debt and Sector-wide Break-up of Foreign Liabilities
Amount in Rs crore
End March External Debt
1991 163,001
1992 252,910
1993 280,746
1994 290,418
1995 311,685
1996 320,728
1997 335,827
1998 369,682
1999 414,595
2000 429,271
Source: Census of India’s Foreign Liabilities and Assets, various studies, RBI.

Volatile Portfolio Investments and Stock Market
A substantial portion of foreign capital flows since 1992–93 have been in the form of portfolio
capital. The portfolio investment on the stock markets is like “hot money” and can flow out quickly in
the time of a crisis. Portfolio investments have acquired a stranglehold over the Indian stock markets
and can move the market at will. The consequent high volatility is inimical to the healthy development
of the stock market.

Table 22.12 Sectoral Distribution of Approved FDI
(Aug ust 1991-December 2000)

Sector Amount (Rs crore) % to Total
Fuels 69,218.88 28.06
Telecommunications 45,884.50 18.60
Electrical equipment 24,579.15 9.96
Transportation industry 18,446.76 7.48
Service sector 15,238.90 6.18
Metallurgic industries 14,379.68 5.83
Chemicals other than fertilisers 21,301.62 4.99
Food processing 899.72 3.65
Others 37,653.32 15.25
Total 246,702.53 100.00

Table 22.13 FDI: Actual Flows vs. Approvals
Source: Handbook of Statistics on Indian Economy, 2000, and RBI Bulletin, November 2001, Compiled and Computed from RBI.

The Indian stock market due to the influence of foreign institutional investors (FIIs), undermined
the importance of the manufacturing sector. Within the manufacturing sector, the basic and
intermediate goods suffered severely while consumer goods companies—FII favourites—fared far
better. The stock market has been placing a heavy premium on certain sectors. Consequently, the
manufacturing sector has not been able to attract investment directly from the investors (See Table
22.14). These trends were initiated by FIIs and were accentuated by local manipulators and large
investors.

Table 22.14 Share Price Indices Base on USE-based Classification
Industry Categ ory Share Price Index at the End of 1991 1
Basic goods 36.31
Intermediate goods 43.58
Capital goods 77.40
Consumer non-durables 124.50
Consumer durables 142.90
Source: SEBI Bulletin, March 2001. Notes:

1 Base: Average of the market capitalisation during the first three fortnightly observations.

Increasing Concentration of Economic and Political Power
With the restrictive provisions of FERA out of the way, many Indian large houses and MNCs were
growing—Hindustan Lever and Reliance Industries were among the fastest to grow. The total income
of Hindustan Lever increased from about Rs 1,800 crore in 1991 to Rs 11,400 crore by 1999. The
total income of Reliance Industries during 1991–92 was Rs 2,954 crore which increased to Rs 21,562
crore by 1999–2000. A similar increase occurred in their assets too. (See Table 22.15.)
Global Liberalisation
It was fortunate for India that immediately after the process of reforms was adopted as a national
economic policy, the World Trade Organisation (WTO) agreement was signed. One of the positive
outcomes of the WTO meets has been the solidarity of the developing world. For three consecutive
ministerial meets, from Seattle to Cancun, the developing countries, led by India, exhibited an
extraordinary unity of purpose; and made it amply clear to the developed world that more than 100
developing nations cannot be taken for granted by the minority of the developed West. In an
institutional framework of the WTO, where every country has one vote, the developing counties have
to be heard and their concerns have to be addressed too.

In an institutional framework of the WTO, where every country has one vote, the developing counties have to be heard and
their concerns have to be addressed too.
The main beneficiaries of WTO so far, have been the countries from the North American
continent, the European Union countries, the countries from ASEAN, and APEC countries. All these
counties are also the members of some regional trade groups. Many countries like the United States,
Canada, Mexico, Indonesia, and Vietnam are members of more than one regional trade groupings.
The gains for India have not been on the expected lines, although in 2004–05 the growth of foreign
trade in the country was expected to be more than 20 per cent.
The formal adoption of the framework for future negotiations, adopted by the General Council of
the WTO on July 31, 2004, is a welcome step and may help India in getting the much-awaited benefits.
Prepared with a “give and take” attitude, this is a welcome step, as a deadlock would have affected the
developing countries more. With the hope of a reduction in the export and agricultural subsidies, and
delinking of the social issues for the time being, the biggest trading block of the world may begin to
make a headway. With a view to safeguard the interests of the developing countries, it was agreed to
allow the member countries to take special care of the vulnerable group of the producers in the
agriculture sector, through a “special safeguard mechanism”. For India, the products that need
protection under this mechanism are rice, dairy products, tea, coffee, oilseeds, and horticulture
products like mushrooms, peas, and so on.

The formal adoption of the framework for future negotiations, adopted by the General Council of the WTO on July 31,
2004, is a welcome step and may help India in getting the much-awaited benefits.
It has also been agreed to commence negotiations on trade facilitation, which is one of the
“Singapore Issues”. Such an arrangement would help India to reduce its transaction cost. The
remaining three “Singapore Issues” were dropped from the agenda of the meet. This has been a major
victory for the developing countries, as the trade facilitation negotiations would do no harm to the
interest of the developing world. Hence, this agreed framework for future negotiations might help the
developing countries, including India, in gaining from the WTO agreement. But the actual gain or
loss would be known only after the negotiations on the framework take place and conclude to the
advantage of the Third World.

Table 22.15 Growth in Assets and Income of Hindustan Lever and Reliance Industries During the Post-liberalisation Period
Source: SEBI Bulletin, March 2001.

Note:
Figures in brackets are % increases in 1999–2000 over 1991–92.

Table 22.16 Macro-economic Indicators at a Glance (%)
Source: Economic and Political Weekly, May 10, 2008.
Notes:
AE: Advance estimates; NA: Not applicable.
1 Adjusted for the mergers and conversions in the banking system. Variation for 2005–06 is taken over April 2005.
2 Average for the growth rates of various indicators for 1950s is the average of nine years, that is, from 1951–52 to 1959–60.
3 Average of the period from 1952–53 to 1959–60.
4 As on January 18, 2008 (year-on-year).
5 As on January 26, 2008 (year-on-year).
FUTURE EXPECTATIONS
The process of economic reforms is irreversible, a fact that has been reassured by the economic
policies of the present UPA (United Progressive Alliance) government, being supported by the Left
parties too. The UPA government has given a new dimension to the process of reforms, by giving the
much required impetus to the primary sector. The Union Budget of 2004–05, was full of measures to
boost the rural and agricultural sectors and if this newly prioritised area continues to be the favourite
of the policymakers, things would change for the better for the vast majority living in the rural areas
and subsisting on the primary sector. If the primary sector is able to grow by around 5 per cent
annually, the overall rate of growth of the economy could remain well above 8 per cent in the long
run. Hence, the priorities are right and along with the services and industrial sectors, if reforms are
also extended to the rural and agricultural sectors, the growth rate of the economy is going to be very
high.

The process of economic reforms is irreversible, a fact that has been reassured by the economic policies of the present UPA
(United Progressive Alliance) government, being supported by the Left parties too.
Information Technology (IT) and the related sub-sectors hold a lot of promise for the Indian
economy in the years to come. India is already known for its software competence in the world and
has emerged as an important hub for software development. India has one of the largest trained
workforce in this field and has a comparative advantage over most of the developing countries in this
regard. In addition to the above, the country has also emerged as an important BPO centre, with a
large number of call centres coming on the scene. With the re-election where Barack Obama is the
President of the United States, this subsector ’s growth is really a question.
Biotechnology is yet another area which must be tapped by the policymakers for the rapid growth
of the country. There is a large trained workforce available in this field also, and with the
introduction of specialised studies in areas like bio-informatics in the recent years, this sub-sector
holds the key to rapid development of the services sector in future. Foreign trade is rightly called the
“engine of growth”. During 2004–05, as per the trends available, the growth of the foreign trade was
projected at over 20 per cent. Despite having subdued monsoons and unduly high, global petroleum
prices, the overall growth rate of the GDP was expected to be around 7 per cent due the buoyancy
provided by the external sector. However, the policymakers would have to pay more attention to
ensure a sustainable growth of the external sector, with a view to get a positive effect on the GDP
growth rate.

During 2004–05 as per the trends available, the growth of foreign trade was projected at over 20 per cent in India.
The policies to tap the foreign sector have to be consistent with the milestones fixed by the WTO
agreement. FDI flows to the country are already increasing and must be encouraged by supplementing
the policies. For this, the government has to prioritise the infrastructure sector very high on its list.
With July 31, 2004, the WTO agreement ice has been broken and the stage is set for increasing trade.
India has waited for almost 10 years to reap the harvest of high rate of growth. The policymakers
must not relent at this last hurdle but must try to ensure that the efforts of the last one decade at the
WTO begin to yield results during the year 2005 itself. The country must continue to live up to the
reputation of being one the fastest-growing economies, and such a reputation has to be matched with
performance.

The formal adoption of the framework for future negotiation, adopted by the General Council of the WTO on July 31, 2004,
may help India in getting the much-awaited benefits.
LIBERALISATION—AN ASSESSMENT
The overall post-liberalisation growth of Indian economy has not been inspiring. India lifted its
growth rate during the 1990s but is still underperforming. India will not be able to achieve the
average annual growth of 9 per cent targeted for this decade, unless radical reforms are carried out.
The liberalisation process in the country has not been able to take off in the real sense because the
instrument of change, that is, the bureaucracy has not been reformed. In the reform process, the role
of bureaucracy should have been that of a facilitator. The entire bureaucratic administrative set-up at
the Centre and the states needs to be looked into and redesigned to be in consonance with the
liberalisation philosophy.

The liberalisation process in India has not been able to take off in the real sense because the instrument of change, that is
the bureaucracy has not been reformed.
The reforms would ensure that specialised departments like finance, health, science, and
technology are headed by persons of sound knowledge in their fields. Most jobs today require
professionalism and specialisation. The formulation of policies in areas like insurance, banking,
foreign trade, and telecom, require an in-depth understanding of the subject. In the United States,
specialists like lawyers, economists, and financial experts provide the necessary expertise and also the
latest inputs to the government so that it would be able to formulate the best possible policy.
If the Indian industry is going to be competitive in price, cost, and quality, it must provide a level-
playing field in technology transfers, infrastructure, interest on finance, labour reforms, government
regulations, custom tariffs on imports, taxes of Central and state governments, and so on. The
reforms would invariably involve a restructuring of the administrative set-up, which would ensure an
optimal utilisation of resources for the benefit of citizens. The administration needs to play the role
of a facilitator by providing infrastructure and ensuring that the basic minimum needs of the citizens
expected from the government are fulfilled within the available resources.
The bureaucracy should be made to face competition. If it does not alter its ways, then sooner or
later, the forces of change generated by the economic reforms would do so. The review of the past
policies followed during the first 40 years of planning reveals that there was no alternative to the
present policy of economic reforms. The very purpose of the liberalisation was to remove
unnecessary controls and regulations, liberating the trade and industry from unwanted restrictions,
and to make various sectors of the Indian economy competitive on the global economic platform by
making them produce quality goods in a cost-effective manner.
Liberalisation does not mean simply inviting a good number of foreign companies or MNCs on
whatever terms with whatever objectives in mind and in whatever sector, indiscriminately. By
implication, economic liberalisation suggests that the entire opening up of the economy should
ultimately be for building up the strength of our own. Hence, inviting foreign companies should be a
means and not the end. Liberalisation means removal of controls, and not of regulations.
Liberalisation does not imply any secret deals; on the contrary, it does mean the elements of
transparency and accountability in the functioning and procedures relating to the economy.

Liberalisation does not mean simply inviting a good number of foreign companies or MNCs on whatever terms with
whatever objectives in mind and in whatever sector, indiscriminately.
Privatisations in India have given rise to controversy and criticism. The sale proceeds of public
undertakings are being utilised for meeting the operating expenses or curtailing the budgetary deficit,
instead of creating health and education facilities for the general public and development of
infrastructure for trade and industry. Further, the government is not making any effort to privatise the
loss-making PSUs. Instead, it is privatising the profit-making public enterprises that are beneficial for
the welfare of general public, for example, Balco. Privatisation of loss-making units would definitely
reduce the financial burden on the government. The top 10 loss-making public sector enterprises
(PSEs) are RINL, HFC, FCI, DTC, IA, HEC, IDPL, HSL, HPC, and HSCL. The government should let
the management of the profit-making PSE function autonomously for improving their performance.
In 1992–93, the top 10 profit leaders of PSEs were IOC, NTPC, ONGC, MTNL, SAIL, BPCL, NSML,
HPCL, MMTC, and BHEL.

Privatisations in India have given rise to controversy and criticism. The sale proceeds of public undertakings are being
utilised for meeting the operating expenses or curtailing the budgetary deficit, instead of creating health and education
facilities for the general public and development of infrastructure for trade and industry.
The current comfortable FER primarily reflect short-term capital flow from the FIIs, which can
vanish as easily as they appeared. These are not money flow; their sudden departure to greener
pastures has wrecked havoc on many Third-World economies. Non-economic developments, political
instability, and communal frenzy together contributed to slowing down the pace of economic growth.
The government should tackle the situation firmly, for which it requires political will.

Non-economic developments, political instability, and communal frenzy together contributed to slowing down the pace of
economic growth. The government should tackle the situation firmly, for which it requires political will.
In substance what has been achieved so far is impressive, but is not very encouraging. India has lost
its status as the 10th largest industrial power in the world in the course of last two decades or more.
India’s share in the global exports is just 0.7 per cent. India cannot attain growth in exports while
continuing with stringent controls and licensing of imports in the name of providing protection to
domestic industries and thereby, betting these domestic industries lose their competitive character.
Thus, under the present circumstances, there is no reverse to economic reforms; whatever be the
policy reforms and restructuring programmes, if they are to be adopted in the Indian economy, they
must have the adaptability to Indian soil. They must also serve the interest of the general masses. The
government should take a firm stand on and review the WTO restrictions pertaining to agriculture,
small-scale sector, investment, and trade-related intellectual property rights.

The government should take a firm stand on and review the WTO restrictions pertaining to agriculture, small-scale sector,
investment, and trade-related intellectual property rights.
LIBERALISATION AND GROWTH OF INDIAN ECONOMY
In analysing the growth record of the Indian economy, various scholarly attempts have been made to
identify the turning point from the “traditional” low growth to the “modern” high growth since the
1980s. The simple ordering of the data presented in Table 22.16 provides a somewhat different
picture of the continued slow acceleration in growth except for the decade of the 1970s. What or Who
can explain this continued acceleration? The secular uptrend in domestic growth is clearly associated
with the consistent trends of increasing domestic savings and investment over the decades.
Gross domestic savings (GDS) have increased continuously from an average of 9.6 per cent of
gross domestic product (GDP) during the 1950s to almost 35 per cent of GDP at present; over the
same period, the domestic investment rate has also increased continuously from 10.8 per cent in the
1950s to close to 36 per cent by 2006–07. A very significant feature of these trends in savings and
investment rates is that the Indian economic growth has been financed predominantly by domestic
savings. The recourse to foreign savings—equivalently, current account deficit (CAD)— has been
rather modest in the Indian growth process. We may also note that the two decades, 1960s and 1980s,
when the CAD increased marginally towards 2 per cent of GDP, were followed by a significant BoP
and economic crises.

A very significant feature of these trends in savings and investment rates is that the Indian economic growth has been
financed predominantly by domestic savings.
The long-term upward trends in savings and investment have, however, been interspersed with
phases of stagnation. In particular, during the 1980s, the inability of the government revenues to keep
pace with the growing expenditure resulted in the widening of the overall resource gap. Accordingly,
the public sector savings–investment gap, which averaged 3.7 per cent of GDP during the period from
1950–51 to 1979–80, widened sharply during the 1980s, culminating in a high level of 8.2 per cent of
GDP in 1990–91. The resultant, that is, the higher borrowing requirements of the public sector led the
government to tap the financial surpluses of the household sector through enhanced statutory
preemptions from the financial intermediaries at the below-market-clearing interest rates. As fiscal
deficits began to widen in the 1970s, periodic increases in the SLR were resorted to finance the rising
fiscal gap, indicative of the financial repression regime in place. The SLR was raised from 20 per
cent in the early 1950s to 25 per cent by 1964, and it remained at that level for the rest of the decade.
Beginning in the 1970s, the SLR came to be used more actively, and it was raised in phases reaching
34 per cent by the late 1970s. The process continued during the 1980s as fiscal deficits expanded
further, and the SLR reached a high of 38.5 per cent of net demand and time liabilities (NDTL) of the
banking system in September 1990.
The growing fiscal imbalances of the 1980s spilled over to the external sector and were also
reflected in the inflationary pressures. Along with a repressive and weakening financial system, the
above factor rendered the growth process of the 1980s increasingly unsustainable. The external
imbalances were reflected in a large and unsustainable CAD, which reached 3.2 per cent of GDP in
1990–91. As the financing of such a large CAD through normal sources of finance became
increasingly difficult, it resulted in an unprecedented external payments crisis in 1991 with the
foreign currency assets dwindling to less than $1 bn. The financing problem was aggravated by the
fact that the deficit was largely financed by debt flows up to the late 1980s, reflecting the policies of
the time, which preferred debt flows to equity flows. Indeed, equity flows were almost negligible till
the early 1990s. Moreover, a significant part of the debt flows during the late 1980s was of a short-
term nature in the form of bankers’ acceptances; such flows could not be renewed easily in view of
the loss of confidence following the BoP crisis.
ISSUES AND CHALLENGES
What have we learnt from this review of Indian economic growth and the macro-economic
management over the past 50–60 years? How do we go forward to ensure the continuation of the
growth momentum that was achieved in recent years?
Firstly, Indian economic growth has been largely enabled by the availability of domestic savings.
The continuous acceleration of its growth over the decades has been accompanied by a sustained
increase in the level of domestic savings, expressed as a proportion of GDP. Moreover, interestingly,
despite all the shortcomings and distortions that have existed in the evolving financial sector in India,
the efficiency of resource use has been high with a long-term, incremental capital output ratio (ICOR)
of around 4 per cent, which is comparable to the best achieving countries in the world. Hence, in
order to achieve the 10 per cent + growth, we need to encourage the continuation of growth in
savings in each of the sectors: households, private corporate sector, public corporate sector, and the
government.

Firstly, Indian economic growth has been largely enabled by the availability of domestic savings.
Secondly, the recent acceleration in growth has been enabled by a surge in the private sector
investment and the corporate growth. This, in turn, has become possible with the improvement in
fiscal performance reducing the public sector ’s draft on private savings, thereby releasing resources
to be utilised by the private sector. For the growth momentum to be sustained, it will, therefore, be
necessary to continue the drive for fiscal prudence at both the Central and State-government levels.

Secondly, the recent acceleration in growth has been enabled by a surge in the private sector investment and the corporate
growth.
Thirdly, the generation of resources by the private corporate sector through an enhancement of
their own savings, has been assisted greatly by the reduction in nominal interest rates, which has
become possible through a sustained reduction in inflation, brought about by prudent monetary
policy. Indian inflation, though low now by our own historical standards, is still higher than the world
inflation, and hence, needs to be brought down further. It is only when there is a further secular
reduction in inflation and inflation expectations over the medium term, that Indian interest rates can
approach international levels on a consistent basis. Hence, it is necessary for us to improve our
understanding of the structure of inflation in India—how much can be done by monetary policy, and
how much through other actions in the real economy—so that leads and lags in the supply and
demand in the critical sectors can be removed, particularly in the infrastructure. Sustenance of high
levels of corporate investment are crucially conditioned by the existence of low and stable inflation,
enabling low and stable, normal and real, interest rates.

Thirdly, the generation of resources by the private corporate sector through an enhancement of their own savings, has been
assisted greatly by the reduction in nominal interest rates.
Fourthly, whereas the fiscal correction has gained a credible momentum in the recent years, some
of it has been achieved by a reduction in the public investment. Whereas a desirable shift has taken
place from public to private investment in sectors essentially producing private goods and services,
and there is a move towards public-private partnerships (PPP) in those that have both public-good and
private-good aspects, it is necessary to recognise that public investment is essential in sectors
producing public services. Continued fiscal correction through the restructuring and reduction in
subsidies and continued attention to the mobilisation of tax revenues are necessary to enhance public
sector savings that can then finance an increase in the levels of public investment. If this is not done,
private corporate sector investment would be hampered, and the leads and lags in the availability of
necessary public infrastructure would also lead to inflationary pressures and lack of competitiveness.
Efficiency in the allocation and usage of resources would be helped greatly by better, basic
infrastructure in both rural and urban infrastructure: much of it would need enhanced levels of public
investment.

Fourthly, whereas the fiscal correction has gained a credible momentum in the recent years, some of it has been achieved
by a reduction in the public investment.
Fifthly, a major success story in the Indian reforms process has been the gradual opening of the
economy. On the one hand, trade liberalisation and tariff reforms have provided an increased access
to Indian companies to the best inputs available globally at almost world prices. On the other hand, the
gradual opening has enabled Indian companies to adjust adequately to be able to compete in the world
markets and with imports in the domestic economy. The performance of the corporate sector in both
the output growth and profit growth in the recent years is a testimony to this. It is, therefore, necessary
to continue with our tariff reforms until we reach the world levels, beyond the current stated aim of
reaching levels in the Association of South-East Asian Nations (ASEAN) Community.

Fifthly, a major success story in the Indian reforms process has been the gradual opening of the economy.
As has been mentioned, the Indian CAD has been maintained at around 1 per cent to 1.5 per cent,
historically and in the recent years. The current level of capital flows suggests that some widening of
the CAD could be financed without great difficulty: in fact, the Eleventh Plan envisages a widening to
levels approaching 2.5 per cent to 3.0 per cent. This would need to be watched carefully if it emerges:
we will need to ensure that such a widening does not lead to softening of international confidence,
which would then reduce the capital flows.
It is interesting to note that some empirical studies do not find evidence that greater openness and
higher capital flows lead to higher growth. These authors find that there is a positive correlation
between current account balances and the growth among non-industrial countries, implying that a
reduced reliance on foreign capital is associated with a higher growth. Alternative specifications do
not find any evidence of an increase in the foreign capital inflows directly boosting growth. The
results could be attributed to the fact that even successful developing countries have limited
absorptive capacity for foreign resources, either because their financial markets are underdeveloped,
or because their economies are prone to overvaluation caused by rapid capital inflows. Thus, a
cautious approach to capital account liberalisation would be useful for macro-economic and financial
stability.

It is interesting to note that some empirical studies do not find evidence that greater openness and higher capital flows lead
to higher growth. These authors find that there is a positive correlation between current account balances and the growth
among non-industrial countries, implying that a reduced reliance on foreign capital is associated with a higher growth.
On the other hand, Henry (2007) argues that the empirical methodology of most of the existing
studies is flawed as these studies attempt to look for permanent effects of capital account
liberalisation on growth, whereas the theory posits only a temporary impact on the growth rate. Once
such a distinction is recognised, empirical evidence suggests that opening the capital account within a
given country consistently generates economically large and statistically significant effects, not only
on economic growth, but also on the cost of capital and investment. The beneficial impact is,
however, dependent upon the approach to the opening of the capital account; in particular, on the
policies in regard to liberalisation of debt and equity flows. Recent research demonstrates that
liberalisation of debt flows—particularly short-term, dollar-denominated debt flows—may cause
problems. On the other hand, the evidence indicates that countries are deriving substantial benefits
from opening their equity markets to foreign investors (Henry 2007).

Recent research demonstrates that liberalisation of debt flows— particularly short-term, dollar-denominated debt flows—
may cause problems.
Our approach in regard to the capital account has made a distinction between debt and equity, with a
greater preference for liberalisation of equity markets vis- à -vis debt markets. Equity markets
provide risk capital and this can be beneficial for growth. On the other hand, opening up of the
domestic debt markets to foreign investors in the face of inflation and interest differentials, as is the
case in India at present, can lead to large amount of arbitrage capital. In view of higher domestic
interest rates, open debt markets can attract large amount of capital flows and add further to the
existing volume of capital flows, which are in any case well above the financing requirement of the
country. If the debt markets were open, such excess capital flows would have to be necessarily
sterilised by the RBI in order to maintain domestic macro-economic and financial stability. This
would further add to the sterilisation costs already being borne by the country’s financial sector and
the government. Thus, the debt flows into India are subject to ceilings and such ceilings, would be
appropriate till wedges on account of higher inflation and interest rates narrow significantly.

Opening up of the domestic debt markets to foreign investors in the face of inflation and interest differentials, as is the case
in India at present, can lead to large amount of arbitrage capital.
Finally, we need to recognise that the enhanced levels of savings and investments, and enhanced
levels of capital flows and trade, all necessitate an efficient system of financial intermediation. For
household savings to grow further, households will need to see the continuation of adequate, nominal
and real returns. The efficiency of financial intermediation is then of the essence that financial
savings are, indeed, intermediated to their best uses.

Finally, we need to recognise that the enhanced levels of savings and investments, and enhanced levels of capital flows and
trade, all necessitate an efficient system of financial intermediation.
As in the past, domestic savings are expected to finance the bulk of the investment requirements. In
this context, the banking system will continue to be an important source of financing and there would
be a strong demand for bank credit. Although bank credit has witnessed a sharp growth since 2003–04
onwards, it needs to be recognised that the credit–GDP ratio still remains relatively low. Moreover, a
significant segment of the population remains excluded from banking services. As the growth process
strengthens and becomes more inclusive, it is expected that the demand for financial products could
continue to witness a high growth in the coming years. Thus, it is likely that the growth in bank credit
and monetary aggregates could be higher than what might be expected from historical relationships
and elasticities, in view of the ongoing structural changes. This, however, raises critical issues for the
Central bank such as the appropriate order of monetary/credit expansion. In the absence of a
yardstick, excessive growth in money supply could potentially show up in inflationary pressures over
a course of time, given the monetary lags. Indeed, recent inflationary pressures across the globe are
attributable, in part, to global liquidity glut. In the absence of inflationary pressures as conventionally
measured, excessive money and credit growth could also lead to asset price bubbles, with adverse
implications for banking sector stability and lagged conventional inflation. Thus, the RBI will have to
face ongoing challenges to provide an appropriate liquidity to the system so as to ensure a growth in
a non-inflationary environment. This raises the critical issues of clarity in reading signs of inflation,
asset prices, and systemic liquidity from monetary/credit expansion.
On the sectoral phase, a key issue is that of agricultural growth. In fact, the historical review
suggests strongly that the periods of overall slow growth have invariably been characterised by a
slow agricultural growth, even in the recent years when the weight of agriculture in GDP has reduced
considerably.

On the sectoral phase, a key issue is that of agricultural growth. In fact, the historical review suggests strongly that the
periods of overall slow growth have invariably been characterised by a slow agricultural growth, even in the recent years
when the weight of agriculture in GDP has reduced considerably.
The Eleventh Five-Year Plan projects the sectoral growth rates at around 4 per cent for agriculture
sector, 10 per cent for the services sector, and 10.5 per cent for the industry sector (with
manufacturing growth at 12 per cent). While the targets for industry and services sectors are
achievable, sustaining agricultural growth at around 4 per cent for achieving the growth target of 9
per cent during the Eleventh Plan would be a major challenge, particularly because this sector is
constrained by several structural bottlenecks such as technology gaps, timely availability of factor
inputs, lack of efficient markets for both inputs and outputs, as well as continued policy distortions.
Notwithstanding some improvement in the agricultural performance in the recent years, production
and productivity of major crops continue to be influenced by rainfall during the sowing seasons.
Therefore, apart from institutional support, the immediate requirement is to improve irrigation
facilities through higher public investment and augment the cropped area, as well as yield, through
various other methods. This will need public investment and a better management.
Improved agricultural performance is not only important for sustaining growth but also for
maintaining low and stable inflation. Volatile agricultural production and lower food stocks
internationally are beginning to raise growing concerns about rising food prices, influencing an
overall inflation, both globally and in India. In the medium term, therefore, efforts would have to be
directed towards not only improving the crop yields but also putting in place a market-driven
incentive system for agricultural crops, for a durable solution to address the demand-supply
mismatches and tackle food inflation. Sustained improvement in crop yields requires an enhanced
focus on the revitalisation of agricultural research and developmental extension.

Improved agricultural performance is not only important for sustaining growth but also for maintaining low and stable
inflation.
Coming to infrastructure, the Planning Commission has estimated that infrastructure investment
ought to grow from the current levels of around 4.6 per cent of GDP to 8 per cent of the same for
sustaining the 9 per cent real GDP growth as envisioned in the Eleventh Plan. Thus, the investment in
infrastructure is expected to rise by over 3 percentage points of GDP over the Plan period; over the
same period, the Planning Commission anticipates that the overall investment rate of the Indian
economy should grow by 6 percentage points. In other words, almost one-half of the total increase in
the overall investments is expected to be on account of the infrastructure requirements. For such an
increase in the infrastructure investment to take place over the Plan period, both public and private
sector investment will need to grow much faster than in any previous period.
The sustained growth in private sector infrastructure investment can take place in only those
sectors that exhibit adequate return, either on their own or through PPP. The performance of the
telecom sector has exhibited this convincingly. A renewed focus on the levy of adequate user charges
is, therefore, necessary, for policy measures that provide stability to the flow of infrastructure
revenues (Mohan 2004).

The sustained growth in private sector infrastructure investment can take place in only those sectors that exhibit adequate
return, either on their own or through PPP.
In this context, it needs to be recognised that the use of foreign currency-denominated borrowings
to fund domestic infrastructure projects runs the risk of currency mismatches in view of the fact that
the earnings of such projects are in domestic currency. Thus, large, unanticipated currency
movements can render such unviable projects, thereby endangering the future investments. Caution,
therefore, needs to be exercised in the foreign funding of infrastructure projects, unless appropriately
hedged.

In this context, it needs to be recognised that the use of foreign currency-denominated borrowings to fund domestic
infrastructure projects runs the risk of currency mismatches in view of the fact that the earnings of such projects are in
domestic currency.
CASE
A government decision to exempt personal computers (PCs) from excise duty would make imported
computers significantly cheaper, making it more attractive for companies to import a complete unit
than to have the same, assembled or manufactured in India, after importing components and inputs.
The industry sources said that the price of an imported computer could be about 8 per cent lower than
its locally manufactured version.
At present, Dell is a prominent player that imports computers for sale in India. The other players
including HP and IBM import components and inputs and assemble them here. The domestic
manufacturers such as HCL and Zenith too import components and inputs. The fully finished PCs are
cheaper to import in the present context when compared to the locally manufactured ones because of
the anomaly arising from the 16 per cent countervailing duty (CVD) on the key components that go
into a PC.
Estimates show that fully imported PCs could be cheaper by as much as 2.5 per cent–3 per cent. The
industry says that the budget announcement fully exempts PCs from excise or CVD, but leaves the
CVD on components and inputs like monitors, keyboards, and mouse unchanged at 16 per cent. PC
players get tax benefits, which is the difference between the duty paid on importing the items and
excise duty. In a case where the import of components and inputs continue to attract CVD, the
advantage is taken away, they point out. This, in turn, has led to a situation detrimental to PC
manufacturing in the country.
According to the Manufacturers Association for Information Technology (MAIT), as much as 90
per cent of the market comprises PCs that are either assembled or manufactured in India. The balance
10 per cent are imported ones. The industry warns that if the situation is not rectified, it would
encourage more players to shelve assembling operations and start importing PCs, in effect reversing
the manufactured to imported PC ratio. The biggest losers would be the Indian players.
The hardware companies are, however, hopeful of a resolution. Asked whether Acer would prefer
to import rather than assemble here, its General Manager said, “We are watching the situation. We
would like the government to set right the anomaly by removing the CVD on components and are
optimistic that by the middle of next week, some correction would be effected as MAIT has already
taken up the issue with the Government”.
The industry is demanding that the CVD on all components, as well as the input that go into the
components should be brought down to zero. “This has already started happening, as players have
orders pending which they cannot ship”, the sources said. However, the removal of CVD on
components and inputs may prove to be difficult as some of these are dual-usage items.
As MAIT continues hectic parlays with the officials of IT departments, major players including
HCL and HP are still unwilling to talk about the issue. Wipro InfoTech, however, feels that though the
budget announcement has reduced the price differential between the imported PC and the locally
manufactured PC to a certain extent, the imported computers will still be expensive when compared to
their locally manufactured counterparts. “The cost of logistics, transportation, distribution, service
charges still remain. The removal of 8 per cent excise will not have any significant impact on the
prices of WIPRO PCs”, General Manager of PC Business, Wipro InfoTech said.
Case Question
Do you support the decision of the government?
KEY WORDS
Liberalisation
Privatisation
Remittances
Foreign Exchange (forex)
Exchange Rate
Foreign Equity
Foreign Tie-ups
SEBI
Financial Sector
Statutory Liquidity Ratio (SLR)
Cash Reserve Ratio (CRR)
Banking Reforms
Balance of Trade
Rupee Value
External Debt
External Liabilities
Multinational Corporations (MNCs)
Stock Market
Import Restrictions
New Trade Policy
QUESTIONS
1. What do you mean by liberalisation? Discuss the causes leading to the adoption of liberalisation by the Government of India.
2. Discuss the process of liberalisation.
3. State the provisions of the New Industrial Policy in the liberalisation process.
4. What are the provisions of the New Trade Policy with reference to liberalisation?
5. Critically analyse the impact of liberalisation on the Indian economy.
6. Has the Indian economy benefitted by liberalisation? If yes, discuss the areas where the economy benefitted.
7. Is there any threat to the Indian economy due to liberalisation? Discuss.
REFERENCES
Adhikari, M. (2001). Global Business Management: In an International Economic Environment. New Delhi: Macmillan.
Batra, G. S. and R. C. Dangwal (1999). Globalisation and Liberalisation: New Developments. New Delhi: Deep and Deep
Publications.
Michael, V. P. (2001). Globalisation, Liberalisation and Strategic Management. Mumbai: Himalya Publishing House.
Patel, I. G. (1998). Economic Reform and Global Change. New Delhi: Macmillan.
Roger, B. (2003). International Business. New Delhi: Pearson Education.
CHAPTER 23
Privatisation and Disinvestment of PSUs
CHAPTER OUTLINE
Public Sector Enterprises (PSEs)—the Necessity
A Decade of Performance
Concept, Meaning, and Objectives of Privatisation
Disinvestment Strategies
The Board for Reconstruction of Public Sector Enterprises (BRPSE)
The New Disinvestment Policy and Programme
Case
Summary
Key Words
Questions
References
PUBLIC SECTOR ENTERPRISES (PSES)-THE NECESSITY
The formation of public sector enterprises (PSEs) in India was essential during the early 1950s. There
were various problems confronting the country that needed a solution through a systematic and
planned approach. India was basically an agrarian economy with a weak industrial base, low level of
savings, inadequate investment, and an absence of infrastructural facilities. A significant proportion
of the population was below the “poverty line”. This created considerable inequalities in income,
levels of employment, as well as regional imbalances in economic achievements. It was, thus, a
logical conclusion—India needed to accelerate its economic growth and maintain the growth over a
long time period. The Central and State government’s intervention was inevitable because the private
sector, in the early 1950s, neither had the necessary resources to augment long-gestation projects nor
the managerial and scientific skills to implement long-term projects. In view of the above, some of
the major objectives for setting up of PSEs include the following:

The formation of public sector enterprises (PSEs) in India was essential during the early 1950s. There were various
problems confronting the country that needed a solution through a systematic and planned approach.
1. Ensure rapid economic growth and industrialisation of the country and create the necessary infrastructure for the economic
development,
2. Promote redistribution of income on wealth,
3. Create employment opportunities,
4. Assist the development of small-scale and ancillary industries,
5. Promote import substitutes, and save and earn foreign exchange for the economy, and
6. Earn return on investment and thus, generate resources for development.
Thus, the priorities of the government were removal of poverty, better distribution of income,
expansion of employment opportunities, removal of regional imbalances, accelerated growth of
industrial production, enhanced utilisation of economic resources, and also a wider ownership of
economic power. Discounting the aforementioned social and strategic motives, it became a pragmatic
compulsion to deploy the PSEs as an instrument for a self-reliant economic growth.

The priorities of the government were removal of poverty, better distribution of income, expansion of employment
opportunities, removal of regional imbalances, accelerated growth of industrial production, enhanced utilisation of
economic resources, and also a wider ownership of economic power.
The predominant considerations for a continued large-scale investment in the public sector were
focused towards accelerating growth in the core sectors such as railways, telecommunications,
nuclear power, and defence. Also a large number of PSEs were consumer-oriented industries, such as
drugs, hotels, food industries, and so on. The rationale for setting up such enterprises was to ensure
an easier availability of important products and services and to create a springboard for the emerging
areas like tourism. A large number of private companies were taken up by the government to protect
the employment of labour that is at stake and also to sustain production. PSEs of India are, therefore,
a heterogeneous mix of infrastructrual companies, companies manufacturing consumer goods, and
that engaged in trade and services.

The predominant considerations for a continued large-scale investment in the public sector were focused towards
accelerating growth in the core sectors such as railways, telecommunications, nuclear power, and defence.
A DECADE OF PERFORMANCE
The aggregate turnover of PSEs witnessed a CAGR of 14.9 per cent between 1991–92 and 2001–02.
The operating income was almost 117.06 per cent of the total capital employed during the period.
During the fiscal year 2001–02, the growth in turnover was the highest in enterprises that were
producing and selling goods when compared to the service-based sectors. Sectors like petroleum,
power, coal and lignite; transportation services; industrial development and technical consultancy
services; financial services; telecommunication services; chemicals and pharmaceuticals; steel; the
fertilizers; and contract and construction, recorded a significant increase in the turnover, whereas the
sectors like mining and ores witnessed a significant decline in revenues.

The aggregate turnover of PSEs witnessed a CAGR of 14.9 per cent between 1991–92 and 2001–02. The operating income
was almost 117.06 per cent of the total capital that was employed during the period.
The manufacturing sector of public sector units (PSUs) witnessed a decline in the efficiency rates
when compared to its peers in the private sector during the financial years between 1990–91 and
2001–02. The aggregate cost of production of PSUs as a percentage of sales increased to an extent of
80 per cent during this period. The various inefficiencies in the raw material usage, high wages and
salaries component, and higher debt component made the PSUs non-cost effective in comparison with
its peers in the private sector. The aggregate expense due to wages and salaries, interest costs, and
power costs of the PSUs is around 60 per cent of the aggregate turnover of the manufacturing PSU
companies. In contrast, the private companies have a lesser burden on all the three counts, which adds
up to just over 16 per cent. The wages, salaries, and other benefits form the highest cost component
(23.3 per cent) for PSUs, whereas the same component forms 6.5 per cent of the turnover in the
private sector.
The higher non-cost effective levels have affected the net profit margins (NPMs) of the PSUs
negatively over a period between 1990–91 and 2000–01. The NPMs of the PSUs have consistently
been negative when compared to an average of 6 per cent NPM in the private sector. The decline in
NPMs has affected the dividend outflow to the government. The decrease in internal revenue
generation of the PSUs has compelled the government to increase its assistance to the PSUs in the
form of equity infusions, subsidies, soft loans, and the like. These different types of assistance have
also increased the cost burden on the government. The decrease in dividend flow from the PSUs pose
serious systemic risks to the economy. The blockage of huge cash reserves in the PSUs has decreased
investments in the priority sectors. Table 23.1 gives details of all the public sector and non-
agricultural establishments, showing employment details from 1981 to 2003.
CONCEPT, MEANING, AND OBJECTIVES OF PRIVATISATION
Concept
Just as the concept of a welfare state emerged to save the capitalist system from crises, similarly, the
concept of privatisation is being developed to save the welfare state from crises. In the last decade,
“privatisation” has become an international phenomenon. From Canada to India, the governments
have voted for privatisation as a means of increasing productivity effectively and for growth in the
economy, while offering opportunities for citizens to invest. Each country may have its own reasons
for adopting privatisation, refuting its own social, economic, and political circumstances.

Just as the concept of a welfare state emerged to save the capitalist system from crises, similarly, the concept of privatisation
is being developed to save the welfare state from crises.

Table 23.1 Employment in the Organised Sector
Note: Data in this table cover all establishments in the public sector and all non-agricultural establishments in the same, employing about
10 or more persons.
*Including Local Bodies.
Source: Statistical Outline of India 2006–07, Tata Services Limited, Department of Economics and Statistics.

Meaning
The very word “privatisation” seems to scare people. In Sri Lanka, they coined the word “pau-
perisation” and in China they call it “a strategic adjustment of the layout of the State sector”. In the
United Kingdom, Nigel Lawson coined the term “people’s capitalism” to imply privatisation by
selling shares to the shareholder public. Margaret Thatcher modified the phrase to “popular
capitalism” as she thought the earlier formulation sounded communist, reminding her of a famous
expression, “people is republic”. In India we call it “disinvestments”, perhaps to convey the
government’s desire to disengage from running a business.

The very word “privatisation” seems to scare people. In Sri Lanka, they coined the word “pau-perisation” and in China
they call it “a strategic adjustment of the layout of the State sector”.
Privatisation is part of the process of rethinking the welfare state. Society is searching for new
ways of delivering services because of our collective sense of efficiency. The entrepreneur, not the
bureaucrat, is the “hero” of a society. While we cannot be sure how it will all turn out, privatisation
will be part of the emerging post-welfare state. Privatisation wherever applied, has achieved some
measures of success to the local government.

Privatisation is part of the process of rethinking the welfare state.
Objectives
The government resorts to privatisation with multiple objectives. The major objectives sought by this
exercise are as follows:
1. The reduction of political interference in the management of an enterprise, leading to improved efficiency and productivity, that
is, the functional managers get a free hand in managing the organisation the way they want to.
2. The government also views privatisation as a means of providing adequate competition to the State-run enterprise. Privatisation
could take place in terms of granting permission to the private sector to set up units in an otherwise government-controlled area.

The major objectives sought by the privatisation are reduction of political interference in the management of an
enterprise, leading to improved efficiency and productivity, and as a means of providing adequate competition to
the State-run enterprise.
3. Privatisation in the developed as well as the developing countries, is undertaken for the purpose of cash generation to fund the
ever-increasing expenses.
4. Certain developing nations can look upon privatisation as a means of broad-basing ownership of economic assets, thereby
reducing the problem of concentration of economic power.
The performance of the Central PSEs during the period from 1991–92 to 2004–05 has been shown in
Table 23.2.

Table 23.2 Performance of Central PSEs
Source: Public Enterprise Survey 2004–05 and earlier issues.

DISINVESTMENT STRATEGIES
Before we go into the various issues relating to disinvestment, we must clear one semantic problem.
In India, the term “disinvestment” is used more often than “privatisation”. “Privatisation” implies a
change in the ownership resulting in a change in the management. Disinvestment in that sense is a
wider term extending from dilution of the stake of the government to a level where there is no change
in control to dilution that results in the transfer of management. If, in fact, in a particular enterprise
there is dilution of government ownership beyond 51 per cent, this can result effectively in a “transfer
of ownership”. The extent of dilution needs to be determined as part of the policy of disinvestment.
Table 23.3 provides a summary of disinvestment receipts from 1991 to July 2007. Box 23.1 details the
policy of contraction of the public sector.

“Privatisation” means a change in ownership resulting in a change in management. “Disinvestment” means dilution of the
stake of the government to a level where there is no change in control that results in the transfer of management.
Strategy
The issues relating to disinvestments raise around three questions: why, how, and how much? To
some extent, these issues were addressed by the Committee on Disinvestment, which submitted its
report in 1993. As a background to answering these issues, we also need to look at the evolution of
the role of PSEs in our country as well as their performance.
The origins of PSEs are manifold. The objectives range from building an infrastructure for the
economic development to generating investable resources for the development by earning suitable
returns. Thus, the motivation extends from the theory of commanding heights to the provision of
consumption goods at subsidised rates. Eventually, PSEs are now spread over widely from coal, steel,
and oil at one end to hotel and bread-making at the other. The time has come to critically assess the
sectors in which PSEs must function. This is particularly important in the context that the resources
available with the Centre and the states are limited, and are needed for extending the social
infrastructure in a bigger way. The Eighth Plan identified some of the principles governing public
sector investments as follows:
1. The PSEs should make investments only in those areas where investment is mainly infra-structural in nature and where private
sector participants are not likely to come forth to an adequate extent within a reasonable time perspective.
2. The PSEs must withdraw from areas where no public purpose is served by its presence.
3. The principle of market economy should be accepted as the main operative principle by all PSEs unless the commodities and
services produced and distributed are specifically for protecting the poorest in the society.
The National Common Minimum Programme (NCMP) while emphasising the need to strengthen and
reform the PSEs had also commented: “The question of withdrawing the public sector from non-core
and non-strategic areas will be carefully examined”. The performance of public enterprises can be
judged by several efficiency criteria. However, the financial performance assumes importance as one
of the objectives of creating PSEs was to generate investable resources for development by earning
adequate returns. The picture in this regard is mixed.

The National Common Minimum Programme (NCMP) while emphasising the need to strengthen and reform the PSEs had
also commented: “The question of withdrawing the public sector from non-core and non-strategic areas will be carefully
examined”.
In the fiscal 1995, out of a total of 241 public sector undertakings in the Central sector, about 130
made net profits. The net profits amounted to Rs 12,120 crore. The losses of 109 units amounted to Rs
4,910 crore. It is also interesting to note that about 10 enterprises contributed over two-thirds of the
profits. Out of these 10, six were in the oil sector. The profits of the PSEs would look less impressive
if the oil sector is excluded. In fact, the contribution of the profit-making PSEs to the finances of the
Central government in the form of dividends amounted only to Rs 1,440 crore.
The reform of the public sector, in general, and that of the loss-making units, in particular, has
assumed importance in the context of the financial strain under which all governments, both at the
Centre and in the states, are now operating. The issue of how to handle loss-making enterprises needs
to be faced squarely. One can move away from financial performance and judge the PSEs in terms of
technical efficiency, allocative efficiency, and dynamic efficiency. Technical efficiency basically
relates to the ratio of inputs to outputs.

The reform of the public sector, in general, and that of the loss-making units, in particular, has assumed importance in the
context of the financial strain under which all governments, both at the Centre and in the states, are now operating.

Table 23.3 Summary of Disinvestment Receipts from 1991 to July 2007
*Out of Rs 5,371.11, Rs 4,184 crore constitutes receipts from cross-purchase of shares of ONGC, GAIL, and IOC.
**Out of Rs. 1479.27, Rs 459.27 crore constitutes receipts from cross-purchase of shares of ONGC, GAIL, and IOC.
Source: Department of Disinvestment, Government of India.

Box 23.1 Industries Reserved for Public Sector
The policy of contraction of public sector was adopted under the scheme of privatisation. The
number of industries exclusively reserved for public sector were reduced from 17, in 1956 to
eight in 1991. The number was reduced to six in 1993. Now only three industries are exclusively
reserved for the public sector, viz.,
1. Atomic energy,
2. Mining of atomic minerals, and
3. Railways.

Allocative efficiency relates to correction of market failure leading to better allocation of
resources that will be decided by the price mechanism. Dynamic efficiency relates to innovations and
technological development. Even in relation to these criteria, the results in relation to public
enterprises are mixed. Current profit and/or current loss need not necessarily be the appropriate
criterion for dis-investment. Merely because a unit is profitable, it does not qualify to continue to be
publicly owned, unless it meets a well-defined felt need. Loss-making units need not be excluded from
disinvestment if there are buyers who can make them profitable.

Current profit and/or current loss need not necessarily be the appropriate criterion for disinvestment. Merely because a unit
is profitable, it does not qualify to continue to be publicly owned, unless it meets a well-defined felt need. Loss-making units
need not be excluded from disinvestment if there are buyers who can make them profitable.
Background
The onset of privatisation across the world began with Chile in the mid-1970s and the United
Kingdom from 1979. Domestic fiscal crises and burdensome funding to meet the PSU expansion
requirement accelerated the need to privatise in these countries. In the United Kingdom, privatisation
was carried out aggressively by Margaret Thatcher in the 1980s, with the government letting loose
most of its stake at one go. British Telecom, British Air, British Power, British Petroleum, and British
Rail were some of the major PSUs disinvested.
The United Kingdom’s example was followed by the other European nations including France.
During its divestment programme from 1986 to 1988, France privatised about 66 PSUs, with 42 in
banking, 13 in insurance, 9 in the industry sectors, and 2 in telecommunications. In Germany,
Chancellor Kohl’s government divested stakes in VEBA (energy), Volkswagen (auto), VIAG (metals
and chemicals), and Salzgitter (steel and engineering)—raising DM 10 bn—and pared its holding in
the national carrier Lufthansa to 50 per cent.
In 1989, privatisation became the norm in the Central and Eastern European nations and in the
former Soviet Union during their transitional phase of moving from planned to market economies. In
1986, the Latin American countries started their privatisation process mainly on account of a
deepening fiscal crisis. The Asian financial crisis spurred Bangladesh, Pakistan, and Sri Lanka to
privatise their manufacturing and retail operations in small business, textiles, and agro industries
from the mid-1970s.
Privatisation in India has become a controversial and a debatable issue. It is being criticised for
“selling the family silver to the cronies of the rolling party”. The sale proceeds of public
undertakings are being utilised for meeting administrative expenses or curtailing the budgetary
deficit, instead of creating health and educational facilities to general public and for development of
infrastructure for trade and industry.

The sale proceeds of public undertakings are being utilised for meeting administrative expenses or curtailing the budgetary
deficit, instead of creating health and educational facilities to general public and for development of infrastructure for trade
and industry.
It is argued that much of what the government has collected over the years since independence as
the State’s assets have been now put up for sale. Further, the government is not making any effort to
privatise the loss-making PSUs. Instead, the government is privatising the profit-making public
enterprises, which are beneficial for the welfare of the general public and are adding pride to the
nation. These healthy PSUs require no State support and are efficiently managed. Privatisation of
loss-making units would definitely reduce financial burden on the government. As no one will be
buying the sick PSUs, all efforts are being directed towards selling the healthy ones. Now the
dilemma that is facing the government at this juncture is, that while it will be able to sell all shares of
the profit-making PSUs, it is going to be left with the sick units only.
The Standing Committee on Public Enterprises (SCOPE) has, in 2004, argued that the
government’s disinvestment programme is totally unplanned and has, not benefitted the PSUs. It is
argued that the disinvestment exercise is merely a budgetary, gap-filling mechanism in which neither
the views nor the strengths of any corporation are taken into account prior to the divesting of shares.
Desirability
Broadly speaking, there are two major reasons adduced for disinvestment. One is to provide fiscal
support and the other is to improve the efficiency of the enterprise. The fiscal support argument has
to be given due weightage. The demands on the governments, both at the Centre and in the states are
increasing. There is a compelling need to expand the activities of the State in areas such as education,
health, and medicine. It is, therefore, legitimate that a part of the additional resources needed for
supporting these activities comes from the sale of shares built up earlier by the government out of its
resources. It is, sometimes, argued that the resources raised through disinvestments must be utilised
for retiring past debts, thereby bringing down the interest burden of the government. So long as the
government is a net borrower of a fairly large magnitude, year after year, it does not make any
material difference whether the resources are utilised to retire the past debts or are simply utilised as
part of the receipts. In the latter case, it only results in a lower borrowing requirement.

Part of the sale proceeds should be used as a fiscal support for education, health, and social needs of the general public.
The resource raised through disinvestments must be utilised for retiring past government debts, thereby bringing down the
interest burden of the government.
The second important argument in favour of disinvestment is the contribution that it can make to
improving the efficiency of the working of the enterprise. Leaving aside the extreme case where the
dilution results in the transfer of ownership, even in the case of disinvestment where the dilution is of
a lesser order and where the government control is still retained, the induction of public ownership
can have a salutary effect on the functioning of an enterprise. It increases the accountability of those
in charge of the enterprise. The shareholders would require to be compensated and this will, in turn,
compel the enterprise to run more efficiently and earn more profits. This must be regarded as a part
of the reform and restructuring of public enterprises. Flexibility in ownership can, in effect, impart
efficiency. In fact, the induction of the public into the ownership structure can also create conditions
in which there could be greater autonomy for the functioning of the PSE. Disinvestment can,
therefore, be regarded as a tool for enhancing the economic efficiency.

There could be greater autonomy for the functioning of the PSE.
The other important issue with respect to disinvestment relates to the extent of disinvestment to be
made in an enterprise. Obviously, the level of disinvestment in an enterprise in any year should be
derived from the target level of government ownership in that enterprise over the medium term. The
target levels of ownership could be 26 per cent to ensure a limited control over special resolutions
that are brought in, in the general body meetings of the enterprise: 51 per cent to have an effective
control and 100 per cent for full ownership. The target level of disinvestment should be derived from
the desirable level of public ownership in an activity or unit, consistent with the industrial policy.
The discussion paper quotes from a government document that the extent of disinvestment in
strategic, core and non-core, and non-strategic sector could be “nil”, 49 per cent, and 74 per cent or
more, respectively. The NCMP has also indicated the possibility of withdrawing PSUs from the non-
core and non-strategic sectors. The approach paper of the Ninth Plan also stated that “disinvestment
will be considered up to 51 per cent and beyond in the case of PSUs operating in non-strategic and
non-core sectors”. Now the time has come to define very clearly which enterprise falls into what
category. There is a general degree of consensus that in the non-strategic and non-core sectors,
disinvestment can be beyond 51 per cent. For the rest of the sectors, the criterion of disinvestment can
be the extent of improvement and efficiency that can be brought about, as well as the need to take care
of the financial requirements of the government.
Pricing
An issue that arises with respect to disinvestment relates to the pricing to be adopted for
disinvestment. This, in turn, revolves around the appropriate valuation of the shares and the
modalities that are to be adopted for sale. In general, three methods for the valuation of shares are
adopted: the net asset value (NAV) method, the profit-earning capacity value method, and the
discounted cash-flow method. While the NAV would indicate the value of the asset, it would not be in
a position to indicate the profitability or income to the investors. The profit-earning capacity is
generally based on the profit actually earned or anticipated. The discounted cash flow is a far more
comprehensive method of reflecting the expected income flows to the investors. Of these three
methods, the discounted cash flow method has the greatest relevance though it is the most difficult.

An issue that arises with respect to disinvestment relates to the pricing to be adopted for disinvestment. This, in turn,
revolves around the appropriate valuation of the shares and the modalities that are to be adopted for sale.
Valuation is a difficult exercise whether in the private or the public sector—in India or elsewhere.
This is all the more so when the different valuation methods give different results. It is also to be
noted that while the different valuation methods can provide a benchmark for the price, the price at
which a share can be sold is determined more by the investor perception than any other mechanical
measure of intrinsic worth. There is, therefore, the need for a full disclosure to generate credibility
and investor interest. A rise or fall in the share value of an enterprise soon after disinvestment does
not by itself indicate that shares were underpriced or overpriced at the time of disinvestment. On the
modalities of disinvestment, there are two acceptable and transparent processes available which are as
follows:

1. Offering shares of PSEs at a fixed price through a general prospectus. The offer is made to the general public through the
medium of recognised market intermediaries.
2. Sale of equity through auction of shares among a predetermined clientele, whose number can be as large as necessary or
practicable. The reserve price for the PSE equity can be determined with the assistance of merchant bankers.
The price at which a share can be sold is determined more by the investor perception than any other mechanical measure of
intrinsic worth. There is, therefore, the need for a full disclosure to generate credibility and investor interest.
Both these methods have their own merits and demerits. In the first alternative of “offer for sale”,
difficulties may be encountered in estimating and determining the “fixed” price, if it is offered for the
first time, and the shares have not been actually trading in the stock exchange. On the other hand, this
method has the advantage of spreading the ownership widely among the general public and in a
transparent manner. In the case of those PSEs for which the first sale of equity is yet to be made, or
those where the track record of trading in shares is yet to be established, the tender system would be
advantageous. Once a reasonable market price is established in a normal trading atmosphere over a
reasonable period of time and a public enterprise completes the preparatory work, the fixed price
method would be appropriate.
Utilisation of Proceeds
The original investments in all PSUs were made by the government out of its receipts. These are
public funds and the proceeds of disinvestment should be utilised for the purpose of expanding the
activities of the PSUs and in other areas such as social sector activities, that is, education, health,
eradication of poverty, creating employment, creating infrastructure for industrial development, and
so on. Addressing the joint session of the Parliament, President A.P.J. Abdul Kalam said, “My
government believes that privatisation should increase competition, not decrease it, We also believe
that there must be a direct link between privatisation and social needs, like the use of revenues
generated through privatisation for designated social sector schemes”. Box 23.2 details the steps for
disinvestment.

The proceeds of disinvestment should be utilised for the purpose of expanding the activities of the PSUs and in other areas
such as social sector activities, that is education, health, eradication of poverty, creating employment, creating
infrastructure for industrial development, and so on.
It is surprising that the public sector, in spite of the enormous support and investment from the
government, has failed to perform. If a private sector does well because of the high levels of
professionalism it demands, why can the same not be ensured from the public sector? If PSUs are
given autonomy for day-to-day decision making and allowed to employ competent managers, with
management degrees from reputed management institutes, there is hardly any reason why they should
fail. In fact, many of our PSUs are excellently managed and they rake in good profits. Loss-making
units were actually helpless in the hands of those in power. They suffered for various reasons such as
over-staffing, dumping inferior-quality raw materials, interference in pricing, instigated labour union
strikes, unreasonable demands for high wages, and so on. On the whole, public sectors were rendered
sick systematically, so that they can be sold at throwaway prices to individual buyers from the private
sector. This has been the story of disinvestment in India. Box 23.3 gives the essence of “Navratna”.

If PSUs are given autonomy for day-to-day decision making and allowed to employ competent managers, with management
degrees from reputed management institutes, there is hardly any reason why they should fail.

Box 23.2 Steps for Disinvestment
1. Disinvestment policy of the Government of India

2. Disinvestment Commission of the Government of India
3. Proposal for disinvestment of a Central PSU
4. Consideration of proposal by the Cabinet Committee on Disinvestment (CCD)
5. Clearance of proposal
6. Cleared proposal by CCD
7. Selection of an advisor
8. Invitation of Expression of Interest (EOI) from interested parties by the advisor through newspaper advertisements
9. Receipts of EOI and shortlisting
10. Preparation of information memorandum by the advisor
11. Preparation of draft of the Share Purchase Agreement (SPA) and Share Holder’s Agreement (SHA)
12. Finalisation of SPA and SHA
13. Vetting of the above documents (SPA and SHA) by the Law Ministry and the Central government
14. SPA and SHA are sent to prospective bidders for their final bids (technical and financial)
15. Bids are examined, analysed, and evaluated by the Inter Ministerial Group (IMG)
16. IMG sends recommendation to CCD for final approval of the bids, SPA, SHA, strategic partner, and other related issues
17. Finalisation of the transaction
18. Once the deal is completed, all the related papers and documents are sent to CAG for evaluation of the disinvestment deal
19. The evaluated disinvestment deal is then placed before the Parliament and finally, the same is released to the public.
Box 23.3 Navratna
In line with the policy of liberalisation, the government granted “Navratna” status to PSEs having
a comparative advantage and potential to become global players based on their size, performance,
nature of activities, future prospects, and so on. The enterprises which have a continuous trend of
profit earning during the earlier three year but were not accorded the Navratna status, have been
categorised under “Mini Ratna-I” and “Mini Ratna-II” based on the amount of profit earned.
THE BOARD FOR RECONSTRUCTION OF PUBLIC SECTOR ENTERPRISES (BRPSE)
The Board for Reconstruction of Public Sector Enterprises (BRPSE), announced in the Union Budget
(2005–06) by the Finance Minister P. Chidambaram, has got the approval of the government. The
board will have seven members with a non-official member as the Chairman. Besides, it would have
three non-official members and three secretaries of the government. The board’s recommendations
would be advisory. It would advise the government on the proposals referred to it and the ones that it
takes up suo moto.
Key Responsibilities
Apart from revival, the board will also advise the government on the ways and means for
strengthening the PSEs, in general and making them more autonomous and professional. It will
consider restructuring of finances, organisations; and businesses; including diversification, joint
ventures, mergers, and acquisitions of Central public sector companies; and suggest ways and means
for funding such schemes. In respect of unviable companies, the board would also advise the
government about the source of funds, including the sale of surplus assets of the enterprise for the
payment of all legitimate dues and compensation to workers and other costs. The board will also
monitor the incipient sickness in the Central PSUs.

Apart from revival, the board will also advise the government on the ways and means for strengthening the PSEs, in general
and making them more autonomous and professional.
One of the proposals the new body will take up is the ambitious Rs 12,000 crore plan to revive
about 24 PSUs, largely under the Heavy Industry Ministry. The plan includes about Rs 2,000 crore of
fresh capital infusion into the companies, apart from a write-off of past dues of about Rs 10,000
crore. The proposal will travel to the Finance Ministry, after it is vetted by the BRPSE. If approved by
the North Block, the plan would be put up to the Cabinet Committee on Economic Affairs:
Government approves the Budget proposal for BRPSE.
The board will have seven members with a non-official member as the Chairman. It will have three non-official members and
three secretaries of the government.
The board will advise the government on strengthening the PSEs, in general, and making them more autonomous and
professional.
Trade unions demand a place in the board.
The government is not keen on reviving all the sick PSUs. In fact, it has decided to close down seven
PSUs under the Ministry of Public Enterprises and Heavy Industries, and revive 17 of them. Of the 17
companies the government likes to revive, three would be through the joint venture route. For the
joint venture, the government will have to offer a stake to a strategic investor and the price at which
the new partner will be inducted, is likely to be decided by the group of ministers, which has been
constituted for the following purposes:
Government decides to close down seven PSUs and revive 17 others.
Joint venture route proposed for revival of three units.
Purchase preference scheme extended by a year.
VRS revised to prompt more employees of loss-making units to avail of the scheme.
A clean-up of balance sheets of companies underway.
A special package for revival of HEC (Heavy Engineering Corporation).
Privatisation has become a gray area in India of late. The sale of the efficiently managed PSUs and the
retention of the sick units, which are nearly unmanageable, have together been reducing the assets of
the government while exacerbating its burden. The whole process of privatisation seems to be more
beneficial for the individuals than for the public.

The sale of the efficiently managed PSUs and the retention of the sick units, which are nearly unmanageable, have together
been reducing the assets of the government while exacerbating its burden.
It appears as though the then government’s policy was consciously taking a step towards privatising
all profits and nationalising all losses. For example, Modern Food with assets amounting to more
than Rs 2,000 crore has been sold for a little over Rs 100 crore; Dalmiyas have been allowed to buy
companies worth Rs 300 crore for Rs 26 crore. Balco, a Rs 5,000 crore company has disinvested 51
per cent equity for just Rs 551 crore. Other examples are ITDC, GAIL, VSNL, and ONGC.
The government thinking that privatisation would maximise the revenues and make up for sup-
erior firm efficiency proved wrong. The Tatas acquired CMC in the first week of October 2001 at a
price of Rs 197 per share. A year later, the price hovered around Rs 500. It cannot be that the Tatas
effected a stunning improvement in the firm in such a short period. Another glaring example is the
sale of the Centaur Hotel in Mumbai. A private group, which bought the hotel for Rs 83 crore, sold it
within four months to another private party for Rs 115 crore, and that party put the said hotel for sale
for Rs 350 crore, within a year of its purchase.
The government is in a fiscal distress and is desperate to realise revenues by selling the healthy
PSUs, just to fill up the budgetary deficit gap. In the disinvestment process, the government is not
taking into consideration either the views or the strength of any corporation prior to divesting shares.
The government must rethink before divesting the shares of healthy and profit-making PSUs and save
the public’s sound assets from being sold to the rich for a song.

In the disinvestment process, the government is not taking into consideration either the views or the strength of any
corporation prior to divesting shares. Government must rethink before divesting shares of healthy and profit-making PSUs,
and save the public’s sound assets from being sold to the rich for a song.
It is advisable that the government should adopt the policy of disinvestment in such a way that the
loss-making PSUs be sold, for which the government should provide incentives to the private parties
opting to purchase them, so that the dead property will be canalised in the production process, and the
loss to the government will be reduced. On the other hand, the government should give autonomy to
healthy profit-making and viable PSUs to be, so that they are professionally managed and become
competitive.
THE NEW DISINVESTMENT POLICY AND PROGRAMME

Current Policy on Disinvestment
In May 2004, the government adopted the NCMP, which outlines the policy of the government with
respect to the public sector. The relevant extracts of NCMP are given as follows:

In May 2004, the government adopted the NCMP, which outlines the policy of the government with respect to the public
sector.
The UPA (United Progresive Alliance) government is committed to a strong and effective public
sector whose social objectives are met by its commercial functioning. But for this, there is need for
selectivity and a strategic focus. The UPA is pledged to devolve full managerial and commercial
autonomy to successful, profit-making companies operating in a competitive environment. Generally
profit-making companies will not be privatised.
All privatisations will be considered on a transparent and a consultative case-by-case basis. The
UPA will retain the existing “navratna” companies in the public sector while these companies raise
resources from the capital market. While every effort will be made to modernise and restructure the
sick public sector companies and revive sick industry, chronically loss-making companies will either
be sold-off, or closed, after all the workers have got their legitimate dues and compensation. The UPA
will induct private industry to turn around companies that have potential for revival.
The UPA government believes that privatisation should increase competition, and not decrease it. It
will not support the emergence of any monopoly that only restricts competition. It also believes that
there must be a direct link between privatisation and social needs—like, for example, the use of
privatisation revenues for designated social sector schemes. Public sector companies and nationalised
banks will be encouraged to enter the capital market to raise resources and offer new investment
avenues to retail investors.

The UPA government believes that privatisation should increase competition, and not decrease it. It will not support the
emergence of any monopoly that only restricts competition.
Calling off the Ongoing Cases of Strategic Sale
In conformity with the policy enunciated in NCMP, it was decided in February 2005 to formally call
off the process of disinvestment through a strategic sale of profit-making CPSEs, as enumerated in
the following manner:

Table 23.4
Percentag e of Equity Which was Earlier Proposed to be
Name of the PSE
Sold Throug h Strateg ic Sale
Manganese Ore India Limited 51%
Sponge Iron India Limited 100%
Shipping Corporation of India Limited 54.12% (51% through strategic sale and 3.12% to employees)
61.15% (10% domestic issue, 20% ADR issue, 29.15% strategic
National Aluminium Company Limited
sale, and 2% to employees)
National Building Construction Corporation Limited 74%
National Fertilizers Limited 53% (51% through strategic sale and 2% to employees)
Rashtriya Chemicals & Fertilizers Limited 53% (51% through strategic sale and 2% to employees)
Hindustan Petroleum Corporation Limited 39.01% (34.01% through strategic sale and 5% to employees)
Engineers India Limited 61% (51% through strategic sale and 10% to employees)
Balmer Lawrie and Company Limited 61.8%
Engineering Projects India Limited 74%
Hindustan Paper Corporation Limited 74%
State Trading Corporation of India Limited 75% (65% through strategic sale and 10% to employees)
Sale of Small Portions of Government Equity Through an IPO or FPO Without Changing the Public
Sector Character of CPSE
The government has also approved, in principle, the following:

a. listing of currently unlisted profitable CPSEs (other than Navratnas), each with a net worth in excess of Rs 200 crore, through
an Initial Public Offering (IPO), either in conjunction with a fresh equity issue by the CPSE concerned or independently by the
government, on a case-by-case basis, subject to the residual equity of the government remaining at least 51 per cent and the
government retaining the management control of the CPSE;
b. the sale of minority shareholding of the government in listed, profitable CPSEs, either in conjunction with a public issue of fresh
equity by the CPSE concerned or independently by the government, subject to the residual equity of the government remaining
at least 51 per cent and the government retaining management control of the CPSE; and
c. constitution of a “National Investment Fund” (NIF).
On July 6, 2006, the government decided to keep all disinvestment decisions and proposals on hold,
pending the further review. The disinvestment decisions covered under this decision were:
disinvestment of 5 per cent of the government’s holding in Power Finance Corporation (PFC)
Limited, riding piggyback on a fresh issue of PFC; offer for sale, through book-building process, of
15 per cent equity in National Mineral Development Corporation (NMDC) and 10 per cent equity each
in Neyveli Lignite Corporation Limited (NLC) and National Aluminium Company Ltd. (NALCO).
Later, on November 23, 2006, the government approved an IPO by PFC, consisting of a fresh issue of
equity alone. The IPO of PFC was completed in February 2007.

On July 6, 2006, the government decided to keep all disinvestment decisions and proposals on hold, pending the further
review.
National Investment Fund (NIF)
In pursuance of the policy laid down in NCMP and the decision of the government to constitute NIF,
the proposal for its operationalisation was approved on November 3, 2005. Accordingly, the
Department of Disinvestment (DoD) has issued a resolution on November 23, 2005 (Annexure-13),
constituting “NIF” with the following objectives, structure and administrative arrangements,
investment strategy, and accounting procedure:

In pursuance of the policy laid down in NCMP and the decision of the government to constitute NIF, the proposal for its
operationalisation was approved on November 3, 2005.
Objectives
i. The proceeds from disinvestment of CPSEs will be channelised into NIF, which is to be maintained outside the Consolidated
Fund of India (CFI).
ii. The corpus of NIF will be of a permanent nature.
iii. NIF will be professionally managed to provide sustainable returns to the government, without depleting the corpus. Selected
Public Sector Mutual Funds will be entrusted with the management of the corpus of NIF.
iv. 75 per cent of the annual income of NIF will be used to finance the selected social sector schemes, which promote education,
health, and employment. The residual 25 per cent of the annual income of the Fund will be used to meet the capital investment
requirements of profitable and revivable CPSEs that yield adequate returns, in order to enlarge their capital base to finance
expansion/diversification.
Structure and Administrative Arrangements

NIF will be operated by the selected Fund Managers under the discretionary mode of the Portfolio
Management Scheme, which is governed by SEBI guidelines. The entire work of NIF will be
supervised by the Chief Executive Officer (CEO) of NIF, a senior officer of the government. A part-
time advisory board consisting of three eminent persons, with the requisite expertise to be appointed
by the government, would advise CEO on various aspects of the functioning of NIF.

NIF will be operated by the selected Fund Managers under the discretionary mode of the Portfolio Management Scheme,
which is governed by SEBI guidelines.
Investment Strategy
i. The broad investment strategy is to provide sustainable returns without depleting the corpus.
ii. The investment strategy for NIF will be formulated by the CEO, based on the advice of the Advisory Board, so as to ensure
that the government has a hands-off relationship in terms of the actual investment that is to be done by the Fund Managers.
iii. Only broad guidelines are to be provided under the “discretionary mode” to the Fund Managers, within which individual
investments would be made independently by the Fund Managers. More detailed guidelines specifying investment instruments
and limits for investment in such instruments will be separately specified in the agreements to be entered into between the Fund
Managers and the CEO of NIF, on behalf of the government.
iv. Other operational details such as allocation of funds to the selected Fund Managers, negotiations of management fee and
charges to be paid to the Fund Managers, and so on, will be also decided by the CEO based on the advice of the Advisory
Board. Appropriate mechanisms for regular review and monitoring of the functioning of NIF, emerging market trends, and future
prospects will be instituted.
Accounting Procedure
i. The receipts from disinvestment of CPSEs will be deposited in CFI under the designated Head. Thereafter, these amounts would
be appropriated from the CFI, with a due approval by the DoD, and transferred to the selected Fund Managers through the CEO
of NIF.
ii. The income from NIF will be similarly deposited into CFI and would be appropriated from it for specific purposes, as per the
scheme of appropriation approved from time to time by the Department of Expenditure.
Fund Managers of NIF
The following Public Sector Mutual Funds have been appointed initially as Fund Managers to manage
the funds of NIF under the “discretionary mode” of the Portfolio Management Scheme, which is
governed by the SEBI guidelines.
a. UTI Asset Management Company Limited,
b. SBI Funds Management (Pvt) Limited, and
c. Jeevan Bima Sahayog Asset Management Company Limited.
Disinvestment Programme for 2007–08
MUL
In December 2006, the government decided to sell its residual 10.27 per cent equity in MUL, through
the differential pricing method, to Indian public sector financial institutions, public sector banks, and
Indian mutual funds. The sale was completed in May 2007, realising Rs 2366.94 crore for the
exchequer.
Critical Appraisal
The privatisation policy of the government has been criticised particularly by sociologists,
economists, and communist politicians. However, the industrial policy of the then Chief Minister of
West Bengal, Jyoti Basu, announced in 1994, provided for an opening up of the industrial sector for
large private investments and foreign ventures. It is pertinent to note that even a communist
government felt the need for promoting the private sector and privatising businesses. Hence, the
criticism that privatisation is against the principle of socialism or the socialistic pattern of welfare
state is of no substance.

The privatisation policy of the government has been criticised particularly by sociologists, economists, and communist
politicians.
Round the world, privatisation moves have been criticised. Almost all the past privatisation in India
has given rise to controversy. The first was the state of Modern Foods India Limited (MFIL). The
second was that of Bharat Aluminum Company Limited and the third was Ibvally (Orissa ). The MFIL
case illustrates the problem of valuation—that the value of a firm may not lie in its normal operating
assets, but in something peripheral like the land, which has not much value as a going concern but has
a lot of value on liquidation. Besides, the value of a firm for different buyers would be different as
each buyer looks for a different type of synergy in the candidate firm.
The Balco case illustrates the importance of paying attention to establishing legitimacy first and
choosing the target of privatisation carefully. Initiating privatisation in a big way in an opposition
party-rule State was perhaps a strategic mistake. Besides, whom the unit is sold to is as important as
the price at which it is sold, for the plant must run well after it is privatised. The LB-valley experience
indicates that if the competition is run well with transparent procedures, the outcome would be good
with many bidders. Even more bidders from the United States would have come but for the fact that
escrows were not initially given but agreed to later.

The Balco case illustrates the importance of paying attention to establishing legitimacy first and choosing the target of
privatisation carefully.
It is expected that such disinvestment would bring in the market force and competition in the
working of such enterprises, would introduce autonomy, and would also improve their overall
operating performance. This, however, raises questions such as how such disinvestment would ensure
autonomy to management. How far would privatisation bring additional savings in the country?
Would it lead to additional savings by the private sector or would it be a mere channeling of private
savings by the erstwhile public sector? How are the funds that are raised from disinvestment planned
to be utilised? Would utilising these funds for meeting operating expenses or revenue deficit not
amount to meeting operating expenses out of the sale proceeds of jewellery? Further privatisation of
chronically loss-making units, either by way of sale of individual assets or by outright sale, no doubt
would reduce the financial burden on the government but would require political will.
Suggestions
The key element for improving performance is to let the public enterprise’s management function
autonomously. There is a little indication of a change in the control by the government over the
public enterprises. The enterprise must be free to deal with surplus staff and restructure their
enterprises as they feel necessary. The future profitable operation of public enterprises depends upon
the following factors:
1. Managerial autonomy by removing the controls and guidelines given to the management by the government,
2. Giving up of government control at least by making the board of directors the final authority in the enterprise,
3. Restructuring of enterprises through mergers,
4. Reliance on market for signals on price-product mix, quality, and so on,
5. Cost reduction, improvement in productivity, optimising product mix, and maximum capacity utilisation, and
6. Reducing overstaffing.
The key element for improving performance is to let the public enterprise’s management function autonomously.
CASE
Water services fall in a low-level equilibrium, where the utilities provided limited and low-quality
services, due to insufficient resources. And inadequate service results in fewer resources being
collected. As a consequence, the entire population cannot be adequately covered. And it is the poor
who have to pay the price by incurring substantial costs to seek alternatives. Paradoxically, any
textbook on public economics will tell us that these very arguments make government intervention
imperative. From the early 1990s there has been a surge in privatisation-related projects/proposals in
the water sector in both the developed and the developing countries (to a greater extent), often at the
behest of the World Bank.
The proponents say that the low-level equilibrium in the water sector can be punctured only
through private sector participation (PSP). Oddly enough, the World Bank has increasingly made its
loans conditional on the local governments, privatising their waterworks. The arguments put forward
in favour of privatisation are only a myth. Experience across the world suggests that instead of being
a competitive market, water markets are generally monopolistic.
The high barriers to entry and the low market contestability have resulted in few firms competing
globally. In such a situation, the only option with the State is to regulate the firm. However, the
effectiveness of such regulations is often questionable. There is evidence that firms even refuse to
adhere to the rules of the regulator. Reports indicate that one of the private owners of the water
project challenged the government to take back the franchise if the regulator did not concede to the
company’s demands for changing the terms of the original agreement.
Since the sector has very few firms, terminating the concession is not a realistic option. Sometimes,
the contracts may be difficult to alter or cancel once awarded, even if the circumstances change. Even
in the developed countries, terminating water concession can be very difficult. Large firms, public or
private, generally have principal-agent problems that cause inefficiencies. In addition, in the case of a
regulated sector with information asymmetry (because all the information is not in the public
domain), the private operators may be inefficient to even over the cost prices, as a fixed return is
assured by the regulator.
The assertion that PSP is essential to finance a large investment that is needed in the water sector is
also entirely true. Contrary to expectations, despite privatisation, the financial support from host
governments through subsidies or guarantees remains at significant levels. A review of different
privatisation experiences across the world shows that privatisation is concentrated in poorer countries
and the private water industry is dominated by six MNCs.
The efficiency of private-owned utility is also shrouded in mystery. A recent review of 12
empirical studies by Anwander and Ozuna in the Environment and Development Economics, on the
relative efficiency of public versus private utilities confirms that the effect of privatisation is
ambiguous for the water sector. Only four studies have concluded that private ownership is more
efficient than public ownership. Numerous examples exist of poorly performing privatised utilities.
Several countries in Latin America have in fact reverted to municipal management due to poor
performance of the private operators.
Corruption is another accompanying feature of water privatisation. Recently, a French
government’s move of privatisation was accused of corrupt practices to secure enormous profits.
Moreover, any privatisation which involves just one or very few participants will lack transparency.
Private firms may be able to recover the tariffs better as they have no obligation to maintain supplies
to the non-payer or to keep prices artificially low. To achieve this, they may resort to practices such
as supplying water only to enterprises where they can make huge profits.
For example, the 1995 water privatisation in Puerto Rico left the poor without water while the US
military bases and tourist resorts got adequate supplies. Indian law holds that the groundwater is not a
common/community resource but belongs to the landowner. Any privatisation will result in
unchecked and excessive sinking of bore wells which will
1. lower the water table and
2. overload the water supplies with dissolved salt, fluorine, and arsenic.
In the long run, when the water table lowers and water becomes saline, it will have wide implication
for land-use patterns also. This is what is happening everywhere. In India, Bechtel was involved in the
Dabhol Power Project with Enron. It is now involved in the water privatisation of Coimbatore and
Tirupur, as part of a consortium with Mahindra and Mahindra and United International North West
Water. As with other water privatisation contracts, this one has not been made public.
There exist several other ways to improve the efficiency of water supply, such as public ownership
of resources and operations, public ownership with operations contracted out to private sector, and
community and user participation. Before resorting to PSP, public-private participation through
service or management contracts should be tried out. The influence and control over the pricing of
water tariffs is vital to avoid exploitation of the monopoly power by private firms.
From the investor ’s point of view too, the public-private model works better than the private sector
as the primary task of investing in a country is mitigated to a great extent. The utilities could be
restructured to make them more efficient. One component of restructuring is metering and charging a
volumetric price reflecting the cost of service. It will not only improve the usage of water but will
also reduce the wastage of the same by the users.
Case Questions
1. Do you support privatisation of water utilities?
2. Why are only private ownership and operations being actively pursued? Why must not one first try the other ways and then
resort to handing over the vital resources to the MNCs?
SUMMARY
While the Congress-I initiated the process of economic reform with an emphasis on privatisation and
pushed it to some extent, the BJP and NDA (National Democratic Alliance) government, blatantly and
in a muddle-headed fashion carried forward the banner of privatisation, taking advantage of the fact
that the Congress is not in a position to oppose it, being itself the architect of privatisation. In the
process, the country had to pay enormous costs to meet the budget deficits by fleecing the healthy
PSUs, and in the process, the navratnas are also not spared.
What the country ought to do is to immediately have a fresh look at the role of the highly profit-
making PSUs. Now that the public sector is becoming performance oriented, there is a need to
strengthen professionalism, give more powers to the Managing Directors of the PSUs in decision
making, and reduce their dependence on ministerial control. Only after giving more powers to the
PSUs can they be made more accountable. As there is no conclusive evidence that the private sector is
more efficient than the public sector, whereas facts giving an edge to the public sector, it would be
prudent to abandon the irrational policy of disinvestments of the PSUs and search for other
alternatives to further improve the PSUs’ performance.
KEY WORDS
Privatisation
Fiscal
Disinvestment
Sick Unit
Public Sector
Debt
Profit-earning Capacity
Fiscal Crises
Discount Flow Method
Capital Infusion
Stock
BRPSE
Net Asset Value (NAV)
Merchant Bankers
QUESTIONS
1. Explain the meaning of privatisation. Make a critical analysis of the issue of privatisation.
2. Explain the changes in the public opinion on PSEs and the privatisation move of PSEs in the recent years.
3. Explain the major changes in the policy directions of the government towards PSEs in India.
4. Explain the measures to be followed for the revival of PSEs in India.
5. Discuss the measures taken by the UPA government for the revival of PSEs.
REFERENCES
Datt, R. and K. P. M. Sundharam (2005). Indian Economy. Delhi: Sultan Chand.

Dhar, P. K. (2000). Indian Economy: Its Growing Dimensions New Delhi: Kalyani Pub.
Nib, S. (2004). Disinvestments in India. New Delhi: Sage.
CHAPTER 24
Globalisation
CHAPTER OUTLINE
Background
Views of Scholars on Globalisation
Studies on Globalisation
Efforts of Anglo-Americans
Salient Aspects of Globalisation
Role of Transnational Corporations (TNCs)
Concept and Meaning
Definition
Features
Globalisation is Inevitable
Ten Rules of Global Reforms
India and Globalisation
Government’s Measures Towards Globalisation
Globalisation and Its Impact on the Indian Industry
Effects of Globalisation
Pro-globalisation
Anti-globalisation
Globalisation—an Assessment
A Critical Appraisal of Globalisation
Threats to Globalisation
Case
Summary
Key Words
Questions
References
BACKGROUND
The widespread scholarly emphasis on the economic dimension of globalisation derives partly from
its historical development as a subject of academic study. Some of the earliest writings on the topic
explore in much detail how the evolution of international markets and corporations led to an
intensified form of global interdependence. These studies point to the growth of international
institutions such as the European Union (EU), the North American Free Trade Association (NAFTA),
and other regional trading blocs. The economic accounts of globalisation convey the notion that the
essence of the phenomenon involves “the increasing linkage of national economies through trade,
financial flows, and foreign direct investment (FDI) by multinational firms”. Thus, the expanding of
economic activity is identified as both the primary aspect of globalisation as well as the engine of its
rapid development.

The economic accounts of globalisation convey the notion that the essence of the phenomenon involves “the increasing
linkage of national economies through trade, financial flows, and foreign direct investment (FDI) by multinational firms”.
VIEWS OF SCHOLARS ON GLOBALISATION
Many scholars who share this economic perspective consider globalisation a real phenomenon that
signals an epochal transformation in the world affairs. Their strong affirmation of globalisation
culminates in the suggestion that a quantum change in human affairs has taken place, as a new flow of
large quantities of trade, investment, and technologies has expanded from a trickle to a flood across
national borders. They propose that the study of globalization should be moved to the centre of
social–scientific research. According to their view, the central task of this research agenda should be
a close examination of the evolving structure of global economic markets and their principal
institutions.
STUDIES ON GLOBALISATION
The studies of economic globalisation are usually embedded in thick historical narratives that trace
the gradual emergence of the new post-war world economy to the 1944 Bretton Woods Conference.
Under the leadership of the United States and Great Britain, the major economic powers of the West
decided to reverse the protectionist policies of the inter-war period (1918–39) by committing
themselves to the expansion of international trade. The major achievements of the Bretton Woods
Conference include limited liberalisation of trade and establishment of binding rules on international
economic activities. In addition, the participants of the Bretton Woods Conference agreed upon the
creation of a stable currency exchange system in which the value of each country’s currency was
pegged to a fixed gold value of the US dollar. Within these prescribed limits, individual nations were
free to control the permeability of their borders, which allowed them to set their own economic
agendas, including the implementation of extensive social welfare polices. Bretton Woods also set the
institutional foundations for the establishment of three new international economic organisations.

In Bretton Woods Conference, 1944, the gold-based fixed rate system was set.
The International Monetary Fund (IMF) was created to administer the international monetary
system. Likewise, the International Bank for Reconstruction and Development, or World Bank, was
initially designed to provide loans for Europe’s post-war reconstruction. Beginning in the 1950s, its
purpose was expanded to fund various industrial projects in the developing countries around the
world. In 1947, the General Agreement on Tariffs and Trade (GATT) became the global trade
organisation charged with fashioning and enforcing of multilateral trade agreements. Founded in
1995, the World Trade Organisation (WTO) emerged as the successor organisation to GATT.

The IMF and the International Bank for Reconstruction and Development, or World Bank, were set up in Bretton Woods
Conference in 1944.
In 1947, GATT became the global trade organisation charged with fashioning and enforcing of multilateral trade
agreements.
During its operation for almost three decades, the Bretton Woods system contributed greatly to the
establishment of what some observers have called the “golden age of controlled capitalism”.
According to this interpretation, the existing mechanism of a State’s control over the international
capital movements made full employment and expansion of a welfare state really possible. Rising
wages and increased social services secured in the wealthy countries of the global North gives a
temporary class compromise.
Most scholars of economic globalisation trace the accelerating integrationist tendencies of the
global economy to the collapse of the Bretton Woods system in the early 1970s. In response to
profound changes in the world economy that undermined the economic competitiveness of the US-
based industries, President Richard Nixon decided in 1971 to abandon the gold-based fixed-rate
system. The combination of new political ideas and economic developments, high inflation, low
economic growth, high unemployment, public sector deficits, and two major oil crises within a
decade led to the spectacular election victories of conservative parties in the United States and the
United Kingdom. These parties spearheaded the neoliberal movement towards the expansion of
international markets, a dynamic idea supported by the deregulation of an enormous increase in
global financial transactions.

Most scholars of economic globalisation trace the accelerating integrationist tendencies of the global economy to the
collapse of the Bretton Woods system in the early 1970s.
EFFORTS OF ANGLO-AMERICANS
During the 1980s and 1990s, the Anglo-American efforts to establish a single global market were
further strengthened through comprehensive trade-liberalisation agreements that increased the flow
of economic resources across national borders. The rising neoliberal paradigm received a further
limitation with the 1989–91 collapse of command-type economies in the Eastern Europe. Shattering
the post-war economic consensus of Keynesian principles, free-market theories pioneered by
Friedrich Hayek and Milton Friedman established themselves as the new economic orthodoxy,
advocating the reduction of the welfare state, downsizing of the government, and the deregulation of
the economy. A strong emphasis on “monetarist” measures to combat inflation led to the
abandonment of the Keynesian goal of full employment in favour of establishing more “flexible”
labour markets. In addition, the dramatic shift from a state-dominated to a market-dominated world
was accompanied by technological innovations that lowered the cost of transportation and
communication. The value of world trade increased from $57 bn in 1947 to an astonishing $6 tn in the
1990s.

Shattering the post-war economic consensus of Keynesian principles, free-market theories pioneered by Friedrich Hayek
and Milton Friedman established themselves as the new economic orthodoxy, advocating the reduction of the welfare state,
downsizing of the government, and the deregulation of the economy.
SALIENT ASPECTS OF GLOBALISATION
Perhaps, the two most important aspects of economic globalisation relate to the changing nature of
the production process and the internationalisation of financial transactions. Indeed, many analysts
consider the emergence of a transnational financial system the most fundamental feature of our time.
As sociologist Manuel Castells points out, the process of financial globalisation accelerated
dramatically in the late 1980s as capital and securities markets in Europe and the United States were
deregulated. The liberalisation of the financial trading allowed for an increased mobility among the
different segments of the financial industry, with fewer restrictions, and a global view of investment
opportunities. In addition, the advances in data processing and information technology (IT)
contributed to the explosive growth of tradable financial value. However, a large part of the money
involved in expanding the markets, had little to do with supplying capital for a productive investment,
putting together machines, raw materials, and employees to produce saleable commodities and the
like. Most of the growth occurred in the purely money-dealing currency and securities markets that
trade claims to draw profits from future production. Aided by new communication technologies,
global entries and speculators earned spectacular incomes by taking advantage of the weak, financial
and banking regulations in the emerging markets of the developing countries. By the late 1990s, an
equivalent of nearly $2 tn was exchanged daily in the global currency markets alone.

Perhaps, the two most important aspects of economic globalisation relate to the changing nature of the production process
and the internationalisation of financial transactions.
ROLE OF TRANSNATIONAL CORPORATIONS (TNCS)
While the creation of international financial markets represents a crucial aspect of economic
globalisation, another important economic development in the last three decades also involves the
changing nature of global production. Transnational corporations (TNCs) consolidated their global
operations in an increasingly deregulated global labour market. The availability of cheap labour,
resources, and favourable production conditions in the Third World enhanced both the mobility and
the profitability of TNCs. Accounting for over 70 per cent of the world trade, these gigantic
enterprises expanded their global reach as their FDI rose by approximately 15 per cent annually
during the 1990s. Their ability to disperse manufacturing processes into many discrete phases,
carried out in many different locations around the world, is often cited as one of the hallmarks of
economic globalisation. Indeed, the formation of such “global commodity chains” allows huge
corporations such as Nike and General Motors to produce, distribute, and market their products on a
global scale. Nike, for example, sub-contracts 100 per cent of its goods production to 75,000 workers
in China, South Korea, Malaysia, Taiwan, and Thailand.

Transnational corporations (TNCs) consolidated their global operations in an increasingly deregulated global labour
market. The availability of cheap labour, resources, and favourable production conditions in the Third World enhanced
both the mobility and the profitability of TNCs.
Transnational production systems augment the power of global capitalism by enhancing the ability
of TNCs to bypass the nationally based political influence of trade unions and other workers’
organisations in collective wage-bargaining processes. While rejecting the extreme accounts of
economic globalisation, the political economist Robert Gilpin nonetheless concedes that the growing
power of TNCs has profoundly altered the structure and functioning of the global economy.
These giant firms and their global strategies have become major determinants of trade flows and
of the location of industries and other economic activities around the world. Most of the investments
are in capital and technology-intensive sectors. These firms have become central in the expansion of
technology flows to both industrialised and industrialising economies. As a consequence,
multinational firms (MNCs) have become extremely important in determining the economic,
political, and social welfare of many nations. Controlling much of the world’s investment capital,
technology, and access to global markets, such firms have become major players not only in the
international economic affairs, but in the political affairs as well.

The consequence of globalisation is MNCs are becoming extremely important in determining the economic, political, and
social welfare of many nations.
CONCEPT AND MEANING
The phenomenon of globalisation seems to have occurred in the late 19th century. The share of export
in the gross domestic product (GDP) of 16 major industrialised countries rose from 18.2 per cent in
1900 to 21.2 per cent in 1913. If we consider the period from 1950 to 1999, the world exports rose
from $61 bn in 1950 to $5,460 bn in 1999. In addition, the trade in commercial services amounted to
$1,340 bn in 1999. Over this period, the share of world exports to world output grew from 6 per cent
to 16 per cent; likewise, FDI flows increased to a record of $855 bn in 1999.
While three-fourths of this ($636 bn) were attracted by the developed countries, some of the
developingcountries, especiallyChina, havebeen major beneficiaries in the recent years. Thehigh-per
forming Asian economies, so also some of the Latin American countries, have consistently secured
tremendous gains from a dynamic and vibrant world trade and investment. It is seen from the above
data that the integration of world economy through international trade, at the turn of the last century,
was about the same as it is towards the end of this century. This indicates the presence of international
trade in both the periods.

The integration of world economy through international trade, at the turn of the last century, was about the same as it is
towards the end of this century.
DEFINITION
The IMF defines globalisation as “the growing economic interdependence of countries worldwide
through increasing volume and a 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”.
Charles U.L. Hill defines globalisation as “the shift towards a more integrated and interdependent
world economy. Globalisation has two main components—the globalisation of markets and the
globalisation of production”. Interdependency and integration of individual countries of the world
may be called “globalisation”. Thus globalisation integrates not only economies but also the
societies. The globalisation process includes globalisation of markets, globalisation of production,
globalisation of technology, and globalisation of investment.

Globalisation is nothing but the growing economic interdependence through increasing cross-border transaction in goods
and services.
FEATURES
Globalisation encompasses the following features:
1. Operating and planning to expand businesses throughout the world,

Globalisation enables a business to operate and plan to expand throughout the world.
2. Erasing the differences between domestic- and foreign market,

3. Buying and selling goods and services from/to any country in the world,
4. Establishing manufacturing and distribution facilities in any part of the world, based on feasibility and viability rather than
national consideration,
5. Product planning and development are based on the market consideration of the entire world,
6. Sourcing of factors of production and inputs like raw materials, machinery, finance, technology, human resources, and
managerial skills from the entire globe,
7. Global orientation in strategies, organisational structure, organisational culture, and managerial expertise, and
8. Setting the mind and attitude to view the entire globe as a single market.

Entire globe is becoming a single market.
Box 24.1 explains the management strategies that are to be globalised.

Box 24.1 Management Strategies to be Global
1. Economies of scale, cost reduction, and efficiency in the production process.

2. Organisational restructuring involving men, materials, and management that are suitable for global production.
3. Calibrating to globalisation through FDI capital flow and capital restructuring.
4. Latest technology absorption and modernisation.
5. Cost reduction and quality controls leading to efficiency.
6. Aggressive sales strategy, multimedia marketing, brand promotion, and trademarks and patent rights.
7. Financial strengthening through mergers, FJVS, and acquisitions.
GLOBALISATION IS INEVITABLE
According to the globalist perspective, globalisation reflects the spread of irreversible market forces
that are driven by technological innovation which make the global integration of national economies
inevitable. In fact, globalism is almost always intertwined with the deep belief in the ability of the
markets to use new technologies to solve social problems far better than any alternative course.
When, years ago, the British Prime Minister Margaret Thatcher famously pronounced that “there is
no alternative” (TINA), she meant that there existed no longer a theoretical and practical alternative to
the expansionist logic of the market. In fact, she accused those nonconformists, who still dared to
pose alternatives, as foolishly relying on anachronistic, socialist fantasies that betrayed their inability
to cope with the empirical reality. The governments, political parties, and social movements had no
other choice but to “adjust” to the inevitability of globalisation. Their remaining sole task was to
facilitate the integration of national economies in the new global market. The states and inter-state
system should, therefore, serve to ensure the smooth working of market logic. Indeed, the multiple
voices of globalism convey to the public their message of inevitability with a tremendous consistency.
Below are some examples.

According to the globalist perspective, globalisation reflects the spread of irreversible market forces that are driven by
technological innovation which make the global integration of national economies inevitable.
In a speech on US foreign policy, President Clinton told his audience, “Today we must embrace the
inexorable logic of globalisation—that everything from the strength of our economy to the safety of
our cities, to the health of our people depends on events not only within our borders, but half a world
away”. On another occasion he emphasised that “globalisation is irreversible. Protectionism will only
make things worse”. Clinton’s Under Secretary Eizenstate echoed the assessment of his boss,
Globalisation is an inevitable element of our lives. We cannot stop it any more than we can stop the waves from crashing on the
shore. The arguments in support of trade liberalisation and open markets are strong ones—they have been made by many of you and
we must not be afraid to engage those with whom we respectfully disagree.
Frederick W. Smith, the Chairman and CEO of FedEx Corporation, suggests that “globalisation is
inevitable and inexorable and it is accelerating ... Globalisation is happening, it’s going to happen. It
does not matter whether you like it or not, it’s happening, it’s going to happen”. Journalist Friedman
comes to a similar conclusion, “Globalisation is very difficult to reverse because it is driven both by
powerful human aspiration for higher standards of living and by enormously powerful technologies
which are integrating us more and more every day, whether we like it or not”. But Friedman simply
argues by asserting that there is something inherent in technology that requires a neoliberal system.
He never considers that, for example, new digital communication technologies could just as easily be
used to enhance public-service media as it can be utilised in the commercial, profit-making
enterprises. The choice depends on the nature of the political will exerted in a particular social order.

Globalisation is very difficult to reverse because it is driven by both powerful human aspiration and powerful technologies.
TEN RULES OF GLOBAL REFORMS
Backed by powerful states in the North, the international institutions such as the WTO, IMF, and
World Bank enjoy the privileged position of making and enforcing the rules of the global economy.
In return for supplying the much-needed rules to the developing countries, the IMF and the World
Bank demand from their creditors the implementation of neoliberal policies that further the material
interests of the First World. Unleashed on the developing countries in the 1990s, these policies are
often referred to as “Washington Consensus”. It consists of a 10-point programme that was originally
devised and codified by John Williamson, formerly an IMF advisor in the 1970s.

Washington Consensus consists of a 10-point programme, the purpose of which was to perform the internal economic
mechanism of debtor countries in the developing world.
The programme was mostly directed at countries with large-remaining foreign debts from the
1970s and 1980s. Its purpose was to reform the internal economic mechanisms of debtor countries in
the developing world so that they would be in a better position to repay the debts they had incurred. In
practice, the terms of the programme spelled out a new form of colonialism. The 10 areas of the
Washington Consensus, as defined by Williamson, required Third World governments to enforce the
following reforms:
1. A guarantee of fiscal discipline, and a curb on budget deficits.

2. A reduction of public expenditure, particularly in the military and public administration.
3. Tax reform, aiming at the creation of a system with a broad base and with effective enforcement.
4. Financial liberalisation, with interest rates determined by the market.
5. Competitive exchange rates, to assist the export-led growth.
6. Trade liberalisation, coupled with the abolition of import licensing and a reduction of tariffs.
7. Promotion of FDI.
8. Privatisation of state enterprises, leading to efficient management and improved performance.
9. Deregulation of the economy.
10. Protection of property rights.
To call this programme “Washington Consensus” is no coincidence. The United States is by far the
most dominant economic power in the world, and the largest TNCs are based in the United States. As
the British journalist Will Hutton points out, one of the principal aims of the Economic Security
Council set up by President Clinton in 1993 was to open up 10 countries to US trade and finance. Most
of these “target countries” are located in Asia. Again, this is not to say that the United States is in
complete control of the global financial markets and, therefore, rules supremely over this gigantic
process of globalisation. But it does suggest that both the substance and the direction of economic
globalisation are, indeed, to a significant degree shaped by the US foreign and domestic policy.

The United States is by far the most dominant economic power in the world, and the largest TNCs are based in the United
States.
INDIA AND GLOBALISATION
In the broader Indian context, the earning of foreign exchange and having a comfortable balance of
payment (BoP) position were the fundamental reasons for globalisation. However, the world has
become borderless and a global village. Mass communication media like satellite TV network, fax,
Internet, and the telecommunications have internationalised the Indian consumer ’s preference. There
is no alternative for Indian industry but to globalise its operations to meet the ever-increasing
aspirations of the Indian consumers. With the current “liberalisation” programme of the Government
of India (GOI), many foreign MNCs are entering Indian markets through new projects, acquisitions,
and mergers. They are likely to compete with the Indian domestic industry with their international
mass scales. Unless the Indian industry is sufficiently globalised to counter such competitive threats in
the home market, the Indian domestic industry may find itself becoming unviable.

With the current liberalisation programme of the GOI, many foreign MNCs are entering Indian Market.
Indian industry has, hitherto, been enjoying protection in various forms from the government, to
such an extent that many of them do not really know what a severe competition can do to an industry.
Many products manufactured in India are not cost-effective and do not even measure up to the
minimum quality levels. All these are the result of the complacency accumulated over a long period
of protection. Cost-competitive, high-quality products and services can be effectively offered to
domestic consumers through the international exposure gained from globalisation. Globalisation,
besides adding higher earnings of foreign exchange, provides the companies with an access to a large
global market.
International exposure through globalisation helps companies to acquire and update their
technology, be cost-effective, and ward off future competitive threats in the domestic market.
Innovative management styles witnessed in the global markets can bring in a fresh air of creativity
and professionalism to the Indian industry. Asia is emerging as an important growth region for the
future. The market is here and the resources are available. The government diplomacy is conducive
and compelling. The need for globalisation has thus become pre-eminent for the Indian industry.

International exposure through globalisation helps companies to acquire and update their technology, be cost-effective, and
ward off future competitive threats in the domestic market.
GOVERNMENT’S MEASURES TOWARDS GLOBALISATION
The GOI has taken the following measures in order to globalise the Indian economy:
1. Removing constraints and obstacles to the entry of MNCs into India by diluting and finally scrapping restrictive laws like
Foreign Exchange and Regulation Act, 1973 (FERA). The Foreign Exchange Management Act (FEMA) has been passed by
deleting the clauses which restricted the entry of MNCs.
2. Permitting Indian companies to collaborate with foreign companies in the form of foreign joint ventures (FJVs).
3. Establishing of FJVs by Indian companies in various foreign countries.
4. World Bank-advocated import liberalisation. Consequently, the GOI reduced the import tariffs to 15 per cent.
5. Replacing licences of imports with tariffs.
6. Eliminating various import duties and drastic reduction of other import duties.
7. Lifting the quantitative restrictions (QRs) on 715 goods with effect from April 1, 2001, in order to enhance the efficiency,
quantity, product design, delivery, thus reducing the prices.

By removing export duties, lifting the QRs, and offering incentives to MNCs, the government can globalise the
Indian economy.
8. Removing export subsidies.

9. Replacing licensing of exports with duties.
10. Levying low, flat tax on the export income.
11. Reformulating the policy of export processing zones (EPZs) and export-oriented units (EOUs).
12. Liberalising the inflow of FDI.
13. Offering incentives to MNCs and NRIs (Non-Resident Indians) to invest in India.
14. Allowing foreign institutional investors (FIIs) to invest in the Indian capital market.
15. Expanding the list of items for an automatic approval of foreign equity.
16. Allowing the Indian mutual funds to invest in foreign companies.
17. Allowing the Indian companies to procure capital from foreign countries through “Euro Issues” and “Global Deposit Receipts
(GDR)”.
18. Free the way of investment in FJVs.
19. Devaluing the rupee by lifting exchange controls in a phased manner.
20. Allowing the rupee to determine its own exchange rate in the international market without an official intervention.
21. Full convertibility of rupee in the current account.
22. Acting cautiously regarding convertibility of rupee in the capital account in view of the Asian crisis.
23. Decanalising oil and agricultural trade.
24. Countering anti-dumping measures.
25. Resolving market access issues in the services.
26. Seeking membership in trade blocs.
GLOBALISATION AND ITS IMPACT ON THE INDIAN INDUSTRY

Economic Reforms
The process of economic liberalisation began during Prime Minister Indira Gandhi’s regime in the
early 1980s. It continued in a halting manner during the tenure of her son Rajiv Gandhi’s government
in the late 1980s. The aim of the policies was to move away from a state-controlled, planned economy
with an emphasis on investment in heavy industries run by the public sector, to the one which would
be more market friendly and one which envisaged a greater role for the private enterprises. The
government’s strategy has been to integrate the country’s economy with the rest of the world.

The aim of the policies was to move away from a state-controlled, planned economy withan emphasis on investment in
heavy industries run by the public sector, to the one which would be more market friendly and one which envisaged a
greater role for the private enterprises.
When the economic-reform process began, the country was going through an acute shortage of
foreign exchange. The country’s hard-currency reserves had dwindled to an abysmal level. Earlier, a
part of India’s official gold stocks had been taken out of the country to raise funds. The government
approached the IMF for a structural adjustment loan, which was granted under certain terms and
conditions. These included a drastic reduction in the fiscal deficit, a reduction in money supply, a
cutting down of the import tariff, and a devaluation of the Indian currency. The reduction in the deficit
resulted in a squeeze on the capital investment, especially in the social infrastructure sectors such as
health and education, which was subsequently reversed, as it was not found politically feasible.
Non-economic Developments
Even as the government freed the country’s industrial sector from the licensing system, marking a
radical departure from the past, the industrial production did not pick up quickly. In fact, on account
of the fiscal squeeze among the other things, the Indian industry had to go through a reversionary
phase. Non-economic developments, in particular the demolition of the Babri Mosque in December
1992, the bomb blasts in Bombay in March 1993, the outbreak of plague in August 1994, the political
instability at the Centre during 1996, the Pokhran nuclear test in 1998, and the Kargil war in 2000, all
contributed to slowing down the pace of economic growth. Major financial scandals involving
brokers, bankers, bureaucrats, and politicians were unearthed, and this led to a crash in the then-
booming stock markets and the financial sector.

Even as the government freed the country’s industrial sector from the licensing system, marking a radical departure from the
past, the industrial production did not pick up quickly.
Low Industrial Growth

The changing growth profile of the Indian economy on a trend basis during the pre and post-reform
period has been shown in Table 24.1. It is evident from the above mentioned table that the services
sector has emerged as the dominant growth driver of the economy. If the annual GDP growth has
moved up from 5.4 per cent in the pre-reform period to 6.4 per cent in the post-reform period, it is
almost entirely due to the service-sector growth surging from 6.4 per cent to 8.2 per cent during these
two separate phases. In contrast, the industrial sector has remained stuck at around 6.5 per cent annual
growth.

India has achieved a long-term average compound rate of industrial growth of about 6.5 per cent in the post-liberlisation
period.

Table 24.1 Sectoral Real Growth Rate in GDP
Source: Indian Industry in Post-Liberalisation Era, published by Forum of Free Enterprise, Mumbai, July–August 2001.

Although India has achieved a long-term average compound rate of industrial growth of about 6.5
per cent in the post-liberalisation period, this in itself is not enough. India has lost its status from
being the 10th largest industrial power in terms of the aggregate value added of manufacturing output,
till about the early 1970s, to the being the 17th or 18th at present in the global-league table. Many other
countries which embarked on the industrialisation process much later than India have stolen a march
over it because of their emphasis on (i) economies of scale, (ii) infusion of foreign capital and
technology, and (iii) an outward orientation and a thrust on the export markets.
High Tariffs and Taxes
The customs tariffs for a whole range of industrial products in India are very high and are set to be
brought down to the level of East Asian countries in the next three years (2005–08). In the recent
budget, the Finance Minister announced that he would reduce the number of rates to the minimum
with a peak rate of 15 per cent within the next three years. The Indian industry is further burdened with
heavy indirect taxes. There is a vast disparity between the burdens of domestic indirect taxes
applicable to the Indian industry and similar taxes applicable to the foreign producers in their
respective economies.
The Indian industry cannot effectively exploit the economies of scale unless indirect taxes are
rationalised and customs tariffs progressively reduced. The government should also consider the
other factors for Indian industry to progress such as (i) the removal of quantitative restrictions (ii) the
entry of China into the WTO, (iii) the devaluation of Indian rupee, and (iv) the disparity between the
tariffs and taxes.

The Indian Government should consider the removal of QRs and devaluation of Indian rupee, to progress.
Increased Industrial Unemployment
There are widespread closures of industries, downsizing of jobs due to modernisation and
globalisation, and an increase in the industrial unemployment. There is an urgent need of
strengthening the mechanism of the social safety net. The crux of the problem is about the allocation
of adequate financial resources for the National Renewal Fund (NRF) and using them not only for
retrenchment compensation by way of voluntary retirement benefits but more importantly for
retraining and redeployment of the growing army of labour force, which are likely to be rendered
jobless with the massive onslaught of competition and globalisation.

Unemployment due to modernisation, uncertainty in stock markets, old and new economy syndrome, industrial
consolidation and restructuring and negligible global export are the negative impacts of globalisation.
Uncertainty in Stock Markets
Stock markets are becoming the driving force in the new, market-driven industrial structure that is
coming into existence. In the past, the allocation of resources to the industry was predominantly
determined by the forces of industrial licensing, import controls, pricing, and distribution
regulations. In the implementation of this regime, the perspective planning programmers in the
sequence of five-year plans of the Planning Commission essentially offered the driving principles.
But this is no longer valid now.
There is an uncertainty whether many of our basic and capital goods industries will be looked upon
favourably if they seek the support of capital markets for funding their new programmes of
expansion and diversification. This also raises an important issue that in the event of capital markets
not supporting the future resource needs for the creation of new industrial capacities,which would
then come forward to support the process of further industrialisation, what would be the condition?
Old and New Economy Syndrome

There is a growing perception that the old economy is all “bad old guys and bad old days” while the
new economy is ushering in new hopes of prosperity. The reflection of this thought process is evident
in the growing market capitalisation of IT stocks in the total market capitalisation in the stock
markets. Of course, the recent rapid slide in the IT sector stocks have brought about a substantive
correction in the extreme distortion that was created earlier. Even in the global stock markets
especially, at NASDAQ (National Association of Securities Dealers Automated Quotations), there has
been a precipitous fall in the new technology stocks. The increasing globalisation also means a
transmission of investment sentiments across the stock markets of the world. The Indian markets
cannot be immune to this trend but this fact raises the following questions—Has the old economy
failed us? or Are our wrong policies that have failed most sectors of the old economy? The basic
issue is how to utilise the new economy dynamics to modernise and galvanise the old economy rather
than getting lost in the irrelevant debate of past failures.

The basic issue is how to utilise the new economy dynamics to modernise and galvanise the old economy rather than
getting lost in the irrelevant debate of past failures.
Industrial Consolidation and Restructuring
The post-reform experience suggests that the Indian industry is not averse to the process of
restructuring. In the recent years, there have been significant efforts towards industrial consolidation
and restructuring, including some tough decisions on downsizing, divestments, and global norms of
productivity, cost, and pricing. The classic examples are cement, petrochemicals, steel, and
pharmaceutical industries. This restructuring process needs enormous stimulus, and it must spread
across many other sub-sections of the Indian industry too. The crucial questions are—How far the
reform process of imparting flexibility to labour markets and the reform of bankruptcy laws,
including the repeal of SICA (Sick Industries Companies Act) and the dissolution of BIFR (Board for
Industrial and Financial Reconstruction), facilitate the restructuring of the Indian industry? and How
soon will the proposed reforms become operative and effective given the limitations of a coalition
governance?

How soon will the proposed reforms become operative and effective given the limitations of a coalition governance?
Negligible Global Export
Global markets offer opportunities for all but opportunities by it self do not guarantee the desired
results. For high-performing Asian economies as well as for China, the benefits of globalisation are
clearly reflected in the rising ratio of their trade (imports plus exports) to GDP, which in 2004 was
hovering between 40 per cent and 45 per cent. But in the case of India, even granting the fact that our
trade to GDP ratio has increased in the post-reform period from about 13 per cent of GDP in the early
1990s to about 20 per cent of GDP at 2004, we have a long way to go before we can catch up with the
levels achieved by the Asian Tigers.

The benefits of globalisation for China is, their trade to GDP ratio is rising and is hovering between 40 per cent and 45 per
cent, whereas for India, it is only 20 per cent at present.
In the most significant areas of globally manufactured products like gems and jewellery,
readymade garments, cotton yarn, fabrics, tea, and leather products, India does not have any
meaningful share of global markets. Even in the IT sector, it is the software segment where India is
doing extremely well while the hardware sector remains at a nascent stage only. In substance, what has
been achieved so far is impressive but not very inspiring. India has lost its status as the 10th largest
industrial power in the world, in the course of the last two decades or more. It has also to make a
mark in the export markets of the manufacturing products. India’s overall share in the global exports
is hovering around a modest 0.7 per cent in 2008. All this goes to suggest that in the coming years, the
Indian industry will have to either shape up or ship out.
Other Areas
The gross domestic savings (GDS) as a percentage of GDP declined to 22 per cent in 1998–99 when
compared to 24.3 per cent in 1990–91. The investment rate is 25 per cent and it is believed that the
savings-investment gap will be made up by external funds. But all through the 1990s the exports have
been growing slower than the imports, a continuation of an old trend. In addition, the currency has
been steadily devaluing, implying an increase in the debt-service burden and costlier imports.
The currently comfortable state of external balance primarily reflects short-term capital flows
from the FIIs. FDI, despite wide-ranging incentives, is about $2 bn whereas the corresponding figure
for China is close to $20 bn. The former Prime Minister Chandra Shekhar asserted in an interview
that liberalisation policies will not do any good to our country and instead only strengthen the hands
of the MNCs.
The former Union Finance Minister Madhu Dandavate, while delivering a lecture on “GATT and
Liberalisation”, quoted, “Approximately seven lakh small-scale industries (SSI) in the country have
closed down while another six lacks SSIs and 7000 big industries have become sick in the last 5 years
during India’s march towards globalisation”. Dandavate said that the SSI sector in India was once so
dynamic that it accounted for 40 per cent of the country’s productivity, providing employment to 19.7
million people, and earning about 45 per cent of foreign exchange; the same sector is now on its
deathbed.

The former Union Finance Minister Madhu Dandavate, while delivering a lecture on “GATT and Liberalisation”, quoted,
“Approximately seven lakh small-scale industries (SSI) in the country have closed down while another six lacks SSIs and
7000 big industries have become sick in the last 5 years during India’s march towards globalisation”.
The agriculture sector, which has a major share in the GDP, stands to lose market due to a cheap
agro produce from the developed countries. There is now a considerable evidence to show that in the
last 10 years, the regional inequalities have widened and the rich have become richer. While the
growing inequality creates a class of rich consumers, this bias is easily saturated. Therefore, the
rising inequality does not help in the expansion of mass markets. The globalisation policy of the
government must be in accordance with the circumstances in the country. The government should take
a firm stand and review the WTO restrictions pertaining to agriculture, small-scale sector,
investment, and trade-related intellectual property rights (IPRs).

The GOI should take a firm stand and review the WTO restrictions pertaining to agriculture, small-scale sector, investment,
and trade-related IPRs.
Areas of Concern in the Indian Economy
Globalisation offers both challenges and opportunities for the Indian economy. The challenges are
more serious because of the lack of competitive strength in the Indian industries. India has
experienced a decade of market-oriented reforms and many serious problems too have surfaced in
the mean time. They are as follows:
1. The technology gaps of several years are glaring. The difficulty in securing technology transfers from the developed countries
is more worrisome.
2. Infrastructure bottlenecks.
3. The hardcore reforms such as exit policy, privatisation, and so on, are still politically difficult to implement.

In India, the hardcore reforms such as exit policy, privatisation, etc., are still politically difficult to implement.
4. Indian products or services are not competitive in terms of price, quality, and delivery schedules.
5. The economy, in general, and industries, in particular, are victims of high cost.
6. The market access in the developed countries is very difficult as they are protected by tariff and non-tariff barriers.
7. Most developed countries are unreceptive to India’s problems and are always demanding a larger market access in India.
8. India’s political economy is not very stable. The prevailing system of coalition governance is not conducive for any prompt and
effective change and its implementation too.
9. India’s share of the world exports is a meagre 0.7 per cent and its share of trade in the world services is even less. Hence, it
does not command any bargaining strength in the WTO-level negotiations. Table 24.2 details on the India’s export performance.

India’s share of world exports is a meagre 0.7 per cent and its share of trade in the world services is even less.
Hence, it does not command any bargaining strength in the WTO.
Most of these problems are of our own making and will have to be resolved with our own internal
efforts. At the WTO’s negotiating table, we can only raise issues that are applicable to global trade
and which do not comply with its given provisions and conditionalities. Box 24.2 vividly explains in
points the issues that are to be raised.

Table 24.2 India’s Export Performance
*Calendar years, 1980–81 for 1980, etc.; NA: not applicable.

Source: Statistical Outline of India 2006–07, Department of Economics and Statistics, Tata Services Limited.

Box 24.2 Issues in the Debate
Is increasing globalisation poses the risk of widening the gulf between the developed and the developing nations?
The foreign aid provided by the World Bank and other international financial institutions to the developing and the
underdeveloped nations, over the past few decades, has actually enabled these countries to develop themselves.
The Argentine economy is a burning example of the ineffectiveness of aid (in the form of IMF loans) unless stringent
macro-economic policies are simultaneously implemented.
Has India benefitted from globalisation and foreign aid?
Does a foreign aid hurt the internal potential of an economy to perform on its own, thereby making it over-dependent on the
external monetary help?
Is it the easy inflow of money in the form of aid that becomes the luring factor for the developing nations to become the
developed ones overnight?
Have the developed nations always benefitted in the name of globalisation at the cost of the underdeveloped ones?
EFFECTS OF GLOBALISATION
Globalisation has various aspects which affect the world in several different ways as follows:
Industrial
The emergence of worldwide production markets and broader access to a range of foreign products
for consumers and companies. Particularly, the movement of materials and goods between and within
transnational corporations, and access to goods by wealthier nations and individuals at the expense of
poorer nations and individuals who supply the labour.
Financial
The emergence of worldwide financial markets and better access to external financing for corporate,
national, and subnational borrowers. Simultaneous, though not necessarily purely glo-balistic, is the
emergence of under or un-regulated foreign exchange and speculative markets leading to inflated
wealth of investors and artificial inflation of commodities, goods, and, in some instances, entire
nation’s as with the Asian economic boom-bust that was brought on externally by “free” trade.
Economic
The realisation of a global common market, that is based on the freedom of exchange of goods and
capital.
Political
Political globalisation is the creation of a world government which regulates the relationships among
nations and guarantees the rights that are arising from the social and economic globalisation.
Politically, the United States has enjoyed a position of power among the world powers; in part,
because of its strong and wealthy economy. With the influence of globalisation and with the help of
the United States’ own economy, the People’s Republic of China has experienced some tremendous
growth within the past decade. If China continues to grow at the rate projected by the trends, then it is
very likely that in the next 20 years there will be a major reallocation of power among the world
leaders. China will have enough wealth, industry, and technology to rival the United States for the
position of a leading world power. The European Union, the Russian Federation, and India are among
the other already-established world powers which may have the ability to influence future world
politics.
Informational
An increase in the information flows between the geographically remote locations. Arguably, this is a
technological change with the advent of fibre-optic communications, satellites, and increased
availability of Internet telephony services possibly as an ancillary or unrelated to the globalist
ideology.
Cultural
The growth of cross-cultural contacts, the advent of new categories of consciousness and identities,
such as Globalism—which embodies cultural diffusion, the desire to consume and enjoy foreign
products and ideas, adopt new technology and practices, and participate in a “world culture”; the loss
of languages (and corresponding loss of ideas); and also the transformation of culture.
Ecological
The advent of global environmental challenges, which cannot be solved without any sort of
international cooperation, such as climate change, cross-boundary water and air pollution, over-
fishing of the ocean, and the spread of invasive species. Many factories are built in the developing
countries where they can pollute freely. Globalism and free-trade interplay to increase pollution and
accelerate the same, in the name of an ever-expanding, capitalist-growing economy in a non-
expanding world. The detriment is again to the poorer nations while the benefit is allocated to the
wealthier nations.
Social
An increased circulation by people of all nations with fewer restrictions, provided that the people of
those nations are wealthy enough to afford an international travel, which the majority of the world’s
population is not. An illusory “benefit” recognised by the elite and the wealthy, and increasingly too,
as fuel and transport costs rise.
Transportation
Fewer and even fewer European cars on European roads each year (the same can also be said about
the American cars on American roads) and the death of distance through the incorporation of
technology to decrease travel time. This would appear to be a technological advancement recognised
by those who work in information, rather than the labour-intensive markets, accessible to the few
rather than the many; and if it is indeed an effect of globalism then it reflects the disproportionate
inequitable allocation of resources rather than a benefit to the humanity overall.
International Cultural Exchange

The spreading of multiculturalism and better individual access to cultural diversity (e.g., through the export of Hollywood and
Bollywood movies). However, the imported culture can easily supplant the local culture, causing a reduction in diversity
through hybridisation or even assimilation. The most prominent form of this is Westernisation, but Sinicisation of cultures has
taken place over most of Asia for many centuries. Arguably, the hegemonic effects of globalism and homogenisation of culture
as the capitalist, globalised economy becomes the “only” way that countries may participate through the IMF and the World
Bank, leads to a destruction rather than an appreciation of differences in the culture.
The greater international travel and tourism for the few who can afford for international travel and tourism.
Thegreater immigration, including illegal immigration, except for those countries around the world including the United
Kingdom, Canada, and the United States, who have in 2008 accelerated the removal of illegal migrants and modified laws to
increase the ease of removing those who have entered the country illegally, while ensuring that the immigration policies allow
those, who are more favourable to the stimulation of economy, to enter, primarily focusing on the capital, which the immigrants
can move into a country with them.
The spread of local consumer products (e.g., food) to other countries (often adapted to their culture) including genetically
modified organisms (GMOs). A new and novel feature of the globalised growth economy is the birth of the licensed seed that
will be viable for only one season and cannot be replanted in a subsequent season—ensuring a captive market to a corporation.
All nations may have their food supply controlled by a company that is successful in implementing such GMOs, potentially
through the World Bank or the IMF loan conditions.
Worldwide fads and pop culture, such as Pokemon, Sudoku, Numa Numa, Origami, Idol series, YouTube, Orkut, Facebook,
and MySpace, are accessible to those who have Internet or television, leaving out a substantial segment of the Earth’s
population.
Worldwide sporting events such as FIFA World Cup and the Olympic Games.
Formation or development of a set of universal values—homogenisation of culture.
Technical
The development of a global telecommunications infrastructure and a greater transborder data flow, using such technologies
such as Internet, communication satellites, submarine fibre-optic cable, and wireless telephones.
The increase in the number of standards applied globally, for example, copyright laws, patents, and world trade agreements
(WTAs).
Legal/Ethical
The creation of the International Criminal Court, which the United States has refused to sign onto, and international justice
movements.
The crime importation and the raising awareness of global crime-fighting efforts and cooperation.
Sexual awareness—It is often easy to focus only on the “economic aspects of Globalisation”. This term also has strong social
meanings behind it. As globalisation can also mean a cultural interaction between different countries, and may also have social
effects such as changes in the sexual inequality, this issue has brought about a greater awareness of the different (often more
brutal) types of gender discrimination throughout the world. For example, women and girls in African countries have long been
subjected to female circumcision—such a harmful procedure has been exposed to the world, and since then, the practice is
decreasing in occurrence.
An increasing concentration of wealth in fewer and even fewer hands. The media and other multinational mergers are leading to
fewer corporations that are controlling vaster segments of society and production. The decreasing number in the middle class
group and the increasing number in the poverty group have been observed within the globalised and the deregulated nations.
Globalisation was responsible for the largest sovereign debt default in the world history, bankrupting the entire nation of
Argentina in 2002. Globalisation did, however, benefit the business and finance sectors, that the large corporations and
multinational banks were able to move over $40 bn in cash, out of Argentina literally in the dead of night, as there were no
regulations in this deregulated and globalised country to prevent them from doing so. The banks locking the citizens out of their
own accounts, the 60 per cent-and-above unemployment rate, and the bankruptcy of an entire nation are arguments against
globalisation.
PRO-GLOBALISATION
Globalisation advocates such as Jeffrey Sachs, point to the above average drop in the poverty rates in
countries, such as China, where globalisation has taken a strong foothold, when compared to the
areas that were less affected by globalisation, such as Sub-Saharan Africa, where the poverty rates
have remained stagnant.
Generally, Free Trade, Capitalism, and Democracy are the systems that are widely believed to
facilitate Globalisation. The supporters of free trade claim that it increases economic prosperity as
well as opportunities, especially among the developing nations, enhances civil liberties, and leads to a
more efficient allocation of resources. The economic theories of comparative advantage suggest that
free trade leads to a more efficient allocation of resources, with all countries involved in the trade
benefitting. In general, this leads to lower prices, more employment, higher output, and a higher
standard of living for those in the developing countries.

Generally, Free Trade, Capitalism, and Democracy are the systems that are widely believed to facilitate Globalisation.
ANTI-GLOBALISATION
“Anti-globalisation” is a pejorative term that is used to describe the political stance of people and
groups who oppose the neoliberal version of “globalisation”.
“Anti-globalisation” may involve the process or actions that are taken by a state in order to
demonstrate its sovereignty and practise democratic decision making. Anti-globalisation may occur
in order to put brakes on the international transfer of people, goods, and ideology, particularly those
determined by the organisations such as the IMF or the WTO in imposing the radical deregulation
programme of free-market fundamentalism on local governments and populations. Moreover, as the
Canadian journalist Naomi Klein argues in her book No Logo: Taking Aim at the Brand Bullies (also
subtitled No Space, No Choice, No Jobs), that anti-globalism can denote either a single social
movement or an umbrella term that encompasses a number of separate social movements such as
nationalists and socialists.

“Anti-globalisation” may involve the process or actions that are taken by a state in order to demonstrate its sovereignty and
practise democratic decision making.
In either case, the participants stand in opposition to the unregulated political power of large,
MNCs, as the corporations exercise power through leveraging trade agreements which damage in
some instances the democratic rights of citizens, the environment particularly air-quality index and
rain forests, as well as national governments’ sovereignty to determine the labour rights—including
the right to unionise for better pay and better working conditions, or laws as they may, otherwise,
infringe on the cultural practices and the traditions of the developing countries. Most people who are
labelled “anti-globalisation” consider the term to be too vague and inaccurate. Podobnik states that
“the vast majority of groups that participate in these protests draw on international networks of
support, and they generally call for forms of globalisation that enhance democratic representation,
human rights, and egalitarianism”.
Critics argue that:
Poorer countries are sometimes at disadvantage. While it is true that globalisation encourages free trade among countries on an
international level, there are also negative consequences because some countries try to save their national markets. The main
export of poorer countries is usually agricultural goods. It is difficult for these countries to compete with stronger countries that
subsidise their own farmers. Because the farmers in the poorer countries cannot compete, they are forced to sell their crops at a
much lower price than what the market is paying.
Exploitation of foreign impoverished workers. The deterioration of protections for weaker nations by stronger industrialised
powers has resulted in the exploitation of the people in those nations to become cheap labourers. Due to lack of protections,
companies from powerful industrialised nations are able to offer workers enough salary to entice them to endure extremely long
hours and unsafe working conditions. The abundance of cheap labour gives the countries in power an incentive to not rectify the
inequality between nations. If these nations developed into industrialised nations, the army of cheap labour would slowly
disappear alongside development. With the world in this current state, it is impossible for the exploited workers to escape
poverty. It is true that the workers are free to leave their jobs, but in many poorer countries, this would mean starvation for the
worker, and if possible, even his/her family.
The shift to service work. The low cost of offshore workers have enticed corporations to move production to foreign countries.
The laid-off unskilled workers are forced into the service sector where wages and benefits are low, but turnover is high. This
has contributed to the widening economic gap between the skilled and the unskilled workers. The loss of these jobs has also
contributed greatly to the slow decline of the middle class which is a major factor in the increasing economic inequality in the
United States. The families that were once a part of the middle class group are forced into lower positions by massive layoffs
and outsourcing to another country. This also means that people in the lower class group have a much harder time climbing out
of poverty because of the absence of the middle class group as a stepping stone.
Weak labour unions. The surplus in cheap labour, coupled with an ever-growing number of companies in transition, has caused a
weakening of labour unions in the United States. The unions lose their effectiveness when their membership begins to decline. As
a result, the unions hold less power over corporations that are able to easily replace workers, often for lower wages, and have
the option to not offer unionised jobs anymore.
In December 2007, the World Bank economist Branko Milanovic called the much previous empirical
research on global poverty and inequality into question because, according to him, the improved
estimates of purchasing power parity (PPP) indicate that the developing countries are worse off than
how it was previously believed. Milanovic remarks that “literally hundreds of scholarly papers on
convergence or divergence of countries’ incomes have been published in the last decade based on
what we know now were faulty numbers. With the new data, economists will revise calculations and
possibly reach new conclusions”. Moreover, noting that

In December 2007, the World Bank economist Branko Milanovic called the much previous empirical research on global
poverty and inequality into question because, according to him, the improved estimates of purchasing power parity (PPP)
indicate that the developing countries are worse off than how it was previously believed.
Implications for the estimates of global inequality and poverty are enormous. The new numbers show global inequality to be
significantly greater than even the most pessimistic authors had thought. Until the last month, global inequality, or difference in real
incomes between all individuals of the world, was estimated at around 65 Gini points—with 100 denoting complete inequality and 0
denoting total equality, with everybody’s income the same— a level of inequality somewhat higher than that of South Africa. But the
new numbers show global inequality to be 70 Gini points—a level of inequality never recorded anywhere.
The critics of globalisation typically emphasise that globalisation is a process that is mediated
according to corporate interests, and typically raise the possibility of alternative global institutions
and policies, which they believe address the moral claims of poor and working classes throughout the
globe, as well as environmental concerns in a more equitable way. The movement is very broad,
including church groups, national liberation factions, peasant unionists, intellectuals, artists,
protectionists, anarchists, those in support of relocalisation, and others. Some are reformists (arguing
for a more humane form of capitalism) while others are more revolutionary (arguing for what they
believe is a more humane system than capitalism), and some others are reactionary (arguing that
globalisation destroys national industry and jobs).
One of the key points made by the critics of recent economic globalisation is that income
inequality, both between and within nations, is increasing as a result of these processes. One article
from 2001 found that significantly, in seven out of eight metrics, the income inequality had increased
in the 20 years ending 2001. Also, “incomes in the lower deciles of the world income distri-bution
have probably fallen absolutely since the 1980s”. Furthermore, the World Bank’s figures on absolute
poverty were challenged. The article was sceptical of the World Bank’s claim that the number of
people living on less than $1 a day had held steady at 1.2 bn from 1987 to 1998, because of the biased
methodology.

One of the key points made by the critics of recent economic globalisation is that income inequality, both between and
within nations, is increasing as a result of these processes.
GLOBALISATION—AN ASSESSMENT
India, since political independence, has failed to transform its economy and society into a fully
modern industrial one, despite having been able to hold on to political democracy. This is not to
suggest that no economic or social changes have occurred. The insufficient trans formation is evident
on two counts: firstly, the extent of economic deprivation and poverty is too large to be acceptable by
any yardstick; secondly, and there are many instances of economies around the world, especially in
Asia, which have moved far ahead of India in terms of the living standards in a very decisive fashion.
The apparent reasons are not hard to find. It has been a story of the lack of good governance in terms
of the content of economic policies and in institutional failures.
In the last two decades of the 20th century, there were strong internal and external compulsions of
merging into a global economic system, which was itself marked by major political changes and
economic uncertainties. In choosing to pursue the economic policies of the Washington Consensus,
India has been reducing the space of state intervention to enable the market to work more freely.
However, there are three specific areas where the state should play a more (and not less) active role to
ensure facilitation, coordination, and correction of market failures. Specifically, these entail works
and incentive structures, improved use of resources (both in quantity and efficiency) in building
fundamental capabilities in primary education and basic health, and a more coordinated effort in
generating investments in the physical infrastructure.

In the last two decades of the 20 th century, there were strong internal and external compulsions of merging into a global
economic system, which was itself marked by major political changes and economic uncertainties.
A related aspect of governance in a market economy that is open to free flow of trade and some
international capital movements is, a loss of autonomy in conducting domestic, fiscal and monetary
policies. This loss is not in form, but market integration substantially reduces the power of standard
economic policies to address issues of unemployment, inflation, and growth. One likely outcome is
that India begins to concentrate in competing with other nation states in attracting investments and
trade. The domain of mass politics, so critical to good governance in democratic societies, has begun
to shrink. The political agenda is changing quite rapidly from basic economic issues to regional,
particularistic concerns of community, ethnicity, and religion.

A related aspect of governance in a market economy that is open to free flow of trade and some international capital
movements is, a loss of autonomy in conducting domestic, fiscal and monetary policies.
The lack of good governance affects the poorest 40 per cent (income distribution-wise) of India’s
population the worst. Here, the extent of acute deprivation and destitution desperately needs active
governance in creating fundamental capabilities. The next 40 per cent (relatively better off, but still
very poor by international standards) is deprived from availing- and creating market opportunities
because of the inadequacies of physical infrastructure and inefficiencies of local institutions in
harnessing dynamic energies into productive collective efforts. The top 20 per cent constitute the
power elite and the primary constituents of the distributional coalition. The elite’s material
development has been significant, and it has benefitted from planned interventions of the past and
stands to benefit from a globalised economy of the future.
There is a nascent form of global governance already discernible, based on the Washington
Consensus. There are a number of multilateral institutions that could serve the purpose of further
developing such a governance structure. At the same time, there are numerous groups and
organisations that are raising their voices over other important global concerns such as fairness in
international trade, poverty alleviation, and environmental protection. They are contesting the rising
hegemony of the Washington Consensus. The structure and the ethical basis of future governance in
an integrated world are, therefore, hard to predict just yet. Dominant global trends along with India’s
own experiment with international integration are far removed from the desirable features of good
governance. The two most important features of any global governance structure are democracy and
equity. Good governance must also ensure sustained development opportunities for the poor and
deprived people of the world. It entails, among many other things, new economic policies and
institutions, new lifestyles, and preferences. Above all, it must be able to reconcile the individual
advantage nurtured by the market with a tolerant concern for all.
The overall post-liberalisation growth of the Indian economy has not been inspiring. India lifted its
growth rate during the 1990s but is still under performing. India will not be able to achieve the
average annual growth of 9 per cent, that is targeted for this decade unless radical reforms are carried
out. The liberalisation process in the country has not been able to take off in the real sense because the
instrument of change, that is, the bureaucracy has not been reformed. In the reform process, the role
of bureaucracy should have been that of a facilitator. The entire bureaucratic administrative set-up at
the Centre and the states needs to be looked into and redesigned to be in consonance with the
liberalisation philosophy.

The overall post-liberalisation growth of the Indian economy has not been inspiring. India lifted its growth rate during the
1990s but is still under performing.
The reforms would ensure that some departments like finance, are specialised, and persons of
sound knowledge of their fields head health, science and technology, and so on. Most jobs today
require professionalism, specialisation, and formulation of policies in areas like insurance, banking,
foreign trade, and telecom that requires an in-depth understanding of the subject. In the United States,
specialists like lawyers, economists, financial experts, provide the necessary expertise and the latest
inputs to the government so that it is able to formulate the best possible policy.
The Indian industry, to be competitive in price, cost, and quality, must be provided a level-playing
field in technology transfer, infrastructure interest on finance, labour reforms, government
regulations, customs tariffs on imports, Central- and state government taxes, and the like. The
reforms would invariably involve restructuring of the administrative set-up, which would ensure an
optimal utilisation of resources for the benefit of citizens. The administration needs to play the role
of a facilitator by providing infrastructure and ensuring that the basic minimum needs of the citizens
expected from the government are fulfilled within the available resources.

The Indian industry, to be competitive in price, cost, and quality, must be provided a level-playing field in technology
transfer, infrastructure interest on finance, labour reforms, government regulations, customs tariffs on imports, Central- and
state government taxes, and the like.
The bureaucracy should be made to face competition. If it does not change, then sooner or later the
forces of change generated by the economic reforms would do so. A review of the past policies
followed during the first 40 years of planning reveals that there was no other alternative to the present
policy of economic reforms. The very purpose of the liberalisation was to remove unnecessary
controls and regulation, liberating the trade and industry from unwanted restrictions, and to make
various sectors of the Indian economy competitive on the global economic platform by making them
produce quality goods in a cost-effective manner.

To be globalised, the Indian industry has to be competitive in price, quality, and technology.
Liberalisation does not mean simply inviting a good number of foreign companies or MNCs, on
whatever unreasonable terms, with whatever objectives in mind, and in whatever sector,
indiscriminately. By implication, economic liberalisation suggests that the entire opening up of
economy should ultimately be for building up strength of our own. Hence, inviting foreign
companies (MNCs) should only be means and not an end. Liberalisation means the removal of
control and not of regulations. Liberalisation does not imply any secret deals behind the curtain. On
the contrary, it does mean the elements of transparency and accountability in the functioning and
procedures relating to the economy.

Liberlisation means removal of control and not of regulation.
Privatisations in India have given rise to a controversy. Privatisation has been criticised for
“selling the family silver to cronies of the rolling party”. The sale proceeds of public sector
undertakings (PSUs) are being utilised for meeting the operating expanses or curtailing the budgetary
deficit instead of creating health education facilities to general public, and development of
infrastructure for trade and industry. Further, the government is not taking any effort to privatise the
loss-making PSUs. Instead, the government is privatising the profit-making public sector enterprises
(PSEs) that are beneficial for the welfare of the general public and are pride to our nation, for
example, Balco. The privatisation of loss-making units would definitely reduce the financial burden
on the government. The top 10 loss-making PSEs are RINL, HFC, FCI, DTC, IA, HEC, IDPL, HSL,
HPC, and HSCL. The government should privatise the loss-making PSUs and let the profit-making
PSE managements function autonomously for improving their performance. In 1992–93, the top 10
profit leaders of PSEs were IOC, NTPC, ONGC, MTNL, SAIL, BPCL, NSML, HPCL, MMTC, and
BHEL.
The currently comfortable foreign exchange reserves (FER) primarily reflects a short-term capital
flow from the FIIs, which can vanish as easily as they appeared. These are not money flow; their
sudden departure for greene pastures has wrecked havoc on many Third-World economies. Non-
economic developments, political instability, and communal frenzy contributed to slowing down the
pace of economic growth. The government should tackle the situation firmly, for which it requires
political will.

Non-economic developments, political instability, and communal frenzy contributed to slowing down the pace of economic
growth in India.
In substance what has been achieved so far is impressive but is not very encouraging. India has lost
its status as the 10th largest industrial power in the world, in the course of last two decades or more.
India’s share in the global export is just 0.7 per cent. India cannot attain growth in exports while
continuing with stringent control and licensing of imports in the name of providing protection to the
domestic industries and thereby, losing the competitive character of these domestic industries.
Thus, under the present circumstances, there is no reverse to economic reforms, but whatever
policy reforms and restructuring programmes are to be adopted in the Indian economy, must have its
adaptability in Indian soil and must also serve the interest of the general masses. The government
should take a firm stand and review the WTO restrictions pertaining to agriculture, small-scale
sector, investment, and trade-related IPRs.
A CRITICAL APPRAISAL OF GLOBALISATION
Initially, the pressure for the process of globalisation and liberalisation came from international
institutions—the IMF and the World Bank. These institutions have had a growing influence over the
Indian economy since the mid-1970s. The personnel from these institutions have occupied influential
policy-making positions in the government since then. Their influence over the thinking of our
academics and of the media has been growing ever since. They have funded a growing number of
studies, all over the world and more specifically, in India. They have offered consultancies and
temporary assignments to many influential positions. These institutions have had a package of
policies ready for implementation in India since the late 1980s.
Inevitably, when an economic crisis struck India in 1990, a package was available for
implementation in India and this was to globalise the economy. WTO, the rechristened version of
GATT, appeared on the scene in 1995. Its provisions have moved India farther in the direction of
globalisation. Given the vacuum in thinking among the leadership, political fragmentation, and
instability in the body politics, and the general underpreparation of various sections of Indian elite to
face the challenge, staying out of WTO was never a choice. The multilateral coercion brought to bear
upon a weak nation in joining the WTO was accepted as inevitable. It has been preferred to the
bilateral coercion that would have had to be faced if the nation has to be kept out of the WTO. At the
WTO, the fight among nations is to get others’ markets opened with the least concession from
oneself. A successful battle there requires a well-defined national interest and a will to carry forward
the national agenda.

Inevitably, when an economic crisis struck India in 1990, a need for globalisation and liberalisation was created.
Inevitably, across the political spectrum, there has been the sense of TINA to globalisation and
liberalisation. The Indian ruling elite (at most 3 per cent of the population) has seen globalisation as
the opportunity to join the international elite, and, therefore, they have pushed for it. They are able to
freely consume the same goods that the international elite consumes and can freely move around in
those circles enjoying vacations, sending children abroad for education, and so on. Indian businesses
initially felt that they would be able to use liberalisation to generate larger profits. They have, by and
large, been disabused of these misconceptions as they find that they cannot compete against the MNCs
due to their control over capital and technology. Loss of control of Indian capital over its own
markets is symbolised by the movements in the Indian stock market indices, which are now being
determined by the moods and whims of the foreign investors and the changes in NASDAQ.

There has been the sense of TINA to globalise and liberalise the Indian Economy.
Effectively, the advantage of liberalisation has accrued to foreign capital, and the process of
globalisation has been a one-way street for the nation as a whole. It has affected the economic,
political, and social aspects of our nation. For 97 per cent of the people of this nation, it has meant a
worsening of living conditions and growing social tensions. However, an illusion of prosperity has
been created by the availability of goods and the spawning of casino mentality, created by the capital
gains in the world of finance.
The new technologies being introduced in India under the process of globalisation are highly
capital intensive. The WTO has strengthened its control over technologies of MNCs, of creating
property rights over them. The introduction of e-commerce has the potential of eliminating a large
number of jobs from the services sectors in both the developed and the developing worlds. Those
propagating globalisation in India have not considered the implications of these trends for not only
the poor but also the middle classes. The nation needs a technology policy, which is sadly lacking.
Globalisation and liberalisation are processes of marketisation. Markets, in turn, are based purely
on the purchasing power of economic agents. It is not a democratic institution and in its pure form, it
is not based on the considerations of human values. It does not distinguish between the rich and the
poor, the old and the young, and men and women. These considerations have been superimposed only
by the society, in which we live. International markets are considered to be the most efficient ones, but
there is no inter-national society with universal values to impose on these markets. Hence,
international markets are not moderated by human concerns and have tended to be highly iniquitous,
marginalising the already weak. With some exceptions, disparities have grown across nations, within
nations, across states, and within states.

Globalisation and liberlisation are processes of marketisation.
Markets are based on the notions of “more is better” and “consumer sovereignty”. This has
promoted consumerism and individualism. Inevitably, the vision is based on short-run considerations
and non-communitarian values. There is no place for sacrifice in a market and individual interest
comes before that of the community. But the building of a nation requires a sense of community and
sacrifice. If this has to come up voluntarily, the society has to be seen to be just by all those elements
constituting it. If there is a feeling of injustice, people get alienated and there is an inevitable rise in
social tensions.
Globalisation and liberalisation have fostered in India a growing inequity and marginalisation of
the weak. This has created a sense of social injustice and led to growing social and political tensions.
The aspirations of the dalits, the backward, and women among whom poverty is entrenched have
come up against the wall of new economic policies, which have resulted in growing
underemployment and the rising prices of basic goods.

Globalisation and liberalisation have fostered in India a growing inequity and marginalisation of the weak.
The state, already weakened by corruption, has been further weakened by the new economic
policies. The policies determined in the interest of property groups have had a progressively
narrower social base. At the WTO, the interests of the small and medium farmers, the industrialists,
and of the labourers are being sacrificed in favour of some concessions for big business. The
policies needed by the poor to mitigate underemployment and control inflation have run up against
the barriers of international credit ratings. In this strategic retreat of the State, the policies which were
pro-poor have been increasingly sacrificed.
Many groups and individuals have been fighting battles against liberalisation and globalisation at
local levels. These have not picked up sufficient mass or momentum to be able to pose a challenge to
the new economic policies. The forces that are ranged against are global and have enormous
financial clout. The pace at which the economy is being opened up has left the opponents of these
policies feeling helpless. As the economy globalises, a reversal of these policies is becoming more
and more difficult. This has also generated a sense of despondency.

Many groups and Individuals have been fighting battles against liberlisation at local levels in India.
At the international level also, India has given up its leadership of the Third World. The South
Asian Association for Regional Cooperation (SAARC) never emerged as a regional force and is now
in disarray. G-15 and G-77 do not count much because India has stopped making the effort to give a
lead, perhaps under pressure from a global capital. At the WTO, India has not given a lead to other
nations since 1987. Africans have made some attempts for unity but India has argued against such
attempts. This weakens the capacity of India to fight the challenge of the one-way globalisation, which
is being imposed on it by an international capital.
The social and the cultural aspects of the challenge of globalisation are no less serious than the
economic ones. Success is now being defined in Western terms. Indian artisans are being increasingly
subjected to the demands of the Western market. Many traditional jobs face extinction due to the
emergence of new substitute products. Indian women and the media are increasingly showcasing
fashions that are originating in the West. The family as an institution is coming under an increasing
stress. Even though globalisation has not resolved the problems of the people in the absence of
alternatives, the TINA syndrome has prevailed and no effective challenge has come up yet.
To pose a challenge to globalisation, all the social groups that face the growing hardship today and
have been opposing the new economic policies have to get together to be effective. There is a need to
revive the belief that the nation can do it and has the resources to do so. Even if globalisation is the
aim, it can be done in a much better way by keeping the national interest in mind. However, the
alternative models of development are feasible, and Mahatma Gandhi with his emphasis on catering
to the interest of the last man first showed the way towards building a just society. Fortunately, India
as a large country, is not in the same position as Myanmar or Albania, and can do things differently.
India with its long history has shown that it can, at times, also show the way to the rest of the world.
For this, a vision and a political will need to be developed.

Even if globalisation is the aim, it can be done in a much better way by keeping the national interest in mind. However, the
alternative models of development are feasible, and Mahatma Gandhi with his emphasis on catering to the interest of the
last man first showed the way towards building a just society.
THREATS TO GLOBALISATION
The real threat to globalisation comes from within. A decade into it in its full form, cracks have
appeared in its edifice. The verysoundness ofmanyofits premises are being questioned the world over.
The grim tale of Enron’s rise and fall, the sudden miseries of Argentina due to the forced economic
reform and globalisation, the continuing misuse of domestic MNCs for espionage and sabotage in the
host countries, and the arm-twisting on the free-trade rules to squeeze the weaker countries, are all
symptoms of a deep malaise. Apparently, those who have set the rules are themselves violating them
when the rules do not suit them.

The real threat to globalisation comes from within. A decade into it in its full form, cracks have appeared in its edifice. The
very soundness of many of its premises are being questioned the world over.
Hardly three years ago, Argentina was being touted as a model of the new economic regime, and
was being heralded as a success story of macro-economic stability, like how India is projected now. It
had reduced inflation to almost a zero level. Its structural reform was lauded and its Finance Minister
too was applauded, as an economic wizard. But when the expected results failed to show up, there was
more advice to enforce still higher doses of reform—as India is now being told—until it all finally
collapsed.
We are now being told to do exactly what had failed to click in that model country. The only
exception was the convertibility of rupee, which the foreign experts had dropped after the collapse of
the Asian Tigers. In Argentina, free facilities to foreign investment for a decade did not improve its
industrial growth in any measure. The FDI was confined to primary production like mining, oil and
gas, and of course, automobile.
The privatisation programmes had little effect on the industrial production except helping the
government to fill the budgetary gap. It also tried all other routine remedies—liberalisation of
imports, full play for FIIs, opening up of services, deregulation of banking industry, elimination of
budget deficits, reduction of bank rates and tax, a curb on government spending, and so on. Each of
these worked as a temporary painkiller but failed to make any improvement. Prophetically for us, as
the expected miracle failed, the slash in expenditure led to a slower investment.

The privatisation programmes had little effect on industrial production except helping the government till the budgetary
gap.
These high-profile MNCs could the change government’s decisions in its favour, get deregulations
done for its profit, and appoint its own nominees at crucial government posts. Even after its collapse,
the Bush aides continue to openly arm-twist India for a favourable settlement on Dhab-hol project. So
much for the direct US intervention to favour its MNCs and the latter ’s hold on our rulers. The Enron
scandal has also put the business rating agencies in spot. Hardly a few weeks before the collapse, they
had given impressive ratings to the firm. Another aspect that should throw doubts over the iconisation
of MNCs and their executives has been their continuing nexus with the politicians and the bureaucrats.
How can national governments trust the integrity of the MNCs when they are allowed participation in
sensitive projects? All these aspects poses serious challenges to the corporate-commanded
globalisation.
Considering the present trend of threat appearing out of globalisation, the Indian industrial firms,
who initially welcomed the MNCs, have now started to develop second thoughts on unrestricted entry
of foreign capital. CII (Confederation of Indian Industry) and ASSOCHAM (Associated Chambers of
Commerce and Industry) have also become worried about the activities of MNCs in swallowing up
the Indian firms on some pretext. Thus, a consensus is now emerging that the free and wholesale
globalisation should be replaced by a selective path of globalisation, giving weightage to national
interest.
Although globalisation and liberalisation have their own meaning, the goal is to attain a higher
growth rate, self-reliance, full employment, and a better level of living. They are supposed to attain
growth with equity and should try to improve the condition of the majority of the population living in
these developing countries. Unfortunately, globalisation usually helps a limited population living in
these industrially advanced countries. They are also reaping the advantage of an unequal bargaining
power at the WTO, and are also forcing the developing countries to open up their markets for the
entry of products and investment capital of industrially developed countries. In this connection, the
Human Development Report (1996) observed,

Unfortunately, globalisation usually helps a limited population living in these industrially advanced countries. They are
also reaping the advantage of an unequal bargaining power at the WTO, and are also forcing the developing countries to
open up their markets for the entry of products and investment capital of industrially developed countries.
While globalisation has often helped growth in strong countries, it has bypassed the weak. The poorest countries, with 20 per cent of
world’s people, have seen their share of the world trade fall between 1960 and 1990 from 4 per cent to less than 1 per cent. And
they receive a meagre 0.2 per cent of the world’s commercial lending.
Thus, if everything moves in the same direction then the fate of globalisation will be under a constant
threat. The liberalisation policies will not do any good to our country and instead, only strengthen the
hands of MNCs. The country lost its independence because of one East India Company; but now
hundreds of MNCs are freely operating in India taking advantage of the liberalised policies. The
globalisation policies of the government must be in accordance with the circumstances in the country.
The government should take a firm stand and review the WTO restrictions that are pertaining to
agriculture, small-scale sector, investment, and trade-related IPRs.

The liberalisation policies will not do any good to India and instead, only strengthen the hands of MNCs.
CASE
Softcore Consultancy Services is in the IT sector. It is currently facing a shortage of skilled

manpower and is fuelling a hike in the employee salaries, which has been boosting a 10 per cent to 40
per cent growth during the last couple of years. While there is an abundance of trainable human
resources, a dearth in the skilled manpower is being felt across the industry, and that has resulted in a
hike in salaries.
Typically, salary jumps happen not only in the conventional manner of being promoted but also
because of professionals changing jobs more frequently.The increase in salaries varies from job to
job, and ranks highest in the IT sector where employees get a hike of over 40 per cent when they join
a new establishment. There is no dearth in the entry-level human resources as there is a large supply,
but a severe shortage is felt in the middle-level positions.
According to Mr. Raj, the CEO of Softcore, many new captive and third-party off-shore facilities
that are being set up in the country have led to a competition for skilled human resources that are
already scarce. This is also leading to an ever-widening, demand-supply gap and a rise in the average
salary level for all positions, apart from pushing up the attrition in the existing facilities, he said.
There is a new trend of employees moving to MNCs abroad for higher salaries and global
experience. The salary package and working environment factor are far better in countries like the
United States when compared to India. Then returning to India with a global experience paves the way
for a higher pay and a better position. This is also one reason for the shortage of skilled manpower
and the hike in employee salaries in the IT sector.
Case Questions
1. What are the problems that the Softcore is facing? Suggest some remedies for the same.
2. Do you support globalisation.
SUMMARY
India tried to integrate into the world economy as soon as it became a sovereign state, but with its own
terms and conditions. However, over these years, India has been slowly pressured by several external
forces like the foreign governments, foreign corporations, and international agencies to integrate on
their own terms. The roots of the present globalisation process in India lie way back in the 1980s.
India started to liberate trade in 1977–78. This open policy increased the number of items in the Open
General License (OGL).
Most importantly, we find that “Globalisation” with reference to India has been more of globalisation
in India and less of globalisation of India. In other words, globalisation has been only a one-way
process, that is foreign enterprises have found a favourable way to do business in India since
independence. Foreign companies have invested in India only when the policies of the GOI have
favoured either the market or the efficiency-seeking objectives of the foreign firms. The foreign
firms have either left India or critiqued India otherwise.
From the historical point of view, it is imperative that the GOI, the foreign companies, and the
governments of other nations have to recognise and respect the need for globalisation of India and
have to help the globalisation process take off in a balanced and sustained manner. Hence, while
undertaking policies on the liberalisation of Indian economy, the GOI has to take care of the
“globalisation of India” alone as it has been presumed in the past 15 years.
The policies of the GOI should be able to focus the FDI into the manufacturing sectors and high-
technology areas through which the Indian economy can effectively be a part of the globalisation
process worldwide. With a similar framework of our study, further research may be conducted on the
other developing countries in Asia, to enhance our understanding of the globalisation process in the
same context.
KEY WORDS
Globalisation
Euro
Trade (foreign)
Non-economic Sector
Stock Markets
Economy
Industrial Consolidation
Liberalisation
Public Expenditure
Budget Deficits
Capital Market
Bank Rate
Tariffs
TINA Syndrome
Global Deposit Receipts (GDR)
QUESTIONS
1. What is globalisation? Explain the features of globalisation.

2. Analyse the impact of globalisation on the Indian industry.
3. Examine the benefits of globalisation for the Indian economy.
4. Discuss the threats to the Indian economy from globalisation.
5. Analyse the steps taken by the Indian Government to globalise the economy.
6. Suggest precautionary measures to protect the Indian economy from globalisation.
REFERENCES
Agarwal, N. P. and S. C. Jain (2003). Corporate Governance. Jaipur: Indus Valley Pub.
Arya, P. P., B. B. Tandon, and A. K. Vashisht (2003). Corporate Governance. New Delhi: Deep and Deep Publications.
Balasubramanian, N. (2005). “Corporate Governance in India: Traditional and Scriptural Perspective”, Chartered Secretary,
2(3), 279.
Chandra, R. (2002). Corporate Management. Delhi: Kalpaz Pub.
Desai, A. A. (2003). “Towards Meaningful Corporate Governance”, Chartered Secretary, 33.
Gupta, S. L. (2001). Contemporary Issues in Corporate Restructuring. New Delhi: Anmol Pub.
Jain, R. B. (2004). Corruption-free Sustainable Development: Challenges and Strategies for Good Governance. New Delhi:
Mittal Pub.
Michael, V. P. (2001). Globalisation, Liberalisation and Strategic Management. Mumbai: Himalaya Publishing House.
Munshi, S. and B. P. Abraham (2004). Good Governance, Democratic Societies and Globalisation. New Delhi: Sage.
Pandey, T. N. (2003). “Naresh Chandra Committee on Auditor’s Role in Corporate Governance”, Chartered Secretary, 33,
464.
Prahalad, H. (2002). Computing for the Future. New Delhi: Tata McGraw-Hill.
Rao, P. (2003). “Emerging Trends in Corporate Governance”, Chartered Secretary, 33, 1147.
Reed, D. and S. Mukherjee (2004). Corporate Governance, Economic Reforms, and Development: The Indian Experience.
Scholes, J. (2001). Exploring Corporate Strategies: Text and Cases, 4 th ed. New Delhi: Prentice-Hall.
CHAPTER 25
Foreign Investment
CHAPTER OUTLINE
Meaning
Need for Foreign Investment
Adverse Implications of Foreign Investment
Determinants of Foreign Investment
Government Policies
New Policies
A Comparative Statistical Outline of FDI
Case
Summary
Key Words
Questions
References
MEANING
At the time of independence, India’s technological base and domestic savings were both weak and
stagnant. Therefore, India adopted an import substitution and encouraged foreign private capital and
technology as elements of her strategy for industrial development, in order to fill up the
technological and production gaps and accelerate the development process.

At the time of independence, India’s technological base and domestic savings were both weak and stagnant. Therefore,
India adopted an import substitution and encouraged foreign private capital.
Foreign investment is seen as a means to supplement domestic investment for achieving a higher
level of economic development. It benefits the domestic industry as well as the Indian consumer by
providing opportunities for technological upgradation, giving access to global managerial skills and
practices, optimal utilisation of human and natural resources, making Indian industry internationally
competitive, opening up export markets, providing backward and forward linkages, and providing
access to international quality goods and services.
An investment in a country by individuals of and organisations from other countries is an
important aspect of international finance. This flow of international finance may take the form of
portfolio investment, that is, acquisition of securities or direct investment creation of productive
facilities. Foreign direct investment (FDI) is the outcome of the mutual interest of multinational firms
and host countries. According to the International Monetary Fund, FDI is defined as an “investment
that is made to acquire a lasting interest in an enterprise operating in an economy other than that of
investor”. The investors’ purpose is to have an effective voice in the management of an enterprise.
The essence of FDI is the transmission to the host country a package of capital, managerial skills, and
technical knowledge.

FDI is defined as an “investment that is made to acquire a lasting interest in an enterprise operating in an economy other
than that of investor”.
NEED FOR FOREIGN INVESTMENT
Generally, a Foreign investment is motivated by a private gain but it has many benefits for less-
developed countries (LDC) if proper caution and care are exercised while inviting a foreign
investment. A Foreign investment should be supportive of the progress of the economy, development
of industry, and prosperity of people. It should not be destructive in any form. The following
arguments are advanced in favour of foreign investment:
Raising the Level of Investment. Foreign investment can fill the gap between desired investment
and locally mobilised savings. Local capital markets are often not well developed. Thus, they cannot
meet the capital requirement for large investment projects. Besides, the local non-availability of
access to the hard currency that is needed to purchase investment goods can be difficult. Foreign
investment solves both these problems at once as it is a direct source of external capital.

FDI can fill the gap between the desired investment and locally mobilised savings. It supplies a package of needed
resources. It helps a number of UDCs to possess huge mineral resources.
Upgradation of Technology. Foreign investment can supply a package of needed resources such
as management experience, entrepreneurial abilities, and organisational and technological skills.
Foreign investment brings with it the technological knowledge while transferring machinery and
equipment to developing countries. Similarly, as the foreign-owned enterprises come into
competition with the local firms, the latter category of enterprises are forced to improve their
technology and standards of product quality. Further, the foreign-owned enterprises pressurise and
assist the local support industries to improve the quality of their products and ensure a greater
reliability of delivery, both of which make it necessary for their support industries to upgrade their
technology.
Exploitation of Natural Resourses. A number of underdeveloped countries (UDCs) possess huge
mineral resourses, which await an exploitation. These countries themselves do not possess the
required technical skill and expertise to accomplish this task. Therefore, they have to depend upon a
foreign capital to undertake the exploitation of their mineral wealth.
Development of Basic Economic Infrastructure. Underdeveloped or developing countries
require a huge capital investment for the development of basic economic structure as their domestic
capital is often too inadequate. In such a situation, a foreign investment plays a pivotal role in the
development of basic infrastructure such as transport and communication system, generation- and
distribution of electricity, development of irrigation facilities, and so on.
Improvement in Export Competitiveness. A foreign investment can help the host country to
improve its export performance. It has a positive impact on the host country’s export competitiveness
by raising the level of efficiency and the standard of product quality. Further, a foreign investment
provides the host country a better access to foreign markets. Enhanced export possibility contributes
to the growth of the host economies by relaxing the demand-side constraints on growth. This is
especially important for those countries which have a small domestic market and must increase
exports vigorously to maintain their tempo of economic growth.
Improvement in the Balance-of-Payment (BoP) Position. In case of an adverse (BoP) situation in
the host country, an investment presents a short-run solution to the problem.
Benefit to Consumers. Consumers in the developing countries stand to gain from a foreign
investment through new products and improved quality of goods at competitive prices.
Revenue to Government. The profit generation by a foreign investment in the host country
contributes to the corporate tax revenue in the latter.
ADVERSE IMPLICATIONS OF FOREIGN INVESTMENT
A foreign investment is not an unmixed blessing. The governments in the developing countries have
to be careful while deciding on the magnitude, pattern, and conditions of a private foreign investment.
The possible adverse effects of a foreign investment are as follows:
1. The historically exploitative character of a foreign investment, as a partner of colonialism, naturally arouses deep-rooted
nationalist sentiments and suspicions.
2. There is a widespread belief that is based on sufficient empirical evidence that a foreign capital is essentially interested in loco
technology and highly profitable consumer goods and not in technologically difficult, long-gestation industries, which are of
high priority from the point of view of the host nation.
3. The clue to a direct investment lies not in the physical movement of capital from a developed country to an LDC, but in the
capital formation in the latter through the local operation of a multinational corporation (MNC) that is based in the former.
4. A foreign capital has historically been accused of an attitude of discrimination against the employment of local nationals in the
high-salaried jobs and against local transport, insurance, or credit organisations.
5. The development caused by a foreign investment tends to have an enclave character. That is, to say, it only creates small
pockets of affluence, that are isolated from the mainstream of the host country’s state of social and economic development.
6. Foreign enterprises, by virtue of their financial strength and general competitive efficiency, inevitably obstruct the growth of
indigenous, industrial entrepreneurship.
7. The cost of foreign capital for the host country tends to be very high. That such costly capital imposes a very severe strain on
the host country’s foreign exchange can easily be understood by comparing the quantum of capital inflow, excluding investment
profits with the quantum of foreign exchange outgo, on account of capital and profit remittances.
8. When foreign investments compete with the home investments, the profits in the domestic industries fall, there by leading to a fall
in the domestic savings.
9. The contribution of a foreign firm to public revenue through corporate taxes is comparatively less because of liberal tax
concessions, investment allowances, designed public subsidies, and tariff protection that are provided by the host government.
10. The foreign firms may influence political decisions in the developing countries. In view of their large size and power, national
sovereignty and control over economic policies may be jeopardised. In extreme cases, the foreign firms may bribe the public
officials to secure undue favours.

A foreign investment is not an unmixed blessing. The governments in the developing countries have to be careful while
deciding on the magnitude, pattern, and conditions of a private foreign investment.
DETERMINANTS OF FOREIGN INVESTMENT
The relative importance of foreign investment determinants varies not only between countries but
also between different types of foreign investments. Further, the relative importance of foreign
investment determinants may change over a period of time in a country. The factors influencing the
determination of foreign investment in the host country are explained as follows:
Political Stability. In many countries the political situation is very unstable. Governments change
frequently and so also do the government policies and decisions. Foreign institutional investors (FIIs)
are generally reluctant to invest in countries where political situations are unstable. For example, due
to the unstable political situation in India, not much foreign investment has been attracted in India as
compared to China.

In many countries the political situation is very unstable. The relevant rules and regulations of the host country that are
governing the foreign investment decided the quantum of the latter.
Legal and Regulatory Framework. The relevant rules and regulations of the host country that are
governing the foreign investment decide the quantum of the latter. These rules and regulations pertain
to protection of property rights, ability to repatriate profits, and free market for currency exchange.
The rules, regulations, and administrative procedures of the host country regarding foreign
investment must be transparent.
Size of Market. Large developing countries provide substantial markets where the consumer
demands for certain goods far exceed the available supplies. This demand potential is a big draw for
many foreign-owned enterprises. It explains the massive foreign investment into China since the early
1980s.
Prices and Exchange Rates. Price level and exchange rates of the host country determine the
foreign investment in the country. The instability in prices and exchange rates affect the inflow of
foreign investment.
Access to Basic Inputs. The availability of and access to basic inputs such as oil and gas, minerals,
forestry products, skilled and unskilled labour force, and so on, determines the extent of foreign
investment in the country. Box 25.1 vividly gives the six mantras for FDI.

Box 25.1 Six Mantras for FDI

1. Legislative and policy reforms:
Remove the unnecessary restrictions on equity participation by companies,
Standardise the guidelines for environmental issues,
Strengthen the intellectual property rules, especially in the sectors where India has a comparative advantage with
its educated and skilled workforce, and
Reduce the variance of FDI laws that are based on sector.
2. Government processes and machinery:
Increase the areas for automatic approval,
Reduce the role of the Foreign Investment Development Board (FIDB), and
Streamline the number of agencies that are involved when approvals are necessary.
3. Centre–state dynamics:
Delegate more authority in the selected areas of the states to negotiate FDI projects.
4. Infrastructure:
Increase political commitment, regulatory transparency, and dispute-resolution mechanisms to foreign participation
in infrastructure, and
Focus immediately on the infrastructure of airports, telecommunications, ports, and roads in the selected areas to
make the country more attractive to FIIs.
5. Concentrated zones for FDI activity:
Expand the export processing zones (EPZs) to provide a modern infrastructure in the export-oriented projects,
Use EPZs to provide special procedures for these projects and increase trade openers, and
Expand the use of technology parks and other agglomeration of industries for which India is particularly attractive.
6. Engagement of FIIs:
Create a council of senior Union and State government officials and representatives of large foreign-invested
companies,
Use the council to deepen the insights into issues that impede FDI,
Use the council to develop high-impact actions,
Use the council to learn from these actions and adjust quickly, and
Use the council to build mutual respect and trust.
GOVERNMENT POLICIES
India’s economic development since independence is unique in several ways. The founding fathers
adopted a mixed-economy approach for development. Economic planning and public sector
undertakings (PSUs) were assigned pivotal roles and a socio-economic approach to growth was set
within a framework of parliamentary democracy. The government polices regarding foreign
investment can be discussed under the following heads:
1. Pre-liberalisation policies,
2. Liberalisation polices, and
3. New policies.
Pre-liberalisation Policies
First Plan Period

At the time of independence, the attitude towards foreign capital was one of fear and suspicion. This
was natural on account of the previous exploitative role played by it in “draining away” the resources
from this country. The suspicion and hostility found expression in the industrial policy of 1948
which, though recognising the role of a private foreign investment in the country, emphasised that its
regulation was necessary in the national interest. This attitude expressed in the 1948’s industrial
policy resolution, had the foreign capitalists dissatisfied.

The First Plan period had noticed that the attitude towards foreign capital was one of fear and suspicion.
This was subsequently simplified by the then Prime Minister Nehru in his statement to the
Parliament on April, 6 1949, which for a very long time remained as the only major policy statement.
He declared that the stress on the need to regulate, in the national interest, the scope and manner of the
foreign capital that arose from the past association of foreign capital and control with domination of
the economy of the country. But circumstances having changed, the object of regulation should,
therefore, be the utilisation of foreign capital in a manner most advantageous to the country.
Indian capital needs to be supplemented by foreign capital not only because the national savings
alone would not be enough for the rapid development of the country on the desired scale, but also
because in many cases, scientific, technical, and industrial knowledge and capital equipment can best
be secured along with the foreign capital. Nehru further added that the Government of India would
expect all undertakings, Indian or foreign, to conform to the general requirements of their industrial
policy. In return he assured them of the following:
1. That there would be no discrimination between Indian and foreign interests. As regards the existing foreign interest, the
government did not intend to place any restrictions or impose any conditions which were not applicable to a similar Indian
enterprise.
2. Foreign interest would be permitted to earn profit, subject only to regulations common to all.
3. If and when foreign enterprises were compulsorily acquired, a compensation would be paid on a fair and equitable basis.
Indian capital needs to be supplemented by foreign capital not only because the national savings alone would not be
enough for the rapid development of the country on the desired scale, but also because in many cases, scientific, technical,
and industrial knowledge and capital equipment can best be secured along with the foreign capital.
The Government of India had no desire to injure in any way either British or other non-Indian interest
in India and would gladly welcome their contribution in a constructive and cooperative role in the
development of India’s economy. He assured foreign enterprises that there would be no restriction on
the remittance of profit or withdrawal of foreign capital investment, subject to normal foreign
exchange considerations. If any foreign concern was to be compulsorily acquired, the government
would provide a reasonable compensation.
Second Plan Period. Despite the above assurances, the foreign capital in the requisite quantity did
not flow into India during the First Plan period. During the Second Plan period, the emphasis was on
increasing the foreign exchange resources of the country, and increased foreign investment was
encouraged in order to finance the import of the required plant and equipment. There was a clear shift
of emphasis around 1957, though there was no formal pronouncement to this effect. This was due to
two immediate factors.

During the Second Plan period the emphasis was on increasing the foreign exchange resources of the country.
The Acute Foreign Exchange Situation from 1956 to 57 Onwards. The need for external finance
and know-how becomes all important and even imports were allowed on the condition of securing a
foreign partnership. The Birla Mission was sent abroad in 1957 with the specific object of
encouraging foreign industrialists to invest in India. Both the Indian public and private sectors, till
then were totally opposed to foreign capital, and the government became strong votaries of the
doctrine of foreign capital, that was being essentially complementary to Indian capital. For several
years, foreign investment and know-how were almost indiscriminately allowed even in the non-
essential areas.
Selective Foreign Investment Policy Period (1960–68). By the mid-1960s the manufacturing base
of the economy had considerably broadened, and there was a greater availability of domestic
resources and technical know-how. “Official policy”, therefore, came to relate the role of foreign
capital to its capacity to bridge important technological gaps in the country, particularly with
reference to import substitution and increased export.
A high degree of selectivity came to be exercised in allowing the private foreign investment and
collaboration proposals. Such investment came to be allowed only when it was considered to be
essential and of high priority from the point of view of techno-economic considerations and where
the technology was of an advanced kind, not indigenously available. Since this policy came to be
crystallised around 1968, an outright purchase of technology or a limited-direction royalty
agreement was generally favoured. Foreign equity participation was normally limited to 40 per cent
save in exceptional cases involving substantial export, import substitution, or sophisticated
technology, which could not be secured by any other means.

Foreign equity participation was normally limited to 40 per cent save in exceptional cases involving substantial export,
import substitution, or sophisticated technology, which could not be secured by any other means.
Foreign Investment Policy (1968–90). The year 1968 was a landmark in the evolution of the
foreign investment policy of the Government of India. For the first time after Nehru’s statement, clear
guidelines were issued on the policy of Government of India with regard to foreign investment and
collaboration. There were also big procedural changes.
The Foreign Investment Board (FIB) was set up in December 1968 as a single agency within the
government to deal with all matters relating to foreign investment and collaboration. Since 1973,
under the new industrial licensing procedure, when an applicant submits composite application for
both industrial licence and approval of foreign investment or technical collaborations, such
composite cases are decided by the Projects Approval Board (PAB). With the establishment of the
FIB, the government also laid down clear guidelines for a foreign investment in respect of the areas
in which they would be allowed; in what forms and the conditions to which they would be subject
regarding royalty, lump-sum payment, and so on.
A general decision was taken to limit foreign equity participation to less than 40 per cent, except in
cases where the required technology was highly sophisticated or the projects were export oriented.
From 1980 onwards, the climate for foreign collaborations improved distinctly because of speedy
approval and disposal of collaboration proposals. About 590 proposals were approved in the year
1982 which increased to 1,204 in the year 1985. It is important to note that between 1973 and 1983, as
a result of FERA (Foreign Exchange Regulation Act) the number of foreign majority companies
came down sharply. In two significant cases—IBM and Coca Cola—which were required to bring
down non-resident holdings to 74 per cent and 40 per cent, respectively, but declined to comply with
these requirements, the gover-nment directed the two companies to close their business in India.

It is important to note that between 1973 and 1983, as a result of FERA (Foreign Exchange Regulation Act) the number of
foreign majority companies came down sharply. In two significant cases—IBM and Coca Cola—which were required to
bring down non-resident holdings to 74 per cent and 40 per cent, respectively, but declined to comply with these
requirements, the government directed the two companies to close their business in India.
Significantly, after the liberalisation from 1991 onwards, Coca Cola returned to India. So did IBM
through joint ventures (JVs). Most foreign companies took steps to comply with the FERA guidelines
through disinvestments or through a fresh issue of capital. Only a few chose to wind up their business.
Liberalisation Policies
After pursuing a restrictive policy towards FDI over four decades with a varying degree of
selectivity, India changed tracks in 1990s and embarked on a broader process of reforms that was
designed to increase its integration with the global economy. Among the reform measures that were
implemented included a departure from the restrictive policy towards FDI, a much more liberal trade
policy, besides reforms of capital market and exchange controls.
The New Industrial Policy (NIP) that was announced on July 24, 1991, marked a major departure in
respect to FDI policy, with the abolition of industrial licensing system except where it is required for
strategic or environmental grounds, creation of a system of automatic clearance of FDI proposals
fulfilling the conditions laid down, such as the ownership levels of 50 per cent, 51 per cent, 74 per
cent, and 100 per cent foreign equity; opening of new sectors such as mining, banking, insurance,
telecommunications, and construction; and management of ports, harbours, roads and highways,
airlines, and defence equipment to foreign-owned companies, subject to sectoral caps. Foreign
ownership up to 100 per cent is permitted in the most manufacturing sectors—in some sectors even
on an automatic basis—except for defence equipment where it is limited to 26 per cent and for items
that are reserved for production by small-scale industries where it is limited to 24 per cent. Box 25.2
gives a picture of new conditions for 100 per cent FDI. The dividend that is balancing and the related
export obligation conditions of FIIs, which applied to 22 consumer goods industries, were withdrawn
in 2000.

Liberalisation is essentially a process, whereby liberal values, concepts, and percepts take an operational form.
Liberalisation Trends and Patterns in FDI Inflows
The economic reforms, in general, and liberalisation of FDI policy, in particular, have affected the
magnitude and the pattern of FDI inflows that were received by India. During the 1990s, they showed a
marked increase until 1997, when they peaked at US$3.6 bn. However, after stagnating for a few years
at around US$2.5 bn, they again rose to a level of about $3.4 bn and to $4.3 bn in 2003 (as shown in
Table 25.1). The magnitude of FDI inflows received by India would appear too small, especially if
compared with the inflows received by other countries in the region such as China (around $50 bn in
the recent years).

During the 1990s, the FDI showed a marked increase until 1997 when they peaked at US$3.6 bn. After stagnating for a few
years, it again rose to a level of about $3.4 bn in 2003.
The magnitude of FDI inflows received by India would appear too small, especially if compared with the inflows received by
other countries in the region such as China (around $50 bn in the recent years).
Box 25.2 100% FDI in Construction Sector
The Government of India announced new FDI norms in the construction and real-estate
development sector on February 24, 2005. The new conditions for allowing 100% FDI in the real-
estate sectors stipulates that
Minimum area that is to be developed under each project has been reduced to 25 acres from 100 acres;
Earlier requirement of minimum 20,000 dwelling units for serviced housing plots has been changed to a minimum built-up
area of 50,000 sq. m;
Minimum $10 mn capital investment for wholly owned subsidiaries;
Original investment cannot be repatriated before three years; and
Sale of underdeveloped land barred to prevent speculation in real estate.
In an analysis of the role of liberalisation in explaining the rising inflows of FDI till 1997, Kumar
found that only a part of the increase of FDI inflows could be attributed to liberalisation; a part of the
rise was explained in terms of a sharp expansion in the global scale of FDI outflows during the 1990s.
Secondly, the decline in inflows since 1997 despite a continued liberalisation suggested that the policy
liberalisation is not an adequate explanation of FDI inflows. Macro-economic fundamentals of the
host economies that emerge as the most powerful explanatory variables in the inter-country analysis
of FDI inflows also explain the year-to-year (y-t-y) fluctuations in FDI, though with a lag. This
becomes clear from Table 25.2, which plots the FDI inflows during the 1990s against the fluctuations
in the annual rates of the growth of the industrial output. One finds a good correspondence between
the industrial growth rate in a year and the FDI inflows in the following year. The industrial growth
seems to provide a signal to the FIIs about the prospects of the economy. Therefore, it appears that the
policy liberalisation may be a necessary but not a sufficient condition for FDI inflows.
(US$ mn)

Table 25.1 India’s FDI Inflows, 1991–03
(US$ mn)
Year FDI Inflows
1991 155
1992 233
1993 574
1994 973
1995 2,144
1996 2,591
1997 3,613
1998 2,614
1999 2,154
2000 2,315
2001 3,400
2002 3,450
2003 4,269
Source: UNCTAD, 2004.

Table 25.2 Industrial Growth (left scale) and FDI Inflows (right scale) in India, 1991–03
Year FDI Inflows (US$ mn) Industrial Growth Rate (%)
1991 155 -1.0
1992 233 4.3
1993 574 5.6
1994 973 10.3
1995 2,144 12.3
1996 2,591 7.7
1997 3,613 3.8
1998 2,614 3.8
1999 2,154 4.9
2000 2,315 7.0
2001 3,400 3.5
2002 3,450 6.2
2003 4,269 6.7
Source: UNCTAD and the Government of India data.

The implication of the above discussion is that the recovery of industrial growth rate in 2003–04
was likely to increase FDI inflows in the subsequent year. Some indications of this trend are already
available from India which is emerging as the third, most attractive FDI destination after China and
United States (compared to sixth in 2003), in terms of the FDI confidence index that was developed at
AT Kearney on the basis of a survey of 1,000 global corporations.
Liberalisation and Changing Sectoral Composition of FDI
The sectoral composition of FDI in India underwent a significant change in the 1990s. Table 25.3
presents a sectoral distribution of FDI stock in India at three points of time—1980, 1990, and 1997
(i.e., the latest available year for the stock data). Three characteristics of FDI stock in India can be
noted. Firstly, the share of mining and petroleum along with the plantation sector in FDI stock fell
markedly from 9 per cent in 1980 to only 2 per cent in 1997. Secondly, as the bulk of FDI inflows in
the pre-liberalisation era were directed to the manufacturing sector, it accounted for the bulk of FDI
stock with nearly 87 per cent share in 1980 that declined marginally to 85 per cent in 1990. However,
with the liberalisation of the FDI policy regime in the 1990s, the FDI inflows have been received by
services and infrastructural sectors. This brought the share of manufacturing down to 48 per cent by
1997. During the 1990s, the services clearly emerged as a major sector receiving FDI. The power
generation among other infrastructure sectors (included in “Others”) also attracted a substantial FDI
during the 1990s, bringing the share of “Others” up to nearly 35 per cent from the marginal in 1980
and in 1990.

During the 1990s, the services clearly emerged as a major sector receiving FDI. Power generation among other
infrastructure sectors also attracted a substantial FDI during the 1990s.
Among the manufacturing sub-sectors, the FDI stock in 1997 was also more evenly distributed
between food and beverages, transport equipment, metals and metal products, electricals and
electronics, chemicals and allied products, and miscellaneous manufacturing, unlike a very heavy
concentration in relatively, technology-intensive sectors, viz., machinery, chemicals, electricals, and
transport equipment up to 1990. The infrastructural sectors which commanded nearly half of the total
approved investments in the 1990s had not been open to FDI inflows before and hence, could be
attributed to policy liberalisation.

Table 25.3 Industrial Distribution of India’s Inward FDI Stock, 1980–97
Source: RBI Bulletin (April 1985, August 1993, October, 2000).

It may be useful to look at the distribution of an inward FDI within the services sector, given its
increasing importance in the FDI inflows during the 1990s. A look at the sub-sector break-up of
cumulative approvals of FDI during the 1991–2000 period suggests that about 61 per cent of the
approved services sector of FDI has gone to the telecommunications sector. The financial and
banking sector stood as the second most important services sector to FDI nearly claiming about 14
per cent of the total amount approved. Other important branches were hotel and tourism, and air and
sea transport.
Liberalisation and Changing Sources of FDI in India
European countries were the major sources of FDI inflows into India until 1990. However, their
relative importance steadily declined in the post-liberalisation period, with the share of major
European source countries (which include the UK, Germany, France, Switzerland, Sweden, Italy, and
Netherlands) coming down from 69 per cent and 66 per cent of FDI stock, in 1980 and 1990, to just 31
per cent by 1997. The decline in the relative importance of European countries as sources of FDI to
India has been made more prominent by diversification of the sources of FDI by the country over the
1990s.

European countries were the major sources of FDI inflows into India until 1990. However, their relative importance steadily
declined.
The United States has emerged as the most important source of FDI over this period with a share of
nearly 19 per cent of stock in 1992. See Table 25.4. In 1997 the share of the United States at 13.75 per
cent was, however, deceptive as a large proportion of the United States’ FDI was believed to be routed
through Mauritius, making the island-nation appear as the largest source of investments in India with
Rs 65.46 bn or nearly 18 per cent of the total FDI stock in the economy in 1997. The emergence of
Mauritius as the largest source of FDI can be explained by the Double Taxation Avoidance Agreement
(DTAA), which was signed between Mauritius and India during the 1990s that enables FIIs to
minimise their tax liability, given the tax haven status of Mauritius. Hence, FIIs from other countries,
principally the United States, route their investments through Mauritius to take advantage of the tax
treaty.

Later in the post-liberlisation period, the United States has emerged as the most important source of FDI.
Liberalisation and Mode of Entry: Greenfield vs M&As
An important feature of FDI inflows into India during 1990s is the emergence of mergers and
acquisitions (M&As) as an important channel. During the period 1997–99, for instance, nearly 39 per
cent of FDI inflows into India have taken the form of M&As by foreign companies of the existing
Indian enterprises, whereas in the pre-reform period, FDI entry was invariably in the nature of
Greenfield investments (refer to Table 25.5). This trend may have implications for the impact of FDI,
given the limited potential of acquisitions when compared to the Greenfield entry to add to the stock
of productive capital, generate a favourable knowledge spillovers, and competitive effects.

Table 25.4 Source-wise Distribution of India’s Inward FDI Stock, 1989–97
Source: RBI Bulletin, October 2000.

Table 25.5 Share of M&As in FDI Inflows in India
Source: Kumar (2000).

FDI Inflows into India in a Comparative East Asian Perspective
Although the FDI inflows into Indian economy increased considerably during the 1990s following the
reforms, India’s share would appear too small, especially if it is compared with that of the other
countries in the region such as China. In 2001, India’s reported inflows of about $3.4 bn represented a
mere 1.7 per cent of the total inflows attracted by the developing countries. In contrast, China received
an estimated $46.8 bn of inflows in the same year, representing nearly 23 per cent of the total
developing country FDI inflows. There are also other differences in the sectoral patterns and the
acquisition modes among other characteristics. In what follows we take a brief look at the key
differences and some possible explanations.

Although the FDI inflows into Indian economy increased considerably during the 1990s following the reforms, India’s share
would appear too small, especially if it is compared with that of the other countries in the region such as China.
Magnitudes of FDI Inflows

The comparison of about US$3.4 bn in the annual inflows of FDI by India with US$45 bn of FDI
inflows by China is often made. It has been pointed out, however, that the figures of FDI inflows in
India and China are not comparable because of several differences. Firstly, the Indian figures of
inflows do not follow IMF’s BOP Manual that is followed internationally. The principle difference is
that the Indian figures count only the fresh inflows of equity and do not take into consideration the
reinvested earnings by foreign affiliates in the country nor the inter-corporate debt flows that are
generally included while computing the FDI figures as per the IMF guidelines. Therefore, the Indian
figures tend to under-report the inflows. Secondly, the FDI inflows into China are believed to be
overestimating the real FDI inflows in view of the round-tripping of the Chinese capital to take
advantage of a more favourable tax treatment of FDI. Therefore, the figures of India and China are
not strictly comparable, and they tend to overplay the difference between the intensity of inflows
between the two countries. Finally, the size of the Chinese economy is much larger than the Indian
economy and hence, the figures should be normalised.
Table 25.6 puts the FDI inflows into India and China in a comparative perspective. The reported
figure of FDI inflows into China in 2000, as a proportion of GDP (gross domestic product) is 3.6 per
cent when compared to 0.5 per cent in the case of India. However, when the Indian figures are revised
by taking into account the reinvested earnings and inter-corporate debt, and Chinese figures are
moderated on account of possible round-tripping of FDI inflows (using the estimates provided by the
IFC), the gap in the FDI/GDP ratios narrows in the range of 1.7–2.0 for India and China, respectively.

The FDI Inflows into India in a comparative East Asian perspective. The FDI inflows into China in 2000 as a preparation of
GDP is 3.6 per cent when compared to 0.5 per cent in the case of India.

Table 25.6 FDI Inflows in China and India: A Comparative Perspective, 2000
Source: Srivastava (2003) based on World Bank, World Development Indicators, 2002 and IFC, World Business Environment Survey:
Economic Prospects for Developing Countries, March 2002.
Notes: *Figures published by an official source.
# Based on IFC’s World Business Environment Survey, 2002.

The Indian government has taken steps to revise the definition of FDI flows into the country. A
Committee that was set up by the Reserve Bank of India(RBI), in its report submitted in October 2002,
recommended that the Indian definition be brought on par with the global practice. In June 2003, the
Government of Inida announced that adoption of international norms led to near doubling of FDI
inflow figures from US$2,342 mn to $4,029 mn in 2000–01 and from $3,906 mn in 2001–02 to
$6,131 mn in 2002–03. Even after taking into account the measurement problems, the FDI inflows in
India are low compared to other economies in the region. The studies of determinants of FDI inflows
conducted in the tiles framework of an extended model of location of foreign production have found
that a country’s attractiveness to FDI is affected by structural factors such as market size (income
levels and population); extent of urbanisation; quality of infrastructure; geographical and cultural
proximity with major sources of capital; and policy factors, viz., tax rates, investment incentives, and
performance requirements. In terms of these, while India’s large population base is an advantage, its
low-income levels, low levels of urbanisation, and relatively poor quality of infrastructure are the
disadvantages. Furthermore, the relative geographical and cultural proximity of Indias East Asian
counterparts, with major sources of capital such as Japan and Korea (also the US), for instance, may
have put her at a disadvantage when compared to them. Furthermore, unlike China and some other
countries, India has not employed fiscal incentives like tax concessions to attract FDI. India is also
behind China by at least 12 years in terms of launching reforms. Finally, the ability of China in
attracting the FDI inflows to quite a large extent owes to the large special economic zones (SEZs),
which provide the foreign enterprises better and specialised infrastructure and flexibility from the
domestic regulations, such as labour laws.

The Indian government has taken steps to revise the definition of FDI flows into the country. A Committee that was set up by
the Reserve Bank of India(RBI), in its report submitted in October 2002, recommended that the Indian definition be brought
on par with the global practice.
Quality of FDI Inflows into India and China: Sectoral Composition and Other Differences
India’s post-reform period experiences SLI (Silent Lacunar Infarction) Tests that a substantial
proportion of FDI has gone into services, infrastructure, and relatively low, technology-intensive,
consumer goods manufacturing industries when compared to a high concentration in technology-
intensive manufacturing industries in the pre-reform period. In China and other South-east Asian
countries, the bulk of FDI is concentrated in the manufacturing. In the pre-reform period, FDI was
consciously channelled into technology-intensive manufacturing, through a selective policy. In the
post-reform period, however, opening up of new industries such as services and infrastructure to FDI
has led to a lot of FDI going into them, thus bringing down the tiles share of manufacturing. Within
manufacturing too, now that there is no policy to direct the FDI to certain branches, the consumer
goods industries that did not have so much exposure to FDI have risen in importance. On the other
hand, while following in general a liberal policy towards FDI, China and other South-east Asian
countries have directed the FDI to manufacturing, with export obligations and other incentives such as
pioneer industry programmes. Hence, FDI also accounts for a relatively high share of manufactured
exports in these countries, as observed later. It suggests that while according it a liberal treatment, a
broad direction needs to be given to improve the quality of FDI and make it to contribute more to
industrialisation and building export capability. Specific promotion of export-oriented FDI may also
be fruitful.

China and other South-east Asian Countries have directed FDI to manufacturing with export obligations and other
incentives such as pioneer industry programmes.
Impact of FDI Inflows: Some Issues
Given their intangible assets, MNC affiliates can contribute to their host country’s development with
generation of output, employment, balanced regional development, technological capability, and
export expansion, among other things. The lack of data on the economic activity of enterprises that
are operating in India which are classified by the nationality of ownership has constrained a fuller
appreciation of the role that was played by FDI in the country’s economic development. In what
follows, the findings of existing studies and some observations based on the comparisons of the
samples of enterprises are made to the gather some idea of the impact of FDI.
Place of FDI in India: Shares in Sales, Capital Formation, and GDP
An idea of the relative importance of FDI in India can be had from the share of output or sales of
foreign affiliates in output or sales of the industrial sector. A few attempts have been made in that
direction. Kumar estimated that the foreign-controlled firms accounted for nearly 25 per cent of the
output of larger private corporate sector and 31 per cent in the manufacturing sector in 1980–81.
Arthreye and Kapil, in an attempt to update Kumar ’s estimates, following the same methodology,
found that foreign firms in 1990–91 accounted for about 26 per cent of sales in the manufacturing,
down from 31 per cent in 1980–81. The declining trend of the share of foreign-controlled enterprises
over the 1980–90 period has to do with the restrictive attitude followed by the government, with
respect to FDl during the period. Similar estimates for the post-liberalisation period are not available.
To examine the trends in the share of foreign enterprises during the 1990s in the Indian
manufacturing, we have computed the share of foreign firms in the total value added and the total
sales in a sample of large private sector companies that are quoted on Indian stock exchanges and
included in the RIS (Research and Information System) database compiled by extracting the
information of relevant companies from the Prowess (online) Database of the Centre for Monitoring
Indian Economy (CMIE). The shares that are computed on the basis of the sample such as this, are
useful only to observe trends overtime, as information is not available on the representative nature of
the sample. The shares of foreign enterprises in both value added and sales reveal an increasing trend
in the 1990s, particularly in the late 1990s.
Therefore, the liberalisation policy seems to have led to a rise in the place of foreign enterprises in
the Indian industry. Table 25.7 provides the data for shares of foreign firms in the Indian
manufacturing units during the 1990s. The growing importance of FDI inflows in the Indian economy
can also be judged from the rising ratios of FDI inflows as a proportion of gross fixed capital
formation (GFCF) from 0.3 per cent to 4 per cent, in 1990 and of the inward FDI stock as a
percentage of GDP rising from 0.5 per cent to 5.4 per cent over the same period (refer to Table 25.8).

The liberalisation policy seems to have led to a rise in the place of foreign enterprises in the Indian industry.

Table 25.7 Shares of Foreign Firms in the Indian Manufacturing During 1990s
Source: RIS database.

Table 25.8 Rising Importance of FDI in Indian Economy
Source: UNCTAD.

FDI, Growth, and Domestic Investment
FDI inflows could contribute to the growth rate of the host economy by augmenting the capital stock
as well as with infusion of new technology. However, the high growth rates may also lead to more
FDI inflows by enhancing the investment climate in the country. Therefore, the FDI-growth
relationship is subject to a causality bias (given the possibility of a two-way relationship). What is the
nature of the relationship in India? A recent study has examined the direction of causation between
FDI and growth empirically, from a sample of 107 countries for the 1980–99 period. In the case of
India, the study finds a Granger neutral relationship as the direction of causation was not pronounced.
Furthermore, it has been shown that sometimes the FDI projects may actually crowd out or
substitute the domestic investments from the product or the capital markets, with the market power of
their well-known brand names and other resources and may, thus, be immiserising. Therefore, it is
important to examine the impact of FDI on the domestic investment to evaluate the impact of FDI on
the growth and welfare in the host economy. Our study to examine the effect of FDI on the domestic
investment in a dynamic setting, however, did not find a statistically significant effect of FDI on the
domestic investment in the case of India. It appears, therefore, that the FDI inflows that are received by
India have been of a mixed type, combining some inflows that are crowding in the domestic
investments while others are crowding them out, with no predominant pattern emerging.
Empirical studies on the nature of relationship between the FDI and the domestic investments
suggest that the effect of FDI oil domestic investment depends on the host government policies. The
governments have extensively employed selective policies and imposed various performance
requirements, such as local content requirements (LCRs) to deepen the commitment of MNCs with the
host economy. The Indian government has imposed the condition of phased manufacturing
programmes (or LCR) in the auto industry to promote vertical inter-firm linkages and encourage the
development of the auto component industry (and crowding-in of domestic investments). A case study
of the auto industry where such policy was followed shows that these policies (in combination with
the other performance requirements, viz., foreign exchange neutrality), have succeeded in building all
internationally competitive, vertically integrated auto sector in the country. The Indian experience in
this industry, therefore, is in tune with the experiences of Thailand, Brazil, and Mexico, as
documented by Moran (1998).

Empirical studies on the nature of relationship between FDI and the domestic investments suggest that the effect of FDI oil
domestic investment depends on the host government policies.
Exports and BoPs
A number of developing countries have used FDI to exploit the resources of MNCs such as globally
recognised brand names, best practices technology, or by getting integrated with their global
production networks, among others, for expanding their manufactured exports.
The early studies analysing the export performance of Indian enterprises in the pre-liberalisation
phase reported no statistically significant difference between the export performance of foreign and
local firms. Sharma—in a study, using a simultaneous equation model, was examining the factors and
explaining the export growth in India over 1970–98 period—found FDI to have no significant effect
on the export performance, though its coefficient had a positive sign. Obviously, in a highly protected
setting, both local and foreign firms found it more profitable to concentrate on the domestic market.
For the post-reform period, Agarwal found a weak support for the hypothesis that foreign firms have
performed better than the local firms in India in the post-reform period 1996–2000, though the
estimates were not robust across various technology groupings and the foreign ownership dummy
turned out to be significant at 10 per cent level, only in the case of medium-high technology
industries. Controlling for several firm-specific factors, fiscal incentives, and industry
characteristics, Kumar and Pradhan, in a recent study analysing the export orientation of over 4,000
Indian enterprises in the manufacturing for the 1988–01 period, found that the Indian affiliates of
MNCs appear to be performing better than their local counterparts in terms of export-orientation
overall, though with some variation across industries. In the light of the findings of the earlier studies
that were relating to pre-liberalisation period of no significant difference in the export orientation of
foreign and local enterprises, it would appear that reforms have prompted the foreign MNCs to begin
exploring the potential of India as an export-platform production in a modest manner.

Reforms have prompted the foreign MNCs to begin exploring the potential of India as an export-platform production in a
modest manner.
The studies that are analysing the determinants of the patterns of export orientation of MNC
affiliates across 74 countries in seven branches of the industry over three points of time, have shown
trade liberalisation to be an important factor in explaining the export orientation of the foreign
affiliates. Furthermore, in the host countries with large domestic markets, the export obligations have
been found to be effective for promoting export orientation of foreign affiliates to the Third World
countries. From that perspective, the liberalisation of trade regime during the 1990s in India may have
facilitated the export orientation of foreign affiliates, as borne out from the above.
The export obligations have also been employed fruitfully by many countries to prompt MNC
affiliates to exploit the host country’s potential for export-platform production. For instance, in
China, which has succeeded in expanding manufactured exports with the help of MNC affiliates, the
regulations stipulate that the wholly owned foreign enterprises must undertake to export more than 50
per cent of their output. As a result of these policies, the proportion of foreign enterprises in the
manufactured exports has steadily increased over the 1990s to 44 per cent. The MNC affiliates
account for over 80 per cent of China’s high-technology exports. India has not imposed the export
obligations on MNC affiliates except for those entering the products that are reserved for the SMEs.
However, indirect export obligations in the form of dividend balancing have been imposed for
enterprises the are producing primarily consumer goods (since phased out in 2000). Under these
policies, a foreign enterprise is obliged to earn the foreign exchange that it wishes to remit abroad as
a dividend, so that there is no adverse impact on the host country’s BoPs. Sometimes, a condition of
foreign exchange neutrality has been imposed where the enterprise is required to earn foreign
exchange enough to even cover the outgo on account of imports. Therefore, these regulations have
acted as indirect export obligations, prompting the foreign enterprises to export, to earn the foreign
exchange that is required by them. The evidence that is available suggests that such regulations have
prompted the foreign enterprises in undertaking exports. In the case of the auto industry, in order to
comply with their export commitments and to comply with foreign exchange neutrality condition,
foreign auto majors have undertaken the exporting of auto components from India, which have not
only opened new opportunities for Indian component manufacturers but also in that process, found
profitable opportunities for businesses too. Hence, the exports of auto components from India are
now growing at a rapid rate exceeding the obligations several times over. These regulations have
acted to remove the information asymmetry that has been existing in the minds of the auto majors
about the poor quality of the Indian components. In that respect, India’s experience is very similar to
that of Thailand that has emerged as the major auto hub of South-east Asia.

Under these policies, a foreign enterprise is obliged to earn the foreign exchange that it wishes to remit abroad as a
dividend, so that there is no adverse impact on the host country’s BoPs.
It has been shown that even indirect export obligations such as foreign exchange neutrality and
dividend balancing could be effective in prompting the MNCs to exploit opportunities for an export-
oriented manufacture. In order to comply with the performance requirements that were imposed at the
time of entry, Pepsi developed a model of contract farming in Punjab with a new technology that was
brought in for growing horticulture products of requisite quality and specifications in the country.
This way, the indirect export obligations have helped the country to benefit not only from export
earnings but also from transfer and diffusion of new technology among farmers.
R&D, Local Technological Capability, and Diffusion
For the overall sample of manufacturing, foreign firms appear to be spending more on R&D
(Research and Development) activity in India than on the local firms, though the gap between their
R&D intensities tended to narrow down, and finally vanishing by 2001. Table 25.9 clearly explains in
detail the R&D intensities. A study analysing the R&D activity of the Indian manufacturing enterprises
in the context of liberalisation found that after controlling for extraneous factors, the MNC affiliates
reveal a lower R&D intensity when compared to local firms, presumably on account of their captive
access to the laboratories of their parents and associated companies. The study also observed
differences in the nature of motivation of R&D activity of foreign and local firms. The local firms
seem to be directing their R&D activity towards absorption of imported knowledge and to provide a
backup to their outward expansion. The MNC affiliates, on the other hand, either focus on
customisation of their parent company’s technology for the local market or focus on using the local
technology.

The study also observed differences in the nature of motivation of R&D activity of foreign local firms.
With respect to contribution of FDI to local technological capability and technology diffusion, the
studies find a mixed evidence. Fikkert study covering 305 Indian private sector firms showed that the
firms with foreign equity participation have an insignificant direct effect on R&D, but they tend to
depend significantly more on foreign technology purchases, which in turn tend to reduce R&D. In
view of these findings, Fikkert concludes that “India’s closed technology policies with respect to
foreign direct investment and technology licensing had the desired effect of promoting indigenous
R&D, the usual measure of technological self-reliance”.

The study showed that the firms with foreign equity participation have an insignificant direct effect on R&D.
On the knowledge spillovers from foreign to domestic enterprises, the evidence suggests that they
are positive when the technology gap between the foreign and local enterprises is not wide. When the
technology gap is wide, the entry of foreign enterprises may affect the productivity of domestic
enterprises adversely, that is, there could be negative spillovers.
Some governments, for example, Malaysia, have imposed technology-transfer requirements on
foreign enterprises. However, such performance requirements do not appear to have been very
successful in achieving their objectives. Instead, the other performance requirements such as LCRs or
domestic-equity requirements (DERs) may be more effective in the transfer of technology.

Table 25.9 R&D Intensity of Indian Manufacturing Enterprises Based on Ownership, 1990–01

As observed above, the LCRs and export performance requirements (EPRs) have prompted the
foreign enterprises to transfer and diffuse some knowledge to the domestic enterprises, in order to
comply with their obligations. Similarly, the DERs may facilitate the quick absorption of file
knowledge that was brought in by the foreign enterprises, which is an important prerequisite of the
local technological capability, as is evident from the case studies of the Indian two-wheelers industry,
where Indian JVs with foreign firms were able to absorb knowledge that was brought in by the
foreign partner, and eventually become self-reliant not only to continue production but even to
develop their own world-class models for the domestic market and exports, on their own. Some have
expressed the view that DERs may adversely affect the extent or the quality of technology transfer.
However, it has been shown that MNCs may not transfer key technologies even to their wholly owned
subsidiaries abroad fearing the risk of dissipation the or diffusion through mobility of employees.
Furthermore, even if the content and quality of technology transfer is superior in the case of a sole
venture than in the case of a JV, from the host country’s point of view, the latter may have more
desirable externalities in terms of local learning and diffusion of the knowledge that is transferred.
A recent trend in FDI is that of globalisation of R&D activity, including other knowledgebased
activities such as development of custom software and business-process outsourcing (BPO). Once the
potential of India, as a competitive location for software development, was established by the mid-
1990s, the MNCs began to enter India for setting up their dedicated software development centres.

Once the potential of India, as a competitive location for software development, was established by the mid-1990s, the
MNCs began to enter India for setting up their dedicated software development centres.
Firm Size, Profitability, and Efficiency

Foreign affiliates have been generally larger than their local counterparts. This is to do with their
strategy to employ a non-price rivalry, such as product differentiation that has substantial economies
of scale. As Table 25.10 shows, even with our sample based on the Prowess database, the average size
of foreign firms is larger than that of the domestic firms.
The early studies of profitability in the Indian industry suggested that the foreign affiliates had
higher profit margins on sales than their local counterparts in most of the branches of the Indian
manufacturing. A further analysis of the determinants of the profit margins of both foreign and local
firms suggested that the higher profitability of foreign firms was more due to their preference to
focus on the less-price-elastic upper ends of the market with product differentiation and leaving the
more-price-competitive lower ends of the market for local firms. The study did not find any evidence
for their higher profitability to be, due to their better efficiency of resource utilisation. The trend of
the sample of larger firms that is used for this study even in the post-liberalisation period is
summarised in Table 25.10. The table also suggests that foreign affiliates have not only enjoyed
consistently the higher profit margins but that their profit margins have been more stable when
compared to that of the local firms.

The early studies of profitability in the Indian industry suggested that the foreign affiliates had higher profit margins on
sales than their local counterparts.

Table 25.10 Average Firm Size in Indian Manufacturing, 1990–01

FDI and the Knowledge-based Economy in India: Software and Global R&D Hub
The rise of the IT software and services industry (or software industry) over the 1990s represents one
of the most spectacular achievements for the Indian economy. The industry, which is highly export-
oriented, has grown at an incredible rate of 50 per cent per annum over the past few years and has
established India as an exporter of knowledge-intensive services in the world; and has brought in a
number of other spillover benefits such as of creating employment and a new pool of
entrepreneurship. The Indian software industry has grown at a phenomenal compound annual rate of
over 50 per cent over the 1990s, from a modest export revenue of US$100 mn in 1989–90, to evolve
into over $12 bn export earnings by 2003–04, and has set itself a target of $50 bn of exports by 2008.

The Indian software industry has grown at a phenomenal compound annual rate of over 50 per cent over the 1990s, and
has set a target of $50 bn of exports by 2008.
The success of Indian exports in the software industry is primarily driven by local enterprises,
resources, and talent. The role played by MNCs in software development in India is quite limited.
Although all the major software companies have established development bases in India, their overall
share in India’s exports of software is rather small at 19 per cent. MNCs do not figure among the top
seven software companies in India, that are ranked either on the basis of overall sales or the exports.
Among the top 20 software companies too, no more than six are MNC affiliates or JVs. About 79 of
the 572 member companies of Nasscom are reported as foreign subsidiaries. Some of these are
actually subsidiaries of companies that are promoted by the non-resident Indians in the United States
while some others were Indian companies to begin with but have been subsequently taken over by
foreign companies. The foreign subsidiaries include software development centres of software MNCs
and also subsidiaries of other MNCs that develop software for their parent’s applications, for
example, subsidiaries of financial services companies such as Citicorp, Deutsche Bank, or
telecommunication MNCs such as Hughes and Motorola, among others. In addition, the MNCs have
set up 16 JVs with local enterprises, such as British Aerospace with Hindustan Aeronautics. In all, 95
companies have been controlling foreign participation. The bulk of the entries took place since 1994
by which time India’s potential as a base for software development was already established and not the
other way round.
What is the distribution of gains from the activity of MNC subsidiaries in the software industry
between home and host countries? Apparently, some of the MNC subsidiaries in the software
development are doing pioneering a work for their parents. For example, the Oracle Software
Development Centre that is located in Bangalore has been responsible for designing the “network
computer” that is introduced by Oracle entirely. SAP of Germany has management (DRM [Digital
Rights Managements]) solutions for a high-tech industry developed entirely at SAP Labs, India, a
Bangalore-based subsidiary of SAP. Many other design centres of MNCs in India are doing a highly
valuable development work for them. However, the Indian subsidiaries of these MNCs do not share
the revenue streams that are generated by their developments worldwide. MNCs tend to invoice the
exports of their subsidiaries to them at cost plus 10 per cent to 15 per cent. Therefore, the distribution
of gains is grossly in favour of the home country of MNCs and against the host country, that is, India
in this case.
Most of the export-oriented software companies operate as “export enclaves”, with little linkages
with the domestic economy, if at all. The MNC subsidiaries in the software development, in particular,
derive almost all of their income from their export to their parents. Hence, hardly any vertical
linkages are developed as the domestic operation generates very few knowledge spillovers for the
domestic economy. The bulk of the work done is also of a highly customised nature, having little
application elsewhere. Given the high salaries and perks of a foreign travel, the movement of
personnel from these companies to the domestic firms also does not take place. The employees of
export-oriented firms are generally lured by foreign companies. However, there is a considerable
movement of personnel from the domestic, market-oriented firms to export-oriented firms or
foreign subsidiaries. A survey of the software industry suggested that about 45.6 per cent of the
professionals were recruited by software firms from other companies. The domestic market also
supports the exports of products that are first tried locally and are improved on the basis of feedback
data that are generated before being exported. In terms of technological complexity and
sophistication, some projects in the domestic market are more advanced and challenging than the
export projects.

Most of the export-oriented software companies operate as “export enclaves”, with little linkages with the domestic
economy, if at all.
A survey of the software industry suggested that about 45.6 per cent of the professionals were recruited by software firms
from other companies.
FDI and Global R&D Activity in India
Although the R&D activity of the domestic, market-oriented MNC affiliates is not high when
compared to their local counterparts as observed above, MNCs are increasingly looking to India
because of its relatively well-developed, scientific and technological infrastructure and resources for
setting up global and regional R&D centres that provide solutions to specific R&D problems for their
global operations, besides research collaborations with Indian enterprises having complementary
capabilities. This trend has been encouraged by the development of international communication and
information technologies (ICT) that allow efficient communication between research groups that are
based in different places across the continents through dedicated networks. This enables MNCs to
fragment the R&D projects into smaller sub-projects, some of which could be sub-contracted to units
that are located in the developing countries having particular skills in that particular branch of
knowledge. The internationalisation of R&D that is conducted in this manner involves little risk of
dissipation or diffusion of technology to competitors because of high specificity of the sub-project.
A quantitative analysis of the factors that are explaining the location pattern of the overseas R&D
by US and Japanese MNCs suggested that the countries that are characterised by a large-scale
technological activity and abundant, cheap, but qualified R&D power are most likely to play host to
MNCs’ overseas R&D activity. The Indian government has invested cumulatively in building centres
of excellence in different branches of science and technology. These centres coupled with the relative
abundance of the country in qualified but cheap R&D manpower has begun attracting MNCs to it for
setting up global or home-based, augmenting R&D centres. In the period of 2000–05, nearly 100
MNCs have set up R&D centres in India. These include GE’s $80 mn technology centre at Bangalore,
which is the largest outside the United States and employs about 1,600 people. The list of MNCs that
have set up global R&D centres in India includes Akzo Nobel, AVL, Bell Labs, Colgate Palmolive,
Cummins, DuPont, Daimler–Chrysler, Eli Lilly, GM (General Motors), HP (Hewlitt–Packard),
Honeywell, Intel, McDonald’s, Monsanto, Pfizer, Texas Instruments, and Unilever.

Over the past five years (2000–05) nearly 100 MNCs have set up R&D centres in India.
According to some reports, the Indian R&D centres of the US MNCs have begun to generate a
substantial intellectual property for their parents and have filed more than 1,000 patent applications
with the US Patent and Trademark Office, mostly during 2002 and 2003. The Indian centres of
multinational technology companies expect to double the number of their employees from 40,000 in
2003. The Indian R&D centres of MNCs have begun to play an important role in the knowledge
generation for their parents. For instance, about 30 per cent of all software for Motorola’s latest
phones is written in India.
A look at the illustrative cases of the global R&D centres, R&D JVs, and contracts that are set up by
MNCs in India suggest that most of the R&D centres have been motivated primarily by the abundance
of highly talented R&D personnel in India at a much lower cost than that prevailing in the Western
world. An Indian engineer, for an instance, costs $2,300 per year when compared to one with a
similar profile in the United States for $60,000 per annum.
Secondly, the existence of a few internationally renowned public-funded centres of excellence, such
as the Indian Institute of Science (IISc), National Chemical Laboratory (NCL), and Indian Institute of
Chemical Technology (IICT) have helped India to attract R&D investments from MNCs. Actually, the
Indian research centres of Astra AB and Daimler–Benz were specifically attracted to Bangalore by the
prospects of a collaboration with the IISc. Astra has actually endowed a Chair at IISc to cement its
relationship with it and the Benz Research Centre has contracted a project in avionics to IISc.
Encouraged by its research contracts with IICT and NCL, DuPont has set up a separate Indian
Technology Office at its headquarters to systematically target India for its technology research
activity. Another feature of these investments is that these are all concentrated in a few Indian cities
such as Bangalore and Hyderabad because of the high concentration of innovative activities in these
areas. Bangalore has also been chosen by a number of ICT MNCs as their base for software
development, and is widely referred to as “India’s Silicon Valley”.

The existence of a few internationally renowned publicfunded centres of excellence, such as the IISc, NCL, ITCT, etc., have
helped India to attract R&D investment from MNCs.
Bangalore has also been chosen by a number of ICT MNCs as their base for software development, and is widely referred to
as “India’s Silicon Valley”.
To sum up, the foregoing discussion on the FDI’s role in the software industry and R&D activity
suggests that India’s success owes largely to the cumulative investments that were made by the
government, over the past five decades in building what is now termed as “National Innovation
Systems”. These include resources in the development of a system of higher education in engineering
and technical disciplines, creation of an institutional infrastructure for S&T policy making and
implementation, and building centres of excellence and numerous other institutions for technology
development, among many other initiatives. The Indian government recognised the potential of the
country in computer software, way back in the early 1970s, and started building the necessary
infrastructure for its fruition, in particular, for the training of manpower. The government also
facilitated a technological capability building with investments in the public-funded R&D institutions
and supporting their projects, by creating computing facilities, and developing an infrastructure for
data transfer and networking. The patterns of clustering of the software development activity and, in
particular, the case study of Bangalore provides a further evidence to the contention that the public-
funded technological infrastructure has crowded in the investments from the private sector in the
skill-intensive activities such as software development. It would appear from the above fact that the
investments made by the governments in the national innovation systems have substantial positive
externalities.

The Indian government recognised the potential of the country in computer software, way back in the early 1970s, and
started building the necessary infrastructure for its fruition, in particular, for the training of manpower.
Policy Lessons
This section overviewed the evolution of the Indian government’s attitude towards FDI, examined the
trends and patterns that are followed in FDI inflows during the 1990s, and considered its impact on the
few parameters of development in a comparative East Asian perspective. The changing policy
framework has affected the trends and patterns of FDI inflows that are received by the country.
Although the magnitude of FDI inflows has increased, in the absence of a policy direction, the bulk of
them have gone into services and soft-technology consumer goods industries, bringing the share of
manufacturing and technology-intensive among them down in a sharp contrast to the East Asian
countries. Although the importance of FDI as a source of capital and output generation has risen, its
impact on direct investment and growth is mixed as some FDI inflows possibly crowd in the domestic
investments while some others crowd them out. The policies like local content regulation wherever
pursued (as phased manufacturing programmes in the auto industry) have yielded desirable results.
India’s experience with respect to fostering export-oriented industrialisation with the help of FDI has
also been much poorer than that of the East Asian economies. However, a recent analysis suggests that
MNCs are beginning to take a serious look at India’s potential as a base for an export-oriented
manufacture. As in the case of the East Asian countries, the performance requirements such as export
obligations wherever imposed (as indirect export obligations dividend balancing on consumer goods
industries) have helped in promoting the MNCs to consider using India as a sourcing base, thus
helping to solve information asymmetry or the perception gap on the country’s potential.

The changing policy framework has affected the trends and patterns of FDI inflows that are received by the country.
In terms of technology and R&D, the manufacturing affiliates of MNCs in India seem to be
spending a relatively smaller proportion of their turnover on R&D activity, after controlling for
extraneous influences. It also appears that the R&D activity of MNC affiliates is geared for
customisation of their technology for local markets or to work on assignments by their parent
companies in contrast to the focus of the R&D activity of the local enterprises, on technology
absorption and external competitiveness. A case study evidence suggests that JV requirements and
vertical inter-firm linkages may facilitate a diffusion of knowledge brought in by MNCs.
India is also attracting an increasing attention from MNCs as a base for their knowledge-based
activities such as software development and global R&D activity. A case study of the MNCs, showing
an involvement in the knowledge-based activities suggests that India’s success owes largely to the
cumulative investments made by the government over the past five decades in building what is now
termed as “National Innovation Systems”, including resources in the development of a system of
higher education in engineering and technical disciplines, creation of an institutional infrastructure
for S&T policy making and implementation, building centres of excellence and numerous other
institutions for technology development, among other initiatives.
The MNC affiliates in India generally enjoy a much better and stable profit margins when
compared to the local enterprises, largely due to their ability to exploit the economies of scale, with
large scales of operations, and their strategy to focus on less price-sensitive upper segments of
markets than because of a greater efficiency per se. In general, the above analysis brings out the role
of the government policy in attracting and benefitting from FDI inflows for development. In the light
of this discussion, we may now draw a few policy lessons for India and other similarly placed
developing countries.

The MNC affiliates in India generally enjoy a much better and stable profit margins when compared to the local enterprises,
largely due to their ability to exploit the economies of scale, with large scales of operations, and their strategy to focus on
less price-sensitive upper segments of markets than because of a greater efficiency per se.
First of all, the liberalisation of FDI policy may be necessary but not sufficient for expanding the
FDI inflows. The overall macro-economic performance continues to exercise a major influence on
the magnitude of FDI inflows by acting as a signalling device for FIIs, about the growth prospects for
the potential host economy. Hence, by paying attention to the macroeconomic performance indicators
such as the growth rates of industry through public investments in socio-economic infrastructure and
other supportive policies, and creating a stable and enabling environment would crowd in the FDI
inflows. The studies have shown that the policies that facilitate domestic investments also pull in FDI
inflows. While investment incentives may not be that efficient, an active promotion of FDI by
developing certain viable projects and getting key MNCs interested in them could be useful in
attracting investments in desirable directions.
The government policies play an important role in determining the quality or developmental
impact of FDI and in facilitating the exploitation of its potential benefits by the host country’s
development. The approval policy that was followed till 1990 channelled the FDI into areas where
capabilities are needed to be built. The various performance requirements such as phased-
manufacturing programmes, EPRs, and domestic ownership requirements have also been employed
by the government to achieve developmental policy objectives. Even with a liberalised policy, some
policy direction to FDI is desirable as has been demonstrated by the case of East Asian countries.
One way to maximise the contribution of FDI to the host development is to improve the chances of
FDI’s crowding in the domestic investments and minimise the possibilities of its crowding out the
domestic investments. In this context, the experiences of South-east Asian countries such as Malaysia,
Korea, China, and Thailand in channelling the FDI into the export-oriented manufacturing through
selective policies and EPRs that were imposed at the time of entry deserve a careful consideration.
The export-oriented FDI minimises the possibilities of crowding-out of domestic investments and
generates favourable spillovers for domestic investments, by creating a demand for intermediate
goods. Another policy that can help in maximising the contribution of FDI inflows is to push them to
newer areas where local capabilities do not exist as that minimises the chances of conflict with
domestic investments. Some governments such as Malaysia have employed pioneer industry
programmes to attract FDI in industries that have the potential to generate more favourable
externalities for the domestic investment. Similarly, because an MNC entry through acquisition of
domestic enterprises is likely to generate less-favourable externalities for the domestic investment
than the Greenfield investments, some governments discourage acquisitions by foreign enterprises.

The best way to maximise the contribution of FDI to the host development is to improve chances of FDI’s crowding in
domestic investments.
Another sphere where governmental intervention may be required to maximise the gains from
globalisation is in diffusion of knowledge that is brought in by the foreign enterprises. An important
channel of diffusion of knowledge that is brought in by MNCs in the host economy is vertical inter-
firm linkages with the domestic enterprises. Many governments—in the developed as well as the
developing countries alike—have imposed LCRs on MNCs to intensify the generation of local
linkages and transfer of technology. The host governments could also consider employing proactive
measures that encourage foreign and local firms to deepen their local content as a number of
countries, for example, Singapore, Taiwan, Korea, and Ireland, have done so successfully. The
knowledge diffusion could also be accomplished by creating sub-national or sub-regional clusters of
inter-related activities which facilitate the spillovers of knowledge through informal and social
contacts among the employees besides traditional buyer–seller links. UNCTAD also highlights the
policy measures that are employed by different governments in promoting the linkages.
The investments made by governments in building up the local capabilities for higher education
and training in technical disciplines, centres of excellence, and in other aspects of national innovation
systems have substantial favourable externalities, as is demonstrated by the case study of FDI in
India’s knowledge-based industries.

The investments made by governments in building up the local capabilities for higher education and training in technical
disciplines, centres of excellence, and in other aspects of national innovation systems have substantial favourable
externalities, as is demonstrated by the case study of FDI in India’s knowledge- based industries.
Finally, in the light of the above, it is clear that it is of a critical importance for the host
governments to preserve a policy flexibility to pursue a selective policy or impose performance
requirements on an FDI, if necessary. Some of the performance requirements have already been
outlawed by the WTO’s Trade Related Investment Measures (TRIMs) Agreement. Attempts have been
made by the developed countries to expand the scope of international trade rules beyond what is
covered under TRIMs and General Agreement on Trade and Services (GATS), and further limit the
policy flexibility that is available to the developing countries by creating the WTO’s multilateral
framework on investment. However, due to developing countries’ resistance to start WTO
negotiations at the Cancun Ministerial Conference of WTO, negotiations on the subject have been
dropped from the agenda of the Doha Round as per the July package agreed at the General Council
Meeting that was held in Geneva at the end of July 2004.
NEW POLICIES
The government has permitted, except for a small negative list, an access to the automatic route for
FDI. The automatic route means that FIIs need only to inform the RBI within 30 days of bringing in
their investment, and again within 30 days of issuing any shares. The negative list includes (i) all
proposals that require an industrial licence as the activity is licensable, and cases where a foreign
investment is more than 24 per cent in the equity capital of units that are manufacturing items that are
reserved for small-scale industries, and all activities that require an industrial licence in terms of the
locational policy; (ii) all proposals in which the foreign collaborator has a previous venture/tie-up in
India; (iii) all proposals relating to acquisition of shares in an existing Indian company in favour of a
foreign/non-resident Indian/overseas corporate body investor; and (iv) all proposals that are falling
outside the notified sectoral policy/caps or under a sector in which the FDI is not permitted and/or
whenever any investor chooses to make an application to the Foreign Investment Promotion Board
(FIPB) and not to avail of the automatic route.

The government has permitted, except for a small negative list, an access to the automatic route for FDI.
The non-banking financial companies (NBFCs) may hold foreign equity up to 100 per cent if they
are holding companies. The minimum capitalisation norms for fund-based NBFCs are (i) for FDI up
to 51 per cent—US$0.5 mn to be brought upfront; (ii) for FDI above 51 per cent and up to 75 per cent
—US$5 mn to be brought upfront; and (iii) for FDI above 75 per cent and up to 100 per cent—US$50
mn, out of which US$7.5 mn to be brought upfront, and the balance in about 24 months.
For the non-fund-based activities, the minimum capitalisation norm of US$0.5 mn is applicable in
respect of all permitted non-fund-based NBFCs with a foreign investment. The FIIs can set up 100 per
cent operating subsidiaries (without any restriction on the number of subsidiaries), without the
condition to disinvest a minimum of 25 per cent of its equity of Indian entities, subject to bringing in
US$50 mn, out of which US$7.5 mn has to be brought upfront and the balance in about 24 months. JV-
operating NBFCs that have 75 per cent or less than 75 per cent foreign investment, will also be
allowed to set up subsidiaries for undertaking the other NBFC’s activities, subject to the subsidiaries
that are also complying with the applicable minimum capital inflow. FDI up to 49 per cent from all
sources is permitted in the private banking sector on the automatic route, subject to conformity with
RBI guidelines. In the process of liberalisation of FDI policy, the following policy changes have been
made: (i) 100 per cent FDI that is permitted for B to B e-commerce; (ii) condition of dividend
balancing on 22 consumer items that are removed forthwith; (iii) removal of cap on the foreign
investment in the power sector; and (iv) 100 per cent FDI that is permitted in oil refining.
The automatic route is available for proposals in the IT sector, even when the applicant company
has a previous JV or technology-transfer agreement in the same field. An FDI’s limit under the
automatic route in the advertising sector has been raised from the existing 74 per cent to 100 per cent.
FDI up to 100 per cent in the film sector, which is already on the automatic route, now will not be
subject to conditions. FDI up to 100 per cent in the tea sector, including plantation, has been allowed
with a prior approval of the government, and would be subject to the following conditions: (i)
Compulsory divestment of 26 per cent equity of the company in favour of an Indian partner/Indian
public within a period of five years; (ii) prior approval of the State government concerned in case of
any future land-use change, and (iii) Automatic route of FDI up to 100 per cent is allowed in all the
manufacturing activities in SEZs, except for the activities that are related to security, strategy, or
environmental concerns.

FDI’s limit under the automatic route has been raised up to 100 per cent in advertisement and telecom sector.
An FDI up to 100 per cent is allowed with some conditions for the following activities in the
telecom sector: (i) ISPs (Internet Service Providers) not providing gateways (both for satellite and
submarine cables); (ii) infrastructure providers supplying dark fibre (IP category I); (iii) electronic
mail; and (iv) voice mail. FDI up to 74 per cent is permitted for the following telecom services that
are subject to licensing and security requirements (proposals with FDI beyond 49 per cent shall
require prior government approval): (i) ISP with gateways; (ii) radio paging; and (iii) end-to-end
bandwidth.
The FDI in the print-media sector is allowed up to 26 per cent of the paid-up equity capital of the
Indian entities that are publishing periodicals and newspapers which are dealing with news and
current affairs. The FDI in the print-media sector is allowed up to 74 per cent of the paid-up equity
capital of the Indian entities that are publishing the Indian editions of foreign, technical, scientific, and
especially magazines and journals. A payment of royalty up to 2 per cent on exports and 1 per cent on
domestic sale, is allowed under the automatic route, on the use of trademarks and brand name of the
foreign collaborator, without any technology transfer.

The FDI in the print-media sector is allowed up to 26 per cent of the paid-up equity capital of the Indian entities that are
publishing periodicals and newspapers which are dealing with news and current affairs.
A Payment of royalty up to 8 per cent on exports and 5 per cent on domestic sales by wholly owned
subsidiaries to off-shore parent companies, is allowed under the automatic route without any
restriction on the duration of royalty payments. The off-shore venture capital funds/companies are
allowed to invest in the domestic venture capital undertakings as well as other companies through the
automatic route, subject only to SEBI regulations and sector-specific caps on FDI. The existing
companies with FDI are eligible for the automatic route to undertake additional activities that are
covered under this route.
An FDI up to 26 per cent is eligible under the automatic route in the insurance sector, as prescribed
in the Insurance Act, 1999, subject to their obtaining a licence from the Insurance Regulatory and
Development Authority. An FDI up to 100 per cent is permitted in airports, with an FDI above 74 per
cent requiring a prior approval of the government. An FDI up to 100 per cent is permitted with the
prior approval of the government in courier services, subject to existing laws and exclusion of
activities relating to distribution of letters.
An FDI up to 100 per cent is permitted with the prior approval of the government for the
development of integrated townships, including housing, commercial premises, hotels, resorts, city
and regional-level urban infrastructure facilities—such as roads and bridges, mass rapid transit
systems, and manufacture of building material in all metros; including an associated commercial
development of the real estate. The development of land and provision of an allied infrastructure will
form an integral part of township development, subject to guidelines. The FDI up to 100 per cent is
permitted on the automatic route for mass rapid transport system in all metropolitan cities, including
an associate commercial development of the real estate.

The government has permitted the FDI up to 100 per cent under the automatic route for different areas like integrated
township, drugs, pharmaceuticals, and hotels and tourism.
Box 25.3 India’s New Foreign Trade Policy (2004–09)
The New Foreign Trade Policy (NFTP) aims to boost foreign trade and double India’s share of
foreign trade from 0.7 per cent in 2003 to 1.5 per cent by 2009. It focuses especially on areas such
as agriculture, handlooms, handicrafts, gems, jewellery, footwear, and leather. The NFTP aims to
achieve the following:
1. Generate employment opportunities in the semi-urban and rural areas.

2. Set up free-trade zones and warehousing zones by allowing a 100 per cent FDI in them.
3. Set up SEZs that will help to boost the handicraft exports. Under the Market Access Initiative Scheme and the Market
Development Assistance Scheme, funds will be allocated to promote handloom exports.
4. Provide a boost for the export industry by exempting all the exported goods and services from service tax.

An FDI up to 100 per cent is permitted in drugs and pharmaceuticals (excluding those that attract a
compulsory licensing or are produced by a recombinant DNA technology and specific cell/tissue-
targeted formulation) placed on the automatic route. The defence industry sector is opened up to 100
per cent for Indian private-sector participation with an FDI permitted up to 26 per cent, both subject to
licensing. This will be subject to guidelines. An FDI up to 100 per cent is permitted on the automatic
route in the hotel and tourism sector.

An FDI up to 100 per cent is permitted in drugs and pharmaceuticals (excluding those the attract a compulsory licensing or
are produced by a recombinant DNA technology and specific cell/tissue-targeted formulation) placed on the automatic
route.
An NRI investment in a foreign exchange is made fully repatriable whereas the investments made
in Indian rupees through rupee account shall remain non-repatriable. The international financial
institutions like ADB (Asian Development Bank), IFC (International Finance Corporation), CDC
(Commonwealth Development Corporation), DEG, and so on, are allowed to invest in the domestic
companies through the automatic route, subject to SEBI/RBI guidelines and sector-specific caps on
FDI. An industrial licence/letter of intent issued by the Secretariat for Industrial Assistance (SIA) in
the past, carrying the condition of export obligation has been exempted from the operation of this
condition for items that stand dereserved by an appropriate Notification. The investment limit is
raised to Rs 5 crore for 41 SSI-reserved items by amending the IDR Act, 1951. The government has
deleted 51 items that were reserved exclusive manufacture in the small-scale sector.
These are highly significant concessions. All the restrictions of the past on foreign investments
seem to have been cleared up and in that process, attempts have been made to integrate the Indian
economy with the global economy in a way it never was after the 1950s. Box 25.3 describes the main
aims of New Foreign Trade Policy (2004–09).
A COMPARATIVE STATISTICAL OUTLINE OF FDI
The following Tables 25.11–25.17 and Figure 25.12 depict a comparative analysis of FDI. The
government has permitted the FDI up to 100 per cent under the automatic route for different areas like
integrated township, drugs, pharmaceuticals, and hotels and tourism.

Table 25.11 Foreign Direct Investment
Source: RBI Monthly Bulletin, May 2008.

Note:
* : Relates to acquisition of shares of Indian companies by non-residents under Section 6 of FEMA, 1999. The data on such acquisitions
have been included as a part of FDI since January 1996.
** : Represents inflow of funds (net) by FIIs.
# : Figures for equity capital of unincorporated bodies for 2006–07 and 2007–08 (April–December) are estimates.
# # :Represents the amount raised by Indian Corporates through Global Depository Receipts (GDRs) and American Depository Receipts
(ADRs).
+ : Data for 2006–07 and 2007–08 are estimated as average of previous two years.
++ : Data pertain to inter-company debt transactions of FDI entities.
‡ : Include swap of shares of US$3.1 bn.
1. Data on FDI have been revised since 2000–01 with an expanded coverage to approach international best practices.
2. These data, therefore, are not comparable with FDI data for the previous years. Also see “Notes on Tables” of Tables 42 and 43.
3. Monthly data on the compartment of FDI as per the expanded coverage are not available.

Table 25.12 State-wise Foreign Direct Investment Proposals Approved During the Period from April 2003 to February 2008
Amount of FDI Approved (in US$

States No. of Approvals
mn)
Maharashtra 917 5,834
Karnataka 520 1,649
Delhi 698 1,505
Andhra Pradesh 233 1,464
Punjab 26 1,125
Tamil Nadu 413 834
Gujarat 108 548
Chattisgarh 4 415
West Bengal 84 161
Haryana 66 108
Uttar Pradesh 58 73
Kerala 51 72
Rajasthan 26 62
Orissa 6 43
Chandigarh 19 29
Others 128 58
State not indicated 301 1,432

Fig ure 25.1 State-wise Foreign Direct Investment Proposals Approved During the Period from April 2003 to February 2008
Source: Lok Sabha Unstarred Question # 4896, Ministry of Commerce & Industry.

I. FDI Equity Inflows:
A. Cumulative FDI Equity Inflows (equity capital components only)

Table 25.13 Fact Sheet on Foreign Direct Investment (FDI) (From August 1991 to February 2008)—I
Cumulative amount of FDI inflows (from August 1991 to March

Rs 232,041 crore US$ 54,628 mn
2007)
Amount of FDI inflows during 2007–08 (from April 2007 to
Rs 80,732 crore US$ 20,136 mn
February 2008)
Cumulative amount of FDI inflows (updated up to February 2008) Rs 312,773 crore US$ 74,764 mn
Note: FDI inflows include the amount received on account of advances that are pending for issue of shares for the years 1999–04.

B. FDI Equity Inflows (company-wise) Available 2000–07
Cumulative amount of FDI Inflows (from April 2000 to February

Rs 252, 168 crore US$ 58,065 mn
2008)

C. FDI Equity Inflows During Financial Year 2007–08
Financial Year 2007–08 (April–March) Amount of FDI Inflows
(in Rs crore) (in US$ mn)
April 2007 6,927 1,643
May 2007 8,642 2,120
June 2007 5,048 1,238
July 2007 2,849 705
August 2007 3,394 831
September 2007 2,876 713
October 2007 8,008 2,027
November 2007 7,353 1,864
December 2007 6,146 1,558
January 2008 6,960 1,767
February 2008 22,529 5,670
2007–08 (up to February 2008) 80,732 20.136
2006–07 (up to February 2007) 53,734 11,888
%ag e g rowth over last year (+) 50% (+) 69%

D. FDI Equity Inflows During Calendar Year 2008
Calendar Year 2008 (January–December) Amount of FDI Inflows

January 2008 6,960 1,767
February 2008 22,529 5,670
Year 2008 (up to February 2008) 29,489 7,437
Year 2007 (up to February 2007) 11.595 2,619
%ag e g rowth over last year (+) 154% (+) 185%

E. FDI Equity Inflows During Calendar Year 2007
Calendar Year 2007 (January–December) Amount of FDI Inflows

Year 2007 (up to December 2007) 79,736 19,156
Year 2006 (up to December 2006) 50,357 11,122
%age growth over last year (+) 58% (+) 72%
Note: *Figures are provisional, subject to reconciliation with RBI, Mumbai

F. Share of Top Investing Countries FDI Equity Inflows (financial year-wise)
Notes: 1. Includes inflows under NRI schemes of RBI, stock swapped and advances pending for issue of shares.
2. Cumulative country-wise FDI inflows (from April 2000 to February 2008)—Annex “A”.
3. %age worked out in Rs terms and FDI inflows that are received through FIPB/SIA+RBI’s automatic route + acquisition of existing
shares only.

G. Sectors Attracting Highest FDI Equity Inflows
Note: Cumulative sector-wise FDI inflows (from April 2000 to February 2008)—Annex“B”.

H. Statement on RBI’S Regional Office-wise (with state covered) FDI Equity Inflows1 (from April
2000 to February 2008)
Source: INDIA 2008, a book published by the Publications Division, Ministry of Information & Broadcasting, Government of India.
Notes:
1 Includes “equity capital components” only
2 The region-wise FDI inflows are classified as per RBI’s—region–wise inflows, furnished by RBI, Mumbai.
3 Represents inflows through acquisition of existing shares by transfer from residents. For this, regionwise information is not provided by
RBI.

II. FDI Inflows Financial Year-wise Data
A. As per International Best Practices

Table 25.14 Fact Sheet on Foreign Direct Investment (FDI) (From August 1991 to February 2008)—II
Source:
Notes:
RBI’s Bulletin, April 2008 (Table No.46–Forelgn Investment Inflows).
1. # Figures for equity capital of unincorporated bodies for 2006–07 and 2007–08 are estimates.
2. + Data in respect of “re-invested earning”and “other capital” for the year 2005–06 and 2006–07 are estimated as average of previous
two years.
3. (P) All figures are provisional.
4. Updated by RBI up to February 2008.
5. * Includes swap of Shares US$3.1 bn.
6. Data on PDI have been revised since 2000–01 with an expend coverage to approach international best practices.
7. Monthly data on components of FDI as per the expend coverage are not available.
8. + RBI has included the amount of US$92 mn for the month of April 2007 during this Bulletin.

B Financial Year-wise DIPP’S FDI Equlty Inflows (Equity capital components only)
Notes:
1. FEDAI (Foreign Exchange Dealers Association of India) conversion rate from rupees to US dollar applied, on the basis of monthly
average rate provided by RBI (DEAP), Mumbai.
2. *Includes stock swap of Shares US$3.2 bn for the year 2006–07.

III. Foreign Technology Transfer (FTC);
(from August 1991 to February 2008)
A. Number of Cumulative FTC Approvals

Table 25.15 Fact Sheet on Foreign Direct Investment (FDI) (From August 1991 to February 2008)—III
No. of cumulative FTC approvals (from August 1991 to February 2008) 7,941
No. of FTC approvals during 2006–2007 (from April 2006 to March
81
2007)
No. of FTC approvals during 2007–2008 (from April 2007 to February
95
2008)

B. Country-wise Foreign Technology Transfer Approvals
C. Sectors-wise Foreign Technology Transfer Approvals
D. State-wise Foreign Technology Transfer Approvals
Soure: INDIA 2008, a book published by the Publications Division, Ministry of Information and Broadcasting, Government of India.

Table 25.16 Statement on Countrywise FDI Inflows (From April 2000 to February 2008)
Note: *Percentage of inflows worked out in terms of rupees and the above amount of inflows are received through FIPB/SIA route,
RBI’s automatic route, and acquisition of the existing shares only.

Table 25.17 Statement on Sector-wise FDI Inflows (From April 2000 to February 2008)
Source: INDIA 2008, a book published by the Publications Division, Ministry of Information and Broadcasting, Government of India.
Notes:
i. Sector-wise FDI inflows data re-classified, as per segregations of data from April 2000 onwards.
ii. *Percentage of inflows worked out in terms of rupees and the above amount of inflows received through FIPB/SIA route, RBI’s automatic route and acquisition of
the existing shares only.
CASE
The policy of foreign ownership of banks continues to dominate the headlines in Andhra Pradesh.
Last week, the Finance Minister announced that the government would allow a creeping increase at
the rate of 10 per cent every year in the foreign ownership of banks in India. Over a period of time
and combined with equivalent voting rights, this would enable FIIs to acquire a complete control of
the Indian private sector banks. Foreign banks, have, of course, been in the forefront in bringing the
consumer finance products such as credit cards and auto loans to the market. But the pioneer in credit
cards was an Indian bank—Andhra Bank—and a public sector one at that.
Among the new generation of private sector banks, barring an exception or two (UTI [Unit Trust of
India] Bank comes to mind), the emphasis is more on the non-fund-based businesses, like
investments, which clearly, an FII would target the old-generation private sector banks, which are
usually very community-centric, but have been playing an extremely strong role in supporting the
small- and medium-scale enterprises (SMSEs). In the manufacturing and trade, some promoters and
big shareholders would undoubtedly sell out at the right price. In the process, the new owners would
acquire a valuable franchise of the well-established SMEs, with a track record and high net-worth
customer base that comes along with it.
Does it matter very much? The loss would clearly be the nation’s. For the public sector and old-
generation private sector banks, despite their many faults and drawbacks, have proved to be the
sinews of economic growth. But for them, would Tirupur, for example, become the world’s largest
hosiery manufacturing and export centre? Can any foreign bank claim to have financed a single,
currently successful unit in that town, from the beginning?
Today’s stock market favourite, Infosys, was first funded by the now, much-derided, state-level
financial institutions. This is not to find fault with the foreign banks in India. After all, their Indian
representatives have been given a mandate and they are bound to follow that. The larger issues of
development are beyond their ken. It is only Indian banks that could be expected to have the feel and
empathy that are necessary to help the struggling entrepreneurs.
Merchant banking for disinvestment, IPOs (initial public offerings), pension fund management, and
financial services for the rich ought to be a part of any banking landscape, but they are at the far end
of the value chain. Wealth has actually been created from a globally efficient production of goods and
services. Policy priorities lie in how to finance the sectors of the economy which foster growth—
agriculture, infrastructure, manufacturing, IT, and so on—and evolve and support institutions that can
achieve it.
Case Question
Do you support this policy of foreign ownership of banks?
SUMMARY
For about a decade since independence, the country had had an open attitude towards FDI. However,
the Second Plan made a significant departure, emphasising self-reliant economic development and a
restrictive approach vis-à-vis FDI, to protect the domestic base of created assets. The underlying
philosophy was that the Transnational Corporations (TNCs), which bring in FDI, cannot be relied
upon to the extent of allowing them to play a major role in the country’s development; the East India
Company syndrome seemed to haunt the policymakers.
Further, in 1973, the FERA came into force. It limited the equity of foreign companies in the Indian
companies to 40 per cent. And in the late 1970s, some foreign companies were asked to leave the
country itself. However, there was a policy reversal in the 1980s. The industrial and trade policy
liberalisation was accompanied by an increasingly receptive attitude to FDI and foreign-licensing
collaborations.
To modernise the industry, a greater role to multinational enterprises was sought to be given. The
exceptions from the general ceiling of 40 per cent on foreign equity were allowed on the merits of
individual investment proposals. Riding the wave of reforms, the full-scale liberalisation measures
were initiated in the 1990s to integrate the Indian economy with the global one.
The RBI was allowed to give an automatic approval for the priority industries. The FIIs were also
given assurances of free remittances of profits and dividends, a fair compensation in the event of
acquisition, and a level-playing field. These changes in the FDI policy were complemented by
bilateral investment treaties (BITs) and double taxation treaties (DTTs), many of which were signed
by India recently. When the economic reforms programme was launched, it was well recognised that
the lack of infrastructure, such as roads and power, was a serious impediment to development.
However, there was confidence that FDI would flow in and address the problem. As a natural
corollary, the State, which was more or less the only investor in these sectors, stopped the further
investment. The foreign investments did flow in but not to the extent expected. In 2001, FDI as a
percentage of GDP was 4.7, among the lowest in the world.
Moreover, whatever FDI came in, more or less bypassed the preferred sectors—roads and power.
After about a decade, it was realised that the State could not withdraw from these crucial sectors. For
example, in the ambitious highway development project, 95 per cent of the funding comes from the
State. But a crucial decade was lost, delaying thereby, the development process. But the think tanks
soon thought that the FDI did not flow in because of bad roads and the poor power situation. But was
not FDI basically invited to improve that road and power sector?
A steering group was constituted in the Planning Commission to study the FDI regulatory regime and
suggest policy measures for increasing the FDI flows. The crux of the group’s recommendations was
to liberalise further. A TNC’s decision to locate in a country is based on the tax structure, special
programmes and schemes, competition regime, entry and establishment requirements, investment
protection, technology transfer, natural resources and skill levels, incentives, and institutional
mechanism. However, determining the FDI flow is a complex process. For example, while India may
seem more attractive than China on most of these counts, it attracts less than one-tenth of the FDI into
the latter.
There are several other broad issues to be considered. To what extent is technology, which has gained
entry, consistent with India’s employment objectives? Has local technological development received a
set-back on account of foreign technology? What are the long-term effects of foreign collaborations
on R&D? What is the precise degree of import substitution brought about in capital and consumer
goods sectors, and what is its quantitative impact on foreign exchange? Finally, what is the net
contribution of foreign companies towards the host country’s export efforts?
KEY WORDS
Infrastructure
Exchange Rate
Domestic Investment
R&D
Technology Transfer
Multinational Enterprises (MNEs)
R&D Hub
FDI Inflow
Foreign Capital
Greenfields Investment
Balance of Payment (BoP)
Liberalisation
Technology diffusion
Backward Linkages
Forward Linkages
Foreign Affiliate
FDI’s Automatic Route
QUESTIONS
1. Explain the policy of the Government of India towards foreign investment.

2. Examine the case for and against foreign investment in India.
3. How far is the control on foreign investment in India justified?
4. Is foreign investment in India necessary? Explain.
5. Discuss the merits and demerits of foreign investment in India.
6. What are the limitations of foreign investment in a developing country?
7. Describe the FERA guidelines for regulating foreign investment in India.
8. Describe the components of foreign investment in India.
9. Outline the growth of foreign investment in India.
10. “To keep pace with industrial development, foreign investment must not be rigidly handled”. Explain in the context of a
developing country like India.
REFERENCES
Bala, I. (2003). Foreign Resources and Economic Development. New Delhi: Deep and Deep Pub.
Batra, G. S. (2004). Globalisation of Financial Markets. Deep and Deep Pub.
Chidambaram and Alagappan (2003). Business Environment. Delhi: Vikas Pub.
Chopra, C. (2003). Foreign Investment in India: Liberalisation and WTO—The Emerging Scenario. New Delhi: Deep and
Deep Pub.
Khan, A. Q. (2002). Strategy for Foreign Investment Management in 21 Century. Allahabad: Kitab Mahal Pub.
Kumar, N. (2002). Globalization and the Quality of Foreign Direct Investment. New Delhi: Oxford University Press.
Paul, H. (2003). The Economic way of Thinking, 10th ed. New Delhi: Pearson Education.
Rao, P. S. (2003). International Business: Text and Cases. Mumbai: Himalaya Pub.
Srinivasan, T. N. (2002). Trade, Finance and Investment in South Asia. New Delhi: Social Science.
Sury, N. (2004). Foreign Direct Investment: Global and Indian Aspects. Delhi: New Century Pub.
CHAPTER 26
Multinational Corporations
CHAPTER OUTLINE
Origin
Meaning
Definition
Objectives
Reasons for the Growth of MNCs
Favourable Impact of MNCs
Harmful Effects of the Operations of MNCs on Indian Economy
Domination of MNCs over Indian Economy
Liberalisation and MNCs
Assessment
Future of MNCs
A Critique of MNCs
MNCs Deal a Blow to Domestic Companies
Case 1
Case 2
Summary
Key Words
Questions
References
ORIGIN
Multinational business operation is not a new concept. It emerged from mercantilist philosophy. The
British East India Company, Hudson’s Bay Corporation, and Royal Africa Company are examples of
multinational companies (MNCs) of the mercantilist era. The post-World War II period has, however,
witnessed a changing hand in colonialism, and there emerged a new thrust for industrial and
technological development, as well as the rise of the United States as the largest industrial power. The
growth of techno-economic power in countries like the United States, the United Kingdom, France,
and Germany, simultaneously gave birth to large business houses which extended their operations
from the parent countries to various host countries, subsequently skyrocketing their turnover.
In the post-independence India, many MNCs have gained ground. Although they have brought in the
latest technology to make their operations successful, they preferred to keep the secrets of their
technology with themselves. The Coca-Cola experience is an example. The company preferred to
wind up its operations instead of divulging its technical secrets. The companies that operate through
their subsidiaries prefer to guard the technical know-how as their monopoly even if they have a
minority shareholding. MNCs from the United States have the largest share of foreign direct
investment (FDI) in India followed by those from the United Kingdom, Germany, Japan, Switzerland,
France, and Canada.

In the post-independence India, many MNCs have gained ground. Although they have brought in the latest technology to
make their operations successful, they preferred to keep the secrets of their technology with themselves.
Over 50 per cent of the subsidiaries operating in India with 100 per cent ownership during 1960-64
declined their ownership to 36 per cent during 1964-70. Over 50 per cent of the companies had 75 per
cent foreign ownership during the same period—1964-70. According to a “running a stop” report, the
share of FDI in the developing countries marked a decline from 31 per cent in 1971 to 27 per cent in
1980.
After the passing of the MRTP Act and FERA Act out of 883 foreign companies operating in India,
817 companies diluted to either 40 per cent or 51 per cent, and about 40 companies came under the
special category of high-technology industries or export-oriented industries. The liberalisation
policy of the Government of India in 1991 raised the limit of foreign-equity participation from 40 per
cent to 51 per cent. The government subsequently planned to permit even up to 150 per cent
participation in export-oriented and technologically sophisticated industries. Foreign-equity
participation and foreign-collaboration agreements emerged as the participation methods of foreign
firms in India. Another important method of operation was through subsidiaries that were operating
in India with a 100 per cent foreign ownership.
MEANING
Multinational Corporations (MNCs) are normally considered as giant firms, which are engaged in
productive activities of a corporate nature, with headquarters located in one definite country and
having a variety of business operations in different countries in a broad-based manner. MNCs are
also called Transnational Corporations (TNCs), which simply indicate that their business operations
extend beyond the boundaries or borders of the country in which they were originally established.

MNCs are considered as giant firms, which are engaged in productive activities of a corporate nature, with headquarters
located in one definite country and having business operations in different countries.
Business operations of MNCs extend beyond the boundaries or borders of the country in which they were originally
established.
DEFINITION
Any business corporation which has holdings, management, production, and marketing extended over
several countries, owns huge resources and extensive potentiality, and encourages a collective
transfer of resources among various countries, with a view to increasing profitability under a
centralised ownership, which is called “multinational corporation”. There is no universally accepted
definition for the term “multinational corporation”. However, the following definitions by Jacques
Maisonrouge, President, 1MB World Trade Corporation, describes an MNC as a company that meets
five criteria as follows:
1. It operates in many countries at different levels of economic development.

2. Its local subsidiaries are managed by the nationals.
3. It maintains the complete industrial organisation including the research and development (R&D) facilities in several countries.
4. It has a multinational Central management.
5. It has a multinational stock ownership.
Author James C. Baker defines MNC as a company:
1. which has a direct investment based in several countries;

2. which generally derives 20 per cent to 50 per cent or more of its net profits from foreign operations; and
3. whose management makes policy decisions based on the alternatives available anywhere in the world.
Hence MNCs are
1. Business enterprises with huge resources and potentiality;

2. Commercial organisations having management, production, marketing, and holdings extended over several countries;
3. Institutions of vitality for international operations;
4. Undertakings that encourage a collective transfer of resources among various countries, at least from the host countries to the
home country and vice versa; and
5. Business concerns of centralised ownership and control.
According to the International Labour Organisation (ILO), “The essential nature of the multinational
enterprises lies in the fact that its managerial headquarters are located in one country, while the
enterprise carries out operations in a number of other countries as well”.
OBJECTIVES
Generally speaking, MNCs consider international investments to accomplish the following

objectives:
1. To expand the business beyond the boundaries of the home country, where they were originally established.
2. Minimise the cost of production, especially the labour cost.
3. Capture the lucrative foreign market against international competitors.

The objective of an MNC is to capture a lucrative foreign market against international competitors.
4. Avail the competitive advantage internationally.

5. Achieve greater efficiency by producing in local markets and then exporting the products.
6. Make the diversification intentionally effective so that a steady growth of business could be achieved.
7. To safeguard the company’s interest in order to get behind the tariff walls.
8. Make the best use of technological advantages by setting up production facilities abroad.
9. Establish an international corporate image.
10. Counter the regulatory measures in the parent country.
REASONS FOR THE GROWTH OF MNCS

MNCs exercise a huge control on the business of world economy. With huge capital resource, latest
technology, and worldwide reputation, these MNCs are diversifying the marketing of their products
in various counties, where they can sell easily whatever products they manufacture. Given the desire
of the people of an underdeveloped country for the products of MNCs instead of their indigenous
products, MNCs have been able to expand the market of their products in these developing countries.
The important reasons behind the growth of MNCs include the following:
1. Expansion of the market territory beyond the boundary of the country due to their international image.
2. Marketing superiorities arising out of its up-to-date market information system, market reputation, effective advertisements and
sales-promotion techniques, and warehousing facilities.
3. Financial superiorities over national firms.
4. Technological superiority over the national companies of the underdeveloped countries.
5. Effective product innovations due to its superior R&D facilities.

MNCs are growing day by day due to their product innovation, modern technologies, and superior R&D facilities.
FAVOURABLE IMPACT OF MNCS
MNCs have had some favourable impact on the Indian economy. Initially, Indian industries
concentrated on the consumer goods sector only. MNCs have helped the Indian industry sector to
diversify its production spectrum which includes steel, light and heavy engineering, petroleum
refinery, man-made fibre manufacture, automobiles, chemicals, pharmaceuticals, and several other
types of industrial products. There are a number of arguments in favour of MNCs as follows:
1. They help to increase the investment level and thereby, the income and employment in the host country.
2. They become vehicles for transfering technology especially to developing countries.
3. They enable the host countries to increase their exports and decrease their import requirements.
4. They work to equalise the cost of factors of production around the world.
5. They provide an efficient means of integrating national economies.
6. They make commendable contribution to R&D due to their enormous resources.
7. They also stimulate domestic enterprises. To support their own operations, they encourage and assist domestic suppliers.
8. They help to increase competition and break domestic monopolies.
9. They help to improve the standard of living in their host countries.

MNCs help to increase competition and improve the standard of living in their host countries.
10. They provide impetus in diversification.

11. They substantially contribute towards professionalisation of management in the host countries.
12. They contribute substantially to improve the balance of payment (BoP) position in the host countries.
13. They contribute towards the national exchequer by way of duties and taxes.
14. They play a vital role in developing the ancillaries in host counties.
15. They are profit-making enterprises which pay high dividends, motivating resource mobilisation among the investors in host
countries.
HARMFUL EFFECTS OF THE OPERATIONS OF MNCS ON INDIAN ECONOMY

The operations of MNCs have had some harmful effects on the Indian economy. The harmful effects
are as follows:
1. The main objective of MNCs is profit maximisation and not the development needs of poor countries; in particular, the
employment needs and relative factor scarcities in these countries.
2. Through their power and flexibility MNCs inflict heavy damage on the host countries through suppression of domestic
entrepreneurship, extension of oligopolistic practices, passing on unsuitable technology and unsuitable products, worsening
income distribution, and so on.

MNCs inflict heavy damage on the host countries through suppression of domestic entrepreneurship, extension of
oli gopolistic practices, passing on an unsuitable technology, and exploitation of manpower.
3. They can have an unfavourable effect on the BoP position of the country through an outflow of large sums of money in the form
of dividends, profits, royalties, interests, technical fees, and so on, leading to an increasing volume of remittance which rose
from Rs 72.25 crore in 1969-70 to Rs 813.5 crore in 1989.
4. They cause distraction of competition and acquire monopoly powers in the long run.
5. The tremendous power of the global corporations may pose a threat to the sovereignty of the nations in which they do their
business.
6. They retard the growth of employment in the home country.
7. They interfere directly and indirectly in the internal political affairs and affairs of other sort too, of the host country.
8. They cause harm by faulty technology transfer to capital-intensive nature, affecting the employment in a labour-supply
economy.
9. They cause a fast depletion of some of the non-renewable natural resources in the host country.
10. Transfer pricing enables MNCs to avoid taxes by manipulating prices on the intra-company transactions.
DOMINATION OF MNCS OVER INDIAN ECONOMY
At present MNCs have a stronghold over the Indian economy. Even during 1970s, about 52.7 per
cent of the total assets of the giant sector were controlled by the MNCs. As per the estimates of the
Industrial Licensing Policy Inquiry Committee, in 1966, there were about 112 MNCs operating in
India with assets worth Rs 10 crore or more. Of these, about 48 were either foreign branches or
Indian subsidiaries of foreign companies. Besides, there were 14 other companies, having heavy
loans and equity capital, which were almost controlled by foreign companies. Thus, these 62
companies had nearly Rs 1,370 crore worth of assets, which jointly constituted about 54 per cent of
the total assets of the giant sector operating in India. D.S. Swamy was of the opinion that a good
number of other companies were also under foreign domination and some of these companies
depended heavily on international financial institutions for financial assistance. Thus during the mid-
1960s, the Western foreign capital mostly dominated the big business of the country, and thereby
controlled the apex of India’s industrial pyramid.

At present MNCs have a stronghold over the Indian economy. Even during 1970s, about 52.7 per cent of the total assets of
the giant sector were controlled by the MNCs.
Another important feature of MNCs in India is that they have been raising a major part of
investment resources within the boundaries of the Indian economy. Sudip Choudhury made a study of
the sources of finance of MNCs during the period 1956-75, by taking a sample of the 50 largest
foreign subsidiaries. The study revealed that of the total financial resources of these companies, only
5.4 per cent were contributed by foreign sources (equity capital and loans); the remaining 94.6 per
cent were contributed by the domestic sources. Another study made by John Martinussen revealed that
the amount of capital issues contributed by foreign participation declined from 61.5 per cent, with all
consent of public limited companies, in 1976 to only 29.5 per cent in 1980. Moreover, about 20 TNC-
affiliated companies also reduced their foreign funding. During the period 1972-83, some of these
companies did not obtain any foreign funds. Thus, in reality, the MNCs mostly collect their capital
from within the country and repatriate a big chunk of their profits to their parent countries.

In reality, the MNCs mostly collect their capital from within the country and repatriate a big chunk of their profits to their
parent countries.
LIBERALISATION AND MNCS
The liberalisation movement was started in 1973. The process was gradually carried forward to the
liberalisation measures initiated in 1991 to attract massive foreign investments. This opened up the
entry of MNCs into India in a big way. In this context, it is relevant to examine the position of MNCs
in the Indian economy in a liberalised environment. The Industrial Policy Resolution of 1991
provided clear-cut measures for encouraging foreign companies and MNCs. Among the various
measures, areas like foreign investments, technology transfer and import of foreign technology,
liberalisation of MRTP and FERA restrictions, and so on, are worth mentioning. Measures to
minimise the bureaucratic control were also a part of the 1991 policy, which encouraged the MNCs
that were operating in India.

In India, liberalisation measures initiated in 1991 opened up the entry of MNCs.
Foreign investment from foreign corporate firms, individuals, and non-resident Indians were
provided considerable incentives in the 1991 policy. Up to 51 per cent of direct foreign equity was
allowed in high-priority areas that were requiring heavy investments and advanced technology,
whereas even 100 per cent foreign equity was permitted in high-priority industries, the tourism
industry, hotels, shipping, and hospitals with repatriation benefits according to the Government
Notification of October 28, 1991. In the export-oriented industries and the sick units’ revival project,
100 per cent equity was already permissible. These measures provided adequate scope for MNCs to
increase their investment opportunities.
MNCs are capable of introducing the most modern technology. The technology import policy
proposed in the Industrial Policy of 1991 was a blessing in disguise for MNCs. They particularly
appreciated the automatic approvals of technology-import agreements in the high-priority areas. The
amendment of pre-entry restrictions on the establishment of new undertakings and the expansion of
the already existing ones announced in the Central Government Ordinance of September 27, 1991,
facilitated the entry of new MNCs, on the one hand and the expansion of the existing ones, on the
other. While the provision restricting the acquisition or transfer of shares of MRTP undertakings in
both MRTP Act and the Companies Act were deleted, new provisions as in Section 108-A to Section
108-1 were included, facilitating the transfer of shares in MRTP companies and dominant
undertakings. This was a step towards encouraging MNCs to make greater investments in India.
Relaxation of provisions regarding mergers, amalgamations, and takeovers by MRTP companies
proved successful for the expansion of MNCs in India. MNCs are now permitted to invest even in
India’s small-scale sector.

In India, the provision restricting the acquisition or transfer of shares of MRTP undertakings in both MRTP Act and the
Companies Act were deleted.
In connection with the liberalisation policy, a number of additional measures were adopted by the
Government of India, which facilitated the effective role of MNCs in the Indian economy. The
measures included relief to foreign investors, devaluation of the Indian rupee, removal of import
restrictions, Liberalised Exchange Rate Management Systems (LERMS), memorandum to IMF
(International Monetary Fund), encouraging foreign tie-ups, FERA and MRTP relaxation,
privatisation of public sector banking and financial sector reforms, GATT agreements, and so on. All
these measures provided additional incentives to MNCs to operate in India in a big way.

India had taken different measures to encourage MNCs, i.e., removal of import restrictions, LERMS, memorandum to IMF,
FERA and MRTP relaxation, GATT agreements, etc.
In fact, foreign investment has been approved as an important component of investment in India by
all governments at the Centre. The 1991 policy strongly stressed the need for encouraging and
facilitating the foreign investment, paving the way for a big push in MNC activities. The process of
liberalisation is expected to go further, opening the doors for a greater MNC participation in India in
the forthcoming years.
ASSESSMENT
In this context, a brief analysis of the MNCs would throw some light on certain important and
interesting aspects of their position in the global business. MNCs are major, powerful industrial
undertakings, which control huge resources not only in their parent countries but also in host
countries. They have emerged as successful business giants with their total foreign sales exceeding
the Gross National Product (GNP) of any of the countries around the globe, except that of the United
States and USSR (Union of Soviet Socialist Republics) (erstwhile).
The value added of all MNCs in 1971 was estimated at $500 bn, about a fifth of the world’s GNP,
excluding the Centrally planned economies. The value added by each of the top 10 MNCs would be in
excess of $3 bn of the GNP of over 80 countries. The amount of annual sales of each of the four
largest MNCs exceeded $10 bn. The annual turnover of each of the top 28 multinational
pharmaceutical firms exceeded $100 bn in 1970, while the annual turnover of the Swiss firm Roche
alone accounted for $850 mn. The annual turnover of each of the largest nine multinational firms
exceeded $400 mn.

The value added by each of the top 10 MNCs would be in excess of $3 bn of the GNP of over 80 countries.
Most of the MNCs have their headquarters in a few developed countries of Europe and North
America. Evidently, four countries, viz., the United States, the United Kingdom, France, and Germany,
have made a foreign investment of $165 bn, which accounted for four-fifths of the total stock of
foreign investment. Out of this, the foreign investment of the US firms amounted to one-half of the
total foreign investment and one-third of the total number of foreign affiliates. The largest 10 MNCs
are based in the United States. The major part of the pharmaceutical line is owned by MNCs. The
largest 28 multinational pharmaceutical companies, which together account for about 60 per cent of
the total world sales, invest over 90 per cent of their total R&D expenditure. Of the 28 firms, 14 are
from the United States, 4 from East Germany, 3 from the United Kingdom and Switzerland each, 2
from France, and one each from Japan and Holland. It is evident that the United States has the majority
of enterprises operating in many countries, thus dominating the international business scene.
Roughly speaking, two-thirds of the total FDI is concentrated in the developed market economies,
whereas the remaining one-third in the less developed countries (LDCs). On the other hand, the share
of the multinational pharmaceutical companies in the LDC markets ranges from 65 per cent to 95 per
cent. In each LDC, a large number of pharmaceutical firms function, of which MNCs enjoy a very
dominating position though the absolute quantum of MNC investment in these countries is
comparatively small. However, the annual turnover of any MNC would exceed the GNP of a small
underdeveloped host country, which means that an effectively operating MNC may enjoy a
dominating position in its host country.

Two-thirds of the total FDI is concentrated in the developed market economies, where as the remaining one-third in the
LDCs.
However, one cannot rule out the existence of locally owned firms that are operating in certain
areas like drugs, which share a minor portion of the market. It is, however, a welcome sign to note
that the share of domestic firms is now constantly increasing in India. Of the total estimated
pharmaceutical production in India (Rs 2,500 mn) in 1970-71, 39 large and medium firms contributed
about 80 per cent to 90 per cent, of which 95 per cent was the contribution of 33 foreign drug
companies. The expenditure on R&D of the multinational drug firms in India has been spectacular. In
fact, over 90 per cent of the expenditure has been of the MNCs. The pharmaceutical industry makes an
expenditure ranging between 7 per cent and 13 per cent of the total sales towards R&D. The larger the
firms, the greater the expenditure on R&D.
In the United States, the four largest firms accounted for 40 per cent, the eight largest firms for 63
per cent, and the 20 largest firms for 95 per cent of the total R&D expenditure in the pharmaceutical
industry. In the United Kingdom, the four largest firms spent about 70 per cent of the total expenditure
on R&D. Conspicuous investment on R&D contributed towards opening new areas of scientific
advancement, while more and more new products found their way to the market to satisfy the needs of
the consumer. Some may level a criticism that the multinationals make their expenditure on R&D with
a view to claiming a tax deduction in India. This allegation may not be entirely false. However, the
investment in R&D is a positive trend in today’s global business.
Aggressive selling, sales promotion, and advertising were given priority, as a business philosophy
of many an MNC. The profit maximisation efforts of MNCs are closely linked with their promotional
efforts. Of the 20 companies with the largest investment in advertising in India in 1992-93, Hindustan
Lever Ltd. (HLL) topped the list with Rs 67.22 crore, while 11 out of 20 were multinationals. On the
basis of the declared profit margin, MNCs, particularly pharma MNCs, earn over 20 per cent.
Although a part of their profit may be repatriated, their activities are bound to contribute to economic
progress not only in India, but also in all the host countries.
Transfer pricing is one of the methods which MNCs use for carrying out effective transactions for
intermediate products and other current inputs imported by their affiliates. This is usually done under
the tied-purchase clause in order to take advantage of the differential rates of taxation in different
countries. In view of the generally higher rate of corporate taxes and lower tariffs on the import of
intermediate and capital goods, there is every incentive for MNCs to reveal low profits in the host
countries by resorting to transfer pricing. The setting of transfer prices at unreasonable levels may
not only serve to minimise a corporation’s overall tax bill but can also be used to circumvent
exchange restrictions, minimise customs duties, satisfy local partners of foreign subsidiaries, and so
no. There can be some element of truth in it. But tax evasion and such other methods cannot solely be
a tool in the hands of a multinational’s ways and means, and legal provisions are there to tackle such
situations in all the countries. Hence, there is no meaning in penalising foreign firms and exonerating
others.

Transfer pricing is one of the methods which MNCs use for carrying over effective transactions for intermediate products
and other current inputs imported by their affiliates.
Multinationals are able to make any investment for sales promotion and advertising, and hence, can
easily penetrate more into the market and capture a major share. Simultaneously, monopoly or
oligopoly price determination would be made, while they are able to retain their technological
monopoly strategy. The monopoly of HLL’s Pears soap or of Coca-Cola can be cited as examples of
technical monopoly. What Lall observed about the pharmaceutical industry is, “The granting of a
long period of virtual monopoly in a product which faces very inelastic demand and which is heavily
promoted violates the main economic justification of patenting”.

Multinationals are able to make any investment for sales promotion and advertising, and hence, can easily penetrate more
into the market and capture a major share.
Very often, MNCs attain the position of market leaders by strategically placing their products in the
market, particularly through different strategies of promotion. Domestic firms follow suit. Thus,
MNCs act as pacesetters and forerunners who establish standards and provide direction to the
respective contempory industry. Thus, business policies and strategies for the respective industry or
market are primarily formulated by multinationals.
According to the surveys conducted by the Reserve Bank of India (RBI) covering the periods 1960-
64, 1964-70, and 1971-74, MNCs generally prefer to operate through their subsidiaries. The Hathi
Committee Report suggested in April 1975 that the multinational drug companies should be taken
over by the government, and entrusted to the National Drug Authority for management. The
Committee headed by Jaisukhlal Hathi, was appointed in February 1974 to go into the various aspects
of drugs and pharmaceutical industry. Indianisation of the drug industry was suggested as the panacea
for all the drawbacks being seen in the drug industry. The report felt that India would not be self-
sufficient if the profit-motivated multinational drug houses were not nationalised, as these companies
worked for their own business interests.
However, a group of three members of the Committee expressed their views in emphatic terms,
which seemed to be more rational and realistic. According to them, the question of a takeover of
multinational units has political overtones. The economic case for takeover of drugs and
pharmaceutical companies needs to be based on the advantages to the community, and a clear
distinction between foreign and Indian firms would be difficult in this respect. If there is a case for
nationalisation of drugs and pharmaceutical firms, the argument would be equally applicable to
Indian companies also.
One should not hold a biased attitude towards multinational firms, as they bring about transfer of
technology and play a tremendous role in suppyling life-saving drugs. In the absence of multinational
drug companies, there would be a severe scarcity of indispensable drugs. Such a situation may
possibly be utilised by unscrupulous elements not only to supply spurious drugs but also to make
exorbitant profit through exploitation. Moreover, the main allegation that the multinationals are
working for their business interest is true in respect of indigenous companies also. On the other hand,
MNCs are expected to function in India within the framework of legal and statutory control. Hence,
there would not be any harm if they operated in India, and nationalisation may not serve its purpose.
In fact, in the changed global scenario, a great future awaits the MNCs.

There would not be any harm if MNCs operated in India within the framework of legal and statutory control.
FUTURE OF MNCS
Multinationals have played a remarkable role in the past not only by producing and distributing
goods and services, but also by creating demand, improving the standard of living, and developing
economies. Even the strongest critiques of multinationals would never discredit the positive
contribution they have made to the developing world. While economic development and growth with
stability are the most desired economic goals which can be achieved only through conspicuous
capital formation and technological development, MNCs make a substantial contribution in this
respect. Both capital and technology are scarce factors in the underdeveloped countries.
Multinationals, by virtue of their control over both these factors, contribute towards technology
development and upgradation as well as in capital formation.

MNCs make substantial contribution in capital formation and technology development, which are scarce factors in the
underdeveloped countries.
In the context of emerging globalisation and internationalisation of business, MNCs would njoy a
greater prominence in the developing and the underdeveloped countries for technology ransfer, on
the one hand and resource mobilisation and capital formation, on the other. As they are expected to
maintain a potential link between the developed home countries and the underdev-eloped and
developing host countries, their role in the developing countries would also substantially increase in
maintaining growth with stability, thus giving the global economy a solid base.
MNCs make a conspicuous investment in the host countries mainly through their subsidiaries
which are expected to increase their investment opportunities not only in the Third World but even in
the erstwhile and existing communist and socialist countries. However, to the extent that foreign
subsidiaries reinvest their earnings in host countries, future investments are determined within the
framework of the parent corporation. Of course, the decisions of the parent corporations are
considerably influenced by the investment climate existing in the host countries and the expected
prospects for the company to accomplish its objectives. As a result of the globalisation trends
emerging all over the world, the investment climate is conducive for substantial investments, making
the future potentially viable for the MNCs to penetrate deep into the vast markets of developing and
backward economies.
The host government’s policies and approaches to foreign investment, monetary and fiscal
policies, manpower availability in economic terms, employment stability, industrial climate, BoP
position, scope for adequate profit margin, repatriation rules, and so on, are vital issues which parent
companies seriously consider before taking investment decisions. As a result of the liberalisation
process initiated in India and other developing countries, the parent companies value liberalisation of
such regulations considerably. However, the actual approach of the government in power has a
considerable impact on the decisions of the foreign investors. In this connection, Sethi’s observation
is relevant as follows:

The host government’s policies and approaches to foreign investment, monetary and fiscal policies, manpower availability,
industrial climate, etc., are vital issues for MNCs to take an investment decision.
Expropriation and confiscatory taxation by host government, especially in developing countries, and practices of discrimination
between foreign- and domestic-owned corporations has led to a number of international political disputes. This problem has been
compounded in those instances in which the capital-exporting country has retaliated through the withdrawal of aid and/or the
imposition of economic sanctions. (This was almost the effect of Pokhran Nuclear Test in May 1998.)
Frequent political changes in the host countries influence the investment decisions of foreign
companies. The policies followed by one political party in power may be substantially altered when
another political party comes to power. This is the reason why foreign investors seem tremendously
concerned with the political stability in the host countries. The example of the Enron Power Project at
Dhabol in Maharashtra is a pertinent example in this respect. The project, which was sanctioned by the
then existing Congress government in Maharashtra, was cancelled by the BJP-Shivsena government
later, that too, after a considerable progress at the cost of hundreds of crores of rupees. This raised a
question mark among the international investors all over the world.
Similarly, the inclination on the part of the host countries to nationalise the business interests of
foreign companies is another important deterrent. Even in India, international business houses were
very sceptical about their immunity after the promulgation of the MRTP and FERA regulations.
However, these legalisations did not go much against the business of the MNCs in India. But during
the Janata Party rule, MNCs like IBM and Coca-Cola had to wrap up their operations here.
After the promulgation of the MRTP and FERA legislations, the Government of India made it clear
that no hasty steps would be taken against the MNCs. However, the Hathi Report of 1975, which
advocated the nationalisation of multinational drug firms, created great anxiety in the MNC circles,
particularly when a national emergency was declared in 1975. It was, however, a great solace for the
foreign companies that no untoward action was taken by the government against these companies. But
the change over to the Janata government at the Centre in 1977 created great anxiety in the minds of
foreign companies.
Later, Rajiv Gandhi’s government formulated a policy of technology transfer, for which foreign
firms were encouraged. While India’s industrial policies were not totally against foreign investment
in the past, the 1991 policy went a step forward to provide incentives to foreign investors. After all,
they were expected to contribute towards the socio-economic goals of the nation. Any MNC can
thrive in India if it follows the dilution principles, while even dilution is not stressed in respect of
companies with sophisticated technology and export orientation. The Industrial Policy of 1991 was
considered to be a policy for globalisation, in which MNCs and foreign investors had been given a
special role to play. India is now a potential market for multinationals to operate and grow. The
investment climate has considerably, rather dramatically, improved here in favour of MNCs, and
hence, they, themselves, have realised that they have a bright future in the country.

Later, Rajiv Gandhi’s government formulated a policy of technology transfer, for which foreign firms were encouraged.
While India’s industrial policies were not totally against foreign investment in the past, the 1991 policy went a step forward
to provide incentives to foreign investors.
Indian companies are at liberty to make investments in other countries for which the RBI provides a
single-window clearance, giving them an opportunity to multinationalise their operations. This means
that the opportunity now exists even for Indian companies to act as MNCs in the future. As a result of
the decline of the communist system, particularly in the erstwhile USSR, and reunification of
Germany, greater opportunities emerged for MNCs to expand their business. The disarrayed
Yugoslavia and its war-torn countries required economic reconstruction. MNCs had to gear up to
accept the challenges of economic reconstruction in these countries. Similar is the case in China with
the largest population in the world. Although its old political system continues to operate, its
economic system has undergone evolutionary changes. Multinationals find a conducive investment
climate in China and relatively speaking, large investments are being made by multinationals there.

RBI provides a single-window clearance, to give liberty to Indian companies, to make investment in other countries.
The nationalisation threat, to some extent, is raised in few countries. In its compilation of cases of
nationalisation of the assets of MNCs, the United Nations identified 875 cases of nationalisation in 62
developing countries between 1960 and mid-1975. In about 10 per cent cases, the assets were later
returned to the previous owners. Many of the nationalisation cases took place in Africa, South of
Sahara, reflecting large-scale nationalisation, and indigenisation programmes took place in few
countries. Of the total number of cases, Africa’s share increased from 30 per cent during 1960-69 to
about 50 per cent during 1970-mid 1974. Over one-third of the total cases were related to natural
resources, followed by banking and insurance. The sector with the next highest number of cases was
petroleum. In the Western hemisphere, the cases in the manufacturing sector experienced a dramatic
increase, accounting for over half of all cases between 1970 and mid-1974. About 78 per cent of all
these cases involved the affiliates of MNCs with headquarters in three countries, viz., the United
States, the United Kingdom, and France. It is interesting to note that more than half of all FDI in
developing countries is from the United States.

More than half of all FDI is from the United States.
The economic climate has now dramatically changed globally. All countries, particularly the
developing and the underdeveloped countries, are inviting multinationals to invest in their countries,
since there is a growing awareness, rather conviction, among economists and administrators that
foreign investment, technology, and technical know-how are indispensable for speeding up the pace
of their economic development. The nationalisation threat has almost been wiped off by the
emergence of the globalisation movement. Countries are now competing among themselves in the
global market to provide facilities, policies, and environment, which will be conducive for the free
flow of foreign capital into their economies. Considering the strengths enjoyed by MNCs, great
opportunities exist for them in these markets.
By virtue of their technological advancement, high resourcefulness, and operational capabilities,
opportunities and openings are available for them in the realm of global business. We have already
made a reference about communist countries, particularly investment opportunities that are available
in China. China, which was known as a closed economy under Chairman Mao, was averse to
capitalism.But after the death of Mao Tse Tung, a sea change has taken place. Now they look to the
West for capital and technology. In the first nine months of 1983, China issued permission for 39 joint
ventures. After the death of Mao, till the end of 1982-83, giant joint ventures were set up in which
foreign investment to the tune of $141 mn was made. Within a year, that is, up to September 1983, the
foreign investment rose to reach $650 mn in 122 projects. China has now joined hands with the
capitalist multinationals in a big way for its economic development. Capitalist MNCs are now the
economic partners of Communist China, which speaks volumes about the indisputable place enjoyed
by the MNCs.

By virtue of their technological advancement, high resourcefulness, and operational capabilities, opportunities and
openings are available for them in the realm of global business.
Such a position of MNCs was highlighted by UNCTAD s World Investment Report of 1993, when it
was reported that FDI in developing countries reached the $40 bn mark in 1992, which had a doubled
by the year 2000. MNCs are the main source of these investment flows. The report also stressed the
role of MNCs in unequivocal terms stating that MNCs are the propelling force leading to a closer
integration of the world economy. One-third of private productive assets in the world are estimated to
be under the common governance of these firms resulting in the emergence of an integrated,
international production system. It was reported that the number of MNCs from 14 leading developed
countries grew from 7,000, which was the number before two decades, to 24,000 in 1993. There were
37,000 multinationals with over 1.7 lakh foreign affiliates functioning in the world in 1992, according
to the report. These companies also generated a global stock of FDI to the tune of $2 tn and sales to
the tune of $5.5 tn, as against the world exports of goods and non-factor services of $4 tn. Many of
these MNCs stayed in business, having evolved new management structure and strategies for
maximising the global advantages, which involve linkages of complex and multiple nature. The
spectacular spot which the MNCs occupy in the world economy today and the increasing role they are
going to play in the years to come can be fully visualised with the emerging business trends.

There were 37,000 multinationals is with over 1.7 lakh foreign affiliates functioning in the world in 1992.
Regional cooperation among the developing countries during the past two decades has also opened
up new fields for MNCs, on the one hand, and opportunities for companies in the developing
countries like India to reshape themselves as multinationals, on the other. The Cartagena Agreement
which came into effect in 1971, signatories of which include Bolivia, Columbia, Chile, Ecuador, Peru,
and Venezuela, stressed on prioritising national enterprises and the capital of member countries,
recognising “that foreign capital investment and the transfer of foreign technology constitute a
contribution necessary for the development of the member countries and must receive assurance of
stability to the extent that they really constitute a positive contribution”. It is widely believed in these
countries that MNCs will be dependent on their ability to evolve ways to deliver economic benefits to
host countries, which are greater than the host countries’ opportunity cost of alternatives.
Raymond Vernon’s study on multinationals has revealed that MNCs have become indispensable
economic forces in the world and that the growing strength of these organisations has created entities
that are gaining a certain independence from the sovereign state. Stephen-son’s observation in
Vernon’s book is conducive to state that not only will the MNCs survive, but they will prevail in a
large measure over the host countries. MNCs will be instrumental in accelerating the generation of
wealth globally in the years to come. If such wealth is properly distributed to countries where it is
most needed, the existence of MNCs will be meaningful, and the developing countries will stand to
benefit by this “goose that lays the golden egg”. Even the worst critics of MNCs agree to the fact that
these giant corporations play a very vital role not only in developing economies and host countries
but in their home countries and economically developed nations. Over the years their prominence
increased, with developing countries chalking out strategies to offer attractive terms to invite MNCs
through memoranda of understanding (MoU) to make FDIs. Some countries have already come out
with appropriate legislations to provide a conducive atmosphere for MNCs, while others are expected
to follow suit. Thus, the scope for MNCs has increased manifold and they are here to stay despite
criticisms against them.

MNCs will be instrumental in accelerating the generation of wealth globally in the years to come. If such wealth is properly
distributed to countries where it is most needed, the existence of MNCs will be meaningful, and the developing countries will
stand to benefit by this “goose that lays the golden egg”.
A CRITIQUE OF MNCS
Despite their positive contribution, MNCs have been criticised on various grounds. Following five
factors will prove this:
Transfer Pricing and Sourcing. MNCs allocate costs and prices for products and services between
various branches and subsidiaries of the same company operating in different countries. “Sourcing”
is essentially the same concept as applied to materials rather than costs. “Sourcing” is defined as the
successive transfer of materials, components, finished products, or services from some points in the
network where they can be most economically produced to some points where they can be most
profitably sold. Host countries consider this strategy applicable to transfer income from country to
country. Some countries, with less controls and more opportunities for MNCs will gain and other
countries, vice verson, would lose in the process. This technique can be used by MNCs to evade tax
and to subvert or control a nation’s export capability and competitiveness, besides being able to hold
down wages, control or dominate market, introduce and improve oligopoly, and influence BoP
position.

The problem generally faced by the host countries due to MNCs are transfer pricing and sourcing, foreign control over key
sectors of the economy, technological monopoly, competition and market leadership, and repatriation of funds.
Foreign Control over Key Sectors of the Economy. MNCs are powerful by virtue of their
control over a substantial amount of resources, latest technical know-how, major market share, high
corporate image, and the like. Obviously, they have the ownership of considerable economic and
social resources, and a substantial control of the corporate sector. There is, therefore, concern among
the national governments that MNCs would strongly influence the economic and political policies of
the host countries. Foreign investments are, therefore, entertained by host governments with caution.
This is the reason why certain regulatory measures are usually adopted by the governments.

MNCs are powerful by virtue of their control over a substantial amount of resources, latest technical know-how, major
market share, high corporate image, and the like. Obviously, they have the ownership of considerable economic and social
resources, and a substantial control of the corporate sector.
Technological Monopoly. MNCs import the latest technology, which may be conducive to the latest
development. However, they would have the monopoly over it; and resultantly, the products would
remain as monopoly products, just like Coca-Cola. The MNCs do not appreciate giving their
technology to the host countries fearing a threat to their very monopolistic status. This would be
detrimental to the technological development in the host countries, keeping them on the periphery of
economic progress.
Competition and Market Leadership. A large number of MNCs are market leaders. Moreover,
due to their control over extensive resources, they are in a better position to provide a strong
competition for the indigenous industry. They enjoy a comparative advantage in a competitive
situation.
Repatriation of Funds. MNCs and foreign companies repatriate funds from the host countries to
the countries of their headquarters or to other countries of their preference, affecting the BoP
position of the host countries. Hence, such financial flows are widely criticised. A foreign company
which makes an investment and takes risk should obviously be allowed to repatriate some part of its
earnings in the host countries, which is a normal aspect of any foreign investment. Taking into
account the contribution made by these companies, such repatriation should not be grudged.
MNCs have also been criticised as being mere profit-oriented companies and least interested in the
developmental needs of the host countries. They tend to evade or undermine the economic autonomy
of the host countries by virtue of their strong position, while they control the market either by
attaining the position of “market leader” or by maintaining a monopoly position. Despite all such
criticisms, the positive contribution made by MNCs in the host countries is widely recognised and
appreciated.

MNCs have also been criticised as being mere profit-oriented companies and least interested in the developmental needs of
the host countries.
MNCS DEAL A BLOW TO DOMESTIC COMPANIES
While Indian firms have been striking bulge bracket deals overseas, MNCs are slowly but surely
picking some gems in the domestic market. Over the last few years, some of the sectoral leaders have
been snapped up by MNCs, who have taken a short cut to hit the bulls’ eye in one of the fastest-
growing emerging markets in the world. While Ranbaxy’s sell-off to Japanese drugmaker Daiichi
Sankyo is the latest to join the list, the other companies in the sectors like cement, electrical products,
and apparel have also witnessed sell-offs.
The first big sale happened way back in 1993 when Ramesh Chauhan sold off a slew of soft-drink
brands to Coca-Cola India. This was followed by a series of small-time sell-offs by Indian business
groups to MNCs, who were looking to set a foothold in India after the economy’s opening up. (Refer
to Table 26.17). While there were numerous sell-offs thereafter, the market leaders were not part of
them in most cases, and MNCs continued to snap up the top players in smaller niche areas. Over the
last three years, a number of blue chips and other category leaders have been bought over by MNCs
or private equity (PE) funds.

Over the last, three years, a number of blue chips and other category leaders have been bought over by MNCs or private
equity (PE) funds.

Table 26.1 The Great Indian Sale— Prominent Sell-offs by Indian Promoters
Source: The Economic Times, Pune, June 12, 2008.
Notes: *-- minority stake; ** -- multiple transactions; # approximate.

For instance, Swiss cementmaker Holcim struck a double deal by acquiring the top two
cementmakers in the country - ACC and Gujarat Ambuja. Holcim started by acquiring the stake of
founder Sekhsaria and Neotia families in Gujarat Ambuja and indirectly got a significant minority
stake in ACC. It later upped its stake through a public offer. The sell-off was prompted by two basic
issues: right valuation and issues related to family succession.
Today, Holcim controls India’s largest cement manufacturer ACC with close to a 43 per cent stake
in the company, besides holding 46 per cent stake in Ambuja Cement (formerly Gujarat Ambuja). It is
not just strategic acquirers who have managed to acquire the sector leaders. In August 2007 PE fund
Blackstone acquired the country’s largest apparelmaker and exporter, Gokaldas Exports. The PE
player bought the promoters’ 50.1 per cent stake in Gokaldas for $165 mn and bought another 20 per
cent through an open offer in what was considered to be an overvalued transaction.
“It was in the interest of the company to partner Blackstone, whose financial strength and stakes in
different companies across the world would help Gokaldas expand and also ensure an assured large
order flow to the company”, says Gokaldas Exports’ Managing Director (MD) Rajendra Hinduja,
whose family still holds 20 per cent in the company and manages the company on a daily basis.
“In textiles, the return on the capital employed and management effort undertaken by the company
is much less when compared to other industries. So it made sense for the promoters to offload stake
in Gokaldas and deploy the money in business where the returns are much higher”, says an industry
source, on why promoters, who had run the company for over 25 years, decided to cede the control to
Blackstone.
In another buyout in the year 2007-08, the Japanese firm Matsushita Electric Industrial bought about
80 per cent of the privately held electric equipmentmaker Anchor Electricals. The Mumbai-based
Shah family that the retains 20 per cent stake pocketed $480 mn for giving up its majority stake in the
firm, which was close to a one-third share in the domestic, electrical products market.

In another buyout in the year 2007-08, the Japanese firm Matsushita Electric Industrial bought about 80 per cent of the
privately held electric equipmentmaker Anchor Electricals.
CASE 1
Ranbaxy Sellout
Ranbaxy, one of the success stories in India, started out as a distributor of medicine and turned into an
MNC by getting over 80 per cent of its business from outside the country. The company Ranbaxy first
came to become headlines when it launched the product “Calmpose” in 1969 which was India’s
answer to Roche’s “Valium”. Thus, it started the journey as an Indian pharmaceutical company into
generic drugs. When the international market was headed by biggies like Pfizer, Novartis, and
GlaxoSmithKline, Ranbaxy’s entry into that arena led to many buyers turning to less-expensive
production houses in India.
Initially, Ranjit Singh and Gurbux Singh, who were distributors for A. Shionogi, a Japanese
pharmaceutical company manufacturing vitamins and anti-TB drugs, started this company in the early
1960s. The name “Ranbaxy” is a fusion of these original promoters. Then, Bhai Mohan Singh took
over Ranbaxy. He was the recipient of the Padma Vibhusan Award in 2005. He passed away on March
28, 2006. Bhai Mohan Singh had collaborated with the Italian pharma company Lapetit Spa (Milan)
and subsequently, bought out its business. Ranbaxy Laboratories Ltd went public in 1973 and the
sleeping-pill Calmpose catapulted the company into the big league.
Later, Parvinder Singh, the eldest son of Bhai Mohan Singh, became the MD in 1982. His brothers
Manjit Singh and Analjit Singh also joined in but later on moved out to other businesses. In 1989,
Bhai Mohan Singh decided a three-way split of his assets. Parvinder Singh was given control over
Ranbaxy, Manjit Singh was made in-charge of Montari Industries, and Anajit Singh was handed over
Max India. However, some differences arose between Bhai and his sons. Bhai Mohan Singh and
Parvinder had a row over expansion and strategy planning for Ranbaxy. This led to an ousting of
Bhai Mohan Singh from the Company in 1999, thus souring the relationship between the father and
son. Parvinder Singh died of cancer on July 3, 1999. He was the recipient of the “Businessman of the
year” in 1998.
Both father and son had a sharp sense for sniffing out a business that had the potential to give their
company another thrust, and they took full advantage of the opportunities presented. Neither spared
any efforts to get the company where they wanted it, and used well their political connections,
whenever the need arose. In the beginning of the year 2006, Malvinder Mohan Singh, son of
Parvinder Singh, took control of the company by becoming the MD and CEO, while his younger
brother Shivinder Mohan Singh was inducted to the company’s board. In an unexpected and stunning
move, one of the country’s largest and fast-growing pharmaceutical company, Ranbaxy has sold its
majority stake of more than 50 per cent to the Japanese drug firm Daiichi Sankyo. On Tuesday June
11, 2006, Daiichi Sankyo announced the acquisition of the stake for over Rs 15,000 crore.
There has been speculations that after the acquisition of Ranbaxy, many other companies may
follow suit. This deal makes Japanese firm Daiichi the 15th biggest drugmaker in the world.
Malvinder Singh will continue as CEO and MD and the company will retain its name. The Singh
family would net in about Rs 10,000 crore by selling their stake. Malvinder Singh would also assume
the position of Chairman of the Board upon the deal’s closure that is expected by March 2009. The
Japanese firm would acquire the entire 34.82 per cent stake from its current promoters Malvinder
Singh and his family. Also, Daiichi would make an open offer for an additional 20 per cent stake in
Ranbaxy at a price of Rs 737 per share, which represents a premium of over 50 per cent on the
average price over the last three months.
Besides the promoters’ 34.8 per cent stake, Daiichi would also get about 9 per cent through issuing
of preferential allotment of shares and some warrants, which could be later converted into another 4.5
per cent holding. These, along with a minimum 8 per cent that the new promoters wish to acquire
through the open offer, would take Daiichi’s holding to above 50 per cent. Post acquisition, Ranbaxy
would become a debt-free firm with a cash surplus of around Rs 2,800 crore (Rs 28 bn). The two
firms said that they plan to keep Ranbaxy a listed entity in India. To some industry observers,
promoters of other Indian pharma companies should take a cue from Ranbaxy’s move. Ranjit
Kapadia, Head of Research (Pharma) and Prabhudas Liladhar, said:
The valuation is about 20 times of Ranbaxy’s EBIDTA and about 4 times its total sales. Its a great deal. Other Indian promoters
should realise that at the right place and at the right time, they should divest their stake instead of clinging on for emotional
attachment.
Even as Indian companies have been on an active acquisition mode globally, there had also been
off-and-on rumours of global companies planning to acquire Indian majors, such as Cipla,
Aurobindo, and Shasun Chemicals. Recently, the Burman family exited the pharma business by selling
its entire 65 per cent stake to the German company Fesenius Kabi. The market was assuming that this
deal will unlock the real value of Indian generic pharmaceutical companies and will trigger more
such deals. The drugs worth more than $90 bn are going off-patent in the near future. At the same
time, many leading MNCs are yet to have a portfolio of the generic drugs.
Indian drugmakers were prevented from bringing out generic versions of patented drugs after the
country introduced the product-patent regime in 2005. The drug-discovery process involves an
investment of billions of dollar and hence, it is impossible for most domestic drugmakers to pursue
the original drug-discovery process. Margins are thin in the global generic business mainly due to
intense competition. Aurobindo Pharma, Cipla, and Orchid Chemicals and Pharmaceuticals usually,
among others, figure on the list of companies that are takeover targets for multinational
pharmaceutical companies.
The predication was that the small players will be compelled to exit the business and only those
with a strong business model can remain in the generic business in future. The Mylan-Matrix deal,
Dabur ’s acquisition earlier, and now the Ranbaxy deal showed that the global pharmaceutical
companies are looking at India in a big way, recognising the country as an important pharma
destination. Whether those companies prefer to set up units from scratch, through acquisitions or
strategic alliances, will vary from one company to another. Big pharma companies are shutting down
facilities and moving manufacturing to countries where the costs are low. Another reason for them to
close down the manufacturing facilities and move to low-cost countries are strict effluent-treatment
norms.
If the promoters of India’s largest drug company felt it better to exit business after many years of
attempts to make it one of the largest in the world, then there must be serious issues with India’s drug
policy. Should the government and other authorities seriously think about it? The pharmaceutical
sector has always maintained that the pharma companies should be allowed to invest their profits in
R&D rather than squeezing them with more price controls for more drugs.
India’s ability to manufacture drugs at almost one-eighth of global cost and availability of quality-
English-speaking scientific personnel with chemistry skills are some of the important factors that
attract big pharmaceutical companies to India. As against this, the rising manufacturing costs and
dwindling pipeline have forced global pharma companies to off-shore manufacturing to locations
such as India. It is unfortunate and shocking to believe that Ranbaxy was going to become part of a
Japanese pharmaceutical company. Its promoters may have thought of exiting this business with the
handsome premium they are getting, than going through the rigours of complex, pharmaceutical
manufacturing processes. “This deal will, at least for sometime, end the euphoria on Indian pharma
going global and conquering the world”, said a leading industry expert.
Case Questions
1. Analyse the reasons behind the Ranbaxy sellout?

2. Suggest the changes in the Drug Policy of India?
3. Do you support the above deal of the Ranbaxy?
CASE 2
The latest proposal of the Government of India in 2005 is to charge tax on foreign BPO companies
which have their core work in India. But question here is, why tax only for who are doing thei core
work here? The logic may be to slow down the growth of MNC in India. But the governmen is
missing the big picture, that is, the BPO services have tax holiday till 2009. The tax holiday itsel was a
price paid by the Indian government to accelerate the BPO sector in India; now this secto is doing
business, which is almost of $3.6 bn in just five years in India. The BPO industries ma give long-term
benefits to India. It is unjust to change the rules in midway, as the government hac decided to give tax
holiday till 2009; this tax holiday itself could have been an incentive for man MNCs to base their
operations in India.
In one stroke, a business decision involving millions of dollars is being made to look stupid
because of this proposal. If, as an example, Intel is considered, having development centres i India to
which outsourcing is done by Intel US, Intel India is given a cost plus remuneration of say $25 per
hour. The chip developed by India is sold by Intel US to its customer abroad at a profit o $100. A
revenue officer may attempt to tax a significant portion of the $100, while computing ii Indian’s
rightful share of tax. The profit of $100 per chip comes not from just a chip-design worl in India, but
also from a great manufacturing development of the market, and consumer market ing, none of
which is done in India. To isolate design as the sole determinant of profit is to mistak a part for the
whole. Its idea, whose time has not come, foreign companies say that it cannot b taxed if its
translations with BPO are at ‘arm’s length and a question of ‘core’, and none of the con activities
does not arise.
Case Questions
1. What is the logic of having government behind this?
2. Does the government stop the growth of BPOs and MNCs in India?
3. Do you support the above proposal? Explain.
SUMMARY
MNCs are major, powerful industrial undertakings, which control huge resources not only in their
parent countries but also in the host countries. They have emerged as successful business giants with
their total foreign sales exceeding the GNP of many countries around the globe except that of the
United States and former USSR. Roughly speaking, two-thirds of the total FDI is concentrated in the
developed market economies, while the remaining one-third in the LDCs.
The host government’s policies and approaches to foreign investment’s monetary and fiscal policies,
manpower availability in economic terms, employment stability, industrial climate, BoP position,
scope for adequate profit margin, repatriation rules, and so on, are vital issues which parent
companies consider before taking investment decisions.
Frequent political changes in the host countries influence the investment decisions of foreign
companies. The policies followed by one political party in power may be substantially altered when
another political party comes to power. This is the reason why foreign investors seem tremendously
concerned about the political stability in the host countries.
After the introduction of the liberalisation policy of 1991, foreign companies are free to operate in
India without any fear. Even 100 per cent equity companies were encouraged for business in various
areas. In a globalised market, these MNCs play a vital role, and they are almost as free as Indian
companies to effectively operate in the Indian business canvas.
KEY WORDS

Liberalisation
LERMS
GNP
Technological Monopoly
Repatriation of Funds
Parent Corporations
Monopoly
LCD
Technology Transfer
Nation Exchequer
Transnational Corporations (TNCs)
Host Countries
Non-renewable Natural Resources
Transfer Pricing
Tax Evasion
Sourcing
Balance of Payment (BoP)
QUESTIONS
1. Explain the impact of foreign aid on the economic development in India. Analyse the problems of foreign aid in India in this
connection.
2. Explain the origin, growth, and domination of MNCs in India.
3. Explain the participation of MNCs through foreign collaboration in India. Explain its favourable and harmful effects.
4. Explain the system of control introduced in India over MNCs and FERA.
REFERENCES
Adhikari, M. (2001). Global Business Management: In an International Economic Environment. New Delhi: Macmillan.
Bhalla, V. R. and R. Shiva (2004). International Business: Environment and Management. Delhi: Amol Pub.
Bhandari, B. (2005). The Ranbaxy Story: The Rise of an Indian Multinational. New Delhi: Penguin.
Cherunilam, F. (2005). International Trade and Export Management. Mumbai: Himalaya Publishing House.
Jaykumar, B. “Ranbaxy Deal May Spur Hostile Bits in India”, June 12, 2008, www.rediff.com/money/2008.
Rao, P. S. (2002). International Business: Text and Cases. Mumbai: Himalaya Publishing House.
Sinha, J. B. P. (2004). Multinationals in India: Managing the Interface of Cultures. New Delhi: Sage.
Vadhani, V. A. (2004). Global Business. Mumbai: Himalaya Publishing House.
“Ranbaxy Sell Off: Other Farma Firms May Follow Suit”, The Economic Times, January 12, 2008.
CHAPTER 27
India’s Import–Export Policies
CHAPTER OUTLINE
Historical Perspective
Liberalisation Policy of Exim
Annexure I
Annexure II
Annexure III
Exim Performance
Exim Policies
India’s Exim Performance
Trade Scenario
Exports
Imports
Export Promotion Measures
Agri-export Zones (AEZs)
Highlights of Foreign Trade Policy (FTP), 2004–09
Case
Summary
Key Words
Questions
References
HISTORICAL PERSPECTIVE
Historically, export and import (exim) controls were first introduced in India in 1939 as a wartime
measure under the Defence of India Act and Rules, 1939. This was primarily with a view to regulate
the available foreign exchange and limited shipping facilities for the war and for limited civil
purposes. After the war the control was continued by an ordinance, and thereafter by the Imports and
Exports (Control) Act, 1947. This Act was initially meant to be in force for only three years, but has
been extended ever since.

Historically, export and import (exim) controls were first introduced in India in 1939 as a wartime measure under the
Defence of India Act and Rules, 1939.
After independence the import control did not undergo any structural change, but its objective
became quite different. The changed objectives were no longer the regulations of wartime or post-
war economy, but to help and guide a planned economic development. Apart from this general
legislation, there are some special legislations having a bearing on various aspects of the import or
the export of specific commodities, for example, the Foreign Exchange Regulation Act (FERA),
1947; Custom Act, 1962; Coffee Act, 1942; Tea Act, 1953; and Coir Industries Act, 1953.
The Import and Export (Control) Act is a short enactment consisting of eight sections. The key
section is Section 3. This Section of the Act empowers the Central government to make provisions by
an order that was published in the Government Gazette “for prohibiting, restricting or otherwise
controlling the import into, and export of goods out of India”. This gives the government the absolute
power not only over the export and import of any commodity but also over the ordinary trade in any
imported commodity. Again, under Section 3, the Central government has promulgated the Import
(Control) Order, 1955 and the Export (Control) Order, 1962.
The Import Control Order has given rise to the system of import licensing. The goods indicated in
this order cannot be imported without a licence from the appropriate licensing authority unless the
government has granted an exemption to any commodity from licensing. Until recently, the list of
goods mentioned in the order was very long and nothing worthwhile was left out of it.
The Import Control Order prescribed some general factors for guiding the issue of licence, for
example, the non-availability of foreign exchange, the interest of the state, and so on. Detailed
guidelines were, however, given through annual announcements made by the Central government
(Ministry of Commerce) in the Import Trade Control Policy Book, popularly known until recently as
the “Red Book”, which was published on or shortly after April 1 every year. Currently, it is in force
for a longer period. There was another accompanying publication titled Import Trade Control
Handbook of Rules and Procedures. In the wake of sea changes in the trade policy in the recent years,
there was then a much smaller Export and Import (Exim) Policy, 2002–07, which sought to usher in
an environment that was free of restrictions and controls.

In the wake of sea changes in the trade policy in the recent years, there was then a much smaller Export and Import (Exim)
Policy, 2002–07, which sought to usher in an environment that was free of restrictions and controls.
The legal frame of export control, as in the case of import control, is provided by the Import and
Export (Control) Act, 1947. Under Section 3 of this Act, the Central government promulgated the
Exports (Control) Order, 1962. The executive authority in respect of export control is vested in the
Chief Controller of Imports and Exports. He is also charged with the responsibility of taking all
follow-up actions in respect of all categories of export obligation cases, that is, cases where industrial
licence, capital goods, imports licence, and foreign investment collaborations have been allowed,
subject to an obligation to export a specified percentage of the products.
The export obligation is enforced through a legal agreement between the Chief Controller and the
undertaking supported either by bank guarantees for an amount equivalent in value to the value of the
goods to be exported, or in lieu of a bank guarantee with an alternative penalty and charges. The
Chief Controller of Imports and Exports also initiates action in case of violation of the terms of the
agreements.
LIBERALISATION POLICY OF EXIM
The new government took office at a time when the balance of payment (BoP) position facing the
country had become critical and foreign exchange reserves (FER) had depleted to dangerously low
levels. The export momentum built up during the period from 1986–87 to 1989–90, when India’s
exports grew at an average annual rate of 17 per cent in terms of US dollars, was lost in 1990–91
when the export growth decelerated to only 9 per cent in terms of US dollars. The exports in April–
May 1991 actually showed a decline of 5.8 per cent in terms of US dollars when compared with
April–May 1990. The imports had to be severely contained in the course of 1990–91 because of the
shortage of foreign exchange. This affected the availability of many essential items and also led to a
distinct slowdown in the industrial growth.
Restoration of viability in our external payments situation was an urgent task requiring action on
several fronts, including macro-economic stabilisation and reforming of trade policy. The trade
policy reform has to aim for a quick revival of the momentum of exports. It is only through the
growth of exports that we can expect to overcome persistent BoP problems, restore international
confidence, and achieve true self-reliance with an expanding economy.
To this end, the government announced an initial package of trade policy reforms on July 4, 1991.
Several changes were introduced in trade policy that aimed at strengthening the export incentives,
eliminating a substantial volume of import licensing, and applying an optimal import compression in
view of the BoP situation.

The government announced an initial package of trade policy reforms on July 4, 1991. Several changes were introduced in
trade policy that aimed at strengthening the export incentives, eliminating a substantial volume of import licensing, and
applying an optimal import compression in view of the BoP situation.
Export Processing Zones (EPZs) and 100 Per cent Export-oriented Units (EOUs). EPZ Scheme
and 100 per cent EOU Scheme were introduced to provide duty-free enclaves, which would enable
entrepreneurs to concentrate on production exclusively for exports. However, with increasing
liberalisation in the Domestic Tariff Area (DTA), the duty advantages enjoyed by EPZs/EOUs have
become less important, while the procedures of customs bonding are very onerous. The schemes
have not, therefore, taken off as expected and they have also not attracted any foreign investment that
was aimed at tapping export markets to the extent that was expected. The working of these schemes
has been reviewed and the following changes have been made:
i. All EOUs/EPZ units will be eligible for exim scrips at the basic rate of 30 per cent applied to net foreign exchange earning.
ii. The duty applicable on DTA sales from EOUs/EPZ units is being reduced to 50 per cent of the normal customs duty, subject to
the duty payable not being less than the excise duty on the same product. The extent of DTA sales will be in accordance with
their entitlement. The DTA sales will be permitted in the ratio of 25:75 in relation to export sales in case of units whose use of
indigenous raw material is more than 30 per cent of production. In all other cases the ratio of permissible DTA sales to export
sales will be 15:85. The procedures for clearing goods from the EOUs/EPZ units for DTA sales are also being streamlined.
iii. In order to encourage exporters to set up EOUs or EPZ units, the net foreign exchange earned by EOUs or EPZ units can be
clubbed with the earnings of their parent/associated companies in the DTA for the purpose of according export house, trading
house, or star trading house status for the latter.
iv. The International Price Reimbursement Scheme (IPRS) for supply of steel to exporters will also be extended to EOUs and EPZ
units. The Development Commissioners (DCs) are being empowered to issue payment authorities in lieu of Joint Chamber of
Commerce and Industry (JCCI) and Export Subsidy (ES).

Under the NIP the working of these schemes has been reviewed and some changes have been made.
Automatic Approval Scheme. Under the New Industrial Policy (NIP), most industries do not require
an industrial licence except for a defined list. The clearances for imports of capital goods have also
been made automatic where capital goods imports are covered by foreign equity or where they are 25
per cent of the value of plant and investment, subject to a limit of Rs 2 crore. With a view in bringing
about a comparable streamlining in the procedure for EOU/EPZ approvals, a system of automatic
approvals is being established for all proposals which fall within certain parameters. Capital goods
imports will be allowed under the automatic approval procedure if they are fully covered by a
foreign equity or if they do not exceed 50 per cent of the value of plant and equipment, subject to a
ceiling of Rs 3 crore. All proposals within the automatic approval parameters will be cleared within
two weeks. All other proposals will be submitted to the Board of Approvals (BoA) for consideration
and decisions, including issue of licences, and will be taken within 45 days.

Under Automatic Approval Scheme, capital goods imports will be allowed if they are fully covered by a foreign equity.
Centralised Clearance. A large number of issues relating to the operation of EOUs/EPZ units,
require a Centralised clearance in the Ministries of Commerce and Industry. Powers are being
delegated to the DCs so that these approvals can be given on a decentralised basis. The specific
approval of the DC would not be required in cases of broad banding by EPZ units, where value
addition is being maintained. The unit concerned would need only to provide a relevant information
to the DC.
Concessions to EOUs/EPZs. The following specific concessions to EOUs/EPZ units have also
been extended:
i. Allowing entry of imported raw material on “provisional assessment” basis to expedite customs clearance,
ii. Permitting units under the EPZ and EOU Schemes to supply/transfer finished goods among themselves,
iii. Replacement of multiple bonds by a single bond for obtaining an import clearance,
iv. Increasing the list of items under the “Special Imprest Licence Scheme” on a selective basis,
v. Expediting supplies from the DTA without any payment of excise duty by issuing pre-authenticated CT-3 form booklets to
EOUs, which would obviate the necessity of approaching the Central Excise offices each time when such exemption is sought,
and
vi. Clarifying that containers that are stuffed in EPZs and EOUs are not to be re-inspected at other points as long as seals are intact.
Private Participation in Warehouses. The government has also decided to allow private parties to
establish bonded warehouses within EPZ for stocking and sale of duty-free raw materials,
components, consumables, and spares to EPZ units and EOUs. This will cut down the delay in
obtaining supplies of duty-free materials, which are in constant and regular demand by exporters.
Simplified Procedure for Import of Capital Goods. The procedure for import of capital goods
has been simplified following the statement on industrial policy. New units and units that are
undergoing a substantial expansion will automatically be granted licences for import of capital goods
other than those in Appendix 1 Part A (Restricted List) of the Exim Policy, without any clearance from
the indigenous availability angle, provided the import of capital goods is fully covered by a foreign
equity or the import requirement is up to 25 per cent of the value of plant and machinery, subject to a
maximum of Rs 2 crore.

The procedure for import of capital goods has been simplified following the statement on industrial policy.
Access to Non-OGL (Open General Licence) Capital Goods. Access to non-OGL capital goods
other than those in Appendix 1 Part A has also been expanded for all exporters and export houses by
the fact that the exim scrips entitlement has been increased and exporters are allowed to use exim
scrips that are earned on their own exports for import of such capital goods.
Harmonising Trade and Customs Classification. The classification system used in the Exim
Policy and the system that is used by the customs, are not identical, and this has often created
difficulties in determining the tariffs that are applicable to different items. The two codes are being
harmonised. This will reduce the scope for a discretionary decision making at lower levels and
introduce a greater transparency in the import policy including the tariff structure.
Canalisation of Exports and Imports. Over the years, a number of items of exports and imports
have been canalised for export or import through specified public sector agencies. The government
has reviewed the list of items thus canalised and has decided that a number of items may be
decanalised. In the case of exports, 16 items are being decanalised immediately. In the case of imports
6 items are being decanalised and placed on OGL while 14 items are being decanalised and listed in
Appendix 3 where they will be available for import against exim scrips. The list of items is given in
Annexure II. There is a strong case for decanalising the imports of more items of raw materials and
placing them on the OGL. However, in view of the present BoP position, a decision on these items is
being deferred. The government’s policy is to progressively reduce the extent of canalisation.

Over the years, a number of items have been canalised for export or import through specified public agencies.
Objectives of Public Sector Trading Organisations. The public sector trading organisations like
the STC (State Trading Corporation) and MMTC (Minerals and Metals Trading Corporation) have
traditionally depended heavily on the canalised trade. They will be now reoriented to achieve the
objectives of emerging as international trading houses that are capable of operating in a competitive
global environment of serving as effective instruments of public policy and of providing adequate
support services to the small-scale/cottage sectors.
Export Houses and Trading Houses. The government will continue to support the development of
export houses and trading houses as instruments for promoting exports. To this end, the following
initiatives are being taken:
i. Export houses, trading houses, and star trading houses received additional licences at varying rates based on their net foreign
exchange earning in the previous year. For the year 1991–92, it was decided to widen the range of items that can be imported
against additional licences. The range will now be the same as that of the exim scrips.
ii. With effect from April 1, 1992, additional licences will stand abolished and export houses, trading houses, and star trading
houses will receive additional exim scrips at the rate of 5 per cent of the FOB (free on board) value of exports.
iii. The government has announced that permission will be given for setting up of trading houses with 51 per cent foreign equity for
the purpose of promoting exports. Such trading houses would be eligible for all benefits that are available to domestic export
and trading houses, in accordance with the Exim Policy.
Foreign Currency Accounts for Exporters. The government has decided to allow the established
exporters to open foreign currency accounts in approved banks and allow exporters to raise external
credits, pay for export-related imports from such accounts, and to move credit export proceeds to
such accounts. This will facilitate the payments by exporters for their essential imports. The Reserve
Bank of India (RBI) will notify details of this scheme separately.

The government has decided to allow the established exporters to open foreign currency accounts in approved banks and
allow exporters to raise external credits, pay for export-related imports from such accounts, and to move credit export
proceeds to such accounts.
Board of Trade (BoT). The Board of Trade (BoT) has been reconstituted and will be activated
once again. The board will be an apex forum to facilitate a close and frequent interaction between
industries and trade, on the one hand, and government, on the other. The government will attach a
great importance to the advice and recommendations of the BoT.
Re-orientation of the Office of CCI&E. The Office of the Chief Controller of Imports and
Exports (CCI&E) is being redesignated as the Directorate General of International Trade. The
principal function of the directorate will, henceforth, be promotion of exports and facilitation of
imports to promote export trade. The government is of the view that the Imports and Exports
(Control) Act, 1947 and the orders thereunder would require a review. Such a review will be made as
soon as possible. Besides, the Manual of Office Procedure and the functions performed by various
port offices will be comprehensively reviewed and a new charter of duties and functions will be
drawn up to reflect the new role of the Directorate.

The government is of the view that the Imports and Exports (Control) Act, 1947 and the orders thereunder would require a
review. Such a review will be made as soon as possible.
State’s Role in Exports Promotion. Exports can only take place if we generate adequate volumes
of surpluses in exportable commodities. The government recognises that State governments have a
major role to play in achieving this objective. The State governments have been requested to exempt
exports from all fiscal levies in order to ensure that our exporters are able to compete effectively in
the world markets. The government has taken steps to strengthen the States’ Cell in the Ministry of
Commerce so that an interface with the State governments becomes more effective. At the same time,
the government has requested, and will continue to persuade, the State governments to set up a
separate Export Promotion Cell or a Directorate of Export Promotion in each State Secretariat.
Reduction in Import Licensing. The recently implemented policy changes imply a substantial
reduction in the extent of licensing and in the number and types of licences. Supplementary licences
for the import of items in Appendices 3 (except for SSI [small-scale industries] and manufacturers of
life-saving drugs and equipment), 4, and 9 of the Exim Policy, 1990–93, have been abolished. The
additional licences which were issued as an incentive to export houses and trading houses stand
abolished with effect from April 1, 1992, and the incentive will take the form of an additional exim
scrips entitlement. To achieve an optimal import containment in the context of the present BoP
situation, several steps have been taken. One of these is the shift of many items which are now on
OGL to the limited permissible list.

The implemented policy changes imply a substantial reduction in the extent of licensing and in the number and types of
licences.
With these changes, the policy for import of raw materials, components, and other inputs that are
needed for production has been simplified. Most raw materials and other inputs (except for those on
the Restricted List) can be freely imported either against exim scrips or on OGL. Some raw materials
continue to be canalised, but in most of these cases the requirements beyond those provided by the
canalising agencies can be met through exim scrips. It is the policy of the government to move to a
situation where imports of essential raw materials and components that are needed for industrial
production are regulated through appropriate tariffs. However, in view of the BoP position which
necessitates a continued import containment, this cannot be done immediately. Many items must,
therefore, remain on the limited permissible list, with imports permitted only against the exim scrips.
Elimination of Licensing and QRs. The medium-term objective of the government is to
progressively eliminate licensing and quantitative restrictions (QRs) on the capital goods and raw
materials/components so that all these items can be placed on OGL, save for a small, carefully
defined negative list. This shift is proposed to be achieved over a period of three to five years. The
government will appoint a high-level committee to work out the modalities of achieving this
transition, keeping in mind the BoP position and the need to rationalise and reduce tariffs
progressively to provide the Indian industry with an appropriate environment to develop international
competitiveness.

The government is trying hard to work out the modalities of achieving this transition.
ANNEXURE I
Products Eligible for Additional Exim Scrips Entitled to 10 Percentage Points

I. Fish and fish products:
Individually quick frozen fish (excluding frog legs) and canned marine products

Box 27.1 Duty Entitlement Passbook Scheme (DEPB)
In order to increase the export–GDP (gross domestic product) ratio, a number of initiatives have been taken in the recent
years. These include a reduction in exploring credit rates, both pre and post-shipment, higher-duty drawback rates on a
range of export items, abolition of value limits on a large number of export products covered under the Duty Entitlement
Passbook Scheme (DEPB), and special financial assistance packages for selected export products having high-value
addition and high-level of international competitiveness.

II. Agricultural items:
Cashew kernels roasted/salted in consumer packs of 1 kg or less
Fresh fruits, vegetables, cut flowers, plants and plant materials, and spices going by air
All types of canned bottle and aseptically packed fruits, vegetable products, and spices
Pulverised/treated guar gum
Instant tea, quick brewing black tea, tea bags, packed tea, tea caddies, and tea chestlets
Instant coffee in all forms
III. Drugs and drug intermediaries (as appearing at S. No. B. II[1] of Appendix 17 of IMPEX Policy)
IV. All electronic products
V. High-technology engineering products (to be notified separately)
ANNEXURE II
List of Import Items to be Decanalised

I. List of items to be decanalised and put under OGL
i. Silk worm
ii. Sodium borate
iii. Old ships
iv. Fluorspar
v. Platinum
vi. Palladium
II. List of import items to be decanalised and put under REP
i. Jute pulp
ii. Manila hemp
iii. Raw sisal fibre
iv. Raw jute
v. Alkyl benzene
vi. Floppy diskettes
vii. Lauric acid
viii. Oleic acid
ix. Stearic acid
x. Palmitic acid
xi. Palm fatty acid
xii. Palm acid oil
xiii. Other fatty acids, pure or mixed, including acid oils
xiv. Soap stocks
ANNEXURE III
List of Export Items to be Decanalised

i. Castor oil
ii. Polyethylene (LD)
iii. Coal and coke
iv. Colour picture tubes and sub-assemblies of colour TVs containing colour TV picture tubes
v. Ethyl alcohol or rectified spirit of any proof degree whether denatured or not
vi. Exposed cinematographic films and videotape cinema films
vii. Khandsari molasses
viii. Molasses
ix. Mill scale scrap
x. Bimetal ore (black iron ore) with manganese content from 3 per cent up to10 per cent of Goa origin
xi. Railway passenger coaches and locomotives
xii. Raw jute, mesta, and jute cuttings
xiii. Sugar
xiv. Iron ore of Redi origin
xv. Iron ore of Goa origin when exported to China or Europe in addition to Japan, South Korea, and Taiwan
xvi. Low-grade bauxite of West Coast origin
EXIM PERFORMANCE
Import Structure
The structure of our imports has undergone a great change in the recent years. The desire for rapid
industrialisation necessitated large imports of machinery, capital goods, transport equipment, and
project goods. Although the earlier manufactured commodities predominated the Indian imports,
over a period of few decades, petroleum, oil, and lubricants (POL) and capital goods have dominated
the imports.
In the recent years, with the progress of import substitution and higher production in the country,
there has been a significant reduction in the imports of cereals and cereal products, fertilizers, and
metals besides many other goods. In the commodity composition of our imports, a few commodities
are important and have accounted for 60 per cent to 80 per cent of our total imports during the late
1990s. These commodities are POL, capital goods, pearls and precious stones, fertilizers, iron and
steel, chemicals, and edible oils.

In the recent years, with the progress of import substitution and higher production in the country, there has been a
significant reduction in the imports of cereals and cereal products, fertilizers, and metals besides many other goods.
An interesting feature of imports during a span of almost 50 years since economic planning that
started in 1951 is that there has been a compulsion in the petroleum import. While its share was
negligible in 1950–51 and was only 1 per cent of the total imports in 1960–61, it increased to 8 per
cent in 1970–71 and to 20 per cent in 1975–76. It reached an exceptionally high peak of 41.95 per cent
in 1980–81, but in 2004–05 it was only 20.4 per cent. The import of petroleum has increased
substantially due to a heavy demand in our country. Also, the price factor caused by politics for
profits of oil-producing countries and the Gulf crisis in the early 1990s are equally responsible
factors.
Over a period of time, there has been a change in the composition of our imports, which is very
desirable. We have to screen and regulate our imports and adjust them according to the requirements
of the economy. The composition of imports in the recent past reveals a rising share of food and
allied products from 3.6 per cent in 1996–97 to 4.5 per cent in 2001–02. The share of POL in the total
imports has increased from 25.65 per cent in 1996–97 to 29 per cent in 2001–02, mainly due to low
international crude oil prices. Similarly, the share of capital goods in the total imports declined from
21.5 per cent in 1996–97 to 16.4 per cent in the first eight months of 1998–99, on account of reduced
imports of transport equipment, machinery (except electrical), and machine tools.
The import growth in 1998–99 was modest with imports recording a growth rate of 9.0 per cent in
US dollar value when compared to a lower growth of 7.2 per cent in the corresponding period of the
previous year. The increase in imports in the year was led by oil imports, which recorded an increase
of 57.8 per cent mainly on account of a sharp and sustained increase in the international prices. Non-
POL imports, however, remained sluggish during the financial year with a marginal increase of 1.1
per cent in the nine months, when compared to an increase of 15.8 per cent in the corresponding
period of the previous year.

The import growth in 1998–99 was modest with imports recording a growth rate of 9.0 per cent in US dollar value when
compared to a lower growth of 7.2 per cent in the corresponding period of the previous year.
The major factors that are responsible for the collapse of non-POL imports were a sharp decline in
the capital goods imports and a downturn in the imports of gold and silver. The non-oil, non-gold,
and silver imports rose by only 0.7 per cent as against an increase of 7.1 per cent in the
corresponding period of the previous year. When compared to the past recoveries, this time the
industrial recovery did not seem to have had any significant impact on imports. The paradox of a
relatively sharp recovery in the industrial growth and low growth of non-oil imports, especially
capital goods imports, was due to a switch from imported to domestically manufactured capital goods
in the wake of restrictions imposed on the import of second-hand capital goods. The stagnation of
non-oil imports also reflected a shift of sourcing from imports to domestic suppliers, particularly for
commodities whose international prices strengthened.
An important component of non-oil imports were the imports of gold and silver. With the
liberalisation of these imports in October 1997, gold and silver imports increased from $3.2 bn in
1997–98 to $4.9 bn in 1998–99, thus raising the share of these imports in the total imports from 7.6
per cent in 1997–98 to 11.6 per cent in 1998–99. The bulk of this increase was on account of the shift
in these imports from the NRI baggage route, the erstwhile preferred route, to the DGCI&S
(Directorate-General of Commercial Intelligence & Statistics) reporting system.
With a view to reduce the import of gold in the long run, the Union Budget 1999–2000 announced
the launching of the Gold Deposit Scheme 1999 to draw out the privately held gold stocks and reduce
India’s dependence on imports. Under the scheme, the investors could deposit gold with banks and
receive fixed-term interest-bearing certificates or bonds in exchange. On maturity, the depositors
could take back their gold or its equivalent in rupees. The scheme evoked a mixed response.

With a view to reduce the import of gold in the long run, the Union Budget 1999–2000 announced the launching of the
Gold Deposit Scheme 1999 to draw out the privately held gold stocks and reduce India’s dependence on imports.
On the other hand, the share of other imports increased sharply from 27.0 per cent in 1996–97 to
35.4 per cent in the year 2004–05, mainly due to a sharp increase in the imports of gold and silver,
which is largely on account of the shift in recording of these imports from the baggage route to the
DGCI&S reporting system. Other commodities whose imports recorded a significant growth in
1998–99 were project goods (73.1 per cent); edible oils (102.5 per cent); manufacture of metals (40.5
per cent); cereals (29.1 per cent); professional instruments and optical goods (15.5 per cent);
chemical materials and products (46.0 per cent); pearls and precious and semi-precious stones (8.2
per cent), and electrical machinery, except electronics (28.3 per cent).
The import growth in 2000–01 was buoyed up by a substantial increase in the POL imports, which
increased by 24.1 per cent mainly due to the continued strength of international crude oil prices. Non-
POL imports declined by 5.9 per cent, indicating a slowing domestic demand and subdued industrial
activity during the year. The decline in non-POL imports was contributed to by lower imports of food
and related items, fertilizers, capital goods imports, and other intermediate goods. The contraction in
the imports of food and allied products in 2000–01 was made up of a sharp decline in the imports of
cereals, sugar, milk and cream, edible oils, oil seeds, cashew nuts, and spices. The decline in the
imports of intermediate/raw material in 2000–01, which was indicative of a weak demand, was mainly
due to the lower imports of items like chemicals, pearls, precious and semi-precious stones, iron and
steel, non-ferrous metals, artificial resins and plastic materials, and metalliferrous ores and metal
scrap. The decline in the capital goods imports continued in 2000–01, with the decline in the imports
of transport equipment and project goods being particularly sharp. These growth trends imply a
decline in the share in the total imports from 5.8 per cent in 1999–2000 to 3.7 per cent in 2000–01 for
food and allied imports, from 12.0 per cent to 11.0 per cent for capital goods imports, and from 32.8
per cent to 29.8 per cent for fertilizers. Correspondingly, the share of fuel imports in the total imports
increased from 27.4 per cent in 1999–2000 to 33.2 per cent in 2000–01.

The import growth in 2000–01 was buoyed up by a substantial increase in the POL imports, which increased by 24.1 per
cent.
The rise in the non-POL imports in 2001–02 was contributed by a higher imports of food and
related items (mainly pulses, edible oil, and spices), capital goods imports, and imports of other
intermediate goods. The imports under the fuel group, fertilizers, and paperboard manufactures and
newsprint, however, contracted in 2001–02. While machinery and transport equipment contributed to
the enhanced imports of capital goods, under intermediate goods, higher imports were recorded for
chemicals, iron and steel, non-ferrous metals, professional instruments and optical goods,
metalliferrous ores and metal scrap, electronic goods, and non-metallic mineral manufactures. A
significant feature of the performance in 2001–02 was the reversal in trend in imports of capital
goods, which increased by 6.3 per cent as against the substantial decline in the preceding two years.
Another highlight was the turnaround in the export-related imports that increased by 1.6 per cent in
2001–02 as against a decline of 10.9 per cent in 2000–01. The major commodities that are posting
contraction in imports during the year included pearls, precious and semi-precious stones, gold and
silver, project goods, cereals, and cashew nuts. These growth trends imply an increase in the share in
the total imports from 3.7 per cent in 2000–01 to 4.5 per cent in 2001–02 for food and allied imports,
11.0 per cent to 11.4 per cent for capital goods, and from 29.6 per cent to 30.2 per cent for the other
intermediate goods over this period.

A significant feature of the performance in 2001–02 was the reversal in the trend in imports of capital goods, which
increased by 6.3 per cent against a substantial decline in the preceding two years.
Correspondingly, the shares of the fuel group declined from 33.2 per cent to 29.5 per cent and that
of the fertilizers from 1.5 per cent to 1.3 per cent, respectively, in 2000–01 and 2001–02. The import
growth in the first seven months of the current financial year has been high, rising by 13.0 per cent
when compared to a modest growth of 1.9 per cent in the corresponding previous period. The growth
has been buoyed up by POL imports, which increased by 16.7 per cent due to the hardening of
international crude oil prices and an off-take in the domestic-energy demand. Non-oil imports,
therefore, increased by 11.5 per cent in April–October 2002 with a decline in the imports of gold and
silver by 14.6 per cent, moderating this growth.
Thus, import growth, net of POL, and gold and silver imports, posted a growth of 15.7 per cent in
April–October 2002 when compared to a rise of 6.5 per cent in the corresponding previous year ’s
period, suggesting an incipient economic recovery during the year 2003–04. The growth has been
contributed by an increased imports of food and allied products (mainly edible oil, cashew nuts, and
spices) and other intermediate products (chemicals, precious and semi-precious stones, electronic
goods, iron and steel, medicine and pharmaceutical products, professional instruments, optical
goods, and computer software in the physical form). The import of capital goods have accelerated by
20.9 per cent (mainly due to transport equipment and non-electrical machinery), indicating a pickup in
the domestic manufacturing activity. The export-related imports also surged by 26.9 per cent during
April–October 2002.
Export Performance
India’s share in the world trade has declined over a period of 50 years. In 1951, when the First Five-
Year Plan was introduced, the share of India’s exports in the world trade was 2.19 per cent. It fell to
1.21 per cent in the exports in 1960–61. The same trend continued in the next decade of planning, as
the share in exports in 1970 was 0.66 per cent. In 1980, India’s share in the world exports fell to 0.42
per cent but rose slightly in mid-1980s, as the share of India’s exports rose to 0.63 per cent in 1985.
However, in 1991, the share of exports fell to 0.53 per cent. In 1994, it improved to 0.61 per cent
and in 1998, the share remained stagnant at 0.6 per cent. At present, the share of India’s exports in the
world is 0.61 per cent. In the 1990s, the decline in India’s share in the world trade was arrested and
reversed; the target now is to raise India’s share to more than 1 per cent. With the success of
industrialisation and a general improvement in the structure of the economy, new commodities have
also become important. At present, India’s exports by major commodity groups are as follows:
1. Manufactures that include engineering goods, chemicals and allied products, cotton yarn, fabrics, jute manufactures, leather and
its manufactures, readymade garments, and gems and jewellery, together accounted for more than 80 per cent of India’s exports
to the world in 1998–99.

Manufacturers that include engineering goods, chemicals, and allied products, etc., together accounted for more
than 80 per cent of India’s exports to the world in 1998–99.
2. Agriculture and allied products category including cashew kernels, coffee, marine products, raw cotton, rice, meat, spices,
sugar, tea, and tobacco.
Manufactures which constitute more than 80 per cent of our total exports, at once reflect the
tremendous strides we have taken in putting up the modern production facilities. If a country’s
industrial power has to be measured today, to a large extent, it can be done through its export basket.
We continue to sell tea, coffee, jute, cotton, leather, spices, and other traditional items even today, but
they reach the world with much value added in the form of processed and packaged items. The change
that has taken place in our export basket is almost revolutionary, with products of our vast
technological and industrial base predominating.
Engineering goods, high-quality cotton and synthetic yarn, fabrics, drugs and pharmaceuticals,
chemicals, automobiles, trucks, TVs and audio systems, plastic and linoleum products, processed
food, computer software, railway coaches, telecommunication equipment, and similar high-
technology items today make up much of our exports, reflecting the technological and industrial
development that has taken place in India over the last five decades. After almost 53 years of
independence, one can say India has come of age as far as its export products are concerned.
The composition of exports reveals a gradual shift during the 1990s. The share of ores and
minerals has declined progressively from 4.6 per cent in 1991–92 to 3.1 per cent in 1997–98, and this
trend has continued during 1998–99, with the share declining further to 2.4 per cent. There was a
marginal improvement of 0.5 per cent in 2000–01, with the share rising to 2.9 per cent and again with
a marginal fall to 2.8 per cent in 2001–02. Overall, since liberalisation, there has been a fall in the
share to the tune of 1.8 per cent.
It is a common phenomenon in the analysis of Indian exports to distinguish between traditional and
non-traditional exports. The share of the three traditional commodities, viz., textiles, jute
manufactures, and tea has been declining. The sectors that have been able to maintain a steady growth
or at least a “healthy stagnation” have been gems and jewellery, leather products, and readymade
garments.
The share of manufactured goods, the dominant sector, has been fluctuating around 75 per cent.
The only exceptional year was 2000–01 when it jumped comfortably to 78 per cent, with an almost 2
per cent fall the following year. The share of agricultural and allied goods has been more variable,
declining from 1991–92 to 1994–95, with a rising in the subsequent two years and dropping again
from 1997–98. This is, in part, due to lack of a consistent agricultural export policy and frequent-
supply considerations restraining the aggressive trade promotion of these exports.
The main commodities that are responsible for the slowdown in the export growth in 1997–98
were cereals and raw cotton in the agricultural sector, ores and minerals, crude and petroleum
products, transport equipment, and electronic goods. In 2000–01, the share of agricultural products
stood at 13.5 per cent and remained constant at 13.4 per cent in 2001–02.
The manufactured exports fared better in 1997–98 with a growth rate (in dollar terms) of 4.7 per
cent, with the other categories of exports recording a negative growth. Among the manufactured
export items posturing a buoyant growth during 1997–98 were gems and jewellery (7.6 per cent),
manufacture of metals (17.4 per cent), and machinery and instruments (9.8 per cent). Among the
agricultural products, the exports of tea and coffee recorded a significant increase in 1997–98 as
against an absolute decline in the previous year.
In 1998–99, the exports showed an across-the-board decline in all commodity groups, with a
decline of 22.4 per cent in ore and minerals, 5.4 per cent in agricultural and allied commodities, 4.6
per cent in the manufactured goods, and 69.5 per cent in crude and petroleum products. Exports that
recorded a poor performance included leather and footwear; dyes and chemicals; cotton yarn,
fabrics, and made-ups; electronic goods; transport equipment; primary and semifinished iron and
steel; raw cotton; raw tobacco; and oilmeals. Among the export commodities that showed high
growth were cereals, tea, handicrafts (excluding carpets), and gems and jewellery.

In 1998–99, exports showed an across-the-board decline in all commodity groups, whereas in 1999–2000, they witnessed a
significant turnaround with a growth rate of 12.9 per cent.
In 1999–2000, exports witnessed a significant turnaround with a growth rate of 12.9 per cent (in
dollar value). The buoyancy was led partly by the revival of world trade on the heels of the East Asian
recovery and a modest recovery in some global commodity prices. In 2000–01, the growth in exports
was spread across all the major commodity groups. The prominent sectors that showed a buoyant
growth included petroleum products, ores and minerals, manufactured goods, and agriculture and
allied sectors, with the agriculture sector stealing the show.
However, the export of gems and jewellery, a major foreign-exchange earner, recorded a decline
of 1.5 per cent during 2000–01. The decline in exports of textiles and chemical-related products also
accounted for a contraction in exports from this dominant sector. Such low-off take could be
attributed to a demand contraction in the developed countries which is resulting from the global
recession.
The growth in exports in 2000–01 was spread across all the major commodity categories, with
exports of petroleum products, ores and minerals, manufactured goods, and agriculture and allied
products, particularly being buoyant. An important feature of this performance was the turnaround in
the exports of agriculture and allied products, which had been declining since 1996–97. The main
products that are responsible for this revival included exports of spirits and beverages, sugar and
molasses, poultry and dairy products, processed foods, meat and preparations, marine products, raw
cotton, oilmeals, pulses, and cereals. The plantation sector, however, continued to record a negative
growth at 6.9 per cent, mainly due to a decline in the exports of coffee. Enhanced domestic refining
capacity was mainly responsible for the surge in exports of petroleum products.

The growth in exports in 2000–01 was spread across all the major commodity categories. But there was a decline in the
value of exports in 2001–02, that spread across both agricultural as well as manufactured commodity groups.
The buoyancy in the exports of ores and minerals was led by the exports of iron ore and processed
minerals. Among the manufactured goods, the exports of engineering goods, chemical and related
products, leather and manufactures, and textiles including readymade garments, posted major gains.
However, the export of gems and jewellery, which is a major foreign-exchange earner, recorded a
decline of 1.5 per cent during 2000–01, the decline being mainly confined to cut and polished
diamonds, with the gold jewellery sector continuing to grow.
The decline in the value of exports in 2001–02 spread across both agricultural as well as
manufactured commodity groups, with a decline of 2.2 per cent and 3.9 per cent, respectively.
Under the manufactured goods, the major exports like gems and jewellery, engineering goods,
textiles—including readymade garments, chemicals and related products, leather and manufactures,
recorded a sharp deceleration or even a decline in the exports. This deceleration/decline was mainly
due to the lower exports of readymade garments and cotton yarn, fabrics, and made-ups under
textiles; ferroalloys and primary and semi-finished iron and steel; and computer software, in the
physical forms under engineering goods; organic chemicals and dyes/intermediates, and coal tar
chemicals under chemical and related products; and leather goods and leather garments under leather
and manufacture exports. However, the exports of specific manufactured goods such as finished
leather, cosmetics and toiletries, non-ferrous metals, machinery and instruments, electronic goods,
and coir and coir manufactures recorded substantial increases in exports during 2001–02.
The decline in agricultural and allied exports (including plantation) in 2001–02 was mainly on
account of the lower exports of tobacco, marine products, spices, and cashew nuts. While the decline
in the exports of tobacco and cashew nuts was due to the lower volume of these exports, the decline in
the unit value contributed to the lower exports of spices and marine products. The plantation sector
continued to record a negative growth of 9.8 per cent on account of both reduced volume and unit
prices for exports of tea and coffee. The exports of cereals (mainly wheat), sugar and molasses,
oilmeals, processed foods, and poultry and dairy products, however, recorded significant increases
during the year. The buoyancy in the export of petroleum products continued in 2001–02, given the
enhanced domestic refining capacity. The growth in the exports of ores and minerals was led by a
19.2 per cent increase in the exports of iron ore (mainly due to a 72 per cent rise in the volume of
these exports). Given such performance, the share in the total exports of the manufactured goods and
agriculture and allied products declined from 78 per cent and 13.5 per cent, respectively, in 2000–01,
to 76.1 per cent and 13.4 per cent, respectively, in 2001–02. Correspondingly, the share of exports of
petroleum products and ores and minerals in the total exports increased to 4.8 per cent and 2.9 per
cent, respectively, during the year.
The continued surge in the exports of petroleum products and ores and minerals further enhanced
the share of these exports in the total exports to 5 per cent and 3.8 per cent, respectively, in the current
financial year. The exports in the other commodity groups like agriculture and manufactured goods
also increased by 3 per cent and 16.3 per cent, respectively, thus making the current upturn in exports,
a broad based one across the major commodity groups. Accelerations in the major exports like gems
and jewellery; engineering goods; chemical-related products; textiles, including readymade
garments; leather and manufactures; and handicrafts, contributed significantly to this recovery. An
important feature of the performance in the recent times is the turnaround in the exports of
agriculture and allied goods, mainly due to higher exports of cereals, tobacco, spices, cashew nuts,
fruits and vegetables, and marine products. The cereal exports spurted by 33.6 per cent, with India
emerging as the world’s second-largest exporter of rice and sixth-largest exporter of wheat.
EXIM POLICIES
Five-year Exim Policy
Till March 31, 1985, India’s Import Policy was announced on an yearly basis. Sometimes, this policy
was even announced on a six-month basis. From April 1985 to March 1988, there was a three-year
Import Policy. Subsequently also three-year policies were announced, but each time the policy was cut
short by a year. However, for the first time in the trade history of the country, a Five-year Exim
Policy was announced by the Government of India on March 31, 1992. The announcement of the new
Exim Policy coincided with the launching of India’s Eighth Five-Year Plan. And on March, 31 1997,
another Exim Policy for the period 1997–02 was announced. The 1997–02 Exim Policy is co-
terminus with the Ninth Five-Year Plan.

On March 31, 1992, a Five-year Exim Policy was announced. Prior to this, it was announced on and yearly basis up to
1985 and later for three years from 1985 to 1992.
Objectives of the Exim Policy
The objectives of the 1997–02 Exim Policy are given below:

1. Accelerating the country’s transition to a globally oriented vibrant economy with a view to derive maximum benefits from the
expanding global market opportunities.
2. Stimulating a sustained economic growth by providing access to essential raw materials, intermediates, components,
consumables, and capital goods that are required for augmenting the production.
3. Enhancing the technological strength and efficiency of Indian agriculture, industry, and services, thereby improving their
competitive strength while generating new employment opportunities.
4. Encouraging the attainment of internationally accepted standards of quality.
5. Providing consumers with good quality products and services at reasonable prices.
The emphasis in the current Exim Policy is on enabling the Indian industry to become technologically
so strong that it can effectively meet the global competition in the new millennium. The old stereotype
objectives have been discarded.
Exim Policy, 1997–02
The Exim Policy, 1997–02 (coinciding with the period of the Ninth Five-Year Plan) sought to
consolidate the gains of the previous policy and further carried forward the process of liberalisation
by deregulating and simplifying the procedures and removing the QRs in a phased manner. It set an
ambitious target of attaining an export level of US$90 bn to US$100 bn by the year 2002 and
achieving a 1 per cent share in the world trade.

The policy sought to consolidate the gains of the previous policy and further carried forward the process of liberalisation,
by deregulating and simplifying the procedures and removing the QRs.
Salient Features
The following were the salient features of the Policy:
1. The exim shall be free, except to the extent that they are regulated by the provisions of this policy.
2. The Central government may, in the public interest, regulate the import or export of goods by means of a Negative List of
Imports or a Negative List of Exports, as the case may be.
3. The negative lists may consist of good—the import or export of which is prohibited, restricted through licensing, or canalised.
4. The prohibited items in the negative list of imports shall not be imported and the prohibited items in the negative list of exports
shall not be exported.
5. Any goods, the export or import of which is restricted through licensing, may be exported or imported only in accordance with a
licence that is being issued in this behalf.
6. Any goods, the import or export of which is canalised, may be imported or exported by the canalising agency specified in the
negative list.
7. No export or import shall be made by any person without an Importer–Exporter Code (IEC) number, unless it is specifically
exempted.
Modified Exim Policy, April 1998
The new government at the Centre, which assumed office in March 1998, announced its Exim Policy
for the year 1998–99 on April 13, 1998. As a part of the annual Exim Policy modification, the
government freed a large number of consumer goods from import restrictions and liberalised all the
major export promotion schemes. This new dose of liberalisation of the trade regime by the new
government was necessitated by the commitments made by India at the World Trade Organisation
(WTO). The timing of the import policy liberalisation coincided with the scheduled review of India’s
trade policy by WTO on April 16 and 17, 1998. Apart from the general global pressure on India to
remove the restrictions on imports, the United States had filed a complaint with the WTO against
India’s import regime.

The policy modification led the government to free a large number of consumer goods from import restrictions and all major
export promotion schemes.
The following were the main provisions of the modified Exim Policy:
1. About 340 more items were shifted from the restricted list to OGL. Thus, out of the total number of 10,202 items that are
covered under the Exim Policy, only 2,200 remained on the restricted list.
2. The revised policy set the export growth target of 20 per cent for the year 1998–99 which, in other words, required a total
export of the order of $41.4 bn during 1998–99.
3. The zero-duty Export Promotion Capital Goods (EPCG) Scheme was extended to all the software exporters by lowering the
threshold limit of importable capital goods from Rs 20 crore to Rs 10 lakh. The lowering of the threshold limit was expected to
help the software companies to proliferate throughout the length and breadth of the country. In other words, they could import
any capital goods without paying any import duty and in return, can sign an export obligation of five times the value of the
capital goods, based on the net foreign exchange earnings, for a period of six years. In the case of garments, agriculture, food
processing, gems and jewellery, electronics, leather, and sports goods and toys, the minimum limit was lowered to Rs 1 crore.
4. In a bid to prevent cheap imports being dumped at unreasonable prices, the government set up an anti-dumping cell called
Directorate General (DG) of Anti-Dumping and Allied Duties. The DG would be responsible for investigation into the alleged
cases of dumping as well as subsidised cases. The DG would also recommend anti-dumping duties where it is found that the
dumped imports are causing harm to the domestic industry. Where harm is caused to the domestic industry by subsidising exports
by the exporting country, the DG would have the jurisdiction to investigate all such cases and recommend possible imposition of
countervailing duties(CVDs). The DG would also advise industry groups and consumers on how to go about collecting
information and procedures that are involved in making out a case for anti-dumping duties.
5. Other provisions included (a) delegation of powers to regional licensing offices, (b) doing away with the minimum value addition
of 33 per cent under advance licensing scheme, (c) simplified procedures for clubbing of advance licence schemes, and (d)
private-bonded warehouses to be set up to import, stock, and sell even the negative list items.
In its effort to further dismantle the import control regime and hasten the integration of the Indian
economy with the world economy, the government announced a revised Exim Policy on March 31,
1999, which came into force on April 1,1999. The new policy freed the import of about 894 items of
consumer goods, agricultural products, and textiles from licensing requirements. In other words, a
number of consumer items could now be imported licence-free, subject only to the payment of import
duty. The physical controls on imports were removed and the only control over imports was fiscal in
nature, that is, adjusting the import duty to regulate the imports. These adjustments were to be made
within the upper limits prescribed by the WTO.

The new policy removed physical controls on imports.
Moreover, another 414 items were removed from the restricted list, allowing these to be imported
against special import licences. India’s international commitments required the removal of licensing
curbs on imports by the year 2003.

The Union Commerce and Industry Minister announced the new Exim Policy of the Government of
India for the year 2000–01 on March 31, 2000. The policy, envisaging a 20 per cent export growth in
dollar terms in 2000–01, brought about a major rationalisation in the export promotion schemes and
hence, launched a series of sector-specific initiatives.
Export Promotion
In a major initiative to boost the exports, the government announced the following measures:
Special Economic Zones (SEZs). On the pattern of the Chinese model, the government announced
the setting up of two SEZs, at Positra in Gujarat and Nangunery in Tamil Nadu. Industrial units that
are located in SEZs will be exempted from a plethora of rules and regulations that are governing
exports and imports. The entire production will have to be exported from these zones. Sales from
DTA can be done only on full payment of customs duty. Several EPZs will shortly be converted into
SEZs. The EPZs located in Kandla, Vizag, and Kochi will be converted into SEZs immediately. It was
further announced that 100 per cent foreign direct investment (FDI) would be allowed in all products
in SEZs.
SEZs would be treated as if they are outside the customs territory of the country. The units would
be able to import capital goods and raw materials duty free. The movement of goods to and from
SEZs would be unrestricted. A fiscal incentive package (including tax holiday) for export units to be
located in SEZs would be announced by the government in a due course.

SEZs would be treated as if they are outside the customs territory of the country. The units would be able to import capital
goods and raw materials duty free.
SEZs have played a crucial role in boosting China’s exports and presently, the country derives 40
per cent of its exports from such zones. However, Chinese SEZs are based on a contract labour
system (hire-and-fire policy). The Commerce Minister, while announcing the Exim Policy,
categorically ruled out any changes in the labour laws. Moreover, there is no system of reservation of
items for SSIs in China. It is unclear if the Government of India would allow the production of
reserved items for small industries in the SEZs. Still further, there are various infrastructure
bottlenecks like power shortage, lack of transport facilities, and, of course, procedural delays. Hence,
the success of SEZs in India is a moot question.
Sector-specific Packages. The Exim Policy, 2000–01 announced sector-specific packages for
seven core areas to boost exports. These areas are—gems and jewellery, pharmaceuticals, agro-
chemicals, biotechnology, silk, leather, and garments. For gems and jewellery exporters, the
government announced a Diamond-Dollar Account Scheme (DDAS). Under the scheme, the export
proceeds can be retained in a dollar account, and the exporters can use the funds in this account for
the import of rough diamonds.

The Exim Policy announced sector-specific packages for seven core areas. The policy announced further financial
incentitives to the states, based on their export performance.
For agrochemicals, biotechnology, and pharmacy units (considered as knowledge-intensive), the

government allowed duty-free import of laboratory equipment, chemicals, and reagents up to 1 per
cent of the FOB value of exports. Similarly, the government increased the duty-free import of
trimmings, embellishments, and other items from 2 per cent to 3 per cent of the total export value.
Involvement of State Governments in Export Promotion. Since the states forego taxes (mainly
sales tax) on exports, they have a very little incentive to promote exports. The Exim Policy, 2000–01
announced financial incentives to states based on their export performance. An incentive scheme with
an initial outlay of Rs 250 crore to secure the state’s involvement in the national export drive was
unveiled. The states can use the funds for export promotion activities such as infrastructure
development. The Commerce and Industry Minister said that he would request the states to treat all the
units that are exporting more than 50 per cent of their turnover as public utility services. This would
enable them to keep their international commitment on delivery schedules. Furthermore, the Minister
observed that the recent spectacular growth of software exports was, apart from India’s knowledge in
high-tech, due to the hands-off policy of the government towards this sector. A similar approach to
hardware electronics is also called for.
Import Liberalisation. The Exim Policy, 2000–01 lifted QRs on 714 commonly used items
(agricultural products and consumer durables), which can now be freely imported. Thus, the
commodities like meat, milk powder, coffee, tea, fish, pickles, cigars and cigarettes, televisions,
radios, tape recorders, footwear, and umbrellas can be imported freely from April 1, 2000. However,
most of these items will attract a peak rate of basic import duty of about 35 per cent, which together
with surcharge and special customs duty will add up to a total of 44 per cent on import duties.
Furthermore, that 44 per cent will be enhanced by a CVD that is equivalent to the domestic excise duty
on the product that is being imported.

The Exim Policy, 2000–01 lifted QRs on 714 commonly used items (agricultural products and consumer durables), which
can now be freely imported.
The lifting of licensing and quota restrictions on 714 import items was in line with India’s WTO
obligations. The government promised to abolish licensing and quota curbs on the remaining 715
items (such as liquor, cars, and so on.) in April 2001. Many critics of the new policy feared that the
removal of licensing and quota restrictions would lead to a surge in imports of these items, hurting
the domestic industry. However, it is noteworthy that import restrictions are being phased out since
1996 but no extraordinary growth has occurred in the import of freed items. The Commerce Minister
has maintained that anti-dumping and anti-subsidy tariffs and other safeguards would be used if there
was a sudden surge in imports, causing a serious injury to the domestic industry.

Many critics of the new policy feared that the removal of licensing and quota restrictions would lead to a surge in imports of
these items, hurting the domestic industry.
The Union Commerce and Industry Minister unveiled the Exim Policy for the year 2001–02 on March
31, 2001.
Removal of QRs
The process of removal of import restrictions, which began in 1991, was completed in a phased
manner by the Exim Policy, 2001–02 with the removal of restrictions on the remaining 715 items.
This was in tune with the commitments made to the WTO. Out of these 715 items, 342 were textile
products, 147 were agricultural products, and 226 were other manufactured products.

The process of removal of import restrictions was completed in a phased manner by the Exim Policy, 2001–02.
However, the import of agricultural products like wheat, rice, maize, copra, and coconut oil was
placed in the category of State Trading. The nominated State Trading Enterprise will conduct the
import of these commodities solely as per commercial considerations. Similarly, the import of
petroleum products including petrol, diesel, and ATF (aviation turbine fuel), was also placed in the
category of State Trading. In all, 27 out of 715 items taken off the QRs list were put under the State
Trading category.
The Minister was confident that the Indian market would not be swamped by imported brands of
commonly used articles. To prevent dumping, the government will take a recourse to anti-dumping
duties and other non-tariff barriers. Arrangements have been made to track, collate, and analyse the
data on 300 sensitive items which mainly comprise farm goods and items that are produced by the SSI
sector.

With a view to boost agricultural exports and provide remunerative returns to the farming
community, the Exim Policy proposed the setting up of agri-export zones (AEZs). Three such zones
are proposed to be set up in Himachal Pradesh, Jammu & Kashmir (to promote export of apples), and
Maharashtra. The government will make efforts to provide an improved access to the produce/
products of the agriculture and allied sectors in the international market. The State governments have
been asked to identify the product-specific AEZs, for the development of export of specific products
from a geographically contiguous area.

The Exim Policy, 2002–07 was unveiled on March 31, 2002. The policy entails several institutional,
infrastructural, and fiscal measures that are intended to promote exports, which are conducive to the
economic development of the country. The following are the salient features of the policy:

The policy entails several institutional, infrastructural, and fiscal measures that are intended to promote exports, which are
conducive to the economic development of the country.
Special Economic Zones (SEZs). Offshore Banking Units (OBUs) shall be permitted in SEZs. The
units in SEZ would be permitted to undertake a hedging of the commodity price risks, provided such
transactions are undertaken by the units on a stand-alone basis. This will impart security to the returns
of the unit.
It has also been decided to permit External Commercial Borrowing (ECB) for a tenure of less than
three years in SEZs. The detailed guidelines will be worked out by the RBI. This will provide
opportunities for accessing the working capital loan for these units at internationally competitive
rates.
Employment Oriented. Export restrictions like registration and packaging requirements are being
removed on butter, wheat and wheat products, coarse grains, groundnut oil, and cashew, which are
sent to Russia. QR and packaging restriction on wheat and its products, butter, pulses, grain and flour
of barley, maize, bajra, ragi, and jowar, were removed on March 5, 2002.
The restrictions on the export of all cultivated (other than wild) varieties of seed, except jute and
onion, have been removed. To promote the export of agro- and agro-based products, 20 AEZs have
been notified. In order to promote the diversification of agriculture, transport subsidy shall be
available for the export of fruits, vegetables, floriculture, poultry, and dairy products. The details
would be worked out in three months.
Three per cent special DEPB rate for primary and processed foods that are exported in retail
packaging of 1 kg or less. An amount of Rs 5 crore under Market Access Initiative (MAI) has been
earmarked for promoting the cottage sector exports coming under the KVIC (Khadi and Village
Industries Commission). The units in the handicrafts sector can also access funds from MAI scheme
for the development of a website for a virtual exhibition of their products.
Under the EPCG scheme, these units will not be required to maintain an average level of exports
while calculating the export obligation. These units shall be entitled to the benefit of export-house
status on achieving lower than the average export performance of Rs 5 crore as against Rs 15 crore
for others. The units in the handicraft sector shall be entitled to duty-free imports of an enlarged list
of items as embellishments up to 3 per cent of FOB value of their exports.
INDIA’S EXIM PERFORMANCE
Foreign trade has played a crucial role in India’s economy, growing at almost three times the growth
of GDP during the last four years. India’s exports cover a wide range of items including engineering
goods, ores and minerals, chemicals and related products, gems and jewellery, and of late, petroleum
products. Imports have increased substantially, bulk of which comprise items like petroleum and
crude products; fertilizers; precious and semi-precious stones for export production; and capital
goods, raw materials, consumables, and intermediates for industrial production and technological
upgradation.

Foreign trade has played a crucial role in India’s economy, growing at almost three times the growth of GDP during the last
four years.
TRADE SCENARIO
India’s total external trade (imports plus exports including re-exports) in the year 1950–51 stood at Rs
1,214 crore. Since then, it has witnessed a continuous increase with occasional downturns. During
2006–07, the value of India’s external trade reached Rs 1,384,368 crore. A statement indicating India’s
total export, import, and the total value of foreign trade and balance of trade from the year 1990–91
to 2006–07(P), in rupee terms, is given in the Table 27.1.
India’s exports of merchandise goods touched the target of US$125 bn in 2006–07, recording a
growth of around 21 per cent in dollar terms. In rupee terms, the exports of merchandise goods
during 2006–07 was valued at Rs 563,800 when compared to Rs 456,483 crore in 2005–06, with a
growth rate of 24 per cent. India’s growth of exports is much higher than that of the world economy
as well as the many major economies of the world.
At the same time, imports increased from Rs 635,013 crore in 2005–06 to Rs 820,568 crore during
2006–07, thereby registering a growth of 29 per cent in rupee terms. The trade deficit in 2006–07 was
Rs (–)256,768 crore as against Rs (–)178,530 crore during 2005–06. India has trading relations with
all the major trading blocks and all the geographical regions of the world. Region-wise and sub-
region-wise spread of India’s trade during 2005–06 and 2006–07 is given in Table 27.2. In dollar
terms, Asia and ASEAN accounted for 48.46 per cent of India’s total exports, followed by West
Europe (24.06 per cent) and United States (20.61 per cent) during 2005–06. India’s imports were
highest from Asia and ASEAN (35.22 per cent), followed by West Europe (21.17 per cent) and United
States (7.78 per cent), during the same period.

India has trading relations with all the major trading blocks and all the geographical regions of the world.

Table 27.1 India’s Foreign Trade
Source: INDIA 2008, a book published by the Publications Division, Ministry of Information and Broadcasting, Govern ment of lindia.
(P) Provisional data.

Table 27.2 Direction of India’s Trade
Note:
*April–January figures.

EXPORTS
The exports in rupee terms have shown an increasing trend and diversification of its base over the
years. While there are year-to-year (y-t-y) variations, the commodities whose exports have been
increasing over the last few years and also in 2006–07 include agriculture and allied products, ores
and minerals, gems and jewellery, chemical and allied products, engineering goods, and petroleum
products. The exports of principal commodities during 2006–07 when compared to the
corresponding period of the previous year are given in the Table 27.3.
IMPORTS
The imports are made to meet the essential requirements of domestic consumption, investment,
production, and as inputs for exports. Bulk imports as a group registered a growth of 42.56 per cent
in rupee terms during the period of April–January of 2006–07 and accounted for 46.56 per cent of the
total imports. This group includes fertilizers, cereals, edible oils, newsprint, and petroleum products.
The other principal imports consist of pearls, gold and silver, machinery, medicinal and
pharmaceutical products, organic and inorganic chemicals, coal, artificial resins, and so on. The
details of Indian imports of principal commodities during the periods of 2005–06 and 2006–07 are
given in the Table 27.4.

Bulk imports as a group registered a growth of 42.56 per cent in rupee and accounted for 46.56 per cent of the total
imports.

Table 27.3 Export of Principal Commodities

Table 27.4 Import of Principal Commodities

EXPORT PROMOTION MEASURES
Export promotion being a constant endeavour of the government, export performance is constantly
monitored, and export strategy and export policies are formulated. In the Foreign Trade Policy (FTP)
for the years 2004–09 announced on August 31, 2004, the government spelt out a bold vision to
double India’s percentage share of global merchandise trade within five years and to focus on the
generation of additional employment. Stability of trade policy regime has yielded positive results and
in the next three years since the inception of the FTP, India’s merchandise exports had recorded an
appreciable growth. According to the latest information published in the World Trade Statistics by the
World Trade Organization (WTO), India’s share in the total world trade (which includes trade in both
merchandise and services sector) has gone up from 1.1 per cent in 2004—that is, the initial year of the
FTP, 2004–09 to 1.5 per cent in 2006.

According to the latest information published in the World Trade Statistics by the World Trade Organization (WTO), India’s
share in the total world trade (which includes trade in both merchandise and services sector) has gone up from 1.1 per cent
in 2004—that is, the initial year of the FTP, 2004–09 to 1.5 per cent in 2006.
Based on the current rates of growth of merchandise and services trade, it is expected that India’s
share in the world trade covering merchandise plus service sector trade may well double from the
level of 2004 to reach 2 per cent mark in 2009. In line with the government’s objective of having an
all-inclusive growth, the Annual Supplement to FTP announced in April, 2007 also focused on
promoting employment-intensive export growth through initiatives like Focus Products, Focus
Market Schemes, the Vishesh Krishi Upaj Yojana as well as sector-specific initiative giving thrust on
handloom, handicrafts, cottage and tiny industries, gems and jewellery, and so on. Under the general
export promotion schemes, the DEPB Scheme had been extended for another year up to March 3,
2008. These measures were aimed to augment and sustain the current rate of export growth in line
with India’s comparative advantage and the emerging situation in the international market (refer to
Box 27.1). The export target for 2007–08 had been fixed at US$160 bn. Box 27.2 details the
procedural simplification measures to boost exports.
SPECIAL ECONOMIC ZONES (SEZS)
India was one of the first in Asia to recognise the effectiveness of the EPZ model in promoting
exports, with Asia’s first EPZ set up in Kandla in 1965. Seven more zones were set up thereafter.
However, the zones were not able to emerge as effective instruments for export promotion on
account of the multiplicity of controls and clearances, the absence of world-class infrastructure, and
an unstable fiscal regime. While correcting the shortcomings of the EPZ model, some new features
were incorporated in the SEZ Policy, which was announced in April 2000. This policy intended to
make SEZs an engine for economic growth, supported by quality infrastructure and complemented by
an attractive fiscal package, both at the Centre and at the State level, with minimum possible
regulations. The salient features of the SEZ Scheme are:
A designated duty-free enclave to be treated as foreign territory only for trade operations and duties and tariffs.
No licence required for import.
Manufacturing or service activities allowed.
SEZ units to be positive net foreign-exchange earner within three years.
Domestic sales subject to full customs duty and import policy in force.
Full freedom for sub-contracting.
No routine examination by customs authorities on exported/imported cargo.
In order to impart stability to SEZ regime and to achieve generation of greater economic activity and
employment through the establishment of SEZs, a SEZ Act has been enacted. The SEZ Act, 2005,
supported by SEZ Rules, has come into effect on February 10, 2006. Incentives and facilities offered
to units in SEZs under the Act for promotion of investment, including foreign investment, include—
duty-free import/domestic procurement of goods for development; operation and maintenance of
SEZ units; 100 per cent Income Tax exemption on export income for SEZ units under Section 10AA
of the Income Tax Act for the first five years, 50 per cent for the next five years thereafter, and 50 per
cent of the ploughed-back export profit for the succeeding five year exemption from Central Sales
Tax; and exemption from Service Tax and Single-window Clearance Mechanism for establishment of
units.

In order to impart stability to SEZ regime and to achieve generation of greater economic activity and employment through
the establishment of SEZs, a SEZ Act has been enacted. The SEZ Act, 2005, supported by SEZ Rules, has come into effect on
February 10, 2006.
All the eight EPZs located at Kandla and Surat (Gujarat), Santa Cruz (Maharashtra), Cochin
(Kerala), Chennai (Tamil Nadu), Visakhapatnam (Andhra Pradesh), Falta (West Bengal), and Noida
(Uttar Pradesh) have been converted into SEZs. Under SEZ Act, formal approvals have been given so
far for setting up of 366 SEZs in the private/joint sector or by the State governments and their
agencies, which include the 142 approvals for which Notifications have already been issued.
The benefit derived from SEZs is evident from the investment, employment, exports, and
infrastructure developments that are additionally generated. An investment of the order of Rs 100,000
crore including an FDI of US$5 bn to US$6 bn is expected by the end of December 2007. About
100,000 direct jobs are expected to be created by December 2007. The benefits derived from the
multiplier effect of the investments and additional economic activity in the SEZs and the employment
generated thus, will far outweigh the tax exemptions and the losses on account of land acquisition.
Stability in fiscal concession is absolutely essential to ensure the credibility of government intensions.

The benefits derived from the multiplier effect of the investments and additional economic activity in the SEZs and the
employment generated thus, will far outweigh the tax exemptions and the losses on account of land acquisition.
Some of the highlights of the SEZ Scheme are as follows:

a. Exports from the functioning SEZs during the last three years are the following:

Table 27.5
Growth Rate (%)
Year Value (Rs Crore)
(Over Previous Year)
2003–04 13,854 39
2004–05 18,314 32
2005–06 22,840 24.7
2006–07 34,787 52. 3
Projected exports from
Rs 67,088 crore
all SEZs for 2007–08
Source: INDIA 2008, a book published by the Publications Division, Ministry of Information and Broadcasting, Government of
India.

b. Investment and employment in the SEZs set up prior to the SEZ Act, 2005:
At present, 1,216 units are in operation in the SEZs. In the SEZs that were established prior to the Act coming into force, there
were 1,098 units providing a direct employment to over 1.93 lakh persons; about 40 per cent of whom are women. Private
investment by entrepreneurs in these SEZs established prior to the SEZ Act was in the order of over Rs 5,844 crore.
c. Investment and employment in the SEZs notified under the SEZ Act 2005:
Current investment and employment—
Investment: Rs 46,075 crore
Employment: 40,153 persons
Expected investment and employment (by December 2009):
Employment: 2,109,589 additional jobs
d. Expected investment and employment if 366 formal approvals become operational:
Employment: 4 million additional jobs
Impact of the SEZ Scheme
The overwhelming response to the SEZ Scheme is evident from the flow of investment and creation
of additional employment in the country. The SEZ Scheme has generated a tremendous response
among the investors, both in India and abroad, which is evident from the list of developers who have
set up SEZs:
Nokia, Tamil Nadu
Quark City, Chandigarh
Flextronics, Tamil Nadu
Mahindra World City, Tamil Nadu
Motorola, DELL, and Foxconn
Apache (Adidas Group), Andhra Pradesh
Divvy’s Laboratories, Andhra Pradesh
Rajiv Gandhi Technology Park, Chandigarh
ETL Infrastructure, Chennai
Hyderabad Gems Ltd., Hyderabad
AGRI-EXPORT ZONES (AEZS)
The setting up of the Agri-export Zones (AEZs) is intended to provide remunerative returns to the
growers by enhancing the marketability of the produce of these zones in the international as well as
domestic markets. These zones are identified by the State governments for an end-to-end development
to promote the export of identified products from a geographically contiguous area. The idea is to
dovetail all the incentive schemes, both Central and State, and evolve a comprehensive package of
services for an intensive delivery to farmers, processors, and exporters. So far, “in principle”
approvals have been accorded for 45 AEZs in 19 different states. The AEZ Scheme has been
introduced to transform rural regions into regional rural motors of the export economy. Box 27.3
gives a list of AEZs in India.

The AEZ Scheme has been introduced to transform rural regions into regional rural motors of the export economy.
HIGHLIGHTS OF FOREIGN TRADE POLICY (FTP), 2004–09
The New Foreign Trade Policy (NFTP) takes an integrated view of the overall development of India’s
foreign trade and essentially provides a roadmap for the development of this sector. It is built around
two major objectives of doubling India’s share of global merchandise trade by 2009 and using the
trade policy as an effective instrument of economic growth with a thrust on employment generation.
The key strategies to achieve these objectives, inter alia, include acts, such as unshackling of control
and creating an atmosphere of trust and transparency; simplifying the procedures and bringing down
the transaction costs; neutralising the incidence of all levies on inputs that are used in export products;
facilitating the development of India as a global hub for manufacturing, trading, and services;
identifying and nurturing the special-focus areas to generate additional employment opportunities,
particularly in semi-urban and rural areas; facilitating technological and infrastructural upgradation
of the Indian economy, especially through import of capital goods and equipment; avoiding inverted
duty structure and ensuring that domestic sectors are not disadvantaged in trade agreements;
upgrading the infrastructure network related to the entire foreign-trade chain to international
standards; revitalising the BoT by redefining its role and inducting into it the experts on trade policy;
and activating Indian embassies as key players in the export strategy.

Box 27.2 Simplification to Boost Exports
The procedural simplification measures that were notified by the Directorate General of Foreign
Trade (DGFT) through a series of Notification issues on August 31, 2004 in India, are as follows:
1. To enable the importing/exporting community to file their annual import/export trade returns, for which the last date has
been extended from October 31 to December 31.
2. The system of near examination by an expert committee for issuance of EPCG licence has been dispensed with. Henceforth,
the EPCG licences can be obtained based on a certificate that is issued by a chartered engineer, certifying the essentiality of
goods.
3. To develop the agricultural infrastructure and promote the export of new agricultural products, new AEZs have been
notified for bananas, oranges, cashew nuts, sesame seeds, lentils, and grams in the states of Maharashtra, Madhya Pradesh,
Tamil Nadu, and Gujarat.
4. Star exporters who seeking are a renewal or upgrada-tion of their existing status shall not be required to file detailed bank-
realisation statements.
Special-focus Initiatives
The FTP 2004 has identified certain thrust sectors that are having prospects for export expansion and
potential for employment generation. These thrust sectors include agriculture, handlooms and
handicrafts, gems and jewellery, and leather and footwear. The sector-specific policy initiatives for
the thrust sectors include, for agriculture sector, introduction of a new scheme called Vishesh Krishi
Upaj Yojana (Special Agricultural Produce Scheme) to boost exports of fruits, vegetables, flowers,
minor forest produce, and their value-added products (refer to Box 27.4). Under the scheme, the
exports of these products qualify for duty-free credit entitlement (5 per cent of FOB value of exports)
for importing inputs and other goods. Other components for the agriculture sector include duty-free
import of capital goods under the EPCG Scheme, permitting the installation of capital goods that are
imported under EPCG for agriculture anywhere in the AEZ, utilising funds from the Assistance to
State for Infrastructure Development Exports (ASIDE) Scheme for development of AEZs;
liberalisation of import of seeds, bulbs, tubers, and planting material; and liberalisation of export of
plant portions, derivatives, and extracts to promote the export of medicinal plants and herbal
products.

The FTP 2004 is a sector-specific policy. The FTP has identified certain thrust sectors having prospects for export
expansion and potential for employment generation.
Box 27.3 AEZs in India
1. Pineapples in Darjeeling
2. Apples in Jalpaiguri regions of West Bengal
3. Gherkins in and around Bangalore, Karnataka
4. Lichees in Udhamsingh, Nagpur, and Nainital, Utta-ranchal
5. Fruits and vegetables in and around Pune
6. Vegetables in some areas of Punjab
7. Potatoes in and around Agra, Uttar Pradesh
8. Mangoes in and around Lucknow, Uttar Pradesh
Within the realm of AEZs, Agri Export Oriented Units (AEOU) having integrated facilities for
procurement and processing would be set up. To ensure good-quality produce, AEZs have to
provide good-quality seeds, pesticides, and micronutrients to farmers.
Box 27.4 Vishesh Krishi Upaj Yojana
The scheme called Vishesh Krishi Upaj Yojana (Special Agricultural Produce Scheme) has been
introduced by India to boost the exports of fruits, vegetables, flowers, minor forest produce, and
their value-added products.
The export of these products shall qualify for a duty-free credit entitlement that is equivalent to 5
per cent of the FOB value of exports.
This entitlement is freely transferrable and can be used for the import of a variety of inputs and
goods.

The special-focus initiative for handlooms and handicraft sectors include the extension of facilities
like enhancing to 5 per cent of FOB value of exports; duty-free import of trimmings and
embellishments for handlooms and handicrafts; exemption of samples for CVD; authorising the
Handicraft Export Promotion Council (HEPC) to import trimmings, embellishments, and samples for
small manufactures; and establishment of a new Handicraft Special Economic Zone.
The major policy announcements under gems and jewellery sector encompass: the permission for
a duty-free import of consumables for metals other than gold and platinum up to 2 per cent of FOB
value of exports; duty-free re-import entitlement for rejected jewellery allowed up to 2 per cent of
FOB value of exports; an increase in the duty-free import of commercial samples of jewellery up to
Rs 1 lakh; and permission to import gold of 18 carat and above under the Replenishment Licence
Scheme.
The specific-policy initiatives in leather and footwear sector are mainly in the form of reduction in
the incidence of customs duties on the inputs and plants and machinery. The major policy
announcements for this sector include an increase in the limit for duty-free entitlements of import
trimmings, embellishments, and footwear components for leather industry to 3 per cent of FOB value
of exports, and that for duty-free import of specified items for leather sector to 5 per cent of FOB
value of exports; of machinery and equipment for effluent treatment plants for the leather industry
that is exempted from customs duty; and re-export of unsuitable imported materials (such as raw
hides and skin and wet blue leathers) has been permitted. The threshold limit of designated “Towns of
Export Excellence” has also been reduced from Rs 1,000 crore to Rs 250 crore in the above thrust
sector.
New Export Promotion Schemes

A new scheme to accelerate the growth of exports called “Target Plus” has been introduced. Under the
scheme, the exporters who are achieving a quantum growth in exports are entitled to duty-free credit,
which is based on the incremental exports substantially higher than the general, actual export target
fixed. The rewards are granted based on a tiered approach. For an incremental growth of over 20 per
cent, 25 per cent, and 100 per cent, the duty-free credits are 5 per cent, 10 per cent, and 15 per cent of
FOB value of incremental exports. Another new scheme called Vishesh Krishi Upaj Yojana has been
introduced to boost exports of fruits, vegetables, flowers, and minor forest produce and their value-
added products. The exports of these products qualify for a dutyfree credit entitlement that is
equivalent to 5 per cent of the FOB value of exports. The entitlement is freely transferrable and can be
used for the import of a variety of inputs and goods.

The new export scheme to accelerate the growth of exports called “Target Plus” has been introduced.
To accelerate the growth in the export of services so as to create a powerful and unique “Served
from India” brand, which is instantly recognised and respected the world over, the earlier Duty-Free
Export Credit (DFEC) Scheme for services has been revamped and re-cast into the “Served from
India” Scheme. The individual service providers who earn a foreign exchange of at least Rs 5 lakh,
and other service providers who earn a foreign exchange of at least Rs 10 lakh are eligible for a duty-
credit entitlement of 10 per cent of the total foreign exchange earned by them. In the case of stand-
alone restaurants the entitlement is 20 per cent, whereas in the case of hotels it is 5 per cent. Hotels
and restaurants can use their duty-credit entitlement for import of food items and alcoholic beverages.
To make India a global trading hub, a new scheme to establish Free Trade and Warehousing Zones
(FTWZs) has been introduced to create a trade-related infrastructure, to facilitate the import and
export of goods and services with freedom to carry out trade transactions in convertible currencies.
Besides permitting FDI up to 100 per cent in the development and establishment of these zones, each
zone would have a minimum outlay of Rs 100 crore and a 5-lakh-sqm built-up area. The units in the
FTWZs qualify for all other benefits as applicable for SEZ units.

To make India a global trading hub, a new scheme to establish FTWZs has been introduced.
Simplification/Rationalisation/Modifications of the Ongoing Schemes
The EPCG scheme has been further improved upon by providing an additional flexibility for
fulfilment of export obligations, facilitating and providing incentives for technological upgradation,
permitting transfer of capital goods to group companies and managed hotels, doing away with the
requirement of certificate from Central Excise (in the case of movable capital goods in the service
sector), and improving the viability of specified projects by calculating their export obligation, based
on the concessional duty permitted to them. The import of second-hand capital goods without any
restriction on age has been permitted, and the minimum depreciated value for plant and machinery to
be re-located into India has been reduced from Rs 50 crore to Rs 25 crore. The new policy has
allowed a transfer of the import entitlement under Duty Free Replenishment Certificate (DFRC)
Scheme in respect of fuel to the marketing agencies authorised by the Ministry of Petroleum and
Natural Gas, to facilitate sourcing of such imports by individual exporters. The DEPB will continue
until replaced by a new scheme to be drawn up in consultation with exporters. Additional benefits
have been provided to EOU, including exemption from service tax in proportion to their exported
goods and services, permission to retain 100 per cent of export earnings in Export Earners Foreign
Currency (EEFC) accounts, extension of income tax benefits on plant and machinery to DTA units
which convert to EOU/Electronic Hardware Technology Park (EHTP)/Software Technology Park
(STP)/Bio-technology Park (BTP) units, allowing an import of capital goods on self-certification
basis and permission to dispose of (for EOU in textiles and garment manufacture) leftover materials
and fabrics up to 2 per cent of CIF (cost, insurance, and freight) value, or quantity of import on
payment of duty on transaction value only. The minimum investment criteria have also been waived
for brass hardware and hand-made jewellery in EOUs. (This facility already exists for handicrafts,
agriculture, floriculture, aquaculture, animal husbandry, IT, and services.) The FTP proposes to set up
BTPs by granting all facilities of 100 per cent EOUs. FTP 2004 introduced a new rationalised scheme
of categorisation of status holders as star export houses, with benchmark for export performance
(during the current and previous three years) varying from Rs 15 crore (for one-star export house) to
Rs 5,000 crore (for five-star export house). The new scheme is likely to bestow status on a large
number of hitherto unrecognised small exporters. Such star export houses will be eligible for a
number of privileges including fast-track clearance procedures, exemption from furnishing of a bank
guarantee, eligibility for consideration under Target Plus Scheme, and so on.

The new policy has allowed a transfer of the import entitlement under DFRC Scheme in respect of fuel to the marketing
agencies authorised by the Ministry of Petroleum and Natural Gas.
Simplification of Rules and Procedures and Institutional Measures
The policy measures that were announced to further rationalise/simplify the rules and procedures
include an exemption for exporters with a minimum turnover of Rs 5 crore and a good track record
from furnishing a bank guarantee in any of the schemes, a service tax exemption for exports of all
goods and services, and an increase in the validity of all licences/entitlements that are issued under
various schemes uniformly for 24 months, a reduction in the number of returns and forms to be filed,
delegation of more power to zonal and regional offices, and time-bound introduction of electronic
data interface (EDI). The institutional measures proposed in FTP 2004 include revamping and
revitalising the BoT, setting up of an exclusive Services Export Promotion Council to map
opportunities for key services in key markets, and also setting up of Common Facility Centres for the
use of professional home-based service providers in State and district-level towns. Pragati Maidan in
Delhi has been transformed into a world-class complex, with state-of-the-art, environmentally
controlled, visitor-friendly exhibition areas and marts. FTP 2004 also proposed provisions to
deserving exporters, on the recommendation of the Export Promotion Councils, of financial
assistance for meeting the costs of legal expenses that were connected with trade-related matters.

The policy measures that were announced to further rationalise/simplify the rules and procedures include an exemption for
exporters with a minimum turnover of Rs 5 crore.
CASE
In yet another step to curb the inflationary pressure during the coming festival season, the
government has eased norms for a duty-free import of vanaspati from Nepal. The STC, which is the
sole agency authorised to import 1-lakh-tonne 1-lt annual quota at nil duty under the Indo-Nepal
Treaty of Trade, has now been allowed to rope in “Associates” to undertake it. This is against the
present arrangement wherein the STC is required to make the imports on its own and not through
third parties.
However, in a public notice issued on October 4 amending an earlier order dated June 24, 2003, the
DGFT extended the facility of importing the annual quota to an “Associate”, appointed by the STC.
Simultaneously, it has granted a further three-month reprieve for utilisation of the 1-lt import quota
fixed for 2003–04. The normal annual-time period for fulfilling the quota entitlement extends from
March 6 of a calendar year to March 5 of the ensuing year.
The treaty also does not allow to carry forward the unutilised quota to the subsequent year. By this
logic, the 2003–04 quota would have ordinarily lapsed on March 5, 2004. But in mid-February, the
DGFT extended the Zero Duty Quota entitlement for 2003–04 by a three-month bill till June 5. On
June 23, this was extended for an additional three months ending September 5. Now the DGFT has
given another extension till December 5, with an additional 1-lt quota for 2004–05, being permitted
for import before March 5, 2005.
According to trade sources, despite the repeated extension given, only 60,000 tonnes out of 1-lt
quota fixed for 2003–04 have so far entered the country. The reason for non-fulfillment of the quota
is STC’s apparent inability to undertake the imports on its own. The move to allow STC to appoint
associate agencies for carrying out imports is expected to facilitate utilisation of the remaining
40,000-tonne quota for the year 2003–04 by the specified deadline of December 5, besides allowing
an additional 1 lakh tonne, to be imported between December 6, 2004 and March 5, 2005 in fulfilment
of the 2004–05 quota.
The domestic vanaspati industry is, however, upset with the latest move having only some time
back secured an order from a Calcutta High Court Bench, restraining the STC from importing
through third parties.
The bench had even directed the STC to pay the regular MFN (Most Favourable Nation) duty of 20
per cent on such imports which, it held, cannot be eligible for duty exemption under the treaty. The
industry’s grouse against allowing the third-party imports was that the entire vanaspati coming in
through this was being “dumped” in the main northern consuming market and that the STC was not
taking any step to ensure a uniform distribution across the country.
But according to DGFT, the associate agencies appointed would import the specific quantity subject
to the overall responsibility of STC, who will ensure its distribution and monitoring as per the
government policy. The import of 1 lakh tonne of vanaspati at the current wholesale prices in Delhi
translates into a business of about Rs 500 crore.
Case Question
Do you support the decision of DGFT?
SUMMARY
The import policy of India was formulated as a part of FTP of the country. During the post-
independence period, the import policy of the country was formulated at different times in order to
limit the volume of the import-preserve foreign exchange, encouraging the imports of items that are
required for industrialisation of the country and modifying the same imports for a better export
promotion.
During the first decade of planning, the country adopted a liberal import policy and, thus, had
suffered a serious foreign exchange crisis at the end of the Second Plan. Considering the situation, the
government reversed its import policy and imposed heavy restriction on imports. In 1962, the
Mudaliar Committee recommended the import of raw materials and other components for various
industries in power, transport, EOUs, import-substituting industries that are producing raw materials
and components, and so on.
In 1966, after the devaluation of the rupee, the import policy was liberalised for 59 priority industries
which included export industries, capital-building industries, and industries that are producing
commodities for a mass consumption. Moreover, after the introduction of a raw agricultural strategy
in 1966, the government permitted the import of agricultural inputs such as seeds, fertilizers,
pesticides, and so on.
In 1977–78, the government introduced an import liberalisation policy, which was carried further
during the 1980s. This was done in order to provide imported inputs to the industrial sector, stimulate
investments, support indigenous research and development programmes, expand export capacities,
earn international competitiveness, and promote import substitutions and self-reliance.
The government announced an Exim Policy, first in 1985, and then in 1988, for a three-year period.
The Exim Policy was revised in 1990. All these polices contained the necessary provisions for import
of capital goods and raw materials for industrialisation, utilisation, and liberalisation of Registered
Export Policy licences, liberal import of technology, and policy for export and trading houses.
In July–August 1991, the Narasimha Rao government announced certain major reforms in the Exim
Policy of 1990, after a necessary review. All these reforms strengthened the export incentives,
eliminated a considerable volume of import licensing, and optimised the import compression.
A new Five-year Exim Policy was announced by the government on March 31, 1992, to establish the
framework for globalisation of India’s foreign trade, to promote the productivity, modernisation, and
competitiveness of Indian industry, and thereby enhance the country’s export capabilities.
The Five-year Exim Policy announced by the government on March 31, 1997, became effective from
April 1, 1997. It was considered an export-friendly policy and expected to boost India’s foreign trade
to the tune of US$100 bn.
The new policies have significantly simplified and streamlined the policies and procedures to
facilitate export promotion and to achieve an accelerated export growth in the emerging scenario of
world trade, which calls for improving our competitiveness in the global markets.
KEY WORDS
Export Processing Zones (EPZ)

Exim Scrip
Open General Licence (OGL)
Antidumping Duties
Diamond Dollar Account Scheme (DDAS)
Export Houses
Trading Houses
Canalisation
Imports
Exports
EPCG
Importer-Exporter Code (IEC)
Negative List of Import/Export
Domestic Tariff Area (DTA)
Custom Duty
Target Plus
POL (petroleum, oil, and lubricants) Imports
QUESTIONS
1. Explain the foreign trade policy that is followed by India since independence.
2. Discuss the export policy of India. Explain the export promotion measures adopted in this context.
3. Analyse the import policy of India. Explain the import substitution measures adopted in this context.
4. Discuss the Exim Policy of India for 1992–97.
5. Critically examine the 1991 trade policy reforms of India with regard to imports and exports.
6. What are the objectives of the Exim Policy, 1997–02. Discuss the sailient features and measures adopted in the policy.
7. Discuss the import liberalisation measures adopted by the government in Exim Policy, 2001.
8. Discuss the important compositional changes in India’s exports.
9. Discuss the important measures adopted in the Exim Policy, 2002–07.
10. Analyse the impact of liberalisation measures that are adopted by the government since 1991 on imports and exports.
REFERENCES
Frances, C. (2005). International Trade and Export Management, 14th ed. Mumbai: Himalaya Publishing House.
Frances, C. (2005). World Trade and Payments: An Introduction. New Delhi: Pearson Education.
Garge, P. (2002). Export of India’s Major Products: Problems and Prospects. New Delhi: New Century Pub.
http:parliamentofindia.nic.in/ls/lsdeb/ls10/ses1/0813089102.htm.
Khurana, P. K. (2002). Export Management, 3rd ed. New Delhi: Galotia Pub.
Kumar, N. and R. Mittal (2002). Export Management. New Delhi: Anmol Pub.
Mithani, D. H. (2004). Money Banking International Trade and Public Finance, 15th ed. Mumbai: Himalaya Publishing House.
CHAPTER 28
Special Economic Zones in India
CHAPTER OUTLINE
Concept and Meaning of SEZ
The History of SEZ
Definition of SEZ
SEZs in India
Benefits from SEZs
Important SEZs in India
Features and Facilities of SEZs in India
SEZ and Export Promotion
SEZ Policy of India: SEZ Act and SEZ Rule
Salient Features/Provisions of SEZ Rules
SEZ Controversy
SEZs—a global Overview
Conclusion
Case
Key Words
Questions
References
CONCEPT AND MEANING OF SEZ
India was one of the first in Asia to recognise the effectiveness of the Export Processing Zone (EPZ)
model in promoting exports, with Asia’s first EPZ set up in Kandla in 1965. With a view to overcome
the shortcomings experienced on account of the multiplicity of controls and clearances, absence of
world-class infrastructure, and an unstable fiscal regime, and also with a view to attract larger
foreign investments in India, the Special Economic Zones (SEZs) Policy was announced in April
2000.
This policy intended to make SEZs an engine for economic growth, supported by quality
infrastructure and complemented by an attractive fiscal package, both at the Centre and at the State
level, with the minimum possible regulations. SEZs in India functioned from November 1, 2000 to
February 9, 2006 under the provisions of the Foreign Trade Policy (FTP), and fiscal incentives were
made effective through the provisions of relevant statutes. SEZ means an area of land that has been
demarcated and is treated as a foreign territory for various purposes such as tariffs, trade, and duties.
SEZs in India enjoy exemptions from income tax, service tax, sales tax, and customs duties. But SEZ
in India is in controversy because of revenue losses due to tax exemption and land acquisition.

This policy intended to make SEZs an engine for economic growth, supported by quality infrastructure and complemented
by an attractive fiscal package, both at the Centre and at the State level, with the minimum possible regulations.
THE HISTORY OF SEZ
The world’s first-known instance of SEZ had been found in an industrial park that was set up in
Puerto Rico in 1947. In the 1960s, Ireland and Taiwan followed suit but in the 1980s, China made the
SEZs gain global currency with its largest SEZ being the metropolis of Shenzhen. From 1965
onwards, India experimented with the concept of such units in the form of EPZs. But a revolution
came in 2000, when Murasoli Maran, the then Commerce Minister, made a tour to the southern
provinces of China. After returning from the visit, he incorporated the SEZs into the Exim Policy of
India. About five years later, SEZ Act (2005) was also introduced and in 2006, SEZ Rules were
formulated.

From 1965 onwards, India experimented with the concept of such units in the form of EPZs.
The history of SEZs in India suggests that the seeds of the basic concept of SEZ were sown in the
mid-1960s. Further, the history also suggests that the basic model of the present-day Indian SEZ was
structured with the establishment of the first EPZ at Kandla in the year 1965. Several other EPZs were
set up at various parts of India in the subsequent years. Lack of good economic policy and inefficient
management of the Government of India soon became the detrimental factors for the success of these
EPZs. Thus, the performance of these EPZs of India fell short of expectations.
The modern-day SEZ came into existence as the economic reforms incorporated in the early 1990s
did not result in the overall growth of the Indian economy. The SEZ Policy of India was devised to act
as a catalyst to promote the economic growth attained in the early 1990. The economic reforms
incorporated during the 1990s did not produce the desired results. The Indian manufacturing sector
witnessed a sudden dip in the overall growth of the industry, during the second-half of 1990s. The
history of SEZs in India suggests that red tape, lengthy administrative procedures, rigid labour laws,
and poor physical infrastructural facilities were the main cause of deterioration of Foreign Direct
Investments’ (FDI) inflow into India. Further, the Indian markets were not mature enough to facilitate
an easy entry for the Foreign Institutional Investors (FIIs) into the Indian economic system.
Furthermore, the legal framework of Indian economy was not that strong enough to prevent any
misuse of Indian markets by the FIIs. Thus, the lack of FII-friendly environment in India prevented the
growth of Indian industry, in spite of the implementation of liberal economic policy by the Central
government. This resulted in the formation of a much larger and more efficient form of the model of
their predecessors with a world-class infrastructural facility.

The modern-day SEZ came into existence as the economic reforms incorporated in the early 1990s did not result in the
overall growth of the Indian economy.
The history of SEZs in India suggests that the present-day SEZ policies of India are well
complimented by the provisions of the Acts and the Rules of SEZ. A number of meetings were held
across India for the formulation of “The Special Economic Zones Act, 2005”, which was
subsequently passed by the Parliament in May 2005. The SEZ Act, 2005 and the SEZ Rules became
effective on and from February 10, 2006. The SEZ Act, 2005 defines the key role for the state
governments in export promotion and creation of infrastructural facilities. A single-window SEZ-
approval mechanism has been facilitated through a 19-member, inter-ministerial SEZ Board of
Approval or BOA. And the decision of the SEZ BOA is binding and final.

The SEZ Act, 2005 and the SEZ Rules became effective on and from February 10, 2006.
DEFINITION OF SEZ
A Special Economic Zone, in short SEZ is a geographically bound zone where the economic laws in
matters related to export and import are more broadminded and liberal when compared to the rest of
the country. SEZs are projected as duty-free areas for the purpose of trade, operations, duty, and
tariffs. SEZ units are self-contained and integrated having their own infrastructure and support
services.
SEZ means an area that has been specified as an enclave that is duty free and is treated as a foreign
territory for various purposes such as tariffs, trade operations, and duties. A SEZ is a geographical
region that has economic laws that are more liberal than a country’s typical economic laws. The
category “SEZ” covers a broad range of more specific zone types, including free trade zones (FTZ),
export processing zones (EPZ), free zones (FZ), industrial estates (IE), free ports, urban enterprise
zones (UEZs), and others.

SEZ means an area that has been specified as an enclave that is duty free and is treated as a foreign territory for various
purposes such as tariffs, trade operations, and duties.
Within SEZs, a unit may be set up for the manufacture of goods and other activities including
processing, assembling, trading, repairing, reconditioning, making of gold/silver, platinum
jewellery, and so on. As per law, SEZ units are deemed to be outside the customs territory of India.
Goods and services coming into SEZs from the domestic tariff area (DTA) are treated as exports
from India, and goods and services rendered from the SEZ to the DTA are treated as imports into
India.
SEZS IN INDIA
SEZs help in the economic and industrial growth of the State and that is why, the Government of India
has made it easy to set up SEZs in India. In India, SEZs can be set up by the State government or its
various agencies, or any other public, private, or joint sector. Even foreign companies can set up
SEZs in India. The main objectives of setting up SEZs in India are as follows:
Generation of additional economic activity,
Promotion of exports of goods and services,
Promotion of investment from domestic and foreign sources,
Creation of employment,
Development of infrastructure facilities,
Simplified procedures for development, operation, and maintenance of SEZs, and also for setting up units and conducting
businesses,
Single-window clearance for setting up an SEZ and a unit in SEZ,
Single-window clearance on matters relating to Central as well as state governments, and
Easy and simplified compliance procedures and documentations with stress on self-certification.
The number of SEZs in India has increased at a very fast pace over the last few years. In India, SEZs
are being set up in many states of the country due to the efforts that are being undertaken by the Indian
government. Consequent upon the SEZ Rules coming into force with effect from February 10, 2006,
BOA has held nine meetings. At present, there are 234 valid formal approvals and 162 in-principle
approvals. Out of the 234 formal approvals, notifications have already been issued to 63 SEZs, till
April 2007.

The number of SEZs in India has increased at a very fast pace over the last few years. In India, SEZs are being set up in
many states of the country due to the efforts that are being undertaken by the Indian government.
The fact that these 234 formal approvals given for setting up SEZs and spread over 19 states/ UTs
(union territories), show that they are not concentrated in any one particular region but all over the
country. The total land area in the 234 formally approved SEZs is about 33,800 ha, out of which
17,800 ha approximately are for the 60 approvals given for the State Industrial Development
Corporation (SIDC).
If we look at the SEZ approvals sectorwise as shown in Figure 28.1, we find that almost 90 per cent
approves for IT and IT related SEZs. The number of SEZs in India has increased at a very fast pace
over the last few years. In India, SEZs are being set up in many states of the country due to the efforts
and facilities that are being undertaken by the Indian government. Box 28.1 details the features of SEZ
in India.

Fig ure 28.1 Sectorwise SEZ Approvals
Source: Official web site of the Ministry of Commerce and Industry, www.sezindia.nic.in

Box 28.1 SEZ in India—a Glance
a. generation of additional economic

activity
b. promotion of exports of goods and
services
Objectives of the SEZ scheme c. promotion of investment from domestic
and foreign sources
d. creation of employment opportunities
e. development of infrastructure facilities
Passed by Parliament in May 2005

Received Presidential Assent on June
SEZ Act, 2005 23, 2005
Came into effect on February 10, 2006,
supported by the SEZ Rules
No. of valid formal approvals 234

No. of notified SEZs 100
No. of formal approvals
134
pending notification
Land requirement Ground realities:
Total land in India: 2,973,190 sq.
km;
Total agricultural land in India:
1,620,388 sq. km (54.5%)
SEZs formally approved (234): 350
sq. km;
In-principle approvals (162): 1,400
sq km;
Total area for proposed SEZs
(FA+IP): 1,750 sq. km.
Total SEZ area would not be more
than 0.86% of agricultural land
234 formal approvals:
Approx.: 33,808 ha
Proposals from SIDCs/state-
government agencies: 60
Land requirement for the 60 proposals:
17,800 ha
No. of valid in-principle 162
approvals
Expected investment and
employment from SEZs (by By the 63 notified SEZs:
December 2009)
Employment: 1,575,452 additional
jobs
If 234 formal approvals
becomes operational
Employment: 4 million additional
jobs
Exports in 2006-07 Rs 34,787 crore
Source: Official web site of the Ministry of Commerce and Industry, www.sezindia.nic.in

BENEFITS FROM SEZS
The benefits derived from SEZs are evident from the investment, employment, exports, and
infrastructural developments that were additionally generated. The benefits are derived from the
multiplier effect of the investments and additional economic activity in the SEZs. The benefits
expected to be generated include:
An investment of the order of Rs 100,000 crore including FDI of US$5 bn-US$6 bn by the end of December 2007 and
500,000 direct jobs by December 2007.
In the year 2007, 1,016 units are in operation in the SEZs, providing a direct employment to over 1.79
lakh persons; about 40 per cent of whom are women. The private investment by entrepreneurs in the
SEZs established prior to the SEZ Act is of the order of over Rs 4,400 crore. In the 63 notified SEZs
which have come up after February 10, 2006, an investment of Rs 13,435 crore has already been made
in less than a year. These SEZs have so far provided a direct employment to 18,457 persons. With the
63 notified SEZs, it is expected that a total investment of over Rs 50,000 crore and 15 lakh additional
jobs will be created by December 2009. If the 234 formal approvals become operational, it is
expected that the total investment of Rs 300,000 crore and four million additional jobs will be created
by December 2009. The study estimates that the projected investment in SEZs over the next 10 years
could be $213 bn, if 75 per cent of the formally approved zones and 25 per cent of the in-principle-
approved SEZ land is developed and becomes operational. The zones are also projected to create 14
million direct and indirect jobs, leading to a 30-per cent rise in the current organised employment.
The exports from the SEZs during the 10-year period could touch $352 bn, nearly half of India’s total
annual exports; with IT and ITES, SEZs are contributing about 30 per cent at $105 bn.

In the year 2007, 1,016 units are in operation in the SEZs, providing a direct employment to over 1.79 lakh persons; about
40 per cent of whom are women.
The exports from the SEZs during the 10-year period could touch $352 bn, nearly half of India’s total annual exports; with
IT and ITES, SEZs are contributing about 30 per cent at $105 bn.
Table 28.1 shows the contribution of SEZ to exports of the country, with 52 per cent growth in the
year 2006-07. From Table 28.1 it is clear that the export from SEZ is continuously increasing. It was
Rs 8,552.3 crore in the year 2000-01 and showed a slight increment up to the year 2004-05. It rose up
to Rs 18,309 crore in the year 2004-05, almost double the amount when compared to the year 2000-
01. But after the enactment of SEZ Act, 2005 the export from SEZ shows a fast-increasing trend. It
rose to Rs 34,787.5 crore in 2006-07 and up to Rs 67,299.6 crore in 2007-08. Table 28.2 shows the
percentage share of SEZ export in the total export of the country continuously increasing except in
the year 2002-03. In 2000-01, the share of SEZ export in the total export of the country was 4.20 per
cent and it increased to 4.39 per cent in 2001-02. In the year 2002-03, the share of SEZ export went
down to 3.94 per cent but it showed a continuously increasing trend. Then it increased to 4.72 per cent
in the year 2003-04 and up again to approximately 5 per cent in the year 2005-06, and had reached the
height of 6 per cent in 2006-07. The SEZ scheme has generated a tremendous response among the
investors, both in India and abroad. This is evident from the fact that several prominent private sector
developers have come forward for establishing SEZs.

The SEZ scheme has generated a tremendous response among the investors, both in India and abroad.

Table 28.1 Exports from the Functioning SEZs During the Last Three Years
Year Export (Rs in crore) Fixed Base Index

2000–01 8,552.3 100
2001–02 9,189.6 107.45
2002–03 10,053.4 117.55
2003–04 13,853.6 161.99
2004–05 18,309 214.08
2005–06 22,839.5 267.06
2006–07 34,787.5 406.76
2007–08 67,299.6 786.92
Source: Official web site of Ministry of Commerce and Industry, www.sezindia.nic.in.

Table 28.2 Percentage Share of SEZ Export in the Total Export of the Country
Source: www.sezindia.nic.in and www.commerce.com.
Note: % share in export = India’s current year export/SEZ’s current year export * 100
IMPORTANT SEZS IN INDIA
Falta Food-processing Unit, West Bengal

Salt Lake Electronic City, West Bengal
Manikanchan Gems and Jewellery, West Bengal
Calcutta Leather Complex, West Bengal
Karnataka Biotechnology and Information Technology Services—SEZ on biotechnology sector in Bangalore’s Electronics City,
over an area of 43 acres
Shree Renuka Sugars Limited—SEZ on sugarcane-processing complex covering 100 ha, comprising a sugar plant, power station,
and distillery, at Burlatti in Belgaum district
Ittina Properties Pvt. Ltd. and three other firms—SEZs in IT sector, covering electronics, hardware, and software sectors in
Bangalore, over an area of 15.732 ha
Divyasree Infrastructure—SEZ in the IT/ITES sector over an area of 20.234 ha in Bellan-dur Amani Kane near Bangalore
Chaitanaya Infrastructure Pvt. Ltd.—SEZ in the IT/ITES sector in Bangalore over an area of 20.24 ha
Bagmane Developers Pvt. Ltd.—SEZ in the IT/ITES sector in Raman Nagar in Bangalore North over an area of 15.5 ha
Shipco Infrastructure Pvt. Ltd.—Free Trade Warehousing Zone (FTWZ) in Karnataka over an area of 120 ha
Hinduja Investments Pvt. Ltd.—SEZ in the textile and apparel sector at Doddamannu-gudde in Bangalore Rural district, over an
area of 100 ha
Wipro Infotech—SEZ on IT/ITES at Electronics City, Sarajpur, Bangalore
Hewlett-Packard India Software Operation Pvt. Ltd.—SEZ on IT
Food-processing and related SEZ services in Hassan, over an area of 157.91 ha
SEZs on pharmaceuticals, biotechnology, and chemical sectors in Hassan, covering 281.21 ha
SEEPZ—Andheri (East), Mumbai
Khopata—Multi-product, Mumbai
Navi Mumbai—Multi-product, Mumbai
FEATURES AND FACILITIES OF SEZS IN INDIA
The features and facilities provided by the Indian government in SEZs are of world-class standards
and have attracted many companies to set up their units in the Indian SEZs. Considering the need to
enhance foreign investment and promote exports from the country, the Government of India has
introduced various types of special incentives and benefits to SEZ units, according to the official web
site www.sezindia.nic.in, of the Government of India, are as follows:
Customs and Excise

SEZ units are free to import from the domestic sources without paying any duty on capital goods, raw materials, consumables,
spares, packing materials, office equipment, DG sets, and so on, for implementation of their project in the zone without any
license or specific approval. Goods which are imported duty free could be utilised over the approval period of five years.
Sales to DTA by SEZ units is always regarded as import and is subject to all normal import duties, including Countervailing
Duty (CD), Special Additional Duty (SAD), and so on.
SEZ units are free from the periodic examination by customs of export and import cargo.

SEZ units are free from the periodic examination by customs of export and import cargo.
SEZ units may sub-contract a part of their production through units in DTA/SEZ/EOU/ EPZ with the permission of the customs
authorities. Sub-contracting may also be permitted for processing abroad with the permission of the BOA.
Income Tax
Part 1—Income Tax Incentives for SEZ Units

The tax exemption for SEZ units that are engaged in manufacture or providing services— Section 10AA has been newly
introduced in the IT Act by SEZ Act, 2005, which provides that the units in SEZ that start manufacturing or producing
articles/things or which start providing services on or after April 1, 2005, will be eligible for a deduction of 100 per cent of
export profits for the first five years from the year in which such manufacture/provision of services commences and 50 per cent
of the export profits for the next five years. Further, for the next five years a deduction shall be allowed of up to 50 per cent of
the profit, as is debited to the profit and loss account, and credited to the Special Economic Zone Reinvestment Reserve Account
(subject to conditions).

The tax exemption for SEZ units that are engaged in manufacture or providing services.
The tax exemption for Offshore Banking Units (OBUs) in SEZ—a deduction in respect of certain incomes would be allowed
under the newly introduced Section 80LA, to scheduled banks or foreign banks having an OBU in SEZ or to a unit of IFSC
(International Financial Services Centre). The deduction shall be for 100 per cent of income for five consecutive years beginning
from the year in which permission/registration has been obtained under the Banking Regulation (BR) Act, the SEBI Act, or any
other relevant law; and 50 per cent of income for the next five years.

The tax exemption for Offshore Banking Units (OBUs) in SEZ.
The interest received by non-residents and non-resident ordinary (NRO) on deposits made with an OBU on or after April 1,
2005 shall be exempt from tax.
The exemption from capital gains—capital gains arising on transfer of assets (machinery, plant, building, land, or any rights in
buildings or land) on shifting of the industrial undertaking from an urban area to any SEZ would be exempt from capital gains
tax. The exemption would be allowable if within a year before or three years after such transfer.

The exemption from capital gains.
A machinery or plant is purchased for the purposes of business of an industrial undertaking in SEZ by the assessee.
An assessee has acquired a land or building or has constructed a building for the purposes of business in SEZ.
The original assets are shifted and establishment of the industrial undertaking is transferred to SEZ; and other specified expenses
are incurred.
The amount of exemption for capital gains would be restricted to the costs and expenses incurred in relation to all or any of the
purposes mentioned above.
Part 2—Income Tax Incentives for SEZ Developer

Tax holiday for SEZ developers—Section 80-IAB has been introduced newly in the IT Act vide SEZ Act, 2005, whereby a
deduction of 100 per cent of profits derived from the business of developing SEZ (notified on or after April 1, 2005) would be
available to the developer of SEZ for any 10 consecutive years out of 15 years beginning from the year in which the SEZ has
been notified.

Tax holiday for SEZ developers.
Exemption under Section 10(23G) that was available to infrastructure capital fund or a cooperative bank on interest and long-
term capital gains investment had been extended to investment made by SEZ developers qualifying for tax holiday under
Section 80-IAB of the IT Act. However, this exemption has been withdrawn with effect from the assessment year 2007-08.

Exemption under Section 10(23G).
Exemption from Dividend Distribution Tax (DDT)—No DDT would be payable by a developer of SEZ on dividend declared,
distributed, or paid on or after April 1, 2005 out of current income.

Exemption from Dividend Distribution Tax (DDT).
Exemption from Minimum Alternate Tax (MAT)—Any income earned on or after April 1, 2005 by an SEZ developer would be
exempt from MAT under Section 115JB of the Act from DTA to SEZ.

Exemption from Minimum Alternate Tax (MAT).
Foreign Direct Investments (FDI)

About 100 per cent FDI is freely allowed in the manufacturing sector in SEZ units under automatic route—except arms and
ammunition; explosives; atomic substances; narcotics and hazardous chemicals; distillation and brewing of alcoholic drinks; and
cigarettes, cigars, and manufactured tobacco substitutes.

About 100 per cent FDI is freely allowed in the manufacturing sector in SEZ units under automatic route
No cap of foreign investments for SSI-reserved items.
Offshore Banking Units (OBUs)

Setting up of OBUs allowed in SEZs.
OBUs are entitled for 100 per cent income tax exemption, for the first three years and 50 per cent, for the next two years.
Banking/External Commercial Borrowings (ECBs)

ECBs by units up to US$500 mn a year allowed without any maturity restrictions.
Freedom to bring in export proceeds without any time limit.
Flexibility to keep 100 per cent of export proceeds in EEFC (Exchange Earners’ Foreign Currency) account and freedom to
make an overseas payment from such account.
Exemption from interest-rate surcharge on import finance.
SEZ units allowed to write off unrealised export bills.
Exemption from interest-rate surcharge on import finance.
Service Tax
Exemption from service tax to SEZ units.

Exemption from service tax to SEZ units.
Sales to DTA
DTA sales can be undertaken subject to achievement of positive NFE (Net Foreign Exchange). NFE shall be calculated
cumulatively for a period of five years from the commencement of commercial production.
For the purpose of calculation, the value of imported capital goods shall be amortised as follows:
First-Second Year: 5 per cent each year.
Third-Fifth Year: 10 per cent each year.
Sixth-Eighth Year: 20 per cent each year.
Exemption from capital gains on transfer of an industrial unit from urban area to an SEZ.

Exemption from capital gains on transfer of an industrial unit from urban area to an SEZ.
Drawback or such other benefits as may be admissible from time to time on goods and services admitted from the DTA for
setting up, operation, and maintenance of units.
All exports from the DTA to the zone shall be exempt from the state and local-body taxes or levies; as in some states, the
exports made to educational institutions, hospitals, hotels, residential and/or commercial complexes, leisure and entertainment
facilities, or any other facilities as may be notified by the State government are not exempt.
Developers of SEZs may import or procure goods from DTA without payment of duty for development, operation, or
maintenance of SEZ.
Exemption from Central Sales Tax (CST) on the supply of goods from the DTA for development, operation, and maintenance of
SEZs.

Exemption from Central Sales Tax (CST).
Income tax exemption for a block of 10 years in the first 15 years of operation.

Income tax exemption for a block of 10 years in the first 15 years of operation.
Investment income in the form of dividends, interest, or long-term capital gains, of an infrastructure capital company from
investments made in an enterprise engaged in the development, operation, or maintenance of an SEZ are exempt from tax.
Foreign investment permitted.
Service tax exemption on services provided to a developer or to a unit located in the SEZ region.
Any activity or transaction in the zone, which is liable for entertainment duty under the Bombay Entertainments Duty Act, 1923
and luxury tax under the Maharashtra Tax on Luxuries Act, 1987, shall not be liable to such tax. The fiscal benefits shall be
applicable for a period of 25 years from the date of notification of the zone by the Government of India or such extended period
as may be decided by the State government.

The fiscal benefits shall be applicable for a period of 25 years from the date of notification of the zone by the
Government of India or such extended period as may be decided by the State government.
With respect to each SEZ all such transactions between the zones or within the zone or both, including the transactions of land
acquisition for development of the zone between the developer or codeveloper and land owners, and land transactions between
the developers or codevelopers and the units, carried out after declaration of the zone by the Government of India, shall be
exempt from the following state taxes, cess, and levies, viz.,
Purchase tax, sales tax, and turnover tax.
Specified sales (lease tax) in respect of lease of goods.
Stamp duty for the first transaction between the developer or codeveloper and the land owner, and the first transaction
between the developer or codeveloper and the units.
Registration fee for the first transaction between the developer or codeveloper and the land owner, and the first
transaction between the developer or codeveloper and the units.
Land-assessment tax.
Electricity duty and tax. (Only for sales to units in processing area.)
Water pollution cess.
Works contract tax.
State government shall
Provide exemption from electricity duty or taxes on sale of self-generated or purchased electric power for use in the
processing area of an SEZ.
Allow generation, transmission, and distribution of power within an SEZ subject to the provisions of the Electricity Act.
Exemptions in Matters Related to Environment

SEZs are permitted to have non-polluting industries in IT and facilities like golf courses, desalination plants, hotels, and non-
polluting service industries in the Coastal Regulation Zone (CRZ) area.
SEZ units are exempted from public hearing under Environment Impact Assessment Notification.

SEZ units are exempted from public hearing under Environment Impact Assessment Notification.
Company Act
Enhanced limit of INR (international normalised ratio) of 2.4 crore per annum is allowed for managerial remuneration.
Agreement to opening of Regional office of Registrar of Companies in SEZ.
Exemption from requirement of domicile in India for 12 months prior to appointment as Director.
Drugs and Cosmetics

Exemption from port restriction under Drugs and Cosmetics Rules.

Exemption from port restriction under Drugs and Cosmetics Rules.
Sub-contracting/contract Farming.
SEZ units may sub-contract part of production or production process through units in the DTA or through other EOU/SEZ units.
SEZ units may also sub-contract part of their production process abroad.
Labour Laws
Normal Labour Laws are applicable to SEZs, which are enforced by the respective state governments. However, state
governments have been requested to simplify the procedures/returns and for introduction of a single-window clearance
mechanism by delegating appropriate powers to Development Commissioners (DCs) of Sez.

Normal Labour Laws are applicable to SEZs.
SEZ AND EXPORT PROMOTION
The SEZ and export promotion facilitated the growth of the Indian SEZs, as per the web site of maps
of India.com, where the provisions of Indian Export Policy is detailed. The main factor for the
underperformance of these SEZs were poor export policy of India, which was loaded with huge taxes
and duties. The Government of India eased the export policy of India to facilitate easy growth of SEZ
and export promotion of Indian goods across international destinations. This created a congenial
environment for the development of a special kind of units within the designated SEZs. These
specialised export-oriented units (EOUs) were created to increase the overall export potential of these
SEZs. Further, these EOUs were devised in such a way that they can focus specifically on the growth
of Indian exports.

The Government of India eased the export policy of India to facilitate easy growth of SEZ and export promotion of Indian
goods across international destinations.
Further, their recipient also facilitates these units to sell their products in the domestic markets in
case of rejection by them, after a payment of designated tax and within the direct tariff area. Only
some exclusive commodities are barred from such selling process. Thereafter, the development of
SEZ and export promotion could be witnessed simultaneously. In other words, these EOUs shared a
reciprocal dependency with the SEZ of India. The provisions of Indian Export Policy, which
facilitated the growth of SEZ and Export Promotion of Indian goods, are as follows:
Exemption of duties on Indian capital goods, and inputs are offered as per the requirements of the approved business activity.
Taxes are either exempted or waived and even reimbursed in case they are paid in advance to the concerned authority.
Duty-free imports of spares, raw materials, capital goods, and consumables are offered as per the requirements of the approved
business activity.
Preferential treatment of these units to the Indian market for an easy dissemination of their products and/or services.

Preferential treatment of these units to the Indian market for an easy dissemination of their products and/or
services.
Rejected commodities (specifically barred commodities that cannot be sold) within an overall limit of 50 per cent may be sold in
the DTA on payment of respective duties as applicable after a proper notification to the Indian customs authorities. And such
sales of commodities in the DTA shall be counted against DTA sale entitlement, and the sale of such rejected commodities (up to
5 per cent of FOB (free on board) value of exports) shall not be subject to achievement of NFE.
All EOU/EHTP/STP/BTP (export-oriented unit/electronic hardware technology park/ software technology park/business
transaction protocol) units may sell their finished products or services (excluding pepper and pepper products and marble). The
units manufacturing electronic hardware and software, the NFE, and direct tariff area, the sale entitlement, shall be judged
separately for their hardware and software products.
Facilitated to retain 100 per cent in foreign currency in EEFC account of the said trader.
Tax waiver of dividends and profits for repatriates, without any application of repatriation tax.
Total tax exemption on corporate incomes as per the provisions of Section 10A and Section 10B of the Indian Income Tax Act.
Easy and automatic acceptance system for the use of existing trademarks, brand names, and technological know-how.
Facilitated with outsourcing of sub-contract capacities for export production against orders secured by other SME (small- and
medium enterprise) units.

Facilitated with outsourcing of sub-contract capacities for export production against orders secured by other SME
(small-and medium enterprise) units.
All SEZ units (excluding gems and jewellery units) may sell goods up to 50 per cent of FOB value of exports subject to
fulfilment of positive NFE on payment of concessional duties. Within the entitlement of DTA sale, the unit may sell in DTA its
products similar to the goods, which are exported or expected to be exported from the units.
Facilitated with outsourcing of sub-contract of production or part of production process to Indian or any foreign units.
The sale to direct tariff agreement is subject to a mandatory requirement of registration for pharmaceutical products, inclusive of
bulk drugs.
For software-services units, the sale in the DTA in any mode, including online data communication, shall be permitted up to 50
per cent of FOB value of exports and/or 50 per cent of foreign exchange earned through exports of such services, where the
payment of such services offered to their overseas clients, is received in foreign exchange.
SEZ units that are associated with manufacturing gems and jewellery may sell up to 10 per cent of FOB value of exports of the
preceding year in direct trade agreement and subject to fulfilment of positive NFE. Further, in the case of a sale of plain
jewellery, the recipient of such trade shall pay a concessional rate of duty as applicable. Furthermore, in the case of studded
jewellery, duty shall be payable as recommended and amended from time to time.
The total exemption of duties/taxes on scrap or waste or remnants, in case the said scrap or waste or remnants are destroyed as
per the approval of the customs authorities of India.
If the end-product is a by-product and is included in the LOP (Letter of Permission), then it may also be sold in the direct tariff
area, subject to achievement of positive NFE on payment of applicable duties within the provisions of such laws. The sale of
such by-products by units is not entitled to direct tariff area sales.
Facilitated with outsourcing of sub-contract capacities for export production against
SEZ POLICY OF INDIA: SEZ ACT AND SEZ RULE
SEZ Act, 2005 came into force with effect from February 10, 2006, with SEZ rules legally vetted and
approved for notification. It is an act to provide for the establishment, development, and management
of the SEZs for the promotion of exports and for matters connected therewith or incidental thereto.
The SEZ rules provide for a drastic simplification of procedures and for a single-window clearance
on matters relating to Central as well as state governments.

The SEZ rules provide for a drastic simplification of procedures and for a single-window clearance on matters relating to
Central as well as state governments.
An important feature of the Act is that it provides a comprehensive SEZ policy framework to
satisfy the requirements of all principal stakeholders in an SEZ—the developer and operator,
occupant enterprise, outzone supplier, and residents. Earlier, the policy relating to the EPZs/SEZs was
contained in the FTP while incentives and other facilities offered to the SEZ developer and units were
implemented through various notifications and circulars issued by the concerned
ministries/departments. This system did not give confidence to investors to commit substantial funds
for the development of infrastructure and for setting up units.

An important feature of the Act is that it provides a comprehensive SEZ policy framework to satisfy the requirements of all
principal stakeholders in an SEZ—the developer and operator, occupant enterprise, outzone supplier, and residents.
Another major feature of the Act is that it claims to provide expeditious and single-window
clearance mechanisms. The responsibility for promoting and ensuring orderly development of SEZs
is assigned to the BOA. It is to be constituted by the Central government. While the Central
government may suo motu set up a zone, proposals of the state governments and private developers
are to be screened and approved by the board. At the zonal level, approval committees are constituted
to approve/reject/modify proposals for setting up SEZ units.
In addition, the DC and his/her office is responsible for exercising an administrative control over a
zone. The Labour Commissioner ’s powers are also delegated to the DC. Finally, Clause 23 requires
that designated courts will be set up by the state governments to try all suits of civil nature and
notified offences that were committed in the SEZs. The affected parties may appeal to high courts
against the orders of the designated courts. The Act offers a highly attractive fiscal-incentive package.
The main objectives of the SEZ Act are as follows:
generation of additional economic activity,
promotion of exports of goods and services,
promotion of investment from domestic and foreign sources,
creation of employment opportunities, and
development of infrastructure facilities.
SEZ Rules of 2006 are the rules which lay down the complete procedure that an individual is required
to follow if he/she intends to develop the SEZ or establish a unit in SEZ. The benefits of various taxes
available to a developer or a unit are also given in the SEZ rule.

SEZ Rules of 2006 are the rules which lay down the complete procedure that an individual is required to follow if he/she
intends to develop the SEZ or establish a unit in SEZ.
SALIENT FEATURES/PROVISIONS OF SEZ RULES
Different minimum land requirement for different classes of SEZs.

Every SEZ is divided into a processing area where the SEZ units alone would come up and a non-processing area where the
supporting infrastructure is to be created.
Simplified procedures for development, operation, and maintenance of the SEZs, and for setting up units and conducting business
in SEZs.
Single-window clearance for setting up of an SEZ.
Single-window clearance for setting up a unit in an SEZ.
Single-window clearance for matters relating to Central as well as state governments.
Simplified compliance procedures and documentation with an emphasis on self-certification.
The Act is expected to trigger a large flow of foreign and domestic investment in SEZs, in both
infrastructure and productive capacity, leading to a generation of additional economic activity and a
creation of employment opportunities.

The Act is expected to trigger a large flow of foreign and domestic investment in SEZs, in both infrastructure and productive
capacity, leading to a generation of additional economic activity and a creation of employment opportunities.
SEZ CONTROVERSY
In spite of the strong objectives of the Indian Government, the SEZ Policy is in the following
controversies:
Generation of a little new activity as there may be relocation of industries to take advantage of tax concessions,
Revenue loss,
Large-scale land acquisition by the developers may lead to displacement of farmers with a meagre compensation,
Acquisition of prime agricultural land, having serious implications for food security,
Misuse of land by the developers for real estate, and
Uneven growth aggravating regional inequalities.
A major controversy surrounding the implementation of the SEZ scheme has been the ruthless
manner that was adapted for acquiring land. News reports highlighted protests across the country
against acquisition of lands for the purpose of establishing SEZs. The “SEZ No More” campaign
gained momentum after the bloody chapter in Nandigram. Regarding displacement and loss of
livelihoods, the picture is even grimmer. The estimates show that close to 114,000 farming
households (each household on an average comprise five members) and an additional 82,000
farmworker families, who are dependent upon these farms for their livelihoods, will be displaced. In
other words, at least 10 lakh (one million) people, who primarily depend upon agriculture for their
survival, will face eviction. Experts calculate that the total loss of income to the farming and the farm-
worker families is at least Rs 212 crore a year. This does not include the income lost (e.g., of artisans)
due to the demise of local rural economies. So, if SEZs prove to be successful in the future and more
cultivated land is acquired, the country will be confronted with the problem of food security.

A major controversy surrounding the implementation of the SEZ scheme has been the ruthless manner that was adapted for
acquiring land.
Another issue related to SEZ is revenue losses due to tax exemption. The Comptroller and Auditor
General (CAG) of India’s report estimates the duty foregone at Rs 8,842 crore in the five-year period
from 2000-01 to 2005-06, while in 2006-07 alone, the revenue loss amounted to Rs 2,146 crore as per
the budget estimates. With more SEZs getting the government approval, the Finance Ministry has
upped the estimated revenue loss from tax concessions to such zones to over Rs 1 lakh crore for the
four-year period from 2006-07 to 2009-10.

Another issue related to SEZ is revenue losses due to tax exemption.
The revenue department has now estimated that the revenue loss for the above period could be as
high as Rs 102,621 crore. Of this, the loss on direct taxes account is estimated to be Rs 53,740 crore
and indirect tax concessions are expected to generate additional losses to the tune of Rs 48,881 crore.
Till date, about 128 SEZs have been notified and Rs 44,142 crore worth of investments have been
made. The total exports from the notified zones are to be about Rs 67,000 crore during 2007-08. Over
the next four years, the total investments in SEZs are expected to be about Rs 3.6 lakh crore. Table
28.3 clearly shows the losses due to SEZ in various periods and in various forms.

The revenue department has now estimated that the revenue loss for the above period could be as high as Rs 102,621 crore.
As far as the issue of employment goes, the total incremental employment generated in all SEZs
between the period February 2006 and December 31, 2007 is 146,128. This includes the earlier seven
EPZs converted to SEZs, 12 state/private SEZs notified prior to the SEZ Act, 2005, and the 195 SEZs
notified under the SEZ Act, 2005. The last category has been at the Centre of all controversies. A total
of 439 SEZs have been formally approved since the SEZ rules were notified in February 2006. Of
this, 195 have been notified. The incremental employment in the 195 SEZs approved under the SEZ
Act, 2005 is 61,015 persons. The Commerce Ministry has claimed this as an impressive employment
generation asserting that a total of six lakh jobs will be created by 2010.

As far as the issue of employment goes, the total incremental employment generated in all SEZs between the period
February 2006 and December 31, 2007 is 146,128.
However, a look at the figures for proposed and actual direct employment (as on December 31,
2007) in the 195 newly notified SEZs shows us that there is no real cause for optimism as far as
employment generation is concerned. As against a proposed direct employment of 2,215,667 persons,
an actual employment of 61,015 persons has occurred, which is only 2.75 per cent of that which was
already proposed. In the case of indirect employment, 100,415 persons have got employment as
against the proposed figure of 3,105,300 persons. Considering both direct and indirect employment,
the actual employment has been a mere 3.03 per cent of the proposed employment. The rate of
employment creation in SEZs have to pick up substantially to reach anywhere near the proposed
figures.

Table 28.3 Losses due to SEZ at Glance
Revenue loss 1 lakh crore (year 2006–10)

Proposed direct employment 2,215,667 persons (year 2006–07)
Actual direct investment 61,015 persons (year 2006–07)
Proposed indirect employment 3,105,300 persons (year 2006–07)
Actual direct employment 100,415 persons (year 2006–07)
No displacement (If all notified SEZs get approval and 114,000 farming households (each household on an average comprise
acquire land) five members) and an additional 82,000 farm-worker families
Total loss of income to the farming and the farm-worker
Rs 212 crore per year
families
Percentage share of SEZ export in the total export of the
5% (year 2005–06)
country
Source: Compiled from various government sources and research articles.

As developing SEZs involves a massive displacement of farmers, it is essential that a systematic
approach should be followed for ensuring balance of interests. Consequently, state governments have
been advised that in land acquisition for SEZs, the first priority should be for acquisition of waste and
barren land and if necessary, single-crop agricultural land. Thus, SEZ is in the controversy since
adapted by the Government.

As developing SEZs involves a massive displacement of farmers, it is essential that a systematic approach should be
followed for ensuring balance of interests.
SEZS—A GLOBAL OVERVIEW
According to the World Bank estimates, as of 2007, there are more than 3,000 projects taking place in
SEZs in 120 countries worldwide. SEZs have been implemented using a variety of institutional
structures across the world ranging from “fully public” (government operator, government
developer, government regulator) to “fully private” (private operator, private developer, private
regulator). In many cases, public sector operators and public sector developers act as quasi-gov-
ernment agencies in that they have a pseudocorporate institutional structure and have budgetary
autonomy. SEZs are often developed under a public-private partnership (PPP) arrangement, in which
the public sector provides some level of support (provision of off-site infrastructure, equity
investment, soft loans, bond issues, and so on) to enable a private sector developer to obtain a
reasonable rate of return on the project (typically, 10 per cent to 20 per cent depending on risk levels).

According to the World Bank estimates, as of 2007, there are more than 3,000 projects taking place in SEZs in 120
countries worldwide.
The SEZ concept proved a success in China and Poland. In China, over 20 per cent of FDI flows
into SEZ and generated about 10 per cent of exports. Poland’s SEZs received 35 per cent of FDI
flows. The success of SEZs in China stemmed from their FII-friendly nature. China provided the
whole package that ensures success of SEZs, which include unique location, large size, attractive
incentive packages, liberal customs procedures, flexible labour laws, strong domestic market, and
allowing local governments to administer the SEZs.
China has accumulated considerable experience with SEZs. The first zone was set up in 1980, as
soon as the nation decided on the economic reforms. India’s SEZ Policy was incorporated in the
EXIM Policy of 2001-02, a decade after the launch of economic reforms, and considerably lagging
behind China. China’s approach has been gradual; it has so far set up only five SEZs. But India simply
seemed to approve left and right, raising scepticism over the real intent behind setting up these zones.

China has accumulated considerable experience with SEZs. The first zone was set up in 1980, as soon as the nation
decided on the economic reforms. India’s SEZ Policy was incorporated in the EXIM Policy of 2001-02, a decade after the
launch of economic reforms, and considerably lagging behind China.
China established the SEZs at strategic locations, that is, close to ports or major industrial
locations. But in India, SEZs have been approved across the length and breadth of the country. In
China, all the five SEZs were developed by the Government. In India, only nine SEZs have been
developed by the government. None of the 234 SEZs that have formal approval is so for developed by
the Indian Government.
China’s SEZs are huge. Shenzhen, the most important SEZ, covers 32,000 ha. In India, there are just
two or three privately developed SEZs, exceeding 1,000 ha. Most of the others approved are less than
100 ha. China’s SEZs have attracted many Fortune 500 companies. Indian SEZs are still not able to
attract worldclass companies.

China’s SEZs have attracted many Fortune 500 companies. Indian SEZs are still not able to attract worldclass companies.
Indian must redesign the SEZ Policy to suit its needs and not borrow the Chinese model. In India,
52 per cent of the total land area is under agriculture and 57 per cent of the workforce relies on
farming. Domestic consumption is a major factor in India than in China. The household consumption
ratio to GDP (gross domestic product) is 68 per cent in India when compared to 38 per cent in China.
This is what the policy must leverage.
CONCLUSION
On the track of China’s growth because of SEZ, the Indian government has considered it as a dream
project to promote export, generate employment, and attract huge investment. SEZs continue to make
waves. Designed to promote manufacturing, enhance exports, and entice foreign capital, SEZs have
proved a great success in China—the pioneer of the concept—as also Poland and the Philippines. But
in India, they have stirred up a hornet’s nest. The policy has been on a roller coaster, especially post
Nandigram and Singur chapters, with fears raised by the people that the SEZ may well be a route to
grab land.
The key elements for the success of SEZs are political will, better infrastructure, zero bureaucratic
hassles, relaxed labour regulations, better fiscal incentives, and domestic and international linkages.
Do all these parameters hold good in India is the question. SEZs in India have flourished due to the
efforts that have been taken by the Government of India. And, therefore, in future too if the Indian
government makes such policies with regard to SEZs that the policies will increase the number of
SEZs, which in turn makes us assume that that may bring growth and prosperity for the country.

The key elements for the success of SEZs are political will, better infrastructure, zero bureaucratic hassles, relaxed labour
regulations, better fiscal incentives, and domestic and international linkages.
CASE
Nandigram Violence
The Nandigram violence was an incident in Nandigram, West Bengal, where, on the orders of the Left
Front government, more than 4,000 heavily armed police stormed the Nandigram area, with the aim
of stamping out protests against the West Bengal government’s plans to expropriate 10,000 acres, (40
sq. km.) of land, for a Special Economic Zone (SEZ) to be developed by the Indonesian-based Salim
Group. The police shot dead at least 14 villagers and wounded 70 more.
The SEZ controversy started when the government of West Bengal decided that the Salim Group of
Indonesia would set up a chemical hub under the SEZ policy at Nandigram, a rural area in the district
of Purba Medinipur. The villagers took over the administration of the area and all the roads to the
villages were cut off. The administration was directed to break the Bhumi Uchhed Pratirodh
Committee’s (BUPC) resistance at Nandigram.
This happened due to the approval given to the chemical hub of Salim group. The Salim Group was
founded by Sudono Salim, who was closely associated with the Indonesian ex-president Suharto.
The chemical hub would require the acquisition of over 14,000 acres (57 sq. km.) of land. The
special economic zone would be spread over 29 mouzas (villages) of which 27 are in Nandigram.
The most of the land to be acquired is multicrop and would affect over 40,000 people. Expectedly, the
prospect of losing land and, thereby, the livelihood raised concerns among the predominantly
agricultural populace. The villagers, who included the supporters of the party in power, CPI(M),
joined hands with the other opposition supporters, organized a resistance movement under the banner
of the newly formed and BUPC (literally, it is a Committee for the Resistance to Eviction from Land).
In defence of the project, the State government stated that it was won by competing with nine other
Indian states. Being in the vicinity of Haldia Petrochemicals and IOC (Indian Oil Corporation)
refinery, which, the CPI(M) claimed, had earlier led to 100,000 jobs that was being created through
the downstream projects, the party argued that this is the best place to build a hub, from the point of
view of a supply-chain integration.
The Salim Group sought around 35,000 acres (140 sq. km.) of land for a series of ambitious
projects. Apart from the SEZ (which is a 50:50 joint venture with the West Bengal Industrial
Development Corporation), it has been assigned the construction of the 100-km long, 100-m wide,
Eastern Link Expressway and the construction of a four-lane road bridge over the Haldia River, from
Haldia to Nandigram, has also been planned. The proposed bridge would provide a link between
Haldia and the proposed site for the chemical hub in Nandigram. The Barasat-Raichak expressway
and the Raichak-Kukrahati bridge will connect Haldia to National Highway 34.
The land acquisition notice was put up on January 3, 2007 by the Haldia Development Authority.
Although the chief minister later verbally dissociated himself from the notice, it was never annulled
by another government notification. According to the CPI(M) newspaper, People s Democracy, 18
November 2007, the chief minister of West Bengal had pointed out that the chemical hub was not to be
placed in Nandigram, but at a desolate sand-head at the mouth of the River Ganges called “Nayachar”.
The resulting mobilization against the proposed hub saw a violent takeover by the villagers, whoever
opposed the project due to fear of losing their owned land. Villagers dug up roads, cut off the
communication cables, and declared Nandigram as a “liberated zone” from the government’s
interference, due to the fear of land acquisition by the government.
The administration was directed to break the BUPC’s resistance at Nandigram, and a massive
operation with at least 3,000 policemen was launched on March 14, 2007. However, prior information
of the impending action had leaked out to the BUPC, who amassed a crowd of roughly 2,000 villagers
at the entry points to Nandigram, with women and children forming the front ranks. In the police
firing, at least 14 people were killed.
The scale of action left the state stunned. Trinamool Congress estimates put the toll at 50. The PWD
Minister of the Government of West Bengal, said about 50 bodies were taken to hospital. In response
to this, the people singled out as CPI(M) members and its supporters and their families were driven
out of the area and their houses were burnt. A week after the March 14 clashes, The Hindu estimated
that around 3,500 persons had been displaced into relief camps as a result of threats from BUPC.
The CPI(M) has accused the Jami Raksha Committee—a coalition of activists from various parties
who oppose land acquisition—of armed attacks on relief camps, which led to three deaths as well as a
series of murders and a gangrape.
Fresh violence erupted. A team of intellectuals and theatre personalities from Calcutta was attacked
by CPI(M) cadre on their return trip, after disbursing relief material that was collected from the
people in various parts of the state.
The deaths in Nandigram have led to a great deal of controversy on the Left in India. The federal
police said that they have recovered many bullets of a type which was not used by police generally,
but was used by the underworld terrorists.
The CPI(M) had adopted the public position that land acquisition will not be made without the
consent of the people of Nandigram. The proposed SEZ has ostensibly been shelved following the
March-14 police action. The local, district, and State administration have, however, maintained that
the chemical hub would be constructed at Nandigram itself.
After the bloodshed at Nandigram and the stiff resistance from opposition parties, such as
Trinamool Congress and Socialist Unity Centre of India (SUCI) and Left Front partners such as RSP
and All India Forward Bloc over the land acquisition, the chief minister on September 3, 2007
expressed the government’s preference for the sparsely populated island of Nayachar, 30 km from
Haldia, to set up the much talked-about chemical hub.
A fresh round of violence came up in November 2007, when the villagers who were thrown out of
Nandigram by the BUPC returned back home. The BUPC had effectively continued to maintain
Nandigram as a “liberated zone” even after the SEZ was cancelled. The return of the villagers was
marred by a violence that was unleashed by the ruling-party cadres over the resisting BUPC cadre in
Nandigram. Nationwide protests have resulted from the new offensive. On November 12, 2007, the
National Human Rights Commission has issued a notice to the West Bengal government directing it to
submit a factual report on the issue.
In May 2008, a fresh violence broke out in Nandigram between the supporters of the BUPC and the
CPI(M) activists. Both sides exchanged fire and hurled bombs at each other.
The first political consequence of the Nandigram issue is the ruling CPI(M) suffered a big jolt
when it lost the control of panchayat in the troubled Nandigram and Singur, in 2008 panchayat poll,
for the first time since 1978.
Case Questions
1. Do you support the land acquisition at Nandigram for SEZ?

2. Considering the above case, what are your views about the SEZ policy of India?
3. Suggest some measures to solve the problem of land acquisition for SEZ?
4. Find out the consequences of Nandigram issue on the political and economic environment of West Bengal.
KEY WORDS

Export Processing Zones (EPZs)
Income Tax Incentives
Tax Exemption
Export Promotion
SEZ Controversy
Land Acquisition
Special Economic Zone Act
Revenue Losses
QUESTIONS
1. Define SEZ and critically analyse the benefits of SEZ to Indian economy.
2. Highlight the history of SEZ and give the salient features/ provisions of the SEZ Rules in India.
3. Write a note on SEZ controversy in India and suggest some measures to handle it effectively.
4. Analyse the contribution of SEZ to the exports of India and explain the facilities given to SEZ for export promotion.
5. Describe the facilities and features of Indian SEZs.
6. Distinguish between Indian SEZ and Chinese SEZ.
7. Write down the objectives of SEZ and outline the status of SEZ in India.
8. Discuss the advantages and disadvantages of SEZ.
9. Suggest suitable measures to overcome the SEZ controversy.
10. Do you think SEZ will contribute to the growth of Indian economy? Comment.
a. SEZ and wealth creation
b. SEZ is nothing but a real estate development
c. SEZ and Nandigram land Acquisition
REFERENCES
“Change SEZ Act for level playing field, says CAG”, Financial Express, March 11, 2008, Online edition,
www.financialexpress.com
Choudhuri, A. (2008), “ARC’s Guidelines for SEZs”, March 25, 2008, www.realestatetv.in/researchdesk
Majumder, S. (2007), “India Needs a Unique SEZ Model”, Business Line, April 24, 2007, Online edition, www.thehindu
businessline.com
Ohri, S. (2008), “Special Economic Zones—Aping the Orient”, January 18, 2008, http://www.legalserviceindia.com/article.
Ranjan, R. K. (2006), “Special Economic Zones: Are They Good for the Country?” CCS Working Paper No. 156, Summer
Research Internship Program 2006, Centre for Civil Society, www.ccsindia.org
“Revenue Loss may Lead to Reversal of SEZ Policy: Study”, Financial Express, February 15, 2008, Online edition, www.
financialexpress.com
“SEZ in India”, May 22, 2008, http://www.sezindia.nic.in
Srivats, K. R. (2007), “Economic Activity in SEZs will Offset Likely Tax Loss” Business Line, July 9, 2007, Online edition,
www.thehindubusinessline.com
“Visible Gains and Employment Proposed and Made in SEZs Notified After SEZ Act, 2005”, (2007), www.sezindia.nic.in
CHAPTER 29
International Business Environment
CHAPTER OUTLINE
The Nature of International Business Environment
Trends in the World Trade and Economic Growth
General Agreement on Tariffs and Trade (GATT)
General Agreement on Trade in Services (GATS)
International Organisations
World Bank (WB)
An Evaluation of IMF-WB
International Finance Corporation (IFC)
Asian Development Bank (ADB)
United Nations Conference on Trade and Development (UNCTAD)
United Nations Industrial Development Organization (UNIDO)
International Trade Centre (ITC)
Generalized System of Preferences (GSP)
Global System of Trade Preferences (GSTP)
Case
Key Words
Questions
References
A competitive business environment is an essential characteristic of globalisation. Nature of

competition varies in different economic systems. In the context of the globalisation process,
tremendous changes are taking place in the business environment of economic systems. Corporate
concern for international business environment is understandable in relation with the globalisation of
business. We throw some light on the international business environment.
Business environment varies from place to place and from time to time. The Japanese business
environment is entirely different from Indian systems, values, cultural factors, socio-economic
background, and so on. On account of their higher productivity and marketing success, Japanese
systems and methods have been subjected to extensive analysis and appreciation. Collectivism,
lifetime employment, stability, total integration of workforce with the organisation, homogeneity, and
so on are the notable aspects of the organisational culture in Japanese corporations.

Business environment varies from place to place and from time to time. The Japanese business environment is entirely
different from Indian systems, values, cultural factors, socio-economic background, and so on.
In contrast to this, we find individualism, one-man decision making, frequent turnover of employee
mobility, alienation of the workforce, and collective coercion of the management by trade unions,
and so on in the business organisations of India. It means that environmental contrasts are most
decisive in the international business arena. The following differences may be most common between
the business environments in developed and developing or underdeveloped countries.
Business Environment in Developing or Underdeveloped

Business Environment in Developed Countries
Countries
1. Research and development (R&D) can be

considered the basic aspect of business environments
like the United States.
2. Corporate financing is well developed and less 1. R&D is marginal in developing countries like India or other
controlled by the government. backward Countries.
3. Multimedia advertisements with few restrictions are 2. Corporate financing is more in the control of the government and,
common. therefore, is less developed.
4. Skilled and committed human resources are 3. Limited media advertisements with greater government
available. restrictions.
5. Monetary standards, values, and transactions remain 4. Manpower which is more committed to their trade unions is
without much fluctuation and control. common.
6. Restrictions and interference of the government is 5. Money is subject to a lot of fluctuation and government control.
minimal. 6. Restrictions and interference of the government is high.
7. Transportation, communication, and infrastructural 7. Transportation, communication, and infra-structural facilities
facilities are excellent, modern, and adequate. require much improvement.
8. Development is uniform. 8. Major part of the economy is backward.
9. Minimum Centralised state control is ensured. 9. Centralised state control is always greater.
10. Greater political stability and less political influence 10. Political instability with high political influence in business.
on business. 11. Political changes affect business contracts.
11. Business contracts are binding even after political 12. Heterogeneous culture and many languages of states.
changes. 13. Labour-management relations are controlled and regulated by
12. Homogeneous culture and one language. the Government of India.
13. Management enjoys greater freedom in collective 14. Trade restrictions are common in spite of the liberalisation policy.
bargaining and effective methods of industrial
relations.
14. Trade barriers are nonexistent.

To sum up, one may observe that the business environment in developing countries like India,
differs substantially from that in the developed market economies. Companies which operate in the
global environment must consider such environmental differences before they formulate policies.
This is the reason managers who operate in a global environment must have a global approach with a
local strategy. Their operational strategies and business policies differ in different economic systems.

Companies which operate in a global environment must have a global approach with a local strategy.
THE NATURE OF INTERNATIONAL BUSINESS ENVIRONMENT
The 1990s and the new millennium clearly indicate rapid internationalisation and globalisation. The
entire globe is passing through a transition period at a dramatic pace. Today, international trade is in
a position to analyse and interpret the global social, technical, economic, political, and natural
environmental factors more clearly.

Today, international trade is in a position to analyse and interpret the global social, technical, economic, political, and
natural environmental factors more clearly.
Conducting and managing international business operations is a crucial venture due to variations in
political, social, cultural, and economic factors from one country to another. For example, most
African consumers prefer less-costly products due to their poor economic conditions, whereas the
German consumers prefer high-quality and high-priced products due to their higher ability to buy.
Therefore, an international businessman should produce and export less-costly products to most of
the African countries and vice versa to the most of the European and North American countries. For
instance, high-priced and high-quality Palmolive soaps are marketed to the European countries and
economically priced Palmolive soaps are exported and marketed to developing countries like
Ethiopia, Pakistan, Kenya, India, and Cambodia. Other factors for a favourable international business
environment are as follows:
International business houses need accurate information to make appropriate decisions. Europe was the most opportunistic market
for leather goods, particularly shoes. Based on the accurate data, The Bata shoe company could make an appropriate decision to
enter various European countries.

International business houses need accurate and timely information to make appropriate decisions.
International business houses need to have not only accurate but also timely information. Coca-Cola could enter the European
market based on timely information, whereas Pepsi entered later. Another example is the timely entrance of Indian software
companies into the US market when compared to those of other countries. Indian software companies also made a timely
decision in the case of Europe.
The size of international business should be large enough in order to have an impact on the foreign economies. Most
multinational companies (MNCs) are significantly large in size. In fact, the capital of some of the MNCs is more than India’s
annual budget and the GDPs (gross domestic products) of some African countries.

The size of international business should be large in order to have an impact on foreign economies.
Most international business houses segment their markets based on the geographical market segmentation. Daewoo, for instance,
segmented its markets as North America, Europe, Africa, Indian sub-continent, and the Pacific.
International markets present more potential than the domestic markets. This is due to the fact that international markets are wide
in scope; varied in consumer tastes, preferences, and purchasing abilities; and different in size of the population, and so on. For
example, IBM’s (International Business Machines Corporation) sales are more in foreign countries than in the United States
itself. Similarly, the sales of Coca-Cola, Procter and Gamble, and Satyam Computers are more in foreign countries rather than in
their own respective home countries.

International markets present more potential than the domestic markets.

TRENDS IN THE WORLD TRADE AND ECONOMIC GROWTH
The international trading system has, for long time, continued to suffer from gross inequalities and
imbalances among the different stratas of economies. The global economic environment,
characterised by intermittent recessions during the last two decades, has further widened the
disparities in the world trading system. Mounting debt burdens, balance of payment (BoP) problems
and deteriorating terms of trade of developing countries, formation of powerful, economic trade
blocs, rollback from multilaterism to bilaterism, growing protectionism, and restricted market access
in the developed countries are a few manifestations of the unjust international commercial order.
These negative features constitute a mammoth destabilising force, and their alarming dimensions
threaten the collapse of a multilateral economic cooperation.
Notwithstanding these constraints and limitations, a large number of developing counties have
started opening up their economies, exposing them to international competition, in their efforts to
integrate with the global economy. The developing countries, whose share in the international
business today is very low, are expected to play a greater role in the future. The GDP and the exports
of the developing countries are projected to grow much faster than that of the developed countries.
The developing countries, which number about 170 and have about 85 per cent of the world
population, account for only about 20 per cent of the world GDP and 22 per cent of the exports.

The developing countries, which number about 170 and have about 85 per cent of the world population, account for only
about 20 per cent of the world GDP and 22 per cent of the exports.
However, the projections are that in the next decade, the developing countries will increase their
share in the world income and trade. In fact, their GDP and exports have grown faster than those of
the developed countries for some time now. According to a World Bank (WB) Staff Report, during
1995–04 the real GDP of the world had grown at an annual rate of 3.3 per cent, which was composed
of an annual average growth rate of 2.8 per cent, for the high-income economies, and 4.9 per cent, for
the developing economies. During the year 2005–08, the high-income economies had grown more
than 2.8 per cent and developing economies more than 6 per cent.

During 1995–04 the real GDP of the world had grown at an annual rate of 3.3 per cent, which was composed of an annual
growth rate of 2.8 per cent for the high-income economies and 4.9 per cent for the developing economies.
This does not mean that all developing countries will grow at high rates. Although the estimated
average annual rate for the developing countries is nearly 5 per cent, East Asia and South Asia in the
developing world would grow at an annual rate of 7.7 per cent and 5.4 per cent, respectively, but the
performance of Sub-Saharan Africa, North Africa, the Middle East, and several countries of the
former Soviet Union may be very poor. According to the WB Report, 1995, the share of the
developing countries in the world output is estimated to increase from 21 per cent in 1994 to 27 per
cent in 2010. This share was about 22 per cent during the 1980s; it is estimated to rise to 38 per cent
during the years 1995–10.

The share of the developing countries in the world output which was 21 per cent in 1994 would increase to 27 per cent in
2010.
GENERAL AGREEMENT ON TARIFFS AND TRADE (GATT)
The General Agreement on Tariffs and Trade (GATT) had its origin in 1947 at a conference in
Geneva. It was founded in the wake of the Second World War in order to prevent the recurrence of
protectionist policies of the then industrialised states which resulted in a prolonged recession in the
West prior to the war. When GATT was signed in 1947, only 23 nations were members of it. By July
1995, the number of signatories had increased to 128 nations. It had further increased to 148 in 2005.

GATT when originated in 1947 was having only 23 nation members, whereas in 2005, was having about 148 countries as
its members.
GATT was transformed into the World Trade Organization (WTO) with effect from January 1995.
Thus, after nearly five decades, the original proposal of an international trade organisation took
shape as the WTO. The WTO, which is a more powerful body than GATT, has a larger role too than
GATT. India is one of the founder members of GATT and WTO. Box 29.1 details in a nutshell, the
history of GATT.

GATT which was founded in 1947 transformed into WTO with effect from January 1, 1995.
WTO is more powerful and has a larger role too than GATT.
India is one of the founder members of GATT and WTO.
Objectives
The primary objective of GATT was to expand the international trade by liberalising trade so as to
bring about an all-round economic prosperity. The preamble to the GATT mentioned the following as
its important objectives:
1. Raising the standard of living.
2. Ensuring full employment and a large and steadily growing volume of real income and effective demand.
3. Developing full use of the resources of the world.
4. Expansion of production and international trade.
GATT embodied certain conventions and general principles governing international trade among
countries that adhered to the agreement. The rules or conventions of GATT required that:
1. Any proposed change in the tariff or other type of commercial policy of a member country should not be undertaken without any
consultation with the other parties of the agreement.
2. The countries that adhere to GATT should work towards the reduction of tariffs and other barriers to international trade, which
should be negotiated within the framework of GATT.
Principles
For the realisation of its objectives, GATT adopted the following principles:
Non-discrimination. The principle of non-discrimination requires that no member country shall
discriminate between themselves in the conduct of international trade. To ensure nondiscrimination,
the members of GATT agreed to apply the principle of “most-favoured nation” (MFN) to all import
and export duties. This means that each nation shall be treated as the MFN. As far as quantitative
restrictions (QRs) are permitted, they too are to be administered without any favour.

Non-discrimination requires that no member country shall discriminate between themselves in the conduct of international
trade.
Box 29.1 History of GATT
The first proposal was made to form the International

Trade Organization (ITO) as a special agency of the
United Nations. The political climate that lingered
1946–47
after the protectionist trade policies of the 1920s and
1930s was not supportive. ITO was abandoned, but
part of its charter was later salvaged as GATT.
GATT was established, bringing together 23 nations
1948 as a try to liberalise the world trade by eliminating
tariffs.
Annecy Round: Tariffs on specific goods were
1949
reduced and some tariff concessions were exchanged.
1950–51 Torquay Round: Some tariffs were reduced and some
tariff concessions were exchanged.
The Dillion Round: It was initiated in response to a
proposal by some European nations to band together
1960–61 under a regional trade agreement: 20 per cent cut in
average tariffs and 35 per cent cut in the tariffs of
manufactured goods for the first time.
Tokyo Round: Agreements covered non-tariff
1973–79
barriers, subsidised exports, and tropical products.
Uruguay Round: It began with the goal of reducing
tariffs by one-third. By this time, GATT had 115
member nations which was 23 in 1947. The round
1986–93 covered agricultural products, included for first time,
as well as trade in services, TRIPS, TRIMs; and
removal of import barriers, tariff and non-tariff
barriers, and MFA was covered.
1994 GATT was renamed as WTO.

Prohibition of QRs. GATT rules seek to prohibit QRs as far as possible and limit restrictions on
trade to the less rigid tariffs. However, certain exceptions to this prohibition are granted to countries
that are confronted with BoP difficulties and to developing countries. Further, import restrictions
were allowed to apply for agricultural and fishery products if the domestic production of these
articles was subject to equally restrictive production or marketing controls.

GATT rules prohibit QRs and limit restrictions on trade to the less rigid tariffs.
Consultation. By providing a forum for continuing consultation, GATT sought to resolve

disagreements through consultation. Eight rounds of trade negotiations were held under the auspices
of GATT. Each round took several years. The Uruguay Round, took more than seven years to
conclude as against the originally contemplated four years. This shows the complexity of the issues
involved in the trade negotiations.

To resolve disagreements through consultation.
GENERAL AGREEMENT ON TRADE IN SERVICES (GATS)

The General Agreement on Trade in Services (GATS) is the first-ever set of multilateral, legally
enforceable rules which cover international trade in services. It was negotiated in the Uruguay Round.
It operates at three levels. First is the main text which contains the general principles and obligations.
Then there are annexures that are dealing with rules for specific sectors. Finally, the commitments to
provide access to the markets of individual countries form a part of the agreement.

The General Agreement on Trade in Services (GATS) is the first-ever set of multilateral, legally enforceable rules which
cover international trade in services.
Principles and Obligations
The general principles and obligations of GATS are very similar to those for trade in goods.
Examples include MFN treatment and national treatment, as well as transparency obligations and
commitments to the development of developing countries. Market-access commitments, like the tariff
schedules under GATT, are an integral part of the agreement.
Scope
The scope of the GATS agreement is particularly broad. It covers all measures affecting
internationally traded services. In fact, it was important in practical terms for negotiators to define
what was meant by the term “trade in services”. The definition which was finally adopted is
particularly wide in scope.

The scope of the GATS agreement is particularly broad. It covers all measures affecting internationally traded services.
Modes of Delivery
The negotiators decided that “trade in services” was far more than that crossed the border as is the
case in trading of goods. Under GATS, “trade” includes all the different ways of providing an
international service. GATS defines four such methods of providing an international service—it calls
them “modes of delivery”.

Under GATS, “trade” includes all the different ways of providing an international service.
Firstly, there are services supplied from one country to another, such as international telephone
calls. In the jargon of the agreement, this is known as the “cross-border supply” of a service.
Secondly, the situation of consumers or firms making use of a service in another country such as
tourism known as the “consumption abroad”. Thirdly, a foreign company may set up subsidiaries or
branches to provide services in another country, such as foreign banks operating in a foreign country.
This is known as the “commercial presence”. Finally, individuals travelling from their country to
supply services in another country, such as fashion models or consultants travelling abroad to work.
This is referred to as the “presence of natural persons”.
Services Sectors and GATS
The result of adopting this far-reaching definition of trade in services was that a vast area of
commercial activity is covered by GATS. We only have to think of the “modes of delivery” that exist
in the financial services sector which includes banking, security trading, and insurance of the
telecommunications services sector, or the professional services sector or tourism, just to mention a
few services sectors. Box 29.2 describes in detail the four modes of delivery.
Key Rules
MFN Treatment. As far as the rules are concerned, as with GATT, if you favour one, you favour
them all. The MFN treatment means treating trading partners equally. Under GATS, if a country
allows foreign competition in a sector, equal opportunities in that sector should be given to service
providers from all other WTO members. Unlike in goods, however, GATS has a special element. It
has lists showing where the countries are temporarily not applying the “MFN” principle of non-
discrimination.

MFN treatment means treating trading partners equally.
National Treatment. An equal treatment or national treatment for foreigners and nationals is
given a different dimension for services when compared to goods. For merchandise trade, it is a
general principle. In GATS, it applies only where a country has made a specific commitment to offer
national treatment, and in such cases, special conditions may be imposed.

National treatment. An, equal treatment or National Treatment for foreigners and nationals.
Box 29.2 GATS
The General Agreement on Trade in Services (GATS) was introduced in 1995 under WTO to
promote further liberalisation and globalisation of services. GATS defined services as occurring
through four possible modes of supply which are as follows:
Mode I
Cross-border supply, that is, supply of a service from one country to another country; such as, provision of diagnosis via
telecommunications.
Mode II
Consumption, that is, the supply of a service from one country to the service consumer of any other member country; such
as, through movement of patients.
Mode III
Commercial presence, that is, supply of services by a service supplier of one country through commercial presence in
another country; for example, establishment of or investment in hospitals.
Mode IV
Movement of natural persons, that is, temporary cross-border movement of service providers; for example, doctors,
chartered accountants, and legal and managerial functionaries.

Transparency. Under GATS, the governments must publish all relevant laws and regulations and
set up enquiry points within their bureaucracies. Foreign companies and governments can then use
these enquiry points to obtain information about regulations in the services sector. And they have to
notify the WTO of any changes in regulations that apply to the services that come under specific
commitments.

Transparency means the governments must set up enquiry points within their bureaucracies.
Regulations: Objective and Reasonable. Traded services do not face tariffs at the border. Unlike
goods, they do not pass through customs houses. In practice, domestic regulations are the most
significant means of exercising influence or control over the services trade. Thus, the agreement says
that the governments should regulate the services reasonably, objectively, and impartially. When a
government makes an administrative decision that affects a service, it should also provide an
impartial means, such as a tribunal, to review the decision.

Objective and reasonable regulation means the governments should regulate the services reasonably, objectively, and
impartially.
Better Access to Markets
Specific Commitments. The commitments of individual countries to open markets in specific sectors
and how open those markets will be are the outcome of negotiations. The commitments appear in
“schedules” that list the sectors being opened. The schedules record the extent of market access being
given in those sectors; for example, whether there are any restrictions on foreign ownership. The
schedules also show if there are any limitations on national treatment; for example, whether some
rights granted to local companies will not be granted to foreign companies.
Binding Market Access. These commitments are “bound”. Like bound tariffs, they can only be
modified or withdrawn after negotiations with the affected countries. This would probably lead to
compensation being paid. Since “unbinding” is difficult, the commitments are virtually guaranteed
conditions for foreign exporters and importers to do business in the sector.
Progressive Liberalisation
As far as liberalisation is concerned, the Uruguay Round was only the beginning. But, GATS requires
more negotiations; an essential part of the Doha Development Agenda (2001) is well under progress.
The goal is to take the liberalisation process further by increasing the level of commitments in
schedules.

But, GATS requires more negotiations; an essential part of the Doha Development Agenda (2001) is well under progress.
Intellectual Property: Protection and Enforcement of Rights
Importance of Ideas. Knowledge and ideas are increasingly an important part of trade. Most of the
value of new medicines and other high-technology products lies in the amount of invention,
innovation, research, design, and testing involved. Films, music recordings, books, computer
software, and on-line services are bought and sold because of the information and creativity they
contain. Their value does not lie in the plastic, metal, or paper used to make them.
Value is in the Idea. It is important that creators have the right to draw advantage from their
inventions, designs, and other creations. These rights are known as “intellectual property rights”.
They take a number of forms. For example, books, paintings, and films come under copyright
protection; inventions can be patented; and brand names and product logos can be registered as
“trademarks”.

It is important that creators have the right to draw advantage from their inventions, designs, and other creations.
Different Levels of Protection. In the past, the extent of protection and enforcement of these rights
varied widely around the world. As intellectual property became more important in trade, these
differences became a source of tension in the international economic relations. New internationally
agreed trade rules for intellectual property rights were seen as a way to introduce more order and
predictability, and for disputes to be settled more systematically.
Enter the TRIPS Agreement. The TRIPS Agreement was construed as an attempt to narrow the
gaps in the way these rights are protected around the world, and to bring them under common
international rules.
TRIPS—What Does it Cover?

The agreement covers five broad areas as follows:
1. How basic principles of the trading system and other international, intellectual property agreements should be applied,
2. How to give adequate protection to intellectual property rights,
3. How countries should enforce those rights,
4. How to settle disputes on intellectual property among members of the WTO, and
5. Special transitional arrangements during the period when the new system is being introduced.

Special transitional arrangements during the period when the new system is being introduced.
TRIPS Agreement covers five broad areas.
Need for Balance. In this process, it is important to recognise that there are various interests
involved. When an inventor or creator is granted patent or a copyright protection, he or she obtains
the right to stop other people from making an unauthorised use of the invention. The society at large
sees this temporary intellectual property protection as an incentive to encourage the development of
new technology and creations. These will eventually be available to all. The TRIPS Agreement
recognises the need to strike a balance. It says intellectual property protection should contribute to
technical innovation and transfer of technology. According to the agreement, producers and users
should benefit, and economic and social welfare should be enhanced.
Basic Principles. As in GATT and GATS, the starting point of the intellectual property agreement is
its basic principles. And as in the other two agreements, non-discrimination features prominently:
both national treatment as well as MFN treatment.
Protecting Intellectual Property. The TRIPS Agreement ensures that adequate standards of
protection exist in all member countries. Here, the starting point is the obligations found in the main
international agreements of the World Intellectual Property Organisation (WIPO). However, the
TRIPS Agreement adds a significant number of new or higher standards.

The TRIPS Agreement ensures that adequate standards of protection exist in all member countries.
Enforcement. Having intellectual property laws is not enough. They have to be enforced. According to the Agreement, the
governments have to ensure that the intellectual property rights can be enforced under their national laws, and that the penalties for
infringement are tough enough to deter further violations. The procedures must be fair and equitable, and not unnecessarily
complicated or costly.

Intellectual property laws should be enforced properly.
INTERNATIONAL ORGANISATIONS
There are several international organisations important to the global economy and business. The
influence of some of them—International Monetary Fund, WB, and WTO—is, indeed, very
important. We will discuss the following international economic organisations:
1. International Monetary Fund (IMF)
2. World Bank (WB)
3. World Trade Organization (WTO)
4. International Finance Corporation (IFC)
5. Asian Development Bank (ADB)
6. United Nations Conference on Trade and Development (UNCTAD)
7. United Nations Industrial Development Organisation (UNIDO)
8. International Trade Centre (ITC)
9. General System of Preferences (GSP)
10. General System of Trade Preferences among developing countries (GSTP)
INTERNATIONAL MONETARY FUND (IMF)
The International Monetary Fund (IMF) was established on December 27, 1945, with 29 member
countries. It began its financial operations on March 1, 1947. It is an organisation of countries that
seeks to promote international monetary cooperation, facilitate the expansion of trade, and thus
contribute towards an increased employment opportunities and improved economic conditions of the
member countries.
Membership in the IMF is open to every country that controls its foreign relations and is able and
prepared to fulfil the obligations of membership. Membership in IMF is a prerequisite for
membership of the WB, as a close-working relationship exists between the two organisations, as well
as among IMF, WTO, and the Bank for International Settlements (BIS).
The IMF had a membership of 182 countries as on September 1, 2000. Currently, the number is
107.
Objectives
The main objectives of IMF are as follows:

1. Promote international monetary cooperation.
2. Facilitate the expansion and balanced growth of international trade.
3. Promote exchange stability and maintain orderly exchange arrangements among members.
4. Assist in establishing a multilateral system of payments in respect of current transactions among member countries, and also
assist in eliminating foreign exchange restrictions that hamper the growth of world trade.
5. Make available to members the general resources on a temporary basis to enable them to correct BoP problems without
resorting to measures that would harm national or international prosperity.
6. Shorten the duration and lessen the degree of disequilibrium in the international BoP of members.

Promote international cooperation, facilitate the expansion and balanced growth of international trade, promote exchange
stability, assist in eliminating foreign exchange restrictions, make resources available to members, and maintain equilibrium
in the BoP of members.
Organisation
The IMF’s organisation consists of
1. Board of Governors,
2. Executive Board,
3. Managing Director,
4. Staff of International Civil Servants, and
5. Development Committee.
The IMF’s organisation consists of Board of Governors, Executive Board, Managing Director, Staff of International Civil
Servants, and Development Committee.
Board of Governors. The Board consists of one governor and one alternate for each member
country. The Board of Governors is the highest decision-making body of the IMF. The governor
appointed by the member country is usually the Minister of Finance or the Central Bank Governor.
The Board of Governors has delegated to the Executive Board all except certain reserved powers. It
normally meets once a year.
The Executive Board. The Board consists of 24 directors who are appointed or elected by the
member countries or a group of countries. The Board is responsible for conducting the businesses of
the IMF. The Managing Director serves as its Chairman. The Board deals with a wide variety of
policies, both in operational and administrative matters, including exchange-rate policies, provision
of IMF financial assistance to member countries, and discussion of issues in the global economy.
Managing Director. The Managing Director of IMF is selected by the Executive Board. He/ she
serves as the head of the organisation’s staff under the Board’s direction and is responsible for
conducting the ordinary businesses of the IMF. He/she serves a five-year term and may be re-elected
to successive terms.
Staff of International Civil Servants. The International Monetary and Financial Committee of the
Board of Governors is an advisory board consisting of 24 IMF governors, ministers, or other
officials of comparable rank. It normally meets twice a year, in April or May, and at the time of the
annual meeting of the Board of Governors, in September or October. Its responsibilities are to guide
the Executive Board and to advise and report to the Board of Governors on issues related to the
management of international monetary and financial system.
The Development Committee. With 24 members, of a comparable rank, of finance ministers or
other officials, the Development Committee generally meets at the same time as the International
Monetary and Financial Committee, and reports to the Board of Governors of the WB and the IMF on
development issues.
Borrowings, Financing Facilities, and Policies
The IMF provides financial assistance to its members to help them correct BoP problems in a manner
that promotes a sustained growth. The assistance is subject to a member ’s commitment to take steps to
address the causes of its payment imbalance. Financing is made available to member countries under
various policies or facilities whose terms address the nature and source of BoP problem that the
country is experiencing.
The maximum amount of financing a member can obtain from the IMF is based on its quota. Under
the regular IMF facilities, a member can generally borrow up to 300 per cent of its quota. Two of the
IMF’s reserve facilities, Contingent Supplemental Reserve Facility (CSRF) and the Contingent Credit
Lines (CCL), do not specify a limit. However, the Executive Board has indicated that the CCL access is
expected to be in the range of 300 per cent to 580 per cent of its quota.

A member can generally borrow up to 300 per cent of its quota.
CCL access is in the range of 300 per cent to 580 per cent of quota.
Regular Landing Facilities consists of a Stand-by Arrangement and Extended Fund Facilities (EFF).
The special Landing Facilities includes Supplement Reserve Facilities (SRF), CCL, and
Compensatory Financing Facilities (CFF). IMF also provides concessional financing facilities to
assist poor countries in their poverty reduction and growth facilities (PRGF) programmes. It supports
its member countries with emergency assistance through the Emergency Financing Mechanism
(EFM). It futher delivers technical assistance in areas, viz., macro-economic policy, monetary and
foreign exchange policy and systems, fiscal policy and management, external debt, and macro-
economic statistics. It began to extend its technical assistance to its members in 1964 in response to
requests for help from newly independent African and Asian countries, to help in establishing their
Central banks and ministries of finance.

Financing Facilities and Policy Landing facilities consist of EFF, SRF and CFF.
Emergency assistance through EFM and technical assistance too given. The resources are from member subscriptions and
borrowings.
Resources
The resources of the IMF come from two sources—(i) subscription by members and (ii) borrowings.
Quotas and Subscriptions. The IMF’s system of quotas is one of its central features. Each member
is assigned a quota expressed in Special Drawing Rights (SDRs). Quotas are used to determine the
voting power of members, their contribution to the Fund’s resources, their access to these resources,
and their share in allocations of SDRs. A member ’s quota reflects its economic size in relation to the
total membership of the Fund. Each member subscribes to the Fund an amount equivalent to its quota,
and the Board of Governors decides on the proportion to be paid in SDRs or in the member ’s
currency. A member is generally required to pay about 25 per cent of its quota in SDRs or in
currencies of other members that are selected by the IMF; it pays the remainder in its own currency.
The quotas of all Fund members are reviewed at intervals of not more than five years. Several
general increases have been agreed in the past to bring fund quotas in line with the growth of the
world economy and the need for additional international liquidity, while special increases from time
to time have been agreed to adjust for differing rates of growth among members and for changes in
their relative economic positions.

The quotas of all Fund members are reviewed at intervals of not more than five years.
As a result of the members’ payments of subscriptions, the IMF holds substantial resources in
members’ currencies and SDRs, which are available to meet member countries’ temporary BoP
needs. Each IMF member has 250 basic votes plus 1 additional vote for each SDR 100,000 of quota.
Thus, the quota defines a member ’s voting power in IMF decisions. As the quota is based on the
criterion of economic size, the developed countries account for a substantially larger share of the
total voting rights, enabling them to significantly influence the decisions.

Each IMF member has 250 basic votes plus 1 additional vote for each SDR 100,000 of quota. .
Borrowings. The quota subscriptions of the member countries are the primary source of the
financial resources for the IMF. The IMF, however, is authorised under its Articles of Agreement to
supplement its ordinary resources by borrowing. The Fund may seek the amount it needs in any
currency and from any source, that is, from official entities as well as from private sources. Two
sources of supplementary financing now exist: the General Arrangements to Borrow (GAB), created
in 1962 and the New Arrangements to Borrow (NAB), created in 1998.
Under the GAB, the IMF is able, under certain circumstances, to borrow specific amounts of
currencies from 11 industrial countries or their Central banks at market-related interest rates. The
NAB, approved in January 1997, seeks to augment substantially the funds that are available under
GAB. Following the Mexican financial crisis in December 1994, it became clear that more resources
might be needed substantially to respond to future financial crises. This led to the initiatives for the
NAB. These are credit arrangements between the IMF and 25 members and institutions that are
prepared to provide the IMF with supplementary resources. Participants in the NAB commit amounts
based primarily on their relative economic strength, as measured by their IMF quotas. Although the
NAB do not replace the existing arrangements (the GAB remain in force), they are the IMF’s first and
principal recourse for supplementary resources.

Participants in the NAB commit amounts based primarily on their relative economic strength, as measured by their IMF
quotas.
Financing Facilities and Policies
The IMF provides financial assistance to members to help them correct the BoP problems in a manner
that would promote a sustained growth. Assistance is subject, in most cases, to the member ’s
commitment to take steps to address the causes of its payment imbalance. Financing is made available
to member countries under various policies, or facilities, whose terms address the nature and source
of the BoP problem that the country is experiencing.
The maximum amount of financing a member can obtain from the IMF is based on its quota. Under
regular IMF facilities, a member can generally borrow up to 300 per cent of its quota. Two of the
IMF’s special facilities—the SRF and the CCL—do not specify a limit; however, the Executive Board
has indicated that CCL access is expected to be in the range of 300 per cent to 500 per cent of quota.
Regular Lending Facilities
The principal way in which the IMF makes its resources available to its members is by selling to them
the currencies of other members or SDRs in exchange for their own currencies. For example, if India
needs US dollars to meet its BoP obligations, it may purchase the dollars from the IMF by exchanging
rupees. Such transactions change the composition, but not the overall size of the Fund’s resources. A
member to which the Fund sells currencies or SDRs, is said to make “purchases” (also referred to as
“drawings”) from the Fund. The IMF levies charges on these drawings and requires that, within a
specified time, members “repurchase” (or buy back) their own currency from the IMF with other
members’ currencies or SDRs.

Regular lending facilities consists of selling to the members the currencies of other members of SDRs in exchange for the
own currencies.
The IMF credit is subject to different conditions depending on the relative size of the financing
provided. For drawings up to 25 per cent of a member ’s quota (called the “first credit tranche”), the
members must demonstrate that they are making reasonable efforts to overcome their BoP
difficulties. Drawings above 25 per cent of quota (“upper credit tranche” drawings) are made in
instalments as the borrower meets certain established performance targets. Such drawings are
normally associated with Stand-by or Extended Arrangements.
Stand-by Arrangement. Under a Stand-by Arrangement, which is typically one to two-year long
but can be as long as three years, a country carries out a programme that it has designed in
consultation with the IMF staff to resolve BoP problems of a largely cyclical nature. The programme
focuses on key macro-economic policy measures and, to receive the financing, the member must
meet the performance criteria marking its successful implementation of the programme. These
criteria—which allow both the member and the IMF to assess progress and may signal the need for
further corrective policies—generally cover ceilings on government-budget deficits, credit, and
external debt, as well as targets for reserves. The country repays the money it has borrowed in about
three to five years.

Stand-by arrangements are to resolve BoP problems of a largely cyclical nature.
Extended Fund Facility (EFF). The IMF provides financial support to its members for longer
periods under EFF. Extended Arrangements are designed to correct BoP difficulties that stem largely
from structural problems and take longer time to correct. A member requesting an Extended
Arrangement outlines its goals and policies for the period of the arrangement, which normally runs
for three years but can be extended for a fourth too, and presents a detailed statement every year of
the policies and measures it will implement over the next 12 months. The repayment period is 4–10
years.

Extended arrangements are designed to correct BoP difficulties that stem largely from structural problems and take longer
period to correct.
Special Lending Facilities
Supplemental Reserve Facility (SRF). The SRF was established in December 1997 in response to an
unprecedented demand for IMF assistance that resulted from the Asian crisis. It is intended to help the
member countries that are experiencing exceptional BoP problems, which are created by a large,
short-term financing need, which is resulting from a sudden and disruptive loss of market confidence.
Assistance is available when there is a reasonable expectation that strong adjustment policies and
adequate support will enable a country to correct its BoP difficulties in a short time. Access under the
SRF is not subject to the usual limits but is based on the member ’s financing needs, its ability to repay
the IMF, the strength of its programme, its record of the past use of IMF resources, and its
cooperation with the IMF.

SRF is intended to help member countries that are experiencing exceptional BoP problems which are created by a large,
short-term financing need, which is resulting from a sudden and disruptive loss of market confidence.
Financing under the SRF, which is provided in the form of additional resources under a Stand-by
or an Extended Arrangement, is generally available in two or more drawings, subject to conditions.
Countries that are drawing under the SRF are expected to repay within 1–1.5 years of the date of each
purchase. The Board may, however, extend this repayment period up to a year. Repayment must be
made no later than 2–2.5 years after the drawing. An interest surcharge is levied on SRF financing to
encourage early repayment.
Contingent Credit Lines (CCL). The CCL was established in 1999 for members that are pursuing
strong economic policies to obtain IMF financing on a short-term basis. Only members that are
satisfying strict eligibility criteria qualify for the CCL. The CCL is intended to be a preventive
measure, solely for members that are concerned about their potential vulnerability to contagion but
are not facing a crisis at the time of the commitment. Thus, the drawings on CCL are not expected to
be made unless a crisis stemming from a contagion strikes. The repayment period for and the rate of
charge on CCL financing are the same as for SRF.

The CCL is intended to be a preventive measure, solely for members that are concerned about their potential vulnerability
to contagion but are not facing a criss at the time of the commitment.
Compensatory Financing Facility (CFF). The CFF (formerly known as the Compensatory and
Contingency Financing Facility [CCFF]) provides timely financing to members that are experiencing
a temporary shortfall in export earnings or an excess in cereal-import costs that are attributable to
circumstances that are largely beyond their control.
Concessional Lending Facility
Poverty Reduction and Growth Facility (PRGF). The IMF’s concessional financing facility to
assist poor countries that are facing persistent BoP problems, known formerly as the Enhanced
Structural Adjustment Facility (ESAF), was renamed as PRGF on November 22, 1999, and given a
more explicit anti-poverty focus. Programmes supported under PRGF are expected to be based on a
strategy that is designed by the borrowing country to reduce poverty, and are formulated with the
participation of civil society and developmental partners. The strategy, to be spelled out in a poverty-
reduction strategy paper, produced by the borrowing country in cooperation with the IMF and the
WB, should describe the authorities’ goals and macro-economic and structural policies for the three
year programme.

PRGF programmes are expected to be based on a strategy that is designed by the borrowing country to reduce poverty.
Review of Facilities
During the financial year 2000, the Executive Board initiated a review of the IMF’s non-concessional
lending facilities and policies to determine if they were all still needed and were appropriately
designed. It agreed to eliminate several financial support mechanisms, including the Buffer Stock
Financing Facility, support for commercial bank debt, debt service-reduction operations, currency
stabilisation funds, and the contingency element of the CCFF. These facilities had been used only
infrequently and, in some cases, had not been used at all for a number of years. The Board also
considered that the other IMF facilities were adequate for the purposes these facilities had originally
been created to serve. At the same time, the Board began a more fundamental discussion about the
IMF’s financing role and how its facilities might best be tailored to the evolving world economic
environment.
Other IMF Policies and Procedures
Emergency Assistance. The IMF provides emergency assistance to members that are facing BoP
difficulties which are caused by a natural disaster. The assistance is available through outright
purchases, usually limited to 25 per cent of quota, provided that the member cooperates with the IMF
to solve its problems. In most cases, this assistance is followed by an arrangement from the IMF
under one of its regular facilities. In 1995, the policy on emergency assistance was expanded to cover
countries that are emerging from civil unrest or international armed conflict, and are unable to
implement regular IMF-supported programmes because of damage to their institutional and
administrative capacity. In April 1999, the Executive Board agreed on the steps to improve the terms
of emergency assistance to post-conflict countries. It also agreed that a second phase of assistance of
up to an additional 25 per cent of quota could be provided to countries that are meeting certain
requirements; for example, the rebuilding process is slow despite the authorities’ efforts and
commitment to reform. It further agreed that the IMF, in carrying out its strategy on overdue financial
obligations, would take into account the special difficulties faced by the post-conflict countries in
arrears.

The IMF provides emergency assistance to members that are facing BoP difficulties which are caused by a natural disaster.
Emergency Financing Mechanism (EFM). The EFM procedures allow for a quick Executive
Board approval of the IMF financial support, under the usual facilities. The EFM is to be used in rare
circumstances which are representing or threatening a crisis in a member ’s external accounts that
requires an immediate response from the IMF. The EFM was established in September 1995 and was
used in 1997, for Philippines, Thailand, Indonesia, and Korea and in July 1998, for Russia.

The EFM is to be used in rare circumstances which are representing or threatening a crisis in a member’s external accounts.
.
Conditionality
When the IMF provides financial support to its member countries, it must be sure that its members are
pursuing policies that will improve or eliminate their external payment problems. The explicit
commitment that the members make to implement corrective measures in return for the IMF’s support
is known as “conditionality”. Fund-conditionality requirements, linking the financial assistance to the
adoption of economic adjustment policies by members, seek to ensure that the member ’s policies are
adequate to achieve a viable BoP position over a reasonable period. This commitment also ensures
that members are able to repay the IMF in a timely manner, which, in turn, allows the IMF’s limited
pool of financial resources to be made available to the other members that are with BoP problems.
The IMF financing, and the important role it plays in helping a country secure other financing,
enables the country to adjust in an orderly way without resorting to measures that would harm its own
or other countries’ prosperity.

The explicit commitment that members make to implement corrective measures in return for the IMF’s support is known as
“conditionality”.
The conditions for IMF financial support may range from general commitments to cooperate with
the IMF in setting policies, to the formulation of specific quantified plans for financial policies. The
IMF financing from its general resources in the upper-credit tranches (that is, where larger amounts
are provided in return for implementation of remedial measures) is disbursed in stages. The IMF
requires a “letter of intent” or a “memorandum of economic and financial policies”, in which a
government outlines its plans as follows:
its policy intentions during the period of the adjustment programme;
the policy changes it will make before the arrangement can be approved;
performance criteria, which are objective indicators for certain policies that must be satisfied on a quarterly, semi-annual, or, in
some instances, monthly basis in order for drawings to be made; and
periodic reviews that allow the Executive Board to assess whether the member’s policies are consistent with the programme’s
objectives.
The conditions for IMF financial support may range from general commitments to cooperate with the IMF in setting
policies.
The conditionality is flexible. The Executive Board’s guidelines on conditionality encourage

members to adopt corrective measures at an early stage. The guidelines stress that the IMF should
take into consideration members’ domestic, social and political objectives, as well as their economic
priorities and circumstances; permit flexibility in determining the number and content of
performance criteria; and emphasise that IMF arrangements are decisions of the IMF that set out, in
consultation with members, the conditions for its financial assistance.
The IMF recognises that not one reform model suits all members, and that individual countries—
both governments and civil society—must have “ownership” of their programmes. Thus, each
member country, in a close collaboration with the IMF staff, designs its IMF-supported programme.
The process involves a comprehensive review of the member ’s economy, including the causes and
nature of the BoP problems, and an analysis of the policies needed to achieve a sustainable balance
between the demand for and the availability of resources.

The IMF recognises that not one reform model suits all members, and that individual countries— both governments and
civil society—must have “ownership” of their programmes.
The IMF-supported programmes emphasise certain key aggregate economic variables— domestic
credit, public sector deficit, international reserves, and external debt—and crucial elements of the
pricing system—including exchange rate, interest rates, and, in some cases, wages and commodity
prices—that significantly affect the country’s public finances and foreign trade, and the economy’s
supply response.
Although the macro-economic policies that are designed to influence aggregate demand (the total
amount of national planned expenditure in an economy), continue to play a key role in many IMF-
supported adjustment programmes, it is widely recognised that measures to strengthen an economy’s
supply side (production of goods and services) are frequently essential to restore and maintain
external viability and sound growth. Among the IMF-supported policy adjustments, which member
countries make to enhance the growth potential and flexibility of their economies, are measures to
remove distortions in the external trade system and in the domestic relative prices, improve the
efficiency and soundness of the financial system, and foster a greater efficiency in the fiscal
operations.
The structural reforms in these areas have been particularly important in programmes under the
EFF and PRGF. The latter focuses particularly on poverty reduction as well. Given the emphasis on
structural reforms in the IMF-supported programmes, a close collaboration with the WB has been
important. During a Stand-by Arrangement, an Extended Arrangement, or an arrangement under the
PRGF, the IMF monitors a member ’s reform programme through a performance criteria that are
selected according to the economic and institutional structure of the country, the availability of data,
and the desirability of focusing on broad macro-economic variables, among other considerations.
The performance under IMF-supported reform programmes is also monitored through periodic
reviews by the IMF Executive Board.
Criticism has been levelled from several corners on the Fund conditionality. One important
criticism is that the conditionalities endanger a nation’s sovereignty. Conditionalities are not
something peculiar to the IMF. Any responsible financial institution will lend only after satisfying
itself about the repaying capacity of the borrower, and it will impose conditions necessary to ensure
proper utilisation of the loan and its repayment. It is true of the public-sector financial institutions in
India too. The IMF and WB cannot be exceptions to this long-standing, well-accepted, and sound
financing principle. However, just as the rehabilitation package drawn up by public-sector financial
institutions in India for sick units need not necessarily be the most appropriate one, the IMF-WB
prescriptions need not necessarily be the most appropriate ones. A nation should, of course, ensure
that it does not accept any conditionality which harms its interests. At the same time, there is no reason
to hesitate to take the assistance of the institutions as and when required because they have been
established to help the needy member countries. In fact, it is the right of every member country to
obtain legitimate assistance from these institutions. It may be noted that, although, in the past, the
communists had a tendency to describe IMF and WB as organs of capitalist imperialism, the
communist countries have themselves come to seek large assistance from these institutions. China and
Russia are now among the largest borrowers from the WB.

Criticism has been levelled from several corners on the Fund conditionality. One important criticism is that the
conditionalities endanger a nation’s sovereignty.
Although conditionality is essential, the appropriateness of any particular set of conditionalities for
a country needs to be carefully evaluated. It has been observed that the IMF’s conditionality has
generally been monetarist and deflationary, obliging the governments to reduce their demand imports
by curtailing the overall demand—cutting back on both private and public spending. These cutbacks
have often reduced consumption, investment, and employment.

Although conditionality is essential, the appropriateness of any particular set of conditionalities for a country needs to be
carefully evaluated.
An alternative strategy would have been an adjustment with growth, which would have aimed more at promoting production, both to
increase exports and to meet a higher proportion of local demand from a local production. Although there have been indications for
a change in the IMF policy in this direction, there is as such no well-articulated agenda of reform.
Technical Assistance
The IMF provides technical assistance in areas within its core mandate, viz., macro-economic policy,
monetary and foreign exchange policy and systems, fiscal policy and management, external debt, and
macro-economic statistics. The IMF began to extend its technical assistance to its members in 1964—
in response to requests for help from newly independent African and Asian countries in establishing
their own Central banks and ministries of finance. The IMF’s technical-assistance activities grew
rapidly and by the mid-1980s, the number of staff members devoted to these activities had almost
doubled.
In the 1990s, many countries—those of the former Soviet Union as well as a number of countries
in Eastern Europe—moved from command to market-oriented economies, turning to the IMF for
technical assistance. The IMF has also recently taken steps to advise countries that have had to re-
establish governmental institutions that are following severe civil unrest—for example, Angola,
Cambodia, Haiti, Lebanon, Namibia, Rwanda, and Yemen. The IMF provides technical assistance in
the following three broad areas:
1. Designing and implementing fiscal and monetary policies.

2. Drafting and reviewing economic and financial legislation, regulations, and procedures; thereby, helping to resolve difficulties
that often lie at the heart of macro-economic imbalances.
3. Institution and capacity building, such as in Central banks, treasuries, tax and customs departments, and statistical services.
Designing and implementing fiscal and monetary policies, drafting and reviewing economic and financial legislation,
regulations, and procedures; and institution and capacity building.
In addition, the IMF provides training to officials from its member countries through courses offered
at its headquarters in Washington, as well as in the Joint Vienna Institute, Singapore Training Institute,
Joint Africa Institute, and other regional and sub-regional locations. Assistance is provided also
through several IMF departments.
External Cooperation. In the recent years, technical-assistance projects have grown both larger
and more complex, requiring multiple sources of financing to support activities. Large projects now
commonly involve more than one IMF department and more than one development partner. Donors
with whom the IMF cooperates include the United Nations Development Programme (UNDP); the
governments of Australia, Denmark, Japan, and Switzerland; WB; and the European Union (UNDP).
These partners currently support nearly one-third of the IMF’s technical-assistance and about one-half
of the cost of short and long-term experts in the field.The government of Japan also makes generous
annual contributions to IMF’s technical assistance programmes and scholarship support. Such
cooperative arrangements with multilateral and bilateral donors not only support activities
financially, but also help to avoid conflicting advice and redundant activities; and have led to a more
integrated approach to the planning and implementation of technical assistance. As the demand for
technical assistance in macro-economic and financial management grows, such arrangements will
become even more valuable.
WORLD BANK (WB)
The International Bank for Reconstruction and Development (IBRD) or the World Bank (WB) was
established in 1945.

WB was established in the year 1945.
Resource
The capital of the Bank is subscribed by its member countries. A substantial contribution to the Bank’s
resources also comes from its retained earnings and flow of repayments of its loans. The Bank
finances its lending operations primarily from its own borrowings in the world capital markets. The
loans generally have a grace period of five years and are repayable over 20 years or less. The loans
of the Bank are directed at more advanced stages of economic and social growth of the developing
countries. The Bank’s interest rates are calculated in accordance with its cost of borrowing.

The WB gives loans to more advanced stages of economic and social growth of the developing countries.
Organisation
All the powers of the Bank are vested in the Board of Governors. The Board consists of Governors
for each member country. The Governors of the Bank have delegated their powers to the Board of
Executive Directors that performs its duties on a full-time basis at the Bank’s headquarters. There are
21 Executive Directors. Each director selects an alternative director. The Bank’s five directors are
appointed by the five members having the largest number of shares of capital stock; the rest are
elected by the Governors representing other member countries.

The Board of Governors consists of Governors for each member country. All powers of the Bank are vested in the Board of
Governors. There are 21 Executive Directors.
The Executive Directors are responsible for the conduct of the general operations of the Bank.
They decide on the bank policy in the framework of the Articles of Agreement. They also decide on
all loan and credit proposals. In practice, they reach most of their decisions by consensus.
Objectives
The objectives of the WB as noted down in its Articles of Agreement are as follows:
1. To assist in the reconstruction and development of territories of the members by facilitating the investment of capital for
productive purposes.
2. To restore the economies of member counties destroyed or disrupted by war, and the reconversion of production facilities to
peacetime needs.
3. To encourage the development of productive facilities and resources in the less-developed countries (LDCs).
4. To promot a private foreign investment by means of guarantees of participation in loans and other investments that are made by
private investors.
5. To supplement a private investment on suitable conditions when a private capital is not available on reasonable terms.
6. Finance for productive purposes out of its own capital funds raised by it and other resources.
7. To promote the long-range balanced growth of international trade and the maintenance of equilibrium in the BoP.
8. To encourage an international investment of the productive resources of members, thereby assisting in raising the productivity, the
standard of living, and the conditions of labour in their territories.
Financing Policies
The WB finances all kinds of infrastructure development such as roads, railways, telecommunication,
ports, and power. It has stepped up its lending for energy development. The largest part of the Bank’s
finances goes for power reforms and energy programmes. The commitment of the Bank for
financing oil and gas developments have shown the greatest increase.
1. Structure Adjustment Lending (SAL). The Bank’s SAL is designed in such a way to achieve a
more efficient use of resources and contribute to a more sustainable BoP in the maintenance of
growth in the face of severe constraints. The Bank’s landing programme lays more importance on the
future growth.

Structure adjustment lending is designed to achieve a more efficient use of resources and contribute to a more sustainable
BoP in the maintenance of growth in the face of severe constraints.
2. Special Action Programme (SAP). The object of the SAP is to help countries implement
adjustment measures and high-priority projects, that are needed to restore credit working and growth.
According to the Bank, the SAP had been highly successful in meeting its objectives, surpassing in
most respects, the expectations set for it.

The object of the SAP is to help countries implement adjustment measures and high-priority projects.
In its lending operations, the Bank is guided by certain policies which have been formulated on the
basis of the Articles of Association.
1. The Bank should properly assess the repayment prospects of the loans. For this purpose, it should consider the availability of
natural resources and the existing productive plant capacity to exploit the resources, and open to the plant, and it should also
consider the country’s post-debt record.
2. The Bank should lend only for specific projects that are economically and technically sound and of a high-priority nature.
3. The Bank lends only to enable a country to meet the foreign exchange context of any project cost. It normally expects the
borrowing country to mobilise its domestic resources.
4. The Bank does not expect the borrowing country to spend the loan on a particular country alone. In fact, it encourages the
borrower to procure machinery and goods for the Bank’s financial projects in the cheapest possible market, which is consistent
with satisfactory performance.
5. It is the Bank’s policy to maintain continuing relations with borrowers, with a view to check the progress of projects and keep in
touch with the financial and economic development in the borrowing countries. This also helps in the solution of any problem,
which might arise in the technical and administrative fields.
6. The Bank indirectly attaches special importance to the promotion of local private enterprises.
The WB gives loans to more advanced stages of economic and social growth of developing
countries.

The WB gives loans to more advanced stages of economic and social growth of developing countries.
WB’s Assistance to India
India is one of the founder members of the WB and is one of the largest beneficiaries of WB’s
assistance. India was the largest beneficiary of WB’s assistance until China became a member of the
WB in 1980. Now, there are a number of larger beneficiaries than India. In 1997, the total WB’s
assistance to India amounted to about 5 per cent of the total Bank’s assistance.
India’s share in the Bank’s global credit has declined over the years. Until 1979–80, WB’s aid to
India accounted for, on an average, about 40 per cent of its total aid. Thereafter, there was a decline in
this share. In 1998, it was about 14 per cent. Apart from the resource crunch the Bank has been facing,
China’s entry into the WB has seriously affected the fund flow to India. Although the WB’s assistance
to India is very large in absolute terms, the per capita assistance has been low. India, with about a third
of the world’s poor, needs a substantial increase in concessional finance to accelerate the
programmes of poverty alleviation and economic development.

India, with about a third of the world’s poor, needs a substantial increase in concessional finance to accelerate the
programmes of poverty alleviation and economic development.
AN EVALUATION OF IMF-WB
The contribution made by IMF and WB in helping the member countries in different ways cannot be
ignored. Studies show that the projects assisted by the WB group could have a significant impact in
the respective countries. The IMF has played an important role in providing international liquidity
and in the structural adjustment programmes. There is, however, a wide gap between aspirations and
achievements. A criticism made often is that these institutions, which are dominated by the developed
countries, have not been paying an adequate attention to the needs of the developing countries.

The IMF has played an important role in providing international liquidity and in the structural adjustment programmes.
The objective of the Bretton Woods Conference was to establish a global monetary and financial
system to promote stable exchange rates, foster the growth of world trade, and international
movement of capital in the desired directions. At the time of the establishment of these institutions,
most of the developing countries were colonies and, therefore, were not represented at the Bretton
Woods. The major concern of these institutions was, naturally, the major problems of the main
participants, that is, the developed countries, and “... there was an almost an inevitable lack of concern
for the interests of the developing countries”. Even after the developing countries have far
outnumbered the developed countries in the total membership of these institutions, the dominance of
the developed countries continues because of the voting system which gives a clear control to the
large contributors.

The objective of the Bretton Woods Conference was to establish a global monetary and financial system to promote stable
exchange rates, foster the growth of world trade, and international movement of capital in the desired directions.
However, as the South Commission observes, the concern for developing countries was not
completely absent; the mandate of the WB included the provision of a development assistance. But in
the early post-war years, financing the reconstruction of war-devastated Europe and Japan received
much more attention than the crying development needs of the developing countries. The proposal
for a Special United Nations Fund for Economic Development (SUNFED), which would offer large-
scale aid on easy terms to developing countries, was rejected in the 1950s mainly because of the
objection raised by the developed countries that the United Nations was involving itself in the
financial aid to developing countries.
The view that in the international management of BoP disequilibria, there should be pressure to
adjust on both surplus countries and deficit countries, rather than only on those in deficit, was also
ignored. If fact, Keynes’ original proposal for an International Clearing Union (the prototype for the
IMF) included the possibility of a penalty on surplus countries—1 per cent of the surplus per month to
encourage them to make adjustments too. Again, only very little could be done by the IMF in solving
the international liquidity problem of the developing countries in comparison with those of the
developed countries. Indeed, the developing countries need a much larger attention of the multilateral
institutions than the developed countries for various reasons. The developed countries have the
capability for and a ready access to commercial borrowing whenever their reserves run short. The
United States, which has the largest deficit among the developed counties, has also had the option of
running a permanent deficit since other countries have been content to hold on to dollars.

The view that in the international management of BoP disequilibria, there should be pressure to adjust on both surplus
countries and deficit countries, rather than only on those in deficit, was also ignored.
The situation for the developing countries is quite different. Due to their poor economic
conditions, the relative burden of their payments deficit is much more than that of the absolute
burden; the absolute deficit itself has been huge. Not only that, the commercial borrowing capability
of these nations is limited; the accessibility has also been limited because of their poor
creditworthiness. It may be recalled here that, in the early 1990s when India’s foreign exchange
reserves (FER) position became very critical, the sources of short-term commercial borrowings
dried up due to the fall in the credit rating. To make matters worse, because of the poor credit ratings,
the developing countries have had to pay an average rate of interest, which was about four times the
rate applied to the developed countries on the commercial borrowings.
Against this background, the IMF system has been ironic as far as the developing countries are
concerned. The unconditional borrowing rights based on the quota are highly discriminate against the
developing countries. What is more draconian has been the allocation of the SDRs and the created
liquid assets, in proportion to the quota. This is like giving away the lion’s share of a cake that was
received as a gift to the fairly well fed, ignoring the severe hunger of those who have been in an
abject starvation.

The unconditional borrowing rights based on the quota are highly discriminate against the developing countries.
One of the major problems of the developing countries is the increase in the debt service due to the
payment commitments of the past debt. There has been a transfer of large amounts of funds from the
developing countries to the creditors as debt service. This has not been compensated by an increased
flow from the IMF to the developing countries. During 1986–90, the IMF was actually withdrawing
funds from the developing countries—a net transfer of $6.3 bn a year despite new concessional
mechanisms such as SAF and the ESAF. WB transfers moved in much the same direction, despite the
softening influence of concessional lending through the IDA. (International Development
Association). In 1991, the net WB transfers were minus $1.7 bn. “The Bretton Woods institutions thus
failed many developing countries at their times of great need”.

One of the major problems of the developing countries is the increase in the debt service due to the payment commitments of
the past debt.
One problem as far as the proper functioning of the IMF has been that it has not had any control
over the rich nations. It could not, therefore, avert the breakdown of the Bretton Woods Association’s
monetary system. It has been rightly observed that the WB is not closer to meeting its mandate, either.
It was “established to borrow the savings of the rich nations and to lend them to poor nations—to
finance sound development projects and programmes, particularly where a private investment failed
or was inadequate. In fact, it has done little to recycle the global surpluses to deficit nations”.
Only a small portion of the total WB’s assistance is in the form of soft loans (IDA credits). The IDA
now represents only 30 per cent of the WB lending. The major part of the WB lending to many
developing countries like India is on commercial terms. This is one of the reasons for the increase in
their debt-service problems. The IBRD lending rates now “float” in line with the world market rates.
This is a major shift from the Bank’s original role of cushioning developing countries against fluctuations in the market interest rates.
The Bank was supposed to raise capital and lend it at rates that it could afford to subsidise because of its own strength and that of its
industrial country partners.
Another limitation is the size of the funds available to the Bank. The availability of funds depends,
inter alia, on the willingness of the developed countries to contribute. It has been pointed out that the
United States which is the largest contributor, is not only reluctant to increase its own contribution,
but also reluctant to let other countries (like Japan which would be able to offer a lot more) to do so
as its own voting power would be correspondingly reduced. In short, “... the quantity and composition
of World Bank lending is clearly inadequate for the challenges it faces in the developing countries”.

In short, “ ... the quantity and composition of World Bank lending is clearly inadequate for the challenges it faces in the
developing countries”.
Despite these failures of IMF–WB, it is necessary to recognise the useful role they have played all
these years by extending different types of assistance to the different categories of countries. The
increase in the membership of these institutions is a clear evidence of their utility. Although the
communists in the past had described these institutions as organs of capitalist imperialism, several
communist countries have become members of these institutions and recently, all the states of the
former Soviet Union and East European countries have become members.
WORLD TRADE ORGANIZATION (WTO)
The eighth round of multilateral trade negotiations held under GATT and lasting for seven years
(1986–93), named the Uruguay Round, resulted in new legal agreements for trade and strengthening
the settlement system. Following this, there was a Ministerial Conference in Marrakesh, Mor-occo, in
April 1994, attended by 125 government representatives from across the world to sign the
establishment of a new successor institution to GATT, viz., the World Trade Organization (WTO). It
is an embodiment of the Uruguay Round results. WTO came into force on January 1, 1995, with all
the assets and liabilities of GATT transferred to the former. Geneva was to be its headquarters. All
GATT committees were superseded by WTO committees. Initially, there were four sub-committees,
which are as follows:
1. Budget, finance, and administration,

2. Institutional, procedural, and legal matters,
3. Trade and environment, and
4. Services.
WTO came into force on January 1, 1995, with all the assets and liabilities of GATT transferred to the former.
WTO ensured that each member country negotiates with its trading partners, its terms of entry into
the multilateral trading system and a market access schedule for goods and services. All the
contracting parties (member countries) pledged to make every effort to quickly conclude a domestic
rectification of the WTO agreement.

WTO ensured that each member country negotiates with its trading partners, its terms of entry into the multilateral trading
system and a market access schedule for goods and services.
Emergence of WTO
WTO’s creation on January 1, 1995, marked the biggest reform of international trade since 1948.
During those 47 years, the international commerce had come under GATT and that had helped to
establish a prosperous multilateral trading system. However by the end of 1980s, an overhaul was
due. The Uruguay Round brought about that overhaul. It was the largest trade negotiation that WTO
ever had. At times, the talks seemed doomed to fail, but in the end the Uruguay Round was successful.
The talk was so immense that some people wondered whether there would ever be another
negotiation like this. WTO is GATT plus a lot more. GATT was a small and provisional institution,
and not even recognised by the law as an international organisation. It has now been replaced by the
WTO. GATT (the agreement) has been amended and incorporated into the new WTO agreements.
GATT dealt only with trade in goods, whereas WTO agreements cover services and intellectual
property as well.

WTO came into force on January 1, 1995 with an objective to help a free trade flow, trade liberalisation, and to set up an
impartial means of settling disputes.
Objectives
WTO is the only international body dealing with the rules of trade among nations. Box 29.3 details
the facts of why an individual should be aware of the WTO. At its heart are the WTO agreements, the
legal ground rules for international commerce and trade policy. The agreements have three main
objectives, which are as follows:
1. To help trade flow as freely as possible.

2. To achieve further liberalisation gradually through negotiations.
3. To set up an impartial means of settling disputes.
In short, WTO is expected to
1. Administer WTO trade agreements.

2. Provide a forum for trade negotiations.
3. Handle trade disputes.
4. Monitor national trade policies.
5. Provide technical assistance and training for developing countries.
6. Cooperate with other international organisations.
Areas of Negotiations
Broadly speaking, WTO has been set up to continue negotiations and bring agreements in the
following areas:
1. Basic telecommunications.
2. Maritime transport.
3. Movement of natural persons.
4. Financial services.
5. General Agreement on Trade and Services (GATS).
6. A reaffirmation of the rule of the law in trade and economic relations.
7. A reversal of long-standing protectionist practices in agriculture, textiles, and clothing.
8. An extension of multilateral rules to services and intellectual property rights.
The economic case for an open trading system based on multilaterally agreed rules is simple enough
and rests largely on commercial commonsense. However, it is also supported by evidence.
Protectionism leads to bloated inefficient companies and can, in the end, lead to factory closures and
job losses. One of the WTO’s objectives is to reduce protectionism.
WTO is run by its governments. All major decisions are made by the membership as a whole,
either by ministers (who meet every two years) or by officials (who meet regularly in Geneva).
Decisions are normally taken by consensus. The highest authority is the Ministerial Conference which
meets at least once in every two years. More routine work is supervised by the General Council.
Numerous other councils, committees, working parties, and negotiating groups cover the wide range
of WTO issues.
WTO and India
India became a founder member of WTO by ratifying the WTO agreement on December 30, 1994.
According to the estimates prepared by the WB, OECD (Organisation for Economic Cooperation and
Development), and GATT Secretariat, the overall trade impact as a consequence of the Uruguay
Round package served as a value addition to the merchandise good by $745 bn by the year 2005. The
GATT Secretariat further projects that the largest increases will be in the area of clothing (60 per
cent); agriculture, forestry, and fishery products (20 per cent); and processed food and beverages (19
per cent). According to the Economic Survey 1994–95,

India is a founder member of WTO.
Since India’s existing and potential export competitiveness lies in the product groups, it is logical to believe that India will obtain
large gains in these sectors. Assuming that India’s market share in world exports improves from 0.5 per cent to 1 per cent, and that
we are able to take advantage of the opportunities that are created, the trade gains may conservatively be placed at 2.7 billion US
dollars extra exports per year. A more generous estimate will range from 2.5 to 7 billion US dollars worth of extra exports.
As a result of the policies of globalisation followed by India after joining the WTO in 1995, India’s
exports increased by $4.1 bn in 1994–95; they surged by $5.5 bn in 1995–96, touching $31.8 bn as
against $26.3 bn in 1994–95. During 1997–98, the exports increased by barely $1.50 bn and during
1998–99, they have declined by $1.3 bn. Obviously, the new policies, the critics believe, have
developed a dependency syndrome on the international market and the Indian economy’s fortunes
have been geared to it.

The critics believe that the new policies have developed a dependency syndrome on the international market, and the
Indian economy’s fortunes have been geared to it.
But the Economic Survey 1994–95 underlined the stark reality that whereas the developed countries
want that under the pressure of the super-state organisation (WTO), the developing counties should
reduce the trade barriers and permit a free flow of goods; but, on the contrary, they themselves want
to pursue protectionist policies to save their interests by erecting trade barriers. The Economic
Survey, therefore, categorically states as follows:

Box 29.3 Why Should an Individual be Aware of the WTO
An individual should be aware of the WTO because he/she is a consumer. Trade and trade policies
are of great importance to consumers everywhere. Consumers are the ultimate beneficiaries of
free trade. They get better access to, have a choice of products that are to be to be consumed, and
increased competition results in the availability of better-quality goods at fair prices. With a
minimum level of knowledge on the international trade system as governed by the WTO, an
empowered consumer will be able to protect his/her rights and interests in areas as diverse as
medicines, vehicles, and financial services.

Unemployment in industrial countries is at the highest level since the 1990s. This has created problems not only in these countries,
but could translate into a clamour for protectionism, threatening multilateral trade. Although several developing countries have
substantially liberalised trade as part of economic reforms, developed countries have raised barriers, threatening marketing access to
items of interest to developing countries.
It is due to the existence of this kind of situation, which exhibits a contradiction between the rhetoric
and reality, that the Indian Parliament has not given its seal of approval to the patents (Amendment)
Ordinance of 1994, which was promulgated on December 31, 1994. Similarly, a Bill to amend the
Trade and Merchandise Marks Act of 1958, to provide for the protection of service marks, introduced
in the Parliament in 1993 has not yet been passed. The fact that the government is not able to get the
approval of the Parliament, for the various legislations introduced by it following the Uruguay
Round Final Act, only confirms the fact that the majority opinion is apprehensive of the intentions of
the developed countries that want to use WTO, to appropriate a major portion of the gains of trade
and leave some crumbs for the developing countries.
INTERNATIONAL FINANCE CORPORATION (IFC)
The International Finance Corporation (IFC) was established in 1956. The IFC has its own operating
and legal staff but draws upon the WB for administration and other services.

IFC was established in 1956.
Mission
The mission of IFC is to contribute to the WB group’s overall purpose of reducing poverty and
improving the living standards by playing a leading role in the development of a sustainable private
sector. The goal of IFC, in partnership with others, is to deliver the development impact. IFC’s basic
tools to achieve these goals are loan and equity financing of private enterprises, mobilisation of
external capital alongside its own resources, and provision of related advisory and technical-
assistance services. But the context of the Corporation’s work has dramatically altered, opening many
new areas of activity.

Its mission was to contribute to the WB groups’ over all purpose of reducing poverty and improving the living standards.
Objectives
The objectives of IFC are to assist the economic development of the LDCs by promoting growth in
the private sector of their economies and help to mobilise domestic and foreign capital for this
purpose. The IFC’s role is to stimulate the flow of private capital into productive private and mixed
private/public enterprises. It acts as a catalyst in bringing together entrepreneurship, investment
capital, and production. The origin of the IFC lies in the recognition by the industrial countries that
the provision of an essential infrastructure for development alone would not be enough to attract
private investment flows to countries where underdevelopment was pronounced. It was necessary, in
addition, to encourage the growth of productive private investment and saving in the developing
world. These broad objectives were translated into specific objectives that were embodied in the IFC’s
Articles of Agreement.

The objectives of IFC are to assist the economic development of the LDCs by promoting growth in the private sector of their
economies and help to mobilise domestic and foreign capital for this purpose.
Main Features of Assistance
The main features of IFC’s assistance are as follows:
1. The IFC makes its investments in partnership with private investors, from the capital-exporting country or from the country in
which the enterprise is located, or both.
2. It is envisaged that the Corporation’s investments will never be more than half of the capital requirements of the enterprise.
3. The minimum investment the IFC will make in an enterprise is fixed at $10,000 or its equivalent, but no upper limit is fixed.
4. The enterprises eligible for loans from the Corporation should be predominantly industrial and contribute to the economic
development of the country.
5. The rate of interest in each case would be a matter of negotiation depending on the risks and other investments.
6. The IFC will not seek or accept a government guarantee for the repayment of any of its investment, nor will it seek formal
government approval of any proposed financing, except when such approval is required by the Law in any country.
One important feature that distinguishes the IFC from the commercial financial institutions is its
commitment to provide project sponsors with the necessary technical assistance that will help to
ensure that their ventures are potentially productive and financially sound. In addition, the
Corporation provides policy assistance to its member governments in support of their efforts to
develop the necessary investment climate that will encourage productive as well as beneficial
domestic and foreign investment.
Recognising the important contributions of financial markets to economic development, the IFC
has a specialised department that is the focal point of the capital-market development activities of the
IFC and the WB. The department provides specialised resources for addressing the financial market
needs and the problems of developing countries. In response to the economic situation, in 1984, the
IFC began to expand its operation in a new area—assisting in the physical and financial restructuring
of the existing firms (corporate restructuring). In addition to corporate restructuring, IFC expanded
its activities into several other new areas too. For example, it helped to create a bonding facility for
construction firms that are operating outside their own country. It helped to establish a secondary
mortgage-marketing institution, and provided financing for a regionally oriented venture-capital
company. The privatisation trend all around the world has greatly increased the role of the IFC.
IFC and India,
The IFC has assisted in a number of projects in India. The New Economic Policy (NEP) of India
which has substantially enhanced the role of the private sector implies a greater role for the IFC in the
industrial development of the country. The Corporation has identified five priority areas in India
where it plans to beef up its activities. These five areas for strengthened activities are capital market
development, foreign direct investment (FDI), access to foreign markets, equity investments, in new
and expanding companies to finance capital investment, and infrastructure. The IFC opened up a
mission in Mumbai to speed up the assessment of project proposals. India is the first of the IFC’s
member countries to benefit from such a decentralisation.

The IFC has identified five priority areas in India for its activities, which are capital market development, FDI, access to
foreign markets, equity investments, and infrastructure.
Firstly, the IFC will invest in a range of financial service companies and provide technical
assistance to help in developing India’s capital market. Secondly, with its global network of contacts,
IFC could act as a catalyst in bringing together the Indian and foreign companies, stimulating the flow
of foreign investment and technology into India. Thirdly, IFC will intensify its efforts to help the
Indian companies gain access to funding in the international financial market through loan
syndications and underwriting of securities. Fourthly, Indian companies need to strengthen their
balance sheet by increasing the equity levels and reducing the debt levels if they have to survive in a
more competitive market. The IFC is giving a special emphasis to equity investments in companies
that are internationally competitive.
ASIAN DEVELOPMENT BANK (ADB)
Some regional development banks have been established to assist the development of the developing
countries in the respective regions—the African Development Bank (AfDB), Asian Development
Bank (ADB), Caribbean Development Bank (CDB), and Inter-American Development Bank (IDB).
The influence of the regional banks is growing as they are becoming more responsive to the special
needs of their own constituencies.
ADB was set up in December 1966 under the auspices of the United Nations Economic
Commission for Asia and Far East (ECAFE) to foster the economic development of Asian countries.
Its headquarters are in Manila. The funds of the ADB are contributed by developed countries such as
Japan, the United States, Canada, West Germany, Australia, and others. The main objectives of the
ADB are as follows:
1. To promote investments in the ESCAP (Economic and Social Commission for Asia and the Pacific) region of public and private
capital for development and
2. To utilise the available resources for financing development, giving priority to those regional, sub-regional, as well as national
projects and programmes which contribute more effectively to the harmonious economic growth of the region as a whole.
At the 23rd Annual Meeting of the Board of Governors of the ADB, the President pointed out that the
Bank’s most appropriate response to Asian and Pacific development in the future lies in the following
three board directions:
1. Greater priority must be placed on alleviating poverty and protecting the environment;
2. The Bank must strengthen its assistance to the private sector to improve productivity and efficiency; and
3. The Bank must work with its developing members to create a policy framework that makes the most efficient use of human and
capital resources.
A major problem which the ADB is facing is “shortage of funds”. The Western donors now show a
lot of interest in the development of Eastern Europe.
UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT (UNCTAD)
The widening trade gap between the developed and the developing countries, the general
dissatisfaction of the developing countries with GATT, and the need for a new organisation for
international economic cooperation in the field of trade and aid, which has been designed to reduce
the trade gap of the developing countries, encouraged the establishment of the United Nations
Conference on Trade and Development (UNCTAD), in 1964, as a permanent organ of the UN General
Assembly. The UNCTAD was designed to serve as a forum in which the trade-related development
issues could be discussed and analysed, to lead to negotiations of international understanding on
issues that were in dispute. The Conference, which is a plenary body of a large number of countries,
meets normally at intervals of four years.

UNCTAD was established in 1964 as a permanent organ of the UN General Assembly. It was designed as a forum in which
the trade-related development issues could be discussed and analysed, to lead to negotiations of international
understanding on issues that were in dispute.
Functions
The principal functions of UNCTAD are as follows:
1. To promote international trade with a view to accelerate the economic development.

2. To formulate principles of and policies on international trade and related problems of economic development.
3. To negotiate multinational trade agreements.
4. To make proposals for putting its principles and policies into effect.
The major activities of UNCTAD include research and support of negotiations for commodity
agreements, and technical elaboration of new trade activities designed to assist the developing
countries in the areas of trade and capital.
Basic Principles
UNCTAD’s action programme and priorities have been laid down in various recommendations
adopted by the first conference in 1964. These recommendations are based on the following basic
principles:
1. Every country has the sovereign right to freely dispose of its natural resources in the interest of the economic development and
well-being of its own people and to freely trade with other countries;
2. Economic relations among countries, including trade relations, shall be based on respect for the principles of sovereign equality
of states, self-determination of people, and non-interference in the internal affairs of other countries; and
3. There shall be no discrimination on the basis of differences in the socio-economic systems, and the adoption of various trading
methods and trading policies shall be consistent with this principle.
A Review of the Functioning of UNCTAD
About eight conferences have been held so far under the auspices of UNCTAD. Given the important
role of primary commodities and natural resources in the external sectors of the developing
countries, the initial focus of UNCTAD was on commodity policy and efforts to stabilise and expand
the export earnings of these countries. In the process, UNCTAD adopted a group approach to
negotiation with OECD countries (i.e., the industrial economies), lining up together (Group B) the
Centrally planned economies of Central and Eastern Europe and the Soviet Union plus a few similar
economies forming their own grouping (Group D), and the developing countries coming together
under the aegis of the Group 77 to coordinate their positions. China formed a separate group. Despite
debates and disagreements over the years, UNCTAD played a key role in the emergence of
1. The Generalized System of Preferences (GSP).

UNCTAD played a key role in the emergence of the GSP, a maritime shipping code, special international
programmes to help the LDCs, and international aid agencies.
2. A maritime shipping code.

3. Special international programmes to help the LDCs.
4. International aid agencies.
During the 1970s, in line with the major changes in the international economic environment, the
breakdown of the Bretton Woods system, oil price, stocks, inflation, and accumulation of debt by
many developing countries, UNCTAD became a central forum for debates between the North and the
South. Its negotiations became politically chartered and most of its sessions during the 1970s and
1980s reflected sharp divisions among participants, even as a global consensus seemed to be
emerging in the 1980s.
UNITED NATIONS INDUSTRIAL DEVELOPMENT ORGANIZATION (UNIDO)
The United Nations Industrial Development Organization (UNIDO), which was set up in January
1967, is an organ of the UN General Assembly. The primary function of UNIDO is to promote
industrialisation in the developing counties by encouraging the mobilisation of national and
international resources. Particular attention is given to manufacturing industries. Unlike UNCTAD,
UNIDO works directly with business firms, generally on an industry basis. The major activities of
UNIDO fall into the following three categories:

UNIDO was established in January 1967 with an objective to promote industrialisation in the developing countries. The
major activities of UNIDO are direct technical assistance to industries, research, and coordination.
Operational Activities. These include direct technical assistance to industries, at the request of the
governments of the developing country and the in-plant training programmes, whereby groups of
technicians and engineers from the developing countries, who are facing a common industrial
problem, are brought together to consider how industry in the more advanced countries avoids or
solves similar problems.
Research. In this area, UNIDO conducts feasibility studies on the requirements for a potential
industry in the developing countries. Export-oriented industries are given a special attention.
Coordination. The coordinating activities of UNIDO include mostly the organisation and
sponsoring of inter-regional and international meetings, seminars, and symposia.
INTERNATIONAL TRADE CENTRE (ITC)
The International Trade Centre (ITC) is the focal point in the United Nations’ system for technical
cooperation with developing countries in trade promotion. ITC was created by the GATT in 1964 and
since 1968, has been operated jointly by GATT (now WTO) and the UN, the latter acting through the
UNCTAD. As an executing agency of the UNDP, ITC is directly responsible for implementing UNDP-
financed projects that are related to trade promotion in the developing countries.

ITC is directly responsible for implementing UNDP-financed projects that are related to trade promotion in the developing
countries.
ITC can advise the developing countries on their overall approach to marketing communications,
as well as on the individual information and publicity activities. This entails establishing a strategy
with broad-communication objectives that are in line with the firm’s international marketing goals
and defining specific actions to achieve those objectives. Trade fairs are one such specific activity.
For instance, ITC can provide guidelines on choosing the most appropriate fairs for firms and
products concerned, preparing the exhibition budget, designing the stands, producing publicity
materials, briefing the participants, manning the stands, following upon business enquiries, and
evaluating exhibition, performance. Similar ITC services are available for planning and executing the
trade missions, solo exhibitions, and store promotions, which all call for skills in conducting
marketing research, selecting participants and products, preparing promotional material, making
detailed arrangements, and following through with business contracts.
For trade-promotion publications, ITC can give advice on developing a publication plan and
determining specific types of publications to be a part of it, such as product and company brochures,
export directories, and trade-promotion bulletins; newsletter; and magazines. Suggestions on content,
graphics, production, and distribution are a part of this service. Briefly, the ITC assists the developing
countries by working with them in the following ways:
1. Developing a national trade promotion strategy, including analysing the export potential, choosing the priority markets, and
setting the export targets;
2. Establishing appropriate government institutions and services, such as a Central trade promotion organisation and services for the
exporters in trade information, export financing, export quality control, export costing and pricing, export packaging, trade fairs
and commercial publicity, legal aspects of foreign trade, international physical distribution of goods, trade promotion services
for small- and medium-sized enterprises (SMSE), and commercial representation abroad;
3. Finding market opportunities for current export products, both non-traditional items and elected primary commodities, and using
effective marketing techniques to promote them abroad; adapting other products to foreign-market requirements and developing
new items for export; and promoting exports of technical consulting services;
4. Training government trade officials, businessmen, and instructors in export marketing and trade promotion, and establishing a
national framework for developing export training over a long term; and
5. Improving import operations and techniques to optimise scarce foreign exchange resources.
The ITC assists the developing countries by working with them in developing a national trade promotion strategy;
establishing appropriate government institutions and services; finding market opportunities for current export products;
Training government trade officials, business men, and institutions in exports; and improving import operations and
techniques.
GENERALIZED SYSTEM OF PREFERENCES (GSP)

The Generalized System of Preferences (GSP) is a scheme designed by the UNCTAD to encourage
the exports of developing countries to developed countries. Under this scheme, the developed
countries grant duty concession on the imports of specified manufactures and semimanufactures from
the developing counties. It was a resolution adopted at UNCTAD-II, held in 1968, in New Delhi, that
led to the introduction of GSP, which is the result of the realisation that temporary advantages in the
form of generalised arrangements for special-tariff treatment for developing countries, in the market
of developed countries, may assist the developing countries to increase their export earnings and so,
contribute to an acceleration in the areas of their economic growth.

The GSP is a scheme designed by the UNCTAD to encourage the exports of developing countries to developed countries.
Under this scheme, the developed countries grant duty concession on the imports of specified manufacturers and semi-
manufacturers from the developing countries.
The EEC (European Economic Community) countries and a number of other countries, such as the
United States, Japan, Norway, New Zealand, Finland, Sweden, Hungary, Switzerland, Australia,
Canada, Austria, Bulgaria, and Poland have introduced GSP. The facility is available to developing
countries; it is subject to certain stringent limitations. The preferential rates of duty allowed on the
import of manufactures and semi-manufactures and processed agricultural products differ in schemes
of different developed countries as each country has developed its own GSP, keeping in view its local
production base and certain other factors. Each scheme has a safeguard clause or an escape to protect
the sensitive sectors in its economy. A particular item qualified for GSP benefits only if the following
conditions are satisfied:
1. The product must be included in the GSP list.

2. The country exporting the items should be declared under the GSP as a beneficiary country.
3. The value-added requirements/process criteria must be complied with.
4. The product must be imported into the GSP donor country from a GSP beneficiary country.
5. The exporter must send to his buyer/importer a certificate of origin in the prescribed form, which is duly filled in and duly signed
by him, and then certified by a designated government authority.
GLOBAL SYSTEM OF TRADE PREFERENCES (GSTP)
The expansion of trade among the developing countries is viewed as an important aspect of economic
cooperation among the developing countries. It is felt that trade preferences can help to achieve the
expansion of South-South trade. Although the UNCTAD gave its sanction to a scheme of trade
preferences as far back as 1968, it was not until 1979 that the Group of 77 (G77) drew up an action
plan for a collective self-reliance. It took three more years for the group to formally adopt a
programme of Global System of Trade Preferences (GSTP).
The G77 Ministerial Conference, held in New Delhi, in July 1985, resolved to complete the first
round of negotiations on GSTP by May 1, 1987. The agreement reached at the Conference included
an across-the-board tariff-preference margin of 10 per cent, the removal or reduction of non-tariff
barriers, selection of specific sectors and products where trade preferences could be extended, and
trade-creating, production-sharing, and marketing arrangements.
The inordinate delay in formulating and implementing a meaningful scheme of GSTP is an
indicator of a lack of unity of purpose and will among the developing countries. Curiously, the GSP,
designed by the major industrialised countries to give tariff concessions in favour of the developing
countries to facilitate an easier access for the latter ’s exports to the former, particularly of
manufactures and semi-manufactures, came into being much faster than the GSTP. Indeed, the
“problem of trade preferences among the developing countries is a complex one. These countries
form an extremely heterogeneous lot with great diversities in the levels of development and
industrialisation, foreign trade regimes and not the least of all, approaches to development”. Further,
however effective the GSTP may be, it can only be one of the many instruments for promoting South–South financial and monetary
cooperation, new payment arrangements and joint debentures in production and marketing. On most of these issues, the developing
countries have made a little progress in the past decade. Unless they display a unity of purpose and sense of urgency backed by a
strong political will, South–South trade will continue to remain on a weak wicket.
The agreement on GSTP adopted at the Ministerial Meeting of the developing countries of the G77,
held in Belgrade, in April 1988, annexed a list of tariff concessions exchange among the 48
participating countries of G77 in the first round of negotiations. India exchanged tariff concessions
with 14 countries. The tariff concessions exchanged in the first round were only modest in terms of
trade and product coverage. But the significant achievement lies in the conclusion of the agreement,
which provided a framework for exchange of trade concessions among the developing countries and
for promoting trade and economic cooperation among themselves.
CASE
The case that came up before the World Intellectual Property Organisation (WIPO) was Hindcool
Petroleum Corporation Ltd. vs Zeel Zunatar. Hindcool is in the business of refining and marketing
petroleum products. It is the second largest company in the country with a turnover of $10,000 mn in
the Fiscal Year (FY) 2001–02. It has 4,500 petrol pumps, 17.3 million consumers, and 17 registered
domain names in its name. Hindcool had registered the domain name Hindpetro.com in 1996, because
it was something that reflected its common abbreviation.
A lapse appears to have happened in 2003, when a domain name was not renewed. How naïve, you
wonder, but Hindcool relied on a software company to do the job. Only subsequently did Hindcool
discover that the name had already been registered by the Domainsite. com in favour of Zeel Zunatar.
The harsh truth perhaps took time to sink in the head of the oil major and at last on May 10, 2004,
Hindcool sent a complaint to WIPO. However, it was “administratively deficient” and took two more
weeks for the company to satisfy all the formal requirements of the uniform domain name dispute
resolution policy as also the appropriate rules of WIPO.
In its complaint, Hindcool made a strong case that Hindpetro belonged to it: that it has coined that
word with “hind” meaning Hindcool and “petro” for petroleum, the trade mark has been used
continuously since 1974 and the domain name is identical to its trademark. Zeel has “no legitimate
interest in the domain name”, argued Hindcool. A case of use in “bad faith” which can lead to use of
the trade mark as passing off. Hindcool informed WIPO of Zeel’s voice mail on July 17, 2004 as
“Seeking $20,000–$21,000 for a transfer of the domain name”. A sum seeming to be “in excess of
likely out of pocket costs”.
What did Zeel have to say on the issue? It said that it relied on the “the non-registration of the
mark” in the United States and stated that WIPO policy “does not arbitrate on claims on trade names”.
Zeel also argued that “Hind” and “Petro”, are also generic form for “skilled farmers” and “rock”,
respectively, and that it intended to use the domain name “Hindpetro” for a “rock collection and
informational site”. It claimed, “The fact that the complainant is a big company in the country does
not automatically mean it was aware of their rights”.
The Arbitration and Mediation Centre reasoned that the domain name was “identical or confusingly
similar”, because it was identical to a trademark in which Hindcool has a right. The name “has clearly
been used continuously and extensively as an abbreviation” by the company and the bourses. “As
such, the reputation acquired through such use would be capable of protection as a trademark at
common law”, it concluded.
Also, the Centre found Zeel to have no “right or legitimate interests” in the domain name, based on
the evidence made available. “There is no evidence that the respondent is commonly known by the
domain name even though it acquired no trademark or service mark rights”, noted the Centre. There
was no evidence that Zeel was making “a legitimate non-commercial use of the domain name without
an intent for commercial gain to misleadingly divert consumers or tarnish the trademark or service
mark in issue”.
Case question
What should WIPO do?
Case analysis
One interesting observation here is that the explanation offered by Zeel for the choice of the name
relied on a less well-known derivation for the roots of the portmanteau word in question. On the
question of “Bad Faith” that Zeel was against, was an “evidence of registration of the domain name
for the purpose of selling it to the complainant for a valuable consideration in excess of the
respondent’s apparent, out-of-pocket expenses”. The decision, therefore, should go in favour of
Hindcool, that the domain name Hindpetro can be transferred to the complainant.
KEY WORDS
Modes of Delivery
Quantitative Restriction (QRs)
Most-favoured Nation (MFN)
Quota
Conditionality
Structure Adjustment Landing (SAL)
Special Action Programme
Special Drawing Rights (SDR)
Compensatory Financing Facility (CFF)
World Bank (WB)
GATS
GATT
Intellectual Property
GSP
IFC
Stand-by Arrangement
Supplemental Reserve Facility (SRF)
Contingent Credit Lines (CCL)
QUESTIONS
1. What do you mean by an international business environment? Explain the different factors that favour an international business
environment.
2. Explain in detail how GATT is responsible for the establishment of WTO.
3. Explain the role of India in WTO and WTO’s role in India’s socio-economic development.
4. Discuss the objectives and organisation of IMF.
5. Discuss the financing policies of WB and its assistance to India.
6. Describe the mission, objectives, and features of the International Finance Corporation (IFC).
7. Discuss the functions and basic principles of UNCTAD.
a. Asian Development Bank (ADB)
b. United Nations Industrial Development Organization (UNIDO)
c. International Trade Centre (ITC)
d. General System of Preferences (GSP)
e. Global System of Trade Preferences (GSTP)
REFERENCES
Adhikary, M. (2001). Global Business Management. New Delhi: Macmillan India.

Bennett, R. (2003). International Business. New Delhi: Pearson Education.
Bhall, V. K. and S. Ramu (2004). International Business, 8th ed. New Delhi: Anmol Pub.
Daniels, J. (2004). International Business: Environments and Operations, 9th ed. New Delhi: Pearson Education.
Francis, C. (2003). International Business Environment, 1st ed. Mumbai: Himalaya Publishing House.
Helen, D. (2003). International Management: Managing Across Borders and Cultures, 4th ed. New Delhi: Prentice-Hall.
John, D. and L. Radebaugh (2002). Business Environment. New Jersey: Prentice Hall.
——— International Business, 8th ed. New Jersey: Prentice Hall.
Rao, S. (2005). International Business [Text and Cases], 4th ed. Mumbai: Himalaya Pub.
Rugman, A. M. (2005). International Business, 3rd ed. New Jersey: Prentice Hall.
Sharam, V. (2005). International Business: Concept, Environment and Strategy. New Delhi: Pearson Education.
CHAPTER 30
World Trade Organization
CHAPTER OUTLINE
Background
Meaning and Agreements
Functions
Principles of Trading
Provisions for Developing Countries
Other Provisions
The WTO Agreement
Liberalising Trade in Goods
Textiles—Back in the Mainstream Rules
Agriculture: Fairer Markets for All
Trade Remedies
Standards and Procedures
Administrative Procedures
Investment Measures
Disputes Settlement Mechanisms
Ministerial Meetings
Trade-related Aspects of Intellectual Property Rights (TRIPs)
Trade-related Investment Measures (TRIMs)
Non-tariff Barriers (NTBs) and Dispute Settlement Mechanism
Anti-dumping Measures
Subsidies
Singapore Ministerial Meeting, 1996
Geneva Ministerial Meeting, 1998
Seattle Ministerial Meeting, 1999
Doha Ministerial Meeting, 2001
Cancun Ministerial Meeting, 2003
WTO from 2005 to 2008
Geneva Package, 2004
Hong Kong Ministerial Conference, December 2005
Key Outcomes and Timelines of the Hong Kong Ministerial Declaration of WTO
Recent WTO Proposals
Conclusion
Summary
Key Words
Questions
References
BACKGROUND
The World Trade Organization (WTO) is one of the most important institutions dealing with
international economic relations. In broad terms, its role is twofold. One, to establish and enforce the
rules of the road for international trade in both goods and services. Two, to progressively liberalise
that trade, in 2006 valued at close to US$12,083 bn every year. While the WTO began its life on
January 1, 1995, its origins are more than half-a-century old. They lie in the economic and social
disaster of the Great Depression of the 1930s. At this time in history, countries turned inwards and
provoked a descending spiral of declining output and trade. The reaction in terms of trade policy was
to resort to extreme protectionism. This meant raising tariffs and other trade barriers to such a level
that imports were drastically reduced. Discriminatory arrangements that favoured some countries and
excluded others became the name of the game.

The World Trade Organization (WTO) is one of the most important institutions dealing with international economic
relations.
The Second World War followed. The war taught many important lessons. One of the most
important was that a secure political future could not be built without a greater economic security.
The search was on for better international instruments of international cooperation. This search bore
fruit at a conference held in Bretton Woods in the United States in 1944. At this Conference, the
International Monetary Fund (IMF) and the World Bank (WB) were created to deal with matters such
as currency instability and financing of post-war reconstruction.
Attempts to create a counterpart, the International Trade Organization (ITO), to deal with problems
of international trade took much longer. An interim arrangement was agreed among a limited number
of countries. However, it did not deal with many of the important aspects of international trade. This
arrangement took the form of the General Agreement on Tariffs and Trade (GATT) and came into
being in 1948. The fully developed answer to the question of what would be the institution to deal with
international trade came half a century later. It came with the birth of the WTO.
Notwithstanding the early failure to create an ITO, there were significant improvements in the
conduct of world trade in the post-war period. This was largely due to two key insights on the part of
those who were responsible for the trade policy. Firstly, there was a realisation that the road to post-
war economic recovery lies only in the progress towards open markets and liberalised trade.
Secondly, trade would not grow unless traders themselves could count on a degree of stability and
predictability in the system. The best way of achieving this was to develop a mutually agreed set of
rules, binding on all members and enforceable through a dispute settlement. Trade would be
conducted according to rules—not by the power of individual nations. Together, these two insights
have shaped the multilateral trading system, and have been fundamental to its success.
The improvements in the post-war trading system have manifested themselves in a variety of ways.
Since 1948 the world trade has consistently grown faster than the world output. In fact, the volume of
trade in goods has grown by an average of 6 per cent a year, whereas the world merchandise output
has increased by 4 per cent a year. In volume terms, that represents an 18-fold increase in the world
trade since 1948. The exports of manufactured goods are now 43 times larger than it was 50 years
ago. The end result is that around one quarter of world production is now traded. This means that one
quarter of world production is subject to the rules of international trade. The institution that creates
and enforces those rules is the WTO.

The end result is that around one quarter of world production is now traded. This means that one quarter of world
production is subject to the rules of international trade. The institution that creates and enforces those rules is the WTO.
Much of the post-war trade expansion can be traced to eight rounds of multilateral trade
negotiations carried out under the auspices of GATT. Each round involved more countries than the
one before. It resulted in dramatic reductions in tariffs on industrial goods. Average tariffs among the
industrialised counties were progressively cut from between 40 per cent and 50 per cent to less than 4
per cent. Most of the non-tariff restrictions—such as quantitative restrictions (QRs)—were
abandoned. As for rules, those contained in the original GATT of 1947 were developed and
elaborated in the light of experience. In this manner, the market-access gains achieved through tariff-
cuts could not be cancelled out by new trade barriers such as subsidies, discriminatory technical
standards, and unreasonable regulations and procedures.
Notwithstanding the considerable expansion in trade, the GATT was in some ways an unsatisfactory
instrument. It was a provisional and makeshift agreement pressed into service because the ITO was
stillborn. Its arrangements of settling disputes were ineffective. If governments chose to disregard the
dispute settlement rulings then they could—and they did. Also, the reach of the GATT rules did not go
beyond trade in goods. The time had come when international commerce also embraced trade in
services and trade-related aspects of intellectual property rights (IPR). As a result, GATT was
replaced by the WTO. The WTO comprises a wide variety of legally binding multilateral trade
agreements covering a vast area of international activity. The rules contained in these agreements are
adhered to by almost 150 countries accounting for well over 90 per cent of the world trade. It was
with the successful conclusion of the Uruguay Round—the eighth round of negotiations under the
auspices of GATT—that the WTO came into being on January 1, 1995.

The WTO comprises a wide variety of legally binding multilateral trade agreements covering a vast area of international
activity.
Thus, it is the WTO which now provides the legal ground rules for international commerce. It has
extended the reach of multilateral trade rules far beyond merchandise trade to trade in services and
trade-related aspects of IPR. The rules also deal with numerous other areas such as dumping, custom
procedures, technical barriers to trade, and sanitary and phytosanitary (SPS) measures. The existing
rules have themselves been greatly strengthened and the effectiveness of the dispute settlement system
has increased greatly. The rules are contained in multilateral trade agreements which are essentially
contracts binding the governments to operate their trade policies in accordance with what was agreed
in the multilateral negotiations.
Why are these agreements that are described as multilateral agreements opposed to global or
international agreements? The answer lies in the fact that while almost 153 countries of the world are
members of the WTO, as on 23 July 2008, some are not. These agreements are very different from
regional trade agreements such as the European Union (EU), NAFTA (North American Free Trade
Agreement), or ASEAN (Association of Southeast Asian Nations) Free Trade Area. Regional trade
agreements have a narrower participation in terms of parties to the agreements. The WTO system is
commonly referred to as the “open and liberal rule-based multilateral trading system”. It is open and
liberal because of the process of progressive removal of trade restrictions. It is a rule-based one as
international trade is conducted according to the agreed rules.

The WTO system is commonly referred to as the “open and liberal rule-based multilateral trading system”.
MEANING AND AGREEMENTS
Different Things to Different People
Perhaps, it is important to recognise at an early stage that the WTO is not without its critics. In
general terms, we frequently hear of what the WTO does and does not do or what it should and
should not do. The criticisms include the accusation that the WTO is non-transparent, non-
democratic, and non-accountable to the public. We hear that the WTO is harmful for the environment
and not sufficiently supportive of any economic development. Nevertheless, is important to make the
following point. When we talk of the WTO, it means different things in different contexts.

The criticisms include the accusation that the WTO is nontransparent, non-democratic, and non-accountable to the public.
Box 30.1 Genesis of WTO
Year Event
The General Agreement on Trade and Tariffs (GATT)
was drawn up to record the results of tariffs
1947
negotiations among 23 countries. The agreement
entered into force on January 1, 1948.
The GATT provisionally entered into force.
Delegations from 56 countries met in Havana, Cuba,
to consider the final draft of the International Trade
1948
Organization (ITO) Agreement; in March 1948, 53
countries signed the Havana Charter establishing an
ITO.
China withdrew from GATT. The US administration
1950 abandoned its efforts to seek a congressional
ratification of the ITO.
A review session modified numerous provisions of
the GATT. The United States was granaed a waiver
1955
from GATA disciplines for certain agricultural
policies. Japan acceded to GATT.
Part IV (on trade and development) was added to the
GATT, establishing new guidelines for trade policies
1965 of and towards the developing countries. A committee
on trade and development was created to monitor
implementation.
The agreement regarding international trade in
textiles, better known as the Multifiber Agreement
(MFA), came into force. The MFA restricted the
1974
export growth in clothing and textiles to 60 per cent
per year. It is renegotiated in 1977 and 1982, and a
gain extended in 1986, 1991, and 1992.
The Uruguay Round is launched in Punta del Esta,
1986
Uruguay.
In Marrakesh, on April 15, the ministers signed the
1994 final act, establishing the WTO and embodying the
results of the Uruguay Round.
1995 The WTO came into force on January 1.
The ministerial meeting in Seattle failed to launch a
new round. Wide-scale protests in Seattle and
1996 elsewhere on the proposed inclusion of labour clause
in the WTO, was the main cause for the failure of the
meet.
2001 Doha Ministerial Meet.
Fifth Ministerial Meet in Cancun, Mexico, from
2002
September 10–14, 2003.
Sixth Ministerial Meet was held in December 2005 in
2005
Hong Kong.
The mini-Ministerial Conference of the WTO that was
held in Geneva during June–July 2006 ended in a
2006
deadlock, conference over the issues that were raised
by the developing countries.
Another mini-Ministerial Conference in Davos in
January and yet another meet in July to finish
2007 negotiations.
Source: Statistical Outline of India 2007–08, published by Tata Services Ltd., Department of Economics and Statistics, Mumbai.

Agreements. For example, the WTO is a set of agreements that create legally binding rights and
obligations for all members. So too, do the commitments to provide an agreed degree of openness of
domestic markets to imported goods and services. The agreements and commitments have been
negotiated multilaterally and agreed to by all WTO members.
Negotiations. The WTO is also an intergovernmental forum where delegations from member
countries meet to discuss and negotiate a number of trade-related matters. In the Trade Policy Review
Body, for example, governments periodically review the trade policies of other members. They also
discuss recent developments in the multilateral trading system.
Secretariat. The WTO is also sometimes referred to in the context of a relatively small secretariat.
The 500 staff members have neither enforcement powers nor any role in the interpretation of the
legal rights and obligations of members. It has an annual budget of less than $90 mn. It is one of the
smaller international organisations dwarfed by the WB, United Nations, IMF, and numerous other
organisations. It is located in Geneva and headed by a Director General (DG).
Governments. Most importantly, the WTO comprises almost 153 sovereign states, the vast
majority of which are democratically elected. They have collectively agreed to conduct their trade
according to multilaterally agreed rules that have been agreed to on a consensus basis. After an
agreement is reached between trade negotiators, the agreements are ratified by the domestic
parliaments of all WTO members countries. To criticise the WTO is—in practical terms—to criticise
the collective action of close to 150 sovereign states acting on the basis of consensus and according
to the rules accepted by their national parliaments.
FUNCTIONS
Institutional Characteristics
Before turning to the substance of the world of the WTO, it is perhaps useful to look at its
institutional characteristics. Formally speaking, the WTO Agreement comprises all specific trade
agreements—such as those relating to agriculture, services, or anti-dumping. They are attached to the
agreement establishing WTO. This agreement was signed in Marrakesh on April 15, 1994, and
marked the closure of the Uruguay Round. The specific agreements come in the form of four
annexures. These annexures contain the multilateral trade agreements as well as other understandings
and decisions reached during the Uruguay Round negotiations. All individual WTO members have
accepted all these—it is all or nothing.

The WTO Agreement comprises all specific trade agreements, such as those relating to agriculture, services, or anti-
dumping.
Ministerial Conferences
The institutional structure of the WTO is such that it is headed by a Ministerial Conference. This is
composed of all members of the WTO and meets at least once in every two years. One such meeting
was in Cancun, Mexico, in September 2003. Prior to that, the ministers met in Doha, Qatar, in 2001,
and in Seattle in 1999. They also met in Singapore in 1996 and Geneva in 1998. Between the sessions
of the Ministerial Conference, the General Council exercises the functions of the Ministerial
Conference. It is also made up of the full membership of the WTO. It is responsible for the continuing
management of WTO and supervises all aspects of its activities. The General Council also meets as
the Dispute Settlement Body (DSB) and as the Trade Policy Review Body.

The institutional structure of the WTO is such that it is headed by a Ministerial Conference. This is composed of all members
of the WTO and meets at least once in every two years.
Taking Decisions
As mentioned earlier, an important characteristic of the decisions taken in the WTO is that they are
adopted on the basis of consensus. An issue is first discussed to the point of all members agreeing, or
at least not opposing the decision. To the extent that voting takes place, it is a mere formality. It is
usually concerned with the pre-negotiated terms of accession of a country to the WTO, or, perhaps, a
waiver to permit a member to deviate from a certain rule. Formally each WTO member has one vote.
The normal rule is that a decision is taken according to the majority of the votes cast. Matters are far
more complicated when it comes to amendments to WTO rules. For certain key articles such as those
relating to non-discrimination, no change is possible unless all members agree formally.

An important characteristic of the decisions taken in the WTO is that they are adopted on the basis of consensus.
Settling Disputes
A further important feature of the WTO is its dispute settlement process. This lies at the heart of
WTO. In all of the diverse multilateral trade agreements, breaking the rules means being taken to
court; in fact, the same court for all breaches of agreement. If, as a result of an enquiry, measures are
found to be in error with respect to WTO rules, they have to be brought into conformity with the
WTO obligations. If they are not, then compensation and retaliation—with the approval of the
General Council sitting as the DSB—are provided for and in this context, the inter-relationship
between the trade agreements is critical. Compensation, for example, can be sought in the form of
improved market access in any of the areas covered by the multilateral trade agreements. It is not
necessarily with respect to the agreement where the breach of obligations was committed.

DSB is the WTO General Council which meets to settle trade disputes.
PRINCIPLES OF TRADING
Much in Common
The various multilateral agreements are sometimes complex and difficult to understand. However,
they are all underpinned by the same basic principles. Understanding these principles simplifies the
task of comprehending the agreements.
Non-discrimination. The pillar of the rule-based multilateral trading system is non-discrimination.
But what does this mean in operational terms? How is it interpreted in the various WTO agreements?
In answering these questions, there are two important aspects to consider as follows:
MFN. Firstly, non-discrimination means that countries cannot discriminate between the same goods coming from different trading
partners. This principle is known as “most-favoured-nation, or MFN” treatment. The name sounds like a contradiction. It
suggests some kind of a special or favoured treatment for one specific country. But in WTO, it actually means the opposite. What
happens under the WTO Agreement is this. Each member treats all the other members equally as “most favoured” trading
partners. If a country improves the benefits that it gives to one member, it has to give the same “best” treatment to all other
members. In this manner, they all remain “most favoured”. This has very practical implications. Grant someone a special favour
—such as in terms of a lower tariff—then you have to do the same for all other WTO members.

MFN treatment—that is, the most favoured nation treatment is the principle of not discriminating between one’s
trading.
National Treatment. However, in WTO rules, non-discrimination applies not only to goods and services from different
supplying countries, but it also means that imported and locally produced goods should be treated equally even after the
foreign goods have entered the local market. Foreign goods and services cannot be discriminated against the local market just
because they are imported. This principle of “national treatment” means giving the product of other countries the same treatment
as one’s own national products. But it also means that charging customs duties on an imported good is not a violation of national
treatment even if the locally produced products are not charged an equivalent tax. National treatment only applies after border
regulations have been dealt with.

National Treatment—that is, the principle of giving other the same treatment as one’s own nationals.
Freer Trade. Some of the multilateral trade agreements are also characterised by provisions to
ensure that trade is carried out in a progressively freer manner. In the past, tariff negotiations were
launched periodically under the auspices of the GATT. While industrial tariffs have been greatly
reduced over the past 50 years, tariff negotiations remain an important aspect of the Doha
Development Agenda. With respect to agricultural products, all non-tariff barriers have been
eliminated and substituted by tariffs. However, these tariffs are in many cases at very high levels, and
an objective of the 2004 agricultural negotiations is to reduce them. Similarly, as far as services trade
is concerned, there is a WTO Agreement which establishes a multilateral framework providing for
the progressive liberalisation of trade in services.
Predictable and Transparent. A further characteristic of the multilateral trading system is the
importance it assigns to conducting business in a predictable and transparent manner. This means that
foreign companies, investors, and governments should be confident that trade barriers will not be
raised arbitrarily. The WTO has created a wide variety of obligations and notification procedures to
ensure that regulations affecting international trade are publicly and freely available. In addition, the
WTO Trade Policy Review Mechanism provides the possibility for WTO members to discuss the
trade policies of other countries. A further important means to ensure security and predictability in
the market transactions is through the commitment to bind market openness. A “bound” tariff, for
example, is a tariff where there is a legal commitment of not to raise it beyond the bound level. The
“binding of a tariff” is considered to be an important contribution to market openness and a
legitimate contribution to the process of trade liberalisation.

The “binding of a tariff” is considered to be an important contribution to market openness and a legitimate contribution to
the process of trade liberalisation.
PROVISIONS FOR DEVELOPING COUNTRIES
Growing Number
Developing countries account for more than two-thirds of the total WTO membership. They
rightfully expect the multilateral trading system to contribute positively to their development
prospects. As a consequence, they play an increasingly important role in all aspects of the work of the
WTO. The outcome is that much attention is paid in the multilateral trading system to the special
needs and problems of developing countries.

Developing countries account for more than two-thirds of the total WTO membership.
Need for Flexibility
The need for additional flexibility with regard to GATT obligations for the developing countries in
terms of their use of commercial policy instruments has long been recognised. For example, the
structural nature of their balance of payment (BoP) problems was recognised almost half a century
ago, along with the flexibility needed in terms of maintaining BoP restrictions. Similarly, the
developing countries have long been able to adopt measures deviating from GATT obligations for
the promotion of a particular industry.
Trade and Development
In fact, in 1965 a special section called the “Trade and Development” was added to the GATT. This
section recognised the need for a rapid and sustained expansion of the export earnings of the less
developed countries (LDCs). To this effect, the developed countries were called upon to assign high
priority to the reduction and elimination of barriers to products of export interest to developing
countries. It also codified in the multilateral trading system the concept of non-reciprocity in trade
negotiations between the developed and the developing countries.

This section recognised the need for a rapid and sustained expansion of the export earnings of the LDCs.
Enabling Clause
The Trade and Development Section of the GATT was further elaborated at the end of the 1970s in the
discussion which has come to be known as the “enabling clause”. This decision consolidated the
concept of “differential and more favourable treatment for developing countries” as well as the
principle of non-reciprocity in trade negotiations. The most significant provision of the enabling
clause is the one which enables members to accord differential and more favourable treatment to
developing counties as a departure from the MFN clause. A number of categories of such treatment
are identified, including preferential tariff treatment accorded by the developed countries to products
originating in the developing countries.
OTHER PROVISIONS
There are other special provisions in favour of developing countries in the WTO multilateral trade
agreements, which include provisions that require WTO members to safeguard the interests of the
developing countries, when adopting their own trade measures; the provision of technical assistance
in the implementation of commitments undertaken by the developing countries; and also providing
technical assistance to ensure that the developing countries benefit from the outcome of negotiations.
Least Developed Countries (LDCs)
What is clear, however, is that while a number of developing countries have benefitted from the
multilateral trading system, the advantage they have drawn has been far from uniform. Some have
done much better than others. Most worrying of all is the position of the world’s 49 poorest nations.
These countries are classified by the United Nations as least developed countries (LDCs). With 10.5
per cent of the world’s population, they account for one-half of 1 per cent of the world trade. This
tiny share is shrinking. Many of these countries are saddled with enormous debts, lack of
infrastructure, and are starved of investment. The LDCs receive an extra attention in the WTO. For
example, WTO members have agreed on a plan of action for the LDCs. This envisages special efforts
to improve access to the markets of the developed countries, including the possibility of removing the
tariffs completely.

These countries are classified by the United Nations. These countries with 10.5 per cent of the world’s population account
for one-half of 1 per cent of the world trade.
Gradual Evolution
The development of the rule-based multilateral trading system has been a gradual one and the
evolution has progressed through many rounds of negotiations. The importance of these rounds
cannot be overemphasised. The most recent of the completed rounds was the Uruguay Round. The
current round is the Doha Development Agenda.
Package Approach
Negotiating through rounds of negotiation can be lengthy. The Uruguay Round took seven-and-a-half
years. However, negotiating agreements in the context of rounds has its advantages. They offer a
package approach to trade negotiations that can sometimes be more fruitful than the negotiations on a
single issue. The size of the package can mean more benefits because participants can seek and secure
advantages across a wide range of issues.
Making Trade-offs
In such a package, the ability to trade off different issues can make an agreement easier to reach. Not
all the outcomes of each of the issues under negotiation is necessarily of benefit—or even of interest
to every country. Nevertheless, for everyone to agree, each country must see that it is in their interest
to adopt the total package. In this manner, a reform in politically sensitive sectors of world trade such
as agriculture can be more feasible in the context of a global package if an agriculture reform is
complemented by other market openings. As far as developing countries are concerned, they have a
greater chance of influencing the multilateral trading system in a trade round than in bilateral
negotiations with powerful trading nations.

As far as developing countries are concerned, they have a greater chance of influencing the multilateral trading system in a
trade round than in bilateral negotiations with powerful trading nations.
Strengths and Weaknesses
But wide-ranging rounds have both strengths and weaknesses. The results of the ongoing debate on
the effectiveness of multi-sector rounds vs single-sector negotiations are ambiguous. At some stages,
the Uruguay Round seemed so cumbersome that reaching an agreement on every subject by all
participating countries appeared impossible.
The Longest of Them All
The Uruguay Round extended from 1986 to 1994 and was by far the largest, longest, and most
productive of the eight rounds of GATT negotiations. It was preceded by seven other rounds,
including the Dillon Round, Kennedy Round, and the Tokyo Round. In some respect, the Uruguay
Round was just more though much more of what had gone before in earlier rounds. The tariffs on
industrialised products were reduced and the defences against non-tariff barriers were strengthened.
The Uruguay Round also reversed earlier failures.

The Uruguay Round extended from 1986 to 1994 and was by far the largest, longest, and most productive of the eight
rounds of GATT negotiations.
The member governments agreed to phase out restrictions on textiles and clothing. They agreed to
ban the so-called “grey area” measures, where governments agreed to operate outside the rules of the
trading system and do private deals to restrict trade. These arrangements were particularly prevalent
in the area of textiles and clothing. The governments also made a start on a long-term effort to
reform trade in the agricultural products. In addition, they negotiated a brand new set of rules,
together with initial market-opening measures, for trade in services. This was a dynamic area of
world trade they had not previously touched. Another new agreement set out rules on minimum
protection to be given to IP through, for example, patents, copyright, and measures against
counterfeiting.
Further, the adoption of the integrated dispute settlement mechanism applying to all areas of trade,
that is, goods, services, and IPR, now provides a solid basis for the multilateral trading system. The
overall results of the Uruguay Round are contained in more than 500 pages of legal texts, plus over
26,000 pages of schedules. These schedules are commitments to provide market access to other
countries for both goods and services. They are an integral part of the WTO Agreement. The whole
package of trade liberalisation and rules was firmly tied together in the agreement establishing the
WTO and placing it under the responsibility of the new institution.

The whole package of trade liberalisation and rules was firmly tied together in the agreement establishing the WTO and
placing it under the responsibility of the new institution.
THE WTO AGREEMENT
What is It
In formal terms, the agreement establishing the WTO is the legal instrument through which all the
countries participating in the Uruguay Round decided to create the WTO. It is a short agreement and
includes provisions on a variety of matters, which include the scope and functions of the WTO and its
relations with other organisations. It also sets out matters that are relating to the legal status of the
WTO and its decision-making procedures.

The agreement establishing the WTO is the legal instrument through which all countries participating in the Uruguay round
decided to create the WTO.
More than a Short Agreement
All the multilateral trade agreements relating to services, agriculture, IP, and so on, which emerged
from the Uruguay Round are annexed to the agreement establishing the WTO. As a result, the
expression “the WTO Agreement” is understood to cover the totality of all the agreements. These
texts are to be found in the volume entitled The Results of the Uruguay Round of Multilateral Trade
Negotiations: The Legal Test.
Bad News and Good News
The WTO agreement is an intimidating document. Its table of contents (TOC) is a list of about 60
agreements, annexures, decisions, and understandings. They are complex and, at times, very difficult
to understand. The good news is, however, that while the WTO Agreement is difficult, and deals with
very different matters, the individual multilateral trade agreements are all underpinned by the same
core principles such as non-discrimination and transparency.

The WTO agreement is an intimidating document. Its table of contents (TOC) is a list of about 60 agreements, annexures,
decisions, and understandings.
Where Are We Today
Returning to the two key roles for the multilateral trading system, liberalising trade and creating and
enforcing the rules of the road, let us take stock of where we are today in terms of the liberalisation
process and the rules that govern international trade.
LIBERALISING TRADE IN GOODS
Industrial Goods: Tariffs

WTO negotiations produce general rules that apply to all members and specific commitments made
by the individual member governments. The specific commitments are listed in “schedules of
concessions”. For trade in goods, in general, these consist of the maximum tariff levels that a country
can apply to a specific product. For agriculture, they also include tariff quotas, limits on export
subsidies, and some kinds of domestic support.

WTO negotiations produce general rules that apply to all members and specific commitments made by the individual
member governments.
Tariffs and Developed Countries
With the implementation of the Uruguay Round results, the tariffs on industrial products imported by
the developed countries were reduced by 40 per cent on an average, from 6.3 per cent to 3.8 per cent.
These tariff reductions are now fully implemented. The proportion of industrial products which enter
the markets of developed countries and face zero MFN duties more than doubled from 20 per cent to
44 per cent of the industrial imports. The share of industrial imports facing duties of 15 per cent or
more decreased from 7 per cent before the Uruguay Round to 5 per cent after the full implementation.
Tariff peaks, that is, high tariffs on individual items, continue to be of concern mainly in textiles,
clothing, leather, rubber, footwear, and travel goods.

The tariffs on industrial products imported by developed countries were reduced by 40 per cent.
Tariffs and Developing Countries
As far as the developing countries are concerned, the tariff levels and the continuing process of
negotiated reductions varies considerably. India, for example, would have reduced its average tariff
on industrial goods from 71 per cent to 32 per cent by the end of 2005, and Korea’s average tariff
will be reduced from 18 per cent to 8 per cent. Most other developing countries have offered a
mixture of tariff reductions and ceiling bindings. The tariff reductions agreed to by the developing
countries in the Uruguay Round were fully implemented by 2005.

As far as the developing countries are concerned, the tariff levels and the continuing process of negotiated reductions
varies considerably.
Binding of Tariffs
As noted, market access schedules are not simply announcements of reduced tariff rates. They are
also commitments of not to increase tariffs above the listed bound rates. For the developed countries,
the bound rates are generally the rates actually charged. Most of the developing countries have bound
the rates somewhat higher than the actual rates, and so the bound rates serve as ceilings.
Tariffs are Bound ... But
Countries can break a commitment of not to raise a tariff above the bound rate but only with
difficulty. To do so they have to negotiate with the countries most affected, and that could result in a
compensation for a trading partner ’s loss of trade.

Countries can break a commitment of not to raise a tariff above the bound rate but only with difficulty.
TEXTILES—BACK IN THE MAINSTREAM RULES
Fighting the Goods Fight
On a sectoral basis, liberalising trade in textile and clothing was a challenge facing the GATT for
some years. Creating an agreement to phase out QRs on textiles and clothing was one of the longest
and hardest-fought issues in the GATT. However, as a result of the Uruguay Round, it is now a
challenge facing the WTO. The trade in this sector is now going through a fundamental change under
a 10-year schedule to phase out QRs.
Outside the System
This means that the system of discriminatory import quotas that has dominated textile trade since the
early 1960s is being phased out. By 1974 till the end of the Uruguay Round, the trade in texiles and
clothing was governed by the MFA. The MFA was a framework for bilateral agreements on unilateral
actions that was a derogation from the rules of the GATT.
The MFA—a Derogation
The bilateral agreements came in the form of quotas limiting imports from the developing countries
into the markets of the developed countries. Industries in the developed countries were facing a
serious damage from rapidly increasing imports. The quotas were the most visible feature of the
MFA. They conflicted with the GATT’s general preference for customs tariffs instead of measures
that restrict quantities. They were also exceptions to the GATT principle of treating all trading
partners equally: in fact, they specified how much the importing country was going to accept from the
individual developing countries.

The bilateral agreements came in the form of quotas limiting imports from the developing countries into the markets of the
developed countries.
Back in the Mainstream
By 2005, the sector was fully integrated into normal GATT rules. In particular, the quotas came to an
end. The importing countries no longer are able to discriminate among the exporters. The agreement
on textiles and clothing (ATC) by itself no longer exists. In fact, it is the only WTO Agreement that
has self-destruction built in.
AGRICULTURE: FAIRER MARKETS FOR ALL
Outside the System
The other sector that was continually at the centre of a heated debate in the GATT and now the WTO
is the agriculture sector. While the original GATT applied to agricultural trade, it contained
loopholes. For example, it allowed countries to use some non-tariff measures such as import quotas,
and to heavily subsidise the activities in this sector. Production and trade in agricultural products
became highly distorted. This was especially due to the use of export subsidies that would have
normally been outlawed for industrial products.
Agreement on Agriculture on Centre Stage
The WTO Agreement on agriculture is a significant first step towards fair competition and less-
distorted trade in agricultural products. It is being implemented over a six-year period with 10 years
for developing countries. The process began in 1995.

The WTO Agreement on agriculture is a significant first step towards fair competition and less-distorted trade in
agricultural products.
Objectives of the Agreement
The most fundamental objective of the agreement is to introduce a reform that will make agricultural
policies more market oriented. The rules and commitments spelled out in the agreement are broadly
directed at three areas. Firstly, improving the market access by removing the various trade
restrictions confronting imports. Secondly, reducing the domestic support in the form of trade-
distorting subsidies and programmes that raise or guarantee farm-gate prices and farmers’ incomes.
And finally, dealing with export subsidies and other methods used to make exports artificially
competitive. Although these are the objectives of the agreement, it should be noted that governments
are permitted to support their rural economies. The preference under the agreement, however, is for
this to be done through policies that do not distort trade.

The most fundamental objective of the agreement is to introduce a reform that will make agricultural policies more market
oriented.
A Better Deal for Developing Countries
There are also special provisions for developing countries in the agreement on agriculture. They do
not have to cut their subsidies or lower their tariffs as much as developed countries. They are also
given extra time to fulfil their obligations. Special provisions are designed to protect the interests of
those countries that rely on the imports for their food supplies. There are also special provisions for
LDCs.

Special provisions are designed to protect the interests of those countries that rely on the imports for their food supplies.
TRADE REMEDIES
Key Agreements
Binding tariffs and applying them equally to all trading partners is the key to the smooth flow of trade
in goods. However, there is more to secure market access than that. It is important, for example, to
ensure that the trading conditions are fair, and that industries in trouble on a short-term basis can have
short-term protection. Three agreements are important in this respect. The first one deals with the
actions that are taken against dumping, that is, selling a product at unfairly low prices. The second
one addresses subsidies that distort competition. And finally, the agreement that deals with emergency
measures to limit the unexpected surges in imports, thereby “safeguarding” the domestic industries.
Let us look at each of these agreements briefly.
Anti-dumping Actions. It is the action taken against dumping. If a company exports a product at a
price lower than the price it normally charges in its own home market, it is said to be “dumping” the
product. Is this unfair competition? Opinions differ. But many governments take action against
dumping in order to defend their domestic industries. The focus of the WTO’s anti-dumping
agreement is on how governments can or cannot react to dumping. Broadly speaking, the agreement
allows but does not oblige, governments to act against dumping. To take antidumping action, a
government must show that dumping is taking place. That means calculating the export price and
comparing it to the exporter ’s home market price. It is then necessary to show that the dumping is
causing injury, and there is a causal link between the dumped goods and injury that is resulting.

GATT 1994 permits the implementation of anti-dumping duties against dumped goods, which causes injury to producers of
competing products in the importing country.
Subsidies and Countervailing Measures. The agreement on subsidies and countervailing

measures defines the term “subsidy” and provides that only specific subsidies are subject to its
disciplines. The criteria for establishing whether a subsidy is “specific” to an industry are laid down.
These are based mainly on their propensity to distort trade. Subsidies are classified as either
prohibited or actionable subsidies. For each category of subsidies the agreement provides different
remedies. The agreement also contains provisions on the use of countervailing measures: the
disciplines relating to countervailing measures are, broadly speaking, similar to those applicable to
anti-dumping cases.
Safeguarding Producers. The agreement on safeguards permits countries to take “safe-guard”
action to restrain the unexpected surges of imports when certain specific conditions are met. This
provides a “safety valve” when there is a surge of imports. This may come, for example, after a tariff
reduction has been implemented. Havin g such a safety valve may encourage countries to undertake
liberalisation commitments that they may not otherwise undertake. It is also a means of avoiding
private bilateral agreements with competitive exporters through the so-called “grey area” measures.
These come in the form of “voluntary” export restraints or other marketsharing agreements. They
have affected trade in several industrial sectors such as automobiles, steel, and electronic products.
They generally work to the disadvantage of the weaker trading partners, particularly the developing
countries. The WTO’s agreement on safeguarding establishes a prohibition against “grey area”
measures and sets a “sunset” clause on all the existing safeguard measures.

Action taken by the importing country, usually in the form of increased duties to offset subsidies given to producers or
exporters in the exporting country.
Action taken to protect a specific industry from an unexpected build-up of imports.
STANDARDS AND PROCEDURES
Technical Barriers to Trade
Access to markets can also be impeded through the use of technical standards. A number of
agreements deal with various technical, bureaucratic, or legal issues that could create hindrances to
trade.
Standards and Technical Regulations. Technical regulations and industrial standards are
important, but they vary from country to country. Having too many different standards makes life
difficult for producers and exporters. If the standards are set arbitrarily, they could be used as a
disguised protection. The agreement on technical barriers to trade tries to ensure that technical
regulations, standards, and conformity assessment procedures do not create unnecessary obstacles to
trade.

Right to Adopt Standards. However, the agreement recognises the countries’ rights to adopt the
standards they consider appropriate. This may be for human, animal, or plant life, or health, for the
protection of the environment, or to meet other consumer interests. Moreover, members are not
prevented from taking measures that are necessary to ensure that their standards are met in order to
prevent too much diversity. The agreement encourages the countries to use international standards
where these exist. They can also employ other mechanisms such as equivalence and mutual
recognition of the standards of others.
Sanitary and Phytosanitary Measures (SPS)
Sanitary and phytosanitary (SPS) measures are measures taken to protect human, animal, or plant life
from risks arising from additives or disease-causing organisms in food. They are also used to protect
a country from the damage caused by the spread of pests. The agreement on the implementation of
SPS measures applies to all such measures which may, directly or indirectly, affect international
trade.

SPS measures or regulations are the government standards to protect human, animal, and plant’s life and health, to help to
ensure that food is safe for consumption.
Role for Scientific Evidence
The governments have the right to take SPS measures. However, they have to ensure that these
measures do not arbitrarily or unjustifiably discriminate among countries where the same conditions
prevail. Moreover, SPS measures must not be applied in a manner which would constitute a disguised
restriction on international trade. They must be based on scientific evidence. As in the case of the
technical barriers to trade agreement, the governments are encouraged to base their measures on
international standards, guidelines, and recommendations whenever and wherever possible.
ADMINISTRATIVE PROCEDURES
Red Tape and Trade
The WTO Agreement also deals with the very basic processes than can have an important influence
on the flow of trade.

The WTO Agreement also deals with the very basic processes than can have an important influence on the flow of trade.
Customs Valuation. For example, it is important for importers to know that the value placed on
imported goods by customs officials is fair and uniform. It is also important from the point of view
of the customs administration that fictitious values are not declared for customs’ purposes. The
agreement on customs valuation provides a set of valuation rules to ensure that these objectives are
met.
Import Licensing. A further potential barrier to trade relates to import-licensing systems that are
applied to administrate QRs. The agreement on import-licensing procedures says that the procedures
should be simple, transparent, and predictable. The objective is also to ensure fair and equitable
application and administration of such procedures. It is also to ensure that the procedures do not
themselves have restrictive or distortive effects on imports.
Pre-shipment Inspection. The practice of employing specialised private companies to check the
shipment details such as price, quantity, and quality, for goods-ordered overseas is called “pre-
shipment inspection”. In particular, it is a process used by governments of some developing countries
to prevent capital flight and commercial fraud as well as customs-duty evasion. In a sense, it is a
means to compensate for inadequacies in the administrative procedures. The agreement on pre-
shipment inspection ensures a non-discrimination in the application of regulations which will relate
to pre-shipment inspection procedures as well as transparency through the prompt publication of
those regulations.
Rules of Origin. An administrative procedure, “rules of origin” can also restrict trade. They are
normally defined as the criteria needed to determine the territorial origin of a product. The main aim
of the agreement is to harmonise the non-preferential rules of origin so that the same criteria can be
applied by all the WTO members whatever their purpose may be.

It is important for importers to know the customs valuation and import-licensing systems, to check the shipment details and
the rules of origin defined as the territorial origin of a product.
INVESTMENT MEASURES
The agreement on trade-related investment measures recognises that certain investment measures
such as a minimum domestic content for exported goods can restrict and distort trade. It states that no
member shall discriminate against foreigners in the application of such measures. An illustrative list
of trade-related measures that are agreed to be inconsistent with the agreement is appended to it.
DISPUTES SETTLEMENT MECHANISMS
A Dispute About What?
What if some of the WTO members believe that the other members are violating trade rules in any of
the agreements mentioned so far? The answer is that they will use the multilateral system of settling
disputes instead of taking action unilaterally. That means abiding by the agreed procedures of the
WTO dispute settlement understanding (DSU). Typically, a dispute arises when one country adopts a
trade policy measure, or takes some action that one or more fellow WTO members consider to be
breaking the WTO Agreements. It can also arise when a member fails to live up to its obligations.
Rapid Settlement
The WTO DSU emphasises that a prompt settlement of dispute is essential if the WTO is to function
effectively. It, therefore, sets out in considerable detail the procedures and the timetable to be
followed in resolving the disputes. If a case runs its full course, it should not normally take more than
one year or 15 months if the case is appealed.

The WTO DSU emphasises that a prompt settlement of dispute is essential if the WTO is to function effectively.
Better than GATT
Under the previous GATT procedure, the rulings could only be adopted by the consensus. This meant
that a single objection could block the ruling. It was, therefore, possible for the losing country to
block the adoption of the ruling. The rulings are now automatically adopted unless there is a
consensus to reject them. Any country wanting to block a ruling has to persuade all other WTO
members including its adversary in the case, to share its view. Although much of the procedure does
resemble the procedure in a court or a tribunal, the preferred solution is for the countries that are
concerned to discuss their problems and settle the dispute by themselves.
Dispute Settlement
Settling disputes is the responsibility of the DSB which is the General Council in another guise. It has
the sole authority to establish a panel of experts to consider a case, and to accept or reject a panel’s
findings or the results of an appeal. It monitors the implementation of rulings and recommendations
and has the power to authorise retaliation when a country does not comply with a ruling.

DSB has the sole authority to establish a panel of experts to consider a case and to accept or reject.
Right to Appeal
Either side can appeal a panel’s ruling. Sometimes both sides do so. Appeals have to be based on
points of law such as legal interpretation. They cannot re-examine the existing evidence or examine a
new evidence.
More is Better
The WTO deals with an increasing number of dispute settlement cases. Does this mean that law and
order are breaking down? Not necessarily. Sometimes, it means that people are turning more to the
courts instead of taking the law in their own hands. There are strong grounds for arguing that the
increasing number of disputes is simply the result of the expanding world trade and the stricter rules
that are now applicable. The fact that more disputes are coming to the WTO reflects a growing faith
in the system.

The fact that more disputes are coming to the WTO reflects a growing faith in the system.
MINISTERIAL MEETINGS
When
The WTO was a result of not only the eighth round of multilateral trade negotiations, at Uruguay, but
it was also built on the progress made in the earlier rounds such as the Tokyo Round and the Kennedy
Round. The process of periodic meetings of ministers has been important in the progress of both
trade liberalisation and the development of rules, sometimes culminating in the launching of a round
of negotiations. The importance assigned by governments to ministerial meetings is underscored by
the fact that they formally agreed that with the creation of the WTO they would hold meetings of
ministers on a regular basis every two years.

The importance assigned by governments to ministerial meetings is underscored by the fact that they formally agreed that
with the creation of the WTO they would hold meetings of ministers on a regular basis every two years.
What Do They Do
The ministerial conferences guide the work of the WTO. The central tasks of the ministerial meetings
are threefold. Firstly, to review what the WTO has been doing. Secondly, to assess the present
situation of international trade relations and to identify the challenges that must be met. Finally, to
agree on the work programme of the WTO for the months and years ahead. This may, for example,
involve the launching of a new round of multilateral trade negotiations.
When and Where
The venues and years of WTO conferences that are held so far are as follows: Singapore, 1996;
Geneva, 1998; Seattle, 1999; Doha, Qatar, 2001; (during which the ministers agreed to launch the
Doha Development Agenda) Cancun, 2003; Geneva, 2004; Paris, May 2005; Hong Kong, December
2005; Geneva, 2006; Potsdam, 2007; and Geneva, July 2008. The objective was to take stock of
progress in the Doha Development Agenda, and to provide an impetus and direction to the process of
negotiations. Each of the ministerial meetings has been very different in terms of location, objectives,
and outcomes. As they have influenced the direction of the WTO, it is worth briefly reviewing each
ministerial meeting in turn, a little later in the chapter.

Each of the ministerial meetings has been very different in terms of location, objectives, and outcomes.
TRADE-RELATED ASPECTS OF INTELLECTUAL PROPERTY RIGHTS (TRIPS)
The subject of IPR or trade-related IPR (TRIPS) has always been very controversial. Intellectual
Property (IP) refers to “a creation of human mind that is of value to the society, while Intellectual
Property Rights (IPR) are rights granted by the state to persons over creation of their mind”. The
WTO’s agreement on TRIPS covers nine categories of IP:
1. Patents
2. Plant and seed variety
3. Micro-organism
4. Copyrights and neighbouring rights
5. Trademarks, including service marks
6. Industrial designs
7. Geographical indications
8. Integrated circuits
9. Trade secrets
The TRIPS Agreement is the most comprehensive multinational agreement on IP. The areas of IP that it covers are
copyrights and created rights.
For each of these categories, certain norms of protection are prescribed. These norms do not
necessarily have to be attained overnight. There is a transition period allowed. Legislations in most of
these items are at various stages of formulation and implementation. Under the TRIPS Agreement,
India agreed to accept applications from January 1, 1995 onwards. The applications are received in
the “mailbox” and are examined with effect from January 1, 2005. Further, the TRIPS Agreement also
makes it obligatory for India to grant exclusive marketing rights (EMRs) to pharmaceuticals and
agro-chemicals which have been given product patents and marketing approval in another member
country of the WTO. India’s major concerns in the area of IPR are as follows:

The TRIPS Agreement also makes it obligatory for India to grant exclusive marketing rights (EMRs) to pharmaceuticals and
agro-chemicals which have been given product patents and marketing approval in another member country of the WTO.
1. Granting of product patents to pharmaceuticals and agro-chemicals.

2. Patenting of micro-organisms or life forms, including patenting of products based on our biodiversity and traditional knowledge
in other parts of the world.
3. Establishing an effective “sui generis system” for the protection of new plant varieties and plant breeders’ rights, which
recognises and rewards the traditional contribution of rural communities to the conservation of biodiversity.
The product patent systems for pharmaceuticals and agro-products became effective from January 1,
1995. By implication, this means that the Indian industry, which enjoyed the freedom of the Indian
Patents Act, 1970, will not have the freedom to do a reverse engineering of the new patented products
that come to the market some time after 2005. It has been observed that it takes at least three to five
years for a new patented drug to come to the market. India’s concern should not be on EMRs, but
more on how to manage the product patent system in future and address our public interest concerns.
For this purpose, an enactment of the required patents legislation complying with the provisions of
the TRIPS Agreement is imperative. Besides, there is an urgent need for modernising our patent
office and strengthening the manpower involved in the administration of the patent system. There are
many other contentious issues such as (1) matters relating to biological resources under TRIPS; (2)
conservation of traditional community knowledge, biodiversity, and the IPs of the community; (3)
safeguards against EMRs; and (4) the sui generis systems, patenting of micro-organisms, and so on.
The Patents (Amendment) Act, 1999, was expected to be ratified by the legislative process that came
into force, effectively from January 1, 2000. But public opinion, as is expected, is sharply divided.
There is an urgent need of spearheading a movement towards the implementation of a national IP
policy. India with its tremendous potential of biodiversity and intellectual capital will have much to
gain from the well-administered patents system. The threat perception about an escalation in
pharmaceutical product prices is surely important from the short-term point of view, but effective
TRIPS will go a long way in bringing in foreign direct investment (FDI) and facilitating a significant
R&D (research and development) activity.

India with its tremendous potential of biodiversity and intellectual capital will have much to gain from the well-administered
patents system.
TRADE-RELATED INVESTMENT MEASURES (TRIMS)
The objective of Trade-related Investment Measures (TRIMs) is to prevent member countries from
resorting to measures that violate non-differential treatment between domestic and foreign investors,
and impose QRs on imports and exports. Towards this end, the WTO provisions explicitly prohibit
the following trade-restrictive and distortive measures:
Local Content Requirement. Mandatory use of local outputs in production.
Trade-balancing Requirement. Imports to be maintained at a specific proportion of exports.
Foreign Exchange Balancing Requirement. Forex made available for imports to equal a certain
proportion of value of forex from exports.
Exchange Restrictions. Free access to forex curbed, resulting in import restrictions.
Export Performance Requirement. Certain proportion of production should be exported.
The agreement provides for a transitional period for an elimination of prohibited TRIMs, with
effect from January 1, 1995—two years for developed countries, five years for developing countries,
and seven years for transitional and least developed economies. TRIMs is currently being
renegotiated and is expected to encompass a wider scope, covering issues in services and competition
policy.

TRIMs is currently being renegotiated and is expected to encompass a wider scope, covering issues in services and
competition policy.
Before 1991, India used to have local-content requirements in the form of the phased
manufacturing programme (PMP). This has now been scrapped and exists only in the form of a
memoranda of understanding (MOU) imposed on the automobile manufacturers. Export
commitments exist in the form of a dividend-balancing requirement that is imposed for FDI in
consumer goods. Although TRIMs are prohibited under certain conditions (Provisions of Article
XVI[IB]), a country may use such measures. India still has such a cover and hence, there is an escape
clause for a temporary period. However, we will eventually have to scrap various TRIMs measures,
say, by 2005. Refer the content under “Hong Kong Ministerial Conference” for the same and further
proposals that are mentioned.
At this stage, it is important to note that as a part of promoting global investment flows, OECD
(Organisation of Economic Co-operation and Development) countries have been keen to take up the
issue of Multilateral Agreement on Investment (MAI) in the WTO negotiations agenda. The demand
of MAI seems to have been temporarily set aside, but would soon come up in some form or other.
MAI will have far-reaching implications as it will involve the following:
1. Further liberalisation of foreign investment by a host country;

2. Fair and equal treatment to foreign investors; and
3. Legal security for investment and effective dispute settlement procedure; indeed, the definition of investments is going to be very
wide to include every kind of asset owned or controlled, directly or indirectly, by a foreign investor.
Obviously, the Indian industry has to continuously monitor the likely impact of the phasing out of
TRIMs and the prospect of MAI eventually becoming a part of the WTO negotiations.

The Indian industry has to continuously monitor the likely impact of the phasing out of TRIMs and the prospect of MAI
eventually becoming a part of the WTO negotiations.
NON-TARIFF BARRIERS (NTBS) AND DISPUTE SETTLEMENT MECHANISM
Most industrial countries as well as a number of developing countries use a variety of non-tariff
barriers (NTBs) such as import-export control, certifications, standards, subsidies, anti-dumping
measures/duties, and so on. As a result, for a number of products, Indian exports have been denied the
market access in countries like the United States, Japan, Canada, Saudi Arabia, and the EU. Thus, the
NTBs are often used as a protectionist measure, which goes against the very spirit of the WTO
mandate.

The NTBs are often used as a protectionist measure, which goes against the very spirit of the WTO mandate.
However, a country can raise these issues with the WTO DSB. The WTO members have agreed that
if they believe fellow members are violating the trade rules under some pretext, they will use the
multilateral system for settling disputes instead of taking action on a unilateral basis. In other words,
the members are required to abide by the agreed procedures and respect the judgement that is based
on an objective assessment of the situation. In fact, India has taken the United States, the EU, and
several others to the Dispute Settlement Panel of the WTO and has won many cases. At the same time,
many other countries also have taken cases against India to the same panel and have won too. During
the 46 years till 1994, there were only 315 cases of dispute settlement under the GATT regime, but in
the short period of 1995 to 1998, as many as 120 cases were brought to the WTO.

India has taken the United States, the EU, and several others to the Dispute Settlement Panel of the WTO and has won
many cases.
ANTI-DUMPING MEASURES
With a commitment to substantial tariff reduction and much freer market access under the WTO
framework, there are growing threat perceptions about dumping of products and services. Broadly
speaking, if a company exports a product at a price lower than the price it normally charges in its
domestic market, it is considered as “dumping” the product. The intensity of competition from
imports is expected to affect the interest of domestic producers and unfair competition can even cause
them a serious injury. While the Indian industry is complaining about dumping of various
manufactured products such as steel, soda ash, pharmaceutical products, polyester film, and
newsprint, many other countries are registering similar complaints about Indian products (e.g, steel,
cotton bed linen, polyester staple fibre) being dumped in their markets.

GATT permits the imposition of anti-dumping duties against dumped goods, equal to the differences between their export
price and their normal value.
In this context, a country can take safeguard measures for protecting its domestic industry under the
provisions of anti-dumping. In India, we have created the Directorate of Anti-dumping under the DG
of Foreign Trade to deal with anti-dumping cases. But even this revamped anti-dumping cell is
inadequately equipped in comparison with many other countries. Illustratively, the United States has
over 1,430 officers—430 in Ministry of Commerce and 1,000 in the US International Trade
Commission. The US steel industry aggressively uses its anti-dumping mechanism to prevent/delay
steel imports in the United States. Even if cases are turned down, time is available to delay imports.
Apart from anti-dumping action, a country can take safeguard measures (emergency action) to
protect the domestic producers against any serious injury or a threat thereof caused by the increased
imports. In case of both anti-dumping and safeguard, certain essential conditions on the quantity of
imports and the extent of injury have to be fulfilled. A knowledge of the intricate complexities of
rules and regulations governing anti-dumping is essential for the Indian industry to effectively protect
its interests.

Apart from anti-dumping action, a country can take safeguard measures (emergency action) to protect the domestic
producers against any serious injury or a threat thereof caused by the increased imports.
SUBSIDIES
Subsidies have been one of the most contentious issues in trade negotiations. Subsidies are considered
to distort resource allocation and harm free trade. But almost all the countries of the world have been
using various types of subsidies as an integral part of their economic policies, either to protect the
income of farmers, to promote exports, or to bring about a balanced regional development. In the
case of export subsidies on the manufactured products, the WTO classifies them under three broad
categories: prohibited, actionable, and non-actionable, and all these are being described in “traffic
light terms” (that is, “red”, “amber”, and “green”). Red export subsidies are those that are prohibited
under the WTO and are, therefore, actionable by the trading partners. Amber export subsidies are
permissible under WTO, but are nonetheless actionable by the trading partners. Green export
subsidies are permissible under WTO and are non-actionable by the trading partners.

Almost all the countries of the world have been using various types of subsidies as an integral part of their economic
policies, either to protect the income of farmers, to promote exports, or to bring about a balanced regional development.
Examples of red export subsidies include the income tax exemption on export profits and
concessional interest rates on export credit. Likewise, special import licences and excessive duty
drawbacks also constitute red export subsidies. Although such subsidies are prohibited, there is an
escape clause for India. This prohibition does not apply to countries that have a per capita income
lower than $1,000; India is covered under this clause. However, if in a particular product, the country
is found to be “export competitive” in the global market, that is, accounting for more than 3.25 per
cent of the world market share of the product, such export subsidies have to be phased out regardless
of whether the per capita income is more or less than the fixed $1,000. In the case of India, for
example, gems and jewellery will disqualify for export subsidies and perhaps, these will have to be
phased out in eight years, that is, by 2005.
While on this subject, another major area relates to the treatment of subsidies under the Agreement
on Agriculture. Here too, green-box measures, which are perceived to have minimal distortive effect
on trade (e.g., R&D, pest and disease control, domestic food security, envi-ronmental assistance,
disaster relief, etc.) are non-actionable. Likewise, even blue-box measures comprising direct payment
under production limiting programmes (e.g., income support to farmers, structural adjustment
assistance, safety net, etc.) are usually not subject to reduction commitment under the WTO
framework. In contrast, amber-box measures (e.g., government buying at a guaranteed price, market
price support, etc.) are seen to be trade distorting and therefore, subject to reduction commitment.
In the context of WTO framework, India will have to redesign its subsidies whether for exports or
for agriculture. Practically, each and every country offers subsidies to subserve its respective socio-
economic objectives. Surely, India cannot be an exception. Thus, while proposing to phase out some
of the export benefits (Section 80 HHC under the Income Tax Act), and reviewing the measurement of
support for agriculture, our policymakers need to think in terms of alternative measures that are
WTO compatible. India’s problems are primarily on account of the fiscal burden of subsidies and
here too, we need a far more careful evaluation of non-merit (and hidden) subsidies, rather than
scaling down the merit subsidies that contribute towards our developmental objectives.

India’s problems are primarily on account of the fiscal burden of subsidies and here too, we need a far more careful
evaluation of non-merit subsidies, rather than scaling down the merit subsidies that contribute towards our developmental
objectives.
SINGAPORE MINISTERIAL MEETING, 1996
At Singapore, in December 1996, the ministers decided to set up three new working groups on trade
and investment, on the interaction of trade and competition policy, and on transparency in
government procurement. These groups have had a continuing impact on the work programme of the
WTO and in ensuring ministerial conferences. So too has the fact that ministers instructed the WTO
Goods Council to look at all possible ways of simplifying trade procedures, an issue sometimes
known as “trade facilitation”.

The Singapore issues were trade investment, trade facilitation, transparency in government procurement, interaction of
trade, and competition policy.
The Singapore Issues
These above mentioned four areas are commonly known as the “Singapore issues”. The working
groups on trade and competition policy and trade and investment were not given the mandate to
negotiate new rules or commitments. The ministers made it clear that no decision had been reached
on whether there would be negotiations in future. In addition, discussions could not develop into
negotiations without a clear consensus decision.
Government Procurement
The working group on transparency in government procurement is, in fact, different. This is largely
because the WTO has already an agreement on government procurement. It is a plurilateral
agreement as only some WTO members have signed it. The decision by ministers in Singapore did
two things. One, it set up a multilateral working group that included all WTO members. Two, it
focused the group’s work on transparency in the government procurement practices.
Labour Standards
Some developed countries, at the urging of trade unions, periodically suggest that the WTO should
consider labour issues. The developing countries have been strongly opposed to these suggestions,
fearing that these concerns are only a cloak for protectionism. At the Singapore meeting, the
ministers reconciled their differences through a statement which expressed their commitment to core
labour standards. They endorsed a collaboration between the WTO and the secretariat of the
International Labour Organization (ILO), but did not support any specific WTO work on labour
standards.
Action for LDCs
At the Ministerial Meeting, the ministers also adopted the comprehensive and integrated WTO plan of
action for LDCs in an attempt to improve their situation in the world trade.
GENEVA MINISTERIAL MEETING, 1998
The Second Session of the Ministerial Conference was held in Geneva in May 1998. It came when the
50th anniversary of the establishment of the multilateral trading system was being celebrated.
Planning for the Future. While some ministers emphasised the need to improve the
implementation of the existing agreements, the others wanted a more forward-looking agenda,
including the possibility of the a new round of negotiations. The ministers decided to establish a
process to ensure the implementation of the existing agreements, and to prepare for the next
Ministerial Meeting. It was envisaged that recommendations would be made regarding the WTO’s
work programme, including further negotiations on trade liberalisation.

It was decided to establish a process to ensure the implementation of the existing agreements, and to prepare for the next
Ministerial Meeting.
Electronic Commerce. At the Geneva meeting, one new subject, electronic commerce, was added
to the WTO work programme. Dramatic though its growth and implications may be, electronic
commerce falls squarely within the WTO’s mandate: the core issue is, however, whether the existing
trade rules are adequate to cover it.
Celebrating 50 Years. The occasion of the 50th anniversary of the multilateral trading system was
marked by a number of heads of the government attending the anniversary meeting. They came from
all parts of the world: President Clinton of the United States, President Fidel Castro of Cuba, and
President Nelson Mandela of South Africa, to mention a few.
SEATTLE MINISTERIAL MEETING, 1999
Launching the Millennium Round. The Third Ministerial Conference took place in the United States,
in Seattle, in December 1999. It was expected to launch a broad work programme for the first years of
the new millennium. A process to prepare for the Seattle Ministerial Conference was organised in
Geneva, but despite negotiations it did not result in a consensus text. There was no draft declaration
with a broad-based support to take to Seattle, for the ministers to launch a new round of negotiations.
It became clear that the ministers would have to take the critical political decisions necessary to
conclude an agreement in Seattle itself.
No Millennium Round. After some days of discussion in Seattle, it was evident that too little time
remained to complete the work of narrowing gaps among the positions of different countries.
Regrettably, ministers had to acknowledge that despite intensive work over the four days of the
Conference, they had simply run out of time. The work of the Conference was formally suspended.

The work of the Conference was formally suspended despite an intensive work over the four days.
Public Demonstrations. The meeting took place against the backdrop of, sometimes, violent street
demonstrations against the WTO. These demonstrations were held by non-governmental
organisations (NGOs) and other groups such as organised labour. The demonstration considerably
hampered the organisation and conducting of such meetings.
DOHA MINISTERIAL MEETING, 2001
The Fourth WTO Ministerial Conference was held in Doha, Qatar, in November 2001. In this
Meeting, the ministers adopted a broad work programme for the coming years, called the “Doha
Development Agenda”. It envisaged negotiations on improving the market access and a variety of
other challenges facing the trading system. The three-year work programme placed the growth of
developing countries at its core.

In this meeting, the ministers adopted a broad work programme for the coming years called the “Doha Development
Agenda.”
Improving Market Access
As far as agriculture was concerned, the negotiations were to open markets, and reduce with a view to
phasing out all forms of export subsidies and trade-distorting, domestic farm support. The market
access for industrial goods was declared to be another priority, and the negotiating mandate focused
on reducing or eliminating tariff peaks and escalation as well as the removal of other non-tariff
barriers. Particular attention was paid to products of export interest to developing countries.

The market access for industrial goods was declared to be another priority.
Singapore Issues to the Fore
It was agreed that negotiations on the Singapore issues would take place after the next Ministerial
Conference, but only on the basis of a decision by an explicit consensus to be taken at that session on
the modalities for negotiations.
Declaration on TRIPs
A declaration on the TRIPS Agreement and public health was also adopted by ministers. This was in
response to the concerns expressed about the possible implications of the TRIPS Agreement for
access to drugs for people in the developing countries. The declaration emphasised that the TRIPS
Agreement does not and should not prevent members from taking measures to protect public health
and reaffirmed the right of members to use the full provisions of the TRIPS Agreement, which
provide flexibility for this purpose.

A declaration on the TRIPS Agreement and public health was also adopted by ministers.
Trade and Environment
A commitment on environment was also taken, and governments would negotiate the relationship
between the existing WTO rules and the trade obligations contained in the multilateral environmental
agreements. They would also negotiate the reduction or elimination of tariff and non-tariff barriers to
environmental goods and services.

A commitment on environment was also taken, and governments would negotiate the relationship between the existing WTO
rules and the trade obligations.
CANCUN MINISTERIAL MEETING, 2003
The Fifth Ministerial Meeting took place in Cancun, Mexico, in September 2003. After the launching
of the Doha Development Agenda in November 2001, there had been intensive negotiations among
WTO members to meet deadlines that were established in the Doha Declaration and where an
agreement was to be reached prior to the Cancun Meeting.
Missed Deadlines
In particular, modalities were to be established for further liberalisation of trade in both industrial and
agricultural goods. In discussing these modalities, it quickly became clear that an agreement on
agriculture would not come that easily. Despite the numerous proposals from the members, there was
no agreement on how to achieve substantial improvements in the market access in agriculture, along
with an eventual phase out of all forms of export subsidies as well as substantial reduction in the
trade-distorting, domestic support. There were also other important areas. For instance, in Cancun,
members were to report on their negotiations on the relationship between the WTO and the many
multilateral environment agreements that contain trade-related provisions. At the time of Cancun, the
position of members remained far apart on this matter as well.
Optimism Prevails
Notwithstanding the challenges facing the delegations in Cancun, many remained optimistic. They
were encouraged, in particular, by a breakthrough in the days prior to the Cancun meeting when an
agreement was struck in making operational the compulsory licensing provisions of the TRIPS
Agreement to improve the access of impoverished nations to essential medicines. Further, the process
of countries acceding to the WTO was progressing, with the accession of Cambodia and Nepal to be
announced in Cancun. These were the first LDCs to accede to the WTO since its establishment.
No Agreement at Cancun
Despite further intensive negotiations among ministers at Cancun, no agreement could be struck on a
number of core issues. In particular, there was no agreement on how to proceed, if at all, with the
Singapore issues, and whether they should be dealt with individually or collectively. A further
stumbling block related to agreement on the modalities for future negotiations in agriculture. An
important development with respect to both these issues was the emergence of 21 developing
countries from very different parts of the world negotiating with a common position. There was also
disappointment on the part of some particularly impoverished developing countries that a more
positive result could not be achieved in removing trade-distorting subsidies for products of special
export interest to them, such as cotton and sugar. The lack of agreement on how to advance in these
critical areas led to the Cancun Meeting ending without a comprehensive declaration.

Despite further intensive negotiations among ministers at Cancun, no agreement could be struck on a number of core
issues.
Issues after Cancun
The Doha Round of trade negotiations, which received a setback when a consensus evaded it at the
Fifth Ministerial Conference of WTO at Cancun in September 2003, got a boost with the members
adopting a Framework Agreement on August 1, 2004, outlining the elements and principles to guide
the further negotiations. The framework is at an interim stage, and further negotiations including
those on detailed modalities and preparing the specific commitments of each member in respect of
agricultural (AMA) and non-agricultural market access (NAMA) will be held before the Sixth
Ministerial Conference of WTO scheduled to be held at China from December 13–18, 2005.
Negotiations on agriculture, which have been taking place in special sessions of the WTO
Committee on Agriculture, have focused on achieving progressive and substantial reforms in the
global agricultural trade. While the discussion leading to Cancun centred around bridging the
divergence among the common positions taken by the European Community (EC), the United States,
and those of the G-20 Alliance, post-Cancun deliberations strengthened the G-20 and emphasised their
outreach to others, in particular, the G-33 Alliance of developing countries on Special Products (SPs),
the Africa Group, and the Cairns Group of agricultural exporting countries. The G-20 was successful
in exposing the EC–US as demanders of substantial market access in the developing countries, in
particular, the large and relatively more advanced among them; and without regard to their legitimate
food and livelihood security and rural development concerns, with only minimal market-access
commitments being called forth from themselves. The G-20 also emphasised the requirement to
eliminate all forms of export subsidies within a credible time frame, and to achieve substantial
reductions in trade-distorting domestic support. In the lead-up to the WTO General Council’s
Decision of August 1, 2004—Framework Agreement—the negotiations among the five interested
parties (FIPs), comprising EC, the United States, Australia, Brazil, and India, resolved the divergent
positions on key aspects of each of the three pillars in the agriculture negotiations.

Negotiations on agriculture have focused on achieving progressive and substantial reforms in global agricultural trade.
The Framework Agreement explicitly agrees to eliminate export subsidies by a credible end date. It
imposes a down payment of 20 per cent on the overall trade-distorting domestic support in the first
year of implementation, besides containing a combination of cuts, disciplines, and monitoring
requirements in the various elements of the domestic support pillar, and a tiered formula for tariff
reductions based on proportionately lower commitments by the developing countries than by the
developed countries. The framework also recognises the critical importance of agriculture to the
economic development of developing countries and the need to enable them to pursue agricultural
policies that are supportive of their development goals; poverty-reduction strategies; food security
and livelihood concerns, including through instruments such as SPs; and a new special safeguard
mechanism (SSM) against likely import surges. The framework, thus, provides a useful basis for
further negotiations on detailed modalities that could help create market-access opportunities for
products of export interest and safeguard small and vulnerable producers of farm products.

The framework also recognises the critical importance of agriculture to the economic development of developing countries.
Under NAMA, the framework identifies the initial elements for future work on modalities for
negotiations. The negotiations per se seek to achieve the objective of reduction or elimination of
tariffs, including tariff peaks, high tariffs, tariff escalation, and non-tariff barriers. The framework
prescribes a continuation of the work on the use of a non-linear formula applicable on a line-by-line
basis. The application of the formula, which is one of the initial elements identified for future work
on modalities for negotiations, has been stated to cover all products; and would commence from the
bound rates for bound tariff lines and the MFN rate for unbound tariff lines. Credit would be given
for autonomous liberalisation, and all non-ad valorem rates would be converted into ad valorem
equivalents based on a methodology negotiated upon. Exemptions from formula seductions have been
granted to members with less than 35 per cent unbound tariff lines who would merely bind all their
tariff lines instead. Flexibility granted to developing countries under the special and differential
treatment (S&DT) and less-than-full reciprocity (LTFR) include both a longer implementation period
as well as applying less-than-formula cuts or no cuts for a specified list of tariff lines or retaining
some of the unbound tariff lines as unbound.

Under NAMA, the framework identifies the initial elements for future work on modalities for negotiations.
On the proposal for sectoral initiatives, India, as most other developing countries, emphasised that
formula approach should be the main modality for negotiation, and sectoral initiative can be
considered only after the precise formula is decided upon. India’s stand has been that the sectoral
initiatives, if any, should focus on specific sectors of interest to the developing nations, with the
concept of “LTFR” in reduction commitments being built into such an initiative. As regards the issue
of non-tariff barriers, the focus was on encouraging the WTO members to make notifications by
October 31, 2004, on such barriers faced by them to facilitate identification, examination,
categorisation, and ultimately negotiations on such barriers. India submitted a notification, within the
given date on some of the NTBs faced by its exports. Although no modalities have been specified in
this context, the framework affirms the need for S&DT for the developing nations.
The salient features of the services component of the Framework Agreement include: members to
strive for high-quality offers in sectors and modes of supply of interest to developing countries to
ensure a substantive outcome and provide market access to all members; special attention to be given
to sectors and modes of supply of export interest to developing countries; recognition of interest of
developing countries and some developed countries in Mode 4 (movement of natural persons);
stipulation of a time limit for submission of revised offers by May 2005; and a general recognition of
interest in intensified negotiations.
India’s core objective in the negotiations in trade and services is to induce our trading partners to
undertake more liberal commitments in cross-border supply of services (Mode 1) and movement of
natural persons (Mode 4). Cross-border supply of services, especially through electronic mode of
delivery, is an area of key interest to India, given that the outsourcing activities are undertaken
through this mode of supply of services with its comparative advantage and potential of ITES (IT-
enabled services). In this context, with regard to movement of natural persons, developing countries,
including India, have taken up a number of related issues, such as recognition of qualifications,
economic needs tests (ENTs), administrative procedures relating to visas, mutual recognition
agreements (MRAs), and social-security contributions, which are likely to be addressed in the current
negotiations. India also aims to encourage a greater inflow of FDI in those sectors in which such
investment could generate spin-off benefits or externalities. While India’s core interest is in the
liberalisation of Mode 1 and Mode 4, the core interest of its trading partners, as evident from the
requests, is in Mode 3 (commercial presence), with a request either to bind the presently applicable
FDI policy or to offer a more liberal policy.

Indian’s core objective in the negotiations in trade and services is to induce our trading partners to undertake more liberal
commitments in cross-border supply of services.
India submitted the initial requests for specific commitments to 62 member countries and in turn,
received the initial requests from 27 member countries in various services sectors. As many as 48
member countries have submitted their initial offers as of now. India submitted its initial offer in
December 2003. Through the initial conditional offer, the existing Uruguay Round commitments in
sectors such as engineering services, computer and related services (CRS), construction and related
engineering services, financial services, health services, and tourism services, have been improved.
Fresh commitments in new sectors such as accounting and bookkeeping services; medical and dental
services; services provided by midwives, nurses, physiotherapists, and para-medical personnel; and
maritime transport services; have also been offered. Horizontally, India’s Uruguay Round
commitments have been improved by way of enhancing the period of stay for business visitors and
also expanding the category of professionals to include contractual service suppliers (CSS), both
employees of enterprises and independent professionals in certain identified sectors. India, in 2005,
engaged in bilateral discussions with trading partners on its initial conditional offers and also on the
response to its requests, particularly in Modes 1 and 4, in the initial offers tabled by its trading
partners.
A significant aspect of the July Framework Decision of August 1, 2004, was the dropping from the
Doha Agenda, the three of the four Singapore issues. With the dropping of issues such as trade and
investment, trade and competition policy, and transparency in the government procurement,
negotiation on only trade facilitation will now commence on the basis of agreed modalities. The
concerns and reservations of the developing countries on starting negotiations on trade facilitation
have largely been met in the modalities for negotiation through an extensive provision of S&DT for
the developing countries and LDCs. These provisions include responsibilities as follows:
1. Extent and timing of entering into commitments shall be related to implementation capacities of the developing countries and
LDCs;
2. Support and assistance for development of infrastructure as part of requirement for taking commitments wherever not required;
3. LDC members will only be required to undertake commitments to the extent consistent with their individual development,
financial and trade needs, or their administrative and institutional capabilities;
4. Developed countries would ensure adequate technical assistance and capacity building for the developing countries and LDCs;
and
5. Concerns of the developing countries and LDCs related to cost implications of proposed measures shall be addressed as an
integral part of the negotiations.
Further, the modalities provide for an establishment of an effective mechanism for coopera-tion
between customs authorities on trade facilitation and customs compliance issues, thus helping to
address issues relating to violation of customs laws. Trade facilitation essentially refers to
simplification, harmonisation, and computerisation of customs-clearance procedures. The agreed
modalities on negotiations on trade facilitation will address these issues through clarification and
improvement of the existing GATT disciplines dealing with freedom of transit; fees and formalities
connected with import and export; and publication and administration of trade regulations. These
disciplines were covered under Articles V, VIII, and X of GATT 1994.

Trade facilitation essentially refers to simplification, harmonisation, and computerisation of customs-clearance procedures.
The General Council’s decision of August 30, 2003, under Para 6 of the Doha Ministerial
Declaration on TRIPS and Public Health, enables manufacture and export of pharmaceutical products
under compulsory licence to countries with limited or no sector, by granting suitable waivers from
various articles under this mechanism. Discussions were under way in the TRIPS Council on the
method of incorporation of the decision in the TRIPS Agreement, that is, whether this may be effected
by inserting a footnote on Article 31 or by creating an Article 31 bis, or by adding an annexure, or by
incorporating the full text of the relevant provision of the decision in the text of the TRIPS
Agreement. The target for completing the process was set for the end of March 2005. An Ordinance
on Patents (Third) Amendment was promulgated by the government on December 26, 2004 to make
the Indian patents law WTO compliant and to fulfil India’s commitment under TRIPS to introduce
product-patent protection for drugs, food, and chemicals with effect from January 1, 2005. The
ordinance is an interim measure and would be discussed in detail in the Parliament in the Budget
session.
Another significant development in the world trade is the expiry of the ATC at the end of 2004,
ending a historic anomaly in the world trading system by putting textiles and clothing on the same
footing as other industries under the WTO. It is important to note that China, which is poised to grab
the lion’s share of global trade in clothing, has a cap of 7 per cent to 8 per cent annual increase in the
export of clothing to the US/EU until January 1, 2008, by virtue of their being a late signatory to the
WTO. India needs to concentrate on this window of opportunity from January 2005 till December
2007, to gain a serious market share while China’s export of clothing is still restricted. It has been
reported that the following appeals from the United States and the EU to China to moderate its
exports, China has undertaken to impose duties on some of its textile exports to ensure a smooth
transition following a lifting of global quotas on textiles and garments. Other options to secure a
greater market access for India could include sectoral-tariff elimination initiative for the textiles and
clothing sector, negotiating a reduction in the MFN tariff in textiles of its major trading partners in
the current Doha Round, and a exploring greater market access under preferential Generalised
System of Preferences (GSP) in the EU/US markets. The determinants of being able to retain and
increase the market share post-ATC will include the following: the ability to adjust, invest, and rise to
the challenges of increased competition; structure, size evolution, and direction of international
textile and clothing production and market; and the condition for any effective market access beyond
that of quotas, as disappearance of quotas, will be only one of the variables in larger post-ATC
market access picture. Preferential market, GSP schemes, and a duty-free treatment will continue to be
advantageous for the preferred suppliers.

Another significant development in the world trade is the expiry of the ATC at the end of 2004, ending a historic anomaly in
the world trading system by putting textiles and clothing on the same footing as other industries under the WTO.
WTO FROM 2005 TO 2008
There is little doubt that, if one excludes the United Nations the WTO is perhaps the most important
international body with a multilateral membership that has been set up after the Second World War. In
fact, it can be argued that the United Nations appears to have lost some of its sheen after the end of the
Cold War with the collapse of the Soviet Union in the closing years of the 1980s. It can, therefore, be
described today as an organisation that has, in all probability, played out its role on the international
stage and is on its way to a quiet burial. Not so the WTO. Since its setting up in 1995, the WTO has
left an indelible mark on the way the national economies conduct their international trade relations.
More importantly, it has succeeded in laying down the guidelines for the future development of the
global trade exchange based on principles, that are totally different from those that influenced
economic ties between the rich and the poor in the past.

Since its setting up in 1995, the WTO has left an indelible mark on the way the national economies conduct their
international trade relations.
As the outgoing DG of the WTO, Supachai Panitchpadki said in 2005, the last 10 years “have
transformed the way in which nations interact commercially”, for which it must be said that the WTO
has been entirely responsible. At the centre of the change that has been brought about is the rapidly
growing realisation among the developing economies—led by the likes of India, China, and Brazil,
among others—that the future scenario of the international trade exchange does not necessarily have
to follow in the footsteps of what has gone before—one where the rich have consistently leveraged
their economic strength to get a better deal in bargains with the poor.
Instead, there is a new-found confidence among the “emerging economies” which is impelling
them to turn up the pressure on the old industrialised nations. The central message that is being
transmitted in the process is that the “traditionally” affluent nations can no longer take their poor
brethren for granted, and that they (the former) will have to fight strenuously for every gain they
expect to make at the negotiating table when discussing the emerging structure of international trade
in the 21st century.
In fact, it is fascinating to plot the growth of this growing assertiveness on the part of the
developing world vis-à-vis the industrialised nations on a graph containing the WTO Ministerial, five
of which have been held so far since the first which took place in Singapore in 1996. In 1996 there
were the well-known four Singapore issues which, for the first time, clearly indicated that the rich
countries would no longer have their way in structuring the world trade in a manner that would
benefit their economies. These four subjects—for inclusion in the WTO scheme of things—were put
on hold, which constituted a first check on the international trade ambitions of the rich.

In 1996 there were the wellknown four Singapore issues which, for the first time, clearly indicated that the rich countries
would no longer have their way in structuring the world trade in a manner that would benefit their economies.
Then came the Geneva Ministerial Meeting (1998) which, from a careful reading of the
Declaration, suggests that it was deliberately meant to be a tame affair—some sort of a holding
operation (mainly on the part of the rich), being used to recover from Singapore and plan for the
future. Seattle followed in 1999 where, for the first time in the history of international trade
negotiations (or any economic negotiation for that matter), both the poor and the rich sides bared
their fangs and for the first time, the have-nots of the world economy refused to sign on the dotted
line prepared for them by the affluent who, incidentally, were also their former colonial masters.
Indeed, it can be said that Seattle represents the crossroads in the evolving history of global trade
exchange where for the first time, an alternative opened up for the economically weak nations, the
important point being that the rich too have come to acknowledge that the ball game from now on
will be totally different from the way it has been played in the past. Since Seattle, there has been a sea
change in the perspective adopted by the developing economies at all WTO events, including, of
course, the Doha (2001) and Cancun (2003) Meetings. At Doha, negotiations were begun for the next
round of multilateral trade negotiations, which would (like the Uruguay Round that preceded it)
ordinarily mark a quantum jump in the organisation of international trade on the road to global
liberalisation.

Since Seattle, there has been a sea change in the perspective adopted by the developing economies at all WTO events,
including, of course, the Doha (2001) and Cancun (2003) Meetings.
The Cancun Conference was supposed to have been a stocktaking event, geared mainly to ensure
that the Doha Development Agenda was firmly on the way to implementation. As everyone knows,
Cancun basically failed to deliver, the proof of that being the extension of the time schedule
originally prepared for completion of the Doha process. So where will all this take us from here?
The stark truth is that, if there is going to be an agreement at the end of the day, someone will have to
give. If the WTO is going to get struck in the quagmire of economic differences between the rich and
the poor, is there any future life for the organisation—a thought which should be pondered over after
a decade of its existence.
True, the organisation has enabled the developing world to find a voice at the table of multilateral
trade negotiations (a long overdue development). But will this hasten the process of a change in
attitude on the part of the industrialised world, which basically means accepting the fact that space will
have to be made for the economic demands of the poor economies, something that would have been
rejected out of hand by the rich even a couple of decades ago.

True, the organisation has enabled the developing world to find a voice at the table of multilateral trade negotiations (a
long overdue development). But will this hasten the process of a change in attitude on the part of the industrialised world.
As Panitchpadki pointed out so very cogently, the fundamental utility of the WTO will have to be
seen a bit differently, by viewing it against the broader canvas of the evolving structure of the
international economy. Briefly, the process of globalisation of the world economy has set in firmly,
bringing with it a host of problems (”fears and concerns”, as the WTO Chief describes them). While
this process has nothing to do with the WTO as such, the problematic spin-offs of the transformation
“have been laid at the feet” of the organisation.
To quote Panitchpadki at some length
The factors driving globalisation are numerous and complex. The WTO is not the problem but rather a part of the solution. There is
no escaping the fact that global problems require multilateral solutions. Absent global rules which address the problems that stem
from an often unpredictable and sometimes unsettling phenomenon, (and) we are left with uncertainty, heightened international
tensions, and possibly chaos. Absent the rule of law, (and) we have the law of the jungle.
The truth is that even the rich cannot prosper in a jungle because a point will come where they will
not hesitate to fight among themselves for available dwindling resources, which cannot but harm their
own interest at the end. So it is beyond doubt that the WTO is indispensable at this juncture of the
evolution of international trade. What makes it especially attractive is that it has helped to strengthen
the position of the poor vis-à-vis the rich, thereby bolstering the forces of fairness in the hitherto
unequal world international trade.

It is beyond doubt that the WTO is indispensable at this juncture of the evolution of international trade.
GENEVA PACKAGE, 2004
With the collapse of the Fifth Ministerial, the 148 WTO member countries re-grouped on July 31,
2004, in an effort to salvage much of the lost ground in Geneva. This marked a step forward and a
positive development for the WTO. Nevertheless, details are yet to be worked out. It established a
framework for establishing modalities in agriculture, market access for non-agricultural products,
trade in services, and trade facilitations. Of these categories, the first two are of immense importance
to developing countries.
HONG KONG MINISTERIAL CONFERENCE, DECEMBER 2005
The negotiations launched at the Doha Ministerial Conference in 2001 received a fresh momentum
with a positive outcome at the Sixth WTO Ministerial Conference at Hong Kong, held during
December 13–18, 2005. The Hong Kong Ministerial Declaration called for the conclusion of
negotiations launched at Doha in 2001 and established time frames and targets in the specific areas.
Among other issues, WTO members agreed that the modalities in AMA and NAMA will be
established by April 30, 2006 and comprehensive draft schedules based on these modalities will be
submitted not later than July 31, 2006. In services, a second round of revised offers was agreed to be
tabled by July 31, 2006 and the final draft schedules are to be submitted by October 31, 2006.
India has engaged in these negotiations to ensure that its core concerns and interests continue to be
adequately addressed as negotiations proceed from one stage to the next. The Minister of Commerce
and Industry participated in a number of mini-ministerial meetings as well as meetings of G-20, G-33,
and FIPs, organised in 2005 to move the negotiations forward. India’s approach to the negotiations
has always been dictated by our national interests, especially our concerns for the millions of farmers
who are dependent for their livelihood on agriculture, as also our objective of stimulating economic
growth and development through trade. Under the overall guidance of the Cabinet Committee on
WTO matters, by negotiating objectives and creating strategies to achieve them, solutions have been
developed based on analytical work and intensive process of dialogue with relevant stakeholders,
including Indian industry; and representatives of trade unions, farmers’ associations, UT/state
governments; and through regular inter-ministerial meetings at the Central government level.

India has engaged in these negotiations to ensure that its core concerns and interests continue to be adequately addressed
as negotiations proceed from one stage to the next.
This process has also included consultations by the Minister of Commerce and Industry with
different political parties, including those held within the Parliamentary Standing and Consultative
Committees attached to the Ministry of Commerce and Industry. Relevant ministries have also been
participating in the negotiating processes in the WTO across the key areas. A full-day workshop with
chief secretaries/officials of all states/UT governments was held in Delhi on May 24, 2005 to apprise
them of the state of play of negotiations at the WTO, to set out the key negotiating issues, and obtain
their inputs. The ministers of Agriculture, and Commerce and Industry, also held discussions on
December 8, 2005 with farmers’ associations.
At Hong Kong, India was proactive in articulating its position on issues of concern to it and other
developing countries, and played a key role in the further strengthening of the developing country
coalitions by bringing together G-20, G-33, and G-90 groups of countries in a broad alliance to
reinforce each other ’s positions on the issues of mutual interest. The Hong Kong Ministerial
Declaration, as finally agreed upon, has addressed India’s core concerns and interests, with sufficient
negotiating space for future work leading to modalities for negotiations in the coming months. The
key outcomes of the Ministerial Conference and the timelines approved in the Hong Kong Ministerial
Declaration are indicated as follows:

At Hong Kong, India was proactive in articulating its position on issues of concern to it and other developing countries,
and played a key role in the further strengthening of the developing country coalitions.
KEY OUTCOMES AND TIMELINES OF THE HONG KONG MINISTERIAL DECLARATION OF WTO
Amendment to the TRIPS Agreement reaffirmed to address the public health concerns of the developing countries.
Duty-free, quota-free market access for all LDCs’ products by all developed countries. The developing country declaring itself
in a position to do so to also provide such access; however, flexibility be to provided in coverage and to phase in their
commitments.
Resolved to complete the Doha Work Programme fully and to conclude negotiations in 2006.
In cotton, export subsidies are to be eliminated by the developed countries in 2006; trade-distorting domestic subsidies are to be
reduced more ambitiously and over a shorter period of time.
To establish modalities in AMA and NAMA by April 30, 2006; draft schedules by July 31, 2006.
In agriculture, to eliminate export subsidies by 2013, with a substantial part in the first half of the implementation period.
On their trade-distorting domestic support, the three heaviest subsidisers to attract the steepest cuts; developing
countries like India with no AMS (aggregate measure of support) will be exempt from any cuts on de minimis and on
overall levels.
Developing countries to have the flexibility to self-designate SPs; price and quantity triggers agreed on SSM.
In NAMA, S&DT elements that are on flexibility, and LTFR in reduction commitments for developing countries,
reaffirmed.
No sub-categorisation of developing countries when addressing the concerns of small vulnerable economies.
To advance the development objectives, a balance in ambition in the market access between AMA and NAMA is required.
In services, to submit requests by February 28, 2006, a second round of revised offers by July 31, 2006, and final draft
schedules by October 31, 2006 is required.
To intensify the consultation on implementation issues, the progress is to be reviewed and appropriate action to be taken by July
31, 2006, including on the TRIPS Agreement and CBD (Convention on Biological Diversity).
To report with clear recommendations for a decision by December 2006 on S&DT.
Clear political guidance given on services, rules, trade and environment, TRIPS, and trade facilitation, for concluding
negotiations in 2006; rapid conclusion of DSU (Dispute Settlement Understanding) negotiations.
The current state of play of negotiations under various areas covered by the Doha Work Programme
are as follows:
At Hong Kong, the WTO ministers had agreed to establish modalities for AMA and NAMA by
April 30, 2006 and submit the draft schedules by July 31, 2006; and also had agreed to conclude the
negotiations across all areas of the Doha Round by the end-year 2006. However, despite the intensive
negotiations, these deadlines could not be met. The intensive discussions from January 2006 to July
2006 had focused mainly on the triangular issues of Domestic Support, AMA, and NAMA. During the
last Ministerial Meeting of the G-6 (Australia, Japan, and G-4 [Brazil, ECs, India, and US]) held in
July 2006, although there were some indications of flexibilities in the positions held by all
participants, the United States maintained that this movement was inadequate. The United States thus
did not reveal any flexibility either to improve its offer under negotiations on agriculture to cut its
own domestic support or to lower its ambition on market-access openings in other countries. In light
of the impasse particularly in agriculture, and ruling out the possibility of finishing the Round by the
end of 2006, the negotiations across the Round as a whole were suspended on July 27, 2006 by the
Director General (DG), WTO, to enable a serious reflection by participants, with a view to resuming
the negotiations when the negotiating environment is appropriate and congenial.

The United States thus did not reveal any flexibility either to improve its offer under negotiations on agriculture to cut its
own domestic support or to lower its ambition on market-access openings in other countries.
Since then, a quiet diplomacy through informal contacts, at ministerial and official levels at the
margins of events, such as ASEAN, continued. The G-20 High-Level Ministerial Meeting held during
September 9–10, 2006 at Rio de Janerio marked the first specific meeting on WTO negotiations. The
G-20 issued a joint statement with country-coordinators of other developing country groupings (G-
33, ACP [Asian, Caribbean, and Pacific], African Group, LDCs, SVEs [Small Vulnerable Economies],
and the Cotton-4 [Benin, Burkina-Faso, Mali, and Chad]), placing the responsibility for successfully
concluding the negotiations on the developed countries (the US and the EU). While calling upon them
to improve substantially their own domestic support and market-access offers, the developing
countries reiterated the development dimension of the Doha Round.
The mandate for NAMA under the Hong Kong Ministerial Declaration seeks to achieve the
objective of reduction or elimination of tariffs, including tariff peaks, high tariffs, and tariff
escalation, in particular on the products of export interest for the developing countries through the
use of a Swiss formula. The coefficients for the Swiss formula would ensure LTFR in reduction
commitments for developing countries. On the unbound tariff lines, the base rate for commencing
formula reductions would be computed on the basis of a non-linear mark-up on the 2001 applied
rates. Flexibilities under Paragraph 8 of the July 2004 Framework Agreement are intended to protect
sensitive lines of developing countries from the purview of formula reductions or bindings. Sectorial
initiatives look at elimination or harmonisation at low-level customs tariffs in the specific sectors
which would purely be on a voluntary basis. Proposals have been made in sectors such as
automobiles, bicycles, chemicals, hand tools, electricals and electronics, forestry, health care, marine
products, gems and jewellery, raw materials, sports goods, textiles and clothing, toys, and so on.
NTBs are yet another element of the NAMA negotiations where the focus has shifted from the
notification of NTBs to seeking specific negotiating proposals from members. Some proposals
cutting across sectors (known as horizontal proposals) relating to export duties, export taxes, and
remanufactured goods were made. On the other hand, vertical proposals pertaining to specific sectors
have been made on labelling in textiles, apparels, footwear and travel goods; harmonisation of
standards in electronics; and wood products. India as part of its NAMA-11 coalition (Refer the
following paragraph for an explanation on NAMA-11) of the developing countries had proposed the
resolution of NTBs through a facilitative mechanism which is intended to expedite resolution of
disputes on NTBs through a fast-track, informal, efficient, and less-adversial mechanism than the
current dispute settlement mechanism that is followed in the WTO. This proposal has enormous
support with co-sponsorship from the African Group, ECs, LDCs, Norway, and Switzerland.

The mandate for NAMA under the Hong Kong Ministerial Declaration seeks to achieve the objective of reduction or
elimination of tariffs, including tariff peaks, high tariffs, and tariff escalation.
A group of 10 developing countries, including India, formed a coalition known as the NAMA-11,
which is negotiating on substantive issues of concern for developing countries. The coalition group
has been instrumental in highlighting the special needs and interests of developing countries, which
include taking on LTFR reduction commitments and use of flexibilities to have a special dispensation
for sensitive tariff lines. The services sector in India accounted for 54.1 per cent of GDP during
2005–06. In the year 2006, India’s service exports grew up to US$73 bn and its imports up to $70 bn.
India’s share in the world trade of export of services was 2.7 per cent during the year 2006. During
the current round of negotiations under the GATS, India has offered to liberalise in a number of
service sectors in its “Revised Offer”, tabled at the WTO in August 2005, and it is in practice too.

A group of 10 developing countries, including India, formed a coalition known as the NAMA- 11, which is negotiating on
substantive issues of concern for developing countries.
The “revised offer” is a substantial improvement over India’s “initial offer” (January 2004). New
areas covered in the revised offer include architectural, integrated engineering and urban planning
and landscape services; veterinary services; environmental services; distribution services;
educational services; recreational, cultural, and sporting services; and the maintenance and repair of
aircraft. Further, coverage and commitments improved in construction and related engineering
services, tourism services, financial services, and so on. New commitments have also been offered in
the cross-border supply in a large range of other business services, professional services, R&D
services, rental and leasing services, real-estate services, and so on.
India seeks, in the services negotiations at the WTO, a market access in the Cross-Border Supply of
Services (Mode 1) and Movement of Natural Persons (Mode 4). India’s Mode 4 objectives are driven
by the competence of its service professionals, and Mode 1 objectives are driven by the strong
competitive edge of India in IT and ITES services. In Mode 1, India wants binding commitments by
WTO member nations so as to ensure predictable and transparent policy regime. In Mode 4, India has
been pushing for issues such as removal of the ENT, clear prescription of the duration of stay,
provisions of renewal and extension of visas, and so on. India wants a market access under Mode 4
for two categories of service suppliers, that is, CSS and Independent Professionals.

India seeks, in the services negotiations at the WTO, a market access in the Cross-Border Supply of Services (Mode 1) and
Movement of Natural Persons (Mode 4).
At the Hong Kong Ministerial Conference, it was agreed that the dynamics of negotiations would
have to include plurilateral requests while retaining the primacy of the request-offer process so as to
raise the ambition levels of the services’ negotiations, while keeping the GATS architecture intact.
Concerns of the developing countries have been addressed adequately in the Hong Kong Ministerial
Declaration. Developing countries with the leadership of India, have managed to secure guidance for
getting the current levels of market access bound in Mode-1 and also a direction to discuss modalities
of doing away with ENTs.

Developing countries with the leadership of India, have managed to secure guidance for getting the current levels of market
access bound in Mode-1 and also a direction to discuss modalities of doing away with ENTs.
The Ministerial Declaration also provides a direction for developing disciplines in domestic
regulations, which is of crucial interest to India, especially disciplining qualification and licensing
requirements and procedures, without which in Mode 4 India may not be able to have “real” market
access. Negotiations on domestic regulations are under way at the WTO. Efforts are being made to
put in place such disciplines before the end of the current round as per the Hong Kong Mandate. India
has argued to strike a balance between the right to regulate and regulations that are really becoming
unnecessary barriers to trade.
In pursuance of the Hong Kong Ministerial Directives, plurilateral discussions under GATS were
initiated at the WTO in Geneva. About 22 plurilateral groups have been formed. India has received
plurilateral requests in 14 different services sectors, including telecom, finance, maritime,
environment, education, air transport, energy, audio visual, and retail. India is the coordinator of the
plurilateral requests on Mode 1 (cross-border supply) and Mode 4 (movement of natural persons)—
the core areas of interest of India at the services negotiations—and is also the cosponsorer of
plurilateral requests on CRS, and architectural, engineering, and integrated engineering services.
At present, the negotiating groups across all areas including services negotiations of the Doha
Round have fully resumed since February 2007. In order to take the services negotiation forward, a
fresh round of revised offers would need to be tabled at the WTO by the member countries. India
would submit its second-revised offer based on the timelines, which would be decided depending on
the outcome of negotiations in AMA and NAMA. The General Council adopted on December 14,
2006, a decision on the transparency mechanism for regional trade agreements. The mechanism has
provisions of early announcement, notification, and subsequent notification of amendments to the
RTA. Enhanced transparency of the RTA is sought to be achieved through a factual presentation of the
RTA by the WTO Secretariat, a single formal meeting on the RTA, who replies to questions posed by
the members and any additional exchange of information in a written form.

At present, the negotiating groups across all areas including services negotiations of the Doha Round have fully resumed
since February 2007.
In a similar decision on December 14, 2006, the General Council also invited the Council for Trade
and development (CTD) to consider a transparency mechanism for Preferential Trade Arrangements
(PTAs) coming within the purview of Article 2 of the Enabling Clause. “Trade Facilitation” is the
only subject from the bundle of four Singapore issues on which negotiation had started pursuant to
the WTO’s July Framework Agreement of 2004. The modalities for negotiation are set out in
Annexure D of the July Framework Agreement. There are three identified aims of negotiation under
Annexure D:, which are (i) to clarify and improve relevant aspects of GATT Articles—Article V
(freedom of transit), Article VIII (fees and formalities connected with importation and exportation)
and Article X (publication and administration of trade regulations); (ii) enhance technical assistance
and support for capacity building in this area; and (iii) to have provision for an effective cooperation
between customs authorities on trade an facilitation and customs compliance issues.
India’s participation in the negotiations has been positive and constructive. In the ongoing
negotiation, the members have already submitted a large number of proposals for clarification of
GATT Articles—V, VIII, and X. India has filed a detailed proposal on how a multilateral cooperation
mechanism would operate (W/68), which has been cosponsored by Sri Lanka. Pursuant to the
proposal submitted by India under Document W/68 on “cooperation mechanism for customs
compliance”, another paper (TN/TF/W/103 dated May 10, 2006) has been filed by India containing
specific elements for “multilateral cooperation mechanism” for exchange of information between the
customs administrations of members. Later, India has filed its textual proposal (TN/ TF/W/123 dated
July 4, 2006) on “cooperation mechanism for systems compliance”, which has also been cosponsored
by Sri Lanka.

India’s participation in the negotiations has been positive and constructive.
India has also presented its own proposals for clarification of the existing provisions of GATT
Articles—VIII and X, vide two papers TN/TF/W/77 dated February 10, 2006 and TN/TF/W/78 dated
February 13, 2006. India has subsequently filed textual proposals vide TN/TF/W/121 and
TN/TF/W/122, both dated July 4, 2006. The negotiations are also looking at the aspect of technical
and financial assistance for capacity building in the developing countries. A proposal (TN/TF/W/82
dated March 31, 2006) has been jointly filed by the People’s Republic of China, India, Pakistan, and
Sri Lanka. This paper addresses the concerns of the developing countries such as (i) the arrangement
of commitments for developing members, (ii) the provision of technical assistance and capacity-
building support; and (iii) the applicability of the dispute settlement mechanism. The Hong Kong
Ministerial Declaration on Trade Facilitation is a good basis for further negotiations on this subject.

The Hong Kong Ministerial Declaration on Trade Facilitation is a good basis for further negotiations on this subject.
The WTO Negotiating Group on rules has been considering proposals from various WTO
members to clarify and improve the existing disciplines of the Anti-Dumping Agreement and
Agreement on Subsidies and Countervailing Measures (ASCM), including fisheries subsidies. In the
area of anti-dumping, the negotiating group on rules has analysed in detail proposals on such issues
as determination of injury/causation, the lesser duty rule, the public interest, prohibition of practice of
zeroing, transparency and due process, interim and sunset reviews, duty assessment, circumvention,
the use of facts available, limited examination and all others rates, dispute settlement, the definition of
dumped imports, affiliation, standing requirements, definition of domestic industry, and so on. In
respect of subsidies and countervailing measures, the Group is considering various proposals for
amendments to the ASCM. The proposals generally seek to strengthen the disciplines in these two
agreements. There is also a proposal to expand the categories of subsidies to be prohibited under
Article 3 of the ASCM. India has made a number of submissions, including a textual proposal
submitted in early 2005 on the mandatory application of Lesser Duty Rule. India is also participating
actively in the negotiations on fisheries subsidies and working closely with other members, including
seeking an effective S&DT in any new disciplines.
The Hong Kong Ministerial Conference directed the Group to intensify and accelerate the
negotiating process in all areas of its mandate, on the basis of the detailed textual proposals before the
Group or the yet-to-be submitted proposals, and complete the process of analysing the proposals by
the members on AD and SCM Agreements as soon as possible, and mandated the Chairman to
prepare, early enough to assure a timely outcome within the context of the 2006, an end-date for the
Doha Development Agenda, consolidated texts of the AD and SCM Agreements that shall be the basis
for the final stage of the negotiations. The Chairman will be submitting his text only when the
negotiations resume, taking into account the progress in other areas of the negotiations.
The deadlines for the establishment of modalities in AMA and NAMA by April 30, 2006 and the
submission of draft schedules by July 31, 2006, had been missed out. Hectic negotiations were held
and efforts were first made to establish the modalities by June 30, 2006. An informal meeting of 31
trade ministers, including from India, was convened by the DG of WTO, Mr. Pascal Lamy, in Geneva
between June 29 and July 1, 2006, but without any success. A meeting of the Trade Negotiations
Committee (TNC) of the WTO was also held on July 1, 2006 wherein the DG was requested to
conduct intensive and wide-ranging consultations, with a view to facilitate the establishment of
modalities in AMA and NAMA. These consultations were to be based on the draft texts prepared by
the Chairs of the respective negotiating groups. The DG was requested to report back to the TNC as
early as possible.

The deadlines for the establishment of modalities in AMA and NAMA by April 30, 2006 and the submission of draft
schedules by July 31, 2006, had been missed out.
Efforts were then made to establish the modalities by July 31, 2006. A meeting of the G-6 WTO
ministers was held in Geneva during July 23–24, 2006, and there was no convergence on the core
issues of substantial reduction of trade-distorting support and other development issues. Following
detailed consultations, the DG of WTO convened an informal meeting of the WTO TNC on July 24,
2006. The DG reported that the gaps remained too wide, and that there was no other option but to
suspend the negotiations under the Doha Development Agenda as a whole, to enable a serious
reflection by participants to review the situation, examine the possible options, and review the
positions too. The report of the DG of WTO was taken note of by the General Council on July 27,
2006.
A soft resumption of negotiations across the board was agreed on the basis of the TNC decision of
November 16, 2006. However, it was only at the meeting of the General Council held on February 7,
2007, that the Chairman of the TNC could report a full-scale resumption of negotiations across the
board. The members then intensified their efforts to reach a decision on full modalities of
negotiations on AMA and NAMA. The G-4 (Brazil, ECs, India, and US) as well as the G-6 held many
meetings at both official and ministerial levels during February–June 2007, with a view to narrowing
down the differences among members especially on agriculture. However, the last G-4 Ministerial
Meeting held in Potsdam (Germany) during June 19–20, 2007 failed to reach any agreement in this
regard. Thereafter, the Chairperson for agriculture negotiations, Ambassador Crawford Falconer and
NAMA’s Chairperson, Ambassador Don Stephenson circulated their own revised draft “modalities”
on both these negotiations on July 17, 2007 for the consideration of members. These drafts are based
on the WTO member governments’ latest positions in the negotiations, as per the understanding of
the two Chairpersons, and are an assessment of what might be agreed for the formulae for cutting
tariffs and trade-distorting agricultural subsidies, and the related provisions. Their release has kicked
off another intensive series of meetings for WTO members to try to reach an agreement, and
probably to amend the drafts. The members are presently examining these two drafts. Serious
negotiations will begin only after the resumption of work in WTO in September 2007.
India attaches utmost importance to the rule-based multilateral trading system. India will continue
to protect and pursue its national interests in these negotiations and work together with other WTO
members, towards securing a fair and equitable outcome of these negotiations, and also ensuring that
the development dimension is fully preserved in the final outcome as mandated at Doha and as
reiterated in the July Framework Decision of August 1, 2004 and the Hong Kong Ministerial
Declaration. Many of the elements and principles agreed so far are concrete expressions to deliver on
the development promises of the Doha Round, including the elimination of the structural flaws in the
agricultural trade. The outcome of the negotiations should not undermine the ability of developing
countries, like India, to safeguard the livelihood and food security of their poor farmers or to
develop their industries and services sectors.

The outcome of the negotiations should not undermine the ability of developing countries, like India, to safeguard the
livelihood and food security of their poor farmers or to develop their industries and services sectors.
RECENT WTO PROPOSALS
“Fresh WTO proposals for a global trade deal, leaves India and other developing countries with little
policy space to protect their farmers and nascent industries”, a senior official said. India felt let down
as the revised texts on agriculture and industrial goods will not allow the developing countries to
shield their farmers and industries from cheap imports if an agreement is signed on the lines of these
proposals.

Fresh WTO proposals for a global trade deal, leaves India and other developing countries with little policy space to protect
their farmers and nascent industries”, a senior official said.
If the new agriculture text is adopted, India will be allowed to designate less number of SPs, which
it can protect from unrestricted imports from agro-exporting countries like the United States, Canada,
and Australia. “Likewise, India’s plea for greater flexibility in protecting its industries, including
small and medium-sized units, has not found much favour in the draft proposals for duty cuts on
manufactured goods”, the official sources said. “The American pressure seems to have played a role
on the revised proposals”, an official said.
”Pressure seems to be mounting on bigger developing countries—like India, China, Brazil, and
South Africa—to 'yield their market’ while the developed prepared for sacrifice”, the official said.
The Doha negotiations, launched in 2001, for a market opening multilateral trade agreement have
remained inconclusive amid differences between the developed and developing countries. The talks
were mandated to be concluded by the end of 2004 but they are till date not concluded. India is upset
that the new proposals, released by the Chairman of the negotiating group on Agriculture, Crawford
Falconer, has set a limit on a safeguard mechanism for protecting its small- and marginal farmers.

The Doha negotiations, launched in 2001, for a market opening multilateral trade agreement have remained inconclusive
amid differences between the developed and developing countries.
CONCLUSION
This obviously cannot deal with the all-pervasive scope and coverage of the WTO. Many crucial
issues have been highlighted but many others have not been commented upon. The objective here is
essentially to provide a glimpse of the WTO and its strategic framework. The world has been a
witness to the rapid spread of influence of the WTO and the consequential forces of globalisation.
The major challenges before the industry is to accept the inevitable, and vigorously work towards
exploiting opportunities that are likely to be unleashed by globalisation. Undoubtedly, the WTO will
impact each and every business, and each and every aspect of various businesses. Following are the
combination of a few crucial “positives” and “negatives” of the new WTO scenario:
1. The WTO is for transparency of policies, rules, and procedures and for multilateral conformism. It is not for insular and
protected economic trade and investment regime.
2. The WTO is for greater and greater market access; it is not for import restriction or import substitution.
3. The WTO does not believe in a mere focus on export orientation, but is consistently and passionately seeking an outward
orientation in the economic polices of member countries.
4. The WTO is not for unrestrained or imprudent use of capital resources in the development strategy, but for deploying capital on
the basis of comparative and competitive advantage of nations.
5. The WTO is not for subsidies, but for wider and effective use of pricing mechanism for allocation of resources domestically and
globally.
6. The WTO is for internal deregulation serving to complement the process of trade and investment liberalisation.
7. The WTO is for promoting a climate for FDI flows based on undistorted trade and investment regime; it is not for substitution of
trade by investment being protected through tariffs and restrictive import-licensing system.
8. The WTO is for competition and globalisation. Therefore, member countries are under compulsion to observe critical macro-
level disciplines—be it fiscal stability, price stability, or exchange-rate management. Consequently, it is not for soft options, be it
high tariffs, QRs, subsidies, or lack of transparency in the policies, procedures, and rules governing trade and investment.
The major challenges before the industry is to accept the inevitable, and vigorously work towards exploiting opportunities
likely to be unleashed by globalisation.
There, invariably, will be proponents and opponents of both WTO and globalisation. It is no one’s
case that commitment to the goals of WTO alone will deliver growth and prosperity across the world,
leave alone in India. The ultimate aim of all these global and domestic efforts is to expand domestic
wealth and ensure the trickling down of prosperity for the betterment of the material lot of millions
of our own people. The WTO happens to be an ongoing process, and the Indian industry has to be
ever vigilant to respond to the challenges in a more positive and proactive way with the support and
cooperation of our policymakers.

It is no one’s case that commitment to the goals of WTO alone will deliver growth and prosperity across the world, leave
alone in India.

Table 30.1 Global Merchandise Trade, 2006

Table 30.2 Trade in Commercial Services, 2003
Note: Commercial services include business (professionals and computer), communication, construction, and related engineering services,
distribution, education, environment, financial (banking and insurance), health and social, travel and tourism, recreational, cultural and
sporting, transport, and miscellaneous.

SUMMARY
The WTO is an international organisation of 153 member countries, which is a forum for negotiating
international trade agreements, and the monitoring and regulating body for enforcing agreements.
The WTO was created in 1995, by passing the provisions of the Uruguay Round of the GATT. Prior
to the Uruguay Round, GATT focused on promoting the world trade by pressurising countries to
reduce tariffs. With the creation of WTO, this corporate-inspired agenda was significantly ratchet
tipped by targeting the so-called non-tariff barriers to trade—essentially any national or local
protective legislation that might be construed as impacting trade.
The WTO has taken charge of administering the new global trade rules, agreed in the Uruguay
Round, which took effect on January 1, 1995. These rules, achieved after seven years of
negotiationsamong 125 countries, establish the rule of law in the international trade. Through the
WTO agreements and market-access commitments, the world income is expected to rise by over $500
bn annually by 2005. The annual global trade growth will be as much as a quarter higher by the same
year than it would otherwise have been.
The WTO, unlike GATT, is empowered to enforce global commerce rules with the imposition of
economic sanctions. The WTO’s rules are also much broader “covering food and environmental
standards, regulation of services such as insurance and transport; how the government can use tax
dollars, copyright and patent law, farm policy, and more”.
The WTO expanded the key aspects of the NAFTA, which had been signed the year before, to the
entire world. Like NAFTA, the WTO vested enforcement panels staffed by trade bureaucrats to
enforce its binding rules. And like NAFTA, the WTO rules subject a broad array of non-trade-related
local and national laws, regulatory structures, and policy approaches to challenge if they are claimed
to pose barriers to trade and investment. In the WTO’s 10 years, there have been 117 cases in which a
country has challenged a law or practice of another country. In all, 15 cases have led to binding WTO
rulings, and another 18 are currently being considered at the WTO tribunals.
The WTO’s tribunals conduct WTO challenge cases in secret. Even briefs from the public are only
accepted by WTO panels if endorsed by a government (NGOs cannot file briefs with the WTO unless
they find a government that is willing to submit the briefs). Furthermore, only national governments
are allowed to participate, so a state attorney general could only assist with defence of a challenge
against a state law if invited by the current administration. A government that has lost a WTO case has
no recourse to appeal outside of the WTO’s limited appellate process. Once a final WTO ruling is
issued, losing countries have only three choices: change their law to conform to the WTO
requirements, pay permanent compensation to the winning country, or face trade sanctions.
KEY WORDS
Dumping
Subsidy
Red Tape
Disputes
Intellectual Property (IP)
Intellectual Property Right (IPR)
TRIMs
TRIPs
Red Export Subsidies
Electronic Commerce
Non-tariff Barriers (NTB)
Negotiation
Multilateral Trading System
Most Favoured Nation (MFN)
National Treatment
Distortive Measures
Amber Export Subsidies
Green Export Subsidies
Trade Facilitation
QUESTIONS
1. What is WTO and what is its role in today’s business environment?

2. Explain the features of the WTO agreement.
3. Explain the administrative procedures of WTO.
4. What is role of WTO in settling disputes regarding trade policies of any country?
5. Write short note on:
1. Singapore Ministerial Conference
2. Geneva and Seattle Ministerial Conference
6. Highlight WTO-related issues after the Cancun Conference of September 2003.
7. Give a brief outline of the WTO structure.
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Glossary
AEZ Agri-Export Zone. An area that provides remunerations to growers by enhancing the
marketability of the produce of these zones in the international as well as domestic market.
Amalgamation The merger of one or more companies with another company, or the merger of two
or more companies to form one company.
Amber export subsidies (Non-actionable subsidies) Subsidies permissible under WTO, but non-
actionable by trading partners.
Ancillary units Investments in plant and machinery on ownership, by lease or hire purchase, up to Rs
75 lakh.
Anti-dumping duties Duties that prevent cheap imports being dumped at unreasonable prices which
may cause harm to the domestic industry.
Assessee A person liable to pay tax under the Income Tax Act.
Assessing officer The Assistant Commissioner, Deputy Commissioner, Assistant Director, Deputy
Director of Income Tax, or the Income Tax Officer.
Assessment year The Income Tax Year, that is, the year in which the income of previous year is to be
assessed.
Audit committee Body that reviews internal audit reports and makes recommendations to the Board.
Authorised dealer A person temporarily authorised, under Section 6 of FERA, to deal in foreign
exchange.
Authorised person Any person authorised by the Reserve Bank of India (RBI) (based on an
application) to deal in foreign exchange or foreign securities.
Automatic route The route under which a foreign investor is required to inform the RBI within 30
days of making the investment.
Average rate of income tax The rate calculated by dividing the amount of income tax by the total
income.
Backward linkages Raw-material-supplying activities or ancillary units of large-scale industries

producing a range of raw materials, intermediates, or components.
BoP Balance of Payment. A double-entry system of record for all economic transactions between the
residents of a country and the rest of the world, carried out in a specific period of time.
BoT Balance of Trade. The balance between imports and exports of the country.
Bank rate The rate at which the central bank of a country buys or rediscounts eligible bills of
exchange, securities, or commercial papers.
Banking reforms Polices designed, formulated, and implemented by the Central Bank, through a
wide network of commercial banks and other institutions.
Bearer certificate A certificate by the delivery of which the title to the securities becomes
transferrable.
Bill market A market where short-term bills (up to 90 days) are bought and sold.
Black income Unaccounted or undisposed income.
Black money Unaccounted money in the hands of income-tax evaders.
Board of directors Representatives of shareholders expected to provide corporate leadership and

strategic- and competent guidance independent of the company management.
BRPSE The Board of Reconstruction of Public Sector Enterprise, an advisory board of the
government.
Budget deficits The excess of a government’s total expenditure over revenue receipts.
Business environment The aggregate of all conditions, events, and influences that surround and
affect business.
Call money market An important sub-market of the Indian money market, meant for very short-term
funds.
Capital asset Property of any kind held by an assessee, which may- or may not be connected to his
business or profession.
Capital goods Goods used within the factory for manufacturing the final product, vide Rule 2(b) of
CENVAT.
Capital infusion The investment of new/fresh capital.
Capital market The market dealing in long-term loanable funds.
CDS Current Daily Status. The activity status of a person for each of the preceding 7 days.
Central financing The planned expenditure of the central government in a Five-Year Plan.
CENVAT MODVAT re-formulated.
Community The part of society which provides the immediate social environment of the company.
CFF Compensatory Financing Facility. A facility that provides timely financing to members of the
IMF, experiencing a temporary shortfall in export earnings.
Conditionality The system in which members make an explicit commitment to implement corrective
measures in return for the IMF’s support.
CPI Consumer Price Index. An index that measures the cost of buying goods or service at different
points of time.
CCLs Contingent Credit Lines. Economic policies to obtain IMF financing on a short-term basis.
Corporate accountability The responsibility of businesses to remain accountable or its obligation to

its constituents, that is, owners, financiers, employees, government, and customers.
Corporate governance A system by which companies are run and the means by which they respond
to their shareholders, employees, and society.
CSR Corporate Social Responsibility. A corporation’s responsiveness to public consensus.
Country risk Exposure to a loss on cross-boarder lending, caused by events in a particular country.
Credit control The proper regulation of the volume of credit.
Cross-functional teams Teams responsible for developing and implementing the ethics management
programme.
CRR Cash Reserve Ratio. The minimum amount of non-interest bearing reserves with the Central
Bank (RBI) required to be held by commercial banks.
Curative provisions Provisions by which a government can take over the management or control of
industrial enterprises and control of supply, price, and distribution of certain commodities.
Custom duty Taxes imposed on goods and services crossing international borders.
Customs tariff Duties are levied on imports at rates specified in the annual budget.
DDAS Diamond Dollar Account Scheme. A scheme under which the export proceeds can be retained
in a dollar account which the exporter can use to import rough diamonds.
Deficit financing Forced savings which are the result of price increases during a period of the
government investment.
Delicensing The abolishing of industrial-licensing requirements to reduce entry barriers and

encourage the flow of private investment.
Demand-pull factors Factors responsible for a faster rise in demand than the available output or
supply, leading to an excess in demand.
Direct taxation A system of taxes on individuals or organisations levied according to income or

wealth.
Discount-flow method A comprehensive method of evaluation by the PSU (public sector unit) that
reflects the expected income flow to the investors.
Disinvestment A process by which a government dilutes its stake in the public sector.
DTA Domestic Tariff Area. The area from which a sale can be conducted only upon the full payment
of custom duty.
Economic inequality An uneven distribution of resources, employment growth, and per capita
income in a country.
Economy A system in which productive units use scarce resources to produce a variety of marketable
products that satisfy human needs.
Electronic commerce Business through electronic media.
Employee-welfare programmes Programmes which provides services, facilities, and amenities to

enable persons employed to perform their work in healthy- and congenial surroundings.
Environmental risk Risk faced by businesses due to the dynamic, social, technological, cultural,
economical, political, and legal environment in a country.
EPCG Zero-duty Export Promotion Capital Goods. A scheme for importing capital goods without
paying any import duty in return for an export obligation for five times the amount.
EPS Employee’s Pension Scheme.
Ethics tools Policies and techniques to manage ethics at a workplace.
Exchange rate The price of one unit of a currency in terms of the number of units of another
currency.
Exemption A special privilege or release.

Exim scrip A replenishment for export-based imports.
EPZ Export Processing Zones. An area with business units engaged in manufacturing, trade, or other
services, separated from the rest of economy by fiscal barriers.
Export promotion zones Resource zones which are promoted and awarded special schemes to
increase export.
External debt The amount raised by government loans from external sources.
External sector The international economy in terms of markets, investment, and technologies.
FDI inflow The flow of investment from different external sources.
FEMA The Foreign Exchange Management Act.
FERA The Foreign Exchange Regulation Act.
Fiscal adjustment The adjustment in the revenue and expenditure of a country.
Fiscal crises Fiscally undesirable situations in which the government has to raise fresh loans to pay
off past loans.
Fiscal policy The policy under which a government uses taxation, public expenditure, and public-debt
programmes to achieve predetermined economic- and social goals and to solve specific problems in
the economy.
Foreign affiliate A foreign enterprise which invests in a host country in cash (foreign exchange) or
kind (technical equipment or infrastructure)
FDI Foreign Direct Investment. An investment made to acquire interest in an enterprise operating in
an economy other than that of the investor.
Foreign exchange certificates Certificates introduced in place of the exim scrip.
Foreign exchange Foreign currency, which includes all deposits, credits, and balances payable.
Foreign investment Investment from foreign corporate bodies, individuals, and non-resident Indians.
Fringe benefit Any privilege, service, facility, or amenity directly-or indirectly provided by an
employer to his/her employees.
GATS General Agreement on Trade and Services.
GATT General Agreement on Tariffs and Trade.

GDP Gross Domestic Product. The total value of all domestic goods produced and services rendered
in the country in its economy over a specified period of time, usually a year. Can also be expressed as
a sum of four major components: personal-consumption expenditure, gross private domestic
investment, government expenditure on consumption, and net investment exports.
GDS Gross Domestic Saving. The saving in the household, private corporate, and public sector.
Geographical factors The locations, seasonal variations, and climatic conditions that influence a
business environment.
GDR Global Deposit Receipt. A mechanism by which shares of a firm are traded indirectly. The
shares are held by a depository, generally a large multinational bank, which receives a dividend on
shares and issues claims against these shares. GDRs are often used to tap multiple foreign markets for
equities with the help of single instruments of depository receipts.
Globalisation A process of global integration of products, technology, labour, investment,

information, and culture.
GNP Gross National Product. The total and final output produced by the residents of a country.
Goods (a) Products manufactured, processed, or mined; (b) Shares and stocks, including those before
allotment; (c) Imported goods in relation to goods supplied, distributed, or controlled.
Green export subsidies Subsidies permissible under the WTO and are non-actionable by the trading
partners.
Grievance An employee’s dissatisfaction or feeling of personal injustice relating to his or her

employment.
GDC Gross Domestic Capital. Gross Domestic Savings and the Net Capital inflow.
GSP Generalised System of Preferences. A scheme designed by the UNCTAD to encourage exports
of developing countries to developed countries.
Host countries The countries where MNCs operate, other than their parent countries.
IEC Importer–Exporter Code.
IFC International Finance Corporation. Its overall purpose is the reduction of poverty and
improvement of living standards through a leading role in the development of the private sector.
IMF International Monetary Fund. An organisation of countries that seeks to promote international
monetary cooperation and facilitate the expansion of trade.
Indian custom waters The waters extending into the sea to a distance of 12 nautical miles, measured
from the appropriate base line on the coast of India.
Indirect tax Taxes the burden of which can be shifted onto others.
Industrial licensing Permission by law to run a business or related activity.
Industrial policy The rules, regulations, principles, policies, and procedures laid down by a
government for regulating, developing, and controlling the industrial undertakings within a country.
Inflation A process in which the general price index (GPI) records a sustained- and appreciable
increase over a period of time.
Infrastructure An umbrella term connoting a physical framework of facilities through which a

variety of goods and services are commonly provided to the public.
Infrastructure risk Risk due to poor or non-available infrastructure.
Internal debt The amount raised by the government from loans within the country.
IPO Initial Public Offering.
LDC Less-developed Countries
LERMS Liberalised Exchange Rate Management System.
Liberalisation The process of freeing the economy from the various regulatory and control
mechanisms of the state and giving greater freedom to private enterprise.
Licence raj A period of restrictions, red-tapism, and corruption.
Licensing To permit by law private initiative and enterprise to provide their goods or services.
LOI Letter of Intent.
Merchant bankers Also known as issuing houses. Insitutions that provide a range of specialised
financial services to their client companies.
MFN Most Favoured Nation.
MNCs Multinational Corporations. Any business corporation which has holdings, management
production, and marketing in several countries and owns huge resources.
MNE Multinational Enterprise

Monetary policy All measures, direct and indirect, which affect the supply of money, liquidity, cost,
direction, availability of credit, and the overall efficiency and development of the financial sector.
Money market A market for lending and borrowing of short-term funds.
Monopoly A market condition where only one seller is available for a particular product.
MRTP Monopolies and Restrictive Trade Practices Act.
Multilateral trading system A mutually agreed-upon set of rules, binding on all members of WTO
and enforceable through a dispute settlement. Trade is conducted according to these rules and not by
the power of individual nations.
National exchequer The system which controls and checks national trade through duties and taxes.
National income The net national product (NNP) (minus indirect taxes).
NAV Net Asset Value. Indicates the value of an asset or unit.
NDC National Development Council. The highest national forum for economic planning in India.
Negotiation Bargaining between two or more countries for certain conditions of trade and tariff.
NTP New Trade Policy. Policies to promote exports, regulate imports, improve terms of trade,
enhance export competitiveness, and create conditions of export-led growth.
NNP Net National Product. Calculated by subtracting depreciation from the GDP.
Nominee directors Directors nominated by shareholders of the organisation.
NPA The National Plan of Action. Formulated to ensure the requisite access of women to information
resources and services.
NSDP Net State Domestic Product.
NTB Non-tariff Barriers. Factors which affect the import- and export mechanism of a country.
OGL Open General Licence.
OMO Open-market Operations. Mainly conducted by the central bank of a country and involve
periodic sale and purchase of government securities in the open market.
Organised enterprises All enterprises either registered with- or coming under the preview of any of
the Acts and/or maintaining annual accounts and balance sheets.
Parent corporations Main corporations whose subsidiaries invest in a host country.

PAN Permanent Account Number. A unique number by which the assessing officer can identify any
person.
Planning commission The commission responsible for five-year economic planning of India.
Comprises eight members.
POL imports Imports of petroleum, oil, and lubricants.
Political stability risk A Risk involved due to unstable political conditions in a country of business.
Previous year The financial year immediately preceding the assessment year.
Privatisation The process by which major economic decisions concerning production, exchange,
distribution, and consumption are entrusted to market forces, and decisions are taken by a large
number of individuals and private economic units.
Public expenditure The expenditure of a government towards activities like developing

infrastructure, industry, health facilities, and education; and for non-development activities like the
maintenance of law and order, and defence.
QR Quantitative Restrictions.
R&D Research and Development
Recession The results of continuous interaction between a number of macro-economic forces which
bring about a fall in the level of aggregate economic activity.
Red export subsidies Subsidies prohibited under the WTO and therefore actionable by trading
partners.
Regional imbalances Extreme regional variations in terms like per capita income, proportion of
population living below the poverty line, working population in agriculture, and employment
opportunities.
Registered exporters Exporters regularly exporting for a period of 3 years, who were permitted to
import capital goods (up to an amount of Rs 10 crore) at a concessional customs duty of 25 per cent
on the condition they take up an export obligation of three times the value of their imports within a
period of 4 years.
Remittances Money sent or invested.
Remuneration The compensation a person receives in return for his/her contribution to an

organisation.
Repatriation The bringing into India of realised foreign exchange and the selling of such foreign
exchange to an authorised person within India.
Revenue deficit The excess of revenue expenditure over revenue receipts.
Risk management Procedures by which board members are informed about risk-assessment and -
minimisation.
Rupee value The value of Indian currency in terms of foreign currency.
SAL Structure Adjustment Landing. A process designed by the World Bank to achieve a more
efficient use of resources.
Schedule industries Industries listed in the I Schedule of the Industrial Development and Regulation
Act, 1951.
SDR Special Drawing Rights. The quota assigned to members of the IMF for supplementing their
reserves in order to maintain stability in the foreign exchange market.
SEBI Securities and Exchange Board of India.
SEZ Special Economic Zone. A duty-free enclave of business firms predominantly engaged in export
production.
Shareholders Owners of a business firm who have a direct stake in it.
Sick unit A unit whose accumulated losses equal or exceed its entire network at the end of a financial
year.
SLR Statutory Liquidity Ratio. The percentage of a deposit a bank is required to maintain in the form
of cash, gold, or any government-approved securities to meet liquidity needs.
Social audit A system by which the social performance of an organisation can be evaluated.
Sourcing The successive transfer of materials, components, finished products, or services from
points in the network where they can be most economically produced to points where they can be
most profitably sold.
Special action programme A World Bank programme designed to mplement adjustment measures
needed to restore credit working and growth.
SRF Supplemental Reserve Facility. A facility that helps member countries of the IMF experiencing
exceptional BoP problems created by a large short-term financing need.
Stand-by arrangement A national program designed in consultation with the IMF to resolve cyclical
BoP problems.
State financing The planned expenditure of the state government in a five-year plan.
Stock Securities issued by corporate organisations offered to individuals and institutional investors.
Stock exchange An organised marketplace where brokers and dealers buy and sell securities of
corporate organisations.
Stock market A highly organised market that provides liquidity to the long-term securities issued by
an organisation.
Subsidy A grant or special monetary benefit given by a government.
Takeover A hostile acquisition of an organisation by another organisation. Sometimes, a takeover

may be by mutual understanding.
Target plus A scheme under which exporters achieving a quantum growth in exports are entitled to
duty-free credit based on incremental exports substantially higher than the general actual export target
fixed.
Tariffs Duties on import goods and services.
Tax evasion The deliberate effort by an individual or a firm to evade the payment of taxes.
Tax A compulsory levy imposed by the government on individuals or economic units.
TDC Technology Development Cell. A department set up to provide technology inputs to improve the
competitiveness and productivity of the small-scale sector.
TIN Tax-payer ’s Identification Number.
Tiny units Investments in plant and machinery on ownership by lease or hire purchase up to Rs 5
lakh.
TNCs Transnational Corporations. Corporations whose business operations extend beyond the
boundaries or borders of the country in which they were originally established.
TPDS Targeted Public Distribution System. Required to distribute national resources.
Trade facilitation The simplifying of trade procedures.
Trade policy Policy regarding import and export.
Tradeables Export-oriented products.

Transfer pricing A method of pricing used by MNCs to carry out effective transactions for
intermediate products and other current inputs imported by their affiliates.
TRIMs Trade-related Investment Measures.
TRIPs Trade-related Intellectual Property Rights.
Two-tier board A board consisting of a supervisory- and a management board.
Unorganised enterprise All unincorporated enterprises and household industries other than the
organised ones which are regulated by any of the Acts. These enterprises do not maintain annual
accounts and balance sheets.
VAT Value-added Tax. A tax levied on the sale of a commodity, assessed on the increased value of
that commodity at each point in the chain of production and distribution.
Wealth tax A tax levied on non-productive assets whose value exceeds Rs 1.5 mn.
WBP Whistle Blower Policy. A policy which provides protection to persons who give information
about unfair employment practices.
World bank An organisation that provides financial assistance to developing nations by giving loans
from capital created by its member countries.
WPI Wholesale Price Index. An index that measures the GPI at the level of second- or subsequent
commercial transactions but before the transaction at the retail level.
WTO World Trade Organization. It facilitates trade between member countries and enforces rules
governing global trade.
X-inefficiency An inefficiency which takes into account the outputs that are produced with the given
inputs.
Acknowledgements
I am indebted to all those who have helped, encouraged and supported me in preparing the second
edition of this book. My special thanks and gratitude go to Padmashree Fatma Rafiq Zakaria,
Chairperson of the Maulana Azad Educational Trust and Society, for her motivation and support for
writing this book. Thanks are due to my institution, the Millennium Institute of Management, and
faculty members, specially Mohd Imran Khan, Vidya Gawali, Akhtar Anwar and Khalid Hashmi.
I would like to thank my publisher, Pearson Education India, specially Raza Khan, Praveen Tiwari,
and Amrita Naskar, for their co-operation and encouragement.
I am also thankful to my family members, specially my wife for her invaluable support.
I solicit critical observation and suggestions from professionals and students.

SHAIKH SALEEM
Copyrig ht © 2010 Dorling Kindersley (India) Pvt. Ltd.
Licensees of Pearson Education in South Asia
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This eBook may or may not include all assets that were part of the print version. The publisher reserves the right to remove any material
in this eBook at any time.
ISBN 978813172755-3
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BUSINESS

Delhi • Chennai • Chandigarh

PREFACE TO THE SECOND EDITION

ABOUT THE AUTHOR

Meaning and Definition

Importance of the Study

Business Environment and Strategic Management

Distribution of Household by Income, 1990–2000

Recent Political Environment

Recent Economic and Financial Environment

The Emergence of Planning

The Planning Commission

The National Development Council

Objectives of Planning in India

Distribution of Public Sector Outlay of Each Plan

Tenth Five-Year Plan (2002–07)

Five-Year Plans—Achievements and Failures

Liberalisation and Planning

Meaning and Objectives of Industrial Policies

Evaluation of the New Industrial Policy

New Trade Policy of 1991

The New Small-Scale Sector Policy of 1991

Recent Policies for Micro and Small Enterprises (MSE) Sector

Industrial Licensing in India

Objectives of Industrial Licensing

Industrial Licensing Act of 1951

Industrial Licensing Policy

Recent Industrial Licensing Policy

Monetary Policy of India

Concept and Meaning of Monetary Policy

Objectives of the Monetary Policy

Differences Between Monetary Policy and Fiscal Policy

Meaning of CRR and SLR

Impact of the Monetary Policy

Measures to Regulate Money Supply

Meaning of Some Monetary Policy Terms

The Monetary Policy and IMF

RBI’s Monetary Policy Measures

RBI’s Monetary Policy, 2008–09

Fiscal Policy of India

Concept and Meaning of Fiscal Policy

Objectives of the Fiscal Policy

Fiscal Policy and Economic Development

Techniques of Fiscal Policy

Merits or Advantages of Fiscal Policy of India

The Shortcomings of the Fiscal Policy of India

Suggestions for Necessary Reforms in Fiscal Policy

Fiscal Policy Reforms

Fiscal Policy Statement, 2008–09

Fiscal Policy—An Assessment

The Indian Financial Systems

Indian Money Market

Call Money Market

Structure of the Financial System

Functions of the Indian Financial System: Promotion of Capital Formation

The Price Policy

Price Movement Since Independence

Objectives of Price Policy

Prices of Industrial Products

7 Stock Exchanges in India

Concept and Meaning of Stock Exchange

Types of Financial Markets

SEBI and Its Role in the Secondary Market