Economic Reforms 1991 - LPG Model (Liberalisation, Privatisation and Globalisation), Indian Economy Notes

Economic Reforms 1991
LPG Model – Liberalisation, Privatisation and Globalisation
Indian Economy Notes

New Industrial Policy, 1991

In order to solve economic problems of our country, the government took several steps including control by the State of certain industries, central planning and reduced importance of the private sector. The main objectives of India’s development plans were:

a)    Initiate rapid economic growth to raise the standard of living, reduce unemployment and poverty;

b)    Become self-reliant and set up a strong industrial base with emphasis on heavy and basic industries;

c)    Reduce inequalities of income and wealth;

d)    Adopt a socialist pattern of development based on equality and prevent exploitation of man by man.

As a part of economic reforms, the Government of India announced a new industrial policy in July 1991. The main objective of the new economic policy is to improve the efficiency of the business mechanism involving multitudes of control, fragmented capacity and reduced competition in the private sector. The thrust of new economic policy is creating a more competitive environment in the economy as a means to improving the productivity and efficiency of the system.

The broad features of this policy were as follows:

a)    The Government reduced the number of industries under compulsory licensing to six.

b)    Policy towards foreign capital was liberalized. The share of foreign equity participation was increased to 51% and in many activities 100 per cent Foreign Direct Investment (FDI) was permitted.

c)    Government will encourage foreign trad­ing companies to assist Indian exporters in export activities.

d)    Foreign Investment Promotion Board (FIPB) was set up to promote and channelize foreign investment in India.

e)    Automatic permission was now granted for technology agreements with foreign companies.

f)     Relaxation of MRTP Act (Monopolies and Restrictive Practices Act) which has almost been rendered non-functional.

g)    Dilution of foreign exchange regulation act (FERA) making rupee fully convertible on trade account.

h)    Disinvestment was carried out in case of many public sector industrial enterprises incurring heavy losses.

i)      Abolition of wealth tax on shares.

j)      General reduction in customs duties.

k)    Provide strength to those public sector enterprises which fall in reserved areas of operation or in high priority areas.

l)      Constitution of special boards to negoti­ate with foreign firms for large investments in the development of industries and import of technol­ogy.

Objectives of the New Industrial Policy, 1991:

The New Industrial Policy,1991 seeks to liberate the industry from the shackles of licensing system Drastically reduce the role of public sector and encourage foreign participation in India’s industrial development. The broad objectives of New Industrial Policy are as follows:

1.    Liberalizing the industry from the regulatory devices such as licenses and controls.

2.    Enhancing support to the small scale sector.

3.    Increasing competitiveness of industries for the benefit of the common man.

4.    Ensuring running of public enterprises on business lines and thus cutting their losses.

5.    Providing more incentives for industrialisation of the backward areas, and

6.    Ensuring rapid industrial development in a competitive environment.

7.    Initiate rapid economic growth to raise the standard of living, reduce unemployment and poverty;

8.    Become self-reliant and set up a strong industrial base with emphasis on heavy and basic industries;

9.    Reduce inequalities of income and wealth;

10.Adopt a socialist pattern of development based on equality and prevent exploitation of man by man.

Steps taken to initiate these objectives

The government announced a New Industrial Policy on July 24, 1991. This new policy deregulates the industrial economy in a substantial manner. The major objectives of the new policy are to build on the gains already made, correct the distortions or weaknesses that might have crept in, maintain a sustained growth in productivity and gainful employment, and attain international competitiveness. In pursuit of these objectives, the government announced a series of initiatives in the new industrial policy as outlined below:

1. Abolition of Industrial Licensing: In a major move to liberalise the economy, the new industrial policy abolished all industrial licensing irrespective of the level of investment except for certain industries related to security and strategic concerns, and social reasons. Now there are only 6 industries for which licensing is compulsory as amended in February 1999. These are alcohol, cigarettes, hazardous chemicals, drugs and pharmaceuticals, electronics, aerospace and defense equipments, and industrial explosives.

2. Public Sector’s Role Diluted: The number of industries reserved for the public sector since 1956 was seventeen. This number has now been reduced to three. They are arms and ammunition and allied items of defense equipment, atomic energy and rail transport.

3. Abolition of Phased Manufacturing Programmes: Devaluation of currency and increasing FDI led government to liberalise local content requirement for indigenous firms.

4. MRTP Act: MRTP Act has been amended to remove the threshold limits of assets in respect of MRTP companies and dominant undertakings. The new industrial policy also states that the government will undertake review of the existing public enterprises in low technology, small-scale and non-strategic areas. Sick units will be referred to the Board for Industrial and Financial Reconstruction for advice about rehabilitation and reconstruction. For enterprises remaining in the public sector it is stated that they will be provided a much greater degree of management autonomy through the system of Memorandum of Understanding (MOU).

5. Free Entry to Foreign Investment and Technology: The Government is committed to promote increased flow of Foreign Direct Investment (FDI) for better technology, modernisation, exports and for providing products and services of international standards.

6. Industrial Location Policy Liberalised: The new industrial policy provides that in locations other than cities of more than 1 million populations, there will be no requirement of obtaining industrial approvals from the centre, except for industries subject to compulsory licensing.

7. Removal of Mandatory Convertibility Clause: A large part of industrial investment in India is financed by loans from banks and financial institutions. These institutions have followed a mandatory practice of including a convertibility clause in their lending operations for new projects.

Impact of Government Policy Changes (New Industrial Policy, 1991) on Business and Industry

1.    Increasing competition: As a result of changes in the rules of industrial licensing and entry of foreign firms, competition for Indian firms has increased especially in service industries like telecommunications, airlines, banking, insurance, etc. which were earlier in the public sector.

2.    More demanding customers: Customers today have become more demanding because they are well-informed. Increased competition in the market gives the customers wider choice in purchasing better quality of goods and services.

3.    Rapidly changing technological environment: Increased competition forces the firms to develop new ways to survive and grow in the market. New technologies make it possible to improve machines, process, products and services. The rapidly changing technological environment creates tough challenges before smaller firms.

4.    Necessity for change: In a regulated environment of pre-1991 era, the firms could have relatively stable policies and practices. After 1991, the market forces have become turbulent as a result of which the enterprises have to continuously modify their operations.

5.    Threat from MNC Massive entry of multi nationals in Indian marker constitutes new challenge. The Indian subsidiaries of multi-nationals gained strategic advantage. Many of these companies could get limited support in technology from their foreign partners due to restrictions in ownerships. Once these restrictions have been limited to reasonable levels, there is increased technology transfer from the foreign partners

LPG Model - Liberalization, Privatisation and Globalization

Liberalization

Liberalization Meaning

The economic reforms that were introduced were aimed at liberalizing the Indian business and industry from all unnecessary controls and restrictions. They indicate the end of the license-permit-quota raj. Liberalization of the Indian industry has taken place with respect to:

a)    Abolishing licensing requirement in most of the industries except a short list,

b)    Freedom in deciding the scale of business activities i.e., no restrictions on expansion or contraction of business activities,

c)    Removal of restrictions on the movement of goods and services,

d)    Freedom in fixing the prices of goods services,

e)    Reduction in tax rates and lifting of unnecessary controls over the economy,

f)     Simplifying procedures for imports and experts, and

g)    Making it easier to attract foreign capital and technology to India.

Advantages of Liberalisation

Liberalisation can well be considered an investment in the future financial well-being of a nation. It helps the banking industry as a whole by providing:

1. Increased financial flexibilities of firms.

2. Reduced transaction costs.

3. Improved allocation efficiency.

4. Attraction of new capital to financial intermediaries.

5. Stronger and more competitive banking institutions.

6. Better and diversified portfolios.

7. More effective conduct of monetary policy.

8. Meaningful competition in banking services by allowing greater role to private sector and foreign banks.

9. Technological up-gradation of banks through wide use of computers and modern communication systems.

10. Removing major regulatory impediments to profitable working of banks.

11. Relaxation in the regulations covering foreign investment and foreign exchange.

12. Easy access to foreign capital.

Problems with Liberalisation

It would be incorrect to expect that liberalization and deregulation will solve all problems just by the initiation of these relaxed policies, it is not so. The major problems concerned with liberalization can be summarized as under:

1.    In so far as fiscal deficits are financed by money creation and growing, financial liberalization serves to accelerate inflation which coupled with an over- valued exchange rate, promotes capital flight.

2.    Liberalisation does raise real interests and results in an increased diversity of financial instruments. Innocent investors may be taken in by the rather fanciful terms offered.

3.    Competition is not automatically enhanced. It can lead to domination by big institution that has market controlling powers.

4.    Distortions in credit allocation or self-dealing by banks can produce efficiency gains.

5.    Deregulation can shorten the horizons of savers and investors, leading to a drawing up of long-term finance.

6.    Sometimes there can be problems of moral hazard.

7.    Pressure on profits and profitability can lead to speculation and create problems of systemic failures.

8.    With fewer entry restrictions, it has been possible for many entrants to make inroads into this lucrative sector, some antisocial elements can enter the field directly or indirectly.

9.    A number of companies can incorporate their own finance companies to make finance available on easy terms for purchase of their products, this phenomenon can also be used against the interest of the society.

10.It should also be noticed that liberalization can also result in the increase in instability. In general, financial liberalization represents a profound change in the economic rules. It can “increase the riskiness of traditional behaviour or introduce new inexperienced players.” In these circumstances, disasters can also take place.

LPG Model - Liberalization, Privatisation and Globalisation

Privatisation

Privatisation Meaning

The new set of economic reforms aimed at giving greater role to the private sector in the nation building process and a reduced role to the public sector. To achieve this, the government redefined the role of the public sector in the New Industrial Policy of 1991. The purpose of the sale, according to the government, was mainly to improve financial discipline and facilitate modernization. It was also observe that private capital and managerial capabilities could be effectively utilized to improve the performance of the PSUs. The government has also made attempts to improve the efficiency of PSUs by giving them autonomy in taking managerial decisions.

Benefits of Privatisation:

1. Improved Efficiency: The main argument for privatization is that private companies have a profit incentive to cut costs and be more efficient. If we work for a government run industry, managers do not usually share in any profits. However, a private firm is interested in making profit and so it is more likely to cut costs and be efficient.

2. Lack of Political Interference: It is argued that governments make poor economic managers. They are motivated by political pressures rather than sound economic and business sense.

3. Short Term view: A government many think only in terms of next election. Therefore, they may be unwilling to invest in infrastructure improvements which will benefit the firm in the long term because they are more concerned about projects that give a benefit before the election.

4. Shareholders: It is argued that a private firm has pressure from shareholders to perform efficiently. If the firm is inefficient then the firm could be subject to a takeover. A government owned firm doesn’t have this pressure and so it is easier for them to be inefficient.

5. Increased Competition: Often privatization of state owned monopolies occurs alongside deregulation – i.e. policies to allow more firms to enter the industry and increase the competitiveness of the market. It is this increase in competition that can be the greatest motivation for improvements in efficiency. However, privatization doesn’t necessarily increase competition; it depends on the nature of the market.

6. Government will raise revenue from the sale: Selling government owned assets to the private sector raised significant sums for government.

Disadvantages of Privatisation

1. Natural Monopoly: A natural monopoly occurs when the most efficient number of firms in an industry is one. Privatisation would create a private monopoly which might seek to set higher prices which exploit consumers. Therefore it is better to have a public monopoly rather than a private monopoly which can exploit the consumer.

2. Public Interest: There are many industries which perform an important public service, e.g. health care, education and public transport. In these industries, the profit motive shouldn’t be the primary objective of firms and the industry.

3. Government loses out on potential dividends: Many of the privatized companies in the India are quite profitable. This means the government misses out on their dividends, instead going to wealthy shareholders.

4. Problem of regulating private monopolies: Privatisation creates private monopolies, such as the water companies and rail companies. These need regulating to prevent abuse of monopoly power. Therefore, there is still need for government regulation.

5. Fragmentation of industries: In India, rail privatization would lead to breaking up the rail network into infrastructure and train operating companies. This led to areas where it was unclear who had responsibility.

6. Short-Term view of Firms: As well as the government being motivated by short term pressures, this is something private firms may do as well. To please shareholders they may seek to increase short term profits and avoid investing in long term projects.

LPG Model - Liberalization, Privatisation and Globalisation

Globalisation

Meaning of Globalisation

Globalizations are the outcome of the policies of liberalisation and privatization. Globalisation is generally understood to mean integration of the economy of the country with the world economy, it is a complex phenomenon. It is an outcome of the set of various policies that are aimed at transforming the world towards greater interdependence and integration. It involves creation of networks and activities transcending economic, social and geographical boundaries.

Globalisation involves an increased level of interaction and interdependence among the various nations of the global economy.  Physical geographical gap or political boundaries no longer remain barriers for a business enterprise to serve a customer in a distant geographical market.

In simple words, The term globalization can be defined as the opening one's economy toward the world economy. It means to integrate the domestic economy with world economy. The govt. of India under the prime minister ship of P. V Narasimham introduced liberalisation, privatization and globalization during 1991. Due to globalization the multinational corporations have been very popular. These corporations transact their business activities more than one countries.

Globalisation and India

Indian economy had experienced major policy changes in early 1990s. The new economic reform, popularly known as, Liberalization, Privatization and Globalization (LPG model) aimed at making the Indian economy as fastest growing economy and globally competitive. The series of reforms undertaken with respect to industrial sector, trade as well as financial sector aimed at making the economy more efficient.

With the onset of reforms to liberalize the Indian economy in July of 1991, a new chapter has dawned for India and her billion plus population. This period of economic transition has had a tremendous impact on the overall economic development of almost all major sectors of the economy, and its effects over the last decade can hardly be overlooked. Besides, it also marks the advent of the real integration of the Indian economy into the global economy.

This era of reforms has also ushered in a remarkable change in the Indian mindset, as it deviates from the traditional values held since Independence in 1947, such as self-reliance and socialistic policies of economic development, which mainly due to the inward looking restrictive form of governance, resulted in the isolation, overall backwardness and inefficiency of the economy, amongst a host of other problems. This, despite the fact that India has always had the potential to be on the fast track to prosperity.

Benefits of Globalisation

a)    Increased Competition: One of the most visible effects is the improved quality of products due to global competition. Customer service and the ‘customer is the king’ approaches to production have led to improved quality of products and services. As the domestic companies have to fight out foreign competition, they are compelled to raise their standards and customer satisfaction levels in order to survive in the market.

b)    Employment: With globalization, companies are moving towards the developing countries and hence generated employment for them. It has given an opportunity to invest in the emerging markets and tap up the talent which is available there. In developing countries, there is often a lack of capital which hinders the growth of domestic companies and hence creates unemployment. In such cases, due to global nature of the businesses, people of developing countries too can obtain gainful employment opportunities.

c)    Investment and Capital Flows: A lot of companies have directly invested in developing countries like Brazil and India by starting production units. Companies which perform well attract a lot of foreign investment and thus push up the reserve of foreign exchange.

d)    Spread of Technical Know-How: While it is generally assumed that all the innovations happen in the Western world, the know-how also comes into developing countries due to globalization. Without it, the knowledge of new inventions, medicines would remain cooped up in the countries that came up with them and no one else would benefited. The spread of know –how can also be expanded to include economic and political knowledge, which too has spread far and wide.

e)    Spread of Culture: Not all good practices were born in one civilization. The world that we live in today is a result of several cultures coming together. People of one culture, if receptive, tend to see the flaws in their culture and pick up the culture which is more correct or in tune with the times. Societies have become larger as they have welcomed people of other civilization and backgrounds and created a whole new culture of their own. Cooking styles, languages and customs have spread all due to globalization. The same can be said about movies, musical styles and other art forms. They too have moved from one country to another, leaving impression on a culture which has adopted them.

Impact of Globalisation of Various Sector of Indian Economy or Role of Globalisation

1)    Impact of Globalization on Agricultural Sector

Agricultural Sector is the mainstay of the rural Indian economy around which socio-economic privileges and deprivations revolve and any change in its structure is likely to have a corresponding impact on the existing pattern of Social equity. The liberalization of India’s economy was adopted by India in 1991. Facing a severe economic crisis, India approached the IMF for a loan, and the IMF granted what is called a ‘structural adjustment’ loan, which is a loan with certain conditions attached which relate to structural change in the economy. Essentially, the reforms sought to gradually phase out government control of the market (liberalization), privatize public sector organizations (privatization), and reduce export subsidies and import barriers to enable free trade Globalization has helped in:

Ø Raising living standards,

Ø Alleviating poverty,

Ø Assuring food security,

Ø Generating buoyant market for expansion of industry and services, and

Ø Making substantial contribution to the national economic growth.

2)    Impact of Globalization on Indian trade and industry:

Globalization has its impact on India which is a developing country. The positive impact of globalization can be analysed as follows:

1. Access to Technology: Globalization has drastically, improved the access to technology. Internet facility has enabled India to gain access to knowledge and services from around the world. Use of Mobile telephone has revolution used communication with other countries.

2. Growth of international trade: Tariff barriers have been removed which has resulted in the growth of trade among nations. Global trade has been facilitated by GATT, WTO etc.

3. Increase in production: Globalization has resulted in increase in the production of a variety of goods. MNCs have established manufacturing plants all over the world.

4. Employment opportunities: Establishment of MNCs have resulted in the increase of employment opportunities.

5. Free flow of foreign capital: Globalization has encouraged free flow of capital which has improved the economy of developing countries to some extent. It has increased the capital formation.

6. Products of superior quality: Products of superior quality are available in the market due to increased competition, efficiency and productivity of the businesses  and this leads to increased consumer satisfaction.

7. Free flow of finance enable the banking and financial institutions in a country to fulfill financial requirements through internet and electronic  transfers easily and help businesses to flourish.

3)    Impact on Financial Sector

Reforms of the financial sector constitute the most important component of India’s programme towards economic liberalization. The recent economic liberalization measures have opened the door to foreign competitors to enter into our domestic market. Innovation has become a must for survival. Financial intermediaries have come out of their traditional approach and they are ready to assume more credit risks. As a consequence, many innovations have taken place in the global financial sectors which have its won impact on the domestic sector also. The emergences of various financial institutions and regulatory bodies have transformed the financial services sector from being a conservative industry to a very dynamic one. In this process this sector is facing a number of challenges. In this changed context, the financial services industry in India has to play a very positive and dynamic role in the years to come by offering many innovative products to suit the varied requirements of the millions of prospective investors spread throughout the country. Reforms of the financial sector constitute the most important component of India’s programme towards economic liberalization.

Growth in financial services (comprising banking, insurance, real estate and business services), after dipping to 5.6% in 2003-04 bounced back to 8.7% in 2004-05 and 10.9% in 2005-06 The momentum has been maintained with a growth of 11.1% in 2006-07. Because of Globalization, the financial services industry is in a period of transition. Market shifts, competition, and technological developments are ushering in unprecedented changes in the global financial services industry.

4)    Impact on Export and Import

India’s Export and Import in the year 2001-02 was to the extent of 32,572 and 38,362 million respectively. Many Indian companies have started becoming respectable players in the International scene. Agriculture exports account for about 13 to 18% of total annual of annual export of the country. In 2000-01 Agricultural product valued at more than US $ 6 million were exported from the country 23% of which was contributed by the marine products alone. Marine products in recent years have emerged as the single largest contributor to the total agricultural export from the country accounting for over one fifth of the total agricultural exports. Cereals (mostly basmati price and non-basmati rice), oil seeds, tea and coffee are the other prominent products each of which accounts from nearly 5 to 10% of the country’s total agricultural exports.

The implications of globalization for a national economy are many. Globalization has intensified interdependence and competition between economies in the world market. This is reflected in Interdependence in regard to trading in goods and services and in movement of capital. As a result domestic economic developments are not determined entirely by domestic policies and market conditions. Rather, they are influenced by both domestic and international policies and economic conditions. It is thus clear that a globalizing economy, while formulating and evaluating its domestic policy cannot afford to ignore the possible actions and reactions of policies and development in the rest of the world. This constrained the policy option available to the government which implies loss of policy autonomy to some extent, in decision-making at the national level.

Negative effect of globalization:

Negative effects of globalization on Indian industry have been: 

1. Rise in demand for labor and the rise in wage rates leading to some increase in costs. 

2. Weakening power of the trade unions over labor in emerging industries and growth sectors like IT, entertainment, internet and mobile services, airlines, banking, insurance, banking services. 

3. Too much competition in the market leading to continuous pressure on raising productivity, enhancing consumer service, improving product quality, in order to survive. 

4. Voluntary retirement for many public sector units. 

5. Too many sales person chasing customers. 

6. Too many cars on the road and traffic congestion. 

7. Growth of consumerism. 

8. Instability in profits due to too much choice among customers. 

9. Shortage power and infrastructure affecting industrial expansion. 

10. Closure of inefficient units supplying costly and shoddy products and loss of jobs. 

11. Two years of large increase in textile industry jobs followed by large loss of jobs due to Rupee appreciation making Indian industry uncompetitive. 

12. Problems of dealing with uncertainty in the international market in terms of demand, supply and prices., 

Obstacles of Globalisation

 The Indian business suffers from many disadvantages in respect of globalization of business. The important problems are following:

a)    Government Policy & Procedures: Government policy procedure in India is among the most complex, confusing and cumbersome in the world. Even after the much publicized liberalization, they do not present a very conducive situation. Government policy and the bureaucratic culture in India in this respect are not that encouraging.

b)    High Cost: High cost of many vital input and factors like raw material and intermediates, power, finance, infrastructure facilities like port etc. tent reduce the international competitiveness of the Indian business.

c)    Poor Infrastructure: Infrastructure in India is very inadequate and insufficient and they for very costly this is the serious problem affecting the growth and competitiveness.

d)    Resistance to Change:  There are several socio-political factors which resist change and this comes in the way of modernization, rationalization and efficiency improvement. Technological resist due to fear of unemployment. The extend labors employed by Indian industry is alarming because of labors of production is low and this may come in offsets the advantages of cheap labors.

e)    Poor quality image: Due to various reasons, the quality of many Indian products is poor. Even when the quality is good, the poor quality image, India has become a handicap.                           

f)     Supply problem: Due the various reason like low production, infrastructure like power, port facilities.

g)    Small Size: Because of the small size and the low level of resources, in many cases Indian firms are not able to compete with the giants of other counties. Even the largest   Indian companies are small compared to the multinational giants.

h)    Limited R&D and marketing Research: Marketing research and R&D in other areas are vital inputs for development of international business. However, these are poor in Indian business. Expenditure on R&D in Indian is less than one percentage of the GNC while it is two to three percent in most of the developed counties. In 1994-95, Indian’s per capital R&D expenditure was less than $3 when it was between $100 and $825 for most of the developed nation.

i)      Growing competition: The competition is growing not only from the firm in the developed countries but also from the developing country firms. Indeed, the growing competition from the developing country firms is a serious challenge to Indian’s International business.

j)      Trade Barriers: Although the tariff barriers to trade have been progressively reduced thanks to the GATT/WTO, the non-tariff barriers have been increasing, particularly in the developed counties.

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