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
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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