Foreign direct policy in India

By Priya Chetty on April 25, 2010

Reforms in trade, industrial and foreign direct investment policy were a central focus of India’s economic reforms in the early stages since 1991. However, their expected effects have not been fully achieved.

Trade policy reform

The pre-reforms period was characterised by a trade policy in terms of high tariffs and pervasive quantitative restrictions on imports. There was a complete ban on import of manufactured consumer goods. In the case of capital goods, raw materials and intermediate inputs, certain lists of goods were freely importable, but for most items where domestic substitutes were being produced, imports were only possible with import licenses. The criteria for issue of licenses were nontransparent, delays were endemic and corruption unavoidable.

The post-reforms period witnessed the following changes:
Abolition of import licensing for capital goods and intermediates, which became freely importable in 1993 and simultaneous switchover to a flexible exchange rate regime.
Removal of quantitative restrictions on imports of manufactured consumer goods and agricultural products from April 1, 2001 due to pressures from the WTO.

Slower and unsteady reduction in tariff rates. Although India’s tariff levels are significantly lower than in 1991, they remain among the highest in the developing world.

Industrial policy

In the pre-reforms period, industrial policy was characterized by multiple controls over private investment that limited the areas in which private investors were allowed to operate and often also determined the scale of operations, the location of new investment and even the technology to be used. In this milieu, the industrial structure that evolved turned out to be inefficient but it could exist only due to high levels of protection granted by the government.

In the post-reforms period, the following changes were witnessed:
The list of industries reserved soley for the public sector was drastically reduced from 18 industries to only 3 industries.Abolition of industrial licensing by the central government except for a few hazardous and environmentally sensitive industries.

Abolition of the requirement that investment by large industrial houses needed a separate clearance under the Monopolies and Restrictive Trade Practices Act in order to discourage concentration of economic power. The Act itself is expected to be replaced by a new competition law that will attempt to regulate anticompetitive behavour in other ways.

As regards reserving production of certain items for the small scale sector, about 800 items were covered by the reservation policy since the late 1970s, which meant that investment in plant and machinery in any individual unit producing these items could not exceed $250,000. Many of the reserved items had a high export potential but the failure to permit development of production units with more modern equipment and a larger scale of production severely restricted India’s export competitiveness. In 2001 14 items were removed from the reserved list, and another 50 in 2002. The removed items include garments, shoes, toys and auto components, all of which are potentially important for exports. In addition, the investment ceiling for certain itemswas increased to $1 million.

Although industrial liberalisation by the central government has happened, it has not received adequate supportive action by the state governments in terms of eliminating complaints of delays, corruption and harassment arising from the interactions of the investors with the state governments.

Foreign direct investment

The new policy allows 100 per cent foreign ownership in a large number of industries and majority ownership in all except banks, insurance companies, telecommunications and airlines. Dramatic simplification of the procedures for obtaining permission by listing industries that are eligible for automatic approval from the Reserve Bank of India up to specified levels of foreign equity ( 100 per cent, 74 per cent and 51 per cent).

For investments in other industries, or for a higher share of equity than is automatically permitted in listed industries, applications are considered by the Foreign Investment Promotion Board that has established a track record of speedy decisions.

Allowing foreign institutional investors to purchase shares of listed Indian companies in the stock market, thereby opening the window for portfolio investment in existing companies. The above reforms have increased the degree of competiton in the domestic markets, and forced the Indian companies to upgrade their technologiesand expand their scales of production to more efficient ones. Industrial restructuring in terms of mergers and acquisitions has taken place and companies have refocussed their activities to concentrate on areas of competence. New dynamic firms have replaced older and less dynamic ones. Quality has become a critical success factor for Indian companies in the presence of foreign owned companies and their products. Foreign direct investment inflows increased from nothing to 0.5 per cent of the GDP.

Despite the reforms on the above lines, export growth and industrial growth in India have been below expectations. One reason for disappointing export performance has been the slow progress in lowering import duties that make India a high cost producer and therefore less attractive as a base for export production by the multinational corporations.

The procedures for obtaining duty free import of inputs are still very complex. FDI in India continues to be predominantly domestic market oriented. The poor quality of infrastructure in India and governance in many states and the inflexibility in the labour market in terms of the permission required to be taken from the state governments to close down a plant or to retrench labour in any unit employing more than 100 workers go a long way in accounting for slower export growth and industrial growth in the second half of the 1990s.


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