Industrial Policy Since 1956

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INDUSTRIAL POLICY SINCE 1956 Prior to the economic reforms of the 1990s, industrial policy in India was characterized by an extensive regime of domestic regulation, a strong bias in favor of the public sector (with several industries reserved for the public sector), a restrictive approach to foreign investment, and very heavy protection of domestic industry from foreign competition. Industrial licensing was a major instrument of control of the private sector; under this system, central government permission was needed for both investment in new units (beyond a relatively low threshold) and for substantial expansion of capacity in existing units. Licensing also controlled technology, output mix, capacity location, and import content. Apart from industrial licensing, large industrial firms needed separate permission for investment or expansion under the Monopolies and Restrictive Trade Practices (MRTP) Act, which aimed to prevent the concentration of economic power. There were price and distribution controls in industries such as fertilizers, cement, aluminum, petroleum, and pharmaceuticals. Almost eight hundred items were reserved for production by small-scale units as a way of protecting the small-scale sector from competition from large companies; investment in plant and machinery in any individual unit producing these reserved items could not exceed $250,000.

There were also barriers to industrial restructuring and exit of firms. The Bureau of Industrial and Financial Reconstruction (BIFR) was set up in 1987 and was assigned the task of separating the nonviable "sick" enterprises from the revivable ones and providing rehabilitation packages for the latter and effective solutions for exit to the former. Because the BIFR came into the picture at a fairly advanced stage of "sickness" and because its powers are not mandatory this has meant that it has not been effective in facilitating this exit of the nonviable sick units within the existing institutional constraints. Labor laws have been relatively inflexible, making it difficult for nonviable firms to exit or for firms to reduce labor if needed. As of May 2005, any firm wishing either to close down a plant or to retrench labor in any unit employing more than one hundred workers can do so only with the permission of the state government, and this permission is rarely granted. These provisions discourage employment and are especially onerous for labor-intensive sectors.

The inefficiencies promoted by the regime of industrial controls were supported by India's trade policy regime, which provided very heavy protection to domestic industry from foreign competition. It was characterized by very high and dispersed tariff rates and pervasive import restrictions. Before 1991 India's import tariffs were among the highest in the world, with duty rates above 200 percent being fairly common. Imports of manufactured consumer goods were completely banned. For capital goods, raw materials, and intermediates, some goods were freely importable, but for most items for which domestic substitutes were being produced, imports were only possible with import licenses. The criteria for issuing these licenses was nontransparent, delays were endemic, and corruption unavoidable. Policies toward foreign investment were quite restrictive, reflecting the general protectionist thrust of India's industrial policy.

Domestic Deregulation and Trade Policy Simplification: 1980–1990

Some steps toward reforming the policy regime were taken during the 1980s. Some of the important initiatives in domestic deregulation included the de-licensing of a number of industries, providing flexibility to manufacturing units to produce a range of products rather than a specified product under a given license, encouraging modernization and innovation by exempting such investments from licensing requirements and making it easier to import foreign technology, providing a broader scope for large industrial firms, and encouraging existing industrial undertakings in certain industries to achieve minimum economic levels of operations. These initiatives had the common theme of reducing reliance on physical controls and experimenting with market orientation in domestic regulation. Reforms of the public sector enterprises were limited to providing somewhat greater autonomy to these enterprises from their administrative ministries through signing a series of MoUs (Memoranda of Understanding).

The trade policy changes during the 1980s focused on the simplification of the existing complex procedures; the protectionist thrust nevertheless remained intact. This process was driven by pressures from domestic industry to allow easier access to imported intermediate inputs for capacity utilization and modernization of capital goods. Export subsidies were given to domestic industries in order to offset the anti-export bias of the import substitution regime.

Although the industrial and trade policy reforms of the 1980s were limited, they did lead to significant improvement in productivity in the manufacturing sector; total factor productivity grew at a rate of 2.7 percent per annum in the 1980s, compared with a growth rate of –0.5 percent per annum in the preceding two decades. This experience was to form the basis for much bolder reforms in the industrial and trade policy regime in the1990s.

Economic Reforms since 1991

Domestic deregulation

Industrial policy was radically overhauled during the reforms of the 1990s, with most central government industrial controls being dismantled. Industrial licensing by the central government has been almost done away with, except for a few hazardous and environmentally sensitive industries. The MRTP Act was abolished so that large industrial houses no longer require a separate additional clearance. Instead, the Competition Act of 2002 was put in place on 14 January 2003. It regulates anticompetitive behavior in other ways. The list of industries reserved solely for the public sector has been drastically reduced to three: defense aircraft and warships, atomic energy generation, and railway transportation.

Removal of the reservation in production of items for the small-scale sector started late but gathered momentum after 2000. Even earlier, since some of the reserved items, such as garments, had high export potential, and small-scale limit was a serious constraint to producing in a cost-effective manner for export, exemptions were granted to units if they were substantially engaged in export activity. Beginning with 2001, when fourteen items were removed from the reserved list, a number of such steps were taken, so that by March 2005, 550 items remained on the list. The unreserved items include some important sectors, such as garments, shoes, toys, and auto components, all of which have strong export potential.

Opening up to imports

A process of radical change in trade policy was set in motion in 1991, although progress here was slower than in industrial liberalization. Import licensing was abolished relatively early for capital goods and intermediates, which became freely importable in 1993, coinciding with the switch to a flexible exchange rate regime. For consumer goods, a process of dismantling the quantitative restrictions on imports was started through the introduction of the Special Import License Scheme, whereby export earnings could be used by exporters to import certain consumer goods. Quantitative restrictions on imports of manufactured consumer goods and agricultural products were finally removed on 1 April 2001, almost exactly ten years after the reforms began.

Progress in reducing tariff protection has been slower and not always steady. The weighted average import duty rate declined from the very high level of 72.5 percent in 1991–1992 to 24.6 percent in 1996–1997. This was followed by a process of slow reversal up to 1999–2000 and a sharp increase in 2000–2001, the latter reflecting the imposition of tariffs on many agricultural commodities in preparation for the removal of quantitative restrictions as part of an obligation to the General Agreement on Tariffs and Trade and the World Trade Organization. In the subsequent years, with the resumption of the reduction in import tariffs, the import-weighted tariff rate was brought down to 18 percent in 2004–2005—still the highest among the developing countries.

A new approach to foreign direct investment

A more liberal approach to foreign direct investment was an important plank of India's reforms during the 1990s. From a policy that was restrictive and selective and that supported mainly technology transfers, foreign investment policy in the 1990s moved toward becoming much more open and proactive. The policy now allows 100 percent foreign ownership in a large number of industries and majority ownership in all except banks, insurance companies, telecommunications, and airlines. A bill to allow up to 74 percent foreign ownership of banks was introduced in Parliament in March 2004. Procedures for obtaining permission have been greatly simplified by listing industries that are eligible for automatic approval up to specified levels of foreign equity (100 percent, 74 percent, and 51 percent). Potential foreign investors investing within these limits need only register with the Reserve Bank of India. For investments in other industries, or for a higher share of equity than is automatically permitted in listed industries, applications are considered by a Foreign Investment Promotion Board that has established a good record of speedy decisions. Beginning in 1993, foreign institutional investors have been allowed to purchase shares of listed Indian companies in the stock market, opening a window for portfolio investment in existing companies.

Public sector reform

Reform of the public sector has been talked about since the 1980s. During the 1990s the government began to undertake sales of minority shares in the better-performing public enterprises, and the enterprises were also given the freedom to access capital markets on the strength of their own performance. They were given more management autonomy in shaping their future. The loss-making enterprises, however, languished for want of budgetary support and political will to close them down.

A Disinvestment Commission was set up in 1997, but privatization was not seriously put on the policy agenda until 2001. The National Democratic Alliance (NDA) government did undertake a few privatizations involving the sale of public sector enterprises with the transfer of management control during the period 2001–2003, the most important being the privatization of Bharat Aluminum Company to a "strategic" private investor. But resistance to privatization was building from within the NDA government when an attempt was made to privatize two oil companies. The United Progressive Alliance (UPA) government, which came to power in 2004, changed the policy to one that is more restrictive. The current policy is that profit-making public sector enterprises will not be privatized, although sale of government equity can continue as long as the government retains 51 percent.

Policies toward infrastructure

Poor infrastructure has been a major constraint on India's industrial performance and competitiveness, especially as the country opens up to foreign competition and seeks to attract investment from abroad. Industrial policy has therefore focused on the need to build better infrastructure, especially electric power generation and distribution, telecommunications, roads, railways, ports, and airports. Prior to 1991, all these infrastructure services were organized as public sector monopolies, and a major challenge of the reforms was how to attract private investment into these sectors in order to meet the enormous investment requirements of upgrading infrastructure. Following the reforms of 1991, these sectors were opened up to private investment at different times with varying degrees of success. Telecommunications is the area in which the effort was most successful. The process was not smooth, and there were many regulatory hiccups on the way. But policy was helped by the fact that the pricing of telecom services (unlike that of power) was not uneconomic; by 2005 there were a handful of strong private sector telecom service suppliers competing effectively with the public sector companies. Access to telecom services has expanded greatly, costs have come down, and quality has improved. Private investment has also been attracted in ports and more recently in airports. In roads, new investment has been dominantly in the public sector, as is the case in most countries, but there has been some limited private sector involvement.

The biggest disappointment has been in the power sector, mainly because both the reform of the incumbent public sector and the setting up of an effective regulatory framework were slow to develop. This was the earliest sector to be opened up, and at one stage there were expectations of being able to attract large investments in generation capacity. These expectations were belied by the continuing financial problems of the distribution segment, which remains unviable because of a combination of unrealistically low tariffs for some sections of consumers (households and farmers) and also very large inefficiencies in collection. Faced with financially bankrupt distribution systems, private investors have been understandably reluctant to invest in generation capacity to supply electricity for which they may not be paid.

In recent years, attempts have been made to depoliticize the process of fixing power tariffs. Following the lead of the central government, a number of state governments have set up independent regulatory commissions for this purpose. Policies are also being directed at improving the efficiency of distribution, both through reforming the existing utilities and by selective privatization. The Electricity Act of 2003 lays out a broad legal framework of regulation for the sector. The act effectively empowers state governments to accelerate power sector reforms by fostering greater competition, increased involvement of the private sector, and better governance. But many details remain to be put in place. The Common Minimum Program of the UPA government has expressed a commitment to review the Electricity Act.

Special economic zones

A May 2005 initiative announced by the government of India is the enactment of a law to establish special economic zones, which would enable industrial units located in the zones to benefit from duty-free entry of imported inputs for production meant for exports, while paying duty on production diverted to the domestic market. The zones will have superior infrastructure and some special facilities, including the possibility of a more liberal labor law regime if the states in which the zones are located request it. Unlike the special regions of China, these zones will be much more compact, but their improved infrastructure should increase their attractiveness to investors.

Role of state governments

Industrial policy reforms by the central government have not always been associated with comparable policy reforms by state governments. Private investors require multiple permissions from state governments to start operations, for example, connections for electricity and water supply, environmental clearances, and other municipal clearances. They also need to interact with the state government administration for their day-to-day operations because of laws governing pollution, sanitation, and workers' welfare and safety. Some states have taken the initiative to ease these interactions and have put in place a process of supportive deregulation to attract private investment. States that have moved faster in this regard have created a better investment climate for private investors and have succeeded in attracting investment. Similarly, states differ in the extent to which they have implemented reform in the power sector, which is a crucial dimension of state policy toward infrastructure. Because liberalization has created a more competitive environment, the payoff from pursuing good policies has increased, thereby increasing the importance of state-level action. It is noteworthy that in one major respect, that is, with regard to modernizing the labor laws to provide the flexibility in shedding labor when necessary, only a few state governments have taken initiatives, while most have resisted reform.


The industrial and trade policy regime has come a long way on the road to reform since 1991. However, the gradual pace of reform has meant that important gaps remain. India's tariff levels are still much higher than those in most developing countries. Infrastructure reforms thus far have been far too slow and inadequate. Important areas remain closed to foreign investment or with equity ceilings that are too low. Approach to privatization has been hesitant. Labor laws continue to be rigid.

Notwithstanding these gaps, there is evidence that in recent years Indian industry has been responding to policy reforms by working toward restructuring and reducing costs in a slow but steady manner. Some star performers have emerged on a global scale, particularly the new knowledge-based industries. In addition to information technology, pharmaceuticals and automotive components are two conspicuous examples of manufacturing industries that have successfully developed a global vision and have subsequently penetrated world markets. Biotechnology and animation industries have also been growing very rapidly. However, Indian industry still falls short of the targets set for its growth, presenting a continuing challenge to India's planners and policy makers.

Isher Judge Ahluwalia

See alsoEconomic Reforms of 1991 ; Foreign Resources Inflow since 1991 ; Industrial Growth and Diversification ; Infrastructure Development and Government Policy since 1950


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Industrial Policy Since 1956

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