ICAI Notes- Government Policies for Business- 3 | Business and Commercial Knowledge (Old Scheme) - CA Foundation PDF Download

THE ECONOMIC CHANGE PROCESS

Mixed economic policies provided a lot of social protection to people, but industrial development was low. The fall of the Warsaw Pact nations including Soviet Union, birth of small states around Russia, formation of European Union and the pressure of heavy developmental loans from agencies like IMF, World Bank and ADB remained the major reasons behind India’s journey towards liberalization.

The effort of globalization coupled with liberalization remained a major shift in policy. India decided to embark upon a faster course of economic journey through multiple reforms program in 1991. The economy was aiming to raise its growth potential. Globalization as a policy helped India in integrating the country’s economy with the world economy.

Industrial policy was reformed first through the New Industrial Policy, 1991. It opened up the foreign capital inflow. The removal of restrictions on investment in projects helped many business sectors to expand. This change in policy also allowed increased access to foreign technology and funding on the other.

Infusion of foreign funds in strong currencies helps a nation to build a strong foreign exchange reserve to buy foreign technology. Foreign funds come in different ways. Foreign Institutional Investors (FIIs) are big fund houses which invest in stock market and also engage in speculation actively. FIIs bring huge investments there is also risk that leave a nation after off-loading their portfolios.

NRIs (Non-Resident Indians) and OCIs (Overseas Citizens of India) invest the foreign currency in India to get better returns. They also enjoy the residential status. But the government actually looks for Foreign Direct Investment (FDI). FDI is meant for setting up of industries. FDI not only brings forex investment, it also enhances employment opportunities.
A series of measures which were taken towards liberalizing foreign investment included:

1. There is dual route of approval of FDI. The Reserve Bank of India articulated the areas of automatic route and the union government outlined the process of approval through government route.
2. Automatic permission was granted for technology agreements in high priority industries and the process of removal of restrictions on FDI in low technology areas as well as liberalisation of technology imports.
3. Permission was granted to Non-Resident Indians (NRIs) and Overseas Corporate Bodies (OCBs) to invest up to 100 per cent capital in high priorities sectors.
4. Hike in the foreign equity participation limits to 51 per cent for existing companies and liberalisation of the use of foreign “brands name”.
5. Signing the Convention of Multilateral Investment Guarantee Agency (MIGA) for protection of Foreign Investments. These efforts were boosted by the enactment of Foreign Exchange Management Act (FEMA), 1999 [that replaced the Foreign Exchange Regulation Act (FERA), 1973] which was less stringent. In 1997, Indian Government allowed 100% FDI in cash and carry wholesale and FDI in single brand retailing was allowed 51% in June, 2006. After a long debate, further amendment was made in December, 2012 which led FDI to 100% in single brand retailing and 51% in multiple brand retailing.

The presence of Samsung, Sony, Coke, PepsiCo, HP, Microsoft, General Motors, Hyundai, Honda, Toyota, Volkswagen, Volvo are some examples of FDI presence in India during the post liberalization days.

NEED FOR REFORMS

During the planned regime, with high rate of taxation, dysfunctions were visible in different areas of the economy. Most of the public sector undertakings were running under losses. Their efficiency remained poor, and per employee production was low. Strong trade-unionism crippled the growth of the private sector. Restrictions in trade stunted the quality of Indian products.
The Government of India took huge loans from various sources, like World Bank, Asian Development Banks, IMF, etc. The loan repayment schedule was like the noose around the neck. Inflation was high and the reserve of foreign currency was at low ebb. India’s spending on defence was increasing and there had been huge demand for infrastructural developments.

India was always helped by the Soviet Union. The freedom movement in Soviet Union loomed large. In the mid-1980s, The Soviet Union got broken and 15 independent states were formed. Russia also opened up its economy. Capitalism got a new breeding ground in Russia and other erstwhile Warsaw pact nations like, Poland, Albania, Czechoslovakia, Hungary, and Bulgaria.

Questions were raised on India’s mixed economic system. Government of India started various experiments on its way to economic freedom. Gold was mortgaged at Bank of England and Foreign Currency loan was arranged for meeting the Foreign Currency Reserve.

In 1992, finally, The Government of India took revolutionary steps to open up the economy. A massive change in economic policy was laid down. Private Sector was given a priority. Many of the loss making Public Sector Enterprises (PSEs) were decided to be closed or divested. Some of the PSEs were first corporatized and the capital was valued and it was decided that a large chunk of shares would be sold to public. The process

was known as disinvestment. Further, a number of private sector banks were given licences to run banking operations.

POLICY, DECISION AND GOAL

A policy emanates from decision and decision is taken in line with goal. Many a time the terms like political goal, decision and policy are used interchangeably. But they do not mean the same. In real life Individuals, organisations and governments are constantly taking decisions. But all the decisions that are taken cannot be categorized as the matters of policy. The essence of decision-making lies in the fact that one has to make a choice from multiple alternatives available to him. In order to take a decision, there must be more than one course of action. Thus, a decision is the act of making a choice. The entire act of decision-making has been developed on the conditions that can improve this activity of finding multiple choices.

In India, the policies are concerned with the general welfare and development of the society, as the nation is a welfare state. The government’s efforts like creation of education and employment opportunities, national defence, economic progress and stabilisation, law and order issues, creation of new states, anti-pollution legislation etc. are the result of substantive policy formulation. These policies have vast areas of operation affecting the general welfare and development of the society as a whole. They have been formulated

keeping in view the prime character of the Indian Constitution, socio-economic problems and the level of moral values of the society.

Regulatory policies are concerned with regulation of national and foreign trade, business, safety measures, public utilities, etc. This type of regulatory policies is laid down by independent organisations that work on behalf of the government. In regulatory activities, these policies are made by the government, pertaining to those services.
Some policies are called distributive policies, which are meant for specific segments of society. It can be in the area of public distribution to people below poverty line (BPL), public welfare, justice for women, health services, etc. These mainly include all public assistance and welfare programmes. Some more examples of distributive policies are adult education programme, food relief, social insurance, immunization camps etc.
India is the largest democracy and the Union Government decides the National goals to be followed. All the state governments have their own legislative assemblies and they outline their goals in tune with the national goals. In the national parliament, the issues of development, defence, trade and commerce are discussed and debated. The national goals are translated into decisions. These decisions are put into actions by designing legislations in the form of Acts. The Union Government through different ministries (for

example, Ministry of Commerce, Ministry of Finance) and various regulatory institutions (like RBI, SEBI, IRDA) may issue codes, guidelines and statutes. These mandatory and recommendatory documents become the Public Policy Statements of the nation.

The process of liberalization was a major policy shift in India’s economic journey. Liberalization made the rules of foreign trade simpler. Foreign exchange related rules were simplified. It became easier for Indian corporate houses to do business abroad. The competition rules, the IT Act, The Intellectual Property Act codified the act of globalization. Foreign funds started to flow in the form of FDI (Foreign Direct  investment). The FII (Foreign Institutional Investors) were permitted to invest in the equity shares quoted in the Indian stocks. The privatization drive helped the government to generate a pool of resources and the stock markets witnessed a number of PSU companies getting listed.

PRIVATIZATION

India initiated its mammoth privatization program in 1991 as a part of its policy stance to usher in macroeconomic stabilization and structural reform effort to cope with stagnation, slow growth in an extremely difficult economic condition.

At that time, the rate of inflation was very high and foreign exchange reserves declined to a dangerously low level. There was a growing domestic consensus that state-owned enterprises (PSUs) were not generating adequate returns and were suffering from low efficiency, and the government expected that privatization of these enterprises would lead to better outcomes. In this context, the two main objectives of privatization in India were:

• to raise revenues to ease the fiscal crunch and;
• to improve the profitability and efficiency of the divested enterprises.

In the 1990’s, the Government of India’s national budget had huge fiscal deficits, and negative balance ofpayments in trade. This boosted the government’s desire and necessity to extract and release the massive investments made in the state owned enterprises and this led to privatization in India. This major thrust on privatization paved way for Foreign Direct Investments (FDI) and rapid liberalization of business regulations,
fiscal policies, industrial practices and protocols as well.
Privatization as a strategy had been experimented in the western world a decade earlier than that experimented in India. During the Prime Ministership of Mrs. Margaret Thatcher, British Coal Mines were privatized; many of the components of National Healthcare Services and School Education Services were privatized. Privatization refers to a managerial approach of changing the ownership structure of one or more government owned institutions. Privatization can be advantageous in terms of the higher flexibility
and scope of innovation it offers along with cost savings, many a times. However, it has an adverse impact on the employee morale and generates fear of dislocation or termination. It looks for accountability and quality in production and service system. Privatization can be successful, if diligent scrutiny by the decision makers is attached to the policy concerned.

In the Indian context, privatization effort was not easy. There were hardly any takers for loss making public sector industries. On the other hand, there had been many takers for surplus making industries like Oil drilling and Refinery companies, or the ones in mineral extracting sectors like Steel Authority of India Limited, National Mineral Development Corporations etc. Government decided to privatize the loss making companies fully and the profit making ones and banks partially. The effort of privatization was accepted by

the society with a lot of resistance during the inception of economic liberalization in the nation.

Privatization helps in a big way to enhance market potencies by enhancing efficiency, quality and competitiveness. Privatization is an essentially effective tool for rapid restructuring and reforming the public sector enterprises. In India (also witnessed in other nations) public sector entities remained inefficient as far as profitability and quality is concerned. They were running without a significant aim and mission. The private sector, on the other hand is perceived to be more self-motivated, prolific and reliable for superior

quality of products and services. Though there are exceptions.

Privatization may be of conceptualized in following prominent types:

• Delegation: Government keeps hold of responsibility and private enterprise handles fully or partly the delivery of product and services. There is active involvement by government. Delegation may happen through contract, franchise, grant, etc.
• Divestment: Government surrenders partial ownership and responsibility and sells the majority stake to one or more private entities in course of time.
• Displacement: The private enterprise expands and gradually displaces the government entity. Deregulation facilitates privatisation if it enables private sector to challenge a government monopoly. The government monopoly through BSNL and MTNL has been displaced by the private sector.
• Disinvestment: Selling a portion of ownership (stake) in a public enterprise to private parties.

FOREIGN DIRECT INVESTMENT IN INDIA (FDI)

Foreign Direct Investment (FDI) plays a very important role in the process of development of a nation. In most of the cases, capital sourced for domestic sources remain inadequate for the purpose of overall development of the nation. Foreign capital is seen as an harbinger of growth. In a sense, it is like filling in the gaps between domestic savings and investment. In the post liberalization and privatization period, India was considered a lucrative place of FDI inflow because of its huge domestic market.

For a closed economy, any national program of privatization for its success needs a successful move towards globalization. Globalization creates a wide market of goods and services. At the same time, foreign funds flow in an economy to be invested in various industries. Foreign funding in good sense creates employment as well as demand. For a steady flow in foreign funds, liberalization of economy is required. Liberalization is

always paired with regulations.

Foreign Direct Investment (FDI) may be described as a flow of capital investment to an enterprise in a nation by another enterprise located in a different nation by capturing a majority stake in ownership in a company in the target country or by expanding operations of an existing business in that country.

Permission for Foreign Direct Investment (FDI) is not uniform for all sectors. Some sectors are opened up for 100% and in some sectors, it is allowed only upto 26%, 49% or 51%.

Foreign Direct Investment (FDI) has always remained a bone of contention and FDI in multi-brand retail, defense etc., are classic examples. It’s often felt that areas like Media and Defense could compromise on India’s security interest and hence no FDI should be permitted. In certain areas, the FDI limit has been capped, like the Insurance Business. Where there is no approval through Automatic Route, the company concerned has to seek permission from Foreign Investment Promotion Board.
Here are a few sectors where FDI is prohibited under both the Government Route as well as the Automatic

Route:

1. Atomic Energy
2. Lottery Business
3. Gambling and Betting
4. Business of Chit Fund
5. Nidhi Company
6. Agricultural (excluding Floriculture, Horticulture, Development of seeds, Animal Husbandry, Pisciculture and cultivation of vegetables, mushrooms, etc. under controlled conditions and services related to agro and allied sectors) and Plantations activities (other than Tea Plantations)
7. Housing and Real Estate business (except development of townships, construction of residential/commercial premises, roads or bridges to the extent specified)
8. Trading in Transferable Development Rights (TDRs)
9. Manufacture of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes.

Recently, there has been a tremendous increase in FDI inflow in India. India generally receives FDI from US, Britain, Singapore, Japan and the USA.
FOREIGN INSTITUTIONAL INVESTORS (FIIs)

We often come across the term FIIs which represent the Foreign Institutional Investors. FIIs are large foreign groups with substantial investible funds. FIIs are registered abroad with a view to investing in other nations to invest in equity market, hedge funds, pension funds and mutual funds. FIIs have strong research team which speculate to invest in a country with a possibility of strong return in equity market. These funds park their funds to fuel a bullish market. Naturally for small period the nation experience inflow of strong foreign currency in its financial system.

Whenever the market reaches a peak and starts declining thereafter, these funds move to another nation. So, the euphoria is short lived. No wonder, national governments look for sustainable FDI investment over FII investment.