India Transformed

by Rakesh Mohan

  Industrial Licensing was abolished for all industries, except for a specified list (Annex II in the document), irrespective of levels of investment. Some industries were to continue to be subject to compulsory licensing, ostensibly ‘for reasons related to security and strategic concerns, social reasons, problems related to safety and overriding environmental issues, manufacture of products of hazardous nature and articles of elitist consumption’. All other existing lists were to be abolished. Phased manufacturing programmes were no longer to be imposed and the previous stringent location restrictions were also abolished, except in cities with population of over 1 million.46

  Foreign Investment: ‘In order to invite foreign investment in high-priority industries, requiring large investments and advanced technology’, it was decided to provide approval for direct foreign investment up to 51 per cent foreign equity in a specified list of industries, which hitherto had been known as the ‘Appendix I Industries’ and were areas in which FERA and MRTP companies had already been allowed to invest on a discretionary basis. This list was appended as Annex III. It was hoped that this framework would make it attractive for companies abroad to invest in India. It was expected that ‘foreign investment would bring attendant advantages of technology transfer, marketing expertise, introduction of modern managerial techniques and new possibilities for promotion of exports. This is particularly necessary in the changing global scenario of industrial and economic cooperation marked by mobility of capital. The government will therefore welcome foreign investment, which is in the interest of the country’s industrial development.’ This was a major departure from previous thinking and practice, where foreign investment was at best tolerated, a far cry from now being welcomed.

  Foreign Technology Agreements: Contrary to the previous practice of the need to obtain specific approvals for every technology agreement, there would now be automatic approvals for foreign technology agreements within specified parameters. Indian companies would be free to negotiate the terms of technology transfer with their foreign counterparts, according to their own commercial judgements.

  Public-sector Policy: Eighteen industries were reserved earlier for investment by public-sector enterprises only. This list was pruned down to a list of only eight industries (listed as Annex I of the document), which essentially covered only minerals, atomic energy, defence equipment and railways. The government therefore moved away from the ‘commanding heights’ philosophy of the 1950s. The policy also paved the way for disinvestment in public-sector companies through the public floatation of shares. It was also stated that private investment would be allowed in these areas selectively, and that this list would be kept under review. An intention was also expressed that action would be taken on sick public-sector enterprises so that they could be closed down after due process. To enable this, a social security mechanism would be created to protect the interests of workers likely to be affected by such rehabilitation packages. This is one aspect of the reform that remains to be implemented even today.47

  MRTP Act: In another major departure from extant policy, the concept of ‘MRTP’ companies was abolished.48 The MRTP Act was to be amended significantly so that it would only deal with competition issues and restrictive trade practices.

  Follow-up to the Industrial Policy Statement

  What we hoped was that this policy would let loose animal spirits in the country as never before: delicensing would set in motion new domestic competition; foreign investors would find new opportunities for investment; entrepreneurs’ enhanced access to foreign technology would upgrade Indian industrial technology; and large companies would become free to become larger and also invest in areas where they could not earlier, including those that were earlier restricted to public-sector companies only. In short, we hoped that the Indian private sector would finally be unleashed and that India could now exhibit the kind of energy that had been demonstrated by the rest of Asia.

  This initial policy action was, of course, confined to industrial policy: much more was needed to be done with respect to the comprehensive reforms outlined by Finance Minister Manmohan Singh. Having seen the effectiveness of centralizing the process in the PMO, A.N. Verma made his steering committee for economic reforms a permanent feature for the following five years of the Narasimha Rao government. The committee met over lunch every Thursday over the next five years, except when A.N. Verma was not in town. Almost all aspects of reforms were first discussed in this relatively informal committee and bureaucratic resistance was hammered in no uncertain terms whenever it came up. The permanent membership of the committee consisted of the secretaries of the main economic ministries: finance, commerce and industry. I had the privilege of attending almost all these meetings on the coat-tails of the successive six industry secretaries over this period. Depending on the subject matter of each meeting, the secretaries of the relevant ministries would be invited in turn. For example, the huge transformation of telecom policy was initiated in this committee, despite the great reluctance of the then telecom ministry, with their officials being dragged, kicking and screaming.

  In addition, Verma set up the Foreign Investment Promotion Board (FIPB), which was announced in the Industrial Policy Statement,49 in the PMO but was serviced by the industry ministry. He chaired this personally every Saturday over the following five years. The expectation was that it was this opening of foreign direct investment that might receive the most opposition, so it was important to give a signal that it was regarded with the utmost importance. The original intention was that there would be active solicitation of large multinationals to invest in India. But it was quickly realized that this was not really feasible in the Indian system and the FIPB soon became and remained an approval mechanism rather than a promotional one. It was shifted out later from the PMO to the finance ministry.50

  As a follow-up to the New Industrial Policy, the Directorate General of Technical Development (DGTD) was soon abolished. Although little commented on, this must rank as one of the most important and consequential administrative decisions to be taken at the time. Abolition of any agency is almost unheard of in the Indian government firmament, let alone one that was as powerful as the DGTD. It was the linchpin of the whole industrial ‘command-and-control’ system as described earlier. It had a large staff, which was rendered non-functional in one stroke. Since civil servants in India cannot just be fired, the staff was reassigned to different ministries, but the organization itself lost its existence. Had there been an industry minister, it is highly unlikely that this could have been done. In comparison, for example, even a strong, committed and powerful liberalizer such as Commerce Minister Chidambaram was not able to abolish and disband the Chief Controller of Imports and Exports: this agency was merely renamed as the Directorate General of Foreign Trade (DGFT), with the same staff continuing in this new avatar, and it continues to exist even today! With the abolition of the DGTD, there was no administrative apparatus left for any kind of administrative industrial controls to creep back into the system, and they mercifully didn’t. As it happened, with the continuation of DGFT, trade reforms took much longer to implement—almost a decade. In any case, with the departure of Commerce Minister Chidambaram in July 1992, there was no driving force to continue with the reforms in a more purposive manner. It is possible that the IMF programme helped in continuing the process despite changes in personnel.

  What Was Not Done

  Although the 1991 Industrial Policy Statement was comprehensive and self-contained, there were three important elements of industrial policy that were not addressed, presumably due to perceived political difficulties—promotion of industrial restructuring, labor reforms and the abolition of small-scale industry reservations. If these areas had also been addressed in the first flush of enthusiasm for reforms during the 1991–96 period, it is likely that the response of Indian industry could have been such that an East Asian-type high growth might have been possible.

  The first issue had actually been thought about a
great deal and found mention in the Industrial Policy Statement, related particularly to the public sector, which already had a number of so-called ‘sick’ enterprises.51 Such enterprises were to be referred to the Board for Industrial and Financial Reconstruction, and a social-security mechanism was to be created to protect the interests of workers likely to be affected.

  Given the comprehensive economic reforms that were being envisaged, it was natural to expect that there would be need for considerable industrial restructuring in light of the new competition and technology modernization that would occur. With the existing labor legislation that effectively prohibited labor flexibility in the industrial sector, and inoperative bankruptcy procedures, the likelihood of smooth industrial restructuring was deemed to be low. Moreover, if the new policies would result in widespread labor distress, the political consequences could be fatal for the success of the new policies. It was also understood that there would be little chance of initiating labor legislation reforms without first putting in place adequate social-security schemes for any displaced labor.

  It is worth recalling that, in recognition of this issue, Finance Minister Manmohan Singh announced the establishment of the National Renewal Fund (NRF) in his 1991–92 Budget speech:

  This Fund will provide a social safety net which will protect the workers from the adverse consequences of technical transformation … The Fund will not merely provide ameliorative measures for the workers affected in the course of technical change but, more importantly, provide retraining to them, so that they are in a position to remain active productive partners in the process of modernization.

  As a follow-up to the industrial policy and the finance minister’s Budget speech, we immediately got to work in the industry ministry. We held widespread consultations with other ministries, including the labor ministry, trade unions and industry bodies. As with other reform activities, this also went through Verma’s steering committee for economic reforms. The NRF was set up by a government resolution on 3 February 1992 to protect the interest of workers affected by industrial restructuring. The Cabinet Committee on Economic Affairs approved the guidelines on 28 October 1992 for operationalizing the NRF. The guidelines were notified on 21 December 1992.52

  The objectives of the fund were:

  To provide assistance to cover the costs of retraining and redeployment of employees arising as a result of modernization, technology upgradation and industrial restructuring.

  To provide funds for compensation of employees affected by restructuring or closure of industrial units, both in the public and private sectors.

  To provide funds for employment-generation schemes both in the organized and unorganized sectors in order to provide a social-safety net for labor needs arising from the consequences of industrial restructuring.

  During the ten months or so that it took to set up the NRF in 1992, the government also succeeded in negotiating an adjustment loan from the World Bank for the purpose.

  After all the work had been done, and the World Bank loan disbursed, for reasons that remain unclear to me to this date, the finance ministry resiled from its own initiative and commitment.

  Had the NRF been successfully put in operation, I do believe that the course of Indian industrialization could well have been different over the twenty-five years that followed. In particular, it is possible that progress could also have been made on labor reforms if the NRF had indeed succeeded in convincing organized labor that industrial restructuring was in their favor, and that they actually had appropriate social protection. A concomitant reform that was also necessary was the overhauling of bankruptcy laws in order to enable the kind of industrial restructuring that was envisaged. Work was also done on this issue under the able guidance of the then additional secretary Jagmohan Bajaj53 in the Planning Commission, but there was no follow-up. In the event, a new bankruptcy law has only just been passed in 2016. The NRF, of course, remained stillborn.

  Coming to labor reforms, this was not really part of any thinking at the time. It was perhaps too hot a political potato to handle, and it remains so to this date. The consequence is there for all to see. Industrial growth over the last twenty-five years has mostly been jobless. Prior to reforms, there was obviously a great deal of redundant labor in many large enterprises. With new technology, modernization, new machinery and new practices, a great deal of productivity enhancement took place in industry, so there was little need for new labor. Given the extant labor laws and inoperative bankruptcy machinery, investors were loath to invest in labor-using industry. Unlike China and other East Asian countries, there has been almost no investment in export-related labor-using industries.

  The third issue relates to the reservation of small-scale industries. There was little thinking or discussion on this issue leading up to the 1991 industrial policy reforms. In fact, a perusal of the 1990 policy document would suggest that, if anything, the prevailing views were much more in the opposite direction. As noted earlier, almost all labor-using consumer industries were reserved for the small-scale sector, the very industries where East Asian industrial exporters made their mark in the world. For example, Chinese clothing exports increased from $30 billion to $190 billion between 1990 and 2014, while Indian exports grew from $5 billion to just $18 billion over the same period; similarly, Chinese footwear exports increased from $9 billion to $56 billion over the same period while Indian exports went up from $0.6 billion to only $3 billion. To be competitive even in these industries requires the use of technology, organization, and marketing skills that can really only be done in large firms. In the clothing industry, for example, almost 60 per cent of employment in China is in firms that employ more than 500 workers; in India, in contrast, the legacy of small-scale reservations and continuing restrictive labor legislation is such that more than 90 per cent of employment in this industry is in firms with less than fifty workers.54 These examples give some idea of the industry and employment losses that India has suffered because of these misguided policies ostensibly aimed at preserving employment.

  This brings me to my last significant failure as an advocate of industrial policy reforms. By the mid-1990s, concern with small-scale industry reservation had begun to grow. I had by then moved to head the National Council of Applied Economic Research (NCAER). Around the same time, the Ministry for Agro and Small-Scale Industries asked Abid Hussain to head the Expert Committee on Small-Scale Enterprises. He once again asked me to become the member secretary of this committee, recalling our earlier association in the textile and industrial export committees of the late 1980s. I readily agreed and formed a small secretariat in the NCAER. As it happened, we had already begun research on this issue in the Council.55 As always, under the sagacious leadership of Abid Hussain, we were able to reconcile the many irreconcilable, different vested interests in the sector and emerge with a unanimous report that recommended the immediate de-reservation of small-scale industries.56 We did, of course, recommend a host of consequent promotional measures to help in the transition. I had assumed that, given the credibility of Abid Hussain, the report would gain serious traction and policy action would follow. Alas, this was not to be, and no action was taken until 2002 when about fifty items were de-reserved.57 This was also the period (1996–99) of unstable governments, between Prime Ministers Narasimha Rao and Atal Bihari Vajpayee. De-reservations did continue in dribs and drabs, and it was not until 2015 that the remaining twenty items were finally de-reserved and the list abolished. The irony is that starting around 2001, as a consequence of WTO commitments, almost all these items could be imported freely: large enterprises abroad could export them freely to India, but similar large enterprises in India were not allowed to manufacture them! Yet, successive governments during the period did not regard this issue as a priority, nor was there any pressure at any time from organized Indian industry.

  This sorry tale provides some idea of the political strength shown in carrying out the comprehensive policy reforms in 1991.

  T
o conclude, the interconnected failure in carrying out reforms related to industrial restructuring, labor legislation and small-scale industry reservations have cost us dearly. Consequently, Indian industry has missed many buses over the last couple of decades and much remains to be done to complete the process started in 1991. One can only hope that, given the consolidation of political power that has now occurred, such reforms can be carried forward and that we can look forward to a new resurgence of industry. With Chinese wages rising consistently, the current time is a great new opportunity for attracting industries that would definitely move out of China over the next decade or so. The current beneficiaries are countries such as Vietnam, Cambodia and the Philippines. There is no reason why we cannot take advantage of this turn of events.

  Other Reforms: A Continuous Process in the 1990s and 2000s

  The industrial policy reforms, as important as they were, were only the first segment of the comprehensive economic policy process that was set in motion in 1991. The first priority was macroeconomic stabilization, which needed simultaneous action on the fiscal front and on the external sector. Finance Minister Manmohan Singh’s 1991 landmark budget immediately set in motion policy actions that brought macroeconomic stability within one year.

  One of the distinguishing features of macroeconomic policymaking during this period was the very cooperative relationship between the ministry of finance and the RBI resulting in coordinated monetary, banking, fiscal and exchange-rate policies right through the 1990s. In his chapter in this volume, C. Rangarajan provides a first-hand account of the sequence of reforms that were carried out in this realm. The gradual, calibrated sequence of financial-sector liberalization contributed to the maintenance of financial stability throughout the 1990s and 2000s despite the occurrence of the East Asian and North Atlantic financial crises. As documented by Jaimini Bhagwati in his chapter, the sequenced financial-sector reforms enabled the institutional reforms and infrastructure building that were needed to develop the capital market. This process continues to this day and still has some way to go.