4/1/1999 THE ECONOMIC REFORMS OF 1991
In July 1991, the tides of the Indian economy were at their lowest ebb. Inflation was running at an all time high of nearly 17%. The foreign exchange reserves were barely enough to support normal imports for the next two weeks. The pressure on the servicing of the foreign debt was so high that India was in danger of being, for the first time, declared a defaulter in the timely payment of its obligations. On July 24, 1991, the Finance Minister presented to the nation a new charter of economic reforms and development which made the world catch its breath with disbelief. For the first time, it was publicly acknowledged that the system of licensing and regulation of industrial ventures, their expansion, and the issue of capital was no longer suitable for the country and that it had to be substantially modified and improved. The slack and struggling economic situation of the country was thus given a long overdue and strong dose of potent economic reform medicine.
a) The New Industrial Policy
It was at this time that the Government of India announced the New Industrial Policy (the "Policy"). An important, but not often remembered, declaration in the New Industrial Policy is that: "Government's policy will be continuity with change".
The Policy declared that only eight critical industries would be reserved for the public sector. These were specified in Annex 1 to the Policy and included important industries like defence industries, atomic energy, coal and lignite, mineral oils, mining of certain ores and metals, certain radioactive minerals and railway transport.
Most of the controls over mergers and amalgamations, setting up of new industrial undertakings and the substantial expansion of industrial capacities that had been regulated by the Monopolies and Restrictive Trade Practices Act 1969 (the "MRTP Act") were abolished.
The Policy announced that all industries except the eighteen (now reduced to sixteen) industries specified in Annex 2 to the Policy would be free from regulation under the Industries (Development and Regulation) Act 1951. No Industrial license would be needed to set up or to expand capacity in those industries if they complied with certain locational and environmental criteria that were separately notified under that Act.
Foreign investment in India companies was considerably liberalized. The threshold of 40% on foreign equity investment in India companies was abolished. Annex 3 to the policy specified a list of 34 industries in respect of which the Reserve Bank Of India was empowered to grant "automatic" approval for foreign equity participation up to 51%. For the first time, a new doctrine of "automaticity" was evolved whereby, foreign equity investment up to 51% in certain sectors would be automatically permitted.
The transfer of technology by foreign companies to licensees or transferees in India was also liberalized. The policy states that automatic permission will be given for technology transfer agreements in respect of industries specified in Annex 2 to the Policy up to a lump sum payment of Rs 10,000,000 (about US$ 277,778). On November 5, 1996, this ceiling was increased to US $ 2,000,000. It was stated that the Government of India would set up a new high-powered regulatory agency called the Foreign Investment Promotion Board (the "FIPB") which was empowered to consider and approve proposals for foreign direct investment and foreign technology transfers. It was declared that "The investment programs of such firms would be considered in totality, free from predetermined parameters and procedures".
Other major decisions taken by or shortly after the New Industrial Policy include:
the abolition of the irrational prohibition of the use of foreign brand names on goods for sale in India;
the opening up of the frontiers of India for foreign trade by making the rupee freely convertible on the trading account and removing almost all restrictions on the import of foreign goods except for a few goods specified in the negative and restricted lists;
the progressive reduction of import duties on most capital goods, industrial raw materials and intermediate products;
even consumer goods are allowed to be freely imported subject to the payment of customs duty;
the abolition of the office of the Controller of Capital Issues;
the deregulation of the capital markets;
the deregulation of the lending rates of banks and financial institutions.
b) The Implementation of the New Industrial Policy, 1991 to 1997
While the automatic approval route for investing up to 51% of the capital issued by companies engaged in the industries enumerated in Annex II has been welcomed and effectively used, the main concern of the foreign investors has been the absence of transparent and published rules that inform the FIPB when it accords approvals to investment proposals involving foreign equity participation between 51% and 100%. The FIPB has been following what is known as a case by case approach. Until January 1997, many of the procedures and policies of the FIPB were not published or readily available. It was therefore difficult for foreign investors to understand the extent and nature of the investment which the FIPB would agree to accept in any given case. To make matters worse, the FIPB had laid down unpublished ceilings on the foreign investment permissible in the capital of companies engaged in certain sectors. For example, in the non-banking financial services sector the FIPB had laid down a capital adequacy minimum of US$ 5,000,000 for an investment exceeding 51% but not exceeding 75% and a capital adequacy minimum of US$ 50,000,000 for an investment exceeding 75%. Likewise, for the establishment of 100% subsidiaries of foreign companies, the FIPB had, in a few cases stipulated that the Indian subsidiaries should not engage any business or activities other than those proposed in the application filed by the holding company.
On November 6, 1996, the Government of India announced two changes in the Policy. The first related to the amendment of the ceiling on the amount of the lump sum royalty or fee for the transfer of technology from Rs 10,000,000 (about US$ 277,778) to US$ 2,000,000. Secondly, the Government abolished the requirement which the Reserve Bank of India used to insist upon while according its automatic approval to foreign investment proposals to the effect that the amount of the foreign equity should be enough to cover the foreign exchange requirements for the import of the capital goods needed for the project.
On December 31, 1996, the Government of India again announced a revision of the policy by adding 16 industries to the existing list of industries specified in Annex 3 to the Policy where the Reserve Bank of India was empowered to grant automatic approval for foreign equity participation up to 51%. These industries include certain mining industries, food products, cotton textiles, wool, silk and manmade fibre textiles, water proof textile fabrics, basic chemicals and chemical products, rubber, plastic, petroleum and coal products, metal products and parts, machinery and equipment, support services for land and water transport, other services incidental to transport not elsewhere classified, renting and leasing services not elsewhere classified and business services not elsewhere classified. It is important to note that the service sector was included for the first time in an official document as being eligible for automatic approval of foreign investment up to 51%.
On the same date, December 31, 1996, the Government of India made an important announcement specifying nine industries where automatic approval would be given by the Reserve Bank of India for foreign investment up to 74%. These industries include certain mining services, basic metals and alloys, certain manufacturing industries, electric generation and transmission, non-conventional energy generation and distribution, construction, land and water transport and storage and warehousing services.
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