30 Years of Economic Reforms | Forced to change for the good

Three decades is a long time and today’s youth may not be able to even visualise the regulatory restraints — almost a stranglehold — under which Indian businesses operated before 1991. The thumb rule was that everything is prohibited unless specifically permitted.

You needed licenses to set up industries and bureaucratic approvals at almost every turn. Foreign investments or even transactions with non-residents were strictly controlled and monitored, and the foreign exchange law had criminal, and not merely civil, consequences. Raising money from the public was very difficult and pricing of new issues was set arbitrarily and not by market forces. Company managements required government approval in several situations, even if all the shareholders agreed to what they wanted to do with their own money.

Also Read: Thirty years of liberalisation: Reforms lifted GDP growth but didn’t create enough jobs

30 Years Of Economic Reforms | Taking stock of Indian banking

During the 1991 economic crisis, I asked an astrologer about India’s future: Shankar Sharma

The economic reforms initiated in 1991 were, of course, largely out of compulsion to avoid the government defaulting on its debts. Yet, the fact that India chose to massively reform the regulations instead of some other alternative has had lasting positive effects.

Perhaps the most significant reform was scrapping the license/quota raj which let bureaucrats decide who can produce what, and of how much quantity. The stated objects of this system sounded noble — avoidance of wastage, duplication, focus on important goods, etc. The actual results were disastrous in terms of perpetual shortages, higher costs, inefficiency, etc. This aspect has been discussed a lot. What also needs to be remembered are some of the stringently restrictive laws which saw a sea-change.

Dreaded FERA

Foreign exchange laws were one. We had the notorious Foreign Exchange Regulation Act (FERA) which closely regulated transactions in foreign exchange. The stated objective was conservation of valuable foreign exchange. But the rules were very stringent and transactions in foreign exchange were micro-managed. An underground economy for dealings in foreign exchange, transfers by ‘hawala’, smuggling, etc. inevitably flourished, which was then pursued by the dreaded enforcement directorate with vast powers resulting in serious punishment. Tales of brutal interrogation were commonly heard.

The Foreign Exchange Management Act (FEMA) replaced FERA in 1999 which had two major changes. One was the near complete freeing of current account transactions (imports/exports of goods/services, etc.) with a short list of restricted transactions.

Capital account transactions (loans/investments, etc.) were still regulated, but substantially freed. So much so that even individuals could send abroad nearly Rs 2 crore every year with just some exceptions/conditions. However, the most refreshing change was that the violation of this law did no longer warrant prison term (a recent amendment though does bring prosecution back for certain serious offences). There are now monetary penalties or other civil consequences.

Market Regulations

Securities laws were practically born around 1991, which replaced the earlier setup which was a weak one to begin with and which often meant the bureaucracy making rules on the go.

Stock markets were seen as gambling dens and largely untrustworthy, with brokers and corporate houses manipulating the prices. By setting up SEBI, what followed, though at a slow and jerky pace, was freedom to corporates to raise monies from the public. This was balanced with a stricter regime over brokers, companies and market participants. Evils of insider trading, fraudulent and manipulative practices, etc. were (and are) legislated against comprehensively.

Market intermediaries, such as stock brokers, now need a registration to operate, which meant following a set of rules that protected investors/clients, and the market generally. The stock markets themselves are closely regulated and the strong hold of brokers over them is eliminated. A framework of good corporate governance consisting of audit committees, independent directors, regulation of related party transactions, etc. is laid down.

While scams, insider trading, front running, price manipulation, etc. are still seen, a series of penal orders, better market intelligence, etc. has helped curb them. While there are still miles to go, there is reason for satisfaction too.

Company Revamp

Then we have the company law. On one hand, the regime was laid back with problems being dealt with either by banning or making provisions for government approvals. Several sets of transactions thus required approaching a bureaucrat. Managerial remuneration too was restricted and higher remuneration required such approval.

The regulator was also not particularly known for vigilance and quick action. This law too saw gradual changes with a major leap finally in 2013. An important step was of giving powers to SEBI over many provisions relating to listed companies.

Also, in many cases, power was given to shareholders instead of requiring government approval. Initially, the new law provided for very strict penal provisions with hefty fines and also prosecution for many small and big violations. This, however, has seen correction with lowering of fines and removal of prison term for many lesser violations. A scheme for small companies and one man companies (OPCs) has also been provided for, supplemented by a separate law for limited liability partnerships that combines the best of partnership with the benefit of limited liability.

The competition law is another regime that has seen a paradigm shift. From a setup which was almost antagonistic to formation of companies beyond a size set at a low benchmark, the mindset has shifted to focus on formation of very large companies with substantial market share. More rational and detailed criteria are also laid down to decide how this market share is calculated. This again has freed scaling up and diversification to most levels to help growth and efficiency in business.

To conclude, the reforms are partial and focussed only on some areas. This may also be due to the fact that they were initiated as a compulsion and hence the emphasis was on those that were mandated from outside. Many other areas, for example labour laws, were barely touched. Also, some regulators such as SEBI have been more dynamic as compared to others.

What is needed is a big second wave of reforms; but this time not by compulsion and not selective, but by a forward-looking comprehensive strategy.