1991-2007 - The Economic Reforms - FDI perspective

After independence, India chose to be a closed economy where all the investments would be planned so that welfare of the masses would be ensured rather than that of a handful few. India was unfavorable for investment with a low growth rate and gloomy prospects. This changed after tentative reforms were introduced in 1985 and then significant economic liberalization was carried out in 1991 by the congress government under the aegis of Dr. Manmohan Singh, the then Finance minister. The reforms were a reaction to the rapid rise in the fiscal deficits (8.5 % of the GDP) and low foreign reserves (~1Bn$) which had left the Indian government with little funds to run the country. The liberalization opened up the Indian economy towards the Foreign Direct Investment in many sectors and government restrictions and regulations were reduced (e.g. abolition of License Raj) to make the atmosphere conducive for business. The tax rates for businesses were reduced as an incentive. Also the trade policy was modulated to allow import of goods that were previously restricted increasing the competition in the local markets thus improving the efficiency of the Indian companies. The government also decided to remove its monopoly form 15 out of 18 sectors leaving its control only on Railways, Defense and Atomic energy.

These reforms resulted in an average growth rate of 6% in the decade 1991 - 2000. However towards the end of this period, growth in the services sector slowed down. The '.com' bubble had burst and the Indian IT companies were finding it increasingly difficult to distinguish themselves from the ailing companies in this sector. As a result the industries improved their efficiencies by a significant amount and by the end of 2003 the Indian IT companies were a leaner and fitter group. Also there was a tremendous improvement in the performance of production sector and the gradual implementation of the policy reforms had started to show results.

However since the last quarter of 2006, there has been a steep rise in the amount of FDI and FII in India. Good performance of Indian companies is one of the reasons but then this sudden influx needs an explanation. One of the important reasons is that in early 2007, the subprime crisis had been triggered in the US and nobody could predict the depth of the trouble. This uncertainty forced the foreign investors and India (along with other members of the BRIC) has been a favorable locations. The advantage with India is its less dependence on the US (around 20% of the GDP) and so a slowdown in the US economy will not have significant effects. Also it is considered that the growth in India is driven by its internal consumption and so it will be sustainable for a long time to come. The recent sellout by foreign investors in the Indian markets is a cause of worry but a good budget announcement in the month of Feb will definitely make the investors think twice before exiting India.

-Mayank