Department of Management Studies

Indian Institute of Technology, Delhi

INDIAN FINANCIAL SYSTEM (SML874) TERM PAPER

MAJOR REFORMS IN THE IFS
NABILUR RAHMAN [2013SMF6634]
SHREYAA RATRA [2013SMT]

1. Introduction
The strengthening of the financial system is a major issues which the emerging economies of the
world face. A number of countries adopted various measures to liberalize their financial sectors in
the late 1980s and the 1990s. India too went ahead with its liberalization efforts in the early part of
the last decade of the century.
The Indian economy has come a long way since the liberalization efforts of the early 1990s.
Financial sector reforms have been at the center stage of since the 1990s. The initiation of the
economic reforms took place at the backdrop of two major developments which were threatening the
economy, the balance of payment crisis and the insolvency of the banking system of the country.

2. The economic liberalization of India in 1991

The economic liberalization of India is an ongoing process which started in 1991 with the aim of
making the economy more market oriented and to encourage the participation of the private sector
and to bring in foreign investors.
2.1. Pre-liberalization policies
Indian economic policy after independence was greatly influenced by the countrys colonial
experience. There was a strong emphasis on import substitution, industrialization under state
monitoring and there was state intervention at the micro level in all businesses especially in labor and
financial markets. The economy comprised of a large public sector and there was a limited role of the
private firms and businesses. The Five-Year Plans of India were influenced by the central planning in
the Soviet Union. A lot of industries such as mining, steel, machine tools, insurance,
telecommunication were nationalized in the mid-1950s. The phase of the Indian economy is
commonly referred to as the License Raj due to the fact that there was a lot of red-tapism and
entrepreneurs were required to follow a number of regulations and get various licenses to start a
business.
2.2. The crisis
India started witnessing problems in its balance of payment from 1985 and this turned into a full
blown-crisis by the end of the decade. The Balance of Payments crisis pushed India to near
bankruptcy and the government had foreign exchange which could finance just three weeks worth of
imports. The International Monetary Fund (IMF) finally came to Indias rescue and chalked out a
bailout plan for India wherein the latter had to pledge 20 tons of gold to the Union Bank of
Switzerland and 47 tons to the Bank of England. The rupee was also devalued in the process. A
number of economic reforms were also enforced upon India as part of the bailout agreement. As part
of the reforms a number of controls by the government were dismantled, taxes and duties were
lowered, the state monopolies were broken and the economy was opened to foreign investors for
trade and investment.

2.3. Measures taken by the government

2.3.1. Industrial Policy
The industrial policy of the country was restructured to a great extent and a lot of the central
governments industrial controls were dismantled. A large scale deregulation of the industrial sector
was done to bring in the element of competition and increase efficiency of the system. The system of
industrial licensing by the central government was almost abolished except for a few hazardous and
environmentally sensitive industries. Also, the list of industries reserved solely for the public sector - which used to cover 18 industries such as iron and steel, oil, mining, heavy plant and machinery,
telecommunications and telecom equipment, minerals, air transport services and electricity
generation and distribution was drastically reduced to three: defense aircrafts, equipment and
warships, atomic energy generation, and railway transport. Restrictions that existed on the import of
foreign technology were also withdrawn.
2.3.2. Trade Policy
It was realized that the practice of import substituting was an inward looking development policy
was no longer suitable in the modern globalizing world. Before the reforms, the trade policy of India
was characterized by high tariffs and pervasive import restrictions. The import of manufactured
consumer goods were completely banned. In capital goods, raw materials and intermediates, certain
lists of goods which were freely importable, but for a lot of items which where domestic substitutes
were being produced, imports were only possible with import licenses. A major hindrance was that
the criteria for issue of licenses were non-transparent and delays were endemic and corruption
unavoidable. The economic reforms aimed at phasing out import licensing and also at reducing
import duties. Import licensing was abolished early for capital goods and intermediates which
became freely importable in 1993, concurrently with the switch to a flexible exchange rate regime.
The quantitative restrictions on imports of manufactured consumer goods and agricultural products
were removed on April 1, 2001, almost exactly 10 years after the reforms began, which was partly
due to a ruling by a World Trade Organization dispute panel on a complaint brought by the United
States.
2.4 Impact of the liberalization efforts
The liberalization efforts of 1991 have had a profound and far reaching influence on the Indian
economy. The total foreign investments into India (including foreign direct investment, portfolio
investment, and investment raised on international capital markets) have grown from a minuscule
US$132 million in 199192 to $5.3 billion in 199596. A number of new cities such as Chennai,
Bangalore, Hyderabad, NOIDA, Gurgaon, Ghaziabad, Jaipur, Pune, Indore and Ahmedabad have
risen to prominence and economic importance and have become centers of rising industries and
destination for foreign investment and firms.
The economic reforms in the 1990s saw India breaking free of the low growth trap which was
euphemistically called the Hindu growth rate of 3.5% per annum. The real GDP growth averaged
5.7% per annum in the 1990s, which then accelerated further to 7.3% per annum in 2000s. During
the decade of the 2000s the growth trajectory peaked with an annual average GDP growth of about
9% for the 5-year period 2004-08. Indias growth acceleration during the last two decades has been
dominated by the services sector. The pace of annual industrial growth had nevertheless picked up
from 5.7% during the 1990s to 9% during 2004-08 before being interrupted by the global financial
crisis

3. SEBI Act
The Securities and Exchange Board of India was established on April 12, 1992 in accordance with
the provisions of the SEBI Act of 1992. Through the act SEBI was setup as a regulator of the
primary markets. Initially SEBI was formed as a non-statutory body without any statutory power.
However in 1995, the SEBI was given additional statutory power by the Government of India
through an amendment to the SEBI Act, 1992.
Proactive vs reactive