Reading Notes

Chapter 2: India: The Emerging Giant by Arvind Panagriya

Phase I: (1951-65): Takeoff under a Liberal Regime

Indias GDP grew at almost 4% per annum during the first two Five Year Plans,
spanning 1951-56 and 1956-61, respectively. During the first four years of the Third
Five Year Plan (1961-66), the growth rate averaged even higher at 4.5%. As Bhagwati
and Desai (1970), note: The overall performance, in terms of absolute and per capita
incomes, of the first three plans is on the whole quite respectable, even though inadequate
to Indias needs in view of her desperately low level of initial income and standard of
living.
While the Industrial Policy Resolution (IPR) of 1948 envisioned an expanded role for
the public sector and also opened the door to licensing of private investment in certain
sectors, the policy regime remained liberal until a balance of payments crisis led to the
adoption of foreign exchange budgeting in mid-1958.
By the early 1960s, the foreign exchange budgeting had the effect of making both trade
and investment licensing regimes highly restrictive. Remarkably however, the rules
governing foreign investment and the operation of multinationals remained quite
liberal throughout phase I.
Nehrus Vision of building a socialistic society with particular emphasis on the
development of heavy industry, on the one hand, and small scale, cottage industry, on
the other played a central role in the determination of the policies and institutions put
in place during the 1950s. The Planning Commission was formed around this time
where the PM was the ex officio chairman- Nehru played an active role in advising the
strategies and planning processes designed by the Planning Commission. Deviations
from his vision did take place at the State level, in areas where Constitution gave states
power to legislate and make policies concurrently with the center (the birth of cooperative federalism).
A Liberal Trade Policy Regime: During 1945, 1946, the scope of Open General
Licensing (OGL) was considerably widened and extended comprehensively to the
Sterling Area countries. During the war, India had accumulated substantial sterling
balances that could be drawn down to import goods from the Sterling Area countries.
Through the British government imposed restrictions on the rates at which these
balances could be drawn down, they did not enforce them rigidly. This allowed the
Open General Licensing regime with respect to the Sterling Area countries to be more
liberal than with respect to the hard currency countries. Since the pound sterling was
not yet convertible into hard currencies, the balances, however, could not be used to
import goods from non-Sterling area countries.
The late 1940s saw the import policy oscillate between liberalization and tightening of
controls, principally according to the availability of the hard currency reserves and
sterling balances. Around 1948, the Finance Minister, introduced foreign exchange
budgeting, which subjected direct imports by each ministry and the imports permitted

to the private sector by the chief controlled of imports for each half year to separate
limits on the use of hard currency and pounds sterling. The manner in which this
budgeting was introduced offers important insights into the policymaking power of
even relatively junior bureaucrats in India. However, foreign exchange budgeting was
later removed in 1949 paving way for a relatively liberal trade policy regime in the
1950s. The attitude of the political leadership towards the trade policy during the 1950s
was one of benign neglect (an attitude or policy of non-interference that is intended to
benefit someone or something more than continual attention would).

The Foreign Investment Regime: In the post-independent era, both private sector and
left wing parties were outright hostile to future foreign investment in the country, and
advocated using the sterling balances to buy out existing foreign investments. The
Industrial Policy Resolution (IPR) of 1948, did indeed incorporate these sentiments.
The Government of India agree with the view of the Industries Conference that, while
it should be recognized that participation of foreign capital and enterprise,
particularly as regards industrial technique and knowledge, will be of value to the
rapid industrialization of the country, it is necessary that the conditions under which
they may participate in Indian industry should be carefully regulated in the national
interest. Suitable legislation will be introduced for this purpose. Such legislation will
provide for the scrutiny and approval by the Central Government of every individual
case of participation (of) foreign capital and management in industry. It will provide
that, as a rule, the major interest in ownership, and effective control, should always be
in Indian hands; but power will be taken to deal with exceptional cases in a manner
calculated to serve the national interest. In all cases, however, the training of suitable
Indian personnel for the purpose of eventually replacing foreign experts will be insisted
upon.
Nehru realized the need for foreign investment in India, seizing the initiative from the
opponents, he incorporated none of the restrictive provisions mentioned (above in the
para 10 of the IPR) in his Foreign Investment Policy Statement, he delivered to the
Parliament in 1949. He accorded national treatment: to the existing foreign interests
and thus, ended any discrimination in favor of domestic enterprises.
Open Foreign Investment Policy Incentives: In 1957, the government gave a number
of concessions to foreign firms, including reduced wealth tax and tax exemption to
foreign personnel. In the 1959 and 1961 budgets, the government lowered taxes on
corporate income and royalties of foreign firms. India also signed agreements to avoid
double taxation, to lower the burden of foreign investors (The major source countries
included, The United States, Sweden, Denmark, West Germany and Japan), In 1961, the
government established the India Investment Center, with offices in the major sources
of private foreign capital to disseminate information and advice on the profitability of
investment in India to foreign investors.
The list of industries kept open to foreign investments: heavy electrical equipment,
fertilizers, and synthetic rubber.

A Restrictive Industrial Policy Regime: Three key elemetns of the industrial policy as
it evolved in Phase I: (based on the Mahalanobis model)
1) Dominant role of the public sector in the development of heavy industry;
(The IPR divided the industries into four kinds:
a) Industries that were to be state monopolies. These were limited to atomic energy,
arms and ammunitions and railways.
b) Basic industries in which the state would have the exclusive right to new
investments, though it could invite private sector cooperation if it was in the
national interest. Six industries were included in this category: iron and steel,
shipbuilding, mineral oils, coal, aircraft production and telecommunications
equipment
c) Industries of national importance that the state might regulate and license in
consultation with the state governments.
d) All other industries would be open to the private sector without constraints.
2) Regulation of private sector investment through licensing: (The implementing
legislation to regulate these activities was the Industries Development and
Regulation Act (IDRA), 1951, enacted within the broader context of the IPR, 1948.
The IDRA sought to regulate industrial investments and production according to the
Plan priorities, encourage small enterprises, achieve regional balance in industrial
development, spell out the circumstances under which the government could take
over the private firms management and control, and regulate distribution and
prices of products. The registration and licensing provisions of the act applied to all
industrial undertakings, defined as an undertaking). The IDRA, 1951 gave the
central government potentially very broad powers to regulate private sector
industry. These were potential powers, so that the degree of regulation depended on
the strictness with which the government chose to exercise the licensing authority
and other powers given to it by the act.)
3) Distribution and Price Controls. (The government was to have the power to
allocate the output of certain commodities at prices below what the market would
fetch. This was motivated by considerations of equity, ensuring an adequate supply
of inputs to priority sectors, and holding the line on inflation. The problem was the
states capacities to ensure this was quite limited and it underestimated the benefits
of foreign trade via specialization in products of comparative advantage,
competition, exploitation of scale economies, transfer of technology embodied in
goods etc.)

Do Read the Summary and Conclusions in Arvind Panagriyas text (India: The Emerging
Giant) (pp 42-46)