Government Policies for Business Growth – CA Foundation BCK Notes Chapter 4

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Government Policies for Business Growth – BCK CA Foundation Notes Chapter 4

India faced foreign exchange crises in 1990. Government of India adopted the policy of Liberalization, Privatization and Globalization (LPG) to overcome the crisis. Government controls on business and industry have since then been dismantled gradually. The process further gained momentum in 2014. Since then rules and regulations have been simplified to increase the ease of doing business. Goods and Services Tax (GST) is the latest step in this process.

4.1 Meaning of Liberalization:
Liberalization of an economy means removing or relaxing Government controls and restrictions on economic activities. It is the process of liberating the economy from unnecessary controls and restrictions on trade, industry, banking system, etc. of the country. It involves abolition of those policies, rules and regulations which impede economic development.

4.2 Liberalization In India Trends And Issues:
The process of economic liberalization in India began primarily in 1991. The economic reforms are being implemented in two stages, namely –

  • First Generation Reforms
  • Second Generation Reforms.

The main trends of liberalization in India are as follows :

(i) Infrastructural Reforms:

  • Opening up of oil exploration and petroleum to foreign investment.
  • Power sector reforms.
  • Private sector participation in infrastructure development.
  • Decontrol of steel.
  • Telecom sector reforms.

(ii) Industrial Reforms:

  • Delicensing of industry.
  • Public sector undertakings allowed access to capital market.
  • Simplification of licensing procedures.

(iii) Fiscal Reforms:

  • Reduction in customs duty.
  • Five year tax holiday to enterprises in specified sectors.
  • Downsizing of some departments.
  • Reduction in personal and corporate taxes.
  • Simplified tax administration.
  • Introduction of Value Added Tax (VAT).

(iv) Capital and Money Market Reforms:

  • Clearing Corporation of India set up.
  • Introduction of Negotiated Dealing System.
  • Floating rate Government bonds re-introduced.
  • Trading in index options, and stock futures introduced.

(v) External Sector Reforms :

  • Removal of import restrictions.
  • Liberalised Exchange Rate Management System (LERMS)
  • Liberalisation of NRI remittances.
  • Encouraging foreign tie-ups.
  • Automatic approval of foreign investment and foreign technology agreements to specified extent.

(vi) Banking Sector Reforms :

  • Reduction in CRR and SLR.
  • Introduction of capital adequacy norms.
  • Setting up of Debt Recovery Tribunals.
  • Issue of guidelines for entry to new private banks.
  • Setting up of IRDA.

Government Policies for Business Growth – CA Foundation BCK Notes Chapter 4

4.3 Impact of liberalization of indian economy:
Liberalization has considerably expanded the scope of private sector in India. Private enterprises can now enter most of the industries. The competitive strength and industrial efficiency have improved. Business opportunities have increased and many Indian companies have established subsidiaries and joint ventures abroad. Liberalisation has also boosted foreign investment in India. Thus, liberalisation has led to radical changes in India’s business environment.

Positive and Negative Effects of Liberalization In India:

Positive Effects Negative Effects
1. Increase in foreign investment 1. Decline in small scale sector
2. Decline in external debt 2. Increase in unemployment
3. Rise in foreign exchange reserves 3. Decrease in GDP rate
4. Increase in tax receipts
5. Increase in production
6. Technological advancement

4.4 Meaning of Privatization:
Privatization means the transfer of ownership and/or management of an enterprise from the public sector to the private sector. It refers to the introduction of private control and ownership in public sector undertakings. According to the World Bank, “privatization is the transfer of State owned enterprises to the private sector by sale (full or partial) of going concerns or by sale of assets following their liquidation.” In the words of Barbara Lee and John Nellis “Privatization is the general process of involving the private sector in the ownership or operation of a State owned enterprise,”.

There are several forms or methods of privatization such as :

  • Denationalization of a public enterprise by its complete sale to the private sector. For example, BALCO. was sold to Sterlite Industries.
  • Divestiture, i.e., the sale of equity in full or part of a public sector undertaking to private sector.
  • Transfer of management of a public sector enterprise to private sector through a management contract.
  • Joint venture, i.e., joint ownership of an enterprise by Government and private sector.
  • Leasing, Le., transferring the use of assets of a public sector unit to private bidders for a specified period.
  • Franchising of public sector services to designated private sector units.

4.5 Trends and Issues – Privatization In India:
The process of privatization began in India mainly after the Industrial Policy of July 1991. Under this policy the number of industries reserved for the public sector was reduced from 17 to 2 – Railways and Atomic Energy. Shares of several public sector enterprises have been sold to mutual funds, workers and the public.

4.6 Impact of Privatization n Indian Economy:
The main reason for privatization in India has been the poor performance of public sector units which results in wastage of national resources and burden on common man.

Positive and Negative Effects of Privatization:

Positive Effects Negative Effects
1. Expansion of market 1. Cut-throat competition
2. Growth of independent money market 2. Rise in monopoly
3. Free flow of resources 3. Increase in inequalities
4. Advancements in technology 4. Takeover of domestic firms
5. Equilibrium in balance of payments 5. Removal of protection to domestic firms
6. Development of infrastructure 6. Affect on national sovereignty
7. Higher living standards
8. International cooperation

4.7 Meaning of Globalization:
Globalization means reduction or removal of Government restrictions on the movement of goods and services, capital, technology and talent across national borders. It is the process of increasing economic interdependence between countries and their economic integration in the form of world economy. Markets become international and global firms consider the whole world as one market.

Government Policies for Business Growth – CA Foundation BCK Notes Chapter 4

4.8 Globalization In India – Trends And Issues:
The process of globalization of Indian economy began largely in 1991 due to the unprecedented balance of payments crisis. Since then the pace of globalization has gained momentum :

  • Foreign Direct Investment upto 100 per cent is now permitted in specified sectors.
  • Foreign investors can invest in Indian companies through GDRs without any lock-in period.
  • Indian companies are allowed to get themselves listed on overseas stock exchanges.
  • Guidelines for Euro issues were liberalised.
  • The Foreign Exchange Management Act (FEMA) has replaced the Foreign Exchange Regulations Act (FERA).

4.9 Impact of Globalization of Indian Economy:
Globalization has made India a huge consumer market. There has been rapid increase in GDP and India’s exports. India has emerged as one of the fastest growing economies in the world. Our foreign exchange reserves are now huge and there has been rapid increase in foreign direct investment (FDI).

Positive and negative effects of globalization:

Positive Effects Negative Effects
1. Expansion of market 1. Cut-throat competition
2. Growth of independent money market 2. Rise in monopoly
3. Free flow of resources 3. Increase in inequalities
4. Advancements in technology 4. Takeover of domestic firms
5. Equilibrium in balance of payments 5. Removal of protection to domestic firms
6. Development of infrastructure 6. Affect on national sovereignty
7. Higher living standards
8. International cooperation

4.10 Foreign Direct Investment (FDI)

4.10.1 Meaning of FDI:
Foreign Direct Investment means investment in a foreign country where the investor claims con¬trol over the investment in terms of actual power of management and effective decision-making. Foreign direct investment typically occurs in the form of setting up a subsidiary, starting a joint venture or acquiring a stake in an existing firm in a foreign country According to the Committee on Compilation of FDI in India (Oct 2002). FDI is “the process whereby residents of one country (the home country) acquire ownership of assets for the purpose of controlling the production, distribution and other activities of a firm in another country (the host country). There are three main categories of FDI-equity capital, reinvested earnings, and lending of funds by a multinational to its affiliate.

When the investor makes only investment and does not retain control over the enterprise it is known as portfolio investment. The investor is interested only in return on his capital and does not want control over the use of the invested capital. Portfolio investment is for a short period and is influenced by short-term gains. On the other hand, foreign direct investment involves long-term commitment and cannot be easily liquidated. Therefore, long-term considerations like political stability, Government policy, industrial prospects, etc. influence it.

Direct investors have direct responsibility for the promotion and management of the enterprise. But portfolio investors have no direct responsibility for promotion and management of the enterprise. Portfolio investment takes place through foreign institutional investors (Fils) like mutual funds and through American Depository Receipts (ADRs) Global Depository Receipts (GDRs) and Foreign Currency Convertible Bonds (FCCBs). ADRs, GDRs and FCCBs are securities issued by Indian companies in the foreign markets to mobilise foreign capital.

4.10.2 Advantages of Foreign Direct Investment:
Foreign direct investment offers the following benefits:
(i) FDI increases the level of investment by supplementing domestic capital. The host country gets scarce capital resources from abroad. As a result, FDI contributes towards the development of infrastructure, industry and service sector in the host country. FDI helps to enhance business activity and raise the level of economic development.

(ii) FDI facilitates transfer of technology, machinery and equipment to the host country. Advanced foreign technology helps to reduce costs and improve quality of products and services. Local firms get the opportunity for technology upgradation.

(iii) FDI can create a managerial revolution in the host country through professional man-agement and employment of sophisticated techniques of organisation and management. Local firms get access to world class management and corporate practices.

(iv) FDI helps to boost employment and incomes in the host country through establish¬ment of new industries and development of ancillary industries. Higher production and income in turn increase the tax revenue of the Government. Material and human resources can be utilised optimally.

(v) FDI can help the host country to increase its exports and reduce imports These add to the foreign exchange resources of the country and improve its balance of payments position. In fact, the Government of India announced economic liberalisation in July, 1991 due to foreign exchange crisis.

(vi) FDI may help to increase competition and break domestic monopolies in the host country. It can overcome trade barriers like tariffs and quotas. FDI can make Indian industries globally competitive.

(vii) FDI offers benefits to the home country also. There is inflow of foreign currency in the form of dividend and interest. Exports of technology machinery and equipment help to enhance industrial activity and employment in the home country.

(viii) There is greater choice of products by consumers. Their standard of living is likely to improve due to better quality and wider choice.

Government Policies for Business Growth – CA Foundation BCK Notes Chapter 4

4.10.3 Disadvantages of Foreign Direct Investment:
Foreign direct investment has been criticised for the following reasons:
(i) FDI tends to flow in the areas of high profits rather than in the priority sectors of the host country.

(ii) Considerable funds are repatriated from the host country in the form of royalty, fees, dividend, interest, etc. on FDI. Such outflows put pressure on the host country’s balance of payments. The cost of FDI is high.

(iii) FDI takes place mainly through multinational corporations. These corporations are large in size and have a wide resource base. They pose a threat to the domestic firms in the host country.

(iv) The technology brought in by the foreign investors may not be appropriate to the market size, resource base, stage of economic development and consumption needs of the host country. Excessive reliance on foreign technology may have an adverse effect on local initiative.

(v) FDI poses a threat to the economic autonomy and political sovereignty of the host country. Some of the multinational corporations have destabilised governments in African countries. Excessive reliance on foreign technology may have an adverse effect on local initiative.

(vi) FDI can lead to adverse effects on domestic savings, and adverse terms of trade for the host country which offers special concessions to attract FDI, Some foreign investors pre-empt investment plans of domestic companies. They engage in unfair and unethical trade practices.

(vii) FDI may involve costs and risks for the home country. Employment opportunities may shrink and balance of payment position may suffer due to FDI.

Government Policies for Business Growth – CA Foundation BCK Notes Chapter 4

4.10.4 Determinants of Foreign Direct Investment:
The volume of FDI in a country depends on the following factors:
1. Natural Resources – Availability of natural resources in the host country is a major determinant of FDI. Most foreign investors seek an adequate, reliable and economical source of minerals and other materials. FDI tends to flow in countries which are rich in resources but lack capital, technical skills and infrastructure required for the exploitation of natural resources. Though their relative importance has declined, the availability of natural resources still continues to be an important determinant of FDI.

2. National Markets – The market size of a host country in absolute terms as well as in relation to the size and income of its population and market growth is another major determinant of FDI. Large markets can accommodate more firms and can help firms to achieve economies of large scale operations. Market access has been the main motive for investment by American companies in Europe and Asia.

3. Availability of Cheap Labour – The availability of low cost unskilled labour has been a major cause of FDI in countries like China and India, Low cost labour together with availability of cheap raw materials enable foreign investors to minimise costs of production and thereby increase profits.

4. Rate of Interest – Differences in the rate of interest prevailing in different countries stimulate foreign investment. Capital tends to move from a country with a low rate of interest to a country where it is higher. Foreign investment is also inspired by foreign exchange rates. Foreign capital is attracted to countries where the return on investment is higher.

5. Socio-Economic Conditions – Size of the population, infrastructural facilities and income level of a country influence direct foreign investment.

6. Political Situation: Political stability, legal framework, judicial system, relations with other countries and other political factors influence movements of capital from one country to another.

7. Government Policies – Policy towards foreign investment, foreign collaborations, foreign exchange control, remittances, and incentives (monetary, fiscal and others) offered to foreign investors exercise a significant influence on FDI in a country. For example, Export Processing Zones have been developed in India to attract FDI and to boost exports.

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