A Decade of Economic Reforms - Review by RBI
[Source: RBI Report on Currency and Finance 2001-2002 dated March 31, 2003]

Module: 1 - Growth, Saving and Investment
(an analysis of the impact of reforms on economic growth and its variability at the aggregate level
besides analysing issues relating to saving and investment)

Real Economy - Services and Infrastructure
Assessment of Progress

As mentioned earlier, much of the growth momentum during the reform process came from services. The reform process in the services sector was integral to macroeconomic reforms, particularly to the structural reforms in the industrial sector. Apart from facilitating the supply response in the private sector, the reforms aimed at improving the efficiency in delivery of services by imparting market competition, thereby enhancing productivity of other sectors.

The improved growth performance witnessed across most sections of the services sector, bears testimony to the relative success of reforms in this segment. Illustratively, the positive outcome of financial sector reforms was reflected in the expanding share of finance, insurance and business services in the value added from services sector. Another area that has witnessed marked improvement is that of telecommunication services. Regulatory reforms and increased competition through private sector participation have resulted in a sharp increase in tele-density, reducing the demand-supply gap and unit cost along with improvement in quality of services offered, leading to higher value added growth.

Despite the current robust growth of the services sector, there is concern regarding medium-term growth sustainability of this sector given its strong linkages with commodity producing sectors and the large share of public administration and defence (PAD). The share of PAD in services has not witnessed any significant decline. Since such services do not directly add to consumer welfare, there is a need for furthering fiscal reforms aimed at pruning unnecessary Government expenditure while promoting greater expenditure in the provision of necessary public goods.

The higher cost of operations of certain services such as power, railways and shipment has spilled over to the manufacturing sector in the form of high input costs. The industrial sector continues to suffer from unstable power supply and high unit costs. The distribution of power could be privatised to help reduce losses arising out of transmission and distribution. Privatisation would, however, be contingent on finding a solution to the issue of outstanding dues of State Electricity Boards (SEBs) and imposition of realistic economic tariffs. The signing of the tripartite agreement relating to the one time settlement of SEBs’ past dues is a step in the right direction.

The operating ratio of the Railways remains high due to the persistence of distortionary pricing of railway services, thus, constraining its ability to release resources for Plan outlay. The restructuring of the Railway services becomes crucial keeping in view the increasing competition from roadways that would get intensified after the completion of the Golden Quadrilateral network. Railways need to operate on commercial lines so that the resources can be generated on a self-sustaining basis ensuring passenger safety as well as technological upgradation. Policy focus, thus, needs to be accorded towards corporatisation of Railways, rationalisation of freight rates, modernisation of rail services and development of commercially viable projects with public-private joint ventures. In case of ports, although some progress has been made towards private sector participation with a view to improving the turn-around period of cargo, the slow pace continues to act as a constraint to trade efficiency.

The process of convergence in the area of telecommunications and Information Technology (IT) needs to be expedited to enable rapid growth and to provide more efficient and cheaper services to users. In the emerging area of information technology, the hardware segment is still not competitive; consequently, there has been poor penetration in terms of information technology applications, infrastructure and services beyond urban areas. This explains a relatively low share of revenue from the domestic market for the software firms. Therefore, the development of communications infrastructure across the country, along with institutional reforms relating to legal and regulatory issues for e-commerce transactions, needs attention. India has labour cost advantage in this sector which is likely to exist for the next 15 to 20 years. Some key issues, however, need to be addressed for the promotion and further growth of the IT sector. These issues are: potential scarcity of talent due to migration of highly skilled labour, high telecom rates and lack of ready infrastructure. Larger lead time in commissioning telecom services and lack of a formal platform to interact with potential players are some of the challenges which need to be addressed to maintain India’s comparative advantage against its competitors like Ireland and China. Issues emerging from the General Agreement on Trade in Services (GATS), particularly on the business process outsourcing and temporary movement of professionals, need also to be carefully negotiated to sustain the export potential of this sector.

A smooth and frictionless labour market accompanied by a safety net is a necessary condition for maximising growth and welfare. Reforms have been hesitant in this important segment of the factor market resulting in a limited role of market forces in determining the demand for labour. In India labour legislations are largely responsible for the rigidities in the labour market that have prevented the restructuring or closure of several non-viable sick industries and redeployment of factors of production to the growing sectors of the economy. Prohibition of retrenchment and closure of industrial units employing more than 100 workers (without Government permission) has led to discriminatory practices like: (i) existence of more capital intensive technologies not related to relative factor prices; (ii) setting up of multiple units negating economies of scale; and (iii) reliance on temporary labour preventing skill formation. Fresh investment, including foreign direct investment has been a casualty, particularly in labour intensive sectors. Ironically, such labour protection measures have contributed to the slow growth of industrial investment and employment.

Reforms are also vital in respect of contract labour. By preventing unbundling of production and its distribution and contracting out of services, the Contract Labour (Regulation and Abolition) Act, 1970 is not in synchronisation with the objective of inculcating flexibility in labour market to maximise efficiency and promote growth. That the necessity of amending these legislations has been recognised by the Government is reflected in policy announcements that have been made, particularly in the Union Budget speech of 2001-02.

In order to accelerate the process of industrial restructuring, several steps are warranted in respect of labour laws. Keeping with the global trend, the requirement of prior permission for closure of a unit may be waived and voluntary retirement schemes (VRS) can be made more attractive. Concomitantly, institutes for imparting technical skills to displaced workers can be established and a safety net can be set up by levying a cess on the corporate sector supplemented by budgetary support, and the floor for retrenchment could be raised to units employing at least 1000 workers as proposed in the Union Budget, 2001-02. As recommended by the Prime Minister’s Economic Advisory Council, the Contract Labour Act should be replaced by an Act, which recognises that outsourcing of services is a normal activity. Regarding public sector, the more challenging tasks would be setting up a fund that creates annuities to finance VRS, workers’ retraining and public sector restructuring