Impact Of Financial Services Liberalization In India

Chapter-4 Impact of Liberalisation and Reforms In Services on the Indian Economy 4.1 Productions and Employment in Services Sectors Reforms in infrastructure and services were undertaken since the early 1990s with varying degrees of success. Reforms in telecommunications have been very successful leading to rapid expansion of telecommunications infrastructure and significant reduction of tariffs. Reform in other key infrastructure sectors, including civil aviation, maritime services, and ports has been slower, although steps have been taken to allow private sector investment in civil aviation, seaports and airports in recent years to augment capacity and improve efficiency. As a result of these reforms and liberalisation, services sectors had achieved significant growth during 1990s. Share of services in GDP increased from 43 per cent in 1993-94 to 51 percent in 2002-03. Services sector employed around 19% of the total workforce in 1999-2000, which suggest that the sector's labour productivity may be considerably higher than the national average. Other infrastructure services, such as electricity, ` gas and water, accounted for 2.5% of GDP. As a significant and growing contributor to the economy, an efficient services sector is crucial for economic growth. 4.1 Sectoral shares in GDP (in per cent) Sectors 1. 2.

Agriculture Industry

    3.     4.

Mining & quarrying Manufacturing Electricity, gas and water supply Construction Services Trade, hotels and restaurant Transport and communications Financial, real estate & business services Community, social & personal services All Sector

1993-94 31.0 26.3

1995-96 28.0 28.1

2000-01 23.8 27.2

2001-02 23.9 26.6

2002-03 22.2 27.1

2.6 16.1 2.4 5.2 42.7 12.7 6.5 11.5 12.0 100.0

2.6 17.9 2.5 5.1 43.9 14.0 6.9 11.4 11.6 100.0

2.3 17.2 2.5 5.2 49.0 14.6 8.3 12.6 13.5 100.0

2.2 16.8 2.5 5.1 49.5 15.1 8.4 12.5 13.5 100.0

2.2 17.1 2.5 5.3 50.7 15.6 8.6 12.7 13.8 100.0

1

As regards employment, during the period from 1993-94 to 1994-95, overall employment increased by only 1.1 per cent per annum and the employment in agriculture was almost stagnant. While employment declined in mining and quarrying, electricity, gas and water supply, and employment growth in manufacturing was only 2.6 per cent per annum. However, all the services sectors (except community, social and personal services which had a negative growth rate) achieved growth rates exceeding five per cent (Table4.2). 4.2 Sectoral Employment during 1983 to 2000 Employment (per cent to total)

Annual growth rate (%)

Sector

1983

19871988

19931994

19992000

1983 to 19871988

1983 to 19931994

1.8 7.4 3.6 2.9

19871988 to 19931994 2.6 1.0 1.2 7.2

2.2 3.7 2.3 5.3

19931994 to 19992000 0.0 -1.9 2.6 -3.6

Agriculture Mining & quarrying Manufacturing Electricity, gas and water supply Construction Trade, hotels and restaurant Transport, storage and communication Financial, real estate & business services Community, social & personal services All Sector

63.2 0.7 11.6 0.3

60.1 0.9 11.9 0.3

60.4 0.8 11.1 0.5

56.7 0.7 12.1 0.3

3.0 7.6

4.4 8.3

3.5 8.5

4.4 11.1

12.1 4.9

-1.4 3.0

4.2 3.8

5.2 5.7

2.9

3.0

3.1

4.1

3.2

3.5

3.4

5.5

0.9

1.0

1.1

1.4

4.7

4.5

4.6

5.4

9.8

10.1

11.1

9.2

3.6

4.1

3.6

-2.1

100

100

100

100

2.9

2.5

2.7

1.1

4.3 Growth in Telecom Services The number of DELs which had increased form 2.15 million in 1981 to 5.07 million in 1991 (CAGR 8.95) had increased to 9.80 million by 1995 and further to more than 32 million on April 1, 2001. In addition, about 3.6 million mobile phones were also added during the later half of the 90s. It needs to be noted that during the last five years the addition in DELs was more than three and half times that of the achievement up to 1995. The traffic in terms of Metered Call Units has also displayed substantial growth during the later half of nineties. The MCUs increased from 5860 crore in 1995 to 18502 crore in 2001 displaying the compound average growth of more than 21.0% during the period. It is quite evident that with the opening of the Telecom sector, both the service providers and also be consumers/subscribers have benefited.

2

Investments: During this period, the public sector operators viz. BSNL, MTNL and VSNL made the major investments. The bulk of the investments in cellular mobile segment were by the private operators. In the basic telephony, the private basic operators added only 0.27 million DELs (fixed phones) during the first four years i.e. about 1.0% of the total DELs added during the Ninth Plan. The total estimated investments by the public sector operators during the first four years of the Ninth Plan (1997-2002) was Rs.62358 crore. The total estimated investment by the private sector (domestic private investment and FDI) during the first four years of the Ninth Plan is Rs.10550 crore. The average annual investment by the public sector operators (viz. BSNL and MTNL) during the first four years of Ninth Plan has been about Rs.12, 952 crore per annum, whereas the investment by the private sector during the same period is about Rs.2637.6 crore per annum. The position of investment by public and private sector operators is given below: ISP Industry - A snapshot As on Nov '01 • • • • • • • • • • • • •

ISP licenses signed 486 ISPs operational 132 Dial-up subscribers 3.5 million Internet users 14 million Average Annual Growth so far 200 % 12000 plus Cyber café’s/Public Access Kiosks 300 plus cities covered 45 + ISPs given In-Principle approval for setting up Int'l Gateways 8-9 ISPs have operationalised Int'l Gateways Total Estimated Investment made so far 5570 Cr. Estimated Investment made on equipment 2335 Cr. Estimated Revenue Generated so far 2050 Cr. Employment Provided (Direct/Indirect) 1.1 lack

Internet Telephony • • •

ISPs made heavy investment on Internet Infrastructure and have taken Internet to thousands of homes/ Cyber Cafes across the Country. ISP Network capable of providing low cost Voice Telephony both for National & Int'l Long Distance ISPs willing to share revenue with Govt. & meet obligations to USO Fund 4.4 Impact of financial sector reforms

3

Scheduled commercial banks (SCBs) improved their performance in 2001-02. The ratio of operating profits to total assets improved from 1.53 per cent in 2000-01 to 1.94 percent in 2001-02. There was also a decrease of net non-performing assets (NPAs) of the commercial banks, which amounted to 5.5 per cent of net advances at end March 2002 compared with 6.2 per cent at end March 2001 and 9.2 per cent in 1996. 92 commercial banks out of 97 banks attained the minimum capital adequacy ratio (CAR) of 9 per cent by end March 2002. The ratio is to be raised to 10 per cent by end March 2003. 23 banks out of 27 public sector banks and 62 banks out of 70 private sector banks had already achieved CAR exceeding 10 per cent by end March 2002. In the early 1990s, along with liberalization policies, the Indian Government began gradually introducing competition in the banking sector. As a result, the number of private banks increased from 46 in 1990 to 73 in 2001. The public sector, however, controls some 80% of total bank assets (2001). In the Export-Import Policy 2002-2007, the Government permitted overseas banking units (OBUs) in the special economic zones; these banks are exempted from prudential requirements such as minimum capital asset ratios and statutory lending requirements. 4.5 India’s Software Exports One of the striking examples of a developing country service export success story is the Indian software industry. Indian software exports increased from $225 million in 1992 to $1.75 billion in 1997 and further to $4 billion in 2000. A recent report projects annual revenues of $87 billion, 2.2 million jobs and market capitalization of $225 billion for the Indian information technology (IT) sector by the year 2008. By that year the IT sectors could account for 35 per cent of India’s exports and can attract $5 billion of FDI per year. These forecasts are feasible considering that India now accounts for only half a percent of the world software market and it has substantial comparative advantage in IT industry. The average cost per line of code at $22 in Germany (the most expensive country) is more than four times of that at $5 in India (the cheapest country) compared with $18 in the USA, and $10 in Ireland and Italy. On considering that the total market for software services amounts to $58 billion in the USA, $42 billion in Europe, $10 billion in Japan, cost savings could be substantial. Other gains from trade liberalisation include a more competitive market structure, wider choice and greater diffusion of knowledge. The movement of service-supplying personnel remains a crucial means of delivery. Although the share of on-shore services in total Indian software exports has a declining trend, about 60 per cent of Indian exports are still supplied through the temporary movement of programmers to the client’s site overseas, compared with 90 per cent share of on-shore services in 1998. 4.6 Information Technology in India

4

The advancement in information technology has a profound impact in country's economy, thus the quality of human life. The convergence of computer, communications and content creates tremendous opportunities as well as challenges. The IT revolution will be of much greater significance than the Industrial Revolution of 17th century. This revolution has opened up new possibilities of economic and social transformations from which both developed and developing countries can potentially benefit. The software industry has emerged as one of the fastest growing sectors in the economy with an annual average growth rate exceeding 50% over the last decade and with a turnover of US$ 8.3 billion (Rs.37, 750 crores) and exports of US$ 6.2 billion (Rs.28, 350 crores) during 2000-01. Despite a series of negative developments, US economic recession, global slowdown and WTC disaster, India's export of Computer Software/Services was able to achieve a growth of 32.73% (27% in US$ term) in the year 2001-02 over the previous year. In value terms export of Computer Software/Services increased to Rs.36500 crore (US$ 7652 million) during 2001-02. Computer software industry achieved an average annual growth rate of over 52% and Software exports growth rate of 61% in the Ninth Plan. The Indian electronics & IT industry have recorded a production of Rs.68, 450 crores in 2000-01 and Rs.86, 900 crores in 2001-02. The Government has targeted an export of US$50 billion by the year 2008 for the Indian software industry. The IT sector in India now employs about 300,000 software developers by about 1000 companies. India has the potential to become a major base of outsourcing data management, customer services, e-commerce, e-business and computer applications for entertainment, scientific research, media work, transport and communications, health, financial and banking services. The ITC sector is setting new standards of corporate governance and transparency due to largely overseas listings. Leading Indian software firms such as Satyam Infoway, Infosys, and Silverline Technologies are listed on U.S. stock exchanges, and more are likely to follow. The sector is projected to generate exports of $20 billion by 2003 (about 4 per cent of current GDP or half of current merchandise exports) and more than ten-fold increase in jobs by 2008. During the last decade FDI inflows into export-oriented production contributed too much of the 250 per cent growth in Chinese exports and to over 200 per cent growth in Philippine exports. If properly promoted, the IT sector could have a similar impact on Indian economy as in the case of East Asian economies in 1990s. The IT software and services industry in India accounts for 2% of India's GDP. It is expected that the Indian software industry will account for 7.7% of India's GDP by 2008. Indian IT software and services exports accounted for 14% of India's total exports of US$ 44 billion during 2000-01. It is expected that by the year 2008, Indian IT software and services exports will account for 35% of India's total exports. India's vibrant IT software and services industry represents around 2% of the overall global software market. The Government and software industry however have set an

5

ambitious goal for the software sector amounting to around $50 billion of software exports by 2008. This implies a share of 6% of the relevant global market. The Indian software professionals have already created their brand image in the global market. Today, more than 260 of the Fortune 1000 companies, i.e. almost one out of every four global giants, outsource their software requirements to India. This clearly establishes that more and more global companies are outsourcing their software requirements to India and are gaining competitive advantage. The Indian software industry has not only been growing exponentially but has been moving up the value chain as well. The industry has evolved from manpower provider to software development to integration and IT business consulting. The Indian software industry moved faster on the value chain ladder and got involved in strategic consulting, brand management, Research & Development and provision of web based and ecommerce kind of interactive services to the customers. Top Indian Computer Software/Services have attained critical mass, in terms of both revenue and market capitalization. Many Info Tech companies with strong branch leadership and famous for system integration & network services are listed on American Stock Exchange and London Stock Exchange. Quality Indian software industry has achieved a remarkable distinction for quality. Currently 46 out of 69 SEI CMM Level 5 certified companies worldwide are located in India. Over 250 Indian Software companies have acquired international quality certifications compared with only 19 in USA, 2 in China and 1 each in Canada and Russia). Further, there is only one company worldwide to have acquired PCMM Level 5 certification, which is an Indian. The SEI-CMM framework has been devised by the Software Engineering institute (SEI), and represents a path of improvements recommended for software organizations to enhance their software process capability. Today, majority of the multinational companies in IT have either Software Development or Research Development Center in India. One third of the e-Commerce start-ups in the Silicon Valley continue to be by Indians. Over half of Fortune 500 companies are outsourcing their software requirements to India. Research & Development(R&D) spending in the software industry in India increased from 2.5% of total spending in 1997-98 to over 4% during 2000-01. It is expected that in the years ahead, spending on R&D would increase to 10% of the total spending. Software Export Destinations India's Computer Software/Services are being exported to 103 countries and demand for Indian IT professionals is increasing from countries such as USA, Germany, Japan, Australia, UK etc. This sector is one of the highest net foreign exchange earners for the

6

country. Almost 62% of the total software exports to North America (USA and Canada); 24% to Europe; 4% to Japan; and 10% to Rest of the World. With the backdrop of slowdown in the US economy, Indian companies are actively expanding into newer markets, increasing their presence in Europe and setting up alliances in Asia. However, contrary to popular belief, in the last few months, many US companies have shown increased interest in the Indian software industry. Also, companies in Europe and Japan are increasing there outsourcing to India.

7

Domestic Market Domestic consumption of IT has also been steadily rising. Since the rapid emergence of minicomputers and microcomputers in the late 70s and the domination of PCs and PC LANs in late eighties, the Indian market has kept pace with technological developments. Uses for IT spread to various sectors with applications such as Passenger Reservation Systems (PRS) of Railways publicly demonstrated the benefits of computerization to the common man. However, the penetration of computers, appliances or internet connections are still too low even by the yardstick of many newly industrialized countries such as China, Malaysia, Singapore, Korea etc. Strengths and Weaknesses India has today the advantages of skilled manpower base envied by a number of nations, strong government-industry-academia user-collaborative relationship for high level R&D, active and healthy competition among states in attracting investment in infrastructure as well as framing IT applications in areas such as e-governance, e learning, e-commerce and promoting entrepreneurship etc., growing software exports and a large potential domestic market. Against the above, India has a rapidly growing yet inadequate infrastructure base, still inconclusive structural reforms in telecom to match the band width demand, a hardware industry yet to come to terms with lack of global production skills, standards, technologies, inability to attract foreign investment and consequent erosion of competitiveness in price and quality for domestic and export markets and poor penetration beyond urban areas in terms of IT appliances, infrastructure and services. Infrastructure, especially telecom, is another major area where future of IT industry would significantly depend on. National backbone, international bandwidth, local access, cost of all these and competitive provision of services have all to develop fully in series of evolutionary steps being undertaken the telecom area. 4.7 Services Trade of India The statistics on international trade in services of India are compiled by the Reserve Bank of India following the recommendations of the IMF's Balance of Payments Manual (BPM5). Unlike trade in goods, between residents and non-residents, which are recorded at the frontier, trade in services suffers from a basic problem due to their intangibility nature. Transactions are usually estimated using either foreign exchange records or surveys of establishments. Foreign exchange records often give insufficient information regarding the precise form of service transaction, while the coverage of survey may not be complete. In compiling the services statistics, a combination of both the methods is adopted.

8

While disseminating the BOP statistics, only the major items under services, necessary for reporting of BOP data to the IMF, are listed. The major heads under 'services' include: travel, transportation, insurance, government not included elsewhere, miscellaneous (communication services, construction services, financial services, software and computer services, news agency services, royalties and license fees, management services and others). Stylized Facts On the basis of BOP data, Pattanaik, Sahoo and Dhall (2002) of the Reserve Bank of India analysed the trend of services exports and imports during 1971 to 2001 and their impact on the overall economic growth. After achieving an average growth rate of 4.5 per cent per annum in 1950s, services exports remained almost stagnant in 1960s, while average growth rate of payments declined from 1.9 per cent in 1950s to 1.1 percent in 1960s (Table-4.3). A strong boost occurred in the 1970s, with the decadal growth of payments at 18 per cent and growth of receipts at 23 per cent. However, the high growth could not be sustained in the 1980s. With structural reforms and liberalization of external sector, the growth rates of both services exports and services imports accelerated in the range of 17 to 18 per cent in the 1990s. Table-4.3: Average Annual Growth Rates of Services Receipts and Payments In the Current Accounts of BOP in India (per cent) Decade

Services receipts

Services payments

1950s 4.5 1.9 1960s 0.0 1.1 1970s 22.7 17.6 1980s 4.4 8.8 1990s 17.7 17.0 1950-2001 9.1 9.9 Source: Pattanaik, Sahoo and Dhall (2002) The mean and variance of shares of different components of services set out in Table-4.4 indicate that there had been a significant change in the structure of services in 1980s and 1990s. Miscellaneous receipts accounting for software and other modern services occupied a predominant position in the 1990s compared to the level in previous decades. The share of travel receipts in total services exports increased to 33-36 per cent in 1980s and 1990s compared with 26% in 1970s and 10% in 1960s. The transport sector had a structural break in 1980's with significant decline in its share in total trade in services from 33-37 per cent in 1950s to 1970s to only 18 per cent in 1990s. However, its share improved marginally to 20 per cent in 1990s.

9

Table-4.4: Components of Services in Balance of Payments (as percentages in total services) Period and Xtrav Mtrav Xtrp Items 1950s: Mean 8.6 18.3 32.9 SD 1.7 6.8 2.0 1960s: Mean 10.5 9.5 34.6 SD 2.4 1.2 5.5 1970s: Mean 25.5 7.5 37.3 SD 9.1 1.7 11.0 1980s: Mean 35.9 11.8 17.1 SD 6.8 2.5 3.1 1990s: Mean 33.0 14.6 20.3 SD 10.0 2.9 6.8 Source: Pattanaik, Sahoo and Dhall (2002)

Mtrp

Xins

Mins

Xgnie

Mgnie

Xmsc

Mmsc

22.6 4.8

7.7 1.1

6.7 2.2

23.4 4.6

22.6 4.7

27.3 2.8

29.8 6.0

29.5 5.5

5.2 1.1

2.4 1.6

29.7 10.2

16.9 4.1

19.9 4.4

39.0 3.1

36.9 6.2

4.7 1.4

1.1 2.0

10.8 3.2

9.4 1.5

21.8 6.6

40.8 5.9

31.5 3.1

2.4 0.4

0.5 0.8

3.1 1.3

4.2 0.7

41.5 8.0

49.6 3.7

30.6 7.2

2.3 0.6

0.3 0.8

1.8 1.7

2.7 0.4

42.6 15.2

49.8 6.2

Notes: Xtrav: Travel receipts; Mtrav: Travel payments Xtrp: Transportation receipts; Mtrp: Transportation payments, Xins: Insurance receipts; Mins: Insurance payments Xgnie: Govt not included elsewhere receipts; Mgnie: Govt n.i.e. payments Xmsc: Miscellaneous services receipts; Mmsc: Miscellaneous services payments.

4.8 Services and Economic Growth Pattanaik et.al. (2002) regressed GDP at constant factor cost on capital stock, organised employment and an indicator of progress in trade in services. Results given in Box-1 indicate that services exports had significant positive impact on GDP. Box-1: Production Fuctions (1) log Y = -4.01 + 0.43 log K + 1.26 log E + 0.05 Ratio + 0.04 Dummy (33.0) (7.42) (5.62) (2.14) (5.68) R-SQ = 0.999,

DW = 1.86,

Sample: 1979-80 to 2000-01

(2) log Y = -4.05 + 0.60 log K + 1.50 log E + 0.07 Trade + 0.04 Dummy (31.0) (6.11) (6.12) (2.74) (5.70) R-SQ = 0.999,

DW = 2.15,

Sample: 1979-80 to 2000-01

Where Y stands for GDP at current market prices, K for net fixed capital stock, E for organised employment, Trade for services trade (i.e. services exports plus services imports), Ratio for the ratio of services trade to GDP, and Dummy for the dummy variable having a value of zero for the years before 1990-91 and a value of 1 for the years 1990-01 to 2000-01.

10

The imports demand for services depend on the level of domestic income, relative prices, import demand of goods and the overall importance of domestic services in the economy. The supply of services exports depends on domestic income, world income, relative prices, and the importance of domestic services in the economy. The regression results taken from the study by Pattanaik et.al. (2001) are given in Box-2. Box-2: Determinants of Services Exports and Imports (a) Demand for Services Imports log MSER = -12.51 + 0.95 log GDP + 0.62 log VM + 0.83 log QM + 0.06 R + 0.57 D (3.59) (3.40) (4.32) (4.57) (1.78) (2.90) R-SQ=0.99, DW=1.50, Sample 1971 to 2001 (b) Supply of Services Exports log XSER = -16.61 + 0.54 log GDP + 2.67 log WY + 0.87 log VX + 0.03 R + 0.96 D (4.18) (1.85) (7.77) (3.60) (1.34) (29.5) R-SQ=0.99, DW=1.30, Sample 1971 to 2001 Where MSER stands for services imports, XSER for services exports, GDP for GDP at constant factor cost, VM for unit value index for imports, QM for volume index for imports, VX for unit value index of exports, WY for index of world income, R for ratio of services GDP to overall GDP, and D for the dummy variable having a value of zero for the years before 1990-91 and a value of 1 for the years 1990-01 to 2000-01. The estimated demand and supply equations have yielded significant coefficients with appropriate signs. The coefficient of income elasticity with regard to world income is greater than unity in the case of service receipts. The relative price impact on service receipts was observed to be higher than that on service payments. It was further observed that real GDP has higher effect on service imports than on service exports with elasticity coefficients of 0.95 and 0.54, respectively. RBI study also indicates that the services exports have a perceptible impact on merchandise trade, as exports and imports are heavily dependent upon the level of infrastructure services including transport, insurance etc.

11