The Indian Tryst with Destiny … And Licenses

Examining the ramifications of the ‘License-Permit-Quota Raj’ on the Indian Economy

On the eve of 15 August 1947, as Pandit Jawaharlal Nehru addressed the nation with the historical ‘Tryst with Destiny’ speech marking Indian independence from a decade shy of two-hundred years of colonialism inflicted by the British, India was plagued with the multitude of challenges that lay ahead of its path viz. rampant poverty, widespread illiteracy, ruinous agricultural and industrial sectors and the structural distortions created in the economy and society by colonialism inter alia. As the whole world awaited with bated breath to see the ‘largest democratic experiment’ ever unfold, the leaders of the company were presented with the task of devising economic policies driven towards bringing India out of poverty and establish a self-sustainable system of economic growth.

The First ‘Five Year Plan’ – launched in 1951 was focussed heavily on the development of the primary sector or the ‘agrarian sector’ at large. The Second Five Year Plan – driven towards the secondary sector viz. the heavy industrial sector – was announced in 1956 subsequent to the December 1954 Parliamentary Session and the Congress Party’s Awadh Session in 1956 wherein the socialist and leftist policies of the Government and the Congress Party were extenuated upon. Therefore, it came to the surprise of none that the Second Five Year Plan of the Planning Commission (also referred to as the Feldman-Mahalanobis Plan) was Neo-Marxist in nature and emphasised on State-led industrialisation. Nehru himself reiterated the Government’s intention in outlining the role of the State by asserting that “the public sector must grow not only absolutely but also relatively to the private sector.” Ergo, the license-permit-quota-Raj was ushered in wherein the control of the State was immense in the sense that it not only decided which company would produce what, but also the amount of production and stipulated its selling prices in the market.

Thus, events dating back to the Congress’ Karachi Resolution (1931) whereby – the State was envisaged to own and control key industries and services; to N.R. Sarkar – the President of Federation of Indian Chambers of Commerce and Industry (hereinafter abbreviated as “FICCI”) – proclaiming that the “days of undiluted laissez-faire are long gone” (1934) and subsequently the stance of leading Indian Capitalists under the Bombay Plan (1945) and the Industrial Policy Resolution (1948); the passing of the Industries Development and Regulation Act (1951); the impressionable role of ‘Nehruvian socialism’ and ‘Stalin-Marxism’ all heavily influenced the State supervision of development along planned lines overseen by the National Planning Commission (hereinafter referred to as the “Planning Commission”) all culminated in the License-Permit-Quota Raj being resumed in Independent India.

The State supervision of development as envisaged by the Planning Commission was undertaken with the passing of the Industries Development and Regulation Act (hereinafter abbreviated as the “IDRA”) in 1951 that endeavoured to oversee the division of activities between the public and private sectors, the prevention of concentration of power and monopolisation, the ensuring of regional balance through a complicated system of controls and industrial licensing. Furthermore, the ensuing crises of the balance of payments and acute shortage of foreign exchange in 1956-57 led to the imposition of stringent imports and foreign exchange controls.

The economic climate of India around this time was fragilely poised, especially with the doubling of defence expenditure due to the Sino-Indian War in 1962 and the subsequent increase in foreign borrowing from 1.4% to 2.4% and Governmental fiscal deficit from 5.6% to 6.7% (in the period of 1960-61 – 1965-66), consequently culminating in the piling up of a whopping debt of 28% to export earnings in 1967-68. This period in the 1960s – termed as “India’s failed liberalisation episode” by economist Arvind Panagariya – was witness to widespread dissatisfaction with the ‘Licensing Raj’, a macroeconomic agricultural crisis of alarming proportions and the delicensing of certain industries on the Swaminathan Committee’s recommendations. As a consequence of the aforementioned, the Bell Mission (appointed by Aid India Consortium, operating under the auspices of the World Bank) proposed the shift from heavy industries (originally part of the Mahalanobis Plan) to the agricultural sector and the devaluation of the Indian Rupee and the relaxation on licensing requirements for most of the intermediate inputs and export subsidies. The Indian Government accordingly adopted these policy changes in June 1966.

Albeit the apparent failures vis-à-vis the devaluation of the Indian Rupee and the timing of the liberalisation policies coinciding against crop failures and consequential economic recession adversely affecting the nation – with regard to the licensing policy changes – the liberalisation experiment failed spectacularly, in the sense that it lacked conviction in its implementation and consistency across the Government in favouring laissez-faire market-friendly policies. Unsurprisingly, the liberalisation drive of 1966-67 was concluded as “unsustainable” and the principle of “domestic availability” was resumed as the norm. Ergo, the bureaucracy-politicians nexus and industrialists who had cut favourable deals with the Government were therefore successful in resisting the liberalisation of the market and extended their vicious stranglehold over the Indian economy.

The ‘License-Permit-Quota Raj’ was notorious for creating a scarcity of resources, often characterised by commodities limited in choices and lacking in quality. The procurement of the licenses itself was a taxing task – both physically due to the Kafkaesque web of red-tapism and economically in that the grant of licenses often included the bureaucracy-politicians nexus lining their own pockets. Industrial tycoon Dhirubhai Ambani himself hinted that “the art of managing government relationships was most critical to business success” – and a ‘market’ came into being for the procurement of licenses. Business competition under the License Raj meant getting licenses before your competitors and licenses were often acquired, not to produce, but to deny their rivals from exploiting such opportunity – such was the nature under the ‘license raj’. The term ‘License Raj’ in itself was coined by the last Governor-General of India – Chakravarthy Rajagopalachari who was heavily critical of this British creation as reflective in his writings prior-independence in 1947 and wanted away with this system which his fellow Parliamentarians chose to employ:

“I want the corruptions of the Permit/Licence Raj to go. […] I want the officials appointed to administer laws and policies to be free from pressures of the bosses of the ruling party, and gradually restored back to the standards of fearless honesty private monopolies created by the Permit/Licence Raj.”

The dissatisfaction with the working of the licensing system culminated in the Government setting up multiple committees seeking suggestions to improve the system. However, the focus of these debates was indifferent to the ramifications the ‘Licensing Raj’ was having on economic growth and efficiency and rather were centred around addressing the complaints the bureaucrats had lodged on the absence of clear guidelines for the consideration of licenses and delays accruing to the piling pendency of license applications. The Monopolies Enquiry Commission (1964) concluded that licensing restricted the entry of smaller firms leading to increased concentration of economic power. The Hazari Committee on Industrial Planning and Licensing Policy (1967) reported that the system allowed influential groups to foreclose the licensing capacity. The Dutt Industrial Licensing Committee (1969) came down heavily on the big-business houses, arguing that they had misappropriated the licensing system to monopolise economic power in their hands – eventually culminating in the Monopolies and Restrictive Trade Practices (hereinafter “MRTP”) Act, 1969. 

Notwithstanding these efforts, the ‘License Raj’ was further reinvigorated with the renewed nationalist socialistic drive under the third Prime Minister Indira Gandhi whose election to office in 1966 saw the nationalisation of banks and insurance; the introduction of the Small-Scale Industries Reservation (hereinafter “SSI Reservation Policy”) policies reserving specific commodities for small-scale enterprises in 1967; the creation of a new layer of regulations stipulated against large firms under the MRTP Act – thereby giving the Government sweeping powers to regulate ‘big business houses’; The Industrial Licensing Policy, 1970 further restricted new production activity of companies under the MRTP Act to a limited number of ‘Appendix I’ industries. In addition to an already exhaustive list of stipulated license procedures, these ‘Appendix I’ industries were further subject to control and approval from the Central Governmental for all cases of new undertakings, substantial expansions, mergers, amalgamations and takeovers under the MRTP Act. Historian Bipin Chandra likened the aforementioned Governmental policy actions as concomitant to the sowing of seeds of a Kafkaesque web of license-quota rules and regulations – a system whose remnants continue to haunt Indian industrialists and entrepreneurs till date.

The Small-Scale Industries Reservation, 1967

The SSI Reservation policy of April 1967 endeavoured to set aside a curated list of items for the exclusive production by small-scale industries (defined as undertakings with investments of 0.75 million rupees or less in plant and machinery). It was stipulated that following the addition of a commodity to the list, no new medium or large enterprise was permitted to compete, and the production capacity of the existing medium and large enterprises was frozen. Although the list began with forty-seven items in 1967, over five-hundred items comprised the list in 1978 – including major export items of large-scale labour abundant countries such as China, Taiwan and Korea. This meant that some of the most capable entrepreneurs from the technical as well as financial standpoint were excluded from the vast majority of the industries.

Industrial Licensing Policy, 1970

Among the several measures undertaken by the Government, the Industrial Licensing Policy was effectuated to limit the scope of foreign exchange to the core and heavy sectors and ‘large industrial houses’– defined as those with fixed assets of 350 million rupees or more. This policy raised the exemption limit on licenses – for new undertakings and from 2.5 million rupees to 10 million rupees in investment in fixed assets viz. land, building and machinery and for registered undertakings holding fixed assets in the excess of 50 million rupees. The policy was in line with the MRTP Act and the FERA in the sense that foreign firms and those warranting foreign investment over 10% were excluded from availing exemptions under the policy. With respect to small-scale industries, the policy stipulated that the SSI reservation was subject to extensions and introduced prioritisation of licensing to the cooperative sector. 

The policy also facilitated the expansion and promotion of exports in that ‘large industrial houses’ were allowed to operate outside the earlier stipulated core and heavy investment sectors – provided they undertook to export at least 60% of the additional output within three years. Similarly, undertakings other than small scale units were now permitted in the small-scale sector – provided they undertook to export 75% of the additional output within three years.

Foreign Investment Regulation and Ensuing Foreign Trade

The failed liberalisation experiment of 1965-67 drew the Government’s attention to foreign exchange outflows resulting from remittances of dividends, profits, and royalties.  On the recommendations of the Mudaliar Committee (1966) restrictions on foreign investment and technology imports were introduced and the predecessor to the FERA – the Foreign Investment Board (FIB) was set-up, thereby mandating prior cabinet approval for all projects involving foreign collaborations either worth over 20 million Rupees or 40% foreign equity share. The nationalist socialist drive under PM Indira Gandhi meant that imports of technology and investment were heavily discouraged in that import of certain commodities as mandated by the Government under three categories was barred.

Commencing from February 1972, the permission for capacity expansion was used by the Government as an instrument for the compulsory dilution of foreign equity shares held by non-bank foreign investors to 40% or less, thereby issuing the additional remainder of the equity to Indian citizens and consequently subjecting the abiding companies to ‘national treatment’. The ramifications of the aggressive implementation of the FERA had a particularly noteworthy affect on the British-dominated tea plantation industry – with forty-five Indian companies taking over the business of one-hundred-fourteen British companies who were forced to wind-up their operations. The restrictive posture adopted by the Indira Gandhi-led Government from 1967-79 consequently saw declines vis-à-vis the number of foreign collaborations approvals from 297 in 1956-57 to 242 and the drastic proportions on the squeeze on foreign financial collaborations from 36.36% in 1956-57 to a mere 16.11% in this time period.

As for foreign trade, exports grew rapidly by 18% in nominal dollars over 1971-96, largely accreditable to the real depreciation of the Indian Rupee. However, with the demise of the Bretton Woods adjustable peg system, the Indian Rupee was pegged initially against the Pound Sterling – on whose devaluation the Rupee was later re-pegged to a basket of undisclosed currencies. Consequently, the exports to GDP ratio subsisted at a mere 5.3% in 1979-80. As for imports, high tariff, low import quotas and the outright banning of certain products meant that such imports were virtually forced to shut off. For instance, the import tariff for cars was a whopping 125% in 1960. However, the situation marginally bettered with the increased remittances as part of the net foreign capital received from abroad, especially in the wake of rises in oil prices and external borrowing saw the imports-to-GDP ratio rise to 8.7% in 1980-81.

In 1985, India had the highest level of tariffs in the world – the nominal tariff rates as a percentage of values were a ridiculously high 146.4% for intermediate goods; 107.3% for capital goods; 140.9% for consumer goods and 137.7 % on manufacturing goods. In addition to the over-regulation of the private sector, the Government nationalized heavy industries –the commanding heights of the economy – and built new state-owned enterprises (SOEs) in areas as diverse as jute mills, hotels and steel plants inter alia. The policy actions under the ‘License Raj’, thereby, created a ‘scarcity economy’, and this scarcity was also inflicted upon foreign reserves – largely due to the active ‘swadeshi’policies undertaken by the Government. The growth of India in comparison to similar developing economies grew at a sluggish rate.

Source: World Bank

The Balance of Payment crisis triggered due to the financing of current account deficits by borrowings from abroad initially arose in the 1970s and progressively worsened towards the end of 1980s was on the verge of collapse in 1991. The economic situation of India was critical with the Government was close to default. India’s foreign exchange reserves stood at a measly USD 1.2 billion in January 1991 and that too was depleted by half by June – an amount barely enough to cover roughly three weeks of essential imports. India was in the need of an International Monetary Fund (IMF) bailout – the price of which was the notorious ‘License Raj’.

The P.V. Narasimha Rao-led Government, therefore, with the landmark Liberalisation, Privatisation and Globalisation economic policy altered the course of the Indian economy permanently. The Balance of Payment crisis was over by the end of March 1994 and foreign exchange reserves rose to USD 15.7 billion. Inflows of both Foreign Direct Investment (FDI) and Foreign Institutional Investment (FII) into India increased massively. The then finance minister of India, Dr. Manmohan Singh whilst concluding the budget famously ended his speech with on a historic note: 

“But as Victor Hugo once said, ‘no power on earth can stop an idea whose time has come.’ I suggest… that the emergence of India as a major economic power in the world happens to be one such idea. Let the whole world hear it loud and clear. India is now wide awake. We shall prevail. We shall overcome.”