Chapter 3

Service Sector Reforms in India

3.1 Agreements under GATS

Agreement establishing the WTO was ratified by India on 30-12-1994. General

Agreement of Trade in Services (GATS) covers the multilateral framework, sectoral
annotations and the schedules of market access. Negotiations of specific commitments are
mandated under Article XIX of GATS. A fresh round of comprehensive negotiations on
specific commitments commenced in the WTO from 1.1.2000. The main aim of these
negotiations was to achieve greater degree of liberalisation in all the service sectors and in all
the four modes of supply of delivery of Services recognised under GATS. These modes of
delivery include the following:

(i) Mode 1 - Cross border supply, e.g. supply of diskettes, architects blueprints, etc
(ii) Mode 2 - Consumption abroad, e.g., a tourist availing of Services abroad.
(iii) Mode 3 - Commercial presence, e.g. form of legal entity established abroad like a
bank branch.
(iv) Mode 4 - Movement of Natural Persons, e.g. physical movement of professionals and
labour for temporary period. It does not cover permanent migration.

The schedule of specific commitments of each Member country involves a positive listing of
sectors/ subsectors and modes of supply where the member country desires to undertake
specific commitments. Those sectors or subsectors, which are not listed, are not subject to
any commitments. Even for the listed sectors/ subsectors and for any particular mode,
Members may keep the commitments as "unbounded" which means no commitments. In the
listed sectors/ subsectors and modes of supply, a Member can schedule some limitations on
market access, national treatment and additional commitments as permitted under relevant
portions of GATS. Thus there is considerable degree of flexibility provided to the Members
under the Approach.

While the negotiations cover all sectors and modes of supply, the emphasis of developed and
developing countries is different. Developed countries in general press for greater
liberalization in mode 3 relating to commercial presence. On the other hand developing
countries including India seek for greater liberalisation of mode 4 relating to "Movement of
Natural Persons". India, in particular, has interests in seeking greater market access for its
professional and skilled labour in mode 4 because of its surplus of skilled manpower in
various service sectors such as financial, telecom, IT, transport and distribution etc.

3.2 India’s Commitment under GATS

India scheduled commitments across a range of services under the GATS. These are:
business services, communication services, construction and related engineering services,
financial services, health and social services, and tourism and travel related services. MFN
exemptions were scheduled for: communication services (audiovisual services and
telecommunication services); recreational services; and transport services (shipping services).
These commitments are unchanged since the previous Review of India.
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India signed the Fourth and Fifth Protocols in 1997 and 1998, respectively. Under the Fourth
Protocol, India scheduled commitments in voice telephony and cellular mobile telephony as
well as value-added services, such as circuit switched data transmission services, facsimile
services, and private leased circuit services. In general, India's current policy is more liberal
than its scheduled bindings. For voice and mobile telephone services, commercial presence
may be established through incorporation in India and a licence from the designated
authority; total foreign equity in the company is scheduled not to exceed 25%, although the
current policy allows foreign equity ownership of up to 49% for these services. India also
declared that it would examine the issue of allowing competition from the private sector in
international long-distance telecommunication services in 2004; this date was brought
forward to 2002.

Under the Fifth Protocol, India raised the limitation on licences for new and existing banks
from 5 to 12 per year. In addition, banks were allowed to install automatic teller machines
(ATMs) at branches and at other places identified by them (ATMs installed in premises other
than branches are treated as new premises and would therefore require new licences). New
commitments were also scheduled in stock broking and financial consultancy services.

3.3 India’s negotiations for Financial Services

Negotiations in financial services are difficult and protected as none of the Member states
particularly the developing countries was prepared to open up across the board. The
framework agreement had two conditions:

(i) The first one is non-discrimination i.e. all countries shall be treated as a Most
Favoured Nation (MFN) basis and
(ii) The second is transparency i.e. all relevant laws and regulations shall be
published.

Initial negotiations in financial services continued till 28-07-1995 when an interim agreement
up to 31-12-1997 was arrived at. India's original schedule in financial services made the
following commitments.

(a) Banking

(i) Only a branch presence

(ii) 5 licenses per year.
(iii) Entry to new foreign banks may be denied if market share of assets of foreign banks
exceeds 15% of total assets of banking system.

(b) Non-Banking Financial Services

Items allowed Limits on foreign equity

Merchant banking, Local incorporation with a maximum equity

Factoring, of 51 per cent by foreign financial services
Financial leasing, suppliers including banks.
Venture capital,
Financial consultancy

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(c) Insurance

No commitment was made by India in life insurance area. In non-life insurance, India
committed to continue with the current practice, which was quite restrictive.

(d) Reinsurance, Retrocession & Insurance intermediation relating to reinsurance.

A minimum of 10% of the premium of overall was committed to be reinsured abroad.

Perceptions regarding India's offer: India's offer though appreciated, was seen to be
restrictive on many counts as given below:

(i) Limitation on the number of new branches.

(ii) ATM restrictions outside branch premises, which was then construed as an additional
branch.
(iii) New branch licenses can be denied when assets of foreign banks exceeds 15% of the
total assets of the banking system.
(iv) Limitations on foreign bank investment: National treatment is denied and investment
which is undertaken by foreign banks already operating in India in other financial
services companies, is not allowed to exceed 10% of owned funds or 30% of the
investee company's capital.
(v) Entry form by non-banking financial companies is limited to local incorporation and
also that the foreign equity is limited to 51%.
(vi) Incomplete sectoral coverage: India's schedule of commitments omits a number of
important non-banking financial services.
(vii) State monopoly on insurance.

India's Enhanced Offer

During negotiations in June-July 1995, India made an enhanced offer, which included
a liberalized policy on ATMs i.e. an ATM will not be treated as a separate branch, an
increase in the number of new bank branches to 8 and inclusion of Stock Broking in the
schedule, with a maximum foreign equity of 49%. This offer was made to obtain substantial
improvements from major trading partners of India in the movement of natural persons
because India possesses a fair advantage in the availability of skilled manpower in several
high-tech areas such as computer software and engineering consultancy etc. It was in India's
interest that free movement of these personnel was allowed into the developed market abroad.

Based on India's enhanced offer, the EU, Norway, Switzerland & Australia tabled an
offer on movement of natural persons for the first time. Their offer does not insist on the
economic needs test.

USA taking an MFN exemption and India's response to it

During the negotiations in June 1995, the USA invoked a MFN exemption on the
ground that the offers of certain commercially important markets remain inadequate in terms
of market access and national treatment.

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 In order to protect our own interests and also to meet the requirement of the Banking
Regulation Act, 1970, India also filed MFN exemptions in Banking, Non-Banking and
Insurance areas, based on the principle of reciprocity. Some of India's trading partners took
strong exception to taking MFN exemptions by India and urged to reconsider the decision.

During the Singapore Ministerial Conference, held in December, 1996, it was agreed
to resume Financial Services negotiations in April, 1997 with the aim of securing
substantially improved market access commitments with a broader spectrum within the
agreed time frame, i.e., by 31.12.1997. Subsequently, it was informed that the Agreement is
to be concluded by December 12, 1997. Negotiations in Financial Services resumed at
Geneva in April 1997. India held bilateral discussions with our major trading partners viz.
USA, EU, Canada, Australia and Switzerland.

The request made by these trading partners are summarized below:

(a) Insurance

(i) Commitment may be made in health insurance as per the announcement made in the
budget for 1997-98.
(ii) It is difficult to sustain a monopoly in the FATS and this was a major concern. The
commitments in this sector would be a deciding factor in the success of the
negotiations. At least some commitments to 'staged' liberalization may be made.
(iii) India has made cross border reinsurance to the extent of overall 10% of the market.
The actual practice is 15% and hence the limit should be raised to 15%.
(iv) Brokers and other intermediaries should be allowed to operate in the markets and
provide direct access to foreign insurance companies.
(v) Representative offices may be permitted to receive income from India.

(b) Banking

(i) India should increase the number of licenses and also provide for a gradual increase in
the market share of the assets of the foreign banks. The more liberal practice of
granting licenses must be bound in the schedule.
(ii) Market share itself should be defined properly in terms of the fund-based assets or
total assets on and off the balance sheet.
(iii) Certain sectors were not covered in banking such as trading on customer's account,
trading in derivative products etc. These services may be included in the banking.
(iv) Subsidiaries/joint ventures should be allowed in banking.
(v) Foreign banks were subject to higher rate of tax. The tax deductibility of Head Office
expenses was limited to a certain percentage. Withholding tax was levied on foreign
banks but not on public sector banks.
(vi) Discrimination against foreign banks in placement of funds by public sector units
should be removed.

(c) Non banking Financial Services

(i) Increase coverage in this sector by binding additional services, which have been
actually allowed in the revised foreign investment policy.
(ii) In actual practice, the Government has allowed higher level of foreign equity. India
should bind actual practice, which is more liberal than the commitments made.
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(iii) In those cases where higher levels of foreign equity have been permitted, the acquired
rights should be permitted. For example, in most of the non-banking financial services
India has allowed 75% or even more foreign equity subject to the approval by the
foreign Investment Promotion Board (FIPB). If a foreign investor has already
obtained approval for higher than 51% foreign equity, he should not be asked to
reduce this holding to the level bound, i.e., 51%, at any time. This is a major issue for
the US and EU that there will be no roll back for the existing investors.
(iv) Securities companies should be allowed to set up branches.

At the conclusion of the negotiations in 1997, India tabled the following revised schedule of
commitments:

(i) MFN exemptions relating to banking services have been withdrawn subject to
other WTO members undertaking MFN-based commitments.
(ii) In banking, number of bank branches to be opened per year for both existing and
new foreign banks increased from 8 to 12 per year.
(iii) In insurance, status quo is maintained. In the area of reinsurance, the existing
binding was aligned to the market.
(iv) In non-banking financial services, both national treatment and market access are
unfound.

The agreement on financial services came into force with effect from 30.1.1999. As per the
revised foreign investment policy, all proposals for foreign equity investment in NBFC are
considered on case by case basis by the FIBP. Foreign investments in non-banking financial
services are permitted in:

(i) Merchant Banking,

(ii) Underwriting,
(iii) Portfolio Management Services,
(iv) Investment Advisory Services,
(v) Financial Consultancy,
(vi) Stock Broking,
(vii) Asset Management,
(viii) Venture Capital
(ix) Custodial Services,
(x) Factoring,
(xi) Credit Reference Agencies,
(xii) Credit Rating Agencies,
(xiii) Leasing and Finance,
(xiv) Housing Finance,
(xv) Forex Broking,
(xvi) Credit Card Business and
(xvii) Money Changing Business.

Minimum capitalization norms are:

Foreign equity less than or equal to 51% : US $ 0.5 MN.

Foreign equity more than 51% But less than or equal to 75 : US $ 5 MN.
Foreign equity ore than 75% : US$ 50 MN.
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100% foreign own NBFCs would act as a holding company and specific activities would be
undertaken by step-down subsidiaries with minimum 25% domestic equity.

Investment proposals in NBFS sector for activities which are not fund based and only
advisory or consultancy in nature, would be subject to a minimum capitalization norm of US$
0.5 million, irrespective of the foreign equity participation level. This would be applicable in
the following permitted NBFC activities for foreign equity investment:

 Investment advisory services

 Financial consultancy
 Credit reference agencies
 Credit rating agencies
 Forex broking
 Money changing business

This would also be subject to the following conditions:

 Such a company will not be permitted to set up any subsidiary for any other activity.
 For purpose of reckoning domestic equity such wholly owned financial consultancy
company would not be eligible to provide equity contribution as a domestic partner for
any NBFC holding operating company.

In regard to restrictions on FII investments in Indian companies, the aggregate limit in any
individual company, which earlier was 24% was increased to 30%.

In regard to tax rates, FIIs are currently taxed on a preferential basis on long-term capital
gains at the rate of 10% compared with 20% for short-term capital gains.

In regard to foreign equity investment in the private sector banks; foreign banking
companies or finance companies including multilateral financial institutions are allowed
foreign equity participation up to 20% as technical collaborator or co-promoters. NRIs are
allowed equity participation in private sector banks up to 40% inclusive of equity
participation by other foreign investors. However, in few cases, the permissible equity
contribution by NRIs has not been fully subscribed.

Government has now decided that in case of shortfall in foreign equity contribution by
NRIs, multilateral institutions would be allowed to contribute foreign equity to the extent of
shortfall in NRI contribution to the equity. The Union Budget for 2003-04 has further
liberalized the FII inflows, which would not be covered under the existing sectoral caps for
Foreign Direct Investment (FDI).

In Banking, new bank branches for existing and new foreign banks being allowed are 15 per
year though our commitment is only for 12 branches per year. The guidelines issued by RBI
so far go also beyond the commitments made in NBFC sector.

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 3.4 Reforms and Liberalisation in Banking and insurance

An efficient financial services sector, capable of mobilizing savings and channelling them
into the most productive uses is essential for India's successful economic restructuring and
long-term development. Although efforts have been made to introduce competition in the
sector, with banking reforms commencing in the early 1990s, banking and insurance are
dominated by state-owned enterprises, some of which continue to face financial problems.
The sector is thus in need of further restructuring. In addition, there is a need to bring
regulation and supervision closer to international best practices.

Under the Reserve Bank of India Act 1934 and the Banking Regulation Act 1949, the RBI is
responsible for supervising the banking sector as well as non-banking financial companies
(NBFCs), the latter under the provisions of the Reserve Bank of India (Amendment) Act
1997. Other institutions supervised by the RBI include urban co-operative banks (jointly with
the state and central governments), regional rural banks, state and district central co-operative
banks (regulated by the RBI and supervised by NABARD and/or state and Central
Governments) and development financial institutions.

Entry requirements for banks were changed in January 2001. Among the changes made,
minimum capital requirements for new banks were raised to Rs.2 billion to rise further to
Rs.3 billion three years latter and minimum capital adequacy ratio requirement of 10%,
which was latter increased to 12% with effect from April 2003. Foreign direct investment of
up to 74% of a bank's equity is permitted. New banks are also allowed to open a quarter of
their branches in rural/ semi urban areas. Foreign banks are also allowed to establish branches
or subsidiaries in India.

In order to regulate the activities of non-bank financial companies, the RBI Act (1934) was
amended in 1987, so as to require NBFCs to, inter alia obtain a Certificate of Registration
from the RBI prior to commencing any financial operations. Foreign direct investment is
allowed up to 100% of equity, depending upon initial investment. Investment by foreigners,
non-resident Indians and Overseas Corporate Bodies (OBCs) are permitted in 18 NBFCs
activities. Following amendments to the RBI Act in 1987, the RBI set up a regulatory
framework for NBFCs in January 1998 to ensure that only financially sound and well
managed NBFCs were allowed to access public deposits.

(a) Banking

Recent policy changes

Several measures were taken since 1991 to strengthen the banking system, to increase banks’
operational autonomy, and to improve the functioning of money and capital markets. With
this objective in view the policy package for commercial banks included a reduction of bank
rate from 12 per cent in 1991 to 6 per cent in April 2003, CRR from 25 per cent in 1991 to
4.50 per cent in June 2003, a reduction of SLR from 38.5 to 25 per cent, a reduction of
nominal interest rates from over 21 per cent to 10.75 per cent to 11.5 per cent in 2003,
tightening of prudential norms for capital adequacy and provisioning for non-performing
assets, an active open market operations and abolition of selective credit controls. Other
measures included decontrol of the prime lending rates of the commercial banks and deposit
rates for term deposits. An array of capital market reforms has been introduced encompassing
primary and secondary markets, equity and debt and foreign institutional investment.
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These measures resulted in a strong growth in bank deposits due to high real interest rates,
particularly longer-term rates. There was abundant liquidity in the system but slow growth of
commercial credit due to sluggish consumer demand and external trade. The low offtake of
commercial credit also reflected a more cautious approach to credit appraisal by banks, which
sought to avoid the accumulation of non-performing assets under the Reserve Bank’s new
prudential norms. By contrast there was a substantial increase of investments by commercial
banks in government securities and bonds, debentures, and shares of the corporate sector.

Commercial bank credits traditionally comprised banks loans, cash credits, overdrafts and
inland and foreign bills purchased and discounted. However, with deregulation of the
financial sector, there has been a shift in the banks’ asset portfolio mix with investments in
money and capital market instruments such as commercial paper, shares and debentures
issued by the commercial sector. Banks also held government securities far in excess of their
obligations for the statutory liquidity ratio (SLR).

As a part of second generation reforms, several measures were announced in the Budgets for
2001-2002 and 2002-03 to strengthen the banking system, to increase banks’ operational
autonomy, and to improve the functioning of money and capital markets. These measures
include the following:

• Establishment of Clearing Corporation

• Screen based trading in G-securities
• Replacement of Public Debt Act by Government Securities Act
• Reduction of Govt equity in banks to 33 per cent
• Voluntary Retirement Scheme for commercial banks
• Legislation on securitisation and foreclosure in banking sector
• Foreign equity to the extent of 74 per cent has been allowed in private commercial banks
• FII portfolio investment will not be subject to the sectoral limits for FDI.
• Indian companies are allowed to invest up to US $100 million abroad.
• A pilot Asset Reconstruction Company to be set up to initiate measures for taking over
NPAs in the banking sector and develop a market for securitised loans.
• Foreign banks allowed to operate as branches or to set up subsidiaries.
• Full convertibility is permitted for deposits by non-resident Indians.
• NRIs can also repatriate their current earnings in India in foreign currency.
• Indian mutual funds are allowed to invest in securities in countries with fully convertible
currencies.
• Administered interest rates to be bench marked to the average annual yields of
Government securities of equivalent maturity.
• State governments allowed prepaying their high cost debts from additional sources at
lower interest rates.
• Establishment of offshore banking units in the Special economic Zones as branches of
banks operating in India is allowed.
• Residents are allowed to open bank accounts in foreign currency with foreign exchange
earned abroad and remittances received from outside.

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 per cent in
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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.

Monetary and credit policies for 2003-04

The basic objective of monetary policies announced by RBI in April 2003 was to contain
inflation around 5 per cent alongwith sustaining overall GDP growth rate in the range of 6 per
cent. In the face of a distinct moderation of the inflation rate, the thrust of the monetary
policy in 2003 is to ensure adequate flow of credits to the productive sectors of the economy
and to support revival of investment demand.

In the financial sector during 2002-03 loan classification and provisioning regulations were
tightened, and foreign entry to the banking system was further liberalised through the lifting
of limits on FDI and FII investment. Actions were taken to strengthen capital markets
including the restructuring of the Unit Trust of India (UTI), Industrial Development Bank of
India (IDBI) and the Industrial Finance Corporation of India (IFCI).

In pursuit with the monetary and credit policy stance announced in April 2003, the cash
reserve ratio (CRR) was reduced by 0.25 percentage point to 4.5 per cent with effect from
June 14, 2003. The bank rate was reduced by 0.25 percentage points from 6.25 per cent to 6
per cent with effect from April 29, 2003.

A system of variable interest rates and deposit rates was introduced and banks were directed
to disclose maximum spread over and below the Prime Lending Rate (PLR) for greater
transparency.

Other major measures announced in the Mid Term policy for the year 2002-03 included the
following:

 Regional rural banks, local area banks and co-operative banks advised not to pay
additional interest on savings accounts over what is payable by commercial banks.
 Banks were allowed to determine their PLR and sub-PLR rates for export credits.
 Banks were free to issue Certificates of Deposits (CDs) on floating rate basis.
 In order to improve credit delivery to the priority sectors, scope of credits to agriculture,
small business and weaker sections of people were expanded.
 System of micro credit finance institutions was strengthened.
 Establishment of offshore banking units in the Special Economic Zones as branches of
banks operating in India was allowed.
 Residents were permitted to open bank accounts in foreign currency with foreign
exchange earned abroad and remittances received from outside.

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 Exchange rate policies

In international categorizations by the International Monetary Fund (IMF), India is regarded as

one of the countries having independent floating exchange rate arrangement. The day to day
fluctuations in the exchange rate of Indian rupee are determined by free market forces for
supply and demand for foreign exchange, such fluctuations reflect both economic
fundamentals and short term speculation. The rupee is also fully convertible on current
account and almost fully convertible on capital account for the non-residents.

The broad principles that have guided India after the Asian crisis of 1997 are:

• Careful monitoring and management of exchange rates without a fixed target or a pre-
announced target or a band.

• A policy to build a higher level of foreign exchange reserves which takes into account
not only current account deficits but also ‘liquidity at risk’ arising from unanticipated
capital movements;

• A judicious policy for management of capital account. India has adopted the golden
principle for capital account convertibility i.e. first liberalising inflows of non-debt
creating financial flows and concentrating on concessional loans from the multilateral
funding agencies followed by liberalisation of the long term commercial loans with strict
monitoring on short-term external loans.

In order to further liberalise the movement of cross-border capital flows, especially in the
area of outward foreign direct investment, inward direct and portfolio investment, non-
resident deposits and external commercial borrowings, RBI announced the following
important measures relating to current and capital account during 2002:

• Considerable liberalisation of release of foreign exchange for individual residents for

most purposes like travel, education, medical expenses etc.

• Non-Resident Indians/ Persons of Indian Origin (NRIs/ PIOs) were permitted to repatriate
assets in India acquired by way of inheritance/legacy, and current income like rent,
dividend, pension and interests.

• Units located in Special Economic Zones (SEZs) are permitted to remit premium for
general insurance policies taken from insurance companies outside India.

• Insurance companies registered with IRDA are allowed issuance of general insurance
policies denominated in foreign currency.

• Corporates are permitted to prepay External Commercial Borrowings (ECBs) up to US

$100 million without permission from RBI up to end-March 2003.

(a) Insurance

The insurance sector is dominated by the Life Insurance Corporation (LIC) for life insurance
and the General Insurance Company (GIC) for general insurance and reinsurance, both of
10
which are state owned. However, with the enactment of the Insurance Regulatory and
Development authority (IRDA) Act in 1999, and amendments to the Life Insurance
Corporation Act, 1956, and General Insurance Business (Nationalisation) Act, 1972, the
sector was opened to competition from private Indian insurance companies. The IRDA Act
established a statutory body, the Insurance Regulatory and Development Authority (IRDA),
on 19 April 2000. The IRDA, which has a Chairman and four full time members appointed
by the Government, has the authority to: regulate and develop the insurance sector in an
orderly manner, particularly in regard to socially weaker and rural sections of society; grant
licences to new companies; and to oversee the functioning of the Insurance Ombudsman,
established in 1998 under the Settlement of Public Grievances Scheme.

Amendments were also made to the Life Insurance Corporation Act, 1956, the General
Insurance Business (Nationalisation) Act, 1972, and related sections of the Insurance Act,
1938, to remove the exclusive monopoly operated by the LIC and the GIC in life and general
insurance services, respectively. As a result of the change in legislation, by February 2001,
the IRDA had issued Certificates of Registration to 17 private Indian insurance companies, of
which ten are in life insurance, six provide general insurance services, and one is a reinsurer.

Under amendments to the Insurance Act 1938, an Indian insurance company is described as:
a company registered under the Companies Act, 1956; with an aggregate foreign equity
participation, either by a company or through its subsidiaries or nominees, of no more than
26% of the paid-up equity capital of the Indian insurance company; and whose sole purpose
is to carry on life, general or reinsurance business. In addition, no insurer is allowed, under
the Act, to provide insurance services unless the company has a paid-up equity capital of
Rs 1 billion; for reinsurance the minimum paid-up equity capital required is Rs 2 billion.
Financial sector companies, such as banks and non-banking financial companies (NBFCs) are
also permitted under the new legislation to invest in the insurance sector through joint-
venture companies, subject to their meeting net worth and other prudential criteria. The
maximum equity that may be held by banks and NBFCs in these joint-venture companies is
currently restricted to 50% of the paid-up capital of the insurance company. Banks and
registered NBFCs not eligible as joint-venture participants may invest in up to 10% of the net
worth of the insurance company, or Rs 500,000, whichever is lower, to provide infrastructure
and services support.

Since their formation, the LIC and GIC have expanded their geographical coverage of the
country, providing services through over 6,000 divisional branch offices. They have also
made a significant contribution to savings and the financing of the public-sector deficit, partly
due to mandatory requirements for investment in government and approved securities. These
requirements also apply to new private-sector entrants to the market under the provisions of
the Insurance Act 1938 and the IRDA (Investment) Regulations, 2000. In addition, every
insurer is required to cede 20% of its insurance business written in India to the GIC for
reinsurance.

Despite the expansion of insurance services in India, insurance spending remains low,
estimated at some US$6 per capita (US$5 at the time of the last Trade Policy Review of
India). Moreover, with a penetration rate of around 22% of the insurable population, it is
expected that the entry of new players in the insurance sector will help increase competition
and product development to the benefit of the Indian consumer. In addition, in order to
ensure that remote areas continue to receive access to insurance services, the IRDA has
issued a regulation requiring all new insurers to expand their services to the rural and social
sectors over a period of five years.
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 3.5 Reforms in industry and Infrastructure

Government has abolished licensing for both industrial production and exports except for a
few sectors, which are important on considerations of national security, public health and
environment. Industrial licensing is now required for only 6 industries which account for less
than 7 per cent of output in manufacturing. Only 4 industries (viz. defense products, atomic
energy, railways, and minerals required for atomic energy) are now reserved for the public
sector.

Foreign investment policy has been liberalised significantly since July 1991. Most of the
sectors (except a few such as agriculture, retail trade etc.) are now open for foreign
investment subject to sectoral caps on equity. Majority participation and equity up to 100 per
cent are allowed in most of the infrastructure sectors.

Indian firms are allowed to raise funds abroad through Global Depository Receipts (GDRs),
Foreign Currency Convertible Bonds and offshore fund. Foreign Institutional Investors
(FIIs), Non-resident Indians (NRIs) and Overseas Corporate Bodies (OCBs) are allowed to
operate in India’s capital markets subject to an individual FII holding by 10 per cent and
collective holding up to 49 per cent of paid up capital for the FIIs, and individual holding of 5
per cent and cumulative holding of 10 per cent by the NRIs/OCBS.

Foreign investors are permitted to pick up disinvested shares of public enterprises, dated
government securities and treasury bills and shares of unlisted companies. The Foreign
Exchange Regulation Act have been amended, and FERA companies (i.e. companies with
more than 40% of foreign equity) can operate like any other Indian Company, and can own
real estate, use their trade marks and brand names for internal sale. India has become a
member of the Multilateral Investment Guarantee Agency (MIGA) and signed treaties for
avoidance of double taxation with 42 countries.

Second generation reforms in industry and infrastructure include the following:

• Electricity Bill 2001 introduced in Parliament

• Reforms in SEBs for Energy audit, commercia-lisation of distribution and restructuring of
SEB
• Accelerated Power Development and Reform
• Enactment of Energy Conversation Act 2001
• Larger funds for National Highway Development
• Model BOT schemes for roads/ bridges
• Corporatisation of DOT and ports
• Private investment in airports
• Convergence Bill to cover telecommunications, IT and broadcasting

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 Many policies were announced in the 2002-03 Budget to encourage private investment in
industry and infrastructure. These measures include the following:

• Public investment in key infrastructure sectors increased and an infrastructure Equity

Fund set up to help in providing equity investment fund for infrastructure projects.
• One time settlement scheme in regard to State Electricity Board (SEB) over dues to the
Central Public Sector Utilities through securitisation and bonds.
• Corporatisation of major ports in a phased manner.
• Concession package for private sector participation in green-field airports.
• Urban Reform Incentive Fund set up to provide incentive for reforms of Rent Control
Act, rationalisation of high stamp duty regime, streamlining approval process for
construction and development of sites, simplification of legal procedures and realistic
user charges to convert agricultural land into non-agricultural use.
• Dismantling of Administered price mechanism for petroleum products from April 2002.
Subsidies on LPG and kerosene to be phased out in the next 3-5 years.
• Dereservation of 50 items relating to agricultural equipment, chemicals and drugs etc.
reserved for the small-scale sector.
• Increase in issue price of urea, DAP and MOP fertiliser by about 5 per cent and reduction
in the subsidy for SSP.

3.6 Telecommunications

The Telecommunication Sector has been the monopoly of the Government of India since its
inception. The telecom reform commenced with the general liberalisation of the
economy in the early 1990s and announcement of a New Economic Policy (NEP)-1991.
Telecom equipment manufacturing was delicensed in 1991 and value-added services were
declared open to the private sector in 1992, following which radio paging, cellular mobile and
other value added services were opened gradually to the private sector. National Telecom
Policy was announced in 1994, with a major thrust on universal service and qualitative
improvement in telecom services and also, opening of private sector participation in basic
telephone services. An independent statutory regulator was established in 1997. Progressively
there was growth in private sector provision of telecom services in the country.

The most important landmark in telecom reforms, however, came with the New Telecom
Policy 1999(NTP-99) which can be terms as the new generation of reforms. Rather than
insisting on the prior fulfillment of its revenue obligations, NTP-99 allowed private providers
to "migrate" from fixed license fee regime to a revenue sharing regime. The regulator was
strengthened, domestic long distance services were opened to the private sector, and the state-
owned basic service provider under the Department of Telecommunications was
corporatised.

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The guiding principles of the NTP-99 are as follows:

• Affordable and effective communications to citizens is the core of the vision and goal of
telecom policy.
• Balance between the provision of universal service to al uncovered areas, including rural
areas, and provision of high level services capable of meeting the needs of the country's
economy.
• Building a modern and efficient telecommunications infrastructure to meet the
convergence of telecom, IT and the media.
• Conversion of PCOs into Public Teleinfo Centres having multimedia capability like
ISDN service, remote database access, government and community information systems
etc.
• Transformation of the telecommunications sector to a greater competitive environment
providing equal opportunities and level playing field for all players.

Specific targets that NTP-99 seeks to achieve are:

• Make available telephone on demand by the year 2002 and sustain it thereafter so as to
achieve a tele-density of 7 by the year 2005 and 15 by the year 1010.
• Encourage development of telecom in rural areas making it more affordable by suitable
tariff structure and making rural communications mandatory for all fixed service
providers.
• Increase rural teledensity from the current level of 0.4% to 4 by the year 2010 and
provide reliable transmission media in all rural areas.
• Achieve telecom coverage of all villages in the country and provide reliable media to all
exchanges by the year 2002.
• Provide Internet access to all district headquarters.
• Provide high-speed data and multimedia capability using technologies including ISDN to
all towns with a population greater than two lakh by the year 2002.

Following key policy decisions have been taken to achieve the NTP-99 targets.

(i) National Long Distance sector was opened with the announcement of guidelines for
licensing of NLDO operators.
(ii) A decision to permit Mobile Community Phone Services was announced on
11.1.2001.
(iii) Multiple Fixed Service Providers (FSPs) licensing guidelines were announced.
(iv) Government proposes to enact a Communications Convergence Bill setting up a
Communication Commission of India, to regulate Information Technology, Telecom
and Broadcasting.
(v) The Government has also announced the opening of International Long Distance on
1st April 2002, two years ahead of schedule.
(vi) ISP's have been allowed to set up International Internet Gateways both Satellite and
Landing stations for submarine optical fibre cables.
(vii) Licenses for Voice Mail/Audiotex service will be granted, on non-exclusive basis,
SDCA (Short Distance Charging Area) wise. License fees and entry fee will be nil.
(viii) Limited Mobility in Local Area on Wireless Loop permitted to existing and new
Basic Service operators.
(ix) Introduction of fourth operator for Mobile Cellular Service under process.

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As a result of the several policy initiatives taken during the 9th Plan period, the fixed lines
increased by about 23% and cellular mobile phones by 75%. The overall growth of the
telecom network (Fixed and Cellular) was about 25.4%. Most of the above growth during the
9th Plan was mainly the contribution of public sector enterprises. However, in the cellular
segment, the private sector made a major dent. It is expected that during the 10 th Plan period
also the growth of telecom network would be about 23%.

As of March 2002, 80 cellular telecommunication licences had been granted to 27 operators.

The subscriber base had grown to over 5.7 million by January 2002, a penetration rate of
some 0.5%. According to the authorities, a major factor in this expansion was the decision
taken in NTP 99 to change the licence fee for private-sector operators from a fixed value to a
percentage of gross revenues; it had been suggested that the high cost of the initial licence fee
may have dissuaded more operators from bidding for licences.

For local telecommunication services, 31 licences have been granted to seven operators; as of
early 2002 private operators had begun providing local fixed-line services in seven service
areas, in addition to the public-sector companies, BSNL and MTNL. In addition to VSNL,
two private companies have signed licences to provide domestic long-distance services; a
letter of intent has been issued to a fourth company. The presence of new operators in fixed
and cellular telecommunication services has resulted in a significant rise in the penetration
rate across the country. The number of fixed-line telephones increased from 14.54 million to
35.51 million (1.7% to an estimated 3.2%) between 1996/97 and January 2002 (41.44 million
including cellular services), a teledensity of over 4%; the authorities believe that the
teledensity is likely to exceed the 7% target of NTP 99. The waiting list for main line
telephones was estimated at 2.8 million, up from 2.4 million in 1995.

Tariff policy, including tariff rates and cross-subsidization of tariffs, has also been addressed
by the Regulator, through successive tariff orders. International tariffs, in particular, have
traditionally been high, partly to cross-subsidize local tariffs and rental charges. The Tray's
tariff orders appear to have rationalized and reduced tariffs and also the cross-subsidisation
substantially over the last few years. Particularly the STD and ISD rates have come down
significantly over the last three years.

Other services such as radio paging were liberalized in 1992; some 137 licences have been
granted, of which 76 are currently operational. Other value-added services that have been
liberalized include V-SAT-based data services, electronic mail, fax on demand, and
electronic data interchange.

3.7 Electricity

Recognition that the public sector may not be able to invest adequately in power generation
prompted the Government to encourage private investment. However, it became evident that
significant amounts of private investment could not be attracted in an environment where the
independent power producer is expected to sell power to a public sector distributor, who may
not be in a position to pay for it. As a result, the inflow of private investment, including FDI,
has been much below target.

The reform process has also required significant co-ordination between the central and state
governments, as electricity is defined as a concurrent subject in the Indian Constitution.
Despite these difficulties, steps are currently being taken to address the problems in this
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sector, including through the formation of central and state regulators to restructure electricity
tariffs, and increased investment to improve infrastructure.

In 1998, Parliament enacted the Electricity Regulatory Commission Act, which envisaged the
creation of an independent regulator, the Central Electricity Regulatory Commission (CERC),
to regulate electricity tariffs. Since then 18 States have established State Electricity
Regulatory Commissions (SERCs); 11 of these have also issued their first tariff orders. The
authorities expect that, over time, tariffs will be rationalised, reducing the need for annual
subsidies to the SEBs and will also address the problem of cross-subsidisation between
industrial and other tariffs.

The Ministry of Power has also signed memoranda of understanding with 20 states to carry
out reform in a time-bound manner. At the same time, the Central Government has provided
financial assistance to facilitate reform in the states through the Accelerated Power
Development Programme (APDP), which commenced in 2000/01; the scheme will assist the
states in renovation and modernisation of the sector, strengthening sub-transmission,
distribution systems, and metering, the latter being one of the causes of transmission losses.

In addition, the Chief Ministers/Power Ministers Conferences held regularly have agreed that
there was an urgent need to depoliticize power-sector reforms, to charge minimum tariff of
50 paise per unit of power supplied to agriculture and to speed up their implementation of
power sector reforms. In order to encourage private investment, the Government has also
developed guidelines for investment in transmission, and foreign investment limits were
raised from 74% to 100% (based on automatic approval) in May 1998.

To consolidate the reforms carried out thus far under one law, the Electricity Bill was
introduced in Parliament in 2001; this aims to make reform in the States mandatory. The Bill
appears to introduce far-reaching changes including: de-licensing generation and freely
permitting so-called captive generation; allowing open access to transmission; permitting
licensed generators to provide transmission, and licensed transmitters to provide generation;
and making the establishment of a State Electricity Regulatory Commission mandatory.
However, the Bill has been criticised because it appears not to require the restructuring of the
SEBs and fails to impose deterrent punishment for theft, and non-payment of bills, etc. In
particular, the need for the restructuring of the SEBs, according to the Government, remains
critical and a major cause of the shortfall of private investment in the sector. The Bill has
been passed in May 2003 by the Parliament.

3.8 Transportation

Road services are being improved, including through upgrading the present national highway
infrastructure and developing new highways connecting major cities. The National Highways
Act, 1956 was amended in 1995 to allow participation by the private sector, which is being
encouraged to invest through build, operate and transfer (BOT) schemes. Incentives for
private-sector investment include tax holidays of up to ten years, and zero rates of import
duty on construction equipment; FDI up to 100% is also permitted. In rail transport, which
was identified recently as a key sector on the verge of a financial crisis, the Railway Budget
of 2002/03 has taken initial steps to address this problem by significantly revising the tariff
structure so as to reduce the cross-subsidy by freight transport of passenger transport; the
classification of freight transport has also been rationalized considerably. Measures have also
been proposed to share expenditure on rail projects with the States. Other revenue-raising
measures taken in recent years include efforts to invite private investment in rail projects
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through, inter alia, the formation of joint ventures with strategic private investors, build,
operate and transfer projects, development of private railway lines with ownership and asset
maintenance rights, as well as the establishment of private freight terminals. According to
the authorities, moreover, private funds of around Rs 30 billion are being tapped every year
for the lease of rolling stock.

In maritime transport, port services are being improved including through the privatization of
some port activities and corporatization of ports, which it is hoped will increase productivity
and improve accountability and transparency in their operations. The Budget of 2002/03
announced that major ports will be corporatized in a phased manner and that new private-
sector ports will be set up.

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