The Impact of Economic Reforms on Industry in India: a Case Study of the Software Industry

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The Impact of Economic Reforms on Industry in India: A Case Study of the Software Industry

N. R. Narayana Murthy
The Indian economy, in the last decade, transitioned from an inward looking, closed economy, to a liberalized,export-oriented one. The software sector witnessed unprecedented growth, with exports growing at a compounded annual growth rate (CAGR) of around 45 percent and domestic software sales at around 35 percent. In fact, before 1991, the Indian software sector was adversely affected by the restrictive economic policies. Thus, this sector provides an appropriate case study on how liberalization of the economy reduced friction to business and accelerated growth.

Growth of the Indian Software Services Industry

The Indian economy, especially the software sector, witnessed robust growth, post-1991. India’s annual software exports increased from US$24 million in 1985 to US$164 million[1] in 1992 to US$7.8 billion[2] in March 2002. Similarly, India’s domestic software sales increased from US$140 million[3] in 1992 to US$2.45 billion[4] in 2001–2002.

The economic reforms of 1991, introduced by the then Finance Minister Dr. Manmohan Singh, laid the foundation for this growth. A company such as Infosys exemplifies the benefits of these reforms. Infosys grew from US$0.13 million in revenues and twelve employees in 1982 to US$3.89 million and 300 employees in 1992, to US$545 million for the year ending March 2002, with 10,700 employees. Infosys, which started with one client in 1982, had eleven clients in 1992. By March 2002, the number of clients had increased to 293. Further, the total investment in business by Infosys increased from US$0.04 million in 1982 to US$2.16 million in 1992 to US$435.67 million by March 2002.

1.1 India before 1991

Before 1991, India adopted an inward-looking policy. There was distrust among the policymakers regarding the intentions of the private sector. Further, imports were restricted. At one point of time, the marginal tax rate was 97 percent. In fact, wealth tax was as high as 8 percent and estate tax was 85 percent.

In addition, the corporate sector faced numerous bureaucratic hurdles. For instance, it took about twenty-five visits to Delhi, and nine to twelve months, for approval to purchase a computer. A clerk in the Reserve Bank of India (RBI) took five days to decide whether the managing director of a software firm could travel abroad for a day.

Business faced difficulties in accessing even basic infrastructure such as phones or data communication lines. For instance, retired government officers were given priority over private companies for phone allotment.

1.2 The Economic Reforms of 1991
The economic reforms, introduced in 1991, laid the foundation for the growth of the software sector in the country. The reforms abolished many restrictive boundaries for business and increased the velocity of decision making in organizations. It decentralized power to regional and state offices. Further, it encouraged better industry orientation among bureaucrats. Companies could now call on their local Software Technology Parks of India (STPI) offices with requests, instead of contacting Delhi each time. In addition, many bureaucratic processes were removed.

The reforms resulted in availability of financing from the equity route. Before the reforms were enacted, raising capital through equity was an unattractive option, since pricing of initial public offerings (IPOs) was controlled by the Controller of Capital Issues—a department under the government of India. For the first time, companies were allowed to decide IPO prices, using market-driven price-earnings ratios. This made equity a viable financing option, especially for software companies that did not have large fixed assets to secure debts.

Another important change was the introduction of current account convertibility. The RBI eased restrictions on accessibility to foreign currency. This made it...
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