Mrs G and the licence permit raj

Financial Express, 2 November 2009

The most striking move by Indira Gandhi, before the declaration of the emergency, was a mid-night ordinance in July 1969. At one stroke, the ordinance gave the government control over a big chunk of the savings of the Indian people. On July 19, 1969, India woke up to headlines that India’s major private sector banks had been nationalised. That stroke of midnight brought a loss of freedom, economic freedom. Like much of the economic policy of the 1969-1976 period, this was one more instance of power being usurped by the state. From 1969, Indira Gandhi turned left seeking political support, and India witnessed an unprecedented increase in control raj. Through the seventies, till the end of the emergency, economic enterprise and private initiative were severely restricted.

Nationalised banks had social objectives such as lending to the priority sector such as small scale industry. But small scale industry was not industry that happened to be small. Many sectors of industry were not allowed to grow large by deliberately keeping them small. Bank nationalisation was followed by small scale industry reservation. The policy of explicitly reserving certain items for production by small companies was created. Indian industry has lost out for years because of being unable to harness economies of scale. While the list of reserved items has become shorter, it has not been before China has thundered ahead building large scale industry, while Indian industry has helplessly stood by and watched.

But then the logic of control raj can be strange. While on one had there was a policy that industries should be small, if there was a large industry that wished to become small, the Industrial Disputes Act (IDA) was passed to prevent it. Until then factories with over 1000 workers used to require government permission for layoffs. The size threshold was amended in 1976 to 300. In 1982, when Indira Gandhi was back in power, this was further reduced to 100. Even today many industrial establishments require prior permission of the appropriate government before layoffs, retrenchment and closure. Most problems connected with the Industrial Disputes Act arise, from this since the government becomes a third party to the dispute even if the employee is satisfied with the severance package. These sections of the Act need to be considered along with other elements of the act which makes any dispute between an employer and an individual workman an industrial dispute regardless of the fact that no other workman nor any trade union is a party to the dispute.

To offer nationalised banks protection from competition, foreign banks were prevented from coming in. Indeed, not just foreign banks, even foreign money was not welcome. Under the Foreign Exchange Regulation Act (FERA) draconian currency controls and restrictions on foreign investment were imposed in 1973. While FERA has been supposedly replaced by a “more liberal” FEMA, the mentality of controls is very much there in FEMA as well.

The central planning logic went into other areas was well. For example, on February 17, 1976 the Urban Land Ceiling Act was passed. It covered 73 towns and cities and imposed a ceiling of 500 to 2000 square metres on urban land holdings. It constitutes a major distortion of the urban land market. While this was a state subject, the Constitution allows Parliament to pass a bill if more than two states agree, and this path was chosen during the emergency. Another law giving disproportional powers to the state was the MRTP. Monopolies and Restrictive Trade Practices (MRTP) Bill was proposed in 1967. It became an act and came into force from June 1, 1970. The MRTP Act, which gave huge powers to the government, sought to check the expansion of large industrial houses with assets over Rs 1 crore in businesses where their share in the market exceeded 33 per cent. The MRTP remained in place even after liberalisation until 2002 when it was replaced by the Competition Act.

The licence and control raj of the seventies shapes every aspect of Indian banking. Banks need a licence to start and only a handful of new banks have been allowed since the bank nationalisation of 1969. Banks need licences to open branches. Until Governor Subbarao changed the rules recently, they even needed licences to open ATMs. Only 18 foreign bank branches are given the licence to open every year. If banks open branches abroad, they need permission. Every product that is launched needs permission from RBI. The authorities decide what the savings bank interest rate is. The authorities decide what the interest rate on lending to certain sectors is. The authorities define who to lend, how much to lend and at what rate to lend. They decide how much a bank has to lend to the government, to the central bank, to agriculture, to small scale industry, to exporters, to students, to rural businesses and so on. Every element of the life a banker is dictated by the authorities. The salaries PSU banks can pay are decided by the government, as are pension benefit. Loan decisions are often known to be influenced by politicians. In summary, nearly everything that can kill growth of a healthy and competitive banking system plagues Indian banking. Undoing all this is going to be a formidable task.

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