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India's Services Sector

India's Services Sector

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Reform efforts and prospects

‘Because of its need to build a consensus for reform, in the longer term India’s rise may prove
even more durable than that of China.’

(AFR 2005)

The far-reaching economic reforms outlined in particular by the Indian Government’s July 1991
Statement on Industrial Policy aimed to foster a more vibrant economy, with far higher growth rates

than those realised over the frst three decades of India’s post-independence period. In addition to
deregulation at the sectoral level (see Chapter 2), the reforms have included signifcant liberalisation
of industrial policy, public sector enterprises, foreign exchange controls, interest rates, competition
policy and taxation (Box 5.1), as well as tariffs and foreign investment (see section on ‘Increased
openness to trade and foreign investment’ below). However commentators such as the World Bank

continue to point to the need for further reforms if recent growth rates are to be sustained and the
growth driven by knowledge-intensive services is to be replicated in other, more regulated areas of
the economy.

The need for ongoing reforms is now more broadly accepted in India. A strongly performing economy,

increasing consumer affuence, a buoyant external sector and record foreign exchange holdings
have given rise to confdence that policy makers will continue down the path of reform. The success
enjoyed by reforming sectors has led to pressure for reforms to reap improved effciencies in other

industries they depend upon.

Owing to the success of deregulation and liberalisation policies of the past decade-and-a-half, both
central and state governments have come to recognise the need for a thriving private sector. For its
part, the Planning Commission’s policies are now focused on facilitating private sector development.
Following the devolution of many economic powers from the centre, state governments are now
competing to attract foreign and domestic investment, which is in turn helping to drive improvements

in policy, infrastructure and the overall business environment. Accordingly, by 2004–05, the public

sector’s share of GDP was just 23.6 per cent.2

Further reinforcing the point, IT–ITES’s success is widely

attributed to the government’s light-handed approach to regulation in that sector (see Chapter 2). The

rapid growth of IT–ITES and other knowledge-based sectors shows clearly that Indian companies
can thrive in the face of international competition.

2

Indian CSO 2006, Statement 18. Includes public services in quasi-government bodies. By comparison, the public sector share

in Australia’s GDP was 22.0 per cent in the December quarter 2005.

INDIA’S SERVICES SECTOR UNLOCKING OPPORTUNITY

PAGE 90

box 5.1: india’s maJor economic reforms since 1991

Industrial policy was signifcantly liberalised in 1991 and reform has continued in the
subsequent period. Compulsory industrial licensing for new undertakings or expansions
was abolished in 1991 for all but 18 industries. The number of industries exclusively
reserved for the public sector was reduced to eight. Today, six industries remain subject to
compulsory licensing (mainly on account of environmental, safety and strategic grounds),
while the only industries exclusively reserved for the public sector are atomic energy and

railway transport. The number of manufacturing industries reserved for the small-scale

sector has been reduced over time, but remains in excess of 50.

• Some public sector enterprises have been partially privatised, although outcomes to date

have been modest and privatisation remains controversial. Numerous public enterprises

have been corporatised while others have been given greater managerial autonomy and

operational fexibility.

Foreign exchange controls have been gradually relaxed since the early 1990s. A
market-determined exchange rate system and full convertibility on the current account
were in place by the early 1990s. Regulatory emphasis in relation to foreign exchange
shifted signifcantly from control over use to management with the passing of the Foreign
Exchange Management Act (FEMA) in 1999. The rupee is today almost fully convertible

on the capital account for non-residents.

• An administered interest rates regime was progressively replaced by a system of market-
determined interest rates during the 1990s.

• The Competition Act 2002 replaced the Monopolies and Restrictive Trade Practices Act
1969, which heavily circumscribed the operations of monopolies. The new Act aims to
curb anti-competitive behaviour and abuse of dominant market positions; and regulates
mergers and acquisitions. The Competition Commission of India, a new regulatory body
with a scrutiny and enforcement role, has been established. Independent regulators have
also been created in a number of sectors.

Taxation reform has focused on broadening the indirect tax base and removing distortions.
A central services tax was introduced in 1994, and has been increased on two occasions

to stand now at ten per cent. Additional services have been progressively brought into the

tax net. Central excise duties on manufactured goods have been replaced by CENVAT, a
16 per cent tax on value added up to the manufacturing stage. A uniform state level VAT
on goods, applying up to the retail stage, was introduced in April 2005, replacing state
sales taxes. The standard tax rate is 12.5 per cent, although some goods attract a four
or a one per cent tax. The tax replaced state-level sales taxes, entry taxes, purchase
taxes and turnover taxes. The four per cent central sales tax levied on interstate sales

of goods is also set to be phased out. In the 2006–07 Budget, the Finance Minister laid
down a target date of April 2010 for the adoption of a national level goods and services

tax, shared between the centre and the states. This will require a merging of CENVAT
and state level VAT in some fashion.

India’s Business Environment: Implications for Australian Companies

PAGE 91

Only the pace of reforms is open to question. Economic reforms since the current United Progressive

Alliance (UPA) government came to power in May 2004 have been more measured than under the
previous National Democratic Alliance (NDA) government led by the Bharatiya Janata Party. During

the election campaign, the Congress Party, the main party within the governing coalition, said it would

pursue economic reforms with a ‘human face’. The ‘National Common Minimum Programme’, a pact

agreed between the UPA government and the Communist and other parties it relies upon to maintain a

majority in India’s lower house of parliament, refects this stance (National Advisory Council 2004).

In general, reforms are more likely to be held up by political opposition when they are dependent on

legislative change rather than administrative decisions and notifcations. Notwithstanding the progress

being made by the Government in achieving reforms on the administrative front, some progress on

fagship reforms such as labour laws and privatisation will be important to convince investors that

the process is retaining momentum.

Reforms in democratic India tend to be take place gradually because of the need to build consensus
for reform among governing coalitions. In the longer term however, India’s democratic processes
should underpin the durability of the reforms, provided reformers can point to improved performance

and benefts for the majority of the Indian population.

Increased openness to trade and foreign investment

India’s improved economic performance has been accompanied by a dramatic increase in its outward

orientation. Trade as a proportion of GDP has increased from 16 per cent in 1990–91 to 40 per cent
in 2004–05. Average applied tariffs have declined signifcantly from prohibitive rates since the early
1990s (Box 5.2), although they still remain higher than in many developing countries.

box 5.2: indian tariffs

Prior to the 1990s reforms, most Indian imports were subject to licensing restrictions and high
tariffs. India’s average tariff on non-agricultural products was reduced from 73 per cent in
1992–93 to 36 per cent in 1997–98 to 31 per cent in 2001–02.3

Maximum tariffs have been

subject to cuts in more recent years. The tariff on most non-agricultural goods was lowered

in January 2004 from 25 to 20 per cent; and the four per cent ‘Special Additional Duty’, which
had been levied on virtually all imports since the 1998–99 budget, was abolished (although it
was reinstated in 2006). The peak rate of customs duty on non-agricultural imports was further
reduced in the 2006–07 Budget from 15 to 12.5 per cent. Lower input costs resulting from the
tariff cuts have signifcantly enhanced the competitiveness of Indian industry.

3

Sourced from successive WTO Trade Policy Reviews of India.

INDIA’S SERVICES SECTOR UNLOCKING OPPORTUNITY

PAGE 92

In addition to tariff reductions, which effectively act as an incentive to export by making production

for domestic consumption relatively less attractive, the Indian Government has instituted a number

of trade measures to encourage exports, with particular focus on the services sector (Box 5.3).

box 5.3: policy measures to support exports

• Numerous Special Economic Zones (SEZs) for both manufacturing and service provision
have been established since April 2000, while eight Export Processing Zones have been
converted into SEZs. The SEZs offer superior infrastructure facilities and tax concessions
with a view to stimulating foreign investment and exports.

• Under the ‘Star Export Houses’ scheme, both merchandise and services exports can
apply for status as Star Export Houses and consequently be eligible for a number
of privileges including fast-track clearance procedures for both exports and imports.
Exporters are categorised according to the value of their exports. Star Export Houses
achieving rapid growth in their exports are entitled to duty credits under the newly

introduced Target Plus scheme.

• The ‘Served from India’ scheme, a revamped version of the earlier duty free export credit

scheme for services, involves duty credit entitlements for service providers depending on

their level of foreign exchange earnings.

• The Export Promotion Capital Goods scheme, accessible by all exporters including
exporters of services, has been made more fexible. Under the scheme, the import of
capital goods at a fve per cent rate of duty is allowed, subject to fulflling an obligation to
export the equivalent of eight times the duty saved over a period of eight years.

• ‘Export Oriented Units’ (EOUs) – units established anywhere which export all their
production – have been extended benefts additional to duty free imports, including
exemption from service tax. EOUs selling some of their output within the ‘domestic tariff

area’ also enjoy some concessions, subject to certain conditions. Units in free trade zones,

export processing zones, electronics hardware/software technology parks, and bio-tech

parks enjoy similar privileges.

• Duty exemption schemes are available, enabling the duty free import of inputs required
for export production.

Source: Directorate General of Foreign Trade 2004

India’s Business Environment: Implications for Australian Companies

PAGE 93

Foreign direct investment (FDI) has an important role to play in India’s development. Both the central

and state governments have assumed a more welcoming stance towards FDI, and this, as well as
increasingly positive sentiment on the part of foreign investors, has resulted in healthier foreign

investment infows (Figure 5.1). The US$7.2 billion infow in 2005–06 is in the vicinity of the US$8
billion a year infow judged necessary to underpin the eight per cent GDP growth rate envisaged for
the Tenth Five Year Plan period (Indian Planning Commission 2002d).

Figure 5.1

FDI picking up

India’s direct investment infows, 1991–92 to 2005–06 (US$ billion)

Note: FDI data have recently been brought into line with international statistical standards by incorporating reinvested earnings and inter-

company debt transactions components. For the years prior to 2000–01, data are only available for the equity component.

Source: DIPP 2006.

In recent years, India has relaxed restrictions on FDI, with higher equity caps and investment
approvals granted automatically (the ‘automatic route’) for most services sectors, although limits on
foreign equity holdings continue to act as a restraint on investors’ operations (see Figure 5.2 and
Table 5.1). India has also streamlined its procedures, set target timeframes and introduced greater

transparency for the consideration of FDI proposals by the Foreign Investment Promotion Board

(FIPB), the body charged with considering FDI in activities not covered by the automatic route (DIPP
2005a). A Foreign Investment Implementation Authority was established in 1999 to facilitate quick

implementation of FDI approvals required by investors to get a project up and running. The Authority

is assisted by ‘Fast-track Committees’ which include state government agencies concerned with the

implementation of projects.

0

1

2

3

4

5

6

7

8

1991–92

1992–93

1993–94

1994–95

1995–96

1996–97

1997–98

1998–99

1999–00

2000–01

2001–02

2002–03

2003–04

2004–05

2005–06

US$ billion

Equity

Total, including re-invested earnings and other capital

INDIA’S SERVICES SECTOR UNLOCKING OPPORTUNITY

PAGE 94

Notwithstanding these central Government policy initiatives, the investment climate in India tends to
vary from state to state. Signifcant differences can exist on such measures as cost and complexity of
regulations and approvals processes; the attitude of state government offcials in facilitating business;

state government incentives; and the availability of trained manpower.

Figure 5.2

Evolution of FDI policy in India

The progressive liberalisation of FDI policy, 1991–2005

Source: DIPP 2005b

Foreign investors and local players – most notably in areas such as information technology,

pharmaceuticals, and flm – also beneft from India’s legislative provisions for the protection of
intellectual property (Box 5.4), although some improvements are still possible on the enforcement

front. Increasingly, Indian companies – particularly in areas such as software development and
biotechnology – are themselves driving reform in this area pushing for greater protection of intellectual
property rights to protect their own innovations.

More sectors opened. Equity caps raised in many other sectors. Procedures simplifed.

Up to 100 per cent under Automatic Route in most sectors, except a small
negative list.

Up to 74/51/50 per cent in 112 sectors under the Automatic Route;
100 per cent in some sectors.

FDI up to 51 per cent allowed under the Automatic route in
35 Priority sectors.

Allowed selectively up to 40 per cent.

2001–05

2000

1997

1991

Pre 1991

FDI policy liberalisation

India’s Business Environment: Implications for Australian Companies

PAGE 95

box 5.4: intellectual property rights

India has implemented a number of major improvements in its intellectual property rights regime

in order to meet its obligations under the 1994 WTO Trade-Related Aspects of Intellectual
Property Rights (TRIPS) Agreement. As a developing country, it had a transition period of fve
years to implement the Agreement, beginning in January 1995. It also had a further fve years to
extend its product patent protection to areas of technology not already protected. It undertook
to meet its patent obligations by a January 2005 deadline, in three phases (Deloitte 2005). The
outcome has been three amendments to the Patents Act, 1970. The Patents (Amendment)
Act, 1999 introduced a transitional facility in the felds of pharmaceuticals and agriculture
chemicals and a system of exclusive marketing rights (previously only process patents were
granted). It included a number of substantive and procedural changes bringing Indian patent law
more into line with international norms. Changes introduced under the Patents (Amendment)
Act 2002 included increasing the term of patents to 20 years from date of fling and extended

patent protection to drugs, foods and chemicals. India acceded to the Paris Convention on
Intellectual Property in 1998.

The Copyright (Amendment) Act 1994 provided protection to all original literary, dramatic,
musical and artistic works, cinematography, flms and sound recordings, and also brought

satellite broadcasting, computer software and digital technology under copyright protection.
The Copyright (Amendment) Act 1999 effected changes to make the law fully compatible
with the provisions of the TRIPS Agreement. India is a party to the Berne Convention for the
Protection of Literary and Artistic Works. The Trademarks Act 1999 served to provide better
protection of trademarks for goods and services.

While the investment environment still has shortcomings, A.T. Kearney’s 2005 FDI Confdence Index,
which is based on a survey of executives from the world’s largest companies, ranked India the second-
most attractive FDI destination in the world, up from third place in 2004. India’s attractiveness to foreign
investors is expected to increase, provided further reforms are initiated and infrastructure, logistics
and regulatory barriers addressed (A.T. Kearney 2005). Table 5.1 details the services sectors which

are open to investment by foreign players.

INDIA’S SERVICES SECTOR UNLOCKING OPPORTUNITY

PAGE 96

Table 5.1

Most sectors now open to FDI

Current foreign direct investment guidelines for services sectors

Sector

Foreign
equity limits

Approval
mechanism

Comments

Infrastructure

Townships, building,
infrastructure and
construction projects

100%

Automatic

Includes hotels, resorts, hospitals,

educational institutions, and greenfeld

airport projects. FDI not permitted in housing
and real estate.

FIPB approval required for more than 74%

equity in airport development.

Tax holidays for development or operation

and maintenance of most infrastructure
projects.

‘Viability Gap Funding’ available for Public
Private Partnership (PPP) infrastructure

projects.

Trading

Retail trading activity

Cash and carry
wholesale trading

100%

Not permitted*

Automatic

*51% FDI permitted in single brand product

retailing and in bulk imports with bonded
warehouses subject to FIPB approval.

100% FDI permitted in export sector trading

and wholesale cash and carry under the
automatic route.

Transport

Domestic airlines

Road and maritime
transport services
Railways

49%

100%

Automatic

Automatic

Not permitted

Direct or indirect participation of foreign
airlines not permitted.

Telecommunications

Telecom services

74%*

Automatic
approval up

to 49%

Includes basic, cellular, unifed access

services, national/international long distance,

V-Sat, public mobile radio trunked services,

global mobile personal communications

services and other VAS.
74% limit relates to foreign investment from

all sources, including institutional investors.
Certain conditions apply to ensure
management of service providers remains
in Indian hands.

*The Indian Government has frozen the
74% level until the FDI rules are consistent

with the licence guidelines. A resolution is

expected in early 2007.

India’s Business Environment: Implications for Australian Companies

PAGE 97

Sector

Foreign
equity limits

Approval
mechanism

Comments

Finance and
insurance

Private banks

74%*

Automatic
approval up

to 5%

74% limit relates to foreign investment from

all sources, including institutional investors.

*This ‘liberalisation’ occurred just prior
to the 2004 elections and implementing

guidelines are yet to be issued by the RBI.
The incoming UPA government postponed
the opening of the sector to 2009. A 10%
shareholding limit in private sector banks

applies in the meantime, except those
identifed for restructuring.

Insurance

26%

Automatic

26% limit relates to foreign investment from
all sources, including institutional investors.

While approval is automatic, a license is
required to operate.

Non-bank fnancial

companies

100%

Automatic

Includes merchant banking, underwriting,
portfolio management services, investment

advisory services, fnancial consultancy,

stock broking, asset management, venture

capital, leasing and fnance.

Selected other
sectors

Computer-related
services, advertising

and flms, R&D

services, construction
and related
engineering services,
Pollution control and
management services,
architectural services,
health-related and
social services,
travel-related services

100%

Automatic

Note:

More liberal arrangements apply for non-resident Indian investments.
Source: DIPP 2005a, and DIPP Press Notes.

INDIA’S SERVICES SECTOR UNLOCKING OPPORTUNITY

PAGE 98

Recognising that a local presence is often necessary to facilitate the export of services abroad
(Indian Department of Commerce 2002), the Indian Government has relaxed restrictions on outward
investment. Increased FDI outfows have followed. FDI abroad in non-fnancial services sectors over
the years 2002–03 to 2005–06 amounted to more than US$1.7 billion, led by India’s information

technology companies which are increasingly adopting a global approach to service delivery

(RBI 2005d, 2006b).

India’s rapidly growing knowledge-intensive services exports have encouraged the Government

to play a more active role in multilateral, regional and bilateral trade negotiations on services and

services-related outward investment. Given both the signifcance of services exports to its economy

and its increasing prominence as an overseas investor, a liberalising outcome to the WTO services

negotiations would clearly be of beneft to India (Box 5.5).4

box 5.5 india’s increasingly active role in trade negotiations
covering services

In the Uruguay Round formally concluded in 1994, India committed to allowing foreign equity

participation in a limited number of sectors, but otherwise made very limited commitments on
services, both in terms of quality and sectoral coverage. India is a key player in the current

WTO Doha Round as a leading Member of the ‘G20’ (developing country agricultural exporters).

While it has adopted a generally conservative position on agricultural market access, it has
become much more ambitious in the services negotiations. India’s initial offer on services
related only to sectors in which it had already made commitments under the Uruguay Round.

However its revised August 2005 offer covered just over half of the 160 sectors and sub-
sectors in the WTO services classifcation list, including higher education and environmental

services in which it had not previously made commitments. While Australia has acknowledged
the improvements in sectoral coverage and depth of commitments in India’s revised offer,
a number of Australia’s requests remain unmet, including those related to FDI restrictions;
limitations in insurance and banking; better access for foreign lawyers; and a more open
regime on telecoms, energy and professional services. India has made no commitments on
mining and energy-related services, areas of key interest to Australia.

India has submitted requests to its trading partners in a number of services sectors, aiming

at more liberal commitments in respect of cross-border supply (Mode 1) and of temporary
entry by business people (Mode 4). Access conditions for the cross-border supply of services
are critical for exports of IT–ITES and other business services. Similarly, in order to facilitate

the temporary movement of Indian professionals in computer-related, hospital and audio
visual services sectors, India is pushing for WTO commitments to facilitate the movement
of contractual services suppliers and independent professionals, including clear prescription

4

The WTO General Agreement on Trade in Services distinguishes between four modes of supply: By virtue of Mode 2:

Consumption abroad, services delivered in India to foreign visitors are counted as exports. Similarly services delivered abroad
through the commercial presence of an Indian enterprise are considered exports under Mode 3: Commercial presence.

India’s Business Environment: Implications for Australian Companies

PAGE 99

box 5.5 (continued)

of duration of stay and the removal of labour market and economic needs tests. It is also
a strong proponent of developing broad disciplines on the domestic regulation of services

covering qualifcation requirements and procedures, licensing and technical standards.
India is particularly interested in recognition of professional qualifcations in sectors such as
computer-related services, hospital services, and architectural services (Indian Department
of Commerce 2002, Indian Ministry of Finance 2006).

Given the potential of India’s conventional and medical tourism industries, as well as its

existing and prospective overseas investment interests in sectors such as ICT,5

it appears to

be in its interests to push more actively for better Mode 2 (consumption abroad) and Mode 3
(commercial presence) access from its trading partners. The Report of the Steering Group on

FDI has advocated automatic approval for up to 100 per cent foreign equity for most sectors

of the economy, although only limited further relaxation has occurred to date under the current
National Congress-led UPA government (Indian Planning Commission 2002d).

India made its frst substantive commitments on services and investment in a Comprehensive
Economic Cooperation Agreement with Singapore, which was signed in June 2005. Under

this agreement, India agreed to allow three major Singapore banks to establish wholly-owned
subsidiaries in its territory, with Singapore making a similar commitment in respect of three
Indian banks. Both countries agreed to ease visa restrictions governing the temporary entry of
business visitors, service suppliers, intra-corporate transferees as well as professionals from

a wide range of occupations. Mutual recognition arrangements for education, experience and

licensing requirements are to be negotiated, initially in the areas of accounting and auditing,
architecture, doctors, dental and nursing. Both countries have undertaken to encourage
close cooperation between their educational institutions and agreed to mutual recognition of
degrees for university admission purposes.

India is pursuing trade agreements covering services and investment with ASEAN, the

Gulf Cooperation Council, Japan, the Republic of Korea, the EU, Thailand, the South Asian

Association for Regional Cooperation member states (through the Framework Agreement on
the South Asia Free Trade Area) and its Bay of Bengal partners (through the Bay of Bengal
Initiative for Multi-Sector Technical and Economic Cooperation). Despite the benefts which
would accrue to India from liberalisation of services trade, it has typically fnalised negotiations

on goods prior to services and investment.

5

Indian investments in Australia are detailed in Chapter 4.

INDIA’S SERVICES SECTOR UNLOCKING OPPORTUNITY

PAGE 100

Rising consumerism and a growing middle class

India’s rapidly increasing middle class and growing consumer affuence are already a draw-card for
foreign investors and exporters. Australian service providers should be aware of these demographic

changes and the opportunities that likely to emerge from them.

The Indian consumer population is characterised by dynamic change and increasing confdence.
With greater media exposure and a population increasingly travelling abroad, Western trends, tastes

and brands are in growing demand, particularly among the younger age group which tends to have

higher aspirations. Around 47 per cent of India’s one billion plus population is under 20 years of age,
including almost 160 million in their teens. By 2015, the under-20 age group will grow to 55 per cent
of the population (Business Standard 2005). Double-income families are becoming increasingly

common as more and more women enter the workforce, providing a spur to consumer spending.

Indian consumers are now more readily able to access fnance in order to purchase goods and
services. By December 2004, the number of credit cards issued by banks and outstanding had grown
to 43 million, up from 27 million just one year earlier (Gopinath 2005). Other forms of consumer credit

are also growing rapidly.

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