India: Law As A Catalyst of Economic Change

Last Updated: 8 September 2005
Article by Hemant Batra

Article by Hemant Batra*


The notion and concept of `Law and Economic Change’ needs to be understood in context of the cogent controls which law exerts on the fiscal and economic policies and directs the course of its development. One need not forget that management of economy by law may be extensive or limited and passive but it has to have one prime objective and that is to attain certain social objectives and economic development through the instrumentality of law, conducive to the situation. In other words, economic change and liberalization are intended to serve the purpose of efficiency.

In today’s civilized society life and law run side by side. No one can live without law, without being affected by law. Any society’s ethical values, attitudes and future aspirations are reflected by its law and legal system. Greater the respect for social manner and civil culture and lesser would be the need for formal systems of law.

While most basic principles and ethical values are common across societies and nations, yet attitudes and practices do show differences among the countries. They may also be different in the same country at different points of time. A nation aspiring to bring in rapid re-distribution of existing wealth and income would tend to emphasize laws that would restrict the individual's right to acquisition of property and hence the individual initiatives. On the other hand, a nation aspiring for the rapid creation of wealth would tend to have fewer laws, so as to unleash individual and collective energies and remove any restrictive barrier that may arise in the process of growth.

Laws and Reforms: Siamese Twins

Laws and reforms are inseparable, laws bring about reforms and reforms bring about new laws. One cannot make out as to which of the two comes first. The process of liberalization entails creation of new ambience where some of our old laws have been rendered either redundant or incompatible and many more laws needing to be re-written. But, if the legal fabrication and handling are not geared up to the economic change that is sought to be brought about, the pace of economic change will be stifled and consequently failing to achieve the desired results. In a society governed by the rule of law, it is the law, which must ensure the proper framework in which the economic change can be brought about smoothly and without any abrasion. The law cannot survive in vacuum, it has to change, re-interpret and recast itself so as to meet the changing norms and values of the society. Law charged with basic values of life does play a vital and driving role in contribution towards social well being by bringing about social and economic change. All of us have to play an important role in bringing about socio-economic changes in our society by facilitating and creating new structures and institutions that help in the process of the said changes. Law has to move forward and keep pace with the changing times.

Law can be good or bad driver of nation’s Economy

A prosperous society may be more concerned about piracy of the intellectual wealth. It may also show greater concern about environmental pollutions that affect the quality of life or about adherence to the highest standards of competence, which a professional is expected to observe. Laws and legal systems, in this manner, codify social values, attitudes and expectations of behaviour from members of the society. They have their own impact, good as well as adverse, on the economic activity of the nation, depending on how far they are consistent with actual conduct, habits and thinking of the majority of members comprising the society. Certain laws, like income tax rates, customs duties, prohibition, etc. are known more for creating certain values in society, which ultimately act as deterrent in the larger interest of the society itself. Similarly, laws relating to economic activity can have different impacts, depending on what their content are. The reason is that ultimately, a law consists of the intent of the law-makers and strategies to achieve this intent. The laws could become coercive, restrictive or highly facilitatory, depending on what the ideals have been accepted and how the drafting has been done. If the intent of the law and the contents of law are to facilitate growth in an unmistakable manner, law has to be drafted accordingly in an unambiguous manner.

Dealing with foreign direct investment, first, basically it depends on real factors, interest rates, tax laws and Government's other economic policies as well as their stability. Law and legal system can, at best, be one factor, but certainly not a major one (in determining the climate of investment). If laws relating to closure, transfer of management and labour appear to be "obstructive", that obstructive character could be an act of design. If the very intention is to protect labour, then it is an act of design. There could be a wide gap between the intent of the law and the contents and the interpretation of the law. Larger the ambiguity, larger the scope for litigation. There is a need to ensure that a law must be drafted in an unambiguous manner so that it is identically understood by legislators (who approve the law), by administrators (who have to administer the law), by administrators (who have to administer the law) and society (which lives with it and is affected by it) and the judiciary (who has to interpret the law). Then only can the intent of the law be fully carried out.

Talking about liberalization, we are creating for ourselves new environments where some of our old laws have been rendered obsolete and many more laws need to be re-written. Liberalization is intended to serve the purpose of efficiency, namely, that whatever resources, are made available to us must be made most productive. Laws need to be under constant revision so that they meet the challenges of today's environments, today's thinking and today's involvement in the global economy. Foreign investors need to be invited to participate under such environments in the spirit of efficiency-oriented growth that all these countries want to pursue. Such a participation pre-supposes the creation of environments which are more or less identical with the best available anywhere in the world. Then only can we attract more resources in quantity and more qualitative resources, to our countries. As to competitiveness, efficiency flowers best in competitive environment, for it impels all of them to make the best use of resources. An investor who comes from abroad would like to feel secure that this approach to liberalization and abiding commitment are administered in the form of legal framework in the country. He would also like to feel secure that there was an adequate statutorily backed regulatory framework for ensuring fairness and observance of all rules of competition.

An investor, domestic or international, basically looks for returns on his investment. The logic of investment is identical across all the countries. Hence domestic as well as foreign investors have to be provided identical opportunities. A level playing ground is needed for all investors in the country in order to bring out the best efforts from both of them. Any discriminatory treatment to anyone can ultimately hurt the overall interest of investment in the economy. An economy, which is largely dependent on domestic savings for investments, cannot afford to discriminate in favour of foreign investors, or (to put it differently), against the interest do domestic investors. At the same time, knowing the need for foreign resources and having decided to invite foreign investment, the laws just cannot discriminate against foreign investment, in order merely to reflect patriotic sentiments. However, the legal system is essentially a domestic one, as there is no universally applicable commercial code for various countries. The philosophy of law may be universal, at least among similar political systems. But the language of legal systems across the countries are distinctly not so. This aspect required attention. Concentrating on the approach to be adopted by the legal system in regard to foreign investment, an environment of mutual trust between domestic investor and foreign investor is to be created. The legal system has to be such as created such a mutual trust among all the investors. An investor needs freedom of both entry and exits. He needs freedom to decide where to locate the industry, how much to produce, how much and where to purchase, how many persons he should employ, and at what prices to sell. He needs freedom to allocate and appropriate high profits after tax. He needs protection from unfair play and restrictive practices from other competitors, suppliers, utilities and tax collectors. He needs inexpensive access to a speedy system of justice and arbitration. He needs laws that reflect a new philosophy, a new business environment, new business requirements-laws that encourage initiative, speedy response, clearances and single-minded pursuit of efficiency, where there cannot be more barriers.

Labour laws continue to remain highly contentious areas in many highly populated developing economies. The issues of exit policy transferability of resources to more productive, business and implementation of productivity-linked incentive structure have become highly essential issues in order to create investors' friendliness about labour. Similarly, a free market for corporate control, that is, takeover and mergers, may be perceived by some as investment-friendly and some as hindrance. Corporate laws need to be re-worked to make them more investor friendly. The ultimate aim is to achieve free mobility of managerial resources and financial resources, with a view to the optimization of country's resources in the long run and making them as productive as possible. And, all this should be in the interest of shareholders and consumers. Laws can be made simpler and complemented by transparent regulations, designed to facilitate a competitive market for corporate control. These can contribute significantly to the productivity of resources. It is only when a transparent regulatory regime could be established that it would become highly comfortable and attractive to the foreign investors.

Good Law does not require interpretation

Despite richness of any language and precision of its grammar, language has a tremendous potential for vagueness, ambiguity, imprecision and even nonsense. And, along with visuals, it has high potential for creating appalling degrees of misleading information and impressions. Hence, it is necessary that the laws that we draft should be very precise for the people, who in bad faith are always intending to abuse the intent of the law. Our courts are known to be courts of law, but we would like that they become increasingly courts of justice.

Indian Para-legal & Economic Analysis

India, the world's largest democracy, is the 7th largest country in the world and the 5th largest economy in terms of purchasing power parity. India's richness and diversity of culture, geographic and climatic conditions, natural and mineral resources are matched only by few other countries in the world. India's enduring institutions, rooted in the principles of democracy and justice, ensure a transparent predictable and secure environment for domestic and foreign private investment. The existence of an independent judiciary, strong legal and accounting system, a free and vibrant press, reservoir of highly skilled manpower, and the use of English as the principal language of business and administration are some of the attractive features of the Indian business environment.

A highly regulated business environment, a pervasive license system and high tariff barriers characterized the Indian economy, until 1991. Sweeping reforms, introduced in 1991 and continued by successive governments, have radically changed the course of the Indian economy. Today, a new spirit of economic freedom is stirring India, bringing sweeping changes in its wake and unleashing the vast potential of the Indian economy. The Government's policies are now relatively simple, transparent and geared towards promoting domestic and foreign private investment. There exists a strong political consensus on the economic liberalization policies at the central and state government levels. This augurs well for the continuation and progressive strengthening of investor friendly policies that have created a sea of opportunities for domestic and foreign investors particularly in the infrastructure sector.

General – Foreign Direct Investment (FDI) Policy - Foreign direct investment is freely allowed in all sectors including the services sector, except where the existing and notified sectoral policy does not permit FDI beyond a ceiling. FDI for virtually all items/activities can be brought in through the automatic route under powers delegated to the Reserve Bank of India (RBI), and for the remaining items/activities through Government Approval. Government approvals are accorded on the recommendation of the Foreign Investment Promotion Board (FIPB).

With a view to injecting the desired level of technological dynamism in Indian industry and for promoting an industrial environment where the acquisition of technological capability receives priority, foreign technology induction is encouraged both through FDI and through foreign technology collaboration agreements. Foreign technology collaborations are permitted either through the automatic route under delegated powers exercised by the RBI, or by the Government. However, cases involving industrial licenses/small scale reserved items do not qualify for automatic approval and would require consideration and approval by the Government. Automatic route for technology collaboration would also not be available to those who have, or had any previous technology transfer/trade-mark agreement in the same or allied field in India.

Today, only two industries are reserved for the public sector i.e., Atomic Energy and Railway transport. Even Arms and ammunition industry and allied items of defence equipment, defence aircraft and warships have been opened up for private investment.

Today, there are very few industries for which industrial licensing is compulsory and these include Distillation and brewing of alcoholic drinks, Cigars and cigarettes of tobacco and manufactured tobacco substitutes, Electronic Aerospace and defence equipment: all types, Industrial explosives including detonating fuses, safety fuses, gun powder, nitrocellulose and matches, Hazardous chemicals, Drugs and Pharmaceuticals.

Today, use of foreign brand names/trade marks for sale of goods in India is allowed.

Today, Indian capital markets are open to foreign institutional investors.

Today, Indian companies are permitted to raise funds from international capital markets.

Today, India has entered into agreements for avoidance of double taxation with over 45 countries.

Today, India has signed several bilateral investment protection agreements.

Today, special investment and tax incentives are extended for exports and certain sectors such as power, telecommunications, electronics, software and food processing.

India since 1991 is undergoing revolutionary fiscal and economic reforms and is undoubtedly moving away from the doctrine of State control, towards a free market economy. Permits, sanctions and controls are giving way to de-regulation, de- centralization, de-nationalization and dis-investment. The notorious restrictions of the past are being cleaned up by a popular will driven with logical and legal mechanism. The reform packages having been introduced in the past and as being introduced now appear to be moving away from restrictions on the movement of foreign exchange in and out of the country. The changing investment climate in the region has swept aside the centrally planned and regulated economies. The agenda of privatization in India or for that matter in almost all the South Asian countries now covers a wide spectrum like industries, banks, development financial institutions, telecommunications, airlines, shipping and road construction and power generation. And, in each of these sectors, law is playing an important role, because it is entering to the privatization of each of these units.

Challenges to the Indian Economic Growth

On the Joint Initiative of EU and India a survey was conducted in December, 2001 for enhancing Trade and Investment. The basic object of the survey was to better understand the European Investors’ perception of investment in India. The said survey was conducted on European-invested companies in India and to European companies’ head offices in Europe.

The outcome of the said survey was as follows:

§ 1. Overall perception of EU investors

The first point aims at measuring the overall perception of EU investors from their experience in India. 48% of the surveyed companies say that they have been successful when their achievements are confronted with their expectations, of which 32% say they have been very successful. Conversely, only 6% are telling that their operations have been either unsuccessful or a failure. Overall, a little less than 50% of EU invested companies intend to increase their investment in the short term (one to two years), with a small 10% declaring that their intention is to reduce it. Over a longer horizon, close to two thirds of the surveyed companies intend to increase their investment (three to five years), while almost none is intending to reduce it on this time frame.


India and for that matter any developing country needs to identify causes in the form of laws and subordinate legislation, which are responsible for economic slowdown. Some of the causes, according to me, are as detailed briefly below –

  1. There is no synchronization between provisions relating to amalgamation and mergers and acquisitions as found under the companies related laws and the laws relating to the securities acquisition. There are too many restrictions operating against the concept of mergers and acquisitions, which are unrealistic in nature and scope.
  2. The system of borrowing of funds needs to be specifically codified defining clearly the commercial terms of relationship between lender and borrower. Today it is like an unguided ship, which goes in any direction as stipulated by the creditor.
  3. There are a plethora of rules and regulation in the form of subordinate legislation, which go to undo the object of the statute under which they are framed. The subordinate legislation needs to be streamlined and one needs to understand that one should resort to the same as a measure of procedure not policy.
  4. It is high time (after terrorist attacks on WTC, USA) that the concerned Governments change their current FDI policy. Today, Government needs to identify, in view of global terrorism and money laundering, right at the entry level the real source of funds and credential of the promoters. Vigilance is need of the hour.

* Hemant BATRA is a Corporate, Commercial & Business Lawyer. He is the Director-Legal Services of Kaden Boriss Consulting Pvt. Ltd., a legal consulting, legal services and legal BPO Company operating from India. He is the elected Secretary General of SAARCLAW (South Asian Association for Regional Co-operation in Law). He is Member of high-powered national legal affairs Committee of Indo-American Chamber of Commerce.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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