WPS5948


 Policy Research Working Paper                       5948




Services Reform and Manufacturing Performance
                        Evidence from India

                              Jens Matthias Arnold
                                 Beata Javorcik
                                 Molly Lipscomb
                                 Aaditya Mattoo




 The World Bank
 Development Research Group
 Trade and Integration Team
 January 2012
Policy Research Working Paper 5948


  Abstract
  The growth of India’s manufacturing sector since                                  all had significant, positive effects on the productivity
  1991 has been attributed mostly to trade liberalization                           of manufacturing firms. Services reforms benefited both
  and more permissive industrial licensing. This paper                              foreign and locally-owned manufacturing firms, but the
  demonstrates the significant impact of a neglected factor:                        effects on foreign firms tended to be stronger. A one-
  India’s policy reforms in services. The authors examine                           standard-deviation increase in the aggregate index of
  the link between those reforms and the productivity of                            services liberalization resulted in a productivity increase
  manufacturing firms using panel data for about 4,000                              of 11.7 percent for domestic firms and 13.2 percent for
  Indian firms from1993 to 2005. They find that banking,                            foreign enterprises.
  telecommunications, insurance and transport reforms




  This paper is a product of the Trade and Integration Team, Development Research Group. It is part of a larger effort by
  the World Bank to provide open access to its research and make a contribution to development policy discussions around
  the world. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The authors may be
  contacted at iborchert@worldbank.org, bgootiiz@worldbank.org, agrover1@worlbank.org, and amattoo@worldbank.org.




         The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development
         issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the
         names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those
         of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and
         its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent.


                                                       Produced by the Research Support Team
                        Services Reform and Manufacturing Performance:
                                      Evidence from India



                                                Jens Matthias Arnold*
                                                  Beata Javorcik**
                                                 Molly Lipscomb***
                                                 Aaditya Mattoo****




Keywords: services reform, manufacturing productivity, foreign direct investment
JEL Codes: L8, F2, D24




_______________________________________________
* OECD Economics Department, 2 rue André Pascal, 75116 Paris, France. Email: jens.arnold@oecd.org. ** Department of
Economics, University of Oxford and CEPR, Manor Road Building, Manor Road, Oxford OX1 3UQ, United Kingdom. Email:
beata.javorcik@economics.ox.ac.uk. *** Department of Economics, University of Notre Dame, Notre Dame, IN 46556, USA.
Email: molly.lipscomb.5@nd.edu **** World Bank, 1818 H Street, NW; MSN MC3-303; Washington, DC 20433, USA.
Email: amattoo@worldbank.org. The authors are grateful to Ann Harrison, Giovanna Prennushi, Arvind Subramanian and
participants of the 2011 Annual Bank Conference on Development Economics, CEPR GIST workshop, DEFI conference and
seminars at DFID and the University of Nottingham for useful comments. This paper is part of a World Bank research project
on trade in services supported in part by the governments of Norway, Sweden, and the United Kingdom through the
Multidonor Trust Fund for Trade and Development, and by the UK Department for International Development (DFID). The
views expressed in the paper are those of the authors and should not be attributed to the OECD, to the World Bank, its
Executive Directors or the countries they represent.
I.          Introduction


A vital element of India‟s rapid economic growth since the early 1990s has been the improved
performance of its manufacturing sector. Output in manufacturing grew by 5.7 percent per year in the
period 1993-2005 (Reserve Bank of India, 2008). Previous explanations for the revival of manufacturing
emphasize trade liberalization, more permissive industrial licensing policies, and the limited labor market
reforms undertaken since 1991 (see review below). In focusing primarily on proximate policies, however,
previous analyses have ignored what we demonstrate is a critical factor, policy reforms in services sectors.


The neglect of services is surprising, first of all, because service inputs, notably finance, transport and
telecommunications, are an important component of inputs to manufacturing, so the potential for
downstream effects is large.1 Moreover, reforms in the 1990s, allowing greater foreign and domestic
competition with greatly improved regulation, have visibly transformed these services sectors.2 Indian
firms are no longer at the mercy of inefficient public monopolies, but can now source from a wide range of
domestic and foreign private sector providers operating in an increasingly competitive environment.
Available evidence suggests that firms today have access to better, newer and more diverse business
services.


In this paper, we address three questions: Has services reform led to an increase in manufacturing
productivity? Have reforms in some services had a bigger impact than in others? Have some
manufacturers (e.g. foreign firms based in India) benefitted more than others? These questions matter
profoundly for policy; not only is services reform in India incomplete, but across the world some of the
1
  These inputs affect inter alia a firm‟s ability to invest in new business opportunities and better production technology, to
exploit economies of scale by concentrating production in fewer locations, to efficiently manage inventories, and to make
coordinated decisions with their suppliers and consumers. Ethier (1982) provides theoretical support for this argument,
showing that access to a greater variety of inputs results in higher productivity among downstream industries. Markusen (1989)
argues that many producer services are both differentiated and knowledge-intensive. Knowledge intensity in turn suggests
strong scale economies in that knowledge must be acquired at an initial learning cost, after which the knowledge-based
services can be provided at a very low marginal cost. His theoretical results suggest the possibility of significant gains from
liberalized trade in producer services. The importance of intermediate inputs for productivity growth has also been emphasized
in theoretical contributions of Grossman and Helpman (1991). A recent theoretical contribution by Jones (2010) draws
attention to how linkages between firms through intermediate inputs result in a multiplier similar to the one associated with
capital in a neoclassical growth model. This multiplier is large because of a high share of intermediates in output and thus helps
account for differences in incomes across countries.
2
  India implemented significant liberalization in both goods and services between 1991 and 2005. Major liberalization reforms
began in 1991 as part of an IMF structural adjustment package, designed to combat balance of payments imbalances, and
continued with the government‟s eighth four year plan from 1992-1996. As we discuss below, the pace of reform in services
was gradual and sought to balance a variety of economic and political considerations.

                                                                2
most intransigent policy restrictions today are in services.3 Convincing evidence that these restrictions
penalize the politically cherished manufacturing sector could provide an impetus to reform.


Exploring whether there is a systematic link between liberalization in services sectors and the
performance of firms in downstream manufacturing industries requires three types of information: a
measure of policy reform in services, a performance measure for manufacturing firms and information on
the linkages between different sectors of the economy.


In preparation for this study, a large amount of information on the state and the history of services reform
was gathered by local consultants employed by the World Bank in India. The information was then
condensed into a composite time-varying policy index for each sector modeled after a similar index
compiled by the European Bank for Reconstruction and Development for countries in Central and Eastern
Europe and reported in their flagship publication Transition Report 2004. The index can take on values
ranging from 0 to 5 and is available for four sectors: banking, telecoms, transport and insurance for the
time period 1991-2004, the period over which most of the significant reforms took place. Constructing the
index is one of the contributions of this study, as it can be used in other research on the impact of Indian
policy reforms.


The performance of manufacturing firms is measured on the basis of total factor productivity estimates
obtained from sector-specific production functions. To take into account the possible simultaneity bias
between unobserved productivity shocks and input choices, we follow the procedure outlined by
Ackerberg, Caves and Frazer (2006) which builds on the earlier work by Olley and Pakes (1996) and
Levinsohn and Petrin (2003). Unlike the latter method, the approach we follow allows for more plausible
assumptions about the timing of the firm‟s decision regarding input choices and optimization errors.


To examine the link between the performance of services users and services sector reforms, our analysis
relates the productivity of manufacturing firms to the state of liberalization in services sectors weighted
by the respective manufacturing sector‟s reliance on inputs from each services sector. The reliance of
manufacturing sectors on services inputs is assessed based on the national input-output matrix. Our

3
  Even in industrial countries, the supposed strategic importance of some services has led to the persistence of restrictions. For
example, witness the barriers to foreign participation in air and maritime transport as well as certain types of communication
services in the United States, and the difficulty in completing the single market for services in the European Union.

                                                                3
identifying assumption is that the effect of reforms in specific services sectors should be more pronounced
in manufacturing sectors relying more heavily on those services inputs. The specification also controls for
the level of import tariffs on output and inputs as well as for firm and year fixed effects.


The analysis is based on firm-level data from the Capitaline database, a commercially available database
including balance sheets, profit and loss statements, and ownership information on large private and
public firms operating in India. Firms included in the database account for 62 percent of India‟s total
manufacturing output during the period covered by the analysis. Our data set forms an unbalanced panel
covering 3,771 firms or 22,558 firm-year observations during the 1993-2005 period.


Our results suggest that policy reforms in services sectors had a significant impact on firms in the
manufacturing sector. The aggregate effect of services liberalization was an increase in productivity of
11.7 percent for domestic firms and 13.2 percent for foreign firms for a one-standard-deviation increase in
the liberalization index. When the individual services sectors are examined in the same specification, a
one-standard-deviation change in the banking sector index corresponds to a 6.5 percent change in
productivity for both domestic and foreign firms. A one-standard-deviation change in the
telecommunications liberalization index corresponds to a 7.2 percent increase in productivity for domestic
firms and a 9.8 percent increase in productivity for foreign firms. A similar change in the transport index
leads to a 19 percent improvement in productivity of all firms. Only foreign firms appear to benefit from
the insurance reform enjoying a productivity boost of 3.3 percent.


Our results are confirmed by an instrumental variables approach in which we instrument for reform in
India using measures of services reform in two countries that can be viewed as India‟s competitors,
namely China and Indonesia. The results are also robust to focusing on structural breaks in services
reform instead of using the reform index. Finally, the results remain unchanged if we control for de-
licensing and lifting of restrictions on FDI inflows in a given manufacturing sector.


This paper proceeds as follows. Section II describes the related literature. Section III describes services
liberalization in India between 1990 and 2005 and presents some evidence on its impact. Section IV
describes the data and the construction of the liberalization index and reviews our estimation procedures.
Section V interprets the results, and section VI concludes.

                                                       4
II.     Related Literature


A review of the relevant literature reveals that: India‟s manufacturing revival has been attributed to almost
everything except its services reforms; even research on other countries tends to attribute changes in
manufacturing performance to goods trade liberalization and foreign direct investment; and, in the few
instances where the role of services reform is considered, the focus has been on specific services like
banking or infrastructural services alone.


India‟s liberalization in the 1990s has made it a rich environment for research on the effects of policy
reform on manufacturing performance. Considering the 1991 reforms as a single event, Krishna and Mitra
(1998) find both price and productivity effects at the firm level. Khandelwal and Topalova (2011)
examine reductions in trade protection in individual industries and find that procompetitive forces,
resulting from lower tariffs on final goods, as well as access to better inputs, due to lower input tariffs,
increased firm-level productivity, with the latter having a larger impact. Sivadasan (2009) considers the
liberalization of both the trade and FDI regime in manufacturing and concludes that both increased firm-
level productivity. In a descriptive analysis, Goldberg et al. (2009) show that trade reform spurred imports
of previously unavailable products. New imported inputs often originated from more advanced countries
and new imported varieties exhibited higher unit values relative to existing imports. Goldberg et al.
(20011a) find that lower input tariffs accounted on average for 31 percent of the new products introduced
by Indian firms, which suggests that an important consequence of the input tariff liberalization was to
relax technological constraints through firms‟ access to new imported inputs that were unavailable prior to
the liberalization.


Other key contributions have looked beyond policy in manufacturing per se, but focused primarily on
institutional factors affecting the distribution of benefits from reforms and liberalization across industries
and states. Besley and Burgess (2004) exploit variation in labor regulations across Indian states and find
that labor market reforms were a significant determinant of manufacturing output per capita. Aghion,
Burgess, Redding and Zilibotti (2008) show that the effects of liberalizing the system of central controls
regulating entry and production activity were stronger in areas where organized labor was relatively weak,

                                                      5
arguing that firms were better able to adapt to the new regime in regions where regulations were more
pro-industry. Harrison et al. (2011) find that market-share reallocations played an important role in
aggregate productivity gains immediately following the start of India‟s trade reforms in 1991. However,
aggregate productivity gains during the overall 20-year period from 1985 to 2004 were driven largely by
improvements in average productivity, which can be attributed to India‟s trade liberalization and FDI
reforms. Goldberg et al. (2011b) investigate the impact of liberalization on Indian firms‟ product choice
and find little evidence of “creative destruction� in the 1990s, i.e. Indian firms infrequently discontinued
product lines even during a period of trade and structural reform. They argue that remnants of industrial
licensing and rigid labor market regulation in the Indian economy prevented firms from adjusting fully to
reforms.


The emphasis on attributing changes in manufacturing performance to changes in trade, investment and
labor market policies in goods characterizes much of the existing empirical work on liberalization in
developing countries. For instance, Pavcnik (2002) uses plant level data from Chile to find that trade
liberalization forces exit of the least productive firms while increasing productivity of the remaining firms
in the import competing sectors. Amiti and Konings (2007) delve deeper into the channels through which
liberalization affects productivity by separately identifying the impact on Indonesian manufacturing of
input and output tariff reductions, and find that the positive effect from increased availability of inputs to
production is twice as strong as the effect from import competition. Halpern et al. (2009) estimate a
structural model of importers using product-level data for all Hungarian manufacturing firms and reach a
similar conclusion.


Empirical research on liberalization of foreign direct investment has produced mixed results. Aitken and
Harrison (1999) find what they term „the market stealing effect‟ of foreign direct investment which
swamps the positive effect of technology transfer on firm productivity in Venezuela. Javorcik (2004)
explicitly distinguishes between intra- and inter-industry effects of foreign direct investment using firm
level data from Lithuania and finds that foreign direct investment has a positive productivity effect on
supplier industries but no significant effect on local competitors in the same industry. Javorcik and Li
(2008) show that entry of foreign retail chains boosts the productivity of the supplying industries in
Romania.



                                                      6
Downstream spillovers arising from policy reform and foreign participation in the services sectors are
qualitatively different from those arising from foreign direct investment in manufacturing industries.
Disruption in the provision of services can result in large delays in production and product delivery, high
information costs and an inability to invest in potentially profitable new activities.                  There has not,
however, been much empirical analysis of the downstream effects of services reform, and the few existing
studies have focused on specific services sectors, usually banking.4 Rajan and Zingales (1998) show that
financial development increases growth. They weight industries by dependence on outside financing (as
estimated from US data) and find that firms which are more dependent on external financing gain more
from financial development than other firms. Bertrand, Scholar and Thesmar (2004) demonstrate that
banking deregulation in France in 1985 led to improved productivity in manufacturing firms. Entry and
exit rates increased following liberalization, suggesting that less productive firms had been protected by
the easy access to credit allocated to large firms by the previously nationalized banking sector.
Productivity effects were particularly strong in banking-dependent sectors. Aghion and Schankerman
(1999) identify channels through which infrastructure and institutions affect entry and exit. They generate
a Dixit-Stiglitz model to demonstrate that infrastructure investment increases the probability of entry by
low cost firms and discourages entry by high cost firms. Thus, infrastructure development is likely to
improve economic performance if it reduces transactions costs thereby increasing competition and
fostering Schumpeterian “creative destruction.�


The present paper is most closely related to Arnold, Javorcik and Mattoo (2011) which uses firm-level
data to show that increased foreign participation in services provision led to improvement in
manufacturing productivity in the Czech Republic in the period 1998-2003. The current paper studies the
more complex and dynamic Indian context with new data on and measures of services reform.
Furthermore, while the previous paper considered the services sector as a whole, in the present paper, by
separating the liberalization measures into measures for banking, telecommunications, transport and
insurance services, we are able to identify the impact of key reforms in individual sectors. Finally, in
contrast to the previous paper, we distinguish between the implications of services liberalization for
domestic and foreign manufacturers.



4
  There is some work on the economy-wide effects of services reform. Mattoo, Rathindran and Subramanian (2006) show that
services liberalization leads to higher levels of economic growth. Eschenbach and Hoekman (2006) find similar evidence for
Eastern Europe.

                                                            7
III.     Services Reform in India


After decades of state dominance, India‟s economic landscape was transformed with the liberalization of
manufacturing in the late 1980s and early 1990s, and the liberalization of services during the 1990s. This
section describes the key reforms in individual services sectors, their determinants and their
consequences. We first provide some evidence that the pattern and pace of services reform reflected
sector-specific political forces that were to an extent exogenous to the developments in the downstream
manufacturing sector. We then show that the reforms had an impact on the performance of the services
sectors.



The Genesis and Pattern of Reform in Services Sectors

In the 1980s, the services sectors in India were dominated by state enterprises, there were restrictions on
entry by private domestic and foreign providers, and prices of services were largely fixed by the
government (World Bank, 2004). The 1990s saw significant liberalization, with greater freedom of
establishment to domestic and, in some cases, foreign providers, greater operational autonomy for
providers, and greater reliance on market-based allocation mechanisms.

The pace of policy reform has, however, varied across sectors and been determined primarily by political
considerations (Hoekman, Mattoo and Sapir, 2007). Sectors in which privatization and competition would
mean restructuring and large scale lay-offs were slower to benefit from the reforms than those in which
incumbents could remain profitable and employment would not decline even as foreign and local private
competitors entered the market. Reforms were also slower to materialize where it was feared that they
could cause a reduction in access to services for poor or rural communities. Most political economy
explanations for the pace and pattern of reforms point to considerations in the services sectors themselves
rather than in downstream industries.5



5
  Chari and Gupta (2008) provide evidence that the de-licensing reforms in India in 1991 categorized certain more concentrated
and less competitive industries as strategic and shielded them from foreign competition by maintaining barriers to foreign
direct investment. They find that profitable state-owned enterprises were likely to be protected, particularly in capital-intensive
industries. Lobbying power by state banks and other services companies in India is likely to have been a factor in delaying

                                                                8
Services sectors in India can today be separated into three broad categories: significantly liberalized,
moderately liberalized and closed. The telecommunications sector was operated solely by the central
government prior to 1992, when the government began to issue select operating licenses to private
providers. In 1994, cellular service began and the government announced the National Telecom Policy
which improved the environment for private investment. In 2002, the government fully opened the long
distance sector of the telecom industry to private competition and eliminated all restrictions on the
number of service providers, except in areas where limits are dictated by the availability of spectrum.
Foreign ownership limitations were also significantly relaxed and now range from 74 percent to 100
percent across different segments.

To those accustomed to the glacial pace of reform in India, the telecommunications experience seems
highly unusual. Discussions with policy-makers suggest that technology trumped all other considerations
in this sector and India sought to exploit new technological possibilities by rapidly introducing
competition.6 Public sector incumbents reincarnated as more or less successful participants with a stake in
a competitive and rapidly growing market. The number of telephone subscribers has increased rapidly,
with most of the increases taking place in private telecommunications services providers (OECD, 2011).
The expansion in scale dwarfed any adverse effects of diminished labor intensity–employment grew by as
much as a third in the six years following the first significant liberalization in 1994. It also became
evident that better access to services could be achieved than what had been possible with public
monopoly, attenuating concerns regarding distributional equity and weakness of regulatory capacity.

In the moderately liberalized sectors, Indian firms are disadvantaged by the legacies of past policies and
are ill-equipped to compete. The best example is the banking sector where nationalization in 1969 of the
largest private sector banks led to a sector dominated by public sector banks committed to directing credit
to areas identified by the government as priorities.7 Directed lending and interest rate regulations
prescribed the credit portfolios which banks were required to hold, putting into question the long term

liberalization of the services sectors into the mid-1990s and in excluding them from the general goods liberalization during the
rapid trade reforms which took place in 1991.
6
  The authors discussed the reform experience with B.K. Zutshi, the first Chairman of the Telecom Regulatory Authority of
India (TRAI), and H.V. Singh, the Secretary and Director of Economy Policy at the TRAI in December 2006.
7
  The Bank Company Acquisition Act of 1969, quoted in Burgess and Pande (2003), explicitly recognizes the goal of
expanding credit to priority sectors through government expansion of the banking system.

                                                               9
solvency of many banks (Reddy, 2005). Banks were also required to hold large percentages of their
portfolios in government securities bought at concessional interest rates. In 1977, the government began
requiring any bank that wanted to open a branch in an area which already had a bank branch to open four
branches in (rural) areas with no financial services (Burgess and Pande, 2005). The effect was to generate
excessive staffing levels, unprofitable rural branches and large levels of non-performing loans. The close
relationship existing between the banks, the government and central bank created the potential for moral
hazard as banks expected government intervention in the event of a failure (Reddy, 2002).

Liberalization of the banking sector was handled by the Reserve Bank of India with a focus on
maintaining the viability of existing banks while increasing competition and efficiency in the sector
(Reddy, 2005). In 1994, liberalization began with increased approval of private sector banks. In 2001, the
government began deregulation of the interest rate, and in 2002, foreign participation in the banking
sector was allowed up to 49 percent in private banks. There was also an increase in the approval rate for
the entry of new private banks. At the same time, India has made banking sector liberalization conditional
on improving the competitiveness of public sector banks through measures such as mergers, voluntary
worker retirement schemes, and the creation of asset management companies to deal with non-performing
assets. A 2004 rule allowed foreign banks to acquire up to a 74 percent stake in branches listed by the
Reserve Bank of India as having weak portfolios; foreign institutions are allowed only a 20 percent stake
in branches which are performing well. Foreign banks may now operate through licensed branches and as
fully owned subsidiaries, but a few key restrictions remain in the banking sector. There is a cap on the
number of licenses for branches at 20 per year for both new and existing banks, and the share of foreign
bank assets in total banking assets may not exceed 15 percent. Despite these limitations in the pace of
reforms, banking concentration has decreased visibly and the market share of new banks has increased to
around 25 percent (OECD, 2011).

The insurance sector has been liberalized more slowly than the other sectors. Prior to liberalization, the
insurance sector was controlled by the Ministry of Finance through publicly owned companies. In 1999,
the Insurance Regulatory Development Authority bill was passed which allowed private sector companies
to enter the insurance market. Foreign equity participation in the insurance sector is restricted to 26
percent and foreign firms are allowed entry only through partnerships or joint ventures. The funds of
policyholders must be retained within the country and there is compulsory exposure to the rural and social



                                                   10
sector, including crop insurance. Entry into the insurance market by private sector providers finally began
in 2002 when twelve private sector insurers entered the market.

All subsectors of transport services were operated primarily by public sector companies prior to
liberalization. Air transport was run by two publicly owned carriers, states controlled the ports for
maritime industries, and a large segment of the shipping sector was heavily regulated and dominated by
publicly owned companies. In 1997, foreign direct investment up to 40 percent was allowed in airlines, 74
percent foreign direct investment was allowed in port construction, and private sector companies were
allowed to contract for infrastructure maintenance and construction. In air transport, for example, the
remarkable increases in passenger traffic can be attributed almost entirely to private entrants (OECD,
2011). Yet transportation sectors remain subject to state level regulations which vary significantly across
states, with trucking particularly susceptible to local political pressures.

Professional services including accounting, legal, and other services sectors such as retail distribution,
postal and rail transport services are formally closed to foreign participation.8 FDI is not allowed in the
accounting and legal sectors. Within distribution services, FDI is not allowed in the retail segment (with
some narrow exceptions, such as single-brand retail) but there are no limits in other areas, except the
requirement of approval for commission agents, franchising services and wholesale trade. The closed
sectors are characterized by domestic firms that are sub-optimal in size and handicapped by an inhibiting
and weak regulatory environment. Many Indian services in closed sectors are highly fragmented by
international standards.9 Here adjustment and employment concerns are the dominant factors impeding
liberalization.

A more detailed survey of the liberalization reforms is provided in on-line Appendix A (attached at the
end of the paper).




8
 As an exception to this general rule, single-brand retailers are allowed.
9
 For example, there are 100,000 chartered accountants in India and 43,000 audit firms, with an average of two chartered
accountants per firm as compared to an average of between 350 and 1500 chartered accountants in the typical affiliates of the
“big four� accounting firms. In retail distribution, the penetration of supermarkets in India is only 2 percent compared to 55
percent in Malaysia and 36 percent in Brazil (World Bank, 2004).

                                                              11
The Impact of Reform


The elimination of barriers to entry in services provoked a dramatic response from foreign and domestic
providers (Gordon and Gupta, 2004). FDI inflows into services following liberalization by far exceeded
those into other sectors. Ten percent of FDI inflows during 1990-2005 went into the transport sector, 9.6
percent of the inflows were into the telecommunications sector, and 9.6 percent of the inflows were into
the financial and other services sector (Ministry of Commerce and Industry, 2008). At the same time, the
services sector grew by an average of 11 percent per year, with the more liberalized sectors generally
growing at relatively faster rates (Chart 1, and Eichengreen and Gupta, 2010). The share of services in
overall value added rose from 39 percent in 1993 to 50 percent in 2004 (National Accounts Statistics,
2005, constant 1993 Rs).

Growth has been particularly strong in the services sectors on which we focus in this paper:
communication services displayed average annual growth rates of 13.6 percent in the 1990s, while
banking grew by 12.7 percent on average, transport grew at an average rate of 6.9 percent and insurance
grew at a rate of 6.7 percent (Gordon and Gupta, 2004). Output per worker in the services sectors in India
has increased by over 7.5 percent per year during the 1990s, clearly outpacing the agricultural or
industrial sectors (Bosworth and Collins, 2008, p.56). Other evidence suggests that strong total factor
productivity growth was at the root of this remarkable performance, not capital deepening or higher
markups (Bosworth, Collins, and Virmani, 2006; Gordon and Gupta, 2004). Indeed, services prices
decreased relative to manufacturing prices, as indicated by a slower pace of growth in the services
deflator than the overall GDP deflator.

The reforms produced striking improvements in sectoral performance. In 1990, the average turn-around
time for a container at major ports in India was 8 days, and at major Mumbai ports the average was 11.
This meant that manufacturing companies exporting their products or importing inputs had to factor in
more than a week of transit time for their goods, which increased the cash outlays necessary for exporting
and importing. By 2005, the average turn-around time at major ports in India had decreased to 3.5 days,
with 4.5 days as the average time at Mumbai ports (see Charts 2 and 3). This reduction in transit time is
likely to have improved the ability of Indian firms to compete in highly variable markets such as textiles
and electronics in which the ability to respond quickly to changes in demand is crucial.


                                                    12
Banerjee and Duflo (2004) find that prior to liberalization even at the most efficient public sector banks,
bank loan approvals in 64 percent of cases were mechanically made for the same loan amount as prior
loans. The rationing of credit by the public sector reduced the ability of companies to respond to new
business opportunities and finance improvements in products or production processes. Because
liberalization allowed banks to set interest rates at their risk adjusted cost of capital and choose diversified
loan portfolios, by 2005 the level of investment by banks increased to 4.75 times the size of investment in
1994. The share of investment by foreign and private banks also increased during the period from 11
percent in 1994 to 24 percent in 2005. Despite the slow pace of reforms, credit provision and investment
have increased across the sector, led by foreign and locally-owned private banks (Reserve Bank of India,
2008).10


Before the beginning of the reforms in telecommunications, the sector was controlled by MTNL, a
publicly owned company which provided local telephone service, and VSNL, a publicly owned company
which provided long distance service. Both companies were plagued by faults, which averaged 19 faults
per 100 stations per month in 1991. In addition, service was poorly distributed and access to new lines
was difficult.11 Businesses were severely handicapped in their ability to communicate with their
customers and suppliers and to coordinate activity across plants. Liberalization has interacted powerfully
with technological change to transform the telecommunications market. By 2005, the number of faults
had declined to 7.5 percent and the waiting lists for telephone services had virtually disappeared in urban
areas (Charts 4 and 5). Even rural customers, projected by critics of the liberalization reforms to lose from
the privatization, saw increases in access to phone lines. Access to internet services, provided initially
only by MTNL, increased quickly as private providers were allowed to enter the market (Chart 6).

In the 1980s, air transport providers and several of the largest shipping companies were publicly-owned
companies. After liberalization, increasing competition from foreign companies put pressure on Indian
carriers to improve their performance. They responded positively, and operating efficiency increased. In
fact, operating revenue per employee in Indian airlines increased over 5 times over the period 1990-2004
from 0.5 million per employee to 2.5 million per employee. The increased efficiency led to continued


10
  More recently, during the financial crisis, credit provision by foreign banks shrank.
11
  The communications minister in the 1980s, C.M. Stephens, declared in parliament that telephones were a luxury, not a right,
and that anyone unsatisfied with their service was welcome to return their phone as there was an eight year waiting list of
people seeking telephone service (Panagariya, 2008 p.372).

                                                             13
growth of Indian carriers in the period 1990-2005, of nearly 15 percent yearly in passenger traffic and 11
percent yearly in cargo traffic (Directorate General of Civil Aviation, 2006).12

Until 2002, private sector competition in the insurance market was proscribed, severely limiting the range
of insurance services on offer. Market penetration of insurance quickly increased following the entry of
private and foreign insurers. After decades of public monopoly, premiums were equal to only 1.9 percent
of GDP in 1999-2000, but they jumped to 2.86 percent of GDP by 2002-2003 (Insurance Regulatory and
Development Authority, 2004). Government projections at the time of liberalization suggested that market
participation by foreign firms in 2005 would reach only 5 percent of the market, but by November 2005,
private firms with foreign shareholding had acquired a 34 percent market share. Over the same period,
there was limited contraction by Indian public sector incumbents (Department of Public Enterprises,
2003).13

In sum, liberalization led to a metamorphosis of services in India from a narrow range of products of sub-
standard quality and poor distribution to the current environment in which service providers are highly
competitive and offer their consumers, including manufacturing firms, a wide range of new and high
quality services products.



IV. Empirical Strategy


In this paper, we investigate whether there is a systematic link between liberalization in services sectors
and the performance of firms in downstream manufacturing industries. This exercise requires three pieces
of information: a measure of policy reform in services, a performance measure for manufacturing firms
and information on the linkages between different sectors of the economy.




12
  Recently, certain private providers, such as Kingfisher Airlines, have experienced financial difficulties
13
   National Insurance Company Limited, Calcutta, New India Assurance Company Limited, Mumbai, and United India
Insurance Company Limited Chennai each cut their staffs by 10 percent, while Oriental Insurance Company Limited, New
Delhi cut its staff by 14 percent (India Knowledge @ Wharton, 2006).

                                                        14
Measuring Services Reform


In order to make the detailed information on services sector reforms in India, which was gathered for this
study, amenable to quantitative analysis, we condense the information into a composite policy index for
each sector. In doing so, we have been guided by a similar index compiled by the European Bank for
Reconstruction and Development for countries in Central and Eastern Europe and reported in the flagship
publication Transition Report 2004. This approach starts from a general template of reforms necessary to
achieve a desirable policy environment, which is then adapted to the specific situation of each sector.


For each services sector k, the time-varying services reform index reformkt ranges from 0 to a maximum
score of 5. An index value of 0 corresponds to a situation where the public sector is either the only
relevant provider of services or has a strong grip on private providers, and there is extremely limited
scope for the market mechanism. Note that all Indian services sectors treated here fall into this highly
restrictive category before the beginning of economic reforms in the early 1990s. A level of 1 indicates at
least some scope for private sector participation and some liberalization of operational decisions,
combined with some very limited scope for foreign participation (limited, for example, by low FDI
ceilings). To qualify for an index value of 2, there must be only a limited degree of interference with
operational decisions by public authorities, substantial price liberalization, and clear scope for foreign
participation even if only in narrowly defined segments and as minority shareholders. Still, the state may
remain a dominant actor in the sector. An index of 3 implies significant scope for private providers,
including foreign ones, clear competitive pressure on the public incumbents from new entrants, and
explicit possibilities for foreign equity participation. A level of 4 is equivalent to little public intervention
and the freedom of operation of private providers, the possibility of majority foreign ownership, and the
dominance of private sector entities. Finally, a level of 5 (not attained in any of the sectors considered
here) would reflect an equal treatment of foreign and domestic providers, a full convergence of regulation
with international standards and unrestricted entry into the sector. The details of how the index was
constructed are presented in on-line Appendix B (attached at the end of the manuscript). The index is
available for four sectors: banking, telecoms, transport and insurance for the time period 1991-2004.




                                                       15
Linkages between Manufacturing Industries and Services Sectors


The next question in our analysis is how to aggregate these sector-specific indices into a single index of
services reform. Given that some services are likely to be more important for manufacturing industries
than others, and that this dependence may vary across different manufacturing industries, an unweighted
average of services sector indices is unlikely to be an appropriate measure of the potential impact of
upstream services liberalization on the performance of manufacturing firms. Instead, we use information
on the intensity with which services inputs are used in the production of a given manufacturing sector. In
particular, we weight each of the reform indices for the four major services sectors (banking, telecom,
transport and insurance) by the proportion αjk of inputs sourced by the manufacturing sector j from the
services sector k to create the index of services reform:


Services _ Index jt   � jk reformkt                                            (1)
                          k




where αjk is based on the input-output matrix pertaining to 1993, the first year of our sample.14 Data from
a national input-output matrix contain information about the average inter-industry sourcing behavior of
firms in a given sector of the economy. For an individual firm, the actual reliance on a given services
sector may be somewhat different, but even if such information were available at the level of each
individual firm (which it is not), such data would risk being endogenous to the performance of the firm,
which would defeat our purpose. By using average information, we lose some precision in measuring the
reliance of firms on services inputs, but we can be less concerned about the endogeneity of this measure.
The fact that we use sourcing information from the 1993 input-output matrix should further minimize the
scope for endogeneity even at the level of the average firm in an industry.




14
    The input-output matrix includes 66 manufacturing sectors and 16 services sectors. The manufacturing sectors were
aggregated to 38 sectors at which sector-specific price deflators were available. The services sectors include: construction,
electricity, gas, water supply, railway transport services, other transport services, storage and warehousing, communication,
trade, hotels and restaurants, banking, insurance, ownership of dwellings, education and research, medical and health, other
services. Input shares are calculated relative to the total value of inputs sourced. Banking services constitute on average 5% of
all inputs, transport 4.4%, telecommunications 1.6% and insurance 1.4%. An alternative normalization, by gross output, leads
to the same conclusions.

                                                              16
In our analysis, we will also distinguish between the effects of reform in individual services sectors. To do
so, we will construct indices capturing the reform in a particular services sector. For instance, we will
define


Banking _ Index jt  � j ,bankingreformbanking,t                            (2)


where αj,banking reflects the proportion of inputs sourced by the manufacturing sector j from the banking
sector, according to the input-output matrix, and reformbanking,t is the state of reform in the banking
industry at time t. We will follow the same approach to construct indices for telecom, insurance and
transport sectors.


For the banking sector, an alternative measure of financial dependence will help us to test the robustness
of the main measure. This alternative is based on Rajan and Zingales (1998), who compute sector
averages of financial dependence based on US data and argue that this is a suitable measure for firms‟
technologically induced demand for external finance in an environment with well-developed financial
markets. The measure is based on a comparison between firms‟ investment outlays and own cash flow.




Measuring the Performance of Manufacturing Firms


Our goal is to provide a fuller explanation of the remarkable improvement in the performance of the
Indian manufacturing sector following the post-1991 economic reforms. We use firm-level data from the
Capitaline database, a commercially available database including balance sheets, profit and loss
statements, and ownership information on large private and public firms operating in India to measure the
performance of manufacturing firms. The database covers 62 percent of India‟s manufacturing output
during the period considered by the analysis, and includes 11,939 firms, of which 5,236 operate in the
manufacturing sector. The data set forms an unbalanced panel covering the period 1993-2005. Firms‟
industry affiliations follow India‟s National Industry Classification (NIC) which encompasses the
manufacturing sectors. After cleaning the data and discarding firms not reporting information on output or
production inputs, we are left with 3,771 firms or 22,558 firm-year observations.



                                                     17
A consistent measurement of firm performance is crucial to our analysis. We use the total factor
productivity (TFP) as our outcome of interest. To control for a possible simultaneity bias arising from the
endogeneity of a firm‟s input selection, which will exist if a firm responds to productivity shocks
unobservable to the econometrician by adjusting its variable input choices, we follow the method
proposed by Ackerberg, Caves and Frazer (2006). Ackerberg et al. build on the widely used estimation
procedures proposed by Olley and Pakes (1996) and Levinsohn and Petrin (2003). Unlike the latter
method, their approach allows for more plausible assumptions about the timing of the firm‟s decision
regarding input choices and optimization errors.


We use the Ackerberg et al. method to estimate sector-specific production functions and obtain the TFP as
the residual from this estimation.15 We group some smaller industries together in order to facilitate the
estimation.16 Following the advice of Ackerberg et al., we use value added as the dependent variable in
the production function. Value added is defined as the sales of firm i in year t less the value of material,
services and energy inputs. All components of value added are expressed in real terms. Capital and labor
inputs (expressed in real terms) are included as independent variables. Material and services inputs (in
real terms) are used to proxy for the productivity shocks.


Nominal output is deflated by a set of wholesale price indices disaggregated at the 2-digit level, while
capital inputs are calculated from detailed data on net values of land, buildings, machinery and computers,
all deflated by the relevant sector deflators. In the absence of data on the number of workers employed,
the labor input is calculated by normalizing the wage bill of each firm by the average wage prevailing in a
given 2-digit sector in a given year. Materials are deflated by input-output coefficient weighted sector
deflators based on the wholesale price index. Energy inputs are deflated using National Accounts
Statistics price indices for “Fuel, Power, Light and Lubricants.� Services inputs are aggregated from
detailed data on reported expenses on travel, transport, legal services and accounting, and non-interest
banking expenses. These items are deflated using a weighted average of services sector deflators from the
national accounts statistics. Given that our interest is in upstream services reform, a proper accounting for
services inputs at the firm level is essential to control for changes in the intensity with which firms use

15
  We are grateful to Carolina Villegas-Sanchez for sharing with us a STATA routine implementing the procedure.
16
  The industry groupings are: food and tobacco; textiles; garments and leather goods; wood, paper and printing; petroleum
products and chemicals; rubber and plastics; non-metallic minerals, iron and steel; metal products; machinery, office, electrical
and communication equipment; lifting, medical and industrial equipment; motor vehicles and other transport equipment.


                                                               18
services in their production, in response to increased product offerings in the service sectors. Summary
statistics for all the variables are presented in Table 1.


To establish whether there exists a link between the performance of manufacturing firms and
liberalization of upstream services sectors, we regress the TFP of a manufacturing firm i operating in
industry j at time t on the aggregated Services_Indexjt-1 lagged one period or disaggregated indices of
services reform. We control for foreign ownership, trade liberalization, firm and year fixed effects. Our
principal estimation equation has the following form:


ln TFP  �i  � 1Services _ Index jt 1  � 2Tariff jt 1  � 3 Input tariff jt 1  � 4 Foreignit  �t  � it
      ijt
                                                                                                                 (3)


Services sectors were not the only item on the post-1991 reform agenda in India. Continued reductions in
manufactured product tariff rates occurring during the same period may also have influenced
manufacturing productivity. To control for changes in tariff rates, we include lagged output tariffs in the
same manufacturing sector (Tariffjt-1) and a weighted measure of input tariffs (Input tariffjt-1). The weights
of the input tariffs are taken from the 1993 input-output matrix, while the aggregation of individual tariff
lines to the 2-digit sector level is achieved using the 1990 import weights. The information on tariffs was
obtained from the World Bank‟s WITS database.17


As many studies find that foreign affiliates tend to outperform domestic producers (see for instance,
Aitken and Harrison, 1999; Arnold and Javorcik, 2009), we include an indicator for foreign-owned firms,
equal to one if the foreign ownership share in firm i is above 10% at time t (Foreignit). In an expanded
specification, we will allow for differential effects of services reform on domestic and foreign firms by
interacting Foreignit with the Services_Indexjt-1.


The dependent variable is firm-specific, but our variables of interest vary at the sector-year level,
therefore, we cluster standard errors at the sector-year level.




17
 The authors are grateful to Rajesh Mehta for providing tariff data for the years in which the figures were missing from
WITS.

                                                          19
As a benchmark, we also use OLS to estimate an augmented Cobb-Douglas production function. To make
it comparable to the Ackerberg et al. procedure, we regress real firm value added (defined as above) on
real labor and capital inputs as well as measures of services reform and other control variables: 18


ln VAijt  � i  �1 j Kit  � 2 j Lit  �3 Services _ Index jt 1  � 4Tariff it 1  �5 Input tariff it 1
 � 6 Foreignit  � t  � it                                                                                           (4)


where VAijt stands for the value added of firm i observed in year t (and manufacturing industry j), Kit
denotes capital, and Lit labor. Note that we allow the coefficients on capital and labor inputs to differ
across 11 manufacturing sectors. As in specification (3), we include firm and year fixed effects and cluster
standard errors at the sector-year level.


Our point estimates for the production function coefficients, presented in Table 2, have reasonable values.
On average, the labor coefficient is 0.73 in the OLS and 0.75 in the Ackerberg et al. specification, and the
capital coefficient is equal to 0.27 in both cases. In 9 of 11 industries, the coefficient on the capital input
is higher in Ackerberg et al. procedure, which is what we would expect to observe under plausible
assumptions (Olley and Pakes, 1996). The average returns to scale are very close to constant (1.00 and
1.01).




18
  A specification with output on the left-hand side and industry-specific coefficients on material inputs, services inputs and
energy leads to very similar results.

                                                               20
V. Results


Baseline Specification


Our baseline regression results from estimating equation (4) are presented in Table 3. We find that the
aggregate services index has a positive and highly significant coefficient estimate, suggesting a strong
role for services liberalization in explaining manufacturing firm productivity in India. A one-standard-
deviation change in the aggregate services index improves manufacturing productivity on average by 9.1
percent.


We also enter the individual service sector reform indices into the regression one by one. We find positive
and statistically significant effects of banking, telecom and transport reforms. For banking, both our
standard input-output weighted index and the Rajan-Zingales weighted measure yield similarly significant
results. There is no evidence that liberalization of the insurance industry led to a better performance of
manufacturing firms.


When we enter the individual sector indices simultaneously (column 7 of Table 3), the banking, the
telecom and the transport index maintain their positive and significant coefficients. The results from this
regression suggest that telecom and transport liberalization have the strongest effects on productivity. A
one-standard-deviation increase in liberalization of the telecom industry yields a 8.8 percent increase in
productivity, and a one-standard-deviation change in transport improves productivity by 14 percent.
Banking reform has a 4.4 percent productivity effect, while the effect for the insurance sector is not
significant at the conventional levels.


Alternatively, we can focus on the magnitude of the effect corresponding to a one-unit change in the value
of the liberalization index. For instance, allowing firms greater operational autonomy and enhancing
scope of foreign participation (change in the index from one to two) leads to a productivity increase of 1.7
percent when the banking sector is reformed, 2.7 percent when the telecom sector is liberalized and 19
percent when the change pertains to the transport industry.




                                                    21
Over the period of our sample, we cannot identify a significant effect from changes in tariff rates on
manufacturing productivity.19 We also find that foreign affiliates tend to exhibit higher productivity than
domestic firms which is consistent with the conclusions of the existing literature (Aitken and Harrison,
1999; Arnold and Javorcik, 2009).


In Table 4, we present the results with our preferred TFP measure estimated based on the Ackerberg et al.
method. We first apply this method to estimate production functions for each of the 11 sectors separately,
and then we regress the TFP obtained from these regressions on services and trade liberalization variables,
the foreign affiliate dummy as well as firm and year fixed effects. Using the Ackerberg et al. measure
leads to three changes in the results. First, the estimated coefficients become larger while maintaining their
significance levels. Second, the insurance index, which did not reach conventional significance levels in
Table 3, now appears to be statistically significant at the 10 percent level in one specification. Third, the
transport index now appears to be statistically significant in both specifications where individual measures
of services reform enter jointly.


When the individual services sectors are examined in the last column of Table 4, a one-standard-deviation
change in the banking sector index corresponds to a 6.6 percent change in productivity. A one-standard-
deviation change in the telecommunications liberalization index corresponds to a 8.4 percent increase in
productivity. A similar change in the transport index leads to a 18.8 percent improvement in firm
performance. No statistically significant effect is found for the insurance sector reform. As before, the
coefficients on tariffs do not appear to be statistically significant.20




Do Foreign Firms Benefit More from Services Liberalization?


Our finding of a significant productivity premium for foreign owned firms is common in the literature.
But does ownership also affect the ability of firms to reap the benefits of upstream services reform?
Liberalization allows entry of foreign services firms which may have stronger links with foreign-owned

19
   In a recent paper, Bollard, Klenow and Sharma (2010) also find that productivity growth in Indian manufacturing since the
1990s is not robustly related to tariff reductions. It is also possible that we do not find significant effects because most of the
tariff cuts took place prior to the time covered by our sample.
20
   In regressions, not reported to save space, we also show that our conclusions are robust to using a translog production
function.

                                                                 22
manufacturing firms and whose local presence could therefore provide greater benefits to foreign-owned
manufacturing firms. Moreover, accustomed to doing business in environments with well-developed
services sectors, foreign firms may derive larger benefits from improvements in services industries. In
order to test this hypothesis, we estimate an expanded specification which includes interaction effects
between the services index and the foreign ownership indicator.


The interaction between foreign ownership and services liberalization is positive and significant for the
aggregate measure (see Table 5). This is also true in all cases when services indices enter one by one,
confirming our intuition that the productivity effect of services liberalization is stronger for foreign owned
firms. This increased effect for foreign owned firms is consistent across services sectors when tested
individually, but is not significant for the banking and the transport sector when all services indices enter
the same model. This may be because multinational firms are relatively well-equipped able to procure
banking and transport services internationally, and are therefore less reliant on the respective domestic
sectors.


The differential impact of liberalization on foreign firms is remarkably strong in the telecommunications
sector. A standard deviation increase in the telecommunications index increases productivity by 7.2
percent for domestic firms while it increases productivity by 9.8 percent for foreign owned firms. Given
the greater need for coordination across national borders, one may find this result intuitive. As for the
insurance reform, only foreign firms seem to be able to appropriate its benefits and see a boost in
productivity of 3.3 percent.




Controlling for Other Reforms


While many observers have considered decreasing tariff protection to be the key explanation behind the
productivity enhancements of Indian firms, recent research suggests that a comprehensive approach may
be warranted, encompassing also other policy changes taking place in India (Harrison et al., 2011).
Against this background, we extend the set of controls in our baseline specification to include industry-




                                                     23
specific measures of de-licensing and FDI reform.21 We do not take into account the labor market reform,
most of which occurred before the first year of our sample 1993 (Ahsan and Pagés, 2009).


To capture the effects of the de-licensing reforms, we use information from Harrison et al. (2011), who
extended the data used by Aghion et al. (2008) to 2004, on the basis of Press Notes from the Ministry of
Commerce and Industry. The de-licensing variable is a dummy that takes on a value of one if any
products in a 3-digit industry have been de-licensed, and zero otherwise. Similarly, the measure of FDI
reform was compiled by Harrison et al. (2011) also based on Press Notes from the Ministry of Commerce
and Industry. It takes on a value of one if any products in a 3-digit industry have been liberalized, and
zero otherwise.22


In Table 6, we present the results from the modified specification. We find a positive correlation between
de-licensing and FDI reform and firm productivity. More importantly for the purposes of this paper, our
results on services reform are barely affected by this change.23




Instrumenting the Services Liberalization Index


In order to ensure that our finding of services reforms improving manufacturing performance is not driven
by reverse causality, we instrument the index of services reform. The intuition behind our instrumental
variables (IV) approach is that India will react to services liberalization undertaken by other countries,
especially economies it views as its competitors, such as China and Indonesia. We measure services
liberalization using the WTO commitments in a given sector. More specifically, we focus on the number
of commitments made by a country expressed as a percentage of possible commitments. For the years
prior to the first full year of the WTO membership of a given country (e.g. 2002 for China), the number of
commitments equals zero. To create an instrument relevant to a particular manufacturing sector, the

21
   According to Harrison et al, by the end of 1991, nearly 85% of industries had been de-licensed, with the share increasing to
over 90% of industries by the end of the 1990s. The FDI liberalization occurred somewhat more slowly, and only in 2000 all
industries became eligible for automatic FDI approval, except those requiring an industrial license or meeting several other
conditions.
22
   We are very grateful to Ann Harrison, Leslie Martin and Shanthi Nataraj for sharing the data with us. Industries have been
converted from 3-digit NIC 87 industry codes to 4-digit NIC98 industry codes. Where direct correspondences were not found,
averages were used at the 2-digit NIC98 level.
23
   Including these additional controls in all other specifications presented in the paper would not change its conclusions.

                                                              24
measure of services liberalization is multiplied by the proportion αjk of inputs sourced by the
manufacturing sector j from the services sector k, as with the services index in equation 1. In this way we
create two instruments: (i) pertaining to China's commitments and (ii) pertaining to Indonesia's
commitments. Each instrument varies by time, manufacturing industry and services sector. An alternative
specification, using instead the commitments of all WTO members yielded similar results (available upon
request).


The results from IV regressions are reported in Table 7. As expected, the first stage results indicate that
Indian services reform responded to services liberalization in China and Indonesia. The F-statistics
suggest that our instruments perform well. The Sargan test does not cast doubt on their validity with the
exception of the specification focusing on the transport sector. The second stage confirms our earlier
finding that services reforms have improved manufacturing performance. This gives us confidence that
reverse causation is not driving our results.


Alternative Measure of Service Reform


While the construction of our services reform index was undertaken with great care and confirmed by
extensive consultations with sector experts in India, a composite index is by its very nature always prone
to measurement imperfections. We therefore wish to check the robustness of our findings to more
parsimonious approaches to measuring services reform. Although a “true� measure of policy reform does
not exist, it may be possible to identify the key structural break points in policy regimes with greater
objectivity than is involved in the construction of a composite index that reflects a judgment of the
relative importance of specific reforms. Hence we check the previous findings by using a simpler measure
of structural breaks for each services sector.24 This is done by identifying the year in which a service
sector experienced the most transformative policy reform and generating a simple indicator variable that
divides years into “before� and “after� this structural break. These policy cornerstones in services sectors
are then weighted by the input-output coefficients linking services and manufacturing sectors, in the same
way as with the policy index:


Breakjt = ajkIkt                                                                                         (5)

24
     Note that it is not possible to do this for the aggregate measure as the timing of structural breaks varies from sector to sector.

                                                                   25
where αjk is the share of inputs sourced from services sector k by manufacturing sector j, and Ikt is an
indicator variable for services sector k taking on the value of one if an observation pertains to the year of
the structural break year or a later period, and zero otherwise.


The structural breaks were determined as follows. The most important reforms in the banking sector
occurred in 2001, when there was full deregulation of the interest rates and banks were allowed greater
flexibility in choosing borrowers and designing loan terms. Liberalization of the banking sector allowed
for improved allocation of credit and increased investment by private and foreign banks.


The most important reforms in the telecommunications sector in India occurred in 2002, when the
government terminated the VSNL (publicly owned telecommunications company) monopoly and allowed
free entry into the long distance sector. This policy reform in the telecommunications sector quickly led to
entry in the sector and intense competition.


For transportation, the most important reform came in 1997 when increased privatization in port
management was allowed. Approval was granted for up to 74 percent foreign ownership in port
management, foreign and private investment in construction, and increased private and foreign investment
in aviation. The effect was to make the transportation industry more competitive, which translated into
gains in the speed with which processes were completed at ports and deliveries were made.


In the insurance industry, 2002 is the most important year of reform, as it marked the registration of
sixteen new providers, and permission for twelve new insurance providers to enter the market. Yet the
insurance reforms were slower to be instituted than the other services reforms.


The results obtained from replacing the services index in equation (4) with the variable Breakjt pertaining
to individual services industries confirm our earlier findings (Table 8). Important policy changes in
services sectors appear to have left their mark on the performance of manufacturing firms dependent on
services inputs. Strong productivity effects can be identified from the banking, telecommunications,
insurance and transport sectors, and as in the index regressions, the coefficients are particularly large for
the telecom and transport sectors. Again when measures for several services industries enter jointly, the

                                                      26
insurance measure loses its statistical significance. As is evident from Table 9, these regressions also
confirm that there is a stronger productivity effect on foreign firms than on domestic firms.




Liberalization Year Falsification Test


In order to ensure that the liberalization measures identify effects of reforms rather than spurious effects
from broader industry-level productivity trends, we test the liberalization discontinuity effect on years
prior to the reform. If the effect captured by the liberalization breaks were simply related to industry
trends, we would expect the coefficient on years prior to the reform to be as large and significant as the
coefficient on our variable of interest.


To implement this test we create a new variable


1 year prior to breakjt = ajkIPkt                                                   (6)


where αjk is the share of inputs sourced from services sector k by manufacturing sector j, and IPkt is an
indicator variable for services sector k taking on the value of one in the year prior to the year of the
structural break, and zero otherwise. We also define an analogous variable for the two-year period
preceding the structural break which we use in an alternative specification.


As is evident from Table 10, we find that in each industry the coefficient on the break in the year of
reform is larger and significantly different from the coefficient on the years preceding the reform. The
results are somewhat weaker in the second specification for the transport reform (the last column) where
the p-value of the test equal 0.126. Only in 3 of 10 specifications is the coefficient on the falsification
variable positive and statistically significant.


Other Robustness Checks


A potential concern is that the service indices increase monotonically over time. This makes the empirical
strategy susceptible to picking up spurious sectoral trends. If the sectors that are intensive in the more

                                                     27
reformed services were more dynamic and productivity grew in these sectors for reasons unrelated to
input improvements, we could get the results obtained so far even in the absence of a true effect of
services liberalization on firm performance.


To address this concern, we replace year fixed effects with sector-specific time trends (we use the sector
aggregation presented in Table 2). The results, presented in Table 11, confirm our earlier findings. We
find a positive link between the aggregate measure of services reform and the performance of downstream
manufacturing firms. As before, larger benefits appear to accrue to foreign affiliates. A similar pattern is
detected for the banking reform. When it comes to the telecom, insurance and transport sectors, the
benefits of services liberalization appear to accrue only to foreign firms. The magnitudes of the effects are
similar to those found in Table 5 and are statistically significant at the 1 percent level.


Finally, we examine whether our results are subject to an autocorrelation problem that could lead to the
underestimation of standard errors, as discussed by Bertrand et al. (2004). To check for this potential
estimation bias, we take their advice and ignore the time-series information when computing standard
errors. We perform the test in three steps. First, we regress the logarithm of TFP on control variables
(other than the services variables) and fixed effects and keep the residuals. Second, we divide the
residuals into two groups: residuals from the years before the structural break and residuals from the post-
break period and calculate a within-firm average for each period. In the last step, we regress the two-
period panel of mean residuals on the Breakjt variable defined in equation (5). We cluster standard errors
for each manufacturing industry. We repeat the procedure for a break in each services sector considered in
the analysis.


As is evident from Table 12, we find positive and statistically significant (at the 1 percent level) effects
for the banking sector, telecoms and insurance reform. Somewhat surprisingly, we obtain a negative
coefficient for the transport reform. Given these findings, we feel reasonably confident that our baseline
results are not subject to the autocorrelation problem.




                                                       28
VI. Conclusions


This paper suggests that previous explanations for the post-1991 growth of India‟s manufacturing sector
have ignored an important factor: the contribution of India‟s policy reforms in services. By gathering
detailed information on the pace of policy reform in Indian services sectors and constructing a series of
reform indices, we demonstrate a strong and significant empirical link between progress in policy reforms
in services sectors and productivity in manufacturing industries. Our findings are robust to a number of
checks, including instrumenting for the pace of reform in Indian services sectors, controlling for trade
liberalization, foreign ownership, sector-specific time trends and autocorrelation. We also investigate the
relative contribution of reform in each of the services sectors to the productivity of manufacturing firms,
and find that liberalization in the banking and telecommunications sectors had the most robust productivity
effects on manufacturing firms over the period. When distinguishing the effect of services reform by
ownership, we find that foreign-owned subsidiaries in India display an even greater ability to reap the
benefits of services reforms than domestic firms.


The particularly robust effects of banking and telecommunications liberalization are intuitive results.
Liberalization in the banking sector has improved capital allocation and allowed investment in higher
return projects. Liberalization of the telecommunications sector has interacted with technological change
not only to enhance the reliability and reduce the cost of communication, but it has also paved the way for
entirely new ways of communication and organizing production. Liberalization of the transport sector
allows easier and less expensive transportation of raw materials and goods for export. However, reforms
in several areas of the transportation sector in India have been slow, and some control over transport
remains at the state level. Given that we cannot capture this state-level variation in our index, the results
for the transportation sector seem somewhat weaker, although significant in a number of specifications.
Insurance sector reforms do not appear to have had a strong influence in our data, possibly due to their
limited scope so far.


Services reforms in India remain incomplete and barriers to domestic and foreign competition exist in
many other countries. This paper suggests that in addition to retarding the development of the services
sectors, these barriers also penalize the manufacturing sector. Wider appreciation of this link may help
create broader political support for services reform. It may also provide greater perspective for

                                                     29
international trade negotiations, which only notionally address impediments to services trade and
investment and continue for the most part to focus on goods – agriculture and manufacturing.




                                                   30
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                                                        33
Charts

Chart 1: Growth Rates of Services Output by Level of Liberalization, 1993-2002




Source: World Bank (2004).



Chart 2: Length of Pre-Berthing Detention at Ports




Source: Ministry of Shipping, Road Transport and Highways, Govt. of India, Indiastat (2008).




                                                            34
Chart 3: Length of Turn-Around Time at Major Ports
      16

                                                                                               Kolkata

      14

                                                                                               Paradip

      12

                                                                                               Chennai

      10
                                                                                               Tuticorin

          8
   Days




                                                                                               Cochin

          6
                                                                                               New
                                                                                               Mangalore
          4
                                                                                               Mumbai

          2
                                                                                               Kandla


          0
              1991   1996   1997   1998   1999   2000   2001        2003   2004   2005




Source: Ministry of Shipping, Road Transport and Highways, Govt. of India, Indiastat (2008).



Chart 4: Phone Faults in Delhi and Mumbai per 100 Stations per month




Source: Department of Telecommunications, Ministry of Communications, Indiastat 2008.




                                                               35
Chart 5: Telephone Faults across India




Source: Department of Telecommunications, Ministry of Communications, Indiastat, 2008.




Chart 6: Growth in Internet Density in India




Source: Ministry of Statistics and Programme Implementation, Indiastat, 2008.




                                                            36
Tables

Table 1: Summary Statistics
Variable                                            Obs   Mean    Std. Dev.

ln TFP Ackerberg et al.                         22558      1.53       1.10
ln Output                                       22558      2.57       2.01
ln Energy                                       22558     -0.12       2.04
ln Capital                                      22558      2.52       1.77
ln Labor                                        22558      0.45       1.79
ln Material inputs                              22558      2.62       1.90
ln Services inputs                              22302      0.27       1.92
Services Index lagged                           22558      0.18       0.10
Banking Index lagged                            22558      0.06       0.07
Rajan Zingales Banking Index lagged             22558      0.71       0.74
Telecom Index lagged                            22558      0.02       0.02
Insurance Index                                 22558      0.01       0.02
Transport Index lagged                          22558      0.10       0.04
Foreign Dummy                                   22558      0.18       0.38
Tariff lagged                                   22558     36.47      17.17
Input Tariff lagged                             22558     16.41       9.38
De-licensing lagged                             22558      0.97       0.15
FDI reform lagged                               22558      0.87       0.33


Table 2: Production function coefficients
                                              OLS                                Ackerberg et al.
                                              Capital     Labor         Sum      Capital            Labor           Sum
Food processing and tobacco products          0.155       0.682          0.837             0.166            0.829   0.995
Textiles                                      0.345       0.604          0.949             0.357            0.543   0.900
Garments, leather goods and shoes             1.002       0.707          1.709             0.074            0.898   0.972
Wood products, paper products, printing and
publishing                                    0.116       0.864          0.980             0.302            0.780   1.081
Coke, fuel, petroleum and chemicals           0.216       0.616          0.832             0.295            0.811   1.106
Plastic and rubber products                   0.326       0.660          0.986             0.261            0.778   1.039
Concrete, cement and glass                    0.139       0.735          0.874             0.437            0.651   1.089
Iron and steel                                0.211       0.611          0.822             0.257            0.677   0.934
Metal products, machinery and tools           0.056       0.832          0.888             0.145            0.831   0.975
Lifting, medical and industrial equipment     0.189       0.824          1.013             0.325            0.678   1.003
Motor vehicles and transport systems          0.218       0.870          1.088             0.312            0.745   1.058




                                                            37
Table 3: Productivity Effects of Services Liberalization. OLS Approach


                                  0.875***
Services Index (t-1)
                                  (0.228)
                                                0.765***                                                               0.620***
Banking Index (t-1)
                                                (0.246)                                                                (0.239)
Banking Index Rajan-Zingales                                   0.164***
weights (t-1)
                                                               (0.033)
                                                                              4.594***                                 4.215***
Telecom Index (t-1)
                                                                              (1.354)                                  (1.320)
                                                                                           0.933                       0.322
Insurance Index (t-1)
                                                                                           (0.930)                     (0.954)
                                                                                                         2.921*        3.282**
Transport Index (t-1)
                                                                                                         (1.587)       (1.548)
                                  0.001         0.000          0.002          0.000        0.000         0.000         0.001
Tariffs (t-1)
                                  (0.002)       (0.002)        (0.002)        (0.002)      (0.002)       (0.002)       (0.002)
                                  -0.002        -0.002         -0.003         0.001        -0.002        -0.004        -0.002
Input Tariffs (t-1)
                                  (0.008)       (0.008)        (0.008)        (0.008)      (0.008)       (0.007)       (0.007)
                                  0.040**       0.041**        0.041***       0.042***     0.044***      0.046***      0.041***
Foreign
                                  (0.016)       (0.016)        (0.016)        (0.016)      (0.016)       (0.016)       (0.016)


Observations                      22,558        22,558         22,558         22,558       22,558        22,558        22,558
R-squared                         0.257         0.256          0.259          0.257        0.255         0.256         0.258
Number of firms                     3771         3771          3771          3771           3771           3771         3771
Notes: The estimated specification is described in equation (4) in the text. The dependent variable is the log of real firm value
added. Explanatory variables include capital and labor, all expressed in real terms and logs. Coefficients on production inputs are
allowed to vary for each of 11 sectors. All specifications include firm and year fixed effects. Robust standard errors, clustered at
the industry-year level, are reported in parentheses. *** denotes significant at the 1 percent level, ** at the 5 percent level, * at
the 10 percent level




                                                                         38
Table 4: Productivity Effects of Services Liberalization. Ackerberg et al. TFP Measure


                                     1.171***
Services Index (t-1)
                                     (0.227)
                                                  1.046***                                                           0.911***
Banking Index (t-1)
                                                  (0.249)                                                            (0.245)
Banking Index Rajan-Zingales                                    0.194***
weights (t-1)
                                                                (0.032)
                                                                              4.765***                               4.037***
Telecom Index (t-1)
                                                                              (1.281)                                (1.213)
                                                                                            1.649*                   0.853
Insurance Index (t-1)
                                                                                            (0.952)                  (0.994)
                                                                                                        3.675**      4.300**
Transport Index (t-1)
                                                                                                        (1.702)      (1.660)
                                     0.001        0.000         0.003         0.000         0.000       0.000        0.001
Tariffs (t-1)
                                     (0.002)      (0.002)       (0.002)       (0.002)       (0.002)     (0.002)      (0.002)
                                     -0.003       -0.003        -0.004        -0.001        -0.003      -0.007       -0.004
Input Tariffs (t-1)
                                     (0.009)      (0.009)       (0.009)       (0.009)       (0.009)     (0.008)      (0.007)
                                     0.027        0.029*        0.030*        0.033**       0.035**     0.041**      0.032**
Foreign
                                     (0.017)      (0.017)       (0.017)       (0.017)       (0.017)     (0.016)      (0.016)


Observations                         22,558       22,558        22,558        22,558        22,558      22,558       22,558
R-squared                            0.032        0.030         0.035         0.030         0.028       0.029        0.034
Number of firms                       3771         3771          3771           3771          3771         3771          3771
Notes: The dependent variable is the log TFP estimated using the Ackerberg et al. method for each of the 11 industries listed in
Table 2. All specifications include firm and year fixed effects. Robust standard errors, clustered at the industry-year level, are
reported in parentheses. *** denotes significant at the 1 percent level, ** at the 5 percent level, * at the 10 percent level




                                                                        39
Table 5: Differential Effect of Services Liberalization on Foreign Firms. Ackerberg et al. TFP Measure

                                      1.106***
Services Index (t-1)
                                      (0.236)
                                      0.135**
Services Index (t-1)* Foreign
                                      (0.063)
                                                   0.932***                                                              0.896***
Banking Index (t-1)
                                                   (0.264)                                                               (0.263)
                                                   0.239**                                                               0.035
Banking Index (t-1) * Foreign
                                                   (0.115)                                                               (0.124)
Banking Index Rajan-Zingales                                      0.182***
weights (t-1)                                                     (0.034)
Banking Index Rajan-Zingales                                      0.026**
weights (t-1) * Foreign                                           (0.012)
                                                                                 4.000***                                3.454**
Telecom Index (t-1)
                                                                                 (1.391)                                 (1.337)
                                                                                 1.442***                                1.198**
Telecom Index (t-1) * Foreign
                                                                                 (0.454)                                 (0.554)
                                                                                              0.914                      0.277
Insurance Index (t-1)
                                                                                              (0.955)                    (0.955)
                                                                                              2.061***                   1.630***
Insurance Index (t-1)* Foreign
                                                                                              (0.449)                    (0.508)
                                                                                                           3.659**       4.347***
Transport Index (t-1)
                                                                                                           (1.700)       (1.656)
                                                                                                           0.258*        -0.225
Transport Index (t-1)* Foreign
                                                                                                           (0.135)       (0.160)
Tariffs (t-1)                         0.001        0.000          0.003          0.000        0.000        0.000         0.001
                                      (0.002)      (0.002)        (0.002)        (0.002)      (0.002)      (0.002)       (0.002)
Input Tariffs (t-1)                   -0.003       -0.003         -0.004         -0.001       -0.003       -0.007        -0.004
                                      (0.009)      (0.009)        (0.009)        (0.009)      (0.009)      (0.008)       (0.007)
                                      0.017        0.021          0.021          0.023        0.024        0.032**       0.021
Foreign
                                      (0.017)      (0.017)        (0.017)        (0.017)      (0.017)      (0.016)       (0.016)

Observations                           22,558       22,558         22,558          22,558       22,558         22,558       22,558
R-squared                              0.032        0.030          0.035           0.030        0.028          0.029        0.035
Number of firms                        3771         3771           3771            3771         3771           3771         3771
Notes: The dependent variable is the log TFP estimated using the Ackerberg et al. method for each of the 11 industries listed in
Table 2. All specifications include firm and year fixed effects. Robust standard errors, clustered at the industry-year level, are
reported in parentheses. *** denotes significant at the 1 percent level, ** at the 5 percent level, * at the 10 percent level




                                                                     40
Table 6: Controlling for De-licensing and FDI Reform. Ackerberg et al. TFP Measure

Services Index (t-1)            1.285***
                                (0.229)
Banking Index (t-1)                           1.212***                                                             1.010***
                                              (0.249)                                                              (0.242)
Banking Index Rajan-
Zingales weights (t-1)                                      0.190***
                                                            (0.031)
Telecom Index (t-1)                                                         5.025***                               4.097***
                                                                            (1.328)                                (1.258)
Insurance Index (t-1)                                                                   2.211**                    1.118
                                                                                        (0.978)                    (0.995)
Transport Index (t-1)                                                                                2.986*        3.569**
                                                                                                     (1.550)       (1.466)
Tariffs (t-1)                   -0.001        -0.001        0.001           -0.001      -0.002       -0.001        -0.000
                                (0.002)       (0.002)       (0.002)         (0.002)     (0.002)      (0.002)       (0.002)
Input Tariffs (t-1)             -0.004        -0.004        -0.005          -0.001      -0.004       -0.007        -0.004
                                (0.008)       (0.008)       (0.008)         (0.008)     (0.009)      (0.008)       (0.007)
De-licensing (t-1)              0.243**       0.217**       0.212*          0.231**     0.217**      0.244**       0.279**
                                (0.110)       (0.109)       (0.109)         (0.111)     (0.109)      (0.110)       (0.113)
FDI reform (t-1)                0.167***      0.173***      0.139**         0.152**     0.164**      0.112*        0.134**
                                (0.064)       (0.065)       (0.064)         (0.066)     (0.065)      (0.057)       (0.057)
Foreign                         0.030*        0.030*        0.033**         0.036**     0.037**      0.043***      0.033**
                                (0.017)       (0.017)       (0.016)         (0.016)     (0.017)      (0.016)       (0.016)


Observations                    22,558        22,558        22,558          22,558      22,558       22,558        22,558
R-squared                       0.036         0.034         0.038           0.033       0.032        0.032         0.037
Number of firms                  3,771        3,771         3,771         3,771          3,771         3,771         3,771
Notes: The dependent variable is the log TFP estimated using the Ackerberg et al. method for each of the 11 industries listed
in Table 2. All specifications include firm and year fixed effects. Robust standard errors, clustered at the industry-year level,
are reported in parentheses. *** denotes significant at the 1 percent level, ** at the 5 percent level, * at the 10 percent level




                                                                       41
Table 7: Productivity Effects of Services Liberalization. Instrumental variables approach using Ackerberg et al. TFP

Second stage regressions
                                              1.277***
Services Index (t-1)
                                              (0.260)
                                                           1.061***                                                        0.864***
Banking Index (t-1)
                                                           (0.247)                                                         (0.280)
                                                                       0.224***
Banking Index Rajan-Zingales weights (t-1)
                                                                       (0.056)
                                                                                      5.459***                        4.199***
Telecom Index (t-1)
                                                                                      (1.469)                         (1.507)
                                                                                                    2.527**           2.646*
Insurance Index (t-1)
                                                                                                    (1.139)           (1.500)
                                                                                                               6.891 10.174**
Transport Index (t-1)
                                                                                                              (4.206) (4.288)
                                              0.0009       0.0004      0.0030         0.0004      0.0002    0.0002    0.0019
Tariffs (t-1)
                                              (0.0018)     (0.0017)    (0.0019)       (0.0018)    (0.0018) (0.0016) (0.0018)
                                              -0.0031      -0.0035     -0.0042        -0.0001     -0.0030   -0.0094   -0.0079
Input Tariffs (t-1)
                                              (0.0090)     (0.0093)    (0.0089)       (0.0090)    (0.0093) (0.0067) (0.0059)
                                              0.027        0.029**     0.030*         0.032*      0.034**   0.045*** 0.038**
Foreign
                                              (0.017)      (0.017)     (0.017)        (0.017)     (0.017)   (0.016)   (0.0160)

Observations                                  22,558       22,558      22,558         22,558      22,558      22,558       22,558
R-squared                                     0.032        0.030       0.035          0.030       0.028       0.028        0.029
Number of firms                               3771         3771        3771           3771        3771        3771         3771

First stage regressions
WTO commitments – China                        2.970***     3.746***    17.665***      1.471***    2.645***    0.675***
                                                (0.229)      (0.288)       (2.282)      (0.199)     (0.598)     (0.196)
WTO commitments – Indonesia                    0.564***     0.210**         1.675      2.117***    0.398**     4.972***
                                                (0.141)      (0.120)       (1.665)      (0.146)     (0.198)     (0.941)
Tariffs (t-1)                                   0.0003       -0.0001    -0.0122***      -0.0000     -0.0000     0.0001
                                               (0.0003)     (0.0001)      (0.0018)     (0.0000)    (0.0000)    (0.0001)
Input Tariffs (t-1)                             0.0006       0.0001        0.0044       -0.0000     -0.0000     0.0004
                                               (0.0005)     (0.0001)      (0.0074)     (0.0001)    (0.0001)    (0.0003)
Foreign                                        0.003***     0.001**         -0.001       0.000      0.000*      -0.001
                                                (0.001)      (0.000)       (0.009)      (0.000)     (0.000)     (0.000)
Test statistics
F-stat                                             129.470     151.650        34.440      291.620    16.590       50.410       20.690
p-value                                             0.000        0.000         0.000       0.000      0.000        0.000        0.000
Sargan test                                         0.068        0.216         0.322       0.763      1.561        6.040        5.345
p-value                                             0.795        0.642         0.570       0.382      0.212        0.014        0.254
Notes: The dependent variable is the log TFP estimated using the Ackerberg et al. method for each of the 11 industries listed in Table 2. All
specifications include firm fixed effects. Robust standard errors, clustered at the industry-year level, are reported in parentheses. *** denotes
significant at the 1 percent level, ** at the 5 percent level, * at the 10 percent level.




                                                                       42
 Table 8: Productivity Effect of Services Liberalization, Structural Break Approach. Ackerberg et al. TFP measure


                                     2.626***                                                                     2.269***
 Banking Break 2001
                                     (0.641)                                                                      (0.549)
                                                       0.484***
 Rajan-Zingales Break 2001
                                                       (0.081)
                                                                      8.126***                                    6.226***
 Telecom Break 2002
                                                                      (2.347)                                     (2.223)
                                                                                     5.218**                      3.015
 Insurance Break 2002
                                                                                     (2.227)                      (1.937)
                                                                                                   8.103***       8.528***
 Transport Break 1997
                                                                                                   (2.628)        (2.633)
                                     0.000             0.003          0.000          0.000         -0.000         0.001
 Tariffs (t-1)
                                     (0.002)           (0.002)        (0.002)        (0.002)       (0.002)        (0.002)
                                     -0.004            -0.004         -0.003         -0.003        -0.010         -0.009
 Input Tariffs (t-1)
                                     (0.009)           (0.009)        (0.009)        (0.009)       (0.007)        (0.006)
                                     0.029*            0.030*         0.034**        0.035**       0.043***       0.034**
 Foreign Dummy
                                     (0.017)           (0.017)        (0.017)        (0.017)       (0.016)        (0.016)

 Observations                        22,558            22,558         22,558         22,558        22,558         22,558
  R-squared                           0.030            0.034           0.029          0.028         0.032           0.036
  Number of firms                     3771             3771            3771           3771          3771            3771
Notes: The dependent variable is the log TFP estimated using the Ackerberg et al. method for each of the 11 industries listed
in Table 2. All specifications include firm and year fixed effects. Robust standard errors, clustered at the industry-year level,
are reported in parentheses. *** denotes significant at the 1 percent level, ** at the 5 percent level, * at the 10 percent level




                                                                       43
 Table 9: Productivity Effect of Services Liberalization, Structural Break Approach.
 Differential Effect of Services Liberalization on Foreign Firms. Ackerberg et al. TFP Measure


                                     2.376***                                                                     2.318***
 Banking Break 2001
                                     (0.667)                                                                      (0.592)
                                     0.649*                                                                       -0.179
 Banking Break 2001 *Foreign
                                     (0.384)                                                                      (0.376)
                                                      0.449***
 Rajan-Zingales Break 2001
                                                      (0.085)
 Rajan-Zingales Break 2001*                           0.097**
 Foreign
                                                      (0.046)
                                                                     6.145**                                      4.962*
 Telecom Break 2002
                                                                     (2.670)                                      (2.626)
                                                                     5.484***                                     3.418
 Telecom Break 2002*Foreign
                                                                     (1.965)                                      (2.256)
                                                                                    3.558*                        1.934
 Insurance Break 2002
                                                                                    (2.122)                       (1.818)
                                                                                    4.884***                      3.266**
 Insurance Break 2002*Foreign
                                                                                    (1.184)                       (1.369)
 Transport Break 1997                                                                              7.983***       8.433***
                                                                                                   (2.640)        (2.640)
                                                                                                   1.306***       0.989**
 Transport Break 1997*Foreign
                                                                                                   (0.481)        (0.471)
                                     0.000            0.003          0.000          0.000          -0.000         0.001
 Tariffs (t-1)
                                     (0.002)          (0.002)        (0.002)        (0.002)        (0.002)        (0.002)
                                     -0.004           -0.004         -0.003         -0.003         -0.010         -0.009
 Input Tariffs (t-1)
                                     (0.009)          (0.009)        (0.009)        (0.009)        (0.007)        (0.007)
                                     0.019            0.012          0.018          0.019          -0.013         -0.025
 Foreign Dummy
                                     (0.017)          (0.018)        (0.017)        (0.017)        (0.024)        (0.024)

 Observations                        22,558           22,558         22,558         22,558         22,558         22,558
 R-squared                            0.030            0.034          0.030           0.029           0.032          0.037
 Number of firms                      3771             3771           3771            3771            3771           3771
Notes: The dependent variable is the log TFP estimated using the Ackerberg et al. method for each of the 11 industries listed in
Table 2. All specifications include firm and year fixed effects. Robust standard errors, clustered at the industry-year level, are
reported in parentheses. *** denotes significant at the 1 percent level, ** at the 5 percent level, * at the 10 percent level




                                                                      44
Table 10: Break falsification test. Ackerberg et al. TFP Measure

                        Banking      Banking      Banking break       Banking break        Telecom break       Telecom break        Insurance      Insurance     Transport      Transport
                        break        break        (Rajan-             (Rajan-                                                       break          break         break          break
                                                  Zingales)           Zingales)
                        2001         2001         2001                2001                 2002                2002                 2002           2002          1997           1997
Break                   2.610***     2.480***     0.528***            0.558***             9.125***            9.794***             5.198**        3.890         8.053***       7.427***
                        (0.662)      (0.706)      (0.084)             (0.091)              (2.528)             (2.605)              (2.345)        (2.417)       (2.635)        (2.633)
Falsification test: 1   -0.070                    0.180                                    4.565*                                   -0.099                       0.381
year prior to break
                        (1.171)                   (0.129)                                  (2.763)                                  (1.836)                      (1.259)
Falsification test: 2                -0.330                           0.161*                                   4.070                               -3.378*                      2.700*
years prior to break                 (0.854)                          (0.095)                                  (2.765)                             (1.961)                      (1.397)
Tariffs (t-1)         0.000          0.000        0.003               0.003*               0.001               0.000                0.000          0.000         -0.000         -0.000
                      (0.002)        (0.002)      (0.002)             (0.002)              (0.002)             (0.002)              (0.002)        (0.002)       (0.002)        (0.002)
Input Tariffs (t-1)   -0.004         -0.004       -0.004              -0.004               -0.003              -0.002               -0.003         -0.003        -0.010         -0.010
                      (0.009)        (0.009)      (0.009)             (0.009)              (0.009)             (0.009)              (0.009)        (0.009)       (0.007)        (0.007)
Foreign Dummy         0.029*         0.029*       0.029*              0.029*               0.033**             0.033**              0.035**        0.036**       0.043***       0.044***
                      (0.017)        (0.017)      (0.017)             (0.017)              (0.017)             (0.017)              (0.017)        (0.017)       (0.016)        (0.016)
Observations          22,558         22,558       22,558              22,558               22,558              22,558               22,558         22,558        22,558         22,558
R-squared             0.030          0.030        0.035               0.035                0.030               0.030                0.028          0.028         0.032          0.033
Break coeff = year(s) prior coeff
F-stat                  5.21        10.74         7.2                 17.09                2.91                4.39                5.02           7.57           6.59           2.36
p-value                 0.023       0.001         0.008               0.000                0.089               0.037               0.026          0.006          0.011          0.126
Notes: The dependent variable is the log TFP estimated using the Ackerberg et al. method for each of the 11 industries listed in Table 2. All specifications include firm and year
fixed effects. Robust standard errors, clustered at the industry-year level, are reported in parentheses. *** denotes significant at the 1 percent level, ** at the 5 percent level, * at
the 10 percent level.




                                                                                           45
Table 11: Differential Effect of Services Liberalization on Foreign Firms. Ackerberg et al. TFP Measure.
Adding Industry Time Trends

                                      0.921***
Services Index (t-1)
                                      (0.300)
                                      0.183***
Services Index (t-1)* Foreign
                                      (0.061)
                                                      0.978***                                                                  1.184***
Banking Index (t-1)
                                                      (0.331)                                                                   (0.333)
                                                      0.273**                                                                   -0.025
Banking Index (t-1) *Foreign
                                                      (0.109)                                                                   (0.128)
Banking Index Rajan-Zingales                                         0.108***
weights (t-1)                                                        (0.039)
Banking Index Rajan-Zingales                                         0.040***
weights (t-1) * Foreign                                              (0.011)
                                                                                    0.339                                       -1.110
Telecom Index (t-1)
                                                                                    (1.872)                                     (1.876)
                                                                                    1.316***                                    0.918*
Telecom Index (t-1) * Foreign
                                                                                    (0.442)                                     (0.550)
                                                                                                   1.841                        2.519
Insurance Index (t-1)
                                                                                                   (1.739)                      (1.958)
                                                                                                   2.257***                     1.909***
Insurance Index (t-1)* Foreign
                                                                                                   (0.492)                      (0.594)
Transport Index (t-1)                                                                                             -0.119        0.295
                                                                                                                  (0.701)       (0.683)
                                                                                                                  0.251*        -0.071
Transport Index (t-1)* Foreign
                                                                                                                  (0.143)       (0.172)
Tariffs (t-1)                         0.000           0.000          -0.000         0.001          0.001          0.001         -0.000
                                      (0.002)         (0.002)        (0.002)        (0.002)        (0.002)        (0.002)       (0.002)
Input Tariffs (t-1)                   0.000           -0.000         0.000          0.001          0.000          0.001         -0.001
                                      (0.004)         (0.004)        (0.004)        (0.004)        (0.004)        (0.004)       (0.004)
                                      0.015           0.022          0.017          0.022          0.021          0.023         0.019
Foreign
                                      (0.016)         (0.016)        (0.016)        (0.016)        (0.016)        (0.017)       (0.017)

Observations                           22,558          22,558          22,558         22,558       22,558          22,558        22,558
R-squared                              0.029           0.029           0.030          0.027        0.028           0.027         0.031
Number of firms                        3771            3771            3771           3771         3771            3771          3771
Notes: The dependent variable is the log TFP estimated using the Ackerberg et al. method for each of the 11 industries listed in Table 2.
All specifications include firm fixed effects. Robust standard errors, clustered at the industry-year level, are reported in parentheses. ***
denotes significant at the 1 percent level, ** at the 5 percent level, * at the 10 percent level




                                                                       46
 Table 12: Robustness Check on Autocorrelation. Ackerberg et al. TFP Measure


                                    2.859***
 Banking Break 2001
                                    (0.686)
                                                     0.412***
 Rajan-Zingales Break 2001
                                                     (0.061)
                                                                   30.678***
 Telecom Break 2002
                                                                   (2.411)
                                                                                   15.203***
 Insurance Break 2002
                                                                                   (2.219)
 Transport Break 1997                                                                              -1.453***
                                                                                                   (0.512)

 Observations                       6,142            6,142         6,059           6,059           5,440
 R-squared                             0.003            0.007           0.026            0.008      0.001
 Number of firms                       3771             3771            3771             3771       3771
Notes: The dependent variable is the log TFP estimated using the Ackerberg et al. method for each
of the 11 industries listed in Table 2. *** denotes significant at the 1 percent level, ** at the 5
percent level, * at the 10 percent level




                                                                    47
[ON-LINE APPENDICES, NOT FOR PUBLICATION]
Appendix A. Recent History of Services Reform in India

In collaboration with a team of local economists in India, we collected detailed information about policy changes
affecting services sectors, in order to identify the key policy breaks for each sector. The local team consulted
extensively with government and regulatory agencies, business associations, and sector specialists. These
consultations were helpful to get an understanding of the relative importance of different policy changes, and to get
a grasp of the degree to which reforms were actually implemented at a given point in time. One of the main angles
from which we looked at services reform was the degree to which market forces were active in the sector, triggered
by the possibility of new entry into the sector, both domestic and foreign. In some cases, legal or de-facto
restrictions on entry were reduced, leading to actual entry of new providers, and in other cases market discipline
increased due to a potential threat of new entry.

Our investigations took into account any major policy changes enacted between 1991 and 2003. In 1991, India
embarked on a radical change of course in economic policy, involving deregulation and tariff reductions in many
sectors. The initial reforms affected principally manufacturing sectors, while services were generally affected in the
years following the first reforms. We record the first significant changes in financial services, telecommunications
and transport as early as the 1993/94 fiscal year.25 In what follows we highlight some of the major policy changes
we recorded for 4 services sectors, and then describe our strategy for quantifying this information into a services
reform index.

Telecommunications

Initially, the sole provider of telecom services in India was the Department of Telecommunications (DoT), a
government agency. Two large corporate entities were spun off from DoT in 1986, MTNL for Delhi and Mumbai,
and VSNL for all international services.

The process of entry of private players in providing telecommunication services commenced in 1992 with several
licenses issued to the private sector, for a switching capacity of over 1.5 million lines. The first privately-owned
lines in operation were limited to private networks in industrial areas, which emerged during the fiscal year
1993/94.

In the 1994/95 fiscal year, cellular phone service emerged in India, with initially only consumers in major cities
being able to choose between providers. All of these have a minority participation of foreign capital, which is
restricted to 40 percent of equity.

During the same fiscal year, the government announced a new National Telecom Policy, which was the first official
recognition of a move towards a privately operated telecommunications sector. The new policy provided the
guidelines for further private sector engagement in Indian telecommunications. For fixed line services, the
government decided to issue one additional license to provide basic telecom services in each state, additional to the
local public incumbent provider. The licensing process for this begins but is not concluded in this fiscal year.

During 1995/96, the government attempted to auction additional licenses for both landline and cellular services,
with some letters of intent issued to some operators for cellular operations. Rebidding had to take place for landline
licenses in 13 states after the initial bids were considered low. Towards the end of that fiscal year, the telecom
regulator (TRAI) was set up, to regulate further private engagement and settle disputes between operators.



25
  We dated policy changes to the fiscal year rather than to the calendar year. The fiscal year in India starts on April 1 st and
ends on March 31st.
                                                                 48
In 1996/97, the government issued letters of intent for additional licenses in fixed services, and removed restrictions
on cross-border borrowing for telecom projects. The following fiscal year saw the opening up of internet services
for private providers, as well as the expansion of the definition of priority sector lending to include telecoms
projects. This facilitated access to credit for telecom investments. In June 1998, the first private landline services
became operational. By 1998, there was an effective choice of cellular services providers across most of the
country.

During the 1999/00 fiscal year, the government issues a new telecommunications policy, which strengthened the
regulating agency and outlined a further opening up of national long distance to private sector as well as the
liberalization of international calls. Moreover, the licensing fee arrangements were shifted from a fixed license fee
to revenue sharing for existing cellular and fixed line providers which reduced financing constraints of operators.
The Department of Telecommunications was corporatized during the 2000/01 fiscal year.

During the 2002/03 fiscal year, the national long distance sector was opened to the private sector without any
restriction on the number of operators. Despite an initial announcement of liberalizing the international segment in
2004, the government also terminated the VSNL monopoly in international services at the beginning if the 2002/03
fiscal year.


Transport Services

Before the beginning of the reforms in the transport sector, the state played a dominant role in all segments. In air
transport, there were two public monopoly carriers: Indian Airlines for domestic routes and Air India for
international connections. Airport infrastructure was almost entirely operated by the National Airports Authority
and the International Airports Authority, two public sector entities. In maritime transport services, the state
controlled the major ports, and shipping services were controlled by both public and domestic private enterprises.
The latter were tightly regulated by the state, and required official permissions for acquiring and selling a vessel. In
the road transport sector, the public sector was the only provider of road infrastructure, and only nominal tolls were
collected at a few bridges. Transport operations were subject to many rules and regulations related to the
registration of different types of vehicles. Preferential access to credit for small trucking companies implied that
these accounted for about 95 percent of the sector.

In 1990/91, citizens were allowed to apply for a license to operate air taxis, which was a way to circumvent to the
domestic air transport monopoly to a limited degree. Air taxis faced a number of limitations, however. They were
constrained to using small air craft and could not publish regular schedules. In maritime transport, regulation was
changed in 1992/93 so as to allow foreign shipping lines to bring containers from the hinterland to a port and carry
them to destinations abroad without trans-shipment en route. The acquisition and sale of vessels was no longer
subject to government approval as of this fiscal year.

In 1993/94, entry into domestic air services was liberalized substantially with the official abolition of Indian
Airlines‟ monopoly on domestic air services. This resulted in entry into domestic air services and competitive
pressure in the domestic market. In maritime transport, freight and passengers fares which were previously set by
the public sector were decontrolled to promote coastal shipping. In road transport, the National Highways Act was
amended to enable levying of a fee on selected sections of national highways. This was an important step towards
encouraging private engagement in road construction. In addition, most states abolished the “octroi� duty in
1993/94, which had previously acted as an internal tariff levied on the movement of goods across states.

In 1994/95, private participation was invited into the construction of container terminals, warehousing and storage
facilities and for repairs and transportation within ports. In road transport, an amendment was passed to remove
ceilings on the number of stage carriage permits that can be held by an individual or a company, thus facilitating the
emergence of large trucking companies in a sector that was previously restricted to small enterprises. The

                                                          49
government also created the National Highways Authority (NHAI) in order to accelerate the pace of private sector
participation in road building.

During 1995/96, operative restrictions on shipping companies were loosened. In particular, these were permitted to
get their ships repaired at any shipyard without seeking prior approval from the government. In the following fiscal
year, local equity requirements for companies owning a ship in India were abolished.

In 1997/98, foreign direct investment (FDI) in airlines was allowed up to a 40 percent ceiling, although foreign
airlines were still barred from investing in the Indian air transport sector. Non-resident Indians were exempted from
the FDI ceiling. In maritime transport, FDI up to 74 percent of equity was allowed in port construction and up to 51
percent in support activities such as pier operation. In road transport, 100 percent private engagement on a BOT
(“Build, operate, transfer�) basis was permitted. Prior to this, the role of the private sector had been dismal, except
as contractors to the government entities involved in infrastructure creation. For up to 74 percent of foreign
participation in the construction, maintenance of roads and bridges, the investment approval was made automatic.
In those cases where the collection of tolls was suspended due to political opposition, the government pledged to
compensate investors according to international norms. The FDI ceiling in port construction was abolished entirely
in 1998/99.

Starting in 1999/00, foreign equity participation in air infrastructure ventures was permitted up to 74 percent with
automatic approvals and up to 100 percent with special permissions. Restructuring of some of the airports of the
Airport Authority of India was envisaged to take place through long term leases to the private sector. In 2004,
private airlines were allowed to operate international routes from India. Private airline Jet Airways has already
gained a market share of 46 percent.


Banking Services

In the initial situation before 1993, public sector banks controlled most of the Indian market for banking services,
coexisting with a few international banks and private banks. The expansion of foreign banks, however, was limited
by a host of explicit and non-explicit hurdles. Branch licensing policy required any bank to obtain a license before
it could open a branch. The Ministry of Finance was responsible for the operations of public sector commercial
banks and the RBI regulated all banks‟ activities. Interest rates of all types were determined by the government, and
market forces were generally not active in this sector.

In the 1993/94 fiscal year, the government passed legislation to establish the in-principle approval of new private
sector banks. The in-principle approval meant that the government was generally open to new entry with no explicit
barriers, but potential entrants still had to go through various clearance processes. Approvals were not easy due to
stringent RBI regulatory supervision. Equity holdings in new private banks up to 20 percent were explicitly allowed
to “foreign institutional investors�, but foreign banks were barred from holding equity in a new private bank in
India. Non-resident persons of Indian origin (termed NRIs) could hold equity of up to 40 percent. As far as
operations are concerned, bank lending norms were liberalized and banks were given more freedom to allocate their
inventories and receivables across different items. They were also allowed greater freedom in deploying their
foreign exchange resources. Seven new private banks entered the market in this fiscal year.

The period between 1994 and 2000 saw only minor changes to banking regulations. A first cautious attempt of
deregulating interest rates was made in 1994/95, but this only affected very large loans and hence a few corporate
houses able to borrow such large amounts. The active interest rates on deposits over 2 years were freed in 1996/97.
Moreover, the ceiling for housing loans to private individuals was raised in 1998/99, and a number of items were
added to the definition of “priority sectors�, to which 40 percent of all lending was funneled by regulation.



                                                          50
In 2000/01, the government revised norms for entry of new banks in the private sector. While the government had
signaled its general acceptance of private entry in 1994/95, this measure reduced the implicit barriers to entry. As of
2000, entry was made easier provided the entrant observed a continuous capital adequacy ratio of 10 percent from
the date of start of operation and opened 25 percent of the branches in rural and semi urban areas. In addition, every
bank was subject to allocating 40 percent of lending to priority sectors. In the same year, the government signaled
its intention to eventually withdrawing from being a major player in the banking sector by reducing the minimum
government equity share in nationalized banks to 33 percent and enabling the public sector banks to raise fresh
equity from the capital.

In 2001/02, the government undertook a major step towards the deregulation of interest rates. Banks were allowed
to lend at rates below the official “Prime Lending Rate� to exporters and other credit worthy borrowers (including
public enterprises). Banks were allowed to set their own lending rates, and to undercut them when necessary. This
marked the emergence of price competition for loans. Private sector banks have grown significantly more important
as lenders by this time.

The restrictions to foreign engagement in the Indian banking sector were significantly reduced in 2002/03. The
clearance process for foreign participation up to 49 percent in private banks was made automatic, rather than case-
by-case as before. Beyond this ceiling for automatic clearance, foreigners could still apply for case-by-case
permission. Foreigners could also acquire capital shares up to 20 percent in public sector banks,

In the Union Budget for 2003/04, the limit of Foreign Direct Investment (FDI) in banking companies was raised
from 49 percent to 74 percent. Aggregate foreign investment in a private bank from all sources allowed up to a
maximum of 74 percent of the paid up capital of the bank. A full opening of the Indian banking sector to foreign
capital, however, is yet to come.


Insurance services

Reforms in the insurance sector commenced only in the second half of the 1990s. Prior to that, insurance was a
public sector dominated sector. Life, general and medical insurance were all only conducted by four public sector
entities under the control of the Ministry of Finance. A handful of very small domestic private sector insurers did
exist. The level of competition was very low as each of the 4 large entities tended to specialize in one or two
segments of the insurance market.

In 1998/99, the government announced its intention to open the Indian insurance industry to the private sector,
including joint ventures between domestic and foreign providers. This announcement was implemented with the
Insurance Regulatory Development Authority (IRDA) Bill passed in December 1999, which explicitly opened up
the insurance sector to private providers, allowed foreign equity in domestic insurance companies subject to a
maximum of 26 percent of capital. Potential new entrants would have substantial freedom with respect to pricing
and management decisions, but would be subject to regulatory supervision. However, an entry permission was still
required, and given the dominance of the public sector enterprises, significant acquisitions were more or less ruled
out.

In 2000/01, the regulator passed 15 regulations regarding freedom of operations of private insurance companies as
well as explicit disclosure norms. While this was important to define the rules of private entry, actual entry of
private insurers did not take place before 2002. During the 2002/03 fiscal year, 12 new companies, among which
life insurance and general insurance companies, were granted licenses and started business. In 2005, the
government announced its intention to raise the FDI limit in the insurance sector from 26 percent to 49 percent.




                                                          51
Appendix B. The Construction of the Services Policy Reform Index

In order to make the services policy information amenable to quantitative analysis, we translated the policy changes
into a sector-specific reform index, taking values from 0 to 5.26 Our primary concern was to maintain comparability
across sectors, because our empirical strategy measures firms‟ exposure to upstream services reform by means of a
weighted sum of the state of reform in four services sectors. Common definitions of what level of reform
constitutes a given value of the index were used to preserve comparability. We started out with a general template
of degrees of openness that is not specific to any sector, and then adapted this template to the specificities of each
of the four services sectors.

In our general template, we attach an index value of 0 to a situation where hardly any progress has been made and
the public sector is either the only relevant provider of services or has an extremely strong grip on private
providers. A level of 1 indicates at least some scope for private sector participation and some liberalization of
operational decisions, combined with some very limited scope for foreign participation (limited, for example, by
low FDI ceilings or announced only as intentions). In order to qualify for an index value of 2, we required that there
be only a limited degree of interference with operational decisions by public authorities, a substantial price
liberalization, and clear scope for foreign participation even if only in narrowly defined segments and as minority
participations. Still, the state remains a dominant actor in the sector. An index of 3 implies significant scope for
private providers, including foreign ones, a noticeable competitive pressure on the public incumbents from new
entrants, and explicit possibilities for foreign equity participation. A level of 4 is equivalent to little public
intervention into the freedom of operation of private providers, the possibility of majority foreign ownership, and
the dominance of private sector entities. Finally, a level of 5 would be equal treatment of foreign and domestic
providers, a full convergence of regulation with international standards and unrestricted entry into the sector.

In adapting the template to sectors, one needs to take into account that in some sectors liberalization can proceed at
different paces in different segments. In telecommunications, for example, developing countries are typically
quicker to allow private (and foreign) capital into cellular services than into landlines. In segments where private
entry is possible, operators tend to face relatively little public intervention in the operation of their business. As a
result, one is likely to observe a coexistence of segments in which market forces can govern more freely with others
that remain a public monopoly. In other sectors such as banking, there is no such natural division into segments.
Instead, one might find a situation in which private (and foreign) entry has taken place into the provision of almost
all banking products, but significant public interference with private decisions remains in the form of directed
lending to priority sectors or interest rate restrictions. Hence the need to rephrase the index definitions for different
sectors while trying to maintain the same sense of “average� openness associated to a given level of the services
reform index. In what follows we present the sector-specific definitions of the index, and juxtapose these with the
actual reform events that determined progress to the next level of the index. To illustrate India‟s reform progress in
the services sectors we analyze in this paper, Figure 1 gives a graphical illustration of the variation contained in the
services reform index.




26
  The European Bank for Reconstruction and Development produces a similar set of indices for transition countries in their
2004 Transition Reform, and some of the definitions used in that index have inspired the construction of our index.
                                                             52
Figure B1. A graphical representation of the Services Policy Reform Index




                                                            53
Telecommunications

    Definition of step                                              Year of achievement in India, and accomplishments indicating
                                                                    reform progress
0        Clear public sector dominance with no private
         sector involvement
         At most announcement of future private sector role
         strong political interference in management
         decisions
         low tariffs and extensive cross-subsidies
1        Some first instances of private sector involvement,        1993/94   The first private networks in industrial areas were
         but limited to particular segments of the market.                    licensed and put in operation. Licensing process for
         Some liberalization of operational decisions where                   cellular service begins, envisaging the possibility for
         private sector is involved.                                          foreign participation.
         At most there is talk about allowing foreign
         presence, but not yet in operation.
2        Private participation begins in important segments         1994/95   Private cellular service providers emerge in major cities,
         of the market, most likely the cellular segment                      all of which have some foreign equity. Process of issuing
         (which tends to be the first to rely on private                      further licenses to private sector begins. New Telecom
         participation).     In     these   segments,      public             Policy announced to define framework for further
         interference with operational decisions is limited.                  private sector participation.
         There is clearly defined scope for foreign                           FDI possible up to 49 percent.
         participation, but with certain limits.
         In other segments, the public sector remains
         dominant, with fixed-line tariffs still politically set.
3        Significant scope for private providers, including         1999/00   New Telecom Policy issued which defines the way ahead
         foreign ones, beyond one segment of the market.                      for a complete opening of national and international
         Some competitive pressure on pre-reform fixed line                   long distance market. Regulator strengthened, licensing
         incumbent.                                                           fee arrangement made more favorable for private
         Explicit     possibilities     for   foreign      equity             operators.
         participation.
4        Hardly any public intervention in cellular and             2002/03   National long distance market fully open with no
         value added services, where the private sector is                    restrictions on the number of operators. Public
         dominant and foreign investors significantly                         monopoly in international gateways abolished.
         present. Free entry into relevant segments of the
         fixed line market. Comprehensive regulatory and
         institutional reforms.
5        Private sector providers dominate in almost all            -
         segments. Effective regulation through independent
         regulator including a coherent framework to deal
         with interconnection and licensing. Effective
         competition in most segments of the market with
         unrestricted entry.




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Transport

Definition of step                                             Year of achievement in India, and accomplishments indicating
                                                               reform progress
0     Little progress, public sector is the sole provider of
      all infrastructure, and has dominant stakes in
      several segments of the transport sector. Where the
      public sector is not an operator such as in road
      transport, it regulates operations heavily.
1     Increased scope for private sector participation in      1993/94   Abolition of the formal monopoly in domestic air
      some segments of the sector.                                       services, entry into domestic air services. Liberalization
      Some liberalization of operational decisions                       of prices in maritime freight and passenger transport.
      Some limited scope for foreign participation in serv               Explicit recognition of the possibility to levy user fees
      provision                                                          on national highways, which was considered a
      At most there is talk about allowing foreign                       precondition for private engagement.
      presence, but not yet in operation.
2     Private participation begins in important segments       1997/98   FDI in air transport up to 40 percent is allowed
      of the market. In these segments, public                           (although foreign airlines are excluded). Majority FDI
      interference with operational decisions is limited.                possible in the construction and operation of ports. First
      There is clearly defined scope for foreign                         private sector engagement in road infrastructure under
      participation, but with certain limits. In other                   the “Build, Operate, Transfer� scheme.
      segments, the state remains the dominant actor.
3     Significant scope for private providers, including       2004/05   Private airlines permitted to serve international routes.
      foreign ones, beyond one segment of the market.                    Both public sector airlines feel significant competitive
      Some competitive pressure on public sector                         pressure from private competitors.
      operators.
      Explicit     possibilities   for    foreign     equity
      participation.
4     Important segments are almost free of public             -
      intervention, with private sector operators being
      dominant and significant foreign engagement
      present. Free entry into relevant segments of the
      transport market.
5     Private sector providers dominate in almost all          -
      segments. Effective competition in most segments
      of the market with unrestricted entry. Equal
      treatment of foreign and domestic providers.




                                                                   55
Banking

Definition of step                                            Year of achievement in India, and accomplishments indicating
                                                              reform progress
0     Little progress, public sector plays the dominant
      role. Where there are private operators, their
      operations and scope of services on offer are tightly
      regulated.
1     Increased scope for private sector participation.       1993/94   Legislation passed to signal government’s in-principle
      Some liberalization of operational decisions, but                 approval of new private entry into banking sector. 7
      directed lending remains prevalent. Some limited                  new banks enter the market. FDI up to 20 percent but
      scope for foreign participation in domestic banks.                foreign banks are barred. Banks given more freedom to
                                                                        allocate their inventories and receivables across different
                                                                        items.
2     Significant private participation becomes possible.     2000/01   Discretionary barriers to entry into banking sector are
      Public interference with operational decisions and                lowered significantly. State signals its intent to
      discretionary barriers to entry are limited. There is             eventually withdraw from the banking sector.
      clearly defined scope for foreign participation, but
      with certain limits. The state remains a dominant
      actor.
3     Significant scope for private banks, including          2001/02   Major interest rate deregulation allows banks to set
      explicit    possibilities   for    foreign    equity              prices more freely. Private sector banks gain more
      participation. Some competitive pressure on public                relevance as lenders and begin to crowd out public
      sector operators.                                                 sector banks in some instances.
4     Important segments are almost free of public            2002/03   Foreign participation in Indian banks is made
      intervention, with private sector operators being                 significantly easier. Clearance for up to 49 percent of
      dominant and significant foreign engagement                       equity is automatic, and majority ownership is possible
      present. Free entry into relevant segments of the                 subject to case-wise approval.
      transport market. Majority foreign ownership is
      possible.
5     Private sector providers dominate in almost all         -
      segments. Effective competition in most segments
      of the market with unrestricted entry. Equal
      treatment of foreign and domestic providers. Full
      convergence of regulation with international
      standards.




                                                                  56
Insurance

Definition of step                                            Year of achievement in India, and accomplishments indicating
                                                              reform progress
0     Little progress, public sector plays the dominant
      role.
1     Increased scope for private sector participation.       1999/00   Bill passed to open up the insurance sector to private
      Some liberalization of operational decisions, but                 entry, including foreign equity participation up to 26
      still massive intervention. Some limited scope for                percent. Substantial freedom with respect to pricing, but
      foreign participation but low FDI ceilings.                       strict regulatory supervision. Discretionary entry
                                                                        permission was required, and no acquisitions possible
                                                                        due to public sector dominance.
2     Significant private participation becomes possible.     -
      Public interference with operational decisions and
      discretionary barriers to entry are limited. There is
      clearly defined scope for foreign participation, but
      with certain limits. The state remains a dominant
      actor.

3     Significant scope for private banks, including          2002/03   Entry of 12 new private providers of insurance services,
      explicit    possibilities  for    foreign     equity              which constitutes a massive shake-up of the market.
      participation. Some competitive pressure on public                Competitive pressure on incumbent public insurers. FDI
      sector operators.                                                 ceiling remains at 26 percent.
4     Most operational decisions are almost free of public    -
      intervention, with private sector operators being
      dominant and significant foreign engagement
      present. Free entry into relevant segments of the
      market. Majority foreign ownership is possible.
5     Private sector providers dominate. Effective            -
      competition in most segments of the market with
      unrestricted entry. Equal treatment of foreign and
      domestic providers. Wide array of insurance
      services available at competitive prices. Full
      convergence of regulation with international
      standards.




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