# **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.<sup>26</sup> 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.

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