during the first half of the nineties, the structure and operation of existing Indian firms was not significantly altered.

From the perspective of the financial sector, Mohan (2004) notes: “The exuberance of investment activity in the mid-1990s also led to the creation of over capacity in industry, including some uncompetitive capacity that led to erosion of profits which, in turn, perhaps explains the poor performance of the stock market during this latter period.” This investment boom was accompanied by a large increase in public equity issues. Data in Mohan (2004) indicate that such issues rose from 0.7 percent of GDP during the 1980s to 1.1 percent during the Eighth Plan period, 1992/93-1996/97, almost vanishing during the Ninth Plan period, 1997/982001/02, at 0.1 percent.<sup>22</sup> And Mor et al. (2005, p. 5) describe the impact on the financial sector thus: “These mounting NPAs (non-performing assets) together with excess capacity, suggests a strong possibility that these two developments were linked to each other in a causal fashion. Almost 4 in 5 projects experienced large delays in implementation and a few celebrated cases could not complete financial closure because of the collapse of equity markets. Three of the five major financial institutions, Unit Trust of India (UTI), Industrial Finance Corporation of India (IFCI) and Industrial Development Bank of India (IDBI) had to be given large infusions of capital by the Government of India.” <u>Large Cuts in Public Investment.</u> In addition to the firm-level microeconomic restructuring, cuts in public infrastructure investment are likely to have contributed to the slowing of private investment as there appears to be a “crowding in” effect (RBI 2002). IMF (2002) estimates a model of private investment growth in India for 1970/71 – 1999/2000. The estimation results indicate that only public sector investment in infrastructure had a positive effect on private investment, a result corroborated by RBI (2002). Higher growth in public consumption or other public investment inhibited private investment growth. Almost 70 percent of the slowdown in private investment in the late 1990s was attributed to a deterioration in the composition of public expenditures, which shifted towards public consumption and non-infrastructure investments after 1995/96 compared to the earlier part of the decade. The estimated impact is roughly divided equally between the negative effect of weaker growth of infrastructure investments and of faster growth of other public spending.

<u>Key structural reforms have taken time to reach a critical mass.</u> It took some time for the stronger competitive pressures from trade liberalization and the entry of new firms to feed through. Forbes (2002, p. 149) wrote: “It is only in the last four years _(i.e., 1996-99)_ as industrial growth has fallen and industry has come under the dual pressure of competition from imports and falling margins that firms have been forced to look at which activities they really wish to retain.” (Material in italics added) Moreover, the most dramatic decline in effective tariffs did not take place until the early part of this century.

**_Third Stage_** The third stage coincides with the resurgence in growth starting in 2003/04.  It has its roots in the restructuring which began during the second stage, in which import competition and the resultant compression of profit margins compelled firms to restructure and become more innovative.  As noted previously, firm-level evidence from the transition countries indicates that hard budgets and competition—especially when they threaten firms’ survival—can lead to profound microeconomic restructuring.  An interesting feature is that some element of

> 22 Mohan (2004), Table 9, page 333.

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