Education business, in India is neither good nor bad. It is a business, which should be regulated by the forces of supply and demand rather than government interference.
The college managements should be able to charge whatever they want from students to run the establishment. When asking for any amount is legitimate, all the money that changes hands would be legitimate. Also, if the amount is too high for the services provided, the demand would go down and the management would be forced to lower it.
Also, the government should allow anybody to start any number of colleges for any reason, as long as they meet the national and university standards. If, for any reason they cannot keep up with the standards, the management should be made responsible for the transfer of all the students affected to other good quality colleges with all the expenses borne by the management. This is just a theory though, as more creative ways of enforcement can always be implemented.
Furthermore, no management would want to give the seats in its college only to students who are willing to pay the best price. This will only result in diminishing quality of the institution and it would only makes it more difficult for the management to demand more money. Also, the best students would always be courted by the best colleges so that they can improve the institution's reputation and this would result in those students getting scholarships or other incentives to attend a specific college.
These all would deem that the government would have to do away with the entrance examination or even make it just a benchmark against with the admission committees can evaluate a student. We all know that a high entrance rank would never translate to high accomplishments, whether it is in academics in college or in the professional world. So the government could alter entrance examination to be like a rating test like SAT, GRE, GMAT etc and let the managements decide who should get admitted based on the score, interviews etc. As I have said before, a free market system would ensure that the managements would make sure that their student population is a balanced mix of people with merit; whether it is their own merit or their parents' financial merit.
Also, there is one thing that the government can do. It can offer subsidized or cheap education through its network of colleges and can create any kind of requirements. It can offer the education only to the financially challenged students. It can also increase the number of seats in its colleges so that the private managements cannot compete with the government ones without lowering the fees.
Additionally, most of the time the quality of an institution is defined by its students rather than the infrastructure, facilities or faculty. For example, I graduated from College of Engineering, Adoor. There is this College of Engineering, Chengannnur, by the same management (IHRD). As far as faculty is concerned, they are all from the same IHRD employee pool who are rotated every once in a while. As far as infrastructure is concerned, I guess Adoor had better facilities. But, Chengannur was more reputed. Since it is reputed, only better students managed to get in there and hence it maintained the quality.
This could be reinforced by the case of Harvard University. The same facilities could be found in at least a dozen universities in the United states. But when it comes to Law or Medicine, Harvard is the best. The main reason is the selection process. Thousands apply to Harvard every year and they go through a strict selection procedure. They go through tests, interviews and other hurdles and only the best of the best manage to get into Harvard and all of them would be among the best brains in the world. So once you get into Harvard and graduate, you'd be commanding supreme respect everywhere regardless of whether you are an idiot (In which case, you are highly unlikely to get into Harvard in the first place).
So, in essence, in a free market environment, a talented young person can easily find quality education at a cheap price. If one management doesn't want to offer him a scholarship or a tuition waiver, a competitor may do so to woo him. Giving a full scholarship to talented people is not throwing money away, from a business point of view. That is an investment that would increment the quality of your product. And that would attract better talent in turn and the demand could be converted to money by the management.
So in conclusion, the government policy should be in such a way as to provide a free market solution for the education system, by providing good competition, by strong anti-monopoly regulations and through providing perks to managements that provide cheap education through tax breaks.