Banking, Financial

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2. Financial Awareness_________________________________________
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3. Economic Awareness ________________________________________

1 - 195

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Banking Awareness STATIC GK

Index

Chapter 1 - Banking System in India ________________________________________________ 1

Chapter 2 - Reserve Bank of India _________________________________________________ 9
Chapter 3 - Banking Regulation by RBI _____________________________________________ 13
Chapter 4 - Types of Banks ______________________________________________________ 23
Chapter 5 - Types of Banking _____________________________________________________ 33
Chapter 6 - Types of Bank Accounts _______________________________________________ 36
Chapter 7 - Loans and Securities __________________________________________________ 39
Chapter 8 - Basel Committee _____________________________________________________ 41
Chapter 9 - Cheque / Demand Draft / Cards _________________________________________ 42
Chapter 10 - Basics of Indian Currency _____________________________________________ 44
Chapter 11 - National Financial Institutions __________________________________________ 47
Chapter 12 - International Financial institutions _______________________________________ 51
Chapter 13 - Legislations in Banking and Finance - I ___________________________________ 57
Chapter 14 - Latest Banking Concepts ______________________________________________ 61

Banking Test __________________________________________________________ 66

Answer Key ___________________________________________________________ 76

Financial Awareness
Chapter 1 - Overview of Indian Financial Market System _____________________________ 1
Chapter 2 - Money Market and its Instruments _____________________________________ 8
Chapter 3 - Capital Market and its instruments _____________________________________ 11
Chapter 4 - Basics of Stock Market ______________________________________________ 15
Chapter 5 - Basics of Financial Awareness - I _____________________________________ 22
Chapter 6 - Basics of Financial Awareness - II _____________________________________ 25
Chapter 7 - Important Financial Terminologies _____________________________________ 29
Banking Test __________________________________________________________ 31
Answer Key ___________________________________________________________ 41
Economic Awareness STATIC GK

Index

BASICS OF ECONOMY
A. Introduction to Economics _______________________________________________ 1
B. National Income _____________________________________________________ 11
C. Growth and Development _______________________________________________ 21
D. History of Indian Economy ______________________________________________ 27
E. Economic Planning in India ______________________________________________ 40
F. Fiscal Policy ________________________________________________________ 55

G. Inflation __________________________________________________________ 67
H. Taxation __________________________________________________________ 75
I. Government Schemes _________________________________________________ 93
J. Land Reforms _______________________________________________________ 100

K. Sectors of Economy __________________________________________________ 117

L. Industries in India ____________________________________________________ 120
M. Agriculture ________________________________________________________ 139
N. Food Processing ____________________________________________________ 153
O. Socio-Economic Problems ______________________________________________ 155
Question Bank ______________________________________________________ 167
Answer Key ________________________________________________________ 195
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 Banking
Awareness 1

CHP 1 Banking System in India

Banking system is the important system for any economy in the world. In India, banking system is
centuries old system but it was not as planned as it is today. There were few communities in India who are
involved in banking system, for example Mahajans, Shroffs etc. But modern or planned banking system
originated after Europeans‘ entry into the Indian subcontinent.

In India, modern banking dates back to the latter half of the 18th century. The General Bank of India,
founded in 1786, and the Bank of Hindustan (1770–1829) were the first banks.

The State Bank of India, which began as the Bank of Calcutta in June 1806, and nearly soon changed its
name to the Bank of Bengal, is the largest and oldest bank that is still in operation. The Bank of Bombay
and the Bank of Madras, the other two presidency banks that were founded with charters from the British
East India Company, were the other two. This was one of the three presidential banks. The three banks
joined in 1921 to become the Imperial Bank of India, which later changed its name to the State Bank of
India in 1955 upon India's independence. Before the Reserve Bank of India was founded in 1935, the
presidency banks and its successors operated as quasi-central banks for a long time.

All of India's major banks that the government did not already own were nationalised in 1969, and they
have remained so ever since. They can compete and conduct business like commercial banks since they
are managed under a system known as "profit-making public sector undertaking" (PSU). There are four
different types of banks in the Indian banking sector, in addition to PSUs and state banks, which have
been joined during the 1990s by new private commercial banks and a number of foreign banks.

In terms of availability, product selection, and reach, banking in India was generally fairly developed, yet it
is still difficult to reach the poor and those living in rural areas. The State Bank of India has increased the
number of its branches, and the National Bank for Agriculture and Rural Development offers services like
microfinance as part of its initiatives to solve this.

A. History of Banking

History of Banking in India in Brief (Before & After Independence)

Phases of Indian Banking System

The advancement in the Indian banking system is classified into 3 distinct phases:

1. The Pre-independence Phase i.e. before 1947

2. Second Phase from 1947 to 1991
3. Third Phase 1991 and beyond

1. The Pre-independence Phase i.e. before 1947

 This stage is distinguished by the existence of several banks (more than 600).
 India's banking system was established in 1770 with the establishment of the Bank of Hindustan
in Calcutta (now Kolkata), which stopped operations in 1832.
 Following that, other banks emerged but failed, including the first commercial bank in India and
General Bank of India (1786–1791).

 While some others like Bank of Bengal (est. 1806), Bank of Bombay (est. 1840), Bank of
Madras (est. 1843) merged into a single entity in 1921 which came to be known as Imperial Bank
of India.
 Imperial Bank of India was later renamed in 1955 as the State Bank of India.
 In accordance with the Hilton Young Commission's recommendations, the Reserve Bank
of India was established in April 1935 (Set up in 1926).
 Most banks during this time period were tiny in size and experienced a high rate of failures.
Because of this, there is little public trust in these institutions, and deposit mobilisation was also
extremely slow. People kept utilising unstructured businesses (moneylenders and indigenous
bankers).
 Banking
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Awareness

 Some successful banks which continue to lead even today:

(1) Allahabad Bank (est. 1865)

(2) Punjab National Bank (est., 1894, with HQ in Lahore (that time)
(3) Bank of India (est. 1906)
(4) Bank of Baroda (est. 1908)
(5) Central Bank of India (est. 1911)

2. The second phase from 1947 to 1991

Broadly the main characteristic feature of this phase is the Nationalization of the banks.
With the view of economic planning, nationalization emerged as an effective measure.

Need for nationalization in India:

(a) The banks mostly catered to the needs of large industries, big business houses.
(b) Sectors such as agriculture, small-scale industries and exports were lagging behind.
(c) The poor masses continued to be exploited by the moneylenders.

Following this, in the year 1949, 1st January the Reserve Bank of India was nationalized. Fourteen
commercial banks were nationalized on 19th July 1969. Smt. Indira Gandhi was the Prime Minister of
India in 1969.

The following banks were nationalized:

1. Central Bank of India

2. Bank of India
3. Punjab National Bank
4. Bank of Baroda
5. United Commercial Bank
6. Canara Bank
7. Dena Bank
8. United Bank
9. Syndicate Bank
10. Allahabad Bank
11. Indian Bank
12. Union Bank of India
13. Bank of Maharashtra
14. Indian Overseas Bank

Six more commercial banks were nationalized in April 1980.

These are mentioned below:

1. Andhra Bank
2. Corporation Bank
3. New Bank of India
4. Oriental Bank of Commerce
5. Punjab & Sindh Bank
6. Vijaya Bank

 Meanwhile, on the recommendation of the Narasimhan committee, Regional Rural Banks (RRBs)
were formed on Oct 2, 1975. The objective behind the formation of RRBs was to serve the large
unserved population of rural areas and promoting financial inclusion.

 With a view to meet the specific requirements of different sectors (i.e. agriculture, housing, foreign
trade, industry) some apex level banking institutions were also set up like:
(a) NABARD (est.1982)
(b) EXIM (est. 1982)
(c) NHB (est. 1988)
(d) SIDBI (est. 1990)
 Banking
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3. Third phase 1991 and beyond

 With the liberalisation of economic policy during this time, the process of developing banks grew
significantly.
 A sizable segment of the population remains unaffected by banking services even after
nationalisation and the laws that followed.
 In light of this, the Narasimham committee recommended allowing participants from the private
sector to enter the banking system in 1991.
 Following this, the RBI granted licences to 10 private companies, of which only a small number—
ICICI, HDFC, Axis Bank, Indusland Bank, and DCB—were able to meet market demands.
 In 1998, the Narsimham committee again recommended the entry of more private players. As
a result, RBI gave a license to the following newbies:
 Kotak Mahindra Bank (2001)
 Yes Bank (2004)
 After the third cycle of bank licensing in 2013–2014, IDFC Bank and Bandhan Bank were
established in 2015.
 The RBI also recommended the establishment of two new categories of banks, namely Payment
Banks and Small Banks, in order to promote financial inclusion.
 In 2015, the RBI granted in-principle licences to 10 applications to establish Small Finance Banks
and 11 firms to create Payments Banks.

Note:
 A licence to operate as a Small Finance Bank (SFB) and Payments Bank in India was granted to
the bank by the RBI in accordance with Section 22(1) of the Banking Regulation Act, 1949.
 An External Advisory Committee examined and assessed the applications for the Committee on
Small Banks. Usha Thorat, a former deputy governor of the RBI, served as the chair of the EAC for
small banks.
 An external advisory committee (EAC) examined and assessed these applications for the
Committee on Payment Banks. Dr. Nachiket Mor, Director of the Reserve Bank of India's Central
Board, served as the chair of the EAC Committee for Payment Banks.

B. Banking and Financial Reforms in India

List of Banks, Headquarter

a. Public Sector Banks & Private Sector Banks

Banks Headquarters Tagline

Allahabad Bank Kolkata A Tradition of Trust
Andhra Bank Hyderabad Where India Banks
Axis Bank Mumbai Badhti Ka Naam Zindagi
Bank of Baroda Vadodara India‘s International Bank
Bank of India Mumbai Relationship beyond Banking
Bank of Maharashtra Pune Ek Parivaar, Ek Bank
Bandhan Bank Kolkata Aapka Bhala, Sabki Bhalai
Canara Bank Bengaluru Together We Can
Central Bank of India Mumbai Central to You Since 1911
Corporation Bank Mangalore Prosperity for all
Citi Union Bank Tamil Nadu Trust And Excellence since 1904
Dena Bank Mumbai Trusted Family Bank
Dhanlaxmi Bank Kerala [Link]
Federal Bank Kochi Your Perfect Banking Partner
HDFC Bank Mumbai We understand your world
IDBI Bank Mumbai Banking for All,"Aao sochein Bada"
Indian Bank Chennai Your Own Bank
Indian Overseas Bank Chennai Good People to Grow With
ICICI Bank Mumbai Hum hai na/Khayal Apka
IDFC Bank Mumbai Banking Hatke
IndusInd Bank Mumbai We Make You Feel Richer
Karnataka Bank Mangaluru Your Family Bank, Across India.
Karur Vysya Bank Tamil Nadu Smart way to Bank
Kotak Mahindra Bank Mumbai Let‘s make money simple
 Banking
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Lakshmi Vilas Bank Chennai The Changing Face Of Prosperity

Oriental Bank of Commerce Gurugram, Haryana Where Every Individual is Committed
Punjab National Bank New Delhi The Name You can Bank Upon
Punjab & Sind Bank New Delhi Where Service is a way of Life
RBL Bank Mumbai Apno ka Bank
State Bank of India Mumbai The Banker to Every Indian
Syndicate Bank Manipal, Karnataka Faithful and Friendly
South Indian Bank Thrissur, Kerala Experience Next Generation Banking
UCO Bank Kolkata Honours Your Trust
Union Bank of India Mumbai Good People to Bank with
United Bank of India Kolkata The Bank that begins with 'U'
Vijaya Bank Bengaluru A Friend You Can Bank Upon
Yes Bank Mumbai Experience our expertise

b. All India Financial Institutions

EXIM Bank Mumbai

NABARD Mumbai
NHB New Delhi
SIDBI Lucknow

c. Small Finance Banks

Au Small Finance Bank Jaipur Chalo Aage Badhe

Capital Small Finance Bank Jalandhar, Punjab Vishwas se Vikas tak
Equitas Small Finance Bank Chennai It‘s Fun Banking
ESAF Small Finance Bank Thrissur, Kerala Joy of Banking
Fincare Small Finance Bank Bengaluru Banking On More
Jana Small Finance Bank Bangaluru Paise Ke Kadar
North East Small Finance Bank Guwahati Your Door Step Banker
Suryoday Small Finance Bank Belapur, Navi Mumbai A Bank of Smiles
Ujjivan Small Finance Bank Bengaluru Bharosa, Aake bharose par
Utkarsh Small Finance Bank Varanasi Apki Umeed ka Khata

d. Payments Banks

Airtel Payments Bank New Delhi -

India Post Payments Bank New Delhi Aapka Bank Aapke Dwar
FINO Payments Bank Mumbai Qadar aapki mehnat ki
Paytm Payments Bank Noida -
Aditya Birla Idea Payments Bank Mumbai -
Jio Payments Bank Mumbai -

First in all Banks

1. The First Bank in India – Bank of Hindustan

2. First Governor of RBI – Mr. Osborne Smith
3. First Indian governor of RBI – Mr. C D Deshmukh
4. First Bank to Introduce ATM in India – HSBC
5. First Bank to introduce saving Bank in India – Presidency bank in 1830
6. First Bank to Introduce Cheque system in India – Bengal Bank 1784
7. First Bank to introduce Internet Banking – ICICI BANK
8. First Bank to introduce Mutual Fund – State Bank of India
9. First Bank to introduce Credit Card in India – Central Bank of India
10. First Foreign Bank in India – Comptoire d’Escompte de Paris of France in 1860
11. First Joint Stock Bank of India – Allahabad Bank
12. First Indian bank to open branch outside India in London in 1946 – Bank of India
13. First Indian Bank started with Indian capital – Punjab National Bank
14. First Regional Rural Bank name Prathama Grameen Bank was started by – Syndicate Bank
 Banking
Awareness 5

15. First Universal Bank in India – ICICI Bank

16. First bank in India listed in New York Stock Exchange (NYSE) – ICICI Bank
17. First Bank in India to launch Talking ATMs for differently able person – Union Bank of India
18. First Bank in India to launch its own Payment Aggregators – State Bank of India. (SBIePay)
19. Country‘s first all woman bank – Bhartiya Mahila Bank
20. First India bank Got ISO – Canara Bank.

1. LPG Reforms
 The latest changes or movements will be covered separately in ―Schemes of the government‖ and
latest Economic Survey‖.
 Financial changes since independence will be covered in ―Indian Financial System‖.
 In this chapter, the focus will be on features and impacts of economic reforms of 1991.

Background of Economic Reform:

• After following an inward looking economic policy for 4 decades, India decided to change gears
towards a liberalized economy in 1991 due to various domestic and international compulsions.
• The reasons for economic reform in 1991 included factors like
 Collapse of Soviet Union that had emerged as India‗s major trading partner
 The gulf war of 1991 spiked prices of oil and stopped remittances from gulf countries,
increasing India‗s BOP deficit suddenly
 The expansionary policy of 1980s started showing its negative effects. The policy was at fault
because majority of money pumped into the economy was used for expanding consumption
rather than expanding investment in capital goods. As discussed in macroeconomics, the
quality of deficit is determined by its usage in an economy. While deficit incurred for expanding
capital creation capacity of an economy is considered self-correcting, deficit for consumption is
dangerous above a certain level. Unfortunately, India incurred heavy expenditures on
expansion of aggregate consumption of the economy, which resulted in high BoP deficit for the
country. The public debt to GNP ratio increased through 1980s to 60 percent at the end of the
decade, doubling in 10 years‘ time.
 The restrictive trade and industrial licensing framework between 1950-90 resulted in a serious
loss of efficiency as well as competition of public sector enterprises. Return on investment and
growth rate of these enterprises fell in 4 decades till 1991.

The 1991 economic reforms changed the course of Indian economy completely. By the time the crisis
occurred, there was considerable support among key figures for a thorough reform of the economy:

The reforms can be broadly categorized into stabilization policies and structural reform policies. While
stabilization policies were meant to correct the lapses and put the house in order in short term, structural
changes were meant to accelerate economic growth in medium to long term.

Changes made through economic reforms were:

 Fiscal stabilization- to contain growing fiscal deficit

 Internal Liberalization- freedom to private enterprises, both domestic and global
 Integration with global economy- removing various economic and policy level controls to link
domestic economy with the world economy.
Foreign trade and Investment reforms-

1. Import Licensing policy has been dismantled. All tariff and non- tariff barriers have been phased
out. They are now followed as an exception in emergency like situations. Only consumer goods can
have tariff and non- tariff barriers. Agriculture still has tariffs of as low as 10%. This has been
made to protect Indian agriculture from foreign cheap imports. Foreign Investment norms in India
and outside India have been liberalized. India is now one of the largest recipients of foreign
investment.
2. Rupee has been made fully convertible on current account since 1994.
3. Institutional reform in capital market- SEBI and IRDA have been setup as independent regulators
of Indian capital and Insurance market respectively.
 Banking
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Awareness

Industrial Licensing reforms:

 New Industrial Policy: The NIP abolished the industrial approval or licensing system which had
been in place since Independence. The Industrial licensing system demanded approval of the
government at every stage of performance of an enterprise, thus hurting efficiency and
encouraging red-tapism. The NIP allowed industrial licensing in only 14 specified industries. These
were related to environment protection, national security and social well-being. Only 2 industries
are now reserved for the public sector- atomic energy and railway transport.

Financial Sector reforms-

1. Permission to private companies and foreign ventures to set-up banks in India. 3 phases of private
licensing of banks have been carried out till date. The first one was carried out in 1993, second in
the year 2001 and third in the year 2013.
2. The administered interest rate regime has been done away with in phases. Administered interest
rate means that the government decides on the interest rate to be charged by banks to customers.
Due to the policy of administered interest rates, interest rates being charged were lower than cost
of capital to banks and thus pushed banks into losses.
3. Cross subsidization of lending rates undermined profits of banking sector. This means that some
sectors were charged very low rates as an incentive at the cost of other sectors and profits of
banks.
4. Government interference in deciding loans was reduced. A greater autonomy to banks and FIs has
made them more efficient and profitable.

Structural Reforms-

 Foreign trade and Investment reforms

 Industrial licensing reforms
 Financial sector reforms

Stabilization reforms focused on two things- deficit reduction and inflation control. The structural and
stabilization efforts can also be classified according to the more popular LPG reforms i.e. Liberalization,
Privatization and Globalization.

Liberalization- Liberalization consisted of the following reforms:

 Industrial licensing- removal of licensing requirements

 Export import policy- easier and market oriented exchange methods and liberalization of import
and export rules
 Technology upgradation- opening up of the economy to foreign technology
 Fiscal and financial policy- fiscal reforms through FRBM, tax reforms by reducing tax rates,
financial reforms through SEBI and IRDA, autonomous and powerful RBI
 Foreign exchange and investment policy- FDI and FII allowed in Indian market, currency devalued
and subsequently made floating.

Privatization:

 Disinvestment
 Autonomy to PSUs

Globalization- Integration of domestic economy with global economy. Globalization has resulted in
greater integration and interdependence between India and the world economy.

 Outsourcing- outcome of globalization

 Abiding to WTO rules and laws

2. MERGER

A merger is the coming together of two businesses to create one new business. The only distinction
between a merger and an acquisition or takeover is that in a merger, the existing shareholders of both
participating companies retain a shared interest in the new corporation, whereas in an acquisition, one
company buys the majority of the stock of the second company with or without the consent of the second
company.
 Banking
Awareness 7

Introduction to Mergers and Acquisitions in Banking Sectors:

Over the past few years, there have been a number of enormous mergers in the banking industry. Among
the most notable mergers are those between ICICI Ltd. and its banking arm, ICICI Bank Ltd., Global Trust
Bank and Oriental Bank of Commerce, and IDBI and its banking arm, IDBI Bank Ltd.

Recent Mergers:

Year of Name of the Banks Name of the Banks Merged into

Merger Acquired
2020 April Indian Bank Allahabad Bank
2020 April Punjab National Bank Oriental Bank of Commerce and United Bank of India
2020 April Canara Bank Syndicate Bank
2020 April Union Bank of India Corporation Bank and Andhra Pradesh
2019 April Bank of Baroda Vijaya bank and Dena Bank
2017 April State Bank of India Bhartiya Mahila Bank (BMB)
2017 April State Bank of India All the 5 associates of SBI
2014 Nov Kotak Mahindra Bank ING Vyasya Bank
2010 May ICICI Bank Bank of Rajasthan

Some of the past mergers are:

 Grind lay Bank merged Standard Charted Bank

 Times Bank with HDFC Bank
 Nedungadi Bank with Punjab National Bank

Successful Approach to Mergers and Acquisition Integration

Year of Merger Name of the Banks Name of the Banks Merged into
Acquired
1985 Canara Bank Lakshmi Commercial Bank
1993 Punjab National Bank New Bank of India
1994 Bank of India Bank of Karad
1999 Union Bank of India Sikkim Bank
2000 HDFC Bank Times Bank
2001 ICICI Bank Bank of Madura
2008 HDFC Bank Centurion Bank of Punjab

Merits of Bank Mergers and Acquisitions:

 Mergers will enable banks to quickly expand their customer base and scale their operations.
 Additionally, it enables the company to bridge any product or technological gaps and, after being
acquired by the large corporation, will support the company's efficient upgrade of its technological
foundation.
 By combining, it will increase the business and banking operations' efficiency ratio and reduce their
risk factor ratio
 Additionally, it will contribute to the modernization of technology, an increase in profit, and a rise
in living standards.

Demerits of Bank Mergers and Acquisitions:

 The primary drawback is compliance and risk consistency, and because both merging firms have
different perspectives on the world and different risk cultures, this has a detrimental effect on their
capacity to make money.
 Poor culture fit is another drawback, which is why many bank mergers finally fail. The bank simply
takes into account the perspective of combining on paper, not taking their employees or culture
into account.
 Banking
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Awareness

Important Sections and Law-Related Points:

 Section 44 of the Banking Regulation Act of 1949 contains requirements regarding the merger of
two banking institutions.
 Sections 391 to 394 of the Companies Act of 1956 regulate the merger of a banking company and
a non-banking company.

C. Establishment years of Financial Institutions in India

Imperial Bank of India 1921

Reserve Bank of India (RBI) April, 1, 1935
Industrial Finance Corporation of India (IFCI) 1948
State Bank of India July, 1, 1955
Industrial Credit and Investment Corporation India Ltd.(ICICI) 1955
Life insurance corporation of India (LIC) Sept, 1956
Export Credit Guarantee Corporation of India (ECGC) 30, July, 1957
Industrial Development Bank of India (IDBI) July, 1964
General Insurance Corporation (GIC) Nov, 1972
Regional Rural Banks Oct, 2, 1975
Housing development and finance Corporation Ltd (HDFC) 1977
EXIM Bank January, 1, 1982
IRBI( now it is called IIBIL since march 1997) March, 20,1985
Board for Industrial and Financial Reconstruction 1987
Securities and Exchange Board of India (SEBI) April, 12, 1988
National Housing Bank July, 1988
Small Industries Development Bank of India (SIDBI) 1990
Bharatiya Reserve Bank Note Mudran Private Limited 1995
Rural Infrastructure and Development Fund (RIDF) April, 1, 1995
Infrastructure Development Finance Company (IDFC) Jan, 31, 1997
Unit Trust of India Feb, 1, 2003
Bifurcation of UTI (UTI-i & UTI-ii) Feb, 2003
Indian Infrastructure Finance Company (IIFCL) April, 2006
National Payments Corporation of India Dec, 2008
 Banking
Awareness 9

CHP 2 Reserve Bank of India

The Royal Commission on Indian Currency and Finance, also known as the Hilton-Young Commission,
recommended the establishment of a central bank in 1926 to enhance banking infrastructure across the
nation and to separate the government's control of currency and credit. This is how the Reserve Bank
came to be. The Reserve Bank of India Act of 1934 set in motion a series of events that culminated in
the start of operations in 1935 and formed the Reserve Bank on April 1, 1935 as the banker to the central
government. As the Indian economy has altered since then, the Reserve Bank's position and
responsibilities have experienced significant adjustments.

The Reserve Bank's Central Office was initially built in Calcutta but was eventually relocated permanently
to Mumbai in 1937. The Governor sits at the Central Office, which is also where policies are created. The
Reserve Bank was initially privately owned, but since being nationalised in 1949, the Indian government
has full ownership of the institution.

A central board of directors oversees all operations at the Reserve Bank. In accordance with the Reserve
Bank of India Act, the board is chosen by the Indian government.

 Appointed/nominated for a period of four years

 Constitution:
 Official Directors
 Full-time : Governor and not more than four Deputy Governors
 Non-Official Directors
 Nominated by Government: ten Directors from various fields and two government Officials
 Others: four Directors - one each from four local boards

A. Main Functions

Monetary Authority:
 Formulates implements and monitors the monetary policy.
 Objective: maintaining price stability and ensuring adequate flow of credit to productive sectors.

Regulator and supervisor of the financial system:

 Prescribes broad parameters of banking operations within which the country's banking and
financial system functions.
 Objective: maintain public confidence in the system, protect depositors' interest and provide cost-
effective banking services to the public.

Manager of Foreign Exchange

 Manages the Foreign Exchange Management Act, 1999.
 Objective: to facilitate external trade and payment and promote orderly development and
maintenance of foreign exchange market in India.

Issuer of currency:
 Issues and exchanges or destroys currency and coins not fit for circulation.
 Objective: to give the public adequate quantity of supplies of currency notes and coins and in good
quality.

Developmental role
 Performs a wide range of promotional functions to support national objectives.

Related Functions
 Banker to the Government: performs merchant banking function for the central and the state
governments; also acts as their banker.
 Banker to banks: maintains banking accounts of all scheduled banks.
 Banking
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B. Governors of RBI

List of RBI Governors-

RBI Governors Names Time Period 1935-2022

Sir Osborne Smith April 1, 1935 – June 30, 1937
Sir James Braid Taylor July 1, 1937 – February 17, 1943
Sir C.D. Deshmukh August 11, 1943 – June 30, 1949
Sir Bengal Rama Rau July 1, 1949 – January 14, 1957
K.G. Ambegaonkar January 14, 1957 – February 28, 1957
H.V.R Lyengar March 1, 1957 – February 28, 1962
P.C Bhattacharya March 1, 1962 – June 30, 1967
L.K. Jha July 1, 1967 – May 3, 1970
B.N. Adarkar May 4, 1970 – June 15, 1970
S. Jagannathan June 16, 1970 – May 19, 1975
N.C. Sen Gupta May 19, 1975 – August 19, 1975
K.R. Puri August 20, 1975 – May 2, 1977
M. Narasimham May 3, 1977 – November 30, 1977
I.G. Patel December 1, 1977 – September 15, 1982
Manmohan Singh September 16, 1982 – January 14, 1985
Amitav Gosh January 15, 1985 – September 4, 1985
R.N. Malhotra February 4, 1985 – December 22, 1990
S. Vpnldraramanan December 22, 1990 – December 21, 1992
C. Rangarajan December 22, 1992 – November 21, 1997
Bimal Jalan November 22, 1997 – September 6, 2003
Y.V. Reddy September 6, 2003 – September 5, 2008
D. Subbarao September 5, 2008 – September 4, 2013
Raghuram G. Rajan September 4, 2013 – September 4, 2016
Urjit Ravindra Patel September 4, 2016 – December 10,2018
Shaktikanta Das December 12, 2018 – to date

C. Subsidiaries of RBI

1. Deposit Insurance and Credit Guarantee Corporation of India (DICGC)

Establishment: Deposit Insurance and Credit Guarantee Corporation (DICGC) came into
existence on July 15, 1978.
DICGC was formed by merging Deposit Insurance Corporation (DIC) and Credit Guarantee
Corporation of India Ltd. (CGCI)
The functions of the DICGC are governed by the provisions of DICGC Act 1961 framed by the
Reserve Bank of India.

Role of DICGC: DICGC was established for providing insurance of deposits and guaranteeing of
credit facilities. At present, DICGC insures each depositor of a registered insured bank upto a
maximum of Rs.5 Lakh for all bank deposits, such as saving, fixed, current, recurring deposits. The
credit guarantee scheme of DICGC is presently not operative due to availability of alternative
guarantee schemes.

Authorised Capital: Rs 50 Crore

Headquarters: Mumbai

Banks under the purview of DIGCG: Deposit insurance is a requirement for all domestic banks.
Therefore, the DICGC registers and insures all public sector banks, private sector banks, local area
banks, regional rural banks, small finance banks, payments banks, foreign bank branches
operating in India, as well as all state, central, and primary cooperative banks (Urban Cooperative
Banks).
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Maximum deposit amount insured by the DICGC: Rs 5 lakh (Principle + Interest)

If you have deposits with more than one bank, deposit insurance coverage limit is applied
separately to the deposits in each bank.
DICGC has the power to cancel the registration of an insured bank if it fails to pay the premium for
three consecutive half-year periods.

When does DICGC pay:

1. If a bank goes into liquidation
2. If a bank is reconstructed or amalgamated / merged with another bank

2. Bharatiya Reserve Bank Note Mudran Private Limited (BRBNMPL)

Establishment: On February 3rd, 1995, the Reserve Bank of India (RBI) formed Bharatiya
Reserve Bank Note Mudran Private Limited (BRBNMPL) as a completely owned subsidiary.
According to the Companies Act of 1956, the BRBNMPL has been registered as a private limited
company.

Role of BRBNMPL: To argument the production of bank notes in India to enable the RBI to bridge
the gap between the supply and demand for bank notes in the country.

Headquarters: Bengaluru

The company manages 2 Presses one at Mysore in Karnataka and the other at Salboni in West
Bengal.

3. Reserve Bank Information Technology Private Limited (ReBIT)

Established: 2016

Role of ReBIT: It has been set up by the Reserve Bank of India, for its IT and cyber security
needs and to ensure cyber resilience of Indian banking.

Deliver and manage IT projects of RBI; Assist RBI in performing risk-based supervision of
regulated entities; Safeguard RBI assets by detecting and responding to cyber-threats.

4. Indian Financial Technology and Allied Services (IFTAS)

Function and Role of IFTAS– Financial Technology and Allied Services (IFTAS) is a wholly-owned
subsidiary of the Reserve Bank of India, mandated to design, deploy & support IT-related services
to all Banks and Financial Institutions in the country and also to the Reserve Bank of India.

It manages & operates the financial messaging platform (SFMS) that comprising of Real-Time
Gross Settlement and National Electronic Funds Transfer.

INFINET is also managed by IFTAS.

IFTAS operates CLOUD (Indian Banking Community Cloud), the only community cloud in the
country, hosting cloud based solutions (Platform, Core, Channel, Corporate, etc.) dedicated to the
Banking & Financial Community.

The IFTAS has taken over the Indian Financial Network (INFINET), Structured Financial Messaging
System (SFMS) and the Indian Banking Community Cloud (IBCC) from the IDRBT, effective April
01, 2016.
The Director, IDRBT, is the Chairman of The Indian Financial Technology and Allied Services.

5. Reserve Bank Innovation Hub (RBIH)

The RBIH has its registered office in Hyderabad and has been registered as a section 8 company
under the 2013 Companies Act.
By utilising technology and establishing an atmosphere that would support and foster innovation,
the Reserve Bank of India established the Reserve Bank Innovation Hub (RBIH) to encourage
innovation throughout the financial industry.
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Awareness

A Governing Council (GC) headed by a Chairperson would direct and oversee RBIH. The first
Chairperson of the Governing Council of RBIH was Shri Senapathy (Kris) Gopalakrishnan, co-
founder and previous co-Chairman of Infosys. Aside from the Chairperson, there are 9 other
members of RBIH's governing council.

6. National Housing Bank (NHB)

Establishment: NHB was set up on July 9, 1988 under the National Housing Bank Act, 1987.

Role of NHB: To promote a sound, healthy, viable and cost effective housing finance system to
cater to all segments of the population and to integrate the housing finance system with the
overall financial system.

Owned: Fully owned by Government of India (100%)

Headquarters: New Delhi

NHB RESIDEX– It is India‘s first official housing price index, was an initiative of the National
Housing Bank (NHB), undertaken at the behest of the Government of India, Ministry of Finance.
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CHP 3 Banking Regulation by RBI

A. Monetary Policy and its objectives
Monetary policy is controlled by Central banks around the world whose basic purpose is to control the
money supply in the wake of controlling the inflation. If money supply is high there will be inflation in
market, on the other hand if money supply is less there will be deflation.

Monetary policy is the method used by the central bank to influence the money supply in order to
accomplish specific macroeconomic o bj e ct i ve s . A c o m po ne nt o f monetary policy, credit policy
governs the amount and rate of credit advances made by banks. Objectives of monetary policy are:

• Accelerating growth of economy

• Price stability
• Exchange rate stabilization
• Balancing savings and investment
• Generating employment historically,

Monetary Policy Committee is the deciding body of the monetary policy in India. It was constituted in
2016. It is entrusted with the responsibility of deciding the different policy rates including MSF, Repo Rate,
Reverse Repo Rate, and Liquidity Adjustment Facility.

It consists of six members in which government nominee consists of three and the other three members
are from RBI with the governor being the ex-officio chairperson. The decision is taken by the process of
voting. The governor does not enjoy a veto power to overrule the other panel members, but has a casting
vote in case of a tie.

Relation between Inflation and Economic Growth

With increase in money supply, people demand more

products because they have more funds in hand. Greater
demand for products leads to inflation. At the same time, on
account of increase in money supply, people invest more
money, leading to higher economic growth.

To conclude, in times of increase in money supply, inflation

rate as well as economic growth increases. (One is
undesirable, and the other is desirable). On the contrary, if
there is decease in money supply, the rate of inflation as well
as the growth rate decreases.

Working of Monetary Policy

When inflation rates are high in the economy, the main focus of the RBI is to target inflation and, thus,
the growth objective is side lined. Inflation targeting is given priority over economic growth because
inflation affects both rich and poor, whereas economic growth mainly benefits the rich. To counter inflation,
demand needs to be reduced, so the RBI reduces the money supply in the economy by making credit
dearer (costlier). Thus, in times of high inflation, the RBI adopts dear/tight money policy.

On the contrary, when inflation rate is low or moderate, the main focus of the RBI is on increasing
growth in the economy. Therefore, the RBI increases money supply by making credit cheaper. Thus, in
times of low or moderate inflation, the RBI adopts cheap/easy money policy.
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Types of Monetary Policy

1. Expansionary Monetary Policy

It is also called easy money policy or cheap money policy. Here

RBI decreases the rates, to increase the supply of money in the
market and hence bring the economy out of recession or
slowdown.

But this policy has risks associated with it like bringing huge
inflation. Also, there is a time lag between the time when policy
is announced and when it takes effect in the economy. Thus at
times expansionary monetary policy may not have desired
impact on the economy in terms of growth

2. Contractionary Monetary Policy

It is also called Dear Money Policy or tight money policy. RBI increases the rates to decrease money
supply in the economy and hence bring inflation under control.

Tools to implement Monetary Policy- There are two types of tools which RBI uses to implement the
monetary policy. They can be classified into two categories:

1) Quantitative or General tools: They influence the total volume of credit

2) Qualitative tools or Selective Tools: They influence the selective or particular use of credit.

QUANTITATIVE TOOLS

Bank Rate

The Bank Rate is the rate at which the RBI give loans to commercial banks on a long-term basis. The RBI
utilises it as a tool to control credit and the money supply.

Today, LAF (Repo rate) is utilised to manage the money supply in the economy rather than Bank rate as a
mechanism for doing so. Bank rate is used as a penal rate now. eg. If a bank doesn‗t maintain the
required levels of CRR/SLR, then RBI can impose penalty on such banks. Now Bank rate has been aligned
with MSF.

SLR (Statutory Liquidity Ratio)

The portion of time deposits (fixed deposits) and demand liabilities (savings bank and current accounts)
that banks are required to hold in the form of specifically designated liquid assets, such as cash, gold, and
government securities, as well as other RBI-approved securities, such as public sector bonds SLR attempts
to make sure that the banks contribute to the government's demand for finances in some small but
significant way. From 38.5 percent in 1991 to less than 20 percent today, SLR has gradually reduced.

Uses of SLR

Thus SLR on the one hand is used to remove excess liquidity of the banking system and hence control
inflation and on the other hand, it is used to mobilize revenue for the government. SLR helps banks during
the time of bank run. Banks usually keep more than the required SLR. RBI wants banks to hold a part
of the money in near cash so that they can meet any unexpected demand from depositors at short notice
by selling the bonds.

In India, historically, banks ‗SLR has been high as they need to bear the burden of the government‗s
fiscal deficit. The government borrows from the banks every year to bridge the fiscal deficit. A cut in SLR
indicates that RBI is confident of the government‗s commitment to fiscal consolidation. (Due to Fiscal
deficit, government borrows from banks. Government borrows it by keeping government securities (g-
secs) as collateral. On the other hand, banks keep a part of their NDTL in government securities (-due to
SLR requirements). These funds kept in g-secs ultimately flows to the government and helps it to meet its
borrowings requirements).
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To fight inflation, SLR is increased, as it will make the banks to keep more money as reserve (which they
can‗t lend).It decreases the funds which the banks can lend in the economy. Therefore banks lend it at
high rate of interest. People decrease borrowings which decreases liquidity in the economy & hence a fall in
inflation.

While to fight recession or slowdown, RBI intends to increase flow of money in the economy. Now banks
should increase liquidity in the market, which they should decrease the interest rate, so that people
borrow more .For this, the reserve with the bank should increase, hence SLR is decreased.

In nutshell, SLR is used to:

1. Control inflation
2. Helps banks in time of bank run
3. Helps the government in meeting its borrowing requirements

Cash Reserve Ratio (CRR)

 CRR is a financial instrument used to control the money supply. It refers to the portion of bank
deposits that a bank must retain in cash on hand at the RBI. No interest is paid on CRR deposits.
 To control inflation and liquidity, CRR is modified.
 Less money is available for banks to lend to participants in the economy the higher the CRR.
Hence controlling inflation. While to fight deflation, CRR is decreased. It also helps banks during
times ofbank run.
 The RBI collects interest on the shortfall from the bank at the bank rate as if the defaulting bank
had borrowed the money from the central bank if a bank fails to meet its CRR standards.
 The RBI's action is appropriate because it is the only means the central bank has to impose
discipline on the banks, yet the banks find it annoying.
 Former State Bank of India chairman Pratip Chaudhuri advocated the phase-out of the CRR in
2012. He claimed that the CRR policy has prevented the nation from growing and that its
elimination would enable banks to reduce lending rates. Chaudhuri favoured eliminating the CRR
and increasing the SLR by 4.75 percent. Since the RBI does not pay any interest, the CRR acts like
a tax on the banking system, placing the banks at a competitive disadvantage versus non-banking
financial companies and mutual funds.
 With the rising non-performing assets of the banking industry, dwindling margins of commercial
banks and the strain on their profitability, there is every justification for the commercial banks to
clamor for marked reduction in the CRR, However scrapping CRR is not a solution since CRR is
needed as safety valve for the Financial system. However interest should be paid on CRR so that
banks do not consider it as burden.

Open Market Operations of RBI

 In order to affect the amount of money and credit in the economy, the RBI uses OMOs, which are
effectively purchases and sales of government securities made in the open market (which
primarily consists of banks and financial institutions). While sales of government assets absorb
surplus liquidity and reduce credit, purchases of them boost credit by injecting money into the
market. The RBI's most significant and adaptable monetary policy tool is open market
operations. A l t h o u g h the total stock of government securities is unaffected by open market
operations, the percentage owned by the RBI, commercial banks, and cooperative banks is.
 A central bank uses quantitative easing, an unconventional monetary strategy, to cut interest
rates and expand the money supply by buying government bonds and other securities on the
open market.
 By saturating financial institutions with capital in an effort to encourage more lending and
liquidity, quantitative easing expands the money supply. When short-term interest rates are at or
near zero, quantitative easing - which does not require printing new currency - is taken into
consideration.

‘Operation Twist’

 Operation Twist is whi ch the central bank purchases long-term government debt with the money
it receives from the sale of short-term securities, which lowers the interest rates on the latter.
 Operation Twist was initially implemented in 1961 as a me a ns o f boo sti ng t he val ue of the
dollar and boosting economic activity.
 Operation Twist was so successful in June 2012 that the rate on the 10-year US Treasury fell to a
200-year low.
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 The simultaneous acquisition and sale will lower long-term loan interest rates, which could result in
an increase in economic activity.
 OMOs are largely carried out to keep the system's liquidity level high, which shows that the
RBI is willing for banks to pass down reduced rates to borrowers.
 The action of Operation Twist by the RBI was encouraging for the market. This step may become
a driving factor for long-term economic activity and the addition of new investment stock.

Liquidity Adjustment Facility (LAF)

LAF is a facility that was introduced in 2000 and is provided by

the Reserve Bank of India to the scheduled commercial banks
(aside from RRBs) and primary dealers to park excess funds
with the RBI in case of excess liquidity on an overnight basis in
exchange for the collateral of government securities, including
State Government securities.

LAF essentially makes it possible to control liquidity on a daily

basis. LAF operates through repurchase agreements (repos
and reverse repos), with RBI acting as the other party in each
transaction. The RBI periodically sets the interest rate for LAF.
It is different from OMOs as OMOs involve outright purchase /
sale of security while LAF is for lending / borrowing.

In India, RBI lends on a short term basis to banks on the security of the government paper (repo). Banks
promise to repurchase the security at a later date – over night or few days. RBI charges a repo rate
for the money it lends. Hence repo rate is the rate of interest at which RBI lends to banks and other
Financial Institutions for short term on the basis of government securities which are used as collateral.

A longer-than-one-day repo is referred to as a term repo. The word term indicates a lengthier time frame.
Therefore, it is a mechanism for banks to obtain funding from the RBI for periods longer than one day. The
bank seeking the loan should provide the RBI with securities, just like in a repo. Since the loan will last
longer, the bank should charge a greater interest rate than the repo rate.

Different lengths of repo are used in India. 7 days, 14 days, and 28 days are the typical periods. Term
repo's overall goal is to maintain liquidity in the banking sector.

Marginal Standing Facility (MSF)

Reserve Bank of India‗s (RBI) introduced marginal standing facility (MSF) in May 2011. The MSF is
generally set 25 basis points above the repo rate – the rate at which banks borrow from RBI. Banks are
permitted to resort to MSF only after exhausting borrowing on the basis of government securities that are
held in excess of requirements of statutory liquidity ratio (SLR).

Only scheduled commercial banks are eligible to participate in the MSF scheme. The central bank has the
right to accept or reject partially or fully, the request for funds under this facility.

MSF scheme is provided by RBI by which the banks can borrow for overnight purposes up to 2% of their
net demand and time liabilities (NDTL) i.e. 2% of the aggregate deposits and other liabilities of the banks.
Minimum amount which can be borrowed is 1 crore and then multiples of 1 cr.

LONG TERM REPO OPERATIONS

The LTRO is a tool that allows the central bank to lend money to banks for one to three years at the
current repo rate in exchange for collateralized government assets with a similar or longer term.

What distinguishes it from MSF and LAF?

The LTRO provides banks with liquidity for their one- to three-year needs, in contrast to the RBI's present
windows of liquidity adjustment facility (LAF) and marginal standing facility (MSF), which provide funds for
their short-term needs of 1-28 days. LTRO operations are designed to stop the market's short-term
interest rates fromdiverging significantly from the repo rate, which serves as the policy rate.
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Why is it important?

 Banks' cost of funds decreases as they may obtain long-term capital at lower rates.
 They consequently lower the interest rates for borrowers.
 LTRO assisted RBI in making sure that banks decrea s e d their MCF-based lending rate while
maintaining policy rates.
 LTRO also demonstrated to the market that RBI's monetary policy will use new instruments in
addition to repo rate revisions and open market operations to accomplish its stated goals.
 The Long Term Reverse Repo Operation (LTRO) is a tool for facilitating the flow of credit into the
economy and the transmission of monetary policy actions. This aids in supplying the banking
system with liquidity.
 The repo rate is used to provide funds through the LTRO. This indicates that banks can obtain loans
for one, three, or more years at the same daily repo interest rate. However, compared to short-
term (repo) loans, loans with longer maturities (in this case, 1 and 3 years) typically have higher
interest rates.
 The LTRO programme will complement the current Liquidity Adjustment Facility (LAF) and Marginal
Standing Facility (MSF) activities, according to the RBI.
 From the week beginning February 15, 2020, the central bank has been conducting LTROs for one-
and three-year tenors of appropriate amounts for up to a total value of Rs 1,00,000 crore at the
policy repo rate.
 LTROs are carried out using the Core Banking Solution (E-KUBER) platform. A predetermined rate
would be used to conduct the procedures.
 The minimum bid would be in multiples of Rs 1 crore. The maximum amount that any one bidder
may provide is unrestricted.

Marginal Cost of Lending Rate (MCLR)

Currently, banks are a little hesitant to adjust their interest rates to the RBI's changes to the repo rate.
For short-term financing, commercial banks rely heavily on the RBI's LAF repo. However, despite the
periodic adjustments in the repo rate, they are unwilling to alter their own lending rates and deposit rates.
Every time the RBI changed the repo rate, it verbally pressured banks to adjust their lending rates as
well. However, despite lowering their lending and deposit rates, banks were still not transferring the gain
to their clients. Only until the banks adjust their individual lending and deposit rates will the goal of
modifying the repo be achieved.

Implications of MCLR on monetary policy

The so-called monetary transfer is made easier by the MCLR system, which is its novel feature. Banks
must take the repo rate into account when determining their MCLR.
Prior to the base rate system, banks onl y occasionally changed the base rate. They waited a long
time or for significant repo cutbacks to result in a matching decrease in their base rate.
Banks are now required to publis h merely the interest rate each month under the MCLR. This
indicates that such a swift modification will prompt them to think about changing the repo rate.

MCLR depends on the following:

 Marginal cost of funds

 Negative carry on account of CRR
 Operating costs; Tenor premium.
 Marginal Cost: It should be charged on the basis of following factors:

Interest rates are provided for a variety of accounts, including savings, current, term, and foreign currency
deposits. Borrowings: Repo rate, short-term interest rate, etc. rupee long-term borrowing rate Net worth
return calculated in compliance with capital adequacy standards.

The expense that banks must bear to maintain reserves with the RBI is known as negative carry on
account of CRR. The CRR that banks hold is not earning interest from the RBI. The cost of such unused
cash might be deducted from consumer loans.

Operating costs: are the outlays that banks make for daily operations.

Tenor premium: denotes that higher interest can be charged from long term loans (A tenor
premium is the compensation for the risk associated with lending for a longer time.)
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Objectives of MCLR

 To enhance how effectively policy rates are transferred to bank lending rates. to increase openness
in the process banks use to determine lending rates to guarantee access to bank credit at interest
rates that are reasonable for both borrowers and banks.
 To improve banks' long-term value and ability to contribute to economic growth while also making
them more competitive.

Comparison of Base Rate and MCLR

While Base rate depends on cost of funds, margin, operating expenses and [Link] depends on
marginal costs of funds, tenor premium, operating expenses and CRR.

Linking Bank Lending Rates to External Bench- mark

A five member panel of RBI headed by Dr. Janak Raj has recommended linking the bank lending rates
to amarket benchmark in order to hasten the monetary policy transmission.
Currently, the banking lending rates are determined by the MCLR or marginal cost of funds lending rate
introduced in 2016.

Major Findings of the Panel

The study noted that banks indulged in malpractices which include violation of RBI guidelines, inflating of
base rate and arbitrary adjustment of spreads.
Also, despite 18 months, since the launch of MCLR, only 40 percent of the corporate portfolio and one-
fourth of the retail portfolio are under it. One of main reasons was that banks charged a onetime fee to
switch over to MCLR. Also, there was no proper information handout by the banks for switching over
MCLR.

Recommendations of the Panel

1. The panel advised that all interest rates for loans be linked to one of the three external
benchmarks: Treasury bill rates, Certificate of deposit rates or repo rate.
2. The lending rates must be reset every quarter compared to the current practice of resetting of
once ayear.
3. Banks migrate all existing borrowers to the new proposed regime without any charges or fees.
4. The decision of the spread over the external bench- mark should be left to the commercial
judgement of banks.

Pros
1. Linking lending rates to an external benchmark would decrease the discretion of a bank and
reduce the arbitrariness with which banks calculate the base rate and MCLR.
2. Interest rate resetting in a quarter is more likely to result faster monetary policy transmission.
3. The panel‗s recommendation that banks be allowed to link deposits to external benchmark as
well will help in avoiding asset-liability mismatch.

Cons
1. Linking lending rate to the market rate might make the lending rates volatile.
2. T-bills being government securities are the funding cost of the government and not the
banks. And there- fore it seems unfair to link bank lending rates to T-bills.
3. With lesser buyers (also called shallow or thin market), T-bills and CDs rate may not work in
favour of the banks.
4. RBI‗s repo rate on the other hand brings back the question of calculation of tenor and premium
resulting in the problem of spreads.

Qualitative tools

Margin requirements
RBI can prescribe the %age of total value which a person will get as a loan when mortgaging property or a
security. E.g. If Mr. X wants to take a loan from a bank, he will mortgage his property, say of worth 1cr.
Rupees. For such type of loans, RBI can prescribe a margin(say 60%).That means Mr. X will now get a
loan of [Link] RBI has to counter inflation, it can increase the margin requirements(say 70%).In that
case Mr. X will get a loan of only [Link] bring growth, margin requirement will be decreased.
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Consumer credit Regulation

Under it, RBI can increase or decrease the amount to be paid as down payment in case of taking a loan.
Moreover the maximum number of EMIs (or tenure of the loan) can be increased or decreased based on
the conditions prevailing (whether it is inflation or deflation).

Selective Credit Controls

On the RBI's instructions, certain businesses may receive more c r ed it fr o m b a nks , w hi l e other
businesses may receive less. Therefore, by granting them less credit, selective credit controls can be
used to achieve a variety of objectives, such as deterring traders from stockpiling and black selling
particular important commodities. For specific industries as part of SCCs, the RBI may ration credit or raise
interest rates. The overall amount of credit in SCCs remains constant, but the amount lent and the cost of
credit may alter for a particular sector or sectors.

Moral Suasion

A persuasion measure used by Central bank to influence and pressure, but not force, banks into adhering
to policy. Measures used are closed door meetings with bank directors, increased severity of inspections,
discussions, appeals to community spirit etc.

Direct Action

This method is adopted when a commercial bank doesn‗t cooperate with the central bank in achieving its
desirable objectives. RBI punishes the erring bank. Punishment can involve penal interest, refusal to lend
money under LAF and in exceptional cases, even cancelling the license.

Importance of Monetary Policy

It is a truth that monetary policy has become more crucial to managing the economy in the age of
globalisation. Fiscal policy is typically resisted by democratically elected governments because it forces
them to implement unpopular measures like budget cuts or tax increases. Indirect tax reduction is a
limited option that is only occasionally used, as it was in 2009. Political realities favour monetary policy
playing a larger role during periods of inflation, deflation, and/or disinflation (deflation is drop in prices and
disinflation is drop in the rate of growth of prices).

While monetary policy may be more effective in battling inflation and deflation, fiscal policy may be better
suited to combating unemployment since it allows the government to increase expenditure on public
works projects, which in turn creates jobs. A serious economic crisis has a limit to how much monetary
policy can do to support the economy.

By lowering interest rates and expanding the money supply, monetary policy can combat economic
decline. This was the case during the 2008–2009 global financial crisis, which included India.

But once interest rates reach zero or near zero, the central bank can do no more; economists call it the
―Liquidity trap. What Japan did during the late 1990s. That is liquidity is trapped in banks – banks do not
want to lend as credit may turn into bad asset. Businesses do not want to borrow as demand has slumped.
It is a classic case of liquidity trap and was seen all over the world including India in the downturn in 2008-
09.

Many economists suggested that the Japanese government had to adopt a more aggressive fiscal policy, if
necessary running up a significant government deficit, to encourage increased spending and economic
growth given the country's stagnating economy and low interest rates. Then, monetary policy was shown
to be essentially useless.
When lower interest rates prove ineffective, unorthodox measures are used, as was the case in the USA
when the Federal Reserve (the country's central bank) turned to quantitative easing.

Monetary policy has grown from simply increasing the money supply to keep up with both population
growthand economic activity. It must now take into account such diverse factors as:

 Signals to the economy by way of rate and reserve adjustment

 Exchange rates
 Credit quality
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International capital flows of money on large scales with globalization and the increase in the flow of funds
highly speculative in character, monetary pol- icy acquires unprecedented importance for the country. The
following will illustrate the point further that globalization challenges monetary policy.

Management of the exchange rate is a crucial part of the monetary policy as exchange rate holds the key
to many important macro-economic goals and dictates foreign flows inflows and outflows. It has a close
bearing on money supply and inflation and interest rates for instance, if foreign inflows flood the country, in
order to maintain its monetary stability; RBI has to buy the foreign currency to save the rupee from
excessive appreciation. The rupee that is printed has to be sucked out with Government securities as
otherwise it will be inflationary.

Similar to how the US Fed's adoption of quantitative easing could present us with enormous difficulties.
In India, a sterilisation effort was launched in 2004 with the Market Stabilization Bond Scheme. Under
the MSS, the RBI creates government securities to stifle excessive market liquidity and stop inflation. Such
sterilisation can be costly because to the interest that must be paid on the money that was so sucked out.
Therefore, the effort to stop rupee appreciation results in an excess of money supply, which is an
expensive operation. Increased interest rates and CRR may also be required because they harm growth
while lowering inflation. The latter was observed in India between 2006 and 2008.

After the 2008 global financial crisis monetary policy faces another challenge: financial stability; as
banks go bankrupt and other financial institutions are destabilized.

Thus, monetary policy acquires enormous importance during globalization.

Market Stabilization Bonds

As part of the Market Stabilization Scheme, the RBI started floating government securities and T-Bills in
2004 to remove excess liquidity from the market. Because the RBI has been purchasing dollars from the
market, there is too much liquidity. MSS is a central bank sterilisation initiative. The RBI is unable to drain
the vast supply of rupees created by the purchase of dollars from the market using the typically accessible
government assets. The MSS was therefore launched.

Limitations of monetary policy and the challenges faced by developing nations in implementing
it
 Developing countries have difficulty successfully implementing monetary policy. The fundamental
problem is that priorities are set by the government's fiscal policy, and the central bank is not
actively involved in decisions about whether to increase the money supply via borrowing. The
central government has the exclusive right to implement welfare programmes, international trade
policies, tax policies, and other measures, and the central bank primarily supports these initiatives.
 As per the critics, the monetary policy of RBI has played only a limited role in controlling the
inflationary pressure between 2012 to 2015, RBI changed the interest rates umpteen number of
times but was unable to bring down inflation rates. We can conclude that the role of monetary
policy in combating inflation is strictly limited. Monetary Policy can control inflation caused due to
increase in demand but it can‗t control supply shock inflation.

 Other difficulties are:

a. Existence of Black Money: Black Money limits the working of the monetary policy. Black
money is not recorded since the borrowers and lenders keep their transactions secret.
Consequently, the supply and demand of money also doesn‗t remain as desired by the
monetary policy.
b. Large non monetized sector: People mostly live in rural areas where barter is practiced.
Hence monetary policy fails to influence this large segment of economy.
c. Main source of banks’ money is general public: So the lending rates of banks are decided
by the deposit rate and not the repo rate. People in developing countries don‗t have many
investment options. Therefore banks in these countries have high deposits.
d. Conflict in Fiscal policy and monetary policy: Public borrowing and subsidies increase
money flow into the market. So even if rates are increased, it won‗t have an effect on the
economy.
e. Supply Side Constraints: Monetary policy can have impact on demand side inflation only. It
can‗t control inflation which is due to shortage of supply due to failed monsoons, hoarding etc.
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Interest Rates and their Significance

Interest rates are the rates given for money deposited in banks, for investi n g in bonds, for borrowing
money from banks and other financial institutions, etc.

Investors seek low lending costs, while savers want greater interest rates. There must be harmony. The
following factors affect interest rates:

1. Inflation: The higher the inflation, the higher the interest rates because the same amount of
money should not buy more due to inflation when invested incommodities and other assets.
2. Need for growth: lower interest rates reduce cost of credit and facilitate investments for growth.
3. Promotion of savings (If savings have to be in- creased, deposit rate have to be increased).
4. Government‘s need to borrow: the magnitude of government‗s borrowing programme also
determines interest rates. The more the borrowing, the higher the lending interest rates for the
general public and the corporates.
5. Need to generate demand: As interest rates come down, consumer demand for credit goes up
and there will be a stimulus for growth.

Deregulation of Interest Rates

Interest rates have been deregulated as a result of banking sector changes. It implies that the RBI will
no longer intervene wi t h the banks' decision to set their own lending and borrowing rates. The
justification is that

(i) Banks are quick to change rates in response to market circumstances;

(ii) It is important to encourage financial innovation;
(iii) Through regulation, populism can be stopped.
(iv) competitive rates may be advantageous to investors and savers;
(v) More dynamic global alignment is feasible, etc.

Difference between Floating and Flexible Rates of interest

Interest rates come in two varieties: fixed and variable. It is known as a flexible interest rate regime if
they are both offered at the same time (when they coexist). An underlying benchmark rate serves as the
foundation for floating interest rates. In other words, the interest rate offered "floats" in reference to the
interest rate of a government security instrument with a similar maturity (5 years, 10 years, etc.), as set
by the market. Therefore, rather than being "fixed," floating interest rates are generally determined by the
market. The effective rate is changed every quarter, every two years, or every year. While the fixed
interest rate remains the same throughout the loan's term.

RBI’s Clean Note Policy-

The RBI's "Clean Note Policy" aims to provide the public with high-quality banknotes and coins while taking
dirty notes out of circulation. This policy directs Banks to do the following:

 Stop stapling note packets; instead, use paper bands to keep them closed.
 Notes should be categorised as re-issuables and non-issuables.
 Only publish pristine notes.
 Put an end to all writing on the banknotes' watermark windows.

On average, one out of every five paper notes in circulation (about 20 percent) is disposed of every year
after becoming filthy.

PROMPT CORRECTIVE ACTION framework

What is it?

The RBI uses a system called PCA, or prompt corrective action, to keep an eye on banks with subpar
financial data. If a bank's capital ratios, asset quality, or profitability deviate from predetermined
standards, the PCA framework classifies the bank as hazardous.

Depending on how a bank performs on these ratios, it has three risk threshold levels, with 1 being the
lowest and 3 the greatest. The capital to risk-weighted assets ratio (CRAR) of a bank must be greater than
7.75 percent but less than 10.25 percent to fall under threshold 1. People who have CRARs of more than
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6.25 percent but less than 7.75 percent come under the second cutoff. The third threshold level is where a
bank is placed if its common equity Tier 1 (the basic minimum capital required by CRAR) falls below 3.625
percent.

Banks having a net NPA of at least 6% but less than 9% fall under threshold 1, and those with a net NPA
of at least 12% fall under the third threshold level.

Why is it important?

A bank must maintain a sufficient level of capital in order to carry out its operations because the majority
of bank activities are supported by deposits that must be returned. PCA is designed to help warn the
regulator, investors, and depositors, if a bank is about to have difficulty. Prior to a crisis escalating,
difficulties are to be avoided. In essence, PCA supports RBI's monitoring of banks' key performance
indicators and the implementation of remedial actions aimed at regaining a bank's financial stability.

The RBI may enact a corrective action plan in response to a breach of any of the risk thresholds specified
above. The RBI may impose limitations on dividend payments, branch growth, and management
compensation in accordance with the threshold levels. Only in a dire circumstance, a breach of the third
criteria, would designate a bank as a potential candidate for resolution by merger, reconstruction, or
wound up.

In the past year, 11 public sector banks have been placed under PCA due to the significant decline in
state-owned banks' financial standing brought on by growing NPAs. According to the FY18 financials of the
21 PSBs, 17 can be subject to PCA based alone on the net NPA threshold, and nine based solely on ROA
(negative for two consecutive years).

Why should I care?

If a bank in which you hold deposits falls under PCA, don‘t press the panic button. The RBI‘s corrective
measures may bode well for your bank. But do keep a watch on the RBI‘s PCA announcements, as they
can offer vital cues on the performance of your bank.

Contrary to the perception, PCA does not really limit the normal lending operations of banks. Arguments
that so many banks slipping into PCA has stifled credit growth are overdone. While the RBI has placed
restrictions on credit by PCA banks to unrated borrowers or those with high risks, it hasn‘t invoked a
complete ban on their lending.

The RBI Act's Section 7 gives the Central Government the authority to communicate with the
Governor of the RBI and advise him or her to take action on certain matters that it deems important and
in the public interest. After consulting with the bank's governor, the central government may occasionally
command the bank in ways it deems appropriate for the general good. After Section 7 is invoked, a
Central Board of Directors is given broad supervision and direction over the Bank's operations. This board
has the authority to exercise all of the Bank's legal authority and perform all acts. In India after
independence, Section 7 had never been applied. It was neither even used when the country was close
to the economic crisis in 1991 and nor in the aftermath of the 2008 recession crisis.
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CHP 4 Types of Banks

A. Central Banks

Central Banks are bankers' banks, and these banks trace their history from the Bank of England. They
ensure stable monetary and financial policies from one nation to the next and are crucial to the nation's
economy. Implementing monetary policy, overseeing gold and foreign exchange reserves, deciding on
official interest rates, serving as a banker to the government and other banks, and regulating and
monitoring the banking sector are typical duties.

These institutions purchase government debt, control the printing of paper money, and frequently serve as
commercial banks' lender of last resort. Today, these commercial banks are referred to as banks. All of a
nation's commercial banks are subject to oversight, regulation, and supervision by its central bank. It also
serves as a banker for the government. The currency and credit policies of any nation are controlled and
coordinated by it. India's national bank is called the Reserve Bank of India.

Central Banks of Various Countries:

 US Federal Reserve Bank (USD)

 European Central Bank (EUR)
 Bank of England (GBP)
 Bank of Japan (JPY)
 Swiss National Bank (CHF)
 Bank of Canada (CAD)
 Reserve Bank of Australia (AUD)
 Reserve Bank of New Zealand (NZD)

B. Commercial Banks

Commercial Banks are those profit seeking institutions which accept deposits from general public and
advance money to individuals like household, entrepreneurs, businessmen etc. with the prime objective of
earning profit in the form of interest, commission etc. The Reserve Bank of India, the country's central
bank and highest financial authority, oversees the activities of all of these institutions. The difference
between these two rates, which commercial banks charge to borrowers and pay to depositors, is their
primary source of income. ICICI Bank, State Bank of India, Axis Bank, and HDFC Bank are a few examples
of commercial banks.

Activities of Commercial Banks

The main functions of a commercial bank can be segregated into three main areas:
(i) Payment System
(ii) Financial Intermediation
(iii) Financial Services.

(i) Payment System

The payments system in an economy is centered on banks. A payment is the method used to settle
financial transactions. Checks written on behalf of customers are one of the primary ways that banks assist
in the settlement of financial transactions. Additionally, the payments system in modern banking includes
electronic banking, wire transfers, the settlement of credit card transactions, etc. Banks are essential in
every one of these transactions.

(ii) Financial Intermediation

A bank's second main duty is to accept various deposit types from clients and subsequently lend these
monies to borrowers, a process known as financial intermediation. In terms of finance, bank deposits are
the banks' liabilities, while the loans they distribute and the investments they make are their assets.
Depositors' needs for liquidity, safety, and return on investment in the form of interest are met by bank
deposits, which is a valuable function. On the other hand, bank investments and loans serve a crucial role
in directing capital toward both financially and socially advantageous applications.
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(iii) Financial Services

Banks today are more and more involved in providing customers with a wide range of financial services,
such as investment banking, insurance-related services, government-related business, foreign exchange
businesses, wealth management services, etc., in addition to their role as financial intermediaries.
Profitability of a bank is increased by revenue from offering such services.

Classification of commercial banks

Scheduled banks:- Banks which have been included in the Second Schedule of RBI Act 1934. To be
eligible for this inclusion, a bank must satisfy the following three condition:

1. It must have a paid up capital and reserves for an aggregate value of at least Rs. 5,00,000.
2. It must satisfy the RBI, that its affairs are not conducted in a manner detrimental to the interest of
its depositors; and
3. It must be a corporation and not a partnership or a single owner firm.

Scheduled banks enjoy certain privileges such as free/concessional remittance facilities

through the offices of the RBI and its agents and borrowing facilities from the RBI. In return,
the scheduled are under obligation to:

1. Maintain an average daily balance of cash reserves with the RBI at rates stipulated by it; and
2. Submit periodical returns to the RBI under various provisions of Reserve Bank of India Act, 1934
and the Banking Regulation Act 1949 (as amended from time to time).

They are categorized as follows:

 Public Sector Banks:- are those banks in which majority of stake is held by the government. Eg.
SBI, PNB, Syndicate Bank, Union Bank of India etc.
 Private Sector Banks:- are those banks in which majority of stake is held by private individuals.
E.g. ICICI Bank, IDBI Bank, HDFC Bank, AXIS Bank etc.
 Foreign Banks:- are the banks with Head office outside the country in which they are located. Eg.
Citi Bank, Standard Chartered Bank, Bank of Tokyo Ltd. etc.
 Regional rural banks were brought into operation with the objective of providing credit to the
rural and agricultural regions and were brought into effect in 1975 by RRB Act. These banks are
only allowed to conduct business in the territories designated by the Indian government. State
government and a sponsor bank jointly own these banks. An institution that had been nationalised
and a state cooperative bank were to support this event. As an illustration, consider Prathama
Bank, which is situated in Moradabad, U.P.

Nonscheduled commercial banks:- Banks which are not included in the Second Schedule of RBI Act
1934. The statutory cash reserve requirement applies to non-scheduled banks as well. However, they are
not compelled to retain them with the RBI; they are free to keep these balances on their own. They are
not permitted to borrow money from the RBI for standard banking needs, although they are permitted to
ask the RBI for accommodations in exceptional situations.

C. Cooperative Banks

Cooperative Banks were established in 1912 under the Cooperative Societies Act, under the jurisdiction,
ownership, management, and operation of cooperative societies. These banks can be found both in urban
and rural locations. Although these banks do the same tasks as commercial banks, they offer financing to
small businesses, salaried individuals, and farmers, among other groups, and their interest rates are lower
than those of other banks.

There are three types of cooperative banks in India, namely:

a. Primary credit societies: These are formed in small locality like a small town or a village. The
members using this bank usually know each other and the chances of committing fraud are
minimal.
b. Central cooperative banks: These banks have their members who belong to the same district.
They function as other commercial banks and provide loans to their members. They act as a link
between the state cooperative banks and the primary credit societies.
c. State cooperative banks: these banks have a presence in all the states of the country and have
their presence throughout the state.
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D. Local Area Banks

With a view to promote banking facilities in local area, providing institutional mechanisms for promoting
rural savings and to mobilize credit facility for viable economic activities in the rural area Local Area
Banks are established there. These LABs are categorized under private sector and included in the
second schedule of RBI Act, 1934. Following are some points to be kept in mind w.r.t Local Area Banks
(LABs):-

 These LABs are restricted to operate maximum in three districts.

 They will be extending loan facility to agricultural requirements, agro-trade, agro-industrial
accomplishments, non-husbandry accomplishments etc.
 These banks will observe the priority sector lending target at 40% of Net Bank Credit as other
banks do.
 The minimum paid up capital of LABs shall be Rs. 5 cr. However, they are required to increase
their capital from Rs. 5cr to Rs. 25 cr. in next 5-7 years.
 1st LAB in India – Krishnabim Samrishi Local area Bank.
 An LAB should maintain a minimum capital adequacy ratio of 15%.
 The contribution towards capital of a LAB by a single family should not exceed 40% of the total
paid up capital of the LAB. Proposals having diversified share holdings are always preferred.
 LABs irrespective of their limited scope of operation are allowed to conduct all the functions of a
scheduled commercial bank.
 The entire promoters' contribution towards equity shall carry a 'lock-in' period of three years from
the date of issue of license and at least 40% will be locked in for a further period of two years
beyond the aforesaid period of three years subject to review before completion of five years.
 The ministry has identified 120 unbanked locations for which LAB operation was proposed.
 The Raghuram Rajan Committee, in 2009 decided to promote more local area banks in order to
spur the financial inclusion drive by Central government and Ministry of Finance.

An excellent idea for reaching the neighbourhood market is Local Area Bank. Residents of the surrounding
neighbourhood would feel a sense of loyalty and trust as a result of the bank's and its offices' proximity to
them. Additionally, this will raise funds in places where there are no banking services available. On the
other hand, given the high fixed costs of such small banks, questions about their profitability and the
integrity of its small promoters may arise.

E. Development Banks
Development banks are those financial organisations whose main objective (drive) is to provide money for
society's most fundamental needs. The nation's social and economic sectors flourish and thrive as a result
of this funding. However, because of variances in communal organisation, economies, and other factors,
social demands vary from area to region.

Development banks are financial organisations created to finance (lend) money at a reduced interest rate.
Such lending is authorised to advance and expand crucial industries, including agriculture, business,
housing, and related endeavours.

Following World War II, development banking was established. It offered funding for the war-damaged
businesses and buildings to be rebuilt. In India, development banking began as soon as the country gained
its freedom. The arrangement of development banks in India is depicted below.

Development banks in India are classified into following four groups:

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I. Industrial Development Banks: The Industrial Development Bank of India (IDBI), the Small
Industries Development Bank of India, and the Industrial Finance Corporation of India (IFCI) are a few
examples (SIDBI).

IFCI - The first development bank in India is called IFCI, or Industrial Finance Corporation of India. The
Industrial Finance Corporation Act of 1948 allowed for its creation, which took place on July 1st, 1948. It
was reorganised as a business in 1993 to provide greater operating flexibility. The primary goal of IFCI is
to offer medium- and long-term financial support to big industrial enterprises, especially when
conventional bank financing is insufficient for the project or when the concerned party cannot economically
obtain funds through the issuance of shares.

IDBI Bank Limited is an Indian financial service company headquartered Mumbai, India. RBI categorised
IDBI as an "other public sector bank". It was established in 1964 by an Act of Parliament to provide credit
and other facilities for the development of the fledgling Indian industry. It is currently 10th largest
development bank in the world in terms of reach.

For both new construction and expansion, modernization, and diversification projects, IDBI offers financial
support in both rupees and other currencies. As a result of the financial sector reforms the government
has announced since 1992, IDBI also offers indirect financial assistance through the refinancing of loans
provided by State-level financial institutions and banks as well as through the rediscounting of bills of
exchange resulting from the sale of domestic machinery on a payment-deferred basis. In keeping with its
government-mandated "development banking" charter, IDBI has taken a leading role, especially during
the pre-reform era (1964–91), in fostering broad-based industrial development in the nation.

SIDBI -In accordance with an Act of the Indian Parliament, the Small Industries Development Bank of
India (SIDBI) was established on April 2, 1990. It currently serves as the primary financial institution for
the promotion, financing, and development of the micro, small, and medium-sized enterprise (MSME)
sector and coordinates the operations of the other institutions involved in related endeavours. The Bank
currently offers direct help through its branch offices and refinances support via a network of qualified
member lending institutions for MSMEs. SIDBI also extends financial assistance in the form of loans,
grants, equity and quasi-equity to Non-Government Organisations / Micro Finance Institutions (MFIs) for
on-lending to micro enterprises and economically weaker sections of the society, enabling them to take up
income generating activities on a sustainable basis.

SFC - There was a demand for specialised financial institutions to handle the financial needs of small- and
medium-sized businesses. In light of this, on September 28, 1951, the Central Government passed the
State Financial Corporation Act, giving state governments the authority to create financial corporations
that will function only inside their respective states. Between Rs. 50 lakhs and Rs. 5 crores in share capital
may be allowed for the State Financial Corporation. With the Central Government's previous approval, it
may be enhanced by up to Rs. 10 crores.

The main functions of SFCs are:-

(i) To provide loans for a period not exceeding 20 years to industrial units.
(ii) To underwrite the issue of shares, debentures and bonds for a period not exceeding 20 years of
industrial units.
(iii) To give guarantee to loans taken by industrial units for a period not exceeding 20 years.
(iv) To make payment of capital goods purchased in India by these industrial units.
(v) To subscribe to the share capital of the industrial units, in case they wish to raise additional capital.

SIDCO-Small Industries Development Corporations are state-owned companies or agencies in the

states of India which were established at various times under the policy of Government of India for the
promotion of small sale industries.

A few of the SIDCOs are:

 Kerala Small Industries Development Corporation Limited
 Small Industries Development Corporation of Jammu and Kashmir.
 Tamil Nadu Small Industries Development Corporation Limited (TANSIDCO).

II. Agricultural Development Banks: It includes, for example, National Bank for Agriculture & Rural
Development (NABARD).

NABARD is an apex development bank in India having headquarters based in Mumbai and other branches
are all over the country. The National Bank for Agriculture and Rural Development was conceived of by the
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Committee to Review Arrangements for Institutional Credit for Agriculture and Rural Development
(CRAFICARD), which was established by the Reserve Bank of India (RBI) under the chairmanship of Shri B.
Sivaraman (NABARD). It was created on July 12, 1982, under a special Act of the Parliament. Its primary
goal was to improve rural India by boosting credit flow to the agricultural and rural non-farm sectors. On
July 12, 2022, it celebrated its 50th anniversary. "Matters relating to policy, planning, and operations in
the realm of credit for agricultural and other economic activities in rural areas of India" have been
accredited to it. RBI sold its stake in NABARD to the Government of India, which now holds 99% stake.
NABARD is active in developing financial inclusion policy and is a member of the Alliance for Financial
Inclusion.

III. Export-Import Development Banks: It includes, for example, Export-Import Bank of India (EXIM
Bank).

Export-Import Bank of India is the premier export finance institution of the country, established in
1982 under the Export-Import Bank of India Act [Link] its inception, Exim Bank of India has been
both a catalyst and a key player in the promotion of cross border trade and investment. Government,
Reserve Bank of India, Export Credit Guarantee Corporation of India, a financial institution, public sector
banks, and members of the business community are all represented on the board of directors that
oversees Exim Bank.

The Bank's functions are segmented into several operating groups including:

 Corporate Banking Group which handles a variety of financing programmes for Export Oriented
Units (EOUs), Importers, and overseas investment by Indian companies.
 Project Finance / Trade Finance Group handles the entire range of export credit services such as
supplier's credit, pre-shipment Agri Business Group, to spearhead the initiative to promote and
support Agri-exports. The Group handles projects and export transactions in the agricultural sector
for financing.
 Small and Medium Enterprise: The group handles credit proposals from SMEs under various
lending
 programmes of the Bank.
 Export Services Group offers variety of advisory and value-added information services aimed at
investment promotion.
 Export Marketing Services Bank offers assistance to Indian companies, to enable them establish
their products in overseas markets. The idea behind this service is to promote Indian export.
Export Marketing Services covers wide range of exports oriented companies and organizations.

IV. Housing Development Banks: It includes, for example, National Housing Bank (NHB).

India's National Housing Bank (NHB) was established on July 8, 1988, in accordance with Section 6 of the
National Housing Bank Act, and is a state-owned bank and regulatory body (1987). The corporate office is
in New Delhi. The Reserve Bank of India owns the organisation, which was founded to encourage the
purchase of private real estate. The NHB also oversees and funds other efforts like research and IT
projects in addition to social housing programmes.

NHB has been established to achieve the following objectives –

a. To promote a sound, healthy, viable and cost effective housing finance system to cater to all
segments of the population and to integrate the housing finance system with the overall financial
system.
b. To promote a network of dedicated housing finance institutions to adequately serve various
regions and different income groups.
c. To augment resources for the sector and channelise them for housing.
d. To make housing credit more affordable.
e. To regulate the activities of housing finance companies based on regulatory and supervisory
authority derived under the Act.
f. To encourage augmentation of supply of buildable land and also building materials for housing and
to upgrade the housing stock in the country.
g. To encourage public agencies to emerge as facilitators and suppliers of serviced land, for housing.
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Payment Banks: By making opening a bank account simpler for everyone, these payment banks hope to
promote financial inclusion. That's also why the accounts' cash limit is only set at Rs. 1 lakh; while this
restriction may seem extremely low to most readers, if you frequently spend time outside of the banking
system, it is actually a respectable sum. The main impact will be felt in domestic remittances as it will be
simpler for people to send money home to smaller towns and villages while working in urban areas. The
new payment banks will also make people less dependent on cash, even for small sums, and since a
mobile wallet could be a bank account soon, this move could, over time, have a big impact on m-
commerce. Payment banks are permitted to pay customers interest on the money that is being deposited
and can take deposits up to Rs. 1 lakh per customer. They can be utilised for savings or current accounts.
This is a significant step forward for businesses that previously operated as mobile wallets (a subset of
Pre-Paid Instrument, or PPI), as it increases the funds limit and permits interest to be paid on deposits,
making it more appealing for customers to hold their money with Paytm or m-Pesa.

A payment bank cannot, however, lend money to individuals or issue credit cards, unlike a typical bank.
Additionally, the payment banks are restricted to using customer deposits to buy only government
securities.

While the payment banks can't issue credit cards, they can issue ATM and debit cards. This is also crucial
when looking at it from the perspective of financial inclusion, as it now allows someone to deposit cash
into an m-Commerce bank account from Delhi, and a relative in a small town who has the debit card can
easily withdraw cash from any ATM or, in more remote areas, through any point of sale terminal with a
"business correspondent," or essentially an authorised partner for the bank. The purpose of bank branches
will be served by these partners, although the payment banks are free to establish branches if they so
choose. Theoretically, one of them may be a little convenience store in a village that offers mobile
recharges.

IMPS and NEFT transfers allow you to link your savings bank accounts to payment banks. As was already
established, all banks would accept the payment banks' debit or ATM cards. It makes sense given the goal
of financial inclusion that payment banks cannot accept NRI deposits.

Small Banks: In India, small finance banks are a subset of specialty banks. Banks that hold a small
finance bank licence are permitted to offer the standard banking services of accepting deposits and making
loans. The purpose of these is to give financial inclusion to segments of the economy that aren't currently
served by other banks, like unorganised sector entities, small businesses, marginal farmers, and micro-
and small-scale industries. It is not permitted to create subsidiaries to conduct non-banking financial
services operations. Following a review and the initial five-year stabilisation period, the RBI may expand
the range of activities for small banks. Small finance banks are similar to regular commercial banks except
that their scale of services will be much smaller. These new type of banks should generate at least 75% of
their business from the priority sector (largely agriculture) and mainly from areas where large banks are
not present. Besides, 50% of their loans should be of ticket sizes under Rs 25 lakh.

Like payments banks, the minimum paid-up equity for small finance banks is also fixed at Rs 100 crore.
For small banks, promoters' initial contribution should be at least 40%, which could be brought down to
26% over the next 12 years, RBI guidelines said.

The area of operations would normally be restricted to contiguous districts in a homogenous cluster of
states of union territories so that the Small Bank has a 'local feel' and culture. However, if necessary, it
would be allowed to expand its area of operations beyond contiguous districts in one or more states with
reasonable geographical proximity.
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Neo Banks-

The neo banks are digital banks. They are the banks that only offer online banking services. There is no
physical bank; everything about it is digital.
Neo Banking is a method of offering an entire banking experience via digital platforms, such as a mobile
application.

Benefits of Neo Banks-

 A neobank act as a bridge between the services offered by the traditional banking and the
expectations of a new-age customers.
 Neobank provides personalised experiences, employ data-driven insights and offer value-added
services.
 The biggest attraction of neobanks is that most of them don't have minimum balance
requirements.

Neobank vs traditional bank: While traditional banks continue to struggle with bringing their legacy-
based infrastructure into the digital age, neobanks leverage its modern digital platforms to analyse
customer data and make data-driven decisions.

 Neobanks can also afford to slash customer fees since they don't have to bear the expenses of
running physical locations.
 Neobanks provide hassle free account creation due to their tech-driven nature.

Tailor made products: Being data driven, neobanks can tailor their products to businesses depending
upon their size, scale, and expenses.

 Most of the credit products offered by these banks are focused on people who are new to credit or
who are underserved by the existing banks.
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Payment Banks
Payments banks are a form of specialised banks that the RBI developed in order to advance financial
inclusion and ease the flow of money abroad. The Payments banks can only focus on two sorts of
activities: receiving demand deposits and facilitating payments, making them different from typical
universal banks.

The main target for payment banks will be migrant labourers, self-employed, low income households etc.
as they will offer low cost savings accounts and remittance services so that those who now transact only in
cash can take their first step into the formal banking system. They will be cashing in on mobile technology
and applications to cater to the various services they will be offering and with the use of technology they
can be cost efficient. Payment banks will be acting as add on to the already established banks, rather than
their competitors.

They will enhance financial inclusion by providing:

(i) small savings accounts
(ii) payments/remittance services to: migrant labour workforce, low income households, small businesses,
other unorganised sector entities and other users.

They can accept demand deposits, with a maximum balance of Rs 100000 per individual. They can issue
ATM/Debit cards; but can't issue credit cards. They can act as BC of another bank. Offer internet banking,
sell mutual funds, insurance and pensions. They cannot indulge in lending. CRR is applicable. SLR of 75% -
comprising of upto one year maturity GSecs/T- bills and the remaining (25%) in deposits with other
Scheduled Commercial Banks.

The domestic remittance business in India is thought to be worth around Rs 800-900 billion and
expanding. A significant portion of it, notably that of the migratory labour, could transition to this new
platform now that money transfers are possible through mobile phones.

The government's Direct Benefit Transfer programme, in which beneficiaries' accounts are directly credited
with health care, education, and gas subsidies, can also be significantly implemented with the help of
payment banks.

Payment banks have shown to be extremely well-liked in other developing nations. In Kenya, the country
with the most success stories, two out of every three adults use Vodafone M-Pesa to store money, make
purchases, and send money to friends, family members, and other people.
Union Cabinet has approved the setting up of India Post's payments bank at a total project cost of Rs 800
crore.

Advantages of India Post

1. Extensive reach and spread of Indian postal system to blocks, taluks and villages ensuring last
mile connectivity.
2. Old setup, ease of access, years of trust and familiarity of rural people.
3. Brick and mortar banks are unviable to setup in many of the remote areas.
4. Helpful for migrants, labourers, MSME, poor house hold, enhancing access to financial services and
promoting financial inclusion.

Small Finance Banks (SFBs)

They are specialty banks that cater to and meet the demands of a particular demographic subset of the
general public. Small finance banks will be established with the intention of promoting financial inclusion
through (1) the provision of savings vehicles and (2) the provision of credit to small business units, small
and marginal farmers, micro and small industries, and other unorganised sector entities through high
technology, low cost operations. SFBs were recommended by the Nachiket Mor committee on financial
inclusion. Newly setup SFBs are Au Financiers, Utkarsh Micro Finance etc.

Scope of activities of SFBs

The small finance banks will largely engage in fundamental banking activities, such as accepting deposits
and lending to underserved and unserved groups, such as unorganised sector entities, small business
units, small and marginal farmers, and micro- and small businesses. There won't be any limitations on
where small financing institutions can operate.
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The Reserve Bank's priority sector lending (PSL) criteria mandate that the small financing banks lend 75%
of their adjusted net bank credit (ANBC) to industries that qualify. As required by RBI regulations, SFBs
must maintain their Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR).
At least 50 per cent of its loan portfolio should constitute loans and advances of up to Rs. 25 lakh.
They can sell forex to customers. Sell mutual funds, insurance and pensions and can convert into a full-
fledged bank.

Challenges to Small Finance Banks

 Have to compete with existing public sector banks and RRBs.

 Micro Finance Institution (MFI)/NBFC are specialised in microlending operations with minimal
exposure to banking operations; as a result, they must hire and educate people from the
banking industry.
 The cost of deposit mobilisation will be higher for these banks as they cover rural and
underserved segment.

What do SFBs, PBs, 'on-tap licensing' mean?

 Small Finance Banks (SFBs) offer basic banking services.

 These include accepting deposits and lending to un-served and underserved sections.
 It offers for small businesses, small and marginal farmers, micro and small industries, and the
unorganized sector.
 Payment banks (PBs), on the other hand, as per the existing rules, are not allowed to lend.
 Also, their deposits are capped at Rs. 1 lakh per customer.
 An on-tap' facility would mean that the RBI would accept applications and grant license for
banks throughout the year.

What are the key guidelines?

 Payments banks can apply for conversion into small finance banks (SFBs) after 5 years of
operation provided they meet the eligibility criteria.
 The promoter of a payments bank is eligible to set up an SFB.
 This is permissible, provided that both banks come under the non-operating financial holding
company (NOFHC) structure.
 SFBs Capital - The RBI has also raised the minimum paid-up capital requirement for SFBs from
Rs. 100 crore to Rs. 200 crore.
 It said the promoter should hold a minimum of 40% of the paid-up voting equity capital for 5
years.
 If the initial promoter shareholding is above 40%, it should be brought down to 40% within a
period of 5 years, 30% within 10 years, and 15% in 15 years.
 Schedules bank status - SFBs should be listed within 3 years of reaching a net worth of Rs. 500
crore.
 They will be given the scheduled bank status immediately upon commencement of operations.
 They will also have general permission to open banking outlets from the date of
commencement of operations.
 Urban cooperative banks - The RBI also allowed primary urban cooperative banks to convert into
SFBs.
 This is, provided they comply with the on-tap licensing guidelines.
 The minimum net worth of such SFBs will be Rs. 100 crore.
 This has to be increased to Rs. 200 crore within 5 years from commencement of business.

MUDRA

 MUDRA, or Micro Units Development and Refinance Agency Ltd., is a government-created

development and finance organisation designed to provide micro unit firms with refinancing and a
number of development activities.
 Its primary responsibility is to provide funding to nearly 5.8 crore Non -Corporate Small Business
Sector (NCSB) units of the country through various Last Mile Financial Institutions like Banks,
NBFCs and MFIs.
 The micro enterprises, also known as the Non-Corporate Small Business sector (NCSB), are
marginalised, fragmented, and minuscule entities that have an impact on the lives of almost fifty
crore people. The economic growth is accelerated by their growth performances.
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Awareness

 More than 90% of the NCSB sector, according to official estimates, lacks access to institutional
sources of financing. The purpose of the government's creation of MUDRA Limited as a SIDBI
subsidiary is to finance this sector.

Functioning of MUDRA

Refinancing is MUDRA's primary duty. It will offer refinancing to all Last Mile Financiers, including non-
banking finance companies, societies, trusts, cooperative societies, small banks, scheduled commercial
banks, and regional rural banks that lend to micro and small business entities involved in manufacturing,
commerce, and services. As a Last Mile Financier of small and microbusiness businesses, MUDRA would
also collaborate with state and regional level financial intermediaries.

MUDRA's support to Pradhan Mantri MUDRA Yojana (PMMY)

The Pradhan Mantri A programme known as MUDRA Yojana (PMMY) was introduced by the Indian
government and carried out through MUDRA. Shishu, Kishor, and Tarun are the names of the three items
that make up the scheme's three levels of microbusinesses. These goods show the beneficiary micro unit's
or entrepreneur's stage of development and financial requirements.

The PMMY sets financial limit for these schemes:-

1. Shishu: covering loans upto 50,000/-

2. Kishor: covering loans above 50,000/- and upto 5 lakh
3. Tarun: covering loans above 5 lakh to 10 lakh As per regulations, at least 60% of the loan amount
should be given for Shishu categories.

The MUDRA is also supposed to extend several development functions to the microfinance sector. But the
details of these activities with regard to the MFI sector are yet to be finalized by the government.
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CHP 5 Types of Banking

Retail Banking-

It stands for banking services in which banks cater to individual customers and offer services like savings
accounts, transactional accounts, mortgages, personal loans, debit and credit cards. The term was
introduced to differentiate between different banking services like investment banking, commercial
banking, etc. These banking services are not restricted to specific banking branches or ATMs but are also
extended to internet, mobile-banking space etc. It is divided into two types-

1. Mass retail banking where banks offer standardised products and services to its customers.
2. Class retail banking where banks offer customised products and services tailor-made for a niche
segment of customers.

Virtual Banking-

Virtual or internet banking is a system where all the transactions of the bank are done online and there are
no physical branches of the banks. It is the latest technological breakthrough to provide the customers the
ease of banking while on the go i.e. they don‘t have to personally walk into any bank branch and can
operate ones account or other services online only. The system has gradually moved from ‗nice to have‘ to
a ‗need to have‘ service in some of the developed countries where net-banking have become a new norm
rather than an exception. It is the quickest way to bank and also the cheapest as it saves both time and
money. Many types of bank accounts can be accessed virtually like checking accounts, savings accounts,
certificates of deposits, etc. Thus, users mostly use virtual banks for many services like- checking the
account balance, transfer funds, bill payments, etc. Also, there are no banking hours and thus customers
can operate their accounts at any time of the day. Many banks also allow to open new accounts online. As
there are no physical operations, so these banks have less overhead costs and can thus pass these
savings to customers in form of higher rates of interest on savings, waiving off of bank account fees.

The services can be classified into three categories:

1. Basic level service: They are provided by bank website which gives information on different
products and services.
2. Simple Transactional Service: Under this, the customer carries out simple functions like give
applications for different services, check account balance etc.
3. Fully Transactional Websites: These allow customers to perform core banking functions like
transfer of funds, payments of bills etc.

Green Banking-

The concern for environmental sustainability by the banks has given rise to concept of Green Banking. The
concept of ―Green Banking‖ will be mutually beneficial to the banks, industries and the economy. Green
financing is the part of green banking. Green banking means promoting environmental friendly practices
and reducing your carbon footprints from your banking activities. Green banking aims at improving the
operations and technology along with making the clients habits environment friendly in the banking
business. It is like normal banking along with the consideration for social as well as environmental factors
for protecting the environment. It is the way of conducting the banking business along with considering
the social and environmental impacts of its activities.

Telephone banking-

Telephone banking is a service provided by a bank or other financial institution that enables customers to
perform financial transactions over the telephone, without the need to visit a bank branch or automated
teller machine. Telephone banking times can be longer than branch opening times, and some financial
institutions offer the service on a 24 hour basis. From the bank's point of view, telephone banking reduces
the cost of handling transactions by reducing the need for customers to visit a bank branch for non-cash
withdrawal and deposit transactions.
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Awareness

The password for telephone banking is normally not the same as for online banking. Financial institutions
routinely allocate customer numbers (also under various names), whether or not customers intend to
access their telephone or online banking facility. Customer numbers are normally not the same as account
numbers, because a number of accounts can be linked to the one customer number. Customer numbers
are also not the same as any card number which may have been issued to the customer by the financial
institution. The customer will link to the customer number any of those accounts which the customer
controls, which may be cheque, savings, loan, credit card and other accounts. Some financial institutions
have restrictions on which accounts may be access via telephone banking.

Online banking- (or Internet banking or E-banking) allows customers of a financial institution to
conduct financial transactions on a secure website operated by the institution, which can be a retail or
virtual bank, credit union or building society.

To access a financial institution's online banking facility, a customer having personal Internet access must
register with the institution for the service, and set up some password (under various names) for customer
verification. The password for online banking is normally not the same as for telephone banking. Financial
institutions now routinely allocate customer numbers (also under various names), whether or not
customers intend to access their online banking facility. Customer numbers are normally not the same as
account numbers, because a number of accounts can be linked to the one customer number. The customer
will link to the customer number any of those accounts which the customer controls, which may be
cheque, savings, loan, credit card and other accounts. Customer numbers will also not be the same as any
debit or credit card issued by the financial institution to the customer.

To access online banking, the customer would go to the financial institution's website, and enter the online
banking facility using the customer number and password. Some financial institutions have set up
additional security steps for access, but there is no consistency to the approach adopted.

Core Banking-

Core banking can be defined as a back-end system that processes banking transactions across the various
branches of a bank. The system essentially includes deposit, loan and credit processing. Among the
integral core banking services are floating new accounts, servicing loans, calculating interests, processing
deposits and withdrawals, and customer relationship management activities.

Core banking systems are aimed at empowering existing and probable customers to have a greater
freedom of their account transactions. With technological evolutions, transactions are now safer, faster
and less cumbersome. The fact that these transactions can be executed remotely, from any part of the
world has made core banking systems a significant aspect of banking these days.

Core banking always brings down operational costs considerably, ensuring lesser manpower requirement
for execution. It also enables greater accountability of the customers. Software application based
platforms make core banking systems user-friendly and more efficient. The benefits of core banking
systems are multi-faceted – keeping pace with fast-evolving market, simplifying banking processes and
making it more convenient for the customers, and expanding the outreach of the banks to remote places.

Offshore Banking-

Offshore banking is simply another name for opening a bank account outside of your home country. It may
be more challenging to open an offshore bank account than a domestic bank account because you may
need to prove you have a minimum amount of money or a business relationship with the bank‘s country.
A large number of countries offer offshore banking. A few of the most well-known countries for offshore
banking are tax havens — meaning a country or jurisdiction that has low or no taxes for corporations or
individuals — such as Switzerland, Panama and the Cayman Islands. Other popular places for offshore
banking include Hong Kong, Belize, Bermuda, Singapore and Germany.

Narrow Banking-

The narrow banking proposal defining a class of safe and liquid assets (generally sovereign Government
securities) for investments by weak banks, backed fully by demand liabilities (generally non-interest
bearing deposits) has been considered as a means of deposit protection and a possible solution to the
banking problems. The paper seeks to explain the theoretical implications of the proposal and examine its
implications for the Indian public sector banks facing large non-performing loans. The evidence presented
shows that even without a directive, narrow banking on the asset side are already being practised as part
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of the asset-liability management by these banks. However, given the structure of deposit ownership,
narrow banking in its strict sense does not afford a solution to reforming weak banks. Strictly practiced
narrow banking can neither guarantee deposit protection not turn around the weak banks. On the
contrary, it may expose weak banks to immense market and interest rate risks which can make the
banking system vulnerable to idiosyncratic and systemic risks arising from macroeconomic shocks. The
paper however recognises that some contraction in the scale of operations of weak banks seems to be an
unavoidable by-product of measures which may be necessary to strengthen weak banks.

Kiosk Banking-

The Reserve Bank of India (RBI) defines financial inclusion as the process of ensuring access to financial
services and timely and adequate credit where needed by vulnerable groups such as weaker sections and
low income groups at an affordable cost.

It is conceived that the kiosks will functions with the support of leading banks in the private, public and
cooperative sectors and using the shops as a touch-point for basic banking services such as cash deposits,
withdrawals and remittances apart from micro-credit and insurance. Like the ordinary bank branches, the
kiosks will offer all the basic services of banking.

A retailer can open a no-frills bank account for a customer by recording fingerprint details and taking a
photograph of the customer. The details along with other documents are forwarded to the affiliated bank
branch to carry out the know-your-customer process. Once the account is up, a customer can withdraw,
deposit or remit a maximum of Rs 10,000 per day through the internet-enabled kiosk branch.
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Awareness

CHP 6 Types of Bank Accounts

Types of deposits

Current Accounts, Savings Banking Accounts, Recurring Deposits, and Fixed Deposits are the four standard
deposit account types offered by Indian banks. Due to the fiercer competition lately, some banks have
created new products that combine the advantages of the aforementioned two or more types of deposit
accounts. Different banks have different names for this, such as "2-in-1 deposits," "Smart Deposits,"
"Power Saving Deposits," and "Automatic Sweep Deposits." However, the general public has not shown
much interest in these.

A. Current Accounts are basically meant for businessmen and are never used for the purpose of
investment or savings. There are no restrictions on the number of transactions or the volume of
transactions per day for these accounts, which are the most liquid deposits. Most current accounts are
opened in the names of businesses or companies. The account user can deposit any type of check or
draught written in their name or endorsed in their favour by a third party using the offered check book
function. Banks do not charge interest on these accounts. However, banks impose specific service fees on
these types of accounts.

Features of Current Accounts:

(A) The major reason current account users (mainly businesses) open this account is to make it easier for
them to execute their commercial activities.
(a) There are no limitations on the quantity or frequency of cash or check deposits.
(c) Typically, banks do not offer interest on these current accounts. But recently, a few banks have started
offering unique current accounts that pay interest in accordance with the firms' own rules.
(d) The current accounts are on a continuous basis, hence they have no fixed maturity.

B. Savings Bank Accounts are one of the most popular deposits for individual accounts. In addition to
offering the ability to deposit and withdraw money via checks, these accounts also offer a great deal of
flexibility. Few banks actually follow the restrictions regarding the maximum number of withdrawals per
period and the maximum withdrawal amount. However, banks are entirely within their rights to impose
such limitations if they believe that the account is being used improperly as a current account. The RBI
controlled the rate on savings bank accounts until 24 October 2011, when it was set at 4 percent on a
daily balance basis. However, starting on October 25, 2011, the RBI deregulated the interest rates on
savings accounts, allowing banks to set their own rates as long as they abide by the RBI's rules. Banks are
now obligated to open no-frills accounts per RBI instructions (this term is used for accounts which do not
have any minimum balance requirements). Although Public Sector Banks still only pay 4% interest on such
deposits, certain private banks, including Kotak Bank and Yes Bank, pay between 6% and 7%. Starting
with the fiscal year 2012–2013, interest accrued on saving bank accounts up to Rs 10,000 in a year is
exempt from taxation.

C. Recurring Deposit Accounts are popularly known as RD accounts and are special kind of Term
Deposits and are suitable for people who do not have lump sum amount of savings, but are ready to save
a small amount every month. Such deposits often earn interest at the same rates as are applicable for
fixed deposits and term deposits on the amount previously placed (via monthly installments). These are
the ideal if you want to set up a fund for your child's schooling, your daughter's wedding, a car purchase
without taking out loans, or to save money for the future. In these types of deposits, the person is
typically required to deposit a set sum of money each month (typically a minimum of Rs. 100 each
month). A modest penalty is assessed for any payment default within the month. However, several banks
now also provide a flexible or variable RD in addition to set installment RDs.

These accounts can be funded by giving Standing Instructions by which bank withdraws a fixed amount on
a fixed date of the month from the saving bank of the customer (as per his mandate), and the same is
credited to RD account.

Accounts for recurring deposits typically have maturities between six and one hundred twenty months. A
pass book is typically supplied, in which the individual can find the entries for all of his or her deposits as
well as the interest earned. Banks also state the RD's maturity value under the presumption that the
monthly installments would be paid on time each month. If an installment is late, the interest that will be
paid on the account will be lowered, and a small fee will be added for missing regular installments.
Premature withdrawal of the permitted amount is typically permitted (however, penalty may be imposed
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for early withdrawals). Both single and joint names may be used to open these accounts. There is also a
nomination facility accessible.

The RD interest rates paid by banks in India are usually the same as payable on Fixed Deposits, except
when specific rates on FDs are paid for particular number of days e.g. 500 days, 555 days, 1111 days etc.
i.e. these are not ending in a quarter.

D. Fixed Deposit Accounts or Term Deposits - All Indian banks provide fixed deposit plans with a
variety of tenures ranging from 7 days to 10 years. They are also frequently referred to as FD accounts.
However, these are referred to as "Term Deposits" or even "Bonds" in some other nations. In Fixed
Deposits (FD), the word "fixed" refers to the maturity or tenor period. As a result, depositors are required
to maintain these Fixed Deposits for however long they choose to keep their money in the bank. However,
the depositor can request to close (or break) the fixed deposit early by paying a penalty if necessary
(usually of 1 percent, but some banks either charge less or no penalty). (Some banks introduced variable
interest fixed deposits. The rate of interest on such deposits keeps on varying with the prevalent market
rates i.e. it will go up if market interest rate goes and it will come down if the market rates fall. However,
such types of fixed deposits have not been popular till date).

The rate of interest for Fixed Deposits differs from bank to bank (unlike earlier when the same were
regulated by RBI and all banks used to have the same interest rate structure.) The present trends indicate
that private sector and foreign banks offer higher rate of interest.

The prior trend of higher interest rates being offered by the private sector and foreign banks is no longer
true today. Small banks must now offer greater interest rates in order to draw in more deposits. A bank
FD is typically paid in full on the date of maturity. At the conclusion of each quarter, the majority of banks
also offer the option to pay or credit interest to savings accounts. Interest will be paid at a slightly
discounted rate if interest is desired to be paid every month. The Interest Payable on Fixed Deposit can
now be readily transferred to the Customer's Savings Bank or Current Account on the Due Dates in the
New Computerized Environment.

E. CASA Ratio- Current Account Savings Account is referred to as CASA. To encourage consumers to keep
their money with their banks, banks provide them with this special advantage. The account combines the
advantages of checking and savings accounts.
On the current account, the account pays little to no interest, while on the savings accounts, it pays an
above-average return. The West and Southeast Asia are where CASA is most widely used.
Since CASA is a non-term deposit account, the consumer may use it to meet their regular banking needs.

CASA Ratio:- The CASA Ratio measures how much money is deposited in savings and current accounts
compared to the bank's overall amount of money deposited. The percentage of deposits held in current
and savings accounts at the bank is indicated by the CASA ratio. Additionally, a greater CASA ratio reflects
a bank's improved operational effectiveness. The profitability of the banks in India is assessed using this
ratio as one of the indicators.

F. Bulk Deposit Account- A single rupee term deposit of two crore rupees or more is referred to as a
"bulk deposit" and must be approved in advance by the head of IMD through their Zones for acceptance
by branches. If more than one Fixed Deposit account is opened in a single Customer Id (on the same date)
and the total amount is greater than 2 Crore, the entire deposit shall be deemed to be a Bulk Deposit, and
CBS will notify consumers as appropriate.

G. No Frill Accounts- These accounts aims at providing all necessary banking facilities to consumers at
minimum or nil charges. No-frills bank accounts require zero or very low minimum balance and other
banking facilities such as withdrawals and ATM and Debit card facilities at zero charges to enable universal
access to banking facilities. No-frills bank accounts are now known as Basic Saving Bank Deposit Accounts.

H. Joint Account- You can open a joint account with one or more other people, which is a specific kind of
savings account. Families, business partners, or spouses who are acquainted with one another frequently
form it. Shared access to the funds in joint accounts is customary for account holders. Most banks allow
two or more people to register a joint account, which enables them to combine their funds into one
account for storage. However, every bank in India that offers savings accounts will also offer joint
accounts. A select few banks permit up to four joint holders in such joint accounts.
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Awareness

I. Public Provident Fund-

A long-term savings plan that is highly well-liked in India is the Public Provident Fund (PPF) programme
because it combines tax benefits, returns, and security. By order of the Finance Ministry's National Savings
Institute, the PPF programme was introduced in 1968. The scheme's primary goal is to encourage small
deposits among people and to pay interest on those savings. The PPF programme provides a competitive
interest rate, and there is no tax due on the interest-rate-related returns. Importance of PPF-
 PPF is considered to be one of the best investment tools and is suitable for those with low-risk
appetite.
 The returns are low since this investment tool is market linked.
 The returns are fixed and can be used as a diversification tool and also offers tax-saving benefits.

J. DEMAT Account-
A Demat Account, also known as a Dematerialized Account, offers the option of keeping shares and other
securities electronically. Shares are purchased and maintained in a Demat Account during online trading,
making it simple for consumers to transact. All of a person's investments in bonds, mutual funds,
exchange-traded funds, shares, and government securities are kept together in a demat account.

Demat made it possible for the Indian stock exchange to go digital and improved SEBI oversight.
Additionally, by storing stocks in electronic format, the Demat account decreased the chances of theft,
destruction, and fraud. NSE first made it available in 1996. Initially, investors had to go through a manual
process to open an account, and it took a few days for it to be active. Today, one can open a Demat
account online in 5 mins. The end-to-end digital process has contributed to popularising Demat, which
skyrocketed in the pandemic.

K. HUF Account-
Hindu Undivided Family is known as HUF. By forming a family unit and combining your assets into a HUF,
you can reduce your tax burden. HUF is taxed independently of its constituents. A HUF can be created by a
group of Hindu families. A HUF can be formed by Buddhists, Jains, or Sikhs as well. HUF files tax returns
independently of its members and has its own PAN.
A HUF can claim any exemptions or deductions permitted by the tax laws since it is taxed independently
from its members (e.g., under Section 80). For instance, if you, your spouse, and your two children decide
to form a HUF, all four of you can claim a deduction under Section 80C together with the HUF. HUF is
usually used by families as a means to build assets.

L. Nostro and Vostro Account-

The words "nostro" and "vostro," which refer to the same bank account, are two separate words. When
one bank holds another bank's money on deposit, usually in connection with foreign trade or other
financial activities, the terms are employed.

Bank A uses the term "Nostro account" to refer to "our" account held by Bank B. The term "our money
that is on deposit at your bank" is referred to as "nostro." The Nostro account serves as the bank's official
record of its deposits at other financial institutions. These accounts are frequently used to streamline trade
and foreign exchange settlements. Nostro accounts differ from standard demand deposit bank accounts in
that they are usually held by financial institutions, and they are denominated in foreign currencies.

Bank B refers to the location where bank A's funds are deposited as a "vostro." Vostro, which is short for
"yours," denotes "your money that is on deposit at our bank." A vostro account is similar to any other
bank account. The account is a list of funds due to or held by a third party, usually another bank, though it
can also be a business or a person. Vostro accounts are frequently held by American or British banks on
behalf of foreign banks. The currency of the nation where the money is deposited is used to maintain the
vostro account.

M. Know your Customer-

Customer identification is the most important part of KYC (Know Your Customer), which is now a key
component in the fight against financial crime and money laundering. This is because it comes first and
helps the other stages of the process run more smoothly. The term "Know Your Customer" (KYC) refers to
the procedure through which banks and other financial organisations collect data on the name and address
of their clients. This procedure aids in preventing unauthorised usage of banking services. The banks must
complete the KYC process when creating new accounts.

 The KYC information for its clients must also be routinely updated by banks and other financial
organisations.
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Awareness 39

CHP 7 Loans and Securities

NPA (Non-performing asset)- An asset classified as a non-performing asset (NPA) is one for which the
interest and/or payment of principal has been "past due" for a predetermined amount of time. Loans that
are at risk of default are categorised as NPAs by financial institutions. A loan is deemed to be a non-
performing asset once the borrower has missed 90 days of interest or principal payments. For financial
institutions, non-performing assets are an issue because their revenue comes from interest payments. The
economy's unfavourable pressure can cause a sudden rise in non-performing loans, which frequently
results in significant write-downs.

With a view to moving towards international best practices and to ensure greater transparency, it has been
decided to adopt the '90 days' overdue' norm for identification of NPA, from the year ending March 31,
2004. Accordingly, with effect from March 31, 2004, a non-performing asset (NPA) shall be a loan or an
advance where:

 Interest and/or installment of principal remain overdue for a period of more than 90 days in
respect of a term loan,
 The account remains 'out of order' for a period of more than 90 days, in respect of an
Overdraft/Cash Credit (OD/CC),
 The bill remains overdue for a period of more than 90 days in the case of bills purchased and
discounted,
 Interest and/or installment of principal remains overdue for two harvest seasons but for a period
not exceeding two half years in the case of an advance granted for agricultural purposes, and
 Any amount to be received remains overdue for a period of more than 90 days in respect of other
accounts.

Note: The central banker has determined that now is the moment to tighten provisioning standards and
make debt restructuring challenging since corporate India is reeling from numerous crises and sorely
needs all the help it can get. According to the RBI, loans that are recast after April 1, 2015 should be
classed as non-performing assets (NPAs), and beginning on June 1, 2013, the provisioning standards for
new standard restructured advances will increase from 2.75 to 5%.

Priority Sector Lending-

Priority sector lending by banks in India constitutes the lending to

 Agriculture
 Micro, Small and Medium Enterprises
 Export Credit
 Education
 Housing
 Social Infrastructure
 Renewable Energy
 Others

Pledge-
 The Pledge (in Banking) refers to the mode of creating a charge over movable security to avail the
secured debt from any banks or financial institutions/companies.

In other terms, a pledge is the act of a bank, financial institution, company, or lender placing a charge on
the borrower's moveable property or assets in exchange for the loan the borrower has requested. When a
pledge is made, the property, goods, or assets on which the charge must be created are maintained by the
lender. Additionally, if borrowers fall behind on loan payments, the lender/banks have the authority to sell
the property with prior notice to the borrower in order to recoup the advance/loan. Section 172 of the
Indian Contract Act defines pledge.
 The lender/ bank is known as pledgee whereas the borrower is called pledger.
 The possession of pledged goods/ assets is with the lenders/banks itself whereas ownership of
goods/property remains with the borrower.
 If the borrower defaults or unable to repay the debt/ loan, the lender has rights to sell the pledged
goods without the intervention of court for the recovery of debt by issuing a prior notice to the
borrower.
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 The banks/lender has to take care of pledged goods as the goods will have been returned (original
condition) to the borrower after repayment of debt.
 Even if the bank/lender as a pledgee has a priority in custody over pledged goods but the lender
doesn't have rights to sell the goods in any circumstances until the borrowers deny/ unable to
repay the loan.

Hypothecation
An asset is hypothecated when it is used as collateral to secure a loan. No ownership rights, including any
revenue the asset generates, are forfeited by the asset's owner. However, if the conditions of the
agreement are not met, the lender may take possession of the asset. An assignment, lien, or mortgages
are not the same as a hypothecation.

 Hypothecation occurs when an asset is pledged as collateral to secure a loan. The owner of the
asset does not give up title, possession, or ownership rights, such as income generated by the
asset.
 It occurs most commonly in mortgage lending, where the home serves as collateral but the bank
does not have any claim on cash flows or income generated from it unless the borrower defaults.
 Margin lending in brokerage accounts is another common form of hypothecation found in securities
trading and investing.

Basis Pledge Hypothecation Lien Mortgage Assignment

Goods or
securities such Movable Property or Immovable Current assets or
Collateral
as gold, stocks, assets machinery assets fixed assets
certificates, etc.
Rent Life insurance
House,
Gold, stocks, Vehicle receivable, policies, books of
Examples land,
certificates, etc. financing unpaid fees, debts, receivables,
building,
etc. etc.
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CHP 8 Basel Committee

Basel norms
Basel, a city in Switzerland, serves as the Bureau of International Settlements' principal office (BIS). BIS
promotes central bank cooperation with a focus on financial stability and uniform standards for banking
legislation. The committee currently has 27 member countries. The Basel Committee on Banking
Supervision, a group of central banks, developed the Basel Guidelines, which are broad supervisory norms
(BCBS). The Basel accord refers to a collection of BCBS agreements that primarily address risks to banks
and the financial system. The agreement's goal is to make sure financial institutions have adequate capital
on hand to cover obligations and compensate for unforeseen losses. The Basel Accords for the financial
system have been approved by India.

1. Basel I

The Basel Capital Accord, often known as Basel 1, was first introduced by BCBS in 1988. Credit risk was
essentially its exclusive concern. For banks, it established capital and the structure of risk weights. 8
percent of risk-weighted assets was chosen as the minimal capital requirement (RWA). Assets having
various risk profiles are referred to as RWA. For instance, a security backed by collateral would be less
risky than a personal loan with no security. In 1999, India adopted the Basel 1 principles.

2. Basel II

Basel II guidelines, which were regarded as the improved and revised versions of Basel I accord, were
released by BCBS in 2004. Three criteria formed the basis of the recommendations. Banks were required
to create and employ stronger risk management procedures in monitoring and managing all three types of
risks, including higher disclosure requirements. Banks should maintain a minimum capital adequacy ratio
of 8% of risk assets. Banks must voluntarily submit to the central bank information about their risk
exposure. Basel II regulations have not yet been fully implemented in India and other countries.

3. Basel III

Basel III regulations were published in 2010. These regulations were put in place in reaction to the 2008
financial crisis. As banks in the developed nations were undercapitalized, overleveraged, and relied more
on short-term funding, it was considered that the system needed to be strengthened even further.
Additionally, Basel II's requirements for capital amount and quality were deemed insufficient to limit any
additional risk. The goal of Basel III regulations is to increase the capital-intensiveness of the majority of
banking activities, including trading book activities. The rules emphasise four crucial banking criteria,
namely capital, leverage, funding, and liquidity, in an effort to encourage a more robust banking system.
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Awareness

CHP 9 Cheque/Demand
Draft/Cards
Different Kinds / Types of Cheques

1. Bearer Cheque
A check is referred to as a bearer cheque if the words "or bearer" that appear on its front are not
removed. Any other party that brings the bearer check to the bank for payment, as well as the person
named therein, is eligible to receive payment. Such checks, however, carry a certain amount of danger
because, in the event that one is misplaced, the finder may claim money from the bank.

2. Order Cheque
A check is referred to as an order cheque when the word "carrier" that normally appears on its face is
crossed out and the words "or order" are placed in its place. Such a check is payable to the payee named
therein or any other person to whom it is endorsed (transferred).

3. Uncrossed / Open Cheque

An "Open Cheque" or "Uncrossed Cheque" is a check that has not been crossed. One can receive the
payment of such a check at the bank's counter. A bearer check or an order check both qualify as open
checks.

4. Crossed Cheque
Crossing a check refers to making two parallel lines on the cheque's face, either with or without the
addition of additional text such as "& CO," "Account Payee," or "Not Negotiable." Crossed checks can only
be credited to the payee's account; they cannot be cashed at the cashier's window of a bank.

5. Anti-Dated Cheque
If a cheque bears a date earlier than the date on which it is presented to the bank, it is called as "anti-
dated cheque". Such a cheque is valid upto six months from the date of the cheque.

6. Post-Dated Cheque
If a cheque bears a date which is yet to come (future date) then it is known as post-dated cheque. A post-
dated cheque cannot be honoured earlier than the date on the cheque.

7. Stale Cheque
If a cheque is presented for payment after six months from the date of the cheque it is called stale
cheque. A stale cheque is not honoured by the bank.

Cheque Truncation System-

Truncation is the process of halting the physical check flow from the drawer issued by the presenting bank
on its way to the branch of the paying bank. Instead, the clearing house sends an electronic image of the
cheque together with pertinent information, such as the MICR band, presentation date, presenting bank,
etc., to the paying branch. Therefore, other than in extraordinary cases for clearing purposes, the
requirement to carry the physical instruments between bank offices is eliminated through cheque
truncation. By doing this, the associated costs of moving the physical checks are effectively eliminated, the
time needed for their collection is decreased, and the entire process of processing checks is made more
elegant.

Demand draft (DD)

It is a method used by individuals to make transfer payments from one bank account to another. Demand
drafts are marketed as a relatively secure method for cashing checks. The major difference between
demand drafts and normal checks is that demand drafts do not require a signature in order to be cashed.
DDs are also known as "remotely created checks".

There are a few advantages to the use of a demand draft over other types of payment options. Unlike
credit card transactions, where it may take anywhere from twenty-four to forty-eight hours for the money
to appear in the merchant's bank account, the funds from a demand draft are normally posted on the
same day of the transaction. For the consumer, the use of this type of draft also means there is no amount
applied to a credit card balance that is in turn subject to interest. The funds are drawn from the buyer's
checking or savings account, often with no additional fees assessed for the transaction.
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A major drawback to the use of a demand draft is the increased potential for fraud. Since no signature is
required in most cases, unscrupulous individuals could obtain the bank account information and make
unauthorized purchases with relative ease. This inherent weakness has led to use of the demand draft as
part of various scams involving both domestic and international fraud. For this reason, consumers should
take steps to protect their banking information, and only provide it to vendors they know well and can
reasonably trust.

Debit & Credit Card

A credit card is a card that a financial institution issues that gives the owner the opportunity to borrow
money, typically at the point of sale. Interest-bearing credit cards are typically used for short-term
borrowing. Borrowing limits are pre-determined based on an individual's credit score, and interest typically
starts one month after a purchase is made. Debit cards are electronic cards that banks offer that give their
customers access to their accounts so they can make cash withdrawals or make purchases. As a result,
bank customers no longer need to visit the bank to withdraw money from their accounts; instead, they
may simply use an ATM or make an electronic payment at merchant locations. This type of card, as a form
of payment, also removes the need for checks as the debit card immediately transfers money from the
client's account to the business account.

A debit card can be prepaid or connected to a bank account. The card uses money that the cardholder
(customer) has previously deposited with a financial institution in either scenario. A credit card, on the
other hand, is a type of loan. The financial institution serves as the consumer's credit front when a
consumer utilises a credit card (a loan). The user pays a few weeks after getting the monthly statement,
which includes a total of the purchases and a charge for them.

White Label ATM (WLA)-

White label ATMs are automated teller machines (ATMs) installed, owned, and run by organisations other
than banks (WLAs). WLAs may be run by non-bank entities that were incorporated in India in accordance
with the Companies Act of 1956. In September 2015, the government approved up to 100% of Foreign
Direct Investment (FDI) under the automatic method. According to the Payment and Settlement Systems
(PSS) Act of 2007, non-bank businesses may establish WLAs in India after receiving RBI authorization.
Such non-bank entities had to be at least Rs 100 crore in net worth. The Reserve Bank of India (RBI)
originally granted permission to Tata Communications Payment Solutions Limited (TCPSL) to open White
Label ATMs in India. It was introduced under the name "Indicash."

Brown Label ATM (BLA)-

The idea of cost sharing serves as the foundation for Brown Label ATM. While network connectivity and
cash management are provided by the sponsor bank in Brown Label, ATM hardware is held by the service
provider. However, the sponsor bank's logo can be found on the ATM. Banks can save money by using
Brown Label ATM. RuPay Card, VISA Card, MasterCard and Maestro card

RuPay Card- Indian domestic card Rupay Card was created and released by NPCI in 2012. It was
incorporated into the Indian payment system to lessen the monopoly of foreign gateways like Visa and
MasterCard because they are foreign or American firms and their commission is large, meaning that the
cost of the transaction is high. Thus, RuPay Card can be referred to as an Indian payment gateway. It
functions similarly to a Visa or Master Card and has a low commission. All Indian banks and financial
institutions accept electronic payments through RuPay.

Plastic Card- When we use any type of ATM card for the transaction at the place of hard cash, this card is
known as plastic money and the transaction resulting from it is called cashless payment. It can be done
via any ATM, Visa Card, MasterCard or RuPay Card.

VISA Card and Master Card- Most of the banks in the globe have access to Visa Card and MasterCard
through a foreign payment gateway. There is no particular distinction between a MasterCard and a Visa
Card. These two cards are both ATMs, and they function similarly. Since they are international cards,
paying is simple everywhere.

But neither Visa nor MasterCard in fact issue any credit cards to anyone. Both of these are ways to pay. To
issue credit cards using the payment methods, they depend on banks from other nations. As a result, the
bank determines the interest rates, bonuses, annual fees, and all other charges. As a result, when you pay
your payment, you are paying the bank or organisation that issued your Visa or MasterCard.
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CHP 10 Basics of Indian Currency

CURRENCY OF INDIA
Production

 The Security Printing and Minting Corporation of India Limited (SPMCIL), owned by the
Government of India, is responsible for printing notes and minting coins.
 It has printing presses at Nasik in Maharashtra and Dewas in Madhya Pradesh.
 It also has four mints for coin production at Mumbai, Noida, Kolkata and Hyderabad.
 The Bharatiya Reserve Bank Note Mudran Pvt. Ltd. (BRBNMPL), owned by the RBI, also has
printing presses at Mysore in Karnataka and Salboni in West Bengal.

Currency System in India - Issuance and Distribution

RBI has selected branches of banks called Currency Chest or (ICMC) which facilitate the distribution of
currency.
 They have been established with State Bank of India, six associate banks, nationalized banks,
private sector banks, a foreign bank, a state cooperative bank and a regional rural bank.
 They distribute notes and coins to other bank branches in their area.

Notes and their features:

Five hundred Rupee Note:

Currency Value 500
Dimension 63×150 mm
Obverse Design Mahatma Gandhi
Reverse Design Red fort
Colour Stone Grey
Signature RBI governor

Two hundred Rupee Note:

Currency Value 200

Dimension 66×146 mm
Obverse Design Mahatma Gandhi
Reverse Design Sanchi Stupa
Colour Bright Yellow
Signature RBI governor
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Hundred Rupee Note:

Currency Value 100

Dimension 66×142 mm
Obverse Design Mahatma Gandhi
Reverse Design Rani ki vav (Queen's stepwell)
Colour Lavender
Signature RBI governor

Fifty Rupee Note:

Currency Value 50
Dimension 66×135 mm
Obverse Design Mahatma Gandhi
Reverse Design Hampi with chariot
Colour Fluorescent Blue
Signature RBI governor

Twenty Rupee Note:

Currency Value 20
Dimension 63×129 mm
Obverse Design Mahatma Gandhi
Reverse Design Ellora Caves
Colour Green-Yellow
Signature RBI governor
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Ten Rupee Note:

Currency Value 10
Dimension 63×123 mm
Obverse Design Mahatma Gandhi
Reverse Design Konark and the Sun Temple
Colour Chocolate brown
Signature RBI governor

Bharatiya Reserve Bank Note Mudran Private Limited-

Bharatiya Reserve Bank Note Mudran Private Limited (BRBNMPL) was established by Reserve Bank of India
(RBI) as its wholly owned subsidiary on 3rd February 1995 with a view to augmenting the production of
bank notes in India to enable the RBI to bridge the gap between the supply and demand for bank notes in
the country. The BRBNMPL has been registered as a Private Limited Company under the Companies Act
1956 with its Registered and Corporate Office situated at Bengaluru.

The company manages 2 Presses:

1) Mysore in Karnataka
2) Salboni in West Bengal.

The present capacity for both the presses is 16 billion note pieces per year on a 2-shift basis.
The Board of Directors headed by a non-Executive Chairman nominated by Reserve Bank of India oversees
the overall affairs of the Company. The Managing Director is the whole time Chief Executive of the
Company and is also a member of the Board. The members of the Board of Directors are persons of high
eminence drawn from various professional fields. The Managing Director is assisted by a team of senior
officers in the Corporate Office and two presses at Mysore and Salboni.
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CHP 11 National Financial

Institutions
NABARD (National Bank for Agriculture and Rural Development) (1982) Government of India
(100%)
1. Regulates coop banks & RRBs. Acts as coordinator/ supervisor in the operations of rural credit
institutions like RRBs and Rural Coop banks (RBI has delegated its supervisory powers in case of
rural sector to NAB- ARD while retaining its regulatory powers)
2. RIDF (Rural Infrastructure Development Fund) management.
3. Provides credit for the promotion of agriculture, MS- MEs, cottage and village industries,
handicrafts and other rural crafts and allied economic activities in rural areas.
4. Offers training and research facilities for banks, co-operatives in matters of rural development
5. It doesn‗t extend direct credit at individual level but extends indirect financial assistance by way of
refinance (NABARD finances those institutions which provide financial assistance to rural
sector).NABARD provides direct finance to institutions as may be approved by the Central Govt.
6. Helps with funds to state coop banks, RRBs, MFIs, coop societies etc. To fund farmers, cottage
industries etc. handicrafts

SIDBI (Small Industries and Development Bank of India) (1990)

Small Industries Development Bank of India (SIDBI), set up on April 2, 1990 under an Act of Indian
Parliament, presently acts as the Principle Financial Institution for the Promotion, Financing and
Development of the Micro, Small and Medium Enterprise (MSME) sector and also co-ordinates the
functions of the institutions engaged in similar activities. Presently, the Bank provides refinance support
through a network of eligible member lending institutions for onward lending to MSMEs and direct
assistance is channelised through the Bank‘s branch offices. SIDBI also extends financial assistance in the
form of loans, grants, equity and quasi-equity to Non-Government Organisations / Micro Finance
Institutions (MFIs) for on-lending to micro enterprises and economically weaker sections of the society,
enabling them to take up income generating activities on a sustainable basis.

National Housing Bank (NHB) -

The National Housing Policy, 1988 envisaged the setting up of NHB as the Apex level institution for
housing. Thus, NHB was set up on July 9, 1988 under the National Housing Bank Act, 1987. NHB is wholly
owned by Reserve Bank of India, which contributed the entire paid-up capital. The general
superintendence, direction and management of the affairs and business of NHB vest, under the Act, in a
Board of Directors. The Head Office of NHB is at New Delhi. NHB has been established to achieve, inter
alia, the following objectives –

a) To promote a sound, healthy, viable and cost effective housing finance system to cater to all segments
of the population and to integrate the housing finance system with the overall financial system.
b) To promote a network of dedicated housing finance institutions to adequately serve various regions and
different income groups.
c) To augment resources for the sector and channelize them for housing.
d) To make housing credit more affordable.
e) To regulate the activities of housing finance companies based on regulatory and supervisory authority
derived under the Act.
f) To encourage augmentation of supply of buildable land and also building materials for housing and to
upgrade the housing stock in the country.
g) To encourage public agencies to emerge as facilitators and suppliers of serviced land, for housing.

Securities and Exchange Board of India

It was established on April 12, 1992 in accordance with the provisions of the Securities and Exchange
Board of India Act, 1992. SEBI has its Headquarter in Mumbai. Controller of Capital Issues was the
regulatory authority before SEBI came into existence; it derived authority from the Capital Issues
(Control) Act, 1947. Initially SEBI was a non-statutory body without any statutory power. However, in the
year of 1995, the SEBI was given additional statutory power by the Government of India through an
amendment to the Securities and Exchange Board of India Act 1992. In April 1998, the SEBI was
constituted as the regulator of capital markets in India under a resolution of the Government of India.
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Awareness

SEBI has to be responsive to the needs of three groups, which constitute the market:

 the issuers of securities

 the investors
 the market intermediaries.

SEBI has three functions rolled into one body: quasi-legislative, quasi-judicial and quasi-executive. It
drafts regulations in its legislative capacity, it conducts investigation and enforcement action in its
executive function and it passes rulings and orders in its judicial capacity. Though this makes it very
powerful, there is an appeal process to create accountability.
Functions of SEBI are of two types-
1. Regulatory functions
2. Developmental functions

1. Regulatory function
a) Registration of brokers and sub-brokers and other players in the market
b) Registration of collective investments schemes and Mutual Funds
c) Regulation of stock exchanges and other self-regulatory organisations (SRO) merchant banks etc
d) Prohibition of all fraudulent and unfair trade practices
e) Controlling Insider Trading and takeover bids and imposing penalties for such practices

2. Development functions
a) Investor education
b) Training of intermediaries.
c) Promotion of fair practices and Code of conduct for all S.R.O.s
d) Conducting Research and Publishing information useful to all market participants

Export-Import Bank of India is the premier export finance institution of the country, established in
1982 under the Export-Import Bank of India Act [Link] its inception, Exim Bank of India has been
both a catalyst and a key player in the promotion of cross border trade and investment. Exim Bank is
managed by a Board of Directors, which has representatives from the Government, Reserve Bank of India,
Export Credit Guarantee Corporation of India, a financial institution, public sector banks, and the business
community. The Bank's functions are segmented into several operating groups including:

 Corporate Banking Group which handles a variety of financing programmes for Export Oriented
Units (EOUs), Importers, and overseas investment by Indian companies.
 Project Finance / Trade Finance Group handles the entire range of export credit services such as
supplier's credit, pre-shipment Agri Business Group, to spearhead the initiative to promote and
support Agri-exports. The Group handles projects and export transactions in the agricultural sector
for financing.
 Small and Medium Enterprise: The group handles credit proposals from SMEs under various
lending programmes of the Bank.
 Export Services Group offers variety of advisory and value-added information services aimed at
investment promotion.
 Export Marketing Services Bank offers assistance to Indian companies, to enable them establish
their products in overseas markets. The idea behind this service is to promote Indian export.
Export Marketing Services covers wide range of export oriented companies and organizations.

MSME
The Government of India enacted the Micro, Small and Medium Enterprises Development (MSMED)
Act, 2006 in terms of which the definition of micro, small and medium enterprises is as under.

 Enterprises engaged in the manufacture or production, processing or preservation of goods as

specified below:
 A micro-enterprise, where the investment in Plant and Machinery or Equipment does not
exceed one crore rupees and turnover does not exceed five crore rupees.
 A small enterprise, where the investment in Plant and Machinery or Equipment does not
exceed ten crore rupees and turnover does not exceed fifty crore rupees.
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 A medium enterprise, where the investment in Plant and Machinery or Equipment does not
exceed fifty crore rupees and turnover does not exceed two hundred and fifty crore rupees.

Bank Board Bureau-

It was set up in February 2016 as an autonomous body– based on the recommendations of the RBI-
appointed Nayak Committee.

 It was part of the Indradhanush Plan.

 It will make recommendations for appointment of whole-time directors as well as non-executive
chairpersons of Public Sector Banks (PSBs) and state-owned financial institutions.
 The Ministry of Finance takes the final decision on the appointments in consultation with
the Prime Minister‘s Office.
 Banks Board Bureau comprises the Chairman, three ex-officio members i.e Secretary, Department
of Public Enterprises, Secretary of the Department of Financial Services and Deputy Governor of
the Reserve Bank of India, and five expert members, two of which are from the private sector.

Deposit Insurance and Credit Guarantee Corporation (DICGC)

It was founded in 1978 after the Parliament passed the Deposit Insurance and Credit Guarantee
Corporation Act, 1961, that merged the Deposit Insurance Corporation (DIC) and the Credit Guarantee
Corporation of India Ltd. (CGCI).

 It is a fully-owned subsidiary of Reserve Bank of India and provides deposit insurance.

 It protects deposit accounts up to a ceiling of INR 5 lakh per bank account holder.
 If a deposit balance of a bank account holder in a single bank exceeds INR 5 lakh, the DICGC will
pay up to INR 5 lakh, comprising interest and principal, if the bank goes bankrupt.

National Payment Corporation of India-

National Payments Corporation of India (NPCI), an umbrella organisation for operating retail payments and
settlement systems in India, is an initiative of Reserve Bank of India (RBI) and Indian Banks‘ Association
(IBA) under the provisions of the Payment and Settlement Systems Act, 2007, for creating a robust
Payment & Settlement Infrastructure in India.
Its objective is to-
 To offer improved infrastructure for the entire banking industry to create a robust physical and
digital payment and settlement system.
 To simplify, merge and incorporate various payment systems with varying standards of coverage
into a single national standard uniform and business process for all retail money transactions.
 To design and promote an effective financing process or system that saves time and cost for
individuals who make retail transactions on a daily basis.

Insolvency and Bankruptcy Board of India-

The Insolvency and Bankruptcy Board of India was established on 1st October 2016 under the Insolvency
and Bankruptcy Code, 2016 (Code). It is a key pillar of the ecosystem responsible for implementation of
the Insolvency and Bankruptcy Code, 2016 that consolidates and amends the laws relating to
reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time
bound manner for maximization of the value of assets of such persons, to promote entrepreneurship,
availability of credit and balance the interests of all the stakeholders. Its objective is-

 It is a unique regulator: regulates a profession as well as processes. It has regulatory oversight

over the Insolvency Professionals, Insolvency Professional Agencies, Insolvency Professional
Entities and Information Utilities.
 Write and enforce rules for processes, namely, corporate insolvency resolution, corporate
liquidation, individual insolvency resolution and individual bankruptcy under the Code.
 Promote the development of, and regulate, the working and practices of, insolvency professionals,
insolvency professional agencies and information utilities and other institutions, in furtherance of
the purposes of the Code.
 It has also been designated as the ‗Authority‘ under the Companies (Registered Valuers and
Valuation Rules), 2017 for regulation and development of the profession of valuers in the country.
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ECGC (Export Credit Guarantee Corporation of India Ltd.)

 ECGC Limited, formerly known as Export Credit Guarantee Corporation of India was founded on
the 30th of July, 1957.
 It is one of the oldest initiatives of the Government of India.
 ECGC Ltd. was established in 1957 with the aim of advancing exports from India by giving credit
risk insurance and related services for exports. Over the years, it has designed different export
credit risk insurance products to cater to the needs of Indian exporters. ECGC is basically an
export promotion company, seeking to improve the competitiveness of exports from India by
providing them with credit insurance covers.
 The Corporation has introduced various export credit insurance schemes to meet the requirements
of commercial banks offering export credit. The insurance covers enable the banks to extend
timely and adequate export credit facilities to the exporters. ECGC keeps its premium rates at a
reasonable level.
 ECGC provides (i) a range of insurance covers to Indian exporters against the risk of non –
realization of export proceeds due to commercial or political risks (ii) different types of credit
insurance covers to banks and other financial institutions to enable them to extend credit facilities
to exporters and (iii) Export Factoring facility for MSME sector which is a package of financial
products consisting of working capital financing, credit risk protection, maintenance of sales ledger
and collection of export receivables from the buyer located in overseas country.

CGTMSE (Credit Guarantee Fund Trust for Micro & Small Enterprises)
 It was initiated in the year 2000. The corpus for the scheme was contributed by the Government
and SIDBI in the ratio of 4:1.
 This corpus was to be raised to Rs.2500 crore by the end of the 11th Plan.
 A trust was established by the Ministry of Micro, Small and Medium Enterprises and Small
Industries Development Bank of India (SIDBI) so as to implement the Credit Guarantee Fund
Scheme for Micro and Small Enterprises.

The extent of coverage provided by the scheme includes up to 80% for –

1. Micro and small enterprises that are operated and owned by women entrepreneurs.
2. All credits or loans were given to the North-eastern states in India including the state of Sikkim.
3. Eligible institutions under the scheme include scheduled commercial banks (Public Sector
Banks/Private Sector Banks/Foreign Banks) and select Regional Rural Banks (which have
been classified under the 'Sustainable Viable' category by NABARD).
4. Other eligible institutions include National Small Industries Corporation Ltd. (NSIC), North Eastern
Development Finance Corporation Ltd. (NEDFi) and SIDBI.
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CHP 12 International Financial

Institutions
IMF
Introduction
In July 1944, the United Nations (UN) met in Bretton Woods, New Hampshire, where the International
Monetary Fund (IMF) was born. It is a group of 189 member nations, each of which is represented on the
IMF's executive board in proportion to its financial weight, giving the most economically powerful nations
in the world the majority of voting rights. IMF's main office is in Washington, DC, in the United States.

Objectives
Below given are the broad objectives of the IMF:
 Foster global monetary cooperation
 Secure financial stability
 International trade facilitation
 Promote high employment and sustainable economic growth
 Poverty reduction across the world

Functions
1. Financial Assistance: The IMF lends money to member nations experiencing balance of
payments issues in order to replenish foreign reserves, stabilise currencies, and improve the
environment for economic growth. Governments must implement structural adjustment plans that
are supervised by the IMF.

2. IMF Surveillance: The IMF keeps an eye on the global monetary system as well as the 189 of its
member nations' financial and economic plans. The IMF emphasises potential stability risks as part
of this process, which occurs both globally and in specific nations, and offers guidance on
necessary policy adjustments.

3. Capacity Development: It gives central banks, finance ministries, tax authorities, and other
financial institutions technical support and training. Developing robust legal frameworks,
enhancing governance, modernising banking systems, increasing public revenue, and improving
the reporting of macroeconomic and financial data are all aided by this. Additionally, it aids nations
in advancing toward the Sustainable Development Goals (SDGs).

Governance Structure
a. Board of Governors
 Each member nation has a governor and a backup governor on the board. Two governors are
chosen by each of the member nations.
 The IMF and World Bank Group Boards of Governors typically get together once a year for their
annual meetings to discuss the activities of their respective organisations.

b. Ministerial Committees
 The Board of Governors is advised by two ministerial committees which are given below:
1. International Monetary and Financial Committee
2. Development Committee

c. Executive Board
 It is 24-member Executive Board elected by the Board of Governors.
 It conducts the daily business of the IMF and exercises the powers delegated to it by the Board of
Governors & powers conferred on it by the Articles of Agreement.

d. IMF Management
 IMF‘s Managing Director is both chairman of the IMF‘s Executive Board and head of IMF staff.
 The Managing Director is appointed by the Executive Board by voting or consensus.

e. IMF Members
 Any other state, whether or not a member of the UN, may become a member of the IMF in
accordance with IMF Articles of Agreement and terms prescribed by the Board of Governors.
 Membership in the IMF is a prerequisite to membership in the IBRD.
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Special Drawing Rights (SDR)

The IMF uses Special Drawing Rights (SDRs) as its unit of account rather than actual money.
 By adding up the values of an SDR basket of currencies in U.S. dollars at market exchange rates, o
 ne can calculate the SDR's currency value.
 The U.S. Dollar, Euro, Japanese Yen, Pound Sterling, and Chinese Renminbi are among the
currencies in the SDR basket (included in 2016).
 The valuation basket is examined and changed every five years, and the SDR currency value is
determined every day (apart from IMF holidays and other times the IMF is closed for business).
 SDRs are claims on currencies held by IMF members that can be exchanged for them.

IMF and India

 International trade has undoubtedly increased as a result of IMF regulation in the area of money.
In that sense, India has benefited from these successful outcomes.
 India experienced significant balance of payments deficits after partition, especially with nations
using the dollar and other hard currencies. The IMF was the one that saved her.
 India received loans from the Fund to help with financial challenges brought on by the 1965–1971
Indo–Pak conflict.
 India bought foreign currencies from the IMF worth Rs. 817.5 crores between the IMF's founding
and March 31, 1971, and the money has been fully repaid.
 Since 1970, the establishment of the Special Drawing Rights has boosted the amount of assistance
that India, along with other IMF members, can receive from it (SDRs created in 1969).
 India was forced to take out loans from the Fund as a result of the sharp increase in the cost of its
imports, including food, gasoline, and fertiliser.
 India received a sizable loan in the amount of approximately Rs. 5,000 crores in 1981 to help it
overcome a foreign exchange crisis brought on by a protracted current account balance of
payments deficit.
 India sought significant amounts of foreign funding for its numerous river projects, land
reclamation plans, and communication system development. The only practical way to secure the
requisite cash was to borrow from the International Bank for Reconstruction and Development
because private foreign finance was not available (i.e. World Bank).
 To evaluate the condition of the Indian economy, India has used the expertise of IMF
professionals. India has benefited in this way from impartial review and guidance.
 Since the increase in oil prices starting in October 1973 has completely thrown India's balance of
payments out of whack, the IMF has started providing oil facilities by creating a special fund for
the purpose.
 India has held a unique position on the Fund's Board of Directors. India had so contributed in a
respectable way to the formulation of the Fund's policies. As a result, India is now more respected
internationally.

World Bank-

Organisations that make up the World Bank

 Group are the International Bank for Reconstruction and Development (IBRD) and the
International Development Association (IDA).
 At the 1944 Bretton Woods Conference, it was founded alongside the IMF.
 A worldwide partnership of 189 nations and its five constituent organisations, the World Bank
Group is devoted to eradicating poverty and fostering prosperity.
 The World Bank Group's five development institutions are:
1. International Bank for Reconstruction and Development (IBRD)
2. International Development Association (IDA)
3. International Finance Corporation (IFC)
4. Multilateral Guarantee Agency (MIGA)
5. International Centre for the Settlement of Investment Disputes (ICSID)

IBRD-
 The International Bank for Reconstruction and Development (IBRD) describes itself as a global
development cooperative.
 It includes 189 countries as members.
 It is the largest development bank in the world.
 It helps creditworthy middle-income and low-income countries by providing loans, guarantees,
advice services, and risk management tools.
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 More than 60% of the IBRD's portfolio is made up of middle-income nations.

 IBRD finances investments in a variety of areas and provides technical assistance and experience
at all stages of a project's development.
 The IBRD only works with sovereign governments, not private companies.
 It also aids governments in improving their countries' investment climate, eliminating service
delivery bottlenecks, and strengthening institutions and policies.
 The IBRD gets the majority of its funding from global financial markets.

IDA-
 The IDA's principal goal is to provide grants and low-interest loans to the world's poorest
countries.
 It makes loans to developing countries with the lowest Gross National Income (GNI), the worst
credit ratings, and the lowest per capita income.
 The International Development Association (IDA) aims to supplement the activities of the
International Bank for Reconstruction and Development (IBRD).
IFC-
 The IFC (IDA + IBRD) is the World Bank's sister organisation. It is the world's largest development
organisation that focuses on the private sector in underdeveloped countries.
 It serves as the WBG's commercial sector wing.
 It promotes economic development by funding for-profit and commercial ventures aimed at
alleviating poverty and advancing development.
 It also helps projects by mobilising third-party resources.
 The IFC collaborates with the private sector to promote entrepreneurship and the development of
long-term businesses.
 The International Finance Corporation (IFC) offers investment, advisory, and asset management
services.
 It makes loans to companies and private-sector projects.

MIGA-
 MIGA's main purpose is to increase cross-border investment in poor countries by providing lenders
and investors with guarantees (political risk insurance and credit improvement).
 Guarantees are provided by the agency to protect investments from non-commercial risks.
 It places a special emphasis on fragile and conflict-affected countries.
 Products for political risk insurance include:
1. Coverage for losses caused by war, terrorism, and civil unrest.
2. Expropriation by governments is covered.
3. Coverage in the event of a contract breach.
4. In the event that you are unable to lawfully convert your local currency into hard cash, you will
be protected.
 Credit enhancement is a type of insurance that protects consumers when governments fail to meet
their financial obligations.
 In 1994, India became a member of the MIGA.

ICSID-
 It resolves conflicts between investors and governments.
 It also works as an administrative register and settles state-to-state disputes under investment
treaties and free trade agreements.
 Arbitration, conciliation, or fact-finding are all options for resolving conflicts at the Centre.
 It also disseminates information about international investment law.
 India is not a member of the ICSID because it believes the organization's structure and functioning
favour industrialised countries.
 The BRICS Arbitration Centre (BRICS Centre) was established by India to handle and strengthen
international arbitrations with foreign investors. Although this is currently limited to the BRICS
countries, it will eventually be made available to all emerging countries.

World Trade Organisation

The World Trade Organization celebrated its silver anniversary on January 1st, 2020. On January 1st,
1995, the world trade organisation was founded. It was the largest change to global trade since the end of
World War II. Since its creation, the global organisation has presided over commerce, ensuring that it
flows with some semblance of order. But in its 25th year, public trust in the world body has reached an all-
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time low. The WTO's ability to arbitrate trade disputes was lost just a few weeks ago. This came after the
United States prevented the Appellate Body, the WTO's highest judicial body, from operating.

The WTO has 164 members (including European Union) and 23 observer governments (like Iran, Iraq,
Bhutan, Libya etc).

Goals of WTO-
 Lowering trade barriers through negotiation and working.
 Stimulating economic growth and development.
 Cutting the cost of doing business internationally.
 Encouraging good governance through transparency and reduction I corruption.
 Supporting the environment and health.
 Contributing peace and stability through multi-lateral trading system.

GATT to WTO
The Bretton Woods Conference, which took place in 1944 and provided the groundwork for the post-
World War II financial system by creating the International Monetary Fund (IMF) and the World Bank, is
where the General Agreement on Tariffs and Trade (GATT) had its start. The conference attendees also
advocated for the creation of an additional organisation that would be known as the International Trade
Organization (ITO), which they saw as the system's third leg.

 The UN Conference on Trade and Employment adopted the Havana Charter, a proposed charter for
the ITO that would have established stringent regulations covering trade, investment, services,
company conduct, and employment practises.
 The Havana Charter never entered into force, primarily because the U.S. Senate failed to ratify it.
As a result, the ITO was stillborn.
 Meanwhile, an agreement as the GATT signed by 23 countries in Geneva in 1947 came into force
on Jan 1, 1948 with the following purposes:
1. to phase out the use of import quotas
2. to reduce tariffs on merchandise trade
 The GATT became the only multilateral instrument (not an institution) governing international
trade from 1948 until the WTO was established in 1995.
 Despite its institutional deficiencies, the GATT managed to function as a de facto international
organization, sponsoring eight rounds (A round is a series of multilateral negotiations) of
multilateral trade negotiations.

Limitations of GATT
 The GATT was only a set of rules and multilateral agreements and lacked institutional structure.
 The GATT 1947 was terminated and WTO preserved its provisions in form of GATT 1994 and
continues to govern trade in goods.
 The trade in services and intellectual property rights were not covered by regular GATT rules.
 The GATT provided for consultations and dispute resolution, allowing a GATT Party to invoke GATT
dispute settlement articles if it believes that another Party‘s measure caused it trade injury.
 The GATT did not set out a dispute procedure with great specificity resulting in lack of deadlines,
laxity in the establishment of a dispute panel and the adoption of a panel report by the GATT
Parties. It made the GATT as a weak Dispute Settlement mechanism.

The Marrakesh Agreement, which founded the World Trade Organization, was the result of the
Uruguay Round, which was held from 1987 to 1994 (WTO). The WTO integrates the GATT's guiding
principles and offers a more robust institutional structure for its application and expansion.

Principles of WTO

Governance Structure of WTO

1. Ministerial Conference
 It is the WTO's highest-ranking decision-making body.
 It brings together all of the WTO's participants, which are either nations or customs unions.
 It can make decisions regarding every issue covered by any multilateral trade agreement
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2. General Council
 It is the highest-level decision-making body located in Geneva.
 It has representatives from all member governments.

3. The Trade Policy Review body

 The WTO General Council meets as the TPRB to undertake trade policy reviews of Members.
 The TPRB is thus open to all WTO Members.

4. Dispute Settlement Body

 To resolve issues between WTO members, the General Council meets as the Dispute Settlement
Body (DSB).
 Any agreement in the Uruguay Round's Final Act that is covered by the Understanding on Rules
and Procedures Governing the Settlement of Disputes may be the subject of such disputes (DSU).

5. Appellate Body
 It was created in 1995 in accordance with Article 17 of the Understanding on Rules and Procedures
Governing the Settlement of Disputes, with its headquarters in Geneva (DSU).
 For a four-year term, the DSB must nominate individuals to serve on the Appellate Body.
 The legal conclusions and findings of a panel may be upheld, modified, or reversed by the
appellate body. Once the Dispute Settlement Body (DSB) has adopted an appellate body report,
the parties to the dispute must accept it.

6. The Council for Trade in Goods (Goods Council)

 The General Agreement on Tariffs (GATT) and Trade governs international trade in products.
 All WTO members make up the Council for Trade in Goods (Goods Council), which is in charge of
managing the GATT agreement's functioning.

7. The Council for Trade in Services (Services Council)

 It functions under the direction of the General Council and is in charge of supporting the General
Agreement on Trade in Services' (GATS) operation and advancing its goals.
 It can create subsidiary entities as needed and is accessible to all WTO members.

8. The Council for Trade-Related Aspects of Intellectual Property Rights (TRIPS Council)
 It keeps track of how the Agreement on Trade-Related Aspects of Intellectual Property Rights is
being implemented (the TRIPS Agreement).
 It offers a venue for discussion of intellectual property issues among WTO Members and fulfils the
duties specifically entrusted to the Council by the TRIPS Agreement.

New Development Bank (NDB) or BRICS Bank-

 It is a global development bank that the BRICS nations jointly formed in 2014 during the sixth
BRICS Summit in Fortaleza, Brazil.
 It was created to support the BRICS and other underrepresented emerging economies' attempts to
build sustainable infrastructure and advance cutting-edge technology-driven growth.
 Its main office is in Shanghai, China.
 The NDB was granted observer status in the UNGA in 2018, creating a solid foundation for
proactive and effective interaction with the UN.

Objectives:
 Fostering development of member countries.
 Supporting economic growth.
 Promoting competitiveness and facilitating job creation.
 Building a knowledge sharing platform among developing countries.

Major Projects funded by NDB in India:

 The Mumbai Metro train, the Delhi-Ghaziabad-Meerut Regional Rapid Transit System, as well as
other Renewable Energy projects have all received finance from it.
 Up to this point, 14 Indian projects totalling about USD 4.2 billion have received NDB approval.
 India announced a USD 1 billion credit agreement with NDB in 2020 to increase infrastructure and
employment in rural areas.
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Asian Development Bank-

It is a regional development bank, which is established on 19 December 1966. Its headquartered is in

Manila, Philippines.

The bank accepts non-regional developed nations as well as members of the United Nations Economic and
Social Commission for Asia and the Pacific (UNESCAP, originally the Economic Commission for Asia and the
Far East or ECAFE).
 ADB now has 68 members, 49 from within Asia.

Voting rights:
 Similar to the World Bank, it employs a weighted voting system where votes are allocated in
accordance with members' capital contributions.
 As of December 31, 2019, the People's Republic of China (6.4%), India (6.3%), Australia (6.3%),
and Japan (each holding 15.6% of the total shares) were the top five shareholders in the Asian
Development Bank (ADB) (5.8 per cent).

Functions and roles:

 Is committed to eradicating poverty in Asia and the Pacific through regional integration,
environmentally sustainable growth, and inclusive economic growth.
 This is accomplished by making investments—in the form of loans, grants, and information
sharing—in infrastructure, health care services, financial, and public administration systems,
assisting countries in better managing their natural resources, preparing for the effects of climate
change, and other areas.

Asian Infrastructure Investment Bank-

 It is an international development institution whose goal is to boost Asia's social and economic
conditions.
 By making investments in environmentally friendly infrastructure and other profitable industries, it
seeks to connect the people, services, and markets that, over time, will improve the lives of
billions of people and create a brighter future.
 It is governed by the multilateral treaty known as the AIIB Articles of Agreement, which went into
effect in December 2015.
 It started operating in January 2016 and has its headquarters in Beijing, China.
 With 57 founding Members, the AIIB launched its activities in 2016. (37 regional and 20 non
regional). It has 103 authorised Members by the end of 2020, or 79 per cent of the world's
population and 65 per cent of its GDP.
 Standard & Poor's, Moody's, and Fitch, three of the leading credit rating agencies, have given AIIB
AAA ratings with a stable outlook since 2017.
 The Economic and Social Council and General Assembly of the United Nations, the two main bodies
of the international organisation that focus on development, both granted AIIB Permanent
Observer status in 2018.
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CHP 13 Legislations in Banking

and Finance – I
Negotiable Instruments Act 1881
 Negotiable Instruments Act 1881 had been passed in 1882 and was modified in 1989 and 2002.
 The act has provisions of Negotiable Instruments such as Promissory Notes, Checks, Drafts , Bills
of exchanges etc.
 Section 4 deals with promissory notes.
 Section 5 deals with Bill of Exchange
 Section 6 deals with Cheque
 Section 9 deals with holder and holder in Due course.
 Section 15 deals with Endorsements

RBI Act, 1934

Important sections of RBI 1934 are as follows-
 Section 3 of the RBI act provides for establishment of Reserve Bank of India for taking over the
management of the currency from Central Government and of carrying on the business of banking
in accordance with the provisions of this Act.
 Section 4 of the RBI Act defines the capital of RBI which is Rs.5 crore.
 Section 7 of the RBI Act empowers the central government to issue directions in public interest
from time to time to the bank in consultation with RBI Governor. This section also provides power
of superintendence and direction of the affairs and business of RBI to Central Board of Directors.
 This section deals with the functioning of RBI. The RBI can accept deposits from the central and
state governments without interest. It can purchase and discount bills of exchange from
commercial banks. It can purchase foreign exchange from banks and sell it to them. It can provide
loans to banks and state financial corporations. It can provide advances to the central government
and state governments. It can buy or sell government securities. It can deal in derivative, repo
and reverse repo.
 Section 18- This section describes emergency loans to banks.
 Section 21- This section assigns RBI the duty of being banker to the central government and
manage public debt.
 Section 22- This section grants power to RBI to issue the currency
 Section 24- This section has provision that highest denomination note could be ₹10,000
 Section 28- This section empowers the RBI to form laws concerning the exchange of damaged and
imperfect notes
 Section 31- This section provides that in India RBI and central government only can issue and
accept promissory notes that are due on request
 Section 42(1)- This section provides that every scheduled bank need to hold an average daily
balance with the RBI.

Banking regulation Act 1949-

The Act provides a structure under which commercial banking in India is supervised and regulated. The Act
supplements the Companies Act, 1956. Primary Agricultural Credit Society and cooperative land mortgage
banks are excluded from the Act. Several powers are provided by the Act to the Reserve Bank of India:
 to license banks, have regulation over shareholding and voting rights of shareholders;
 to supervise the appointment of the boards and management;
 to regulate the operations of banks;
 to lay down instructions for audits; control moratorium, mergers and liquidation;
 to issue directives in the interests of public good and on banking policy, and impose penalties

Consumer Protection Act, 1986

 Consumer Protection Act 1986 was enacted for superior protection of the interest of consumers.
 This Act was replaced by the ‗Consumer Protection Act 2019‘ which came into force on 24th July
2020.

Features of Consumer Protection Act, 1986

 It applies to all goods, services and inequitable trade practices unless specified and exempted by
the Central Government
 It covers all sectors, private, public or co-operative
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 It provides the establishment or setting up of consumer protection councils at the district, state
and central levels to encourage and protect the rights of consumers and three-tier quasi-judicial
machinery to deal with consumer grievances and disputes

Objectives of Consumer Protection

 To protect the consumer from abuse
 To provide a venue for grievances/compensation
 To ensure a superior quality of living by upgrading consumer products and services
 Protecting the consumer against immoral and unfair activities of the traders

Competition Act, 2002-

The Competition Act, 2002 is a law that governs commercial competition in India. It replaced the erstwhile
Monopolies and Restrictive Trade Practices Act, 1969.
The Competition Act aims to prevent activities that have an adverse effect on competition in India.

The Act mainly covers these aspects;

 Prohibition of anti-competitive agreements.
 Prohibition of abuse of dominance.
 Regulation of combination (acquisition, mergers, and amalgamation of certain size)
 Establishment of the competition commission of India.
 Power and functions of the competition commission of India.

Prevention of Money laundering Act, 2002

The objective of the act is to prevent money laundering and provide for punishment and confiscation of
property derived from money laundering. Salient features of the act are as follows:

1. The act provides punishment for indulging in money laundering or facilitating money laundering
with rigorous imprisonment from 3 to 7 years and a fine without any upper limit.
2. The property acquired through money laundering shall be confiscated by the Government India.
3. The order of the executive agency under the act can be challenged before an appellate tribunal
and the order of appellate tribunal can further be challenged before a High Court.
4. Burden of proof is on the accused to explain the source of acquired money.

Banking Ombudsman Scheme, 2006

A quasi-judicial body appointed by the Reserve Bank of India is the Banking Ombudsman. It promises to
give customers a convenient and affordable way to file complaints about subpar banking services.

The Scheme covers all Scheduled Commercial Banks, Scheduled Regional Rural Banks, and Scheduled
Primary Co-operative Banks.

Now, Reserve Bank of India has also widened the scope of Banking Ombudsman Scheme to bring mobile
banking and electronic banking issues within its purview.

Banks will be responsible for the deficiencies arising out of sale of insurance, mutual fund other third party
investment products that banks sell but were not earlier held responsible.

Ombudsman can award compensation of upto INR 1 lakh to the complainant for loss of time, expenses
incurred as also, harassment and mental anguish suffered.

FERA

The Foreign Exchange Regulation Act (FERA) was published in 1973 and went into effect on January 1 of
the following year. The operations of MNCs in India were specifically mentioned in Section 29 of this Act. A
permit was required under the Section for all non-banking foreign branches and subsidiaries with foreign
equity more than 40% in order to form new businesses, buy stock in already-existing corporations, or
acquire another corporation whole or in part.
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Foreign Exchange Regulation Act (FERA), 1973

On January 1, 1973, the Foreign Exchange Regulation Act (FERA) went into effect. The operations of MNCs
in India were specifically mentioned in Section 29 of this Act. A permit was required under the Section for
all non-banking foreign branches and subsidiaries with foreign equity more than 40% in order to form new
businesses, buy stock in already-existing corporations, or acquire another corporation whole or in part.

An Act to Consolidate and Amend Certain Payments, Dealings in Foreign Exchange and Securities,
Transactions Indirectly Affecting Foreign Exchange, and the Import and Export of Currency, for the
Preservation of the Foreign Exchange Resources of the Country and the Appropriate Utilization of the Same
in the Interests of the Country's Economic Development.

Features of FERA:

(1) This Act may be called the Foreign Exchange Regulation Act, 1973.
(2) It extends to the whole of India.
(3) It applies also to all citizens of India outside India and to branches and agencies outside India of
companies or bodies corporate, registered or incorporated in India.
(4) It will take effect on the date that the Central Government may designate in this regard by
announcement in the Official Gazette:
The beginning of this
Act may be referred to in any of its provisions; however, references to the commencement of this Act in
any such provision will be understood to refer to the effective date of that provision.

FEMA-
On August 4, 1998, the Government of India proposed the Foreign Exchange Management Bill (FEMA) in
Parliament. "To consolidate and revise the foreign exchange law with the objective of enabling external
commerce and payments and for supporting the orderly development and maintenance of foreign
exchange market in India," reads the purpose of the bill.

Features of the FEMA

The following are some of the important features of Foreign Exchange Management Act:
a. It is consistent with full current account convertibility and contains provisions for progressive
liberalisation of capital account transactions.
b. It is more transparent in its application as it lays down the areas requiring specific permissions of
the Reserve Bank/Government of India on acquisition/holding of foreign exchange.
c. It classified the foreign exchange transactions in two categories, viz. capital account and current
account transactions.
d. It provides power to the Reserve Bank for specifying, in, consultation with the central government,
the classes of capital account transactions and limits to which exchange is admissible for such
transactions.
e. It gives full freedom to a person resident in India, who was earlier resident outside India, to
hold/own/transfer any foreign security/immovable property situated outside India and acquired
when s/he was resident.
f. This act is a civil law and the contraventions of the Act provide for arrest only in exceptional cases.
g. FEMA does not apply to Indian citizen‘s resident outside India.

RERA Act, 2016

According to the Real Estate (Regulation and Development) Act of 2016, which was passed with the
intention of protecting homebuyers and promoting real estate investments, the Real Estate Regulatory
Authority, or RERA, was established. The Upper House passed the bill for this Act of the Parliament of
India on March 10, 2016. (Rajya Sabha). On May 1st, 2016, the RERA Act went into effect. 52 sections
were informed out of 92 at the time. From May 1 to May 31, 2017, all other provisions took effect.

 Establishment of state level regulatory authorities- Real Estate Regulatory Authority

(RERA): The Act provides for State governments to establish more than one regulatory authority
with the following mandate:
 Register and maintain a database of real estate projects; publish it on its website for public
viewing,
 Protection of interest of promoters, buyers and real estate agents
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 Development of sustainable and affordable housing,

 Render advice to the government and ensure compliance with its Regulations and the Act.
 Establishment of Real Estate Appellate Tribunal- Decisions of RERAs can be appealed in these
tribunals.
 Mandatory Registration: All projects with plot size of minimum 500 [Link] or eight apartments
need to be registered with Regulatory Authorities.
 Deposits: Depositing 70% of the funds collected from buyers in a separate escrow bank account
for construction of that project only.
 Liability: Developer‘s liability to repair structural defects for five years.
 Penal interest in case of default: Both promoter and buyer are liable to pay an equal rate of
interest in case of any default from either side.
 Cap on Advance Payments: A promoter cannot accept more than 10% of the cost of the plot,
apartment or building as an advance payment or an application fee from a person without first
entering into an agreement for sale.
 Defines Carpet Area as net usable floor area of flat. Buyers will be charged for the carpet area
and not super built-up area.
 Punishment: Imprisonment of up to three years for developers and up to one year in case of
agents and buyers for violation of orders of Appellate Tribunals and Regulatory Authorities.

SARFAESI Act 2002

The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act of 2002
was a new law passed by the government in 2002 to speed loan recovery and reduce the number of non-
performing loans in the Indian banking and financial sector.

SARFAESI only works for secured loans when the bank may enforce the underlying security, such as a
hypothecation, pledge, or mortgage. Court involvement is not required in these situations unless the
security is void or fraudulent. However, if the asset in question is an unsecured asset, the bank would
have to ask the court to open a civil lawsuit against the defaulters.

The SARFAESI Act also provides for the establishment of Asset Reconstruction Companies (ARCs)
regulated by RBI. Setting up of ARCs was earlier recommended by Narasimham Committee II.
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CHP 14 Latest Banking Concepts

E-Banking-

All banking services and transactions carried out electronically are referred to as "e-banking" or "Electronic
Banking." Through a public or private network, including the internet, it enables people, organisations, and
companies to access their accounts, conduct business, or gather information about different financial
goods and services.

Popular Types of E-banking Services in India

 Internet Banking: A range of financial and non-financial transactions can be carried out using
this type of online banking service. Online banking, often known as net-banking or online banking,
allows customers to pay utility bills, check account balances, view bank statements, and transfer
money to another bank account.
 Mobile Banking: Customers can conduct both financial and non-financial transactions using a
mobile phone thanks to this electronic banking technology, known as mobile banking. The majority
of banks have released mobile banking apps that are accessible through the Apple App Store and
Google Playstore. Customers can access banking services through the mobile application just like
they can through the online banking interface.
 ATM: Automated Teller Machines (ATMs) are one of the most widely used e-banking platforms.
Customers can use ATMs to withdraw money, deposit cash, modify the PIN on their debit cards,
and do other banking operations. An ATM user needs a password in order to use the machine. If a
transaction is conducted from an ATM belonging to a different bank after the allotted number of
free transactions has been reached, the bank will impose a small cost to the user.
 Debit Cards: Nearly everyone has a debit card. You can avoid carrying cash if you use this card,
which is linked to your bank account. You can make any kind of transaction using a debit card, and
the money is immediately deducted from your account.
 Deposit and Withdraws (Direct): This e-banking feature allows customers to authorise
recurring deposits of paychecks into their accounts. The client can authorise the bank to take
money out of his or her account to pay bills, instalments of any type, insurance premiums, and
many other things.
 Pay by Phone Systems: With this service, a consumer can call their bank to ask them to pay a
bill or transfer money to another account.
 Point-of-Sale Transfer Terminals: This service allows customers to pay for the purchase
through a debit/credit card instantly.
 EFT (Electronic Funds Transfer) System
 ECS (Electronic Clearing Services)

Core Banking Solution-

The banking sector has been significantly dominated by core banking systems (CBS). Delivering
specialised solutions that offer customers comfort while also being sustainable is essential in the ever
evolving banking sector. To do this, CBS frameworks are created.

The nature of core banking solutions varies depending on the types of clientele that the bank serves.
Greater consumer convenience and lower operating costs are the two main objectives of core banking. As
a result, banks win from spending less time and money on repeated tasks, while clients gain from having
greater transactional freedom.

Among the most significant core banking solutions are:

 Internet Banking
 Phone Banking
 Automated Teller Machines (ATMs)
 Fund Transfers remotely and immediately (IMPS, NEFT, RTGS etc.)
 Point of Sale systems
 Banking
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Awareness

The benefits to customers are numerous and include 24/7 banking, speedier services everywhere,
anytime, convenience of banking operations through a single data center, and penetration into remote and
rural areas.

Banks also gain from this. Process uniformity, client retention, enhanced document management and
significant mistake eradication, and better safety & compliance processes are a few of the main benefits.

SWIFT Code-
 Swift Codes serve as a standard format for Business Identifier Codes and are nothing more than
Swift numbers (BIC). Worldwide, banks and financial institutions are identified by their Swift Code.
 It discusses the place and its surroundings. It is also known as a special identification number or
an international bank code. When money needs to be transferred internationally between banks,
the code is utilised.
 It is used for domestic wire transfers and international wire transfers. The Swift Codes are used by
banks to communicate; with the Swift Code or BIC code, communication is transparent.
 For international money transfer services, Swift Code is crucial. Worldwide, there is a network of
banks that utilise Swift Codes. The transfer process is made simpler because it offers the bank a
distinct identification.
 The transfer process is faster with Swift Codes. More than 150 locations throughout the world will
be available for you to mail to. Without a Swift Code, your bank transfer might not reach its
intended recipient.

National Electronic Funds Transfer (NEFT)

It is a nationwide payment system that makes direct money transfers possible. With the use of this
scheme, people, businesses, and corporations can electronically transfer money from one bank branch to
another in the participating nation if they have an account there.

Fund transfers utilising NEFT are available to everyone with an account at a bank branch, including
businesses and individuals. Even those people (walk-in customers) who don't have a bank account can
deposit cash at the NEFT-enabled branches with the request to transfer money using NEFT. Such cash
transfers will be limited to a total of Rs. 50,000 per transaction, though. Such consumers are required to
provide complete information, such as their full address, phone number, etc. Thus, NEFT makes it possible
for senders or originators to start money transfer transactions even if they don't have a bank account.

The NEFT system allows individuals, businesses, or corporations with accounts with a bank branch to
receive money. Therefore, the beneficiary must have a bank account with the local branch of the
destination bank that supports NEFT.

The NEFT system also facilitates one-way cross-border transfer of funds from India to Nepal. This is known
as the Indo-Nepal Remittance Facility Scheme. A remitter can transfer funds from any of the NEFT-enabled
branches in to Nepal, irrespective of whether the beneficiary in Nepal maintains an account with a bank
branch in Nepal or not. The beneficiary would receive funds in Nepalese Rupees.

How does the NEFT system operate?

Step-1: In order to initiate a transfer of funds via NEFT, an individual, business, or corporation must fill
out an application form with information about the beneficiary (such as the beneficiary's name, the bank
branch where the beneficiary has an account, its IFSC, the type of account, and its account number), as
well as the amount to be transferred. The originating bank branch will have the application form on hand.
The sender gives his or her bank branch permission to deduct money from his account and send the
beneficiary the stated amount. Customers who use their bank's net banking service can start an online
request for a funds transfer. Some banks allow NEFT transactions using ATMs as well. Walk-in customers
will, however, have to give their contact details (complete address and telephone number, etc.) to the
branch. This will help the branch to refund the money to the customer in case credit could not be afforded
to the beneficiary's bank account or the transaction is rejected / returned for any reason.

Step-2: The originating bank branch prepares a message and sends the message to its pooling centre
(also called the NEFT Service Centre).
 Banking
Awareness 63

Step-3: The pooling centre forwards the message to the NEFT Clearing Centre (operated by National
Clearing Cell, Reserve Bank of India, Mumbai) to be included for the next available batch.

Step-4: The Clearing Centre sorts the funds transfer transactions destination bank-wise and prepares
accounting entries to receive funds from the originating banks (debit) and give the funds to the destination
banks (credit). Thereafter, bank-wise remittance messages are forwarded to the destination banks through
their pooling centre (NEFT Service Centre).

Step-5: The destination banks receive the inward remittance messages from the Clearing Centre and pass
on the credit to the beneficiary customers‘ accounts.

NEFT offers many advantages over the other modes of funds transfer:
 The remitter need not send the physical cheque or Demand Draft to the beneficiary.
 The beneficiary need not visit his / her bank for depositing the paper instruments.
 The beneficiary need not be apprehensive of loss / theft of physical instruments or the likelihood of
fraudulent encashment thereof.
 Cost effective.
 Credit confirmation of the remittances sent by SMS or email.
 Remitter can initiate the remittances from his home / place of work using the internet banking
also.
 Near real time transfer of the funds to the beneficiary account in a secure manner.

Real time gross settlement –

The Real Time Gross Settlement (RTGS) method allows for the "real time" and "gross" transfer of money
or securities from one bank to another. Payment transactions are settled in "real time," which means there
is no waiting period. As soon as a transaction is processed, it is settled. Gross settlement refers to the
one-to-one settlement of the transaction, which excludes bunching or netting with any other transaction.
This payment network is maintained by the Reserve Bank of India (India's Central Bank). The payment is
regarded as final and irrevocable because it is recorded in the Reserve Bank of India's books.

ECS (Electronic Clearing Service)

For repeatable and recurring transactions, it is an electronic method of payment and receipt. Institutions
use ECS to pay out in bulk quantities for things like dividends, interest, salaries, pensions, etc. or to collect
in bulk things like phone, electricity, and water bills, cess and taxes, loan payments, periodic mutual fund
investments, insurance premiums, etc. ECS enables large-scale money transfers from one bank account to
numerous bank accounts or the opposite.

ECS comes in two main ways: ECS Credit and ECS Debit.
By making a single debit to the bank account of the user institution, an institution can utilise ECS Credit to
provide credit to several beneficiaries (such as employees, investors, etc.) who have accounts with bank
branches at different locations within the jurisdiction of an ECS Centre. ECS Credit facilitates the payment
of funds for the user institution's distribution of dividends, interest, salaries, pensions, etc.

In order to make a single credit to the bank account of the user institution, an institution uses ECS Debit
to raise debits to a large number of accounts (such as utility service users, borrowers, mutual fund
investors, etc.) maintained with bank branches at different locations under the jurisdiction of an ECS
Centre. ECS Debit is helpful for paying periodic or repetitive bills that are owed to the user institution by a
large number of consumers, such as phone, electricity, and water bills, cess and tax collections, loan
instalment repayments, periodic investments in mutual funds, insurance premiums, etc.

ECS Credit offers many advantages to the beneficiary –

 The beneficiary need not visit his / her bank for depositing the paper instruments which he would
have otherwise received had he not opted for ECS Credit.
 The beneficiary need not be apprehensive of loss / theft of physical instruments or the likelihood of
fraudulent encashment thereof.
 Cost effective.
 The beneficiary receives the funds right on the due date.
 Banking
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Awareness

IMPS
A different real-time payment technique is the Immediate Payment System (IMPS).
 Instantaneous payments are made between banks in India via IMPS, which is secure and cost-
effective from both a financial and non-financial standpoint.
 IMPS is a low-cost method of transferring money. Other fund transfer methods like NEFT and
RTGS have far greater fees than IMPS.
 It is not necessary to provide information like an account number or IFSC code. IMPS only need
the beneficiary's mobile number to transmit money.

IFSC or Indian Financial System Code

A bank branch that uses the NEFT (National Electronic Funds Transfer) system is uniquely identified
by an alpha-numeric code. The bank is represented by the first four alphanumeric characters in this 11-
digit number, while the branch is represented by the final six. The fifth character is zero (zero). The NEFT
system makes use of IFSC to pinpoint the banks and branches that are the message's origin and
destination as well as to route messages appropriately to the relevant branches and banks.

MICR Codes –

On the bottom of your bank's check leaves, many of you would have noticed the bar codes printed in
magnetic ink. MICR code, which stands for "Magnetic Ink Character Recognition," is the name given to
these bar codes. The technology utilised to print the code is actually referred to as MICR.

The Reserve Bank of India established a number of brand-new payment methods that are safe and
efficient across the nation at the beginning of the 1980s. The novel MICR-based check clearing technology
was one such crucial new modality.

Apart from being a security bar code to protect your transaction, the MICR code is also an indispensable
part for online money transfers. Every bank branch is given a unique MICR code and this helps the RBI to
identify the bank branch and speed up the clearing process.

Every three of the MICR code's nine digits represents a crucial piece of information about the transaction
and the bank. The city code - which designates the location of the bank branch - is represented by the first
three digits of the MICR code.

It usually corresponds with the PIN code of Indian postal addresses. The following three digits stand for
the bank code, while the final three digits stand for the bank branch code. For instance, if you hold a State
Bank of India (SBI) account in Mumbai (Central), your nine-digit MICR code is 400002009, where 400 is
the city code for Mumbai, 002 is the bank code for SBI, and 009 is the branch number for the Andheri
branch of the bank (West).

All banks have their specific MICR codes that indicate many things about a particular banking operation. All
third party transactions and processing of any such kind can't be possible without MICR code. That is why
MICR code is considered so important in the banking transactions. If you are willing to know more then
check MICR code India and have detailed information. The main role of MICR codes has to be understood
for all types of financial transactions done from one bank to the other.

A bank indicates its MICR code for the account holders by printing it on the check leaves. The bottom of
the check carries the MICRo code of the bank so that one can trace it as and when used. The role of MICR
code India in linking all the banks on different grounds is much important to know. The digit classification
of MICR codes of all the Indian banks is same and uniquely adjusted.

Mere MICR code of a bank can speak up many things about a particular bank and its branch. In fact MICR
code is set in such a manner that only concerned banking personnel can explore them for authentication
purpose. All scheduled and private banks have their MICR code India association that link them on various
grounds. The need is that how MICR code is used and what step is taken in making banking transactions
hassle free. All such steps demand mentioning of MICR code without which nothing can be made worth
usable.

UPI-
Unified Payments Interface (UPI) is an instant real-time payment system, allowing users to transfer money
on a real-time basis, across multiple bank accounts without revealing details of one‘s bank account to the
other party.
 Banking
Awareness 65

 UPI is currently the biggest among the National Payments Corporation of India
(NPCI) operated systems including National Automated Clearing House (NACH), Immediate
Payment Service (IMPS), Aadhaar enabled Payment System (AePS), Bharat Bill Payment System
(BBPS), RuPay etc.
 The top UPI apps include PhonePe, Paytm, Google Pay, Amazon Pay and BHIM, the latter being
the Government offering.

Unstructured Supplementary Services Data-

Text messages are sent via the GSM USSD (Unstructured Supplementary Service Data) protocol. USSD is
comparable to Short Message Service (SMS).

USSD uses codes made up of characters found on a mobile phone. A USSD message, which can be up to
182 characters long, creates a real-time communication session between the phone and another device,
usually a network or server.

USSD can be used for WAP surfing, mobile money services, prepaid callback services, menu-based
information services, and location-based content services.

How it Works-
USSD is used for a variety of things, such as the following:
 USSD banking can be used on any mobile device, even feature phones, in contrast to banking
apps, which require both smartphone and internet connectivity to function.
 Configuration and requests for the network. Mobile device configuration on a network is done
using USSD. Additionally, it offers a list of service alternatives from which a user may select in
order to do things like purchase airtime or inquire about account balances.
 Update requests from customers. In order to obtain updated customer information, USSD can link
with systems for enterprise resource planning (ERP) and customer relationship management
(CRM). As a result, data accuracy and customer service are improved.
 Marketing surveys- USSD can be used for mobile marketing. For example, organizations can
send basic marketing surveys that users can respond to immediately, enabling companies to get
customer feedback in real time.
 Callback services- Service organizations, such as insurance providers and financial services
companies, can use USSD to determine customers' interests by enabling them to request callbacks
after they present their offers.
 Order confirmations- Food delivery providers can use USSD to enable two-way communication
between customers placing orders and the vendors to alert customers when their orders are on the
way.
 Coupons and vouchers- Retailers can use USSD to communicate special offers to customers, as
well as send coupons and vouchers.

Bharat Bill Payment System-

 The National Payments Corporation of India (NPCI) is the system behind the RBI-conceptualized
Bharat Bill Payment System (BBPS).
 It is a one-stop platform for paying all bills, offering customers across the nation an interoperable
and accessible "Anytime Anywhere" bill payment solution with predictability, reliability, and
transaction safety.

Cash, transfer cheques, and electronic modes of payment are all acceptable for BBPS transactions. These
transactions will be handled for the clients by bill aggregators and banks, who will work as operating units.
 66 Question Bank

Banking Test 01 8. Which bank is responsible for financing and

promoting export-import activities in India?

1. Which of the following is NOT a function of a 1. SIDBI 2. EXIM Bank

central bank? 3. NABARD 4. NHB

1. Issuing currency notes 9. Which type of deposit account is suitable for

2. Regulating the stock market someone looking to save small amounts
3. Serving as a banker to the government regularly?
4. Managing foreign exchange reserves
1. Fixed Deposit Account
2. What is the primary feature of a Fixed 2. Current Account
Deposit (FD) account? 3. Recurring Deposit Account
4. Savings Account
1. Unlimited withdrawals
2. No fixed maturity 10. What is the reverse design on the ₹50 note?
3. Fixed interest rate for a set period
4. Variable interest rate 1. Red Fort 2. Sanchi Stupa
3. Hampi with Chariot 4. Rani ki vav
3. Which entity is responsible for printing notes
in India? 11. Where was the original headquarters of the
Reserve Bank of India located?
1. State Bank of India
2. Bharatiya Reserve Bank Note Mudran Pvt. 1. Mumbai 2. Chennai
Ltd. 3. Kolkata 4. Delhi
3. Indian Government Mint
4. National Payment Corporation of India 12. Which of the following is NOT typically a
service offered by virtual banks?
4. The Reserve Bank of India was established on
which date? 1. High interest rates on savings
2. In-person loan applications
1. January 1 1935 2. April 1 1935 3. Online bill payments
3. July 1 1935 4. December 1 1935 4. Mobile banking

5. Which of the following statements about the 13. What is the primary role of the Security
₹500 note are correct? Printing and Minting Corporation of India
Limited (SPMCIL)?
1. The obverse design features Mahatma
Gandhi. 1. Regulating banking activities
2. The reverse design features the Red Fort. 2. Printing notes and minting coins
3. The note's color is Lavender. 3. Managing foreign exchange reserves
4. Conducting monetary policy
1. A and C 2. B and C
3. A and B 4. All of the above 14. What is the primary purpose of a Savings
Account?
6. What is the significance of the CASA ratio for
a bank? 1. To facilitate frequent and large-scale
transactions
1. Indicates the number of accounts in a 2. To help individuals save money while
bank earning interest
2. Measures the efficiency of a bank's 3. To hold large sums of money for
operations businesses
3. Reflects the proportion of deposits in 4. To provide overdraft facilities
current and savings accounts
4. Determines the bank's credit rating 15. Consider the following statements regarding
the Reserve Bank of India:
7. Which Act governs the Reserve Bank of
India? A. The RBI was established on the
recommendations of the Hilton-Young
1. Banking Regulation Act 1949 Commission.
2. Reserve Bank of India Act 1934 B. The RBI's Central Office is located in
3. Companies Act 1956 Kolkata.
4. Foreign Exchange Management Act 1999
 Question Bank 67

C. The RBI is responsible for issuing and 22. Which committee recommended the
regulating currency in India. establishment of Small Finance Banks in
India?
Which of the above statements is/are
correct? 1. Narasimham Committee
2. Nachiket Mor Committee
1. A and B only 2. B and C only 3. Rangarajan Committee
3. A and C only 4. A, B and C 4. Sivaraman Committee

16. Which of the following central banks is 23. Which of the following statements about the
responsible for the Euro (EUR)? ₹200 note are correct?

1. Bank of England A. The note features Mahatma Gandhi on the

2. European Central Bank obverse side.
3. Swiss National Bank B. The reverse side features the Ellora Caves.
4. Bank of Japan C. The note is colored Bright Yellow.

17. Which of the following statements are true 1. A and C 2. A and B

about BRBNMPL? 3. B and C 4. All of the above

A. It is a subsidiary of the RBI. 24. Which of the following is NOT a classification

B. It was established to manage coin of commercial banks in India?
production.
C. It has a press in Salboni, West Bengal. 1. Scheduled Banks
2. Cooperative Banks
1. A and C 2. B and C 3. Non-Scheduled Banks
3. A and B 4. All of the above 4. Industrial Banks

18. Which of the following is a key function of the 25. Which type of account typically does not earn
payment system managed by commercial interest?
banks?
1. Savings Account
1. Regulating stock exchanges 2. Current Account
2. Settling financial transactions 3. Recurring Deposit Account
3. Issuing government bonds 4. Fixed Deposit Account
4. Managing foreign exchange reserves

19. Which of the following is true about the

Reserve Bank of India?

1. It is privately owned.
2. It was initially set up as a public sector
bank.
3. It was nationalized in 1949.
4. It was established under the Companies
Act 1956.

20. What is the significance of the CASA ratio for

a bank?

A. It measures the bank's overall profitability

B. It indicates the proportion of deposits in
current and savings accounts
C. It reflects the bank's creditworthiness
D. It shows the bank's liquidity position

21. Which color is associated with the ₹100 note?

1. Lavender
2. Fluorescent Blue
3. Bright Yellow
4. Green-Yellow
 68 Question Bank

Banking Test 02 9. Which of the following is NOT permitted for

Payment Banks in India?

1. Accepting deposits up to Rs 1 lakh per

1. The Reserve Bank of India was nationalized in customer
which year? 2. Issuing ATM/debit cards
3. Lending money to customers
1. 1948 2. 1949 3. 1950 4. 1951 4. Offering internet banking services

2. What does the term "CASA Ratio" stand for? 10. Which Act does the Reserve Bank of India
manage to oversee foreign exchange in
1. Credit Account Service Agreement India?
2. Current Account Savings Account Ratio
3. Cash Available for Savings Account 1. Foreign Exchange Regulation Act 1973
4. Capital and Savings Account 2. Foreign Exchange Management Act 1999
3. Companies Act 2013
3. Which of the following central banks is 4. Income Tax Act 1961
responsible for the monetary policy of the
United States? 11. What is the primary use of a Public Provident
Fund (PPF) account?
1. European Central Bank
2. Federal Reserve Bank 1. Short-term savings
3. Bank of England 2. High-risk investment
4. Reserve Bank of Australia 3. Long-term savings with tax benefits
4. Foreign currency transactions
4. What is the color of the ₹200 note?
12. Which bank is the first development bank
1. Stone Grey established in India?
2. Bright Yellow
3. Chocolate Brown 1. SIDBI 2. NABARD
4. Fluorescent Blue 3. IFCI 4. EXIM Bank

5. Which subsidiary of the Reserve Bank of India 13. Which of the following statements about
is responsible for insuring deposits? MUDRA loans under the Pradhan Mantri
MUDRA Yojana (PMMY) is NOT true?
1. BRBNMPL 2. DICGC
3. IFTAS 4. ReBIT 1. Loans are provided to small and micro
enterprises.
6. Which city does NOT have a mint for coin 2. The loan amount under the Shishu
production in India? category is up to Rs 50,000.
3. MUDRA loans can only be used for
1. Mumbai 2. Kolkata agricultural purposes.
3. Chennai 4. Hyderabad 4. The loan amount under the Tarun category
is up to Rs 10 lakh.
7. Which of the following statements are true
about the ₹100 note? 14. Which of the following is a major benefit of
offshore banking?
A. The color of the note is Lavender.
B. The reverse design features Hampi with 1. Higher taxation rates
Chariot. 2. Limited financial services
C. The dimension of the note is 66×142 mm. 3. Privacy and asset protection
4. In-person banking only
1. A and B 2. A and C
3. B and C 4. All of the above 15. What is the main feature of kiosk banking?

8. What does the term "Bulk Deposit" refer to in 1. High-value loans

banking? 2. Providing banking services to rural and
low-income areas
1. Deposits of more than Rs. 2 crore 3. Managing corporate accounts
2. Deposits made by a single individual 4. Offering foreign exchange
3. Multiple small deposits made in a single
day
4. Deposits in foreign currency
 Question Bank 69

16. Which of the following is true about the 23. What is the significance of the CASA ratio for
Reserve Bank of India? a bank?

1. It is privately owned. 1. It measures the bank's overall profitability

2. It was initially set up as a public sector 2. It indicates the proportion of deposits in
bank. current and savings accounts
3. It was nationalized in 1949. 3. It reflects the bank's creditworthiness
4. It was established under the Companies 4. It shows the bank's liquidity position
Act 1956.
24. Which type of account allows two or more
17. Which of the following statements about people to share access to the same funds?
Small Finance Banks (SFBs) is correct?
1. Savings Account
1. SFBs are required to lend 75% of their 2. Joint Account
adjusted net bank credit to priority 3. Fixed Deposit Account
sectors. 4. Recurring Deposit Account
2. SFBs can only operate in metropolitan
cities. 25. Which city has the printing press managed by
3. SFBs are not allowed to accept deposits Bharatiya Reserve Bank Note Mudran Pvt.
from customers. Ltd.?
4. SFBs focus exclusively on large-scale
industrial loans. 1. Nasik 2. Dewas
3. Hyderabad 4. Mysore
18. What is the maximum area of operation for a
Local Area Bank (LAB) in India?

1. One district 2. Two districts

3. Three districts 4. Five districts

19. Which color is associated with the ₹50 note?

1. Lavender 2. Fluorescent Blue

3. Bright Yellow 4. Green-Yellow

20. What is the primary role of the Reserve Bank

of India in the Indian economy?

1. Issuing government bonds

2. Regulating the stock market
3. Conducting monetary policy
4. Regulating insurance services

21. What does the term "Vostro Account" refer

to?

1. An account held by a foreign bank in a

domestic bank
2. An account used for domestic transactions
3. A savings account with high interest
4. A joint account held by multiple individuals

22. Which of the following is NOT a feature of

digital banking?

1. Online bill payments

2. Mobile check deposits
3. In-person cash withdrawals only
4. E-statements
 70 Question Bank

Banking Test 03 8. What are the primary objectives of the

International Monetary Fund (IMF)?

1. Which was the first bank to be established in 1. Foster global monetary cooperation and
India? financial stability
2. Promote international trade and
1. Bank of Hindustan employment
2. State Bank of India 3. Poverty reduction worldwide
3. Allahabad Bank 4. All of the above
4. Bank of Baroda
9. Which institution is responsible for regulating
2. Which year was NABARD established? cooperative banks and Regional Rural Banks
(RRBs)?
1. 1980 2. 1982 3. 1985 4. 1990
1. RBI 2. NABARD
3. What does SWIFT code stand for? 3. SIDBI 4. NHB

1. Standard Wire Identification Format 10. Which of the following is NOT a feature of
Technology NEFT?
2. Structured Worldwide Identifier Format
Technology 1. Real-time fund transfer
3. Society for Worldwide Interbank Financial 2. Availability to both account holders and
Telecommunication non-account holders
4. Secure Wire Identification Fund Transfer 3. One-way cross-border transfer to Nepal
4. Cost-effective and secure transfer of funds
4. Which of the following are functions of the
Multilateral Investment Guarantee Agency 11. Which section of the Negotiable Instruments
(MIGA)? Act 1881 deals with promissory notes?

1. Providing political risk insurance 1. Section 4 2. Section 5

2. Offering credit enhancement to investors 3. Section 6 4. Section 9
and lenders
3. Resolving disputes between investors and 12. Which of the following statements are correct
governments regarding NABARD?
4. Supporting cross-border investments in
developing countries 1. NABARD regulates cooperative banks and
RRBs
5. Which year was the Negotiable Instruments 2. NABARD provides direct credit to farmers
Act passed? 3. NABARD manages the Rural Infrastructure
Development Fund (RIDF)
1. 1875 2. 1881 3. 1885 4. 1890 4. NABARD offers training for rural
development
6. Which of the following features are associated
with the Banking Regulation Act 1949? 13. Which bank was the first to introduce ATMs in
India?
1. Licensing of commercial banks
2. Regulation of cooperative banks 1. State Bank of India
3. Supervision of appointments of bank 2. HSBC
boards 3. ICICI Bank
4. All of the above 4. HDFC Bank

7. Which bank is known as India's first 14. Special Drawing Rights (SDRs) of the IMF
'universal bank'? consist of a basket of currencies. Which
currency was added to this basket in 2016?
1. HDFC Bank
2. ICICI Bank 1. Indian Rupee
3. Axis Bank 2. Chinese Renminbi
4. Punjab National Bank 3. Australian Dollar
4. Canadian Dollar
 Question Bank 71

15. Which of the following provisions are true 23. Which of the following best defines E-
under the Prevention of Money Laundering Banking?
Act 2002?
1. Only online transactions
1. Punishment for money laundering includes 2. Banking services offered at physical
rigorous imprisonment from 3 to 7 years branches
2. The burden of proof lies on the prosecution 3. All banking services and transactions
3. Confiscation of property obtained through carried out electronically
money laundering 4. Using mobile apps for banking only
4. All of the above
24. Which bank was established on the
16. Which institution was set up under the recommendations of the Narasimham
Insolvency and Bankruptcy Code 2016? Committee in 1975?

1. NABARD 2. IBBI 1. Regional Rural Banks (RRBs)

3. SEBI 4. NHB 2. National Bank for Agriculture and Rural
Development (NABARD)
17. Which of the following is true about Core 3. State Bank of India (SBI)
Banking Solutions (CBS)? 4. Export-Import Bank of India (EXIM Bank)

1. They provide 24/7 banking services 25. Which year marked the establishment of the
2. They only work for large banks Securities and Exchange Board of India
3. They enhance process uniformity (SEBI)?
4. They are limited to ATM services only
1. 1985 2. 1988 3. 1991 4. 1995
18. Which act was replaced by the Competition
Act 2002 in India?

1. Consumer Protection Act 1986

2. Monopolies and Restrictive Trade Practices
Act 1969
3. Foreign Exchange Management Act 1999
4. SARFAESI Act 2002

19. Where is the headquarters of the

International Monetary Fund (IMF) located?

1. London 2. Geneva
3. New York 4. Washington D.C.

20. Which committee recommended the

establishment of the Reserve Bank of India?

1. Narasimhan Committee
2. Hilton Young Commission
3. Rangarajan Committee
4. Malhotra Committee

21. Which of the following is NOT typically

associated with mobile banking?

1. Accessing account balances

2. Depositing physical cash
3. Transferring funds
4. Paying utility bills

22. Which of the following is a primary function of

the Securities and Exchange Board of India
(SEBI)?
1. Regulating cooperative banks
2. Providing refinance support to MSMEs
3. Controlling insider trading
4. Managing the RIDF
 72 Question Bank

Banking Test 04 3. Regulating cooperative banks

4. Managing rural development

1. Which bank is known as the first 'universal 9. Which institution within the World Bank
bank' in India? Group provides political risk insurance and
credit enhancement?
1. HDFC Bank
2. ICICI Bank 1. International Finance Corporation (IFC)
3. Axis Bank 2. International Development Association
4. Punjab National Bank (IDA)
3. Multilateral Investment Guarantee Agency
2. Which of the following is NOT a function of (MIGA)
the International Monetary Fund (IMF)? 4. International Bank for Reconstruction and
Development (IBRD)
1. Providing loans to countries facing balance
of payments problems 10. Which act governs the regulation of
2. Regulating international trade tariffs competition in India and replaced the
3. Offering technical assistance to member Monopolies and Restrictive Trade Practices
countries Act 1969?
4. Monitoring the global monetary system
1. Competition Act 2002
3. Which of the following are features of the 2. Consumer Protection Act 1986
Unified Payments Interface (UPI)? 3. Foreign Exchange Management Act 1999
4. Prevention of Money Laundering Act 2002
1. Instant fund transfer
2. Requires bank account number for 11. What is the primary role of SIDBI?
transactions
3. Operated by NPCI 1. Financing large infrastructure projects
4. Allows multiple bank accounts in one app 2. Financing Micro Small and Medium
Enterprises (MSMEs)
4. Which institution is responsible for regulating 3. Regulating housing finance companies
Non-Banking Financial Companies (NBFCs) in 4. Issuing government securities
India?
12. Which of the following statements is correct
1. SEBI 2. RBI regarding the MICR code?
3. NABARD 4. SIDBI
1. It is a nine-digit code used for processing
5. Which year marks the nationalization of the cheques
Reserve Bank of India? 2. The first three digits represent the bank
branch
1. 1948 2. 1949 3. 1950 4. 1951 3. It speeds up cheque processing
4. All of the above
6. What does RTGS stand for in the banking
context? 13. Which of the following institutions was set up
under the Insolvency and Bankruptcy Code
1. Real Time Gross Settlement 2016?
2. Real Time General Service
3. Rapid Transaction Guarantee Service 1. NABARD 2. IBBI
4. Regular Time General Settlement 3. SEBI 4. NHB

7. Which section of the Negotiable Instruments 14. Which of the following are true about Core
Act 1881 defines a holder in due course? Banking Solutions (CBS)?

1. Section 4 2. Section 9 1. They provide 24/7 banking services

3. Section 15 4. Section 31 2. They enhance process uniformity
3. They are limited to ATM services only
8. Which of the following functions are 4. They only work for large banks
performed by the Export-Import Bank of
India (Exim Bank)? 15. Where is the headquarters of the
International Monetary Fund (IMF) located?
1. Providing export finance
2. Offering advisory services for investment 1. London 2. Geneva
promotion 3. New York 4. Washington D.C.
 Question Bank 73

16. Which committee recommended the 22. Which of the following are correct regarding
establishment of the Reserve Bank of India? the MICR code?

1. Narasimhan Committee 1. It is a nine-digit code used for processing

2. Hilton Young Commission cheques
3. Rangarajan Committee 2. The first three digits represent the bank
4. Malhotra Committee branch
3. It speeds up cheque processing
17. Which act was replaced by the Competition 4. All of the above
Act 2002 in India?
23. Which year was the Export-Import Bank of
1. Consumer Protection Act 1986 India (Exim Bank) established?
2. Monopolies and Restrictive Trade Practices
Act 1969 1. 1980 2. 1982 3. 1985 4. 1990
3. Foreign Exchange Management Act 1999
4. SARFAESI Act 2002 24. Which banking code is printed on the bottom
of cheque leaves?
18. What are the primary objectives of the
International Monetary Fund (IMF)? 1. IFSC Code 2. SWIFT Code
3. MICR Code 4. BIC Code
1. Foster global monetary cooperation and
financial stability 25. Which institution was set up under the
2. Promote international trade and Insolvency and Bankruptcy Code 2016?
employment
3. Poverty reduction worldwide 1. NABARD 2. IBBI
4. All of the above 3. SEBI 4. NHB

19. Which of the following are functions of the

National Payments Corporation of India
(NPCI)?

1. Operating the UPI system

2. Managing the Bharat Bill Payment System
3. Issuing guidelines for ATM usage
4. Regulating foreign exchange transactions

20. Which of the following statements is true

about the Repo Rate?

1. It is the rate at which banks lend to RBI

2. It is the rate at which RBI lends to banks
3. It is the interest rate on fixed deposits
4. It is the interest rate on savings accounts

21. Which of the following best describes the role

of the National Bank for Agriculture and Rural
Development (NABARD)?

1. It provides long-term loans to large

industries
2. It regulates the Indian stock market
3. It focuses on the credit needs of
agriculture and rural areas
4. It issues guidelines for the country's
monetary policy
 74 Question Bank

Banking Test 05 8. Where is the headquarters of the

International Monetary Fund (IMF) located?

1. Which year marks the establishment of the 1. London 2. Geneva

Securities and Exchange Board of India 3. New York 4. Washington D.C.
(SEBI)?
9. Which of the following is NOT typically
1. 1985 2. 1988 3. 1991 4. 1995 associated with mobile banking?

2. Which of the following statements are correct 1. Accessing account balances

regarding NABARD? 2. Depositing physical cash
3. Transferring funds
1. NABARD regulates cooperative banks and 4. Paying utility bills
RRBs
2. NABARD provides direct credit to farmers 10. Which of the following functions are
3. NABARD manages the Rural Infrastructure performed by NHB?
Development Fund (RIDF)
4. NABARD offers training for rural 1. Regulating housing finance companies
development 2. Promoting a sound housing finance system
3. Directly lending to individual borrowers
3. What does SWIFT code stand for? 4. Providing refinance facilities

1. Standard Wire Identification Format 11. What are the primary objectives of the
Technology International Monetary Fund (IMF)?
2. Structured Worldwide Identifier Format
Technology 1. Foster global monetary cooperation and
3. Society for Worldwide Interbank Financial financial stability
Telecommunication 2. Promote international trade and
4. Secure Wire Identification Fund Transfer employment
3. Poverty reduction worldwide
4. Which institution within the World Bank 4. All of the above
Group provides political risk insurance and
credit enhancement? 12. Which bank was established on the
recommendations of the Narasimham
1. International Finance Corporation (IFC) Committee in 1975?
2. International Development Association
(IDA) 1. Regional Rural Banks (RRBs)
3. Multilateral Investment Guarantee Agency 2. National Bank for Agriculture and Rural
(MIGA) Development (NABARD)
4. International Bank for Reconstruction and 3. State Bank of India (SBI)
Development (IBRD) 4. Export-Import Bank of India (EXIM Bank)

5. Which bank was the first to introduce ATMs in 13. Which of the following is true about Core
India? Banking Solutions (CBS)?

1. State Bank of India 2. HSBC 1. They provide 24/7 banking services

3. ICICI Bank 4. HDFC Bank 2. They only work for large banks
3. They enhance process uniformity
6. Which section of the Negotiable Instruments 4. They are limited to ATM services only
Act 1881 deals with promissory notes?
14. What is the main purpose of the Dispute
1. Section 4 2. Section 5 Settlement Body (DSB) of the WTO?
3. Section 6 4. Section 9
1. To negotiate trade agreements between
7. Which institution regulates Non-Banking member countries
Financial Companies (NBFCs) in India? 2. To resolve disputes between member
countries regarding trade agreements
1. SEBI 2. RBI 3. To provide financial assistance to member
3. NABARD 4. SIDBI countries
4. To monitor the implementation of trade
agreements
 Question Bank 75

15. Which act was replaced by the Competition 23. Which of the following acts empowers the RBI
Act 2002 in India? to issue currency notes in India?

1. Consumer Protection Act 1986 1. RBI Act 1934

2. Monopolies and Restrictive Trade Practices 2. Banking Regulation Act 1949
Act 1969 3. Negotiable Instruments Act 1881
3. Foreign Exchange Management Act 1999 4. Foreign Exchange Management Act 1999
4. SARFAESI Act 2002
24. Which institution regulates Non-Banking
16. Which of the following is NOT a feature of Financial Companies (NBFCs) in India?
NEFT?
1. SEBI 2. RBI
1. Real-time fund transfer 3. NABARD 4. SIDBI
2. Availability to both account holders and
non-account holders 25. Which institution was set up under the
3. One-way cross-border transfer to Nepal Insolvency and Bankruptcy Code 2016?
4. Cost-effective and secure transfer of funds
1. NABARD 2. IBBI
17. Which institution of the World Bank Group 3. SEBI 4. NHB
provides political risk insurance and credit
enhancement to investors and lenders?

1. International Finance Corporation (IFC)

2. Multilateral Investment Guarantee Agency
(MIGA)
3. International Development Association
(IDA)
4. International Bank for Reconstruction and
Development (IBRD)

18. Which section of the Negotiable Instruments

Act 1881 defines a holder in due course?

1. Section 4 2. Section 9
3. Section 15 4. Section 31

19. Which year was the Export-Import Bank of

India (Exim Bank) established?

1. 1980 2. 1982 3. 1985 4. 1990

20. Which banking code is printed on the bottom

of cheque leaves?

1. IFSC Code 2. SWIFT Code

3. MICR Code 4. BIC Code

21. Which institution was established to facilitate

and promote cross-border trade and
investment?

1. NABARD 2. SIDBI
3. Exim Bank 4. ECGC

22. Which year was the Negotiable Instruments

Act passed?

1. 1875 2. 1881 3. 1885 4. 1890

 Answer Key 76

Answer Key

Test 01 Test 02 Test 03 Test 04 Test 05

1. 2 1. 2 1. 1 1. 2 1. 2
2. 3 2. 2 2. 2 2. 2 2. 3
3. 2 3. 2 3. 3 3. 1 3. 3
4. 2 4. 2 4. 4 4. 2 4. 3
5. 3 5. 2 5. 2 5. 2 5. 2
6. 3 6. 3 6. 4 6. 1 6. 1
7. 2 7. 2 7. 2 7. 2 7. 2
8. 2 8. 1 8. 4 8. 1 8. 4
9. 3 9. 3 9. 2 9. 3 9. 2
10. 3 10. 2 10. 1 10. 1 10. 2
11. 3 11. 3 11. 1 11. 2 11. 4
12. 2 12. 3 12. 3 12. 4 12. 1
13. 2 13. 3 13. 2 13. 2 13. 1
14. 2 14. 3 14. 2 14. 1 14. 2
15. 3 15. 2 15. 3 15. 4 15. 2
16. 2 16. 3 16. 2 16. 2 16. 1
17. 1 17. 1 17. 1 17. 2 17. 2
18. 2 18. 3 18. 2 18. 4 18. 2
19. 3 19. 4 19. 4 19. 2 19. 2
20. 2 20. 3 20. 2 20. 2 20. 3
21. 1 21. 1 21. 2 21. 3 21. 3
22. 2 22. 3 22. 3 22. 4 22. 2
23. 1 23. 2 23. 3 23. 2 23. 1
24. 4 24. 2 24. 1 24. 3 24. 2
25. 2 25. 4 25. 2 25. 2 25. 2
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 Financial 1
Awareness

CHP 1 Overview of Indian

Financial Market System
What is a Financial System?

It is a system which comprises of a set of institutions such as Banks, insurance companies, stock
exchanges etc. It also allows the transfer of money between savers and borrowers, where the only
purpose is the generation of wealth.

It comprises of a set of sub-systems of financial institutions (RBI, SEBI, NABARD, and PFRDA etc.),
financial markets (Stock Market, Bond Market, and Commodity Market etc.), financial instruments
(Cheques, Bonds, Securities etc.) and services which help in the generation of capital. A financial system is
a system which converts savings into investment. It plays a significant role in economic growth of the
country by mobilizing extra funds and utilizing them effectively for productive purposes and capital
formation either by government or by any corporate.

It is characterized by the presence of integrated, organized and regulated financial markets, which helps in
meeting the short term and long term financial goals of both the household and corporate sector.

The financial system performs the following functions:

It serves as a link between investors and savers. It helps in utilizing the money in more efficient and
effective manner. It formalizes and channelizes the flow of saving into effective investment.

 It assists in choosing the projects to finance and routinely evaluates how well they are performing.
 It offers a means of payment for the exchange of products and services.
 It offers a method for resource transfer across geographical borders.
 It offers a method for monitoring and limiting the risk associated with allocating credit and
mobilising savings.
 By combining the supply of savings and the demand for investable funds, it encourages the capital
formation process.
 It aids in reducing transaction costs and raising returns. People are motivated to save more by
lower costs.
 It offers comprehensive information to market participants, including individuals, corporations,
governments, etc.

Components/Constituents of Indian Financial system:

The following are the four main components of Indian Financial system

1. Financial institutions
2. Financial Markets
3. Financial Instruments/Assets/Securities
4. Financial Services.

1. Financial institutions: These are the intermediaries who facilitate smooth functioning of the financial
system by making investors and borrowers meet. They mobilize the fund from the investor or saver for the
government or the corporate in order to generate wealth. As Government or corporate will invest that
money for development purpose and some part of return will be given to the investor. So it is win-win
situation for both the parties. Financial institutions provide a whole range of services to the parties who
want to raise funds from the market or common man. Financial institutions act as financial
intermediaries because they act as middlemen between borrowers and saves. For Example- Reserve
Bank of India (RBI), Security and Exchange Board of India (SEBI), National Bank for Agriculture and Rural
Development (NABARD), Pension Fund Regulatory and Development Authority (PFRDA), Insurance
Regulatory and Development Authority (IRDA) etc.

2. Financial Markets: Financial market is the place where trading of funds, bonds, securities happens for
the purpose of generation of wealth by returns. It is a place where investors invest their money. It's
through financial markets that the financial system of an economy works. The main functions of financial
markets are:
 Financial
2 Awareness

1. It helps in facilitation, creation and allocation of credit and liquidity.

2. They serve as intermediaries for channelising of savings.
3. They assist process of balanced economic growth.
4. It also provides financial convenience.

3. Financial Instruments: These are the instruments which help the investor to generate wealth through
contracts, which can be purchased, traded, modified, etc. For example Bonds, Securities, Shares, Mutual
Funds etc.

4. Financial Services: It is defined as the "activities, benefits and satisfaction connected with sale of
money that offers to users and customers, financial related value". For example Banking, Investing and
insurance.

List of Credit rating agencies in India-

1. Credit Rating Information Services of India Limited (CRISIL)

 It was set up in 1987; Credit Rating Information Services of India Limited (CRISIL) is one of
the oldest credit rating agencies in India.
 It became operational in countries which including the UK, USA, Poland, China, Hong Kong,
and Argentina, in addition to India.
 It evaluates the credit worthiness of commercial entities on the basis of their strengths,
market reputation, market share and board.
 It helps the investors in making investment decisions by providing credit ratings for
companies, organisations and banks. Starting from 2016, CRISIL has also ventured into
infrastructure rating.

2. Investment Information and Credit Rating Agency of India (ICRA) Limited

 It was established in 1991 and HQ in Mumbai, Investment Information and Credit Rating
Agency of India uses a transparent rating system to assign comprehensive credit ratings to
corporates.
 It is known for assigning corporate governance rating, mutual funds rating, structured finance
rating, performance rating, etc.

3. Credit Analysis and Research (CARE) Limited

 It is a Credit Analysis and Research Limited (CARE) started its operations in April 1993.
 Its HQ is in Mumbai, it also has regional offices in New Delhi, Kolkata, Pune, Chandigarh,
Ahmedabad, Jaipur, Bengaluru, Coimbatore, Chennai and Hyderabad.
 It offers two categories of bank loan ratings- long-term and short-term debt instruments.
 It is credit ratings that can be used by investors to make informed decisions on the basis of
credit risk and risk-return expectations.
 It can also help companies to raise funds to meet their investment needs.

4. Acuite Ratings & Research (earlier SMERA Ratings Limited)

 It was established in 2011, earlier known as Small Medium Enterprises Rating Agency Of India
Limited is now known as Acuite Rating & Research.
 It has two key parts – Bond Ratings and SME Ratings. It evaluates the credibility of existing
Micro, Small, and Medium enterprises (MSMEs).

5. Brickwork Ratings India Private Limited

 It was formed in 2008.
 Besides being registered with SEBI, Brickwork Ratings (BWR) is also accredited by RBI and
empanelled by NSIC, NCD, MSME ratings and grading services.
 It assigns credit rating to bank loans, capital market instruments, municipal corporations and
SMEs. Besides, it also grades real estate investments, NGOs, hospitals, MFI, etc.
 It provides several rating systems depending upon the different financial instruments.

6. India Ratings and Research Pvt. Ltd.

 It was formed in 1995.
 It determines credit ratings for corporate issuers, project finance companies, financial
institutions, managed funds, structured finance companies and urban local bodies. It was
formerly known as Fitch Ratings India Pvt. Ltd.
 HQ is in Mumbai, it also has other branch offices in Ahmedabad, Chennai, Delhi, Hyderabad,
Bengaluru, Pune, and Kolkata.
 Financial 3
Awareness

7. Infometrics Valuation and Rating Pvt. Ltd.

 It was formed in 1986.
 It was founded by former finance professionals, administrative services personnel bankers and,
Infometrics Valuation and Rating Pvt Ltd is an RBI-accredited and SEBI registered credit rating
agency.
 It offers an unbiased assessment and evaluation of the creditworthiness of banks, non-banking
financial companies (NBFCs), small and medium scale units (SMUs) and large corporates.
 Amongst lenders and investors it aims to reduce any kind of information asymmetry.
 It has transparency as its core value and thus, endeavours to provide accurate and
comprehensive reports and credit ratings to all its clients.

IPO and FPO: Overview

A company or corporate can raise fresh capital either by bank or raise funds from public by issuing of
shares. While there are several ways in which the shares of a company can be issued, here we will discuss
the two types of public issues. In a public offer or issue, a shares of the x company are sold in the primary
market in order to get new investors and thus generate funds. The shares in such an issue are made
available to the general public, who can subscribe to the same. There are two much-popular types of
public issue of shares- follow-on public offering (FPO) and Initial public offer (IPO). Let us try and
understand what an IPO and an FPO is.

IPO is a type of public issue of shares of a company. As the term suggests, an initial public offer is the
first time that a privately owned company's shares are sold to the general public to raise fresh capital. By
filing for an IPO, a company goes public and takes a step towards getting listed on the exchanges.
Thereafter, its shares are available for trading on the exchanges. An IPO thus involves a change in the
ownership (from private to public) of a company.

FPO is not as popular a term as an IPO. An FPO involves the second or subsequent sale of shares of an
already listed or public company. It is thus an additional issue of shares to raise funds.

Differences between IPO and FPO

 An IPO is the initial or first sale of shares of a company to the general public; an FPO is an
additional share sale offer.
 In an IPO, the company or the issuer whose shares get listed is a private company. After the IPO,
the issuer joins the likes of other publicly traded companies. But in an FPO, the shares for sale
belong to a company that has already been listed on the exchanges in the past.
 In an IPO, we have a price bank or a fixed price for the share sale, as decided during the filing
process by the merchant banker and the company. However, in case of an FPO, the price of a
shares are driven or determined by the market as well as the number of shares being increased or
decreased (depending on whether it is a dilutive or non-dilutive FPO).

Primary Market

The primary market is the market that firms sells new stocks, securities, bonds etc. to the public for the
first time. Companies, governments or Public Sector Units can obtain funding through the sale of a new
stock or bond issue. The case of a new stock issue, this sale is called as initial public offering (IPO).
Example of primary market is IPO, private placements, preferential allotments etc.

Features of a primary market are:

 This is the market for new long-term capital. It is called as New Issue Market because of the
primary market is, as it is the market where the securities are sold for the first time.
 In a primary market it issues, the securities which are issued by the company directly to investors.
 It is used for the purpose of setting up for new business or for expanding or modernizing the
existing business.
 The primary market plays the crucial role in facilitating capital formation in the economy.
 It does not include certain other sources of new long-term external finance, such as loans from
financial institutions. Borrowers in the new issue market may be raising capital for converting
private capital into public capital; this is known as 'going public'.
 Financial
4 Awareness

Secondary Market

It is the financial market for trading of securities which are already issued in an initial private or public
offering. Once a newly issued stock is listed on a stock exchange, investors and speculators can easily
trade on the exchange, as market makers provide bids and offers in the new stock.
It is also known as an aftermarket. It is a place where companies can trade their securities. Secondary
markets allow investors to buy and sell shares freely without the issuing company's intervention. Share
valuation is based on performance in these transactions. Consequently, the selling of shares between
sellers and buyers of stock generates income.
Examples of Secondary markets are- BSE, NSE, NASDAQ etc.

Securities are offered to public for the purpose of raising capital or fund, in the primary market. Secondary
market is an equity-trading avenue in which already existing/ pre-issued securities are traded amongst
investors. Secondary market could be either dealer or auction market. While stock exchange is the part of
an auction market, Over-the-Counter (OTC) is a part of the dealer market.

Stocks- They are also known as equity and unit of stock is known as shares. Investors and issuers of
security both can participate in stock markets. Different sized entities participate in the stock market
activities, ranging from small investors to the governments, corporations, large hedge fund traders, and
banks. Corporations, governments, and companies issue securities or stocks in the stock market to
collect funds. The stock market acts as a platform for companies to raise fund for their business and
investors to invest in securities.

Stock markets- It facilitates buyers and issuer for trading of shares. It can exist in both virtual and real
arenas. Stock exchanges with physical locations carry out stock trading on trading floor. This method of
conducting trading, where the traders enter verbal bids, is called open outcry. In virtual stock exchanges,
trading is done by online traders who are connected to each other through internet. In addition to acting
as a market place for stock trading, stock markets also act as the clearinghouse for stock transactions,
which means that stock exchanges collect and deliver the securities and also guarantee payment to the
seller.

Exchange Platforms
Domestic Exchanges:
Indian equities are traded on three major national exchanges: MCX Stock Exchange Limited (MCX-SX),
Bombay Stock Exchange Limited (BSE) and National Stock Exchange of India Limited (NSE).

a) MCX Stock Exchange: It is India's new stock exchange, which is recognized by the Securities and
Exchange Board of India (SEBI) under Section 4 of the Securities Contracts (Regulation) Act, 1956.
It was granted the status of a 'recognized stock exchange' by the Government of India on December 19,
2012. In line with global best practices and regulatory requirements, clearing and settlement of trades is
conducted through a separate clearing corporation-MCX-SX Clearing Corporation Limited (MCX-SX CCL).

Under the regulatory framework of Reserve Bank of India (RBI) AND SEBI, MCX-SX started its operations
in Currency Futures in the Currency Derivatives segment on October 7, 2008. It commenced trading in
Currency Options on August 10, 2012, which received permissions to deal in Interest Rate Derivatives,
Equity, Futures and Options on Equity and Wholesale Debt segments. The Exchange commenced trading in
the Equity segment on February 11, 2013.

Bombay Stock Exchange (BSE): It was Established in 1875, BSE Ltd. (formerly known as Bombay Stock
Exchange Ltd.). It is Asia's first Stock Exchange and one of India's leading exchange groups. BSE has
contributed the growth of the Indian corporate sector by providing it an efficient capital-raising platform,
over the past 137 years. Popularly known as BSE, the bourse was established as "The Native Share &
Stock Brokers Association" in 1875. BSE is a corporatised and demutualised entity, with a broad
shareholder-base, which includes two leading global exchanges, Deutsche Bourse and Singapore Exchange
as strategic partners. For trading in equity, debt instruments, derivatives, and mutual funds BSE provides
an efficient and transparent market. It also provides platform for trading in equities of small-and-medium
enterprises (SME).

More than 5000 companies are listed on BSE making it world's No. 1 exchange in terms of listed members.
It is one of the world's leading exchanges for Index options trading. It is the second in the world to obtain
an ISO 9001:2000 certifications. It is also the first exchange in the country and second in the world to
receive Information Security Management System Standard BS 7799-2-2002 certification for its BSE
Online Trading System (BOLT).
 Financial 5
Awareness

India's most widely tracked stock market benchmark index is the S&P BSE SENSEX. It is traded
internationally on the EUREX as well as leading exchanges of the BRCS nations (Brazil, Russia, China and
South Africa).

National Stock Exchange (NSE): Under the Securities Contracts (Regulation) Act, it was recognised as a
stock exchange in April 1993 .Its operations commenced on Wholesale Debt Market in June 1994. The
capital market segment commenced its operations in November 1994, whereas the derivative segment
started in 2000. NSE introduced a fully automated trading system called NEAT (National Exchange for
Automated Trading) that operated on a strict price/time priority. This system enabled efficient trade and
the ease with which trade was done. Enabling large number of members all over the country to trade
simultaneously, narrowing the spreads, NEAT had lent considerable depth in the market.

The Futures and Options trading system of NSE, called NEAT-F&O trading system, provides a fully
automated screen based trading for S&P CNX Nifty futures on a nationwide basis and an online monitoring
and surveillance mechanism. It supports an order-driven market and provides complete transparency of
trading operations.

International Exchanges
Due to rising globalization, the development at macro and micro levels in international markets is
compulsorily incorporated in the performance of domestic indices and individual stock performance,
directly or indirectly. Therefore, it is important to keep track of international financial markets for better
perspective and intelligent investment.

a) NASDAQ (National Association of Securities Dealers Automated Quotations):

It is a US stock exchange called NASDAQ (National Association of Securities Dealers Automated
Quotations). In the US, it is an electronic screen-based exchange for trading equities securities. The
National Association of Securities Dealers formed it in 1971. The NASDAQ OMX group, whose shares
debuted on its own stock exchange in 2002, nonetheless owns and runs it. The Securities and Exchange
Commission (SEC), which oversees the securities markets in the United States, keeps close eye on the
exchange.
NASDAQ is the world leader in the arena of securities trading, with 3,900 companies (NASDAQ site) being
listed. There are four major indices of NASDAQ that are followed closely by the investor class,
internationally.

i. The NASDAQ Composite is an index of common stocks and related securities, such as ADRs,
tracking stocks, and limited partnership interests that are traded on the NASDAQ exchange. The
Index's projected 3,000+ stock component count makes it an international index since it contains
equities from both US and non-US corporations. It is closely watched in the US and serves as a
gauge of how well technology and growth firms are doing. The index had a base value of 100
points when it first debuted in 1971. It reached new highs as time went on; in July 1995, it closed
above the 1,000-mark, and in March 2000, it reached 5048.62. The dotcom stock market ended
with the drop from this peak.
ii. The NASDAQ 100 is an index made up of 100 of the biggest non-financial companies from around
the world that are listed on NASDAQ. Based on market capitalization, the component businesses'
weights in the index are determined, with certain guidelines limiting the impact of the larger
components. There are no financial companies in the index. However, it also includes businesses
that were founded outside of the US. These two characteristics of the NASDAQ 100 set it apart
from the S&P 500 and Dow Jones Industrial Average (DJIA). Companies from the industrial,
technological, biotechnological, healthcare, transportation, media, and service sectors are
represented in the index.
iii. The Dow Jones Industrial Average (DJIA) was established by Charles Henry Dow. In 1882, he
joined with Edward Jones to found Dow Jones & Co., a financial institution. They created the first
index with 11 equities in 1884. (two manufacturing companies and nine railroad companies). 30
blue-chip industrial corporations with current operations in America are included in the index. The
simple average, which is determined by dividing the total price of all stocks by the number of
stocks, is used to determine the Dow Jones Industrial Average (30).
iv. S&P 500: To further enhance tracking of American stock market performance, Standard and
Poor's, a division of McGraw Hill, established the S&P 500 Index in 1957. The S&P 500 was
included to the US Department of Commerce's index of forward-looking economic indicators in
1968. The S&P 500 is meant to include the 500 US publicly traded companies with the highest
market capitalizations (in contrast to the FORTUNE 500, which is the largest 500 companies in
terms of sales revenue). Approximately three-fourths of all American capitalisation is represented
by the S&P 500 Index.
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6 Awareness

b) LSE (London Stock Exchange):

The London Stock Exchange was established in 1801 and initially listed both British and foreign companies.
The LSE focuses on four key areas:

i. Equity markets: The LSE enables companies from around the world to raise capital. There are
four primary markets; Main Market, Alternative Investment Market (AIM), Professional Securities
Market (PSM), and Specialist Fund Market (SFM).
ii. Trading services: Highly active market for trading in a range of securities.
iii. Market data information: The LSE provides real-time prices, news, and other financial
information to the global financial community.
iv. Derivatives: EDX London, which was established in 2003 with the goal of integrating the cash,
equities, and derivatives markets, is a significant contributor to the derivatives business. It
combines the LSE's power and liquidity with the NASDAQ OMX group's expertise in equity
derivatives.
v. The exchange's derivatives division offers a variety of products with underlying from the Baltic,
Nordic, and Russian markets. Internationally, it sells goods with foundations from Korea,
Kazakhstan, India, and Egypt.

c) Frankfurt Stock Exchange:

Frankfurt, Germany is home to this exchange. Deutsche Börse is the owner and operator of it. The
Frankfurt Stock Exchange controls a sizable portion of the European market as well as more than 90% of
the German market's total turnover. A number well-known trading indexes of the exchange exist, including
the TecDAX, VDAX, DAX, DAXplus, CDAX, DivDAX, LDAX, MDAX, and EuroStoxx 50. The 30 largest
German firms that trade on the Frankfurt Stock Exchange make up the DAX, a blue-chip stock market
index. Prices are obtained from the Frankfurt Stock Exchange's electronic Xetra trading system.

Based on market capitalization figures provided by the World Federation of Exchanges as of November
2018, this ranking of the top 10 largest stock exchanges was created.

This list of top 10 largest stock exchanges is based on the market capitalization data from the
World Federation of Exchanges:

10- Bombay Stock Exchange, India: India's Bombay Stock Market was the region's first stock exchange
when it opened its doors in 1875. The most listed companies on this list are traded on this stock market.
5,749 companies are listed on the BSE, according to Visual Capitalist. The majority of them, though, are
small-caps. It is situated on Mumbai's Dalal Street.

9- Toronto Stock Exchange, Canada: The Toronto Stock Exchange (TSX), which is owned and run by
TMX Group, is one of the top 10 largest stock exchanges in the world with 2,207 listed companies. It does
$97 billion worth of transactions per month on average. The "Big Five" commercial banks of Canada are all
listed on the Toronto Stock Exchange. In 1852, it was founded. The TMX Group and the London Stock
Exchange were in talks to merge back in 2011, but the merger failed to gain shareholder approval.

8- Shenzhen Stock Exchange, China: The Shenzhen Stock Exchange, one of only two freely running
stock exchanges in China, was formally founded in 1990. The Shanghai Stock Exchange is the other. The
majority of the businesses on this list are Chinese-based, and their shares are traded in Yuan. A ChiNext
board, comparable to NASDAQ and comprised of high-growth, high-tech businesses, was introduced by the
Shenzhen Stock Exchange in 2009.

7- London Stock Exchange, United Kingdom: The London Stock Exchange was founded in 1698. It has
more than 3,000 listed companies. It is owned and operated by the London Stock Exchange Group, which
was formed in 2007 following the merger of the LSE with Borsa Italia. The LSE was the world's largest
stock exchange until the end of the First World War, when it lost that title to the New York Stock
Exchange. Some of the biggest companies listed at the LSE are British Petroleum, Barclays, and
GlaxoSmithKline.

6- Euronext, Eurozone: Euronext is a pan-European stock market with its headquarters in Amsterdam,
the Netherlands, and operations in France, Belgium, Ireland, and Portugal. There are about 1,300 listed
companies. In Euronext, stocks are traded in euros. About $174 billion worth of trading occurs there each
month.
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5- Hong Kong Stock Exchange, Hong Kong: In 1891, the Hong Kong Stock Exchange was established.
About half of the nearly 2,000 listed enterprises are from mainland China. In order to switch to electronic
trading, the exchange closed its physical trading floor in 2017. AIA, Tencent Holdings, PetroChina, China
Mobile, and HSBC Holdings are a few of the largest corporations with Hong Kong Stock Exchange listings.

4- Shanghai Stock Exchange, China: It has more than 1,000 listed enterprises and is a non-profit.
Despite having its beginnings in 1866, it was put on hold in 1949 after the Chinese Revolution. The
Shanghai Exchange was established in 1990 as it is known today. The shares of a company listed on the
Shanghai Stock Exchange trade in the local currency, whereas B shares are priced in US dollars for
overseas investors.

3- Tokyo Stock Exchange, Japan: The Tokyo Stock Exchange, which was established in 1878, is one of
the ten biggest stock exchanges in the world. It has about 2,300 listed businesses. Following World War II,
trading at the Tokyo Stock Exchange was halted for four years. It started operating again in 1949. The
Nikkei 225, the largest firms on the TSE, including Toyota, Honda, Suzuki, and Sony, serves as its
benchmark index.

2- NASDAQ, United States: In New York City, the NASDAQ Stock Market was established in 1971.
Because many of the biggest technological companies in the world, including Apple, Microsoft, Facebook,
Amazon, Alphabet, Tesla, Cisco, and others, are listed on NASDAQ, this exchange is known as the "Mecca
of technology businesses."

1- New York Stock Exchange, United States: Founded in 1792, the New York Stock Exchange has
been the world's largest stock exchange since the end of World War I, when it overtook the London Stock
Exchange. It has about 2,400 listed companies. According to data from Gallup, more than 54% Americans
had invested in stocks listed at the NYSE. The NYSE alone accounts for roughly 40% of the world's stock
market capitalization.
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CHP 2 Money Market and its

Instruments
Money Market Mutual Fund-
Money market mutual funds and money funds are two common names for money market funds. They are
good quality short-term debt securities, cash, and cash equivalents. Because of this, money market
mutual funds are seen as secure investments or ones with little to no risk. These funds provide a
predictable rate of risk-free return because to their investments in high-quality assets.

The Purpose of Money Market Mutual Funds for Investors:

There are three instances when money market mutual funds, because of their liquidity, are particularly
suitable investments.

1. Money market mutual funds offer a convenient parking place for cash reserves when an investor is
not quite ready to invest or is anticipating a near-term cash outlay for a non-investment purpose.
Money market mutual funds offer ultimate safety and liquidity. This means that investors will have
an expected sum of cash at the very moment that they need it.

2. An investor holding a basket of mutual funds from a single fund company may occasionally want to
transfer assets from one fund to another. If, however, the investor wants to sell a fund before
deciding on another fund to purchase, a money market mutual fund offered by the same fund
company may be a wise place to park the sale proceeds. Then, at the appropriate time, the
investor may exchange their money market mutual fund holdings for shares of the other funds in
the fund family.

3. To benefit their clients, brokerage firms regularly use money market mutual funds to provide cash
management services. Putting a client's dormant cash into money market mutual funds will earn
the client an extra percentage point (or two) in annual returns above those earned by other
possible investments.

Overview of Indian Financial Market System

Treasury Bills (T-Bills): Similar to corporate, governments also want to raise funds for developmental
purposes, so in this case they bonds, securities etc. So Treasury Bills are issued by the Central
Government and are one of the safest money market instruments to raise funds for government as well as
investor. Since they are instruments with no risk, returns are not very high. T-Bills are exchanged in both
the primary and secondary markets.

T-Bills are issued by the Central Government at a discount from their face value, and the difference
between the price and the maturity value is the interest that the buyer of the instrument will receive.
Through auctions, a bidding procedure establishes the T-price. Currently, the Indian government issues
three different Treasury bill lengths through auctions: 91-day, 182-day, and 364-day.

Call/ notice/ term money market: This a market which refers to trading for a short term as a name
suggest. It may involve monetary value or it may involve goods as well. The money market primarily helps
banks and other organisations like Primary Dealers lend and borrow money. An entity with extra funds
may lend them to a company in need of money on an uncollateralized basis. The length of the loan might
be as short as one day (known as call money) or as long as two weeks or more (known as notice money).
Term money is defined as borrowing or lending money for a duration longer than 14 days. The surplus
funds available to lenders and the demand for them determine the interest rates on such funds.

The Reserve Bank of India oversees this market and establishes rules for the different call/notice money
market participants. The following organisations are allowed to engage in the call/notice money market as
both lenders and borrowers: Scheduled Commercial Banks (apart from RRBs), Co-operative Banks aside
from Land Development Banks, and Primary Dealers.

The call/notice money market allows scheduled commercial banks to borrow up to 125 percent of their
capital funds. However, they should limit their fortnightly average borrowing to no more than 100% of
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their capital funds (Tier I and Tier II capital). In addition, SCBs may lend up to 50% of their capital on any
given day, but average weekly outstanding loan should not be more than 25% of their capital.
By the end of March of the prior fiscal year, cooperative banks are allowed to borrow up to 2% of their
total deposits in the call/notice money market.

Primary Dealers can borrow on average in a reporting fortnight up to 200% of the total net owned funds
(NOF) as at end-March of the previous financial year and lend on average in a reporting fortnight up to
25% of their NOF.

Commercial Paper (CP) These are normally issued the companies to raise fund for a time period upto 1
year. It was introduced in India in 1990 with a view to enabling highly rated corporate borrowers to
diversify their sources of short-term borrowings and to provide an additional instrument to investors.
Subsequently, primary dealers and all-India financial institutions were also permitted to issue CP to enable
them to meet their short-term funding requirements for their operations.

It can be issued for maturities between minimum period of 7 days and maximum up to one year.
Eligible entities for CP issuance include corporations, main dealers (PDs), and All-India Financial
Institutions (FIs). All eligible participants must obtain the credit rating for the issuance of commercial
paper from one of the following agencies: Credit Rating Information Services of India Ltd. (CRISIL),
Investment Information and Credit Rating Agency of India Ltd. (ICRA), Credit Analysis and Research Ltd.
(CARE), FITCH Ratings India Pvt. Ltd., or any other credit rating agency (CRA) that may be designated by
the Reserve Bank of India from time to time. The minimum credit rating is A-2 [according to the definition
and rating symbol set forth by the Securities and Exchange Board of India (SEBI)].The issuers shall ensure
at the time of issuance of CP that the rating so obtained is current and has not fallen due for review.
The return on commercial papers is higher as compared to T-Bills so as the risk as they are less secure in
comparison to these bills. It is easy to find buyers for the firms with high credit ratings. These securities
are actively traded in secondary market.

Commercial bills are short term, negotiable and self-liquidating money market instruments with low risk.
A bill of exchange is drawn by a seller on the buyer to make payment within a certain period of time.
Generally, the maturity period is of three months. Commercial bill can be resold a number of times during
the usance period of bill. The commercial bills are purchased and discounted by commercial banks and are
rediscounted by financial institutions like EXIM banks, SIDBI, IDBI etc.

The fact that commercial bills rediscounted by commercial banks with financial institutions frequently
remain far below Rs. 1,000 crore is proof of the extremely small size of the commercial bill market in
India. The cash credit system of credit distribution, where banks were responsible for cash management,
limited the market for commercial bills. On May 1, 1989, the Reserve Bank removed the 12.5% interest
rate cap for rediscounting commercial bills. The borrowers' ability to manage their finances prudently is
essential to the success of the bills discounting system. Since this discipline was lacking, the Reserve Bank
limited banks' ability to finance bills in July 1992 to the extent of their needs for working capital as
determined by credit standards. However, in order to encourage the 'bills' culture, the Reserve Bank
advised banks in October 1997 that at least 25 per cent of inland credit purchases of borrowers should be
through bills.

Certificate of Deposits (CDs): A certificate of deposit is similar to a promissory note that a bank issues
and that entitles the bearer to interest payments. It is comparable to a term deposit account at a bank.
The certificate displays the value as well as the maturity date and set interest rate. These certifications are
offered in terms ranging from three months to five years. Because certificates of deposits involve a higher
amount of risk than T-Bills, their returns are higher.

Repurchase Agreements (Repo and reverse repo): Repo was introduced in December 1992. Repo is a
repurchase agreement. It means selling a security under an agreement to repurchase it at a
predetermined date and rate. Repo transactions are affected between banks and financial institutions and
among bank themselves, RBI also undertake Repo. In November 1996, RBI introduced Reverse Repo. It
means buying a security on a spot basis with a commitment to resell on a forward basis. Reverse Repo
transactions are affected with scheduled commercial banks and primary dealers. In March 2003, to
broaden the Repo market, RBI allowed NBFCs, Mutual Funds, Housing Finance and Companies and
Insurance Companies to undertake REPO transactions.
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10 Awareness

These transactions are only permitted between RBI-approved parties and only between RBI-approved
securities, like as T-Bills, PSU bonds, corporate bonds, and state and federal government assets. They are
typically borrowed overnight. Sellers of repurchase agreements make a commitment to buy them back at
a specified price and date in the future. On the other hand, the buyer will likewise acquire the securities
and other items with the intent of reselling them to the seller.

Banker's Acceptance:
Banker's Acceptance is like a short-term Investment strategy developed by a non-financial company and
supported by a bank guarantee. Similar to a bill of exchange, it states the buyer's agreement to pay the
seller the stated sum at the designated time. Additionally, the bank ensures that the buyer will reimburse
the seller at a later time. High credit rating businesses may use such a bill. The most popular term for
these securities is 90 days, and they have maturities ranging from 30 to 180 days. These negotiable time
draughts are used by businesses to finance imports, exports, and other types of trade.

Ways And Means Advances

The RBI is providing a facility for the Center and the States to borrow money. These loans are only
intended to assist them in bridging short-term differences in the cash flows of their receipts and outlays.
They aren't a source of money in the traditional sense. The RBI Act of 1934's Section 17(5) permits the
central bank to make loans to the federal government and state governments as long as they are repaid
"not later than three months from the date of the advance."

The interest rate on WMA is the RBI's repo rate, which is basically the rate at which it lends short-term
money to banks. The governments are, however, allowed to draw amounts in excess of their WMA limits.
The interest on such overdraft is 2 percentage points above the repo rate. Further, no state can run an
overdraft with the RBI for more than a certain period.

Bill of Exchange-
A bill of exchange is a legally enforceable agreement between two parties that one would pay the other a
specific sum of money on demand or as of a specific date. The main application of bills of exchange is in
international trade. Their use has decreased as other payment methods have grown in popularity. A bill of
exchange transaction could involve any one of three parties. These are what they are:

 Drawee: This party pays the amount stated on the bill of exchange to the payee.
 Drawer: This party requires the drawee to pay a third party (or the drawer can be paid by the
drawee).
 Payee: This party is paid the amount specified on the bill of exchange by the drawee.

A bill of exchange normally includes the following information:

Title- On the front of the document, the phrase "bill of exchange" is mentioned.

Amount- The whole sum due, represented both quantitatively and verbally.
The deadline for making the required payment- Several days following an occurrence, such as a shipment
or the arrival of a delivery, can be indicated.

Payee- Indicates the party to be paid's name (and conceivably its address).

Identification number- The bill should contain a unique identifying number.

Signature- The bill is signed by a person authorized to commit the drawee to pay the designated amount
of funds.
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CHP 3 Capital Market and its

instruments
Shares-
Companies always want to raise their revenue, for that they either take loan from bank or they take
money from people. So the best option for them is to take money from people, so they issue shares in
equity market.

Shares are units of equity ownership in a company and shareholders are entitled to get any profit that any
company ears. For some companies, shares exist as a financial asset providing for an equal distribution of
any residual profits, if any are declared, in the form of dividends. Shareholders of a stock that pays no
dividends do not participate in a distribution of profits. Instead, they anticipate participating in the growth
of the stock price as company profits increase.

Equity Shares Meaning

These are ordinary shares comprise of the bulk of shares issued by ordinary company. Equity shares are
transferable and are traded actively by investors in stock markets. As an equity shareholder, you are not
only entitled to voting rights on company issues but also have the right to receive dividends.
These dividends, however, are not fixed. Equity shareholders also partake in any losses faced by the
company, limited to the amount they had invested. Equity shares can be further divided based on:

 Share capital
 Definition
 Returns

Classification of Equity Shares based on Share Capital

Here is a look at the classification of equity shares based on share capital:

Authorised Share Capital: Every company, in its Memorandum of Associations, requires to prescribe the
maximum amount of capital that can be raised by issuing equity shares. The limit, however, can be
increased by paying additional fees and after the completion of certain legal procedures.

Issued Share Capital: The amount of the company's capital that has been made available to investors
through the issuance of equity shares is denoted by this term. The issued share capital, for instance,
would be Rs 40 lakh if the company issued 20,000 equity shares at a nominal value of Rs 200 each.
Known as subscribed share capital, subscription share capital is the portion of the issued capital that has
been purchased by investors.

Paid-Up Capital: The sum of money that investors have contributed to hold the company's shares is
referred to as paid-up capital. Both subscribed capital and paid-up capital refer to the same amount
because investors pay the complete amount at once.

Classification Of Equity Shares based on Definition

Here is a look at the classification of equity shares based on the definition:

Bonus Shares: The term "bonus shares" refers to additional shares that are given to current shareholders
either for free or as a bonus.

Rights Shares: The definition of rights shares is that a corporation can offer new shares to its current
shareholders at a set price and within a set timeframe before making them available for trading on stock
markets.

Sweat Equity Shares: The company may award you with sweat equity shares if you have made a
substantial contribution while working for it.

Voting and Non-Voting Shares: Although the majority of shares have voting privileges, the business
may grant shareholders with differential or no voting privileges.

Equity Share Classification Based on Returns

Here are some share categories based on returns:
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12 Awareness

Dividend Shares: A business has the option to prorate dividend payments by issuing new shares in place
of cash.

Growth Shares: These kinds of shares are linked to businesses that experience rapid growth. While such
businesses might not pay dividends, the value of their stocks rises quickly, giving investors financial gains.

Value Shares: These types of shares are traded in stock markets at prices lower than their intrinsic value.
Investors can expect the prices to appreciate over some time, thus providing them with a better share
price.

Preference Shares
These are those shares that enable shareholders to receive dividends announced by the company before
receiving to the equity shareholders. Also, in the event of liquidation of a particular company, the
preferential shareholders are paid off before ordinary shareholders. Following are the different types of
shares in this category:

 Cumulative and Non-Cumulative Preference Shares: In the case of cumulative preference

shares, the benefit is carried over to the following fiscal year if a certain company does not pay an
annual dividend. Unpaid dividend advantages are not offered by non-cumulative preference
shares.
 Participating vs. Non-Participating Preference Shares: Participating preference shares permit
shareholders to earn excess profits following the company's payment of dividends. This is in
addition to receiving dividends. Other than receiving dividends on a regular basis, non-
participating preference shares do not offer any such advantages.
 Convertible/Non-Convertible Preference Shares: While non-convertible preference shares
have no such advantages, convertible preference shares can be converted into equity shares after
fulfilling the necessary requirements by the company's Article of Association (AoA).
 Redeemable/Irredeemable Preference Share: At a set price and time, a firm may repurchase
or claim redeemable preference shares. There is no maturity date for these shares. However, there
are no such restrictions on irredeemable preference shares.

Bonds-
The bond market is a financial market that acts as a platform for the buying and selling of debt
securities. The bond market is a part of the capital market-serving platform to collect fund for the public
sector companies, governments, and corporations. There are a number of bond indices that reflect the
performance of a bond market.

The bond market can also be called the debt market, credit market, or fixed income market. The major
bond market participants are: governments, institutional investors, traders, and individual investors. The
bonds are usually specific to individual issues and there is a lack of liquidity in the bonds. This is the
reason that most of the bonds are held by institutions like banks, mutual funds, and pension funds.

Bond markets are generally decentralized, and unlike stocks and futures, there exists no common
exchange for the bond market. The bond market is less volatile in nature than the stock market, and thus
investors purchase the bond coupon and hold it until it matures. As risk associated with bond investment is
less, the return received is also less.

There are some risks that the bond investors have to face. The change in interest rate is the major risk
that occurs in bond investment. The interest rate and value of bond are inversely proportional to one
another. When the rate of interest increases, the bond value falls considerably as the new issues pay a
higher yield. Conversely, when the interest rate decreases, the bond value rises. The interest rate
fluctuation may depend on the volatility of the bond market and also on the monetary policy of the
country.

Debentures
They are long-term Debt Instruments, which are not backed by Collaterals. Debentures are unsecured
debt backed by the creditworthiness and reputation of the Debenture issuer and documented by an
agreement called an indenture.

Debentures are issued usually by large, financially strong companies with excellent bond ratings. One
example of debenture is an unsecured bond. Debentures have some similarities with Bonds but the terms
and conditions of securitization of Debentures are different from that of a Bond.
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Awareness

A Debenture is regarded as an unsecured investment because there are no pledges (guarantee) or liens
available on particular assets. Nonetheless, a Debenture is backed by all the assets that have not been
pledged otherwise. Normally, Debentures are referred to as freely negotiable Debt Instruments. The
Debenture holder functions as a lender to the issuer of the Debenture.

In return, a specific rate of interest is paid to the Debenture holder by the Debenture issuer similar to the
case of a loan. In practice, the differentiation between a Debenture and a Bond is not observed every
time. In some cases, Bonds are also termed as Debentures and vice-versa. If a bankruptcy occurs,
Debenture holders are treated as general creditors.

Participatory notes
It also called P-Notes are offshore derivative instruments with Indian shares as underlying assets. These
instruments are used for making investments in the stock markets. However, they are not used within the
country. They are used outside India for making investments in shares listed in the Indian stock market.
That is why they are also called offshore derivative instruments.

Participatory notes are issued by brokers and FIIs registered with SEBI. The investment is made on behalf
of these foreign investors by the already registered brokers in India. For example, Indian-based
brokerages buy India-based securities and then issue participatory notes to foreign investors. Any
dividends or capital gains collected from the underlying securities go back to the investors. The brokers
that issue these notes or trades in Indian securities have to mandatorily report their PN issuance status to
SEBI for each quarter. These notes allow foreign high net worth individuals, hedge funds and other
investors to put money in Indian markets without being registered with SEBI, thus making their
participation easy and smooth. P-Notes also aid in saving time and costs associated with direct
registrations.

Investing through P-Notes is very simple and hence very popular amongst FIIs. Overseas investors who
are not registered with SEBI have to go through a lot of scrutiny, such as know-your-customer (KYC)
norms, before investing in Indian shares. To avoid these hurdles, foreign investors take this route. Also,
since the end beneficiary of these notes is not disclosed, many investors who want to remain anonymous
use it. These instruments aid investors who do not want to register with SEBI and reveal their identities to
take positions in the Indian market.

Advantages of participatory notes

Anonymity: Any entity investing in participatory notes is not required to register with SEBI, whereas all
FIIs have to compulsorily get registered. It enables large hedge funds to carry out their operations without
disclosing their identity.
Ease of trading: Trading through participatory notes is easy because they are like contract notes
transferable by endorsement and delivery.
Tax saving: Some of the entities route their investment through participatory notes to take advantage of
the tax laws of certain preferred countries.

Disadvantages of P-notes

Indian regulators are not very happy about participatory notes because they have no way to know who
owns the underlying securities. It is alleged that a lot of unaccounted money made its way to the country
through the participatory note route.

Foreign Direct Investment-

Foreign direct investment (FDI) is when a company takes controlling ownership in a business entity in
another country. With FDI, foreign companies are directly involved with day-to-day operations in the other
country. This means they aren't just bringing money with them, but also knowledge, skills and technology.

Generally, FDI takes place when an investor establishes foreign business operations or acquires foreign
business assets, including establishing ownership or controlling interest in a foreign company.
Routes through which India gets FDI

Automatic Route: The non-resident or Indian company does not require prior nod of the RBI or
government of India for FDI.
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14 Awareness

Government Route: The government's approval is mandatory. The company will have to file an
application through Foreign Investment Facilitation Portal, which facilitates single-window clearance. The
application is then forwarded to the respective ministry, which will approve/reject the application in
consultation with the Department for Promotion of Industry and Internal Trade (DPIIT), Ministry of
Commerce. DPIIT will issue the Standard Operating Procedure (SOP) for processing of applications under
the existing FDI policy.

Foreign Portfolio Investment or Foreign Institutional Investment-

Foreign portfolio investment (FPI) is a common way to invest in overseas economies. These investments
include stocks, bonds, mutual funds etc.

Securities (in FPI) include stocks or American Depositary Receipts (ADRs) of companies in nations other
than the investor's nation. It also includes bonds or other debt issued by these companies or foreign
governments, mutual funds, or exchange-traded funds (ETFs) that invest in assets abroad or overseas.

On a macro-level, foreign portfolio investment is part of a country's capital account and shown on its
balance of payments (BOP). BOP calculates the amount of money flowing from one country to other
countries over a financial year.

Emerging economies that show a potential for growth that is higher than the investor's country tend to see
a high level of participation by foreign investors. Another factor that influences FPIs is an attractive growth
rate.

Commodity Market-
A commodity market is a marketplace for buying, selling, and trading raw materials or primary products.
Commodities are often split into two broad categories: hard and soft commodities. Hard commodities
include natural resources that must be mined or extracted—such as gold, rubber, and oil, whereas soft
commodities are agricultural products or livestock—such as corn, wheat, coffee, sugar, soybeans, and
pork.

Types of Commodities
 Commodities are classified into two types: hard and soft.
 The term 'hard commodities' refers to those that must be extracted from the earth.
 Metals and minerals such as gold, silver, copper, and others fall into this category. Crude oil is
also classified as a hard commodity.
 Soft commodity refers to food grains, edible oil, meat, and livestock.

List of commodities traded

 Edible oilseeds – Mustard seed, Cottonseed, Soybean oil, etc.
 Foodgrains – Wheat, Gram, Bajra, Maize, etc.
 Metals – Gold, Silver, Copper, Zinc, etc
 Spices – Turmeric, Pepper, Jeera, etc.
 Fibers – Cotton, Jute, etc.
 Others – Sugar, Gur, Rubber, Natural Gas, Crude Oil, etc.

Gold, Crude oil, Silver, Copper, Natural Gas, Lead, Soy Oil, Zinc, Soybean, and Castor seed are the
prominently traded commodities.
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Awareness

CHP 4 Basics of Stock Market

A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial
goal. The money thus collected is then invested in capital market instruments such as shares, debentures
and other securities. The income earned through these investments and the capital appreciation realized is
shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the
most suitable investment for the common man as it offers an opportunity to invest in a diversified,
professionally managed basket of securities at a relatively low cost. The mutual funds normally come out
with a number of schemes with different investment objectives, which are launched from time to time. A
mutual fund has to be registered with Securities and Exchange Board of India (SEBI), which regulates
securities markets before it can collect funds from the public. The first mutual fund to be set up in India
was Unit Trust of India in 1964.
The flow chart below describes broadly the working of a mutual fund:

Investors
Passed
back to Pool their
money with

Returns Fund
Manager

Generates
Invest in

Securities

Mutual Fund Operation Flow Chart

There are many entities involved and the diagram below illustrates the organisational set up of a mutual
fund:

Unit Holders

Sponsors
Trustees AMC

The Mutual Fund Transfer Agent

Custodian
SEBI

Advantages of Mutual Funds

 Professional Management
 Diversification
 Convenient Administration
 Return Potential
 Low Costs
 Liquidity
 Transparency
 Flexibility
 Choice of schemes
 Tax benefits
 Well regulated
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16 Awareness

Inflation Index Bond-

A bond known as a "Indexed Bond" is one that is issued by a sovereign and offers the investor a fixed
return regardless of the rate of inflation. The RBI first implemented it in an effort to deter investors from
purchasing actual gold. This bond's primary goals are to safeguard against inflation and ensure capital
security.

Prior to this, the interest earned on bank accounts was negative due to the rising rate of inflation. But now
that these healthy price index-linked inflation-indexed bonds have returned, investors can be guaranteed
that their returns will outpace inflation when they reach maturity.

It is vital to contrast the idea of inflation-indexed bonds with the bank's fixed deposit instrument in order
to comprehend it. On the one hand, fixed deposits provide a set rate of interest on the investment for the
specified number of years, but they do not shield investors from the effect of inflation on the initial
deposit's declining real value.

On the other hand, inflation-indexed bonds provide a fixed minimum real return that is unaffected by the
rate of inflation in the economy. Capital rises with inflation because capital and inflation are directly
proportionate. The actual interest is therefore more than what was previously promised. The amount of
interest payments decreases as a result of deflation. However, the positive point here is that the capital
does not decline below the initial investment or the face value in the case of deflation.

STOCK MARKET

The capital market, as it is known, is that segment of the financial market that deals with the effective
channeling of medium to long-term funds from the surplus to the deficit unit. The process of transfer of
funds is done through instruments, which are documents (or certificates), showing evidence of
investments. The instruments traded (media of exchange) in the capital market are:

1. Debt Instruments

Companies or governments can raise money for capital-intensive projects by using a debt instrument. You
can buy it on the primary market or the secondary market. The borrower-creditor relationship in this type
of instrument ownership does not necessarily indicate ownership in the borrower's company. According to
the trust deed, the contract has a set lifespan, and interest is paid at predetermined intervals (contract
agreement). Therefore, the invested money is returned along with interest that is either paid quarterly,
semiannually, or annually at the conclusion of the contract period. The trust deed may specify a set or
adjustable interest rate. This category's term extends from three to twenty-five years. Investment in this
instrument is, most times, risk-free and therefore yields lower returns when compared to other
instruments traded in the capital market. Investors in this category get top priority in the event of
liquidation of a company.

When the instrument is issued by:

 The Federal Government, it is called a Sovereign Bond;
 A state government it is called a State Bond;
 A local government, it is called a Municipal Bond; and
 A corporate body (Company), it is called a Debenture, Industrial Loan or Corporate Bond

2. Equities (also called Common Stock)

Only businesses can issue this instrument, which can also be purchased on the primary or secondary
markets. Investment in this type of business entitles the investor to ownership of the company as long as
the contract is in effect, unless it is sold on the secondary market to another investor. As a result, the
investor has specific privileges and rights (such as the ability to vote and hold positions in the company).
While the holder of equity receives dividends that may or may not be disclosed, the holder of debts may
be entitled to interest that must be paid. This instrument has a high risk component, which results in a
larger return (when successful).Holders of this instrument however rank bottom on the scale of preference
in the event of liquidation of a company as they are considered owners of the company.
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3. Preference Shares

Investors in this instrument, which corporate entities issue, are given second preference in the event of a
company's bankruptcy (after bond holders). The instrument resembles equity in that authorised share
capital and paid-up capital are computed separately from equity capital and added to it to determine the
total. Because preference shares do not grant holders the power to vote and because their dividend
payments are structured similarly to the interest (coupon) paid on bonds, they can alternatively be
thought of as debt instruments.

Preference shares may be:

Irredeemable, convertible: In this situation, even though dividends (interest) had already been paid, at
maturity of the instrument, the principal amount being repaid to the investor is converted to equity. When
a contract is irredeemable or non-convertible, it can only be sold on the secondary market because the
contract will always be renewed at maturity. Additionally, the instrument won't be changed into equity.

Redeemable: In this case, the principle amount is returned after a predetermined amount of time. It is
strictly regarded as a debt instrument in this instance.
Please take note that interest may be fixed, variable, or cumulative based on the Trust Deed's provisions.

4. Derivatives

These are instruments that are derived from underlying assets, which are securities (as the derivative is
derived from them). The underlying assets determine the derivative's price, risk level, and purpose
because anything that affects the underlying asset must also influence the derivative. A circumstance,
index, or asset could be the derivative. Most developed economies have a high prevalence of derivatives.
Derivatives include, for instance:

Futures, options, swaps, rights, exchange-traded funds, mortgage-backed securities (MBS), asset-backed
securities (ABS), futures, and commodities

Equity shares, preference shares, debentures, and bonds that are issued with the essential characteristics
of other instruments without combining their properties are referred to as pure instruments.

Traded Funds or commodities

Pure Instruments: Equity shares, preference shares, debentures and bonds which are issued with the basic
characteristics without mixing the features of other instruments are called pure instrument.

Hybrid Instruments: Instruments which are created by combining the features of equity, preference,
bonds are called as hybrid instruments.
Example: Hybrid instruments are:- Convertible preference shares Non-convertible debentures with equity
warrant - Partly convertible debentures - Secured premium notes

Terminologies of Stock Market-

Portfolio- Portfolio refers to an investor's assortment of holdings. One stock or many securities may be
included in an investor's portfolio. It includes a wide variety of financial securities, including stocks, bonds,
futures, and options.

Derivative- A financial product known as a derivative derives its value from an underlying asset or
collection of assets. Derivatives include things like futures and options. Typically, underlying assets include
stock market indices, commodities, currencies, and shares.

Futures- Futures are financial agreements to buy or sell an item at a preset price at a future date. They
are frequently used to safeguard against changes in the underlying asset's price or to lessen or prevent
losses due to unfavourable price movements. Additionally, it can be leveraged to make money by
speculating on the underlying asset's price movement.

Call Option- A call option gives the buyer the right but not the obligation to buy an underlying asset at
the strike price on or before the expiry date. The buyer of a call option speculates that the market is
bullish, and the prices of the underlying asset will increase. If at the expiry date, the price of the
underlying asset is below the strike price, the buyer refuses to exercise his right. His loss is limited to the
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18 Awareness

premium paid. If the price of the underlying asset is above the strike price, the profit is the current stock
price minus the strike price, multiplied by the lot size, with the premium deducted as a cost of the call
option.

Put Option- A put option offers the buyer the right, but not the responsibility, to sell the underlying asset
at the strike price on or before the maturity date. The put option holder anticipates a decline in the value
of the underlying asset. The gain is the difference between the strike price and stock's current price,
multiplied by the lot size, if the price of the underlying asset is less than the strike price. The buyer forfeits
the premium they paid in the event that the strike price is higher than the stock price.

Open Interest- The entire amount of outstanding derivative contracts that have not yet been settled is
referred to as open interest. The contract is referred to as open from the moment the buyer and seller
commence it until the other party closes it. If the amount of money moving through the derivative market
is increasing or decreasing, open-interest gives a precise picture of the derivatives trading activity.

Annual Report- The company's annual report provides a financial evaluation. It offers a behind-the-
scenes look at the business's finances and operations. The purpose of an annual report is to give
shareholders comprehensive information about the numerous factors that contribute to a company's
success over the course of a given fiscal year. It provides a summary of the business' operations and any
anticipated or unintended outcomes from the most recent or prior fiscal year.
Investors examine the annual report carefully to assess the company's future potential based on its
historical performance. A general overview of the sectors in which the company operates is included in
annual reports, together with audited financial and income statements, cash flow statements, and maybe
management's discussion and analysis, as well as information on stock market prices and dividend
payments. It could be compared to the company's resume for the most recent fiscal year.

Arbitrage- Arbitrage is the simultaneous purchase and sale of the same securities in different markets to
benefit from the momentary price variations prevailing in different markets. Arbitrage ensures that the
minor price differences in the same securities in different markets are eliminated, leading to uniformed
prices across market exchanges.

Averaging down- When an investor purchases more shares as the stock price gradually drops after the
original acquisition, averaging down results in a reduced average cost per share. Investors engage in it
when they believe that the share is undervaluing it and that the market's general consensus is unfounded.

Bear Market: The term "bear market" refers to a general downward tendency in the market's condition. It
is industry-specific jargon. It indicates a decline in the overall market prices of the equities listed on the
stock exchange. It is deemed bearish when the stock price of a certain stock is falling. Bear Market is
typically caused by investors' pessimism, fear and negative sentiments about the market or the economy.

Bull Market- Bull Market is the exact opposite of Bear Market. It means that the market is on an upward
spiral. It is a result of investors' palpable excitement and optimism about the market or the economy. It
means that the aggregate market prices of the stocks are rising.

Active Return- The term "active return" describes the extra returns that a portfolio produces over a
benchmark, index, or market as a whole. The portfolio's strength and the active management decisions
made by the portfolio manager, such as the deliberate choice to underweight or overweight the assets,
result in active returns, which are the additional returns outside the scope of the portfolio's exposure to
risks and returns to the investments benchmark, index, or market.

Volatility- Volatility is a term used to describe how much stock prices fluctuate from day to day. While
low volatile equities also suffer ups and downs, they do so to a smaller extent than highly volatile stocks
during the trading session. Investing in highly volatile equities has the potential to produce either big gains
or enormous losses.

Beta- The beta factor expresses how volatile a stock's price is in relation to the market's general
movement. If a stock's beta value is 2, it means that its prices move by 2 points for every point that the
market's price changes overall. In other words, if the stock market falls by 1 point, the stock price will fall
by 2 points, and vice versa. The beta is a crucial metric for determining the level of risk a stock introduces
into a portfolio. High beta equities carry risk since they are more susceptible to market fluctuations, but
they also have a larger chance of rewarding investors. Similar to low beta stocks, low beta stocks present
lesser risk but also lower rewards.
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Alpha- The relative return on investment, or alpha, is the amount over the benchmark index or the
general market. An indicator of a stock's performance relative to the market at large is its alpha.
Sometimes a stock may offer a nominal rate of return, say 5%, but that 5% would be the product of
market activity generally and not serve as a true indicator of how well an investment performed. As a
result, Alpha provides a precise evaluation of stock performance that is not dependent on market
fluctuations. Alpha monitors an investment's past active return. An investment that has an Alpha of 10%
will therefore outperform the market as a whole by 10%. Similarly, a return of -10% indicates that an
investment has underperformed the market as a whole by 10%.

Blue Chip Stocks- The top 100 well-known businesses with a large market capitalization and a wide
range of excellent, well-liked goods and services are known as blue chip stocks. These businesses are
valued for their sound and efficient management techniques and frequently have a history of paying out
sizable dividends to their shareholders. When the economy is growing and investors are feeling upbeat,
they frequently drive and lead the market. In times of unfavourable market conditions and economic
downturns, blue chip companies have an admirable track record of steady and predictable development.
They make up a considerable portion of the stock market, and changes in the values of these stocks can
have a significant impact on the market's general trend.

Broker- The broker acts as a go-between for investors and traders, facilitating the movement of money
and stock in return for a commission. An intermediary who helps buyers and sellers conduct business is a
broker. When a business facilitates transactions between buyers and sellers and operates as an agent for
investors, it is referred to as a broker. For these services, the company charges a set cost.

Bid- The bid is the maximum amount a buyer is willing to pay to acquire a stock. A buyer may purchase
stock only if the price does not exceed the bid price he has placed.

Ask- Ask is the minimum amount a holder of a security is willing to sell for. A seller will sell the security
only if the bid price matches or exceeds the ask price.

Close- The term "close" describes the moment at which all trading and investing operations end. 3.30 pm
is the moment that the Indian stock markets close. This is when the day's closing pricing are decided,
which have a big impact on the opening price the following day.

Absolute Returns- Absolute Return is simply the rate of return on an investment attained over a specific
period. It basically measures the gain earned, and loss suffered expressed as a percentage over the initial
investment over a particular period.

Internal Rate of Return-The internal rate of return determines how quickly future cash flows are
discounted to a net present value of zero. The internal rate of return is based on the presumption that an
investment's cash flows constitute periodic increases. To gauge the profitability of possible investments,
it's a crucial statistic.

Extended Internal Rate of Return (XIRR)- Extended Internal Rate (EIR) is the internal rate of return
on total investment when cash flows are erratic due to irregular additions and redemptions made during
the course of the investment. When there are numerous transactions taking place at diverse periods
spaced out over a period of time, XIRR is relevant. Therefore, when it comes to mutual funds, External
Internal Rate of Returns represents real-life events as opposed to Internal Rate of Return.

Dividend- A dividend is money given to the company's shareholders in proportion to the number of
shares they own. A dividend, which is frequently derived from a company's net profits, is the reward given
to shareholders for their confidence in the management and their belief in the potential of the firm through
the amount invested. However, a firm is not required to distribute dividends; it is possible for them to
retain the entire profit as retained earnings. The investor has the option of receiving the dividends in cash
or reinvesting them to acquire more company shares. Also, a company may still distribute dividends even
if it has not made any profits just to maintain the established and steady record of making periodic
dividend payments.

Index- To gauge market performance, the Stock Market Index typically follows the collective movement in
the prices of all the shares listed on the stock market in comparison to the prices of the previous day. It
may also monitor the cumulative price change over time for a hypothetical portfolio of securities belonging
to a specific industry or compiled and arranged according to market capitalization. It acts as a predictor of
stock market fluctuations. The index acts as a standard against which to compare a portfolio's active
returns. It acts as a benchmark for evaluating the performance of a portfolio.
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20 Awareness

Initial Public Offering- The initial selling of securities to the general public is known as an initial public
offering. Here, the company's owners or private investors offer it up for sale to the general public. The IPO
process is how businesses raise funds for potential expansion and development. One of the key drivers
behind the stock market's existence is initial public offerings.

Leverage- In the stock market, leverage refers to borrowing money to invest in more shares than one is
able to afford with the sole goal of increasing earnings. Leverage is the process of amplifying a relatively
little investment force into an equivalently larger reward. Leverage can lead to exponential gains, but it
can also lead to significant losses.

Margin- A margin account enables the investor to obtain credit from the broker in order to purchase more
securities. Margin is the amount that separates the whole value of the stocks in the investor's Demat
account from the loan that was obtained from the broker. Trading on margin entails using capital to its
fullest extent by acquiring more securities than one can reasonably afford. As a result, you can purchase a
correspondingly larger number of shares for a relatively smaller sum. But like any form of leverage, it has
the potential to generate enormous gains as well as large losses.

Initial Margin- The first margin is the sum that the buyer must transfer before borrowing money from
the broker or before the broker loans him money to buy more securities. The buyer must transfer this
minimum amount before he can use margin to purchase more stocks. Initial Margin is determined as a
portion of the total share value in the investor's Demat account. For instance, if a buyer wants to purchase
100 shares at Rs 20, but he is unable to pay Rs 2,000, and he has a margin account with a broker where
the initial margin requirement is 50%, he must pay Rs 1,000 up front before the broker will lend him the
remaining Rs 2,000.

Maintenance Margin-The buyer's maintenance margin is the bare minimum required to keep the position
open. The maintenance margin is computed as a percentage of the entire investment at the time of
purchase. The investor must make sure that after deducting the margin requirement, the market value of
the assets does not drop below the maintenance margin. Using the same example as before, let's suppose
the maintenance margin for a Rs 2,000 investment is Rs 800, or 40% of the total. The amount would be
Rs 750 if the stock's price dropped to Rs 15, after taking into account the investor's 50% margin
requirement. As a result, there is a Rs 50 shortage for the necessary maintenance margin. In such a case,
the buyer must deposit additional funds to restore the account to the maintenance margin or liquidate
certain positions in order to meet the maintenance margin requirements.

Margin Call- A margin call is a notification given by the broker to the seller that the value of the borrowed
funds has fallen below the maintenance margin and that the buyer will need to sell some assets or add
more funds to the account in order to cover the difference between the equity share's current price and
the maintenance margin. The broker will liquidate some open positions to meet the maintenance margin
requirement if you don't meet the margin call.

Moving Average- Moving Average is the average price per share for a specific period of time. Some
standard time frames are 200 days, 100 days and 50 days moving averages.

Short Selling- Selling equities shares that are not your own and are not in your Demat account is known
as short-selling. However, the investor is required to shut out his stake before the day's end. Therefore,
the investor can buy the shares at a lower price than the amount he had sold them for and still make
money if the stock price of the investment he has shorted declines.

However, even if the price of the company the investor shorted rises, the trader will still be required to
fulfill the duty of purchasing back the shares prior to the clearing time and will incur a loss. The basis for
short-selling is the assumption that the market is pessimistic and that share prices would decline.

One-sided market- It refers to rare occurrences wherein a market contains only potential buyers and
potential sellers without both being present simultaneously. It is a situation where the market is heading
in only one direction. In such a case, the market makers quote only the bid price or only the ask price.

Pyramiding- Pyramiding is a strategy that makes use of the increased margin to grow the size of the
position with the margin appraisal achieved by using the unrealized profits from the increase in the value
of current holdings of the same security. The investor that employs pyramiding increases his or her
present holdings' unrealized worth by investing it in additional shares of the same security. Compared to
buying shares with cash, this strategy typically involves a gradual increase in position size because the
margin increments permit smaller purchases.
 Financial 21
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Growth Stocks- Growth stocks are thought to be capable of outperforming the market in the future.
Growth companies have produced significant, long-term, and above-average returns in the market and are
anticipated to keep doing so. Simply put, growth companies have strong historical performance, healthy
and consistent earnings, and are expected to continue growing in the future.

Value stocks-A value stock is one that the investor believes is trading for less than its true worth. Value
stocks are thought to be undervalued but are anticipated to rise to their true intrinsic value. Value
investing entails determining the companies' true intrinsic value by an analysis of their financial
statements, as well as their often-overlooked intangible assets, before having the patience to wait for
prices to decline below that value. Value stocks are bought by investors when they are trading below their
inherent value and sold when their prices have risen to their real value. The net present value of all
anticipated future cash flows over the course of the business's existence is the intrinsic value. Warren
Buffet, the legendary investor, is the most successful practitioner of value investing.

Large-cap stock- Stocks of well-established businesses with a market capitalization of more than Rs
20,000 crores are considered large-cap stocks. Large-cap stocks are typically seen as low-risk investments
since they have a significant market presence and a track record of generating high and consistent
returns. Large organisations' information is readily available. Most businesses use media like newspapers
to promptly provide information about their operations, goods, and expansion plans.

Mid-cap stocks- Stocks of companies with a market capitalization between Rs 5,000 crores and 20,000
crores are considered mid-cap stocks. Investors are drawn to mid-cap companies because they provide
the chance to make exponential gains over the long term. Mid-cap firms are secretive about their internal
business affairs and expansion plans, nevertheless, as they strive to outperform the competition and are
thus secretive about their information. Because of this, it is difficult for investors to assess the potential of
the companies. As a result, cautious investors steer clear of these equities.

Small-cap stocks- The majority of small-cap companies are entrepreneurial endeavours in their early
stages with the potential to generate enormous rewards. It makes sense that they are businesses with
variable returns and modest revenues. These businesses may fail in large numbers. However, many of
these businesses are unicorns that are trading pitifully below their true worth. These companies'
information is not easily accessible. Therefore, those who have a lengthy investment horizon and a strong
appetite for risk can consider investing in these small-cap businesses.
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22 Awareness

CHP 5 Basics of Financial

Awareness - I
Financial Regulators in India-

There are many financial institutions in India and we have many regulators for regulating them in order to
assure the proper functioning of the financial system in our nation. Following are very important financial
regulators in India-
 Reserve Bank of India (RBI)
 Insurance Regulatory and Development Authority (IRDA)
 Security and Exchange Board of India (SEBI)
 Pension Funds Regulatory and Development Authority (PFRDA)

Reserve Bank of India (RBI)

The Royal Commission on Indian Currency and Finance, also known as the Hilton-Young Commission,
recommended the establishment of a central bank in 1926 to enhance banking infrastructure across the
nation and to separate the government's control of currency and credit. This is how the Reserve Bank
came to be. The Reserve Bank of India Act of 1934 set in motion a series of events that culminated in the
start of operations in 1935 and formed the Reserve Bank on April 1, 1935 as the banker to the central
government. As the Indian economy has altered since then, the Reserve Bank's position and
responsibilities have experienced significant adjustments.

The Reserve Bank's Central Office was initially built in Calcutta but was eventually relocated permanently
to Mumbai in 1937. The Governor sits at the Central Office, which is also where policies are created. The
Reserve Bank was initially privately owned, but since being nationalised in 1949, the Indian government
has full ownership of the institution.

A central board of directors oversees all operations at the Reserve Bank. In accordance with the Reserve
Bank of India Act, the board is chosen by the Indian government.

The Reserve Bank's affairs are governed by a central board of directors. The board is appointed by the
Government of India in keeping with the Reserve Bank of India Act.

 Appointed/nominated for a period of four years

 Constitution:
 Official Directors
 Full-time : Governor and not more than four Deputy Governors
 Non-Official Directors
 Nominated by Government: ten Directors from various fields and two government Officials
 Others: four Directors - one each from four local boards

Main Functions

Monetary Authority:
 Formulates, implements and monitors the monetary policy.
 Objective: maintaining price stability and ensuring adequate flow of credit to productive sectors.

Regulator and supervisor of the financial system:

 Prescribes broad parameters of banking operations within which the country's banking and
financial system functions.
 Objective: maintain public confidence in the system, protect depositors' interest and provide cost
effective banking services to the public.

Manager of Foreign Exchange

 Manages the Foreign Exchange Management Act, 1999.
 Objective: to facilitate external trade and payment and promote orderly development and
maintenance of foreign exchange market in India.
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Awareness

Issuer of currency:
 Issues and exchanges or destroys currency and coins not fit for circulation.
 Objective: to give the public adequate quantity of supplies of currency notes and coins and in good
quality.

Developmental role
 Performs a wide range of promotional functions to support national objectives.

Related Functions
 Banker to the Government: performs merchant banking function for the central and the state
governments; also acts as their banker.
 Banker to banks: maintains banking accounts of all scheduled banks.

Insurance Regulatory and Development Authority (IRDA)

All commercial and public sector insurance businesses in India are regulated financially by the Insurance
Regulatory and Development Authority (IRDA), a national body of the Government of India. It controls
how insurance firms operate and compels them to serve the public good. It was created by the IRDA Act of
1999, which was updated in 2002 to include new regulations. Hyderabad serves as the headquarters.

Security and Exchange Board of India (SEBI)

In compliance with the 1992 Securities and Exchange Board of India Act's regulations, it was founded on
April 12th, 1992. Mumbai serves as the home of SEBI. Prior to the creation of SEBI, the regulating body
was the Controller of Capital Issues, which received its jurisdiction from the 1947 Capital Issues (Control)
Act. At first, SEBI lacked any statutory authority and was a non-statutory organisation. However, the
Government of India amended the Securities and Exchange Board of India Act 1992 in 1995 to grant the
SEBI more legislative authority. In accordance with a decision of the Indian government, the SEBI was
established in April 1998 as the country's capital markets' regulator.

SEBI has to be responsive to the needs of three groups, which constitute the market:
 the issuers of securities
 the investors
 the market intermediaries.

SEBI has three functions rolled into one body: quasi-judicial, quasi-executive, and quasi-legislative. As a
legislative body, it creates regulations. As an executive body, it carries out enforcement actions and
investigations. As a judicial body, it issues judgments and orders. Despite the fact that this gives it a lot of
authority, there is an appeals mechanism to establish accountability.

Functions of SEBI are of two types-

1. Regulatory functions
2. Developmental functions

Pension Funds Regulatory and Development Authority (PFRDA)

Pension Fund Regulatory is a pension-related organisation that deals with all issues pertaining to this
industry. The Finance Ministry gave the Indian Government of India permission to create it in 2003. Its
primary duty is to encourage pension fund development and regulation in order to advance elderly income
security. The PFRDA is in charge of choosing managers for many other intermediary organisations,
including pension funds.

Financial Inclusion in India

The process of ensuring vulnerable groups, such as weaker sections and low income groups, have access
to financial services and timely, adequate credit when needed at a reasonable price is known as financial
inclusion.

Everyone in the society should be involved and take part in wise financial management, according to
financial inclusion. In India, a large number of low-income households lack access to any financial
services. They are ignorant about banks' operations. Many of the poor people lack access to banks'
services, even when they are aware of them.

The goal of financial inclusion is to remove these obstacles and offer reasonably priced financial services to
the less fortunate segments of society so they can become financially independent without relying on
charity or other unsustainable sources of funding. The goal of financial inclusion is to increase societal
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24 Awareness

understanding of financial services and money management. Additionally, it seeks to create legitimate,
organised channels for credit for the underprivileged.

Financial Inclusion Schemes in India

The Government of India has been introducing several exclusive schemes for the purpose of financial
inclusion. These schemes have been launched over different years. Following is a list of the financial
inclusion schemes in the country:

 Pradhan Mantri Jan Dhan Yojana (PMJDY)

 Atal Pension Yojana (APY)
 Pradhan Mantri Vaya Vandana Yojana (PMVVY)
 Stand Up India Scheme
 Pradhan Mantri Mudra Yojana (PMMY)
 Pradhan Mantri Suraksha Bima Yojana (PMSBY)
 Sukanya Samriddhi Yojana
 Jeevan Suraksha Bandhan Yojana
 Credit Enhancement Guarantee Scheme (CEGS) for Scheduled Castes (SCs)
 Venture Capital Fund for Scheduled Castes under the Social Sector Initiatives
 Varishtha Pension Bima Yojana (VPBY)

Objectives of Financial Inclusion

1. Financial inclusion aims to make it easier for people to access affordable financial services and
goods such deposits, fund transfer services, loans, insurance, payment services, etc.
2. It attempts to create suitable financial institutions that can meet the requirements of the
underprivileged.
3. Financial inclusion strives to develop and maintain financial sustainability so that the less fortunate
people have a certainty of finances that they struggle to get. These institutions should have clear-
cut laws and should uphold high standards that are existent in the financial business.
4. Financial inclusion also aims to have a large number of institutions that provide cheap financial
help so that there is enough competition and a wide range of options for customers. There are
conventional banking choices available. There are very few institutions, though, that provide low-
cost financial goods and services.
5. Financial inclusion intends to increase awareness about the benefits of financial services among
the economically underprivileged sections of the society.
6. The process of financial inclusion works towards creating financial products that are suitable for
the less fortunate people of the society.
7. Financial inclusion intends to improve financial literacy and financial awareness in the nation.
8. Financial inclusion aims to bring in digital financial solutions for the economically underprivileged
people of the nation.
9. It also intends to bring in mobile banking or financial services in order to reach the poorest people
living in extremely remote areas of the country.
10. It aims to provide tailor-made and custom-made financial solutions to poor people as per their
individual financial conditions, household needs, preferences, and income levels.
11. Numerous governmental and non-governmental organisations are working to increase financial
inclusion. These organisations are committed to facilitating the receipt of documents that have
received official approval. Due to a lack of identification documentation, a large number of the poor
are unable to open bank accounts or submit loan applications. There are a lot of people in rural
areas and tribal settlements who are unaware of documents like PAN, Aadhaar, driver's licences,
and voter identification cards. As a result, individuals are unable to utilise many of the services
provided by public or private institutions. They are unable to get any government assistance to
which they are truly entitled since they lack these documents.
 Financial 25
Awareness

CHP 6 Basics of Financial

Awareness - II
Bonds-
Organizations typically issue bonds for duration longer than a year to raise money through borrowing.
Organizations sell bonds to investors in order to raise cash. A bond is nothing more than a financial
contract under which the issuer promises to pay the principal and interest (in the form of coupons) to the
bondholder after a specific date. (Also known as the maturity date) While some bonds do not pay interest
to investors, the issuers are required to return the principal amount to investors.

Characteristics of a Bond
 A bond is generally a form of debt which the investors pay to the issuers for a defined time frame.
In a layman's language, bond holders offer credit to the company issuing the bond.
 Bonds generally have a fixed maturity date.
 All bonds repay the principal amount after the maturity date; however some bonds do pay the
interest along with the principal to the bond holders.

Types of Bonds

Following are the types of bonds:

 Fixed Rate Bonds- In Fixed Rate Bonds, the interest remains fixed throughout the tenure of the
bond. Owing to a constant interest rate, fixed rate bonds are resistant to changes and fluctuations
in the market.
 Floating Rate Bonds- Floating rate bonds have a fluctuating interest rate (coupons) as per the
current market reference rate.
 Zero Interest Rate Bonds- Zero Interest Rate Bonds do not pay any regular interest to the
investors. In such types of bonds, issuers only pay the principal amount to the bond holders.
 Inflation Linked Bonds- Bonds linked to inflation are called inflation linked bonds. The interest
rate of Inflation linked bonds is generally lower than fixed rate bonds.
 Perpetual Bonds- Bonds with no maturity dates are called perpetual bonds. Holders of perpetual
bonds enjoy interest throughout.
 Subordinated Bonds- Bonds which are given less priority as compared to other bonds of the
company in cases of a close down are called subordinated bonds. In cases of liquidation,
subordinated bonds are given less importance as compared to senior bonds which are paid first.
 Bearer Bonds- Bearer Bonds do not carry the name of the bond holder and anyone who
possesses the bond certificate can claim the amount. If the bond certificate gets stolen or
misplaced by the bond holder, anyone else with the paper can claim the bond amount.
 War Bonds- War Bonds are issued by any government to raise funds in cases of war.
 Serial Bonds- Bonds maturing over a period of time in instalments are called serial bonds.
 Climate Bonds- Climate Bonds are issued by any government to raise funds when the country
concerned faces any adverse changes in climatic conditions.

Rupee Dominated Bonds or Masala Bonds-

2014 saw the introduction of masala bonds by the International Finance Corporation (IFC). The first
masala bonds in India were issued by the IFC to finance infrastructure projects. To raise funds, Indian
organisations or businesses issue masala bonds outside of India. These bonds were issued in Indian
money as opposed to local currency. As a result, the investor will suffer a loss if the rupee rate declines.

Characteristics of Masala Bonds

Masala Bonds are bonds issued outside of India by Indian firms and denominated in rupees. They are debt
securities that aid in attracting overseas investors and raising money in the local currency. These bonds
may be issued by both public and private bodies. These bonds are available for purchase by foreign
investors who want to fund investments in Indian assets. These bonds are offered to residents of that
nation and are backed by the Financial Action Task Force. Investors who subscribe have to be from
countries whose securities commission is a member of the International Organization of Securities
Commissions. These bonds are also available for purchase from multilateral and regional financial
institutions, of which India is a member state.
 Financial
26 Awareness

The RBI states that the bonds issued up to the rupee equivalent of $50 million in a financial year have a
three-year maturity period. For bonds raised over the rupee equivalent of $50 million in a fiscal year, the
maturity period is five years. These bonds are converted at market value on the date that transactions for
their issuance and interest-bearing are settled.

Benefits of Masala Bonds

Masala bonds have various benefits. Both the investors and borrowers get benefits from subscribing and
issuing of these bonds. The benefits for the investors are:

 It offers higher interest rates and thus benefits the investor.

 It helps in building up foreign investors' confidence in the Indian economy.
 It helps strengthen the foreign investments in the country as it facilitates foreign investors'
confidence in Indian currency.
 The capital gains arising from rupee denomination are exempted from tax.
 If the rupee appreciates at the time of maturity, it benefits the investor.

The benefits for the borrowers are:

 It benefits the borrower as there is no currency risk. It saves the borrower from currency
fluctuations.
 Borrowers need not worry about rupee depreciation as the issuance of these bonds is in Indian
currency rather than foreign currency.
 The borrower can mobilise a huge amount of funds.
 It helps the Indian entity issuing these bonds to diversify their portfolio.
 It aids borrowers to cut down their cost as they are issued outside India below 7% interest rate.
 As these bonds issuing are in the offshore market, it helps borrowers to tap a large number of
investors.

Money

Money is a type of economic asset that serves as a universally accepted means of exchange for economic
transactions. Money serves the purpose of lowering transaction costs, specifically the desire double
coincidence.

The three roles or services that money performs—as a medium of trade, a store of value, and a unit of
account—are frequently used to define it. In transactions involving the transfer of goods and services from
one person to another or from one country to another, it is extensively used and accepted. Commodity
money, fiat money, and bank money are the three types of money that economists distinguish between.

Commodity money is a good whose value serves as the value of money. Gold coins are an example of
commodity money. In most countries, commodity money has been replaced with fiat money.

Fiat money is a good, the value of which is less than the value it represents as money. Naira notes are an
example of fiat money because their value as slips of printed paper is less than their value as money.

Bank money consists of the book credit that banks extend to their depositors. Transactions made using
checks drawn on deposits held at banks involve the use of bank money.

Fiduciary Money value is based on the belief that it will be widely used as a means of exchange. Contrary
to fiat money, it is not deemed legal tender by the government, which means that no one is compelled to
accept it as payment by law. Instead, if the bearer requests it, the issuer of fiduciary money makes a
pledge to convert it back into a physical good or fiat currency. Fiduciary money can be used the same as
conventional fiat or commodity money as long as individuals are sure that this promise won't be broken.
Cheques, banknotes, and draughts are a few types of fiduciary currency.

Money Supply
The total amount of money and other liquid assets in an economy on the measurement date is known as
the money supply. Both cash and deposits that can be accessed virtually as easily as cash are roughly
included in the money supply.

Through a mix of their central banks and treasuries, governments issue coin and paper money. By
imposing reserve holding requirements on banks, dictating how to grant credit, and handling other
monetary issues, bank regulators have an impact on the amount of money that is available to the general
people.
 Financial 27
Awareness

According to the type and size of the account in which the instrument is maintained, the various forms of
money in the money supply are typically categorised as Ms, such as M0, M1, M2, and M3.

Types of Money Supply-

M1 (Narrow Money)
All currency notes possessed by the general public on any particular day are included in M1. It also covers
all demand deposits, including savings and current account deposits, held by all banks in the nation.
Additionally, it covers any other deposit made by a bank to the RBI. M1 therefore equals CC, DD, and
Other Deposits.

M2
All of the elements of M1, sometimes known as narrow money, are included in M2, together with the post
office bank savings deposits. M2 then equals M1 plus Post Office Savings Deposits.

M3 (Broad Money)
All publically held banknotes, demand deposits, deposits made by all banks to the RBI, and net time
deposits made by all banks in the nation make up M3. M3 then equals M1 plus bank time deposits.

M4
The RBI uses M4 as its broadest indicator of the money supply. Both the deposits held by the nation's post
office banks and all parts of M3 are included. Of all of them, it is the least liquid. M3 + Post Office Savings
= M4

Famous Interbank Offered Rate-

MIBOR-
A version of India's interbank rate, or the interest rate a bank charges another bank for a short-term loan,
is called the Mumbai Interbank Offer Rate (MIBOR). India realised the need for a reference rate for its debt
market as its financial markets grew, which is how the MIBOR was created and introduced. The Indian
central bank uses MIBOR along with the Mumbai interbank bid and forward rates (MIBID and MIFOR) to
determine short-term monetary policy.

History of MIBOR-
The Committee for the Development of the Debt Market introduced the MIBOR as an overnight rate on
June 15, 1998. On November 10, 1998, the NSEIL introduced the 14-day MIBOR, and on December 1st, it
introduced the one-month and three-month MIBORs. Since its introduction, the majority of money market
transactions conducted in India have been benchmarked on MIBOR rates.

LIBOR
The benchmark interest rate at which the biggest banks in the world lend to one another for short-term
loans is called the London Interbank Offered Rate (LIBOR).

The London Interbank Offered Rate, or LIBOR, is a widely used benchmark interest rate that represents
the cost of borrowing for banks. The Intercontinental Exchange (ICE) will continue to calculate and publish
the rate every day, but it is being phased out because of recent scandals and concerns about its reliability
as a benchmark rate. By June 30, 2023, the Federal Reserve and UK regulators expect LIBOR to be phased
out and replaced by the Secured Overnight Financing Rate (SOFR).

The top and bottom quartiles are left out to eliminate outliers, and the rates obtained from the banks are
sorted in descending order. The LIBOR rate is then calculated using the arithmetic mean of the remaining
data. 35 reference rates are created by repeating the method for each of the 5 currencies and 7
maturities. The most popular reference rate is the three-month LIBOR rate.

Suppose a corporation issued a six-month floating rate note linked to LIBOR. On each coupon date, the
coupon amount will be computed as the par value of the note time one half of the 6 month coupon rate
quoted 6 months earlier. Assuming that the prior six months, LIBOR rate is 4 per cent and the par value of
the note is 100 pounds, the coupon amount at present will be 100time(4%/2) which is equal to 2.

Now, if the 6 month LIBOR rate of the current period changed to 3.25% then the next 6 month coupon will
be 100time(3.25%/2) equal 1.625.
 Financial
28 Awareness

Before ICE, the British Bankers Association (BBA) established LIBOR, however the financial market
watchdogs have replaced the BBA LIBOR with a new administrator as a result of the rigging and
manipulation of LIBOR during the 2008 financial crisis. The Hogg Tendering Advisory Committee chose the
Intercontinental Exchange as the new organisation to manage LIBOR according on the Wheatley Review
Recommendation.

History of LIBOR-
As the market for interest rate-based products started to develop in the 1980s, a standard measure of
interest rates across financial institutions became necessary. BBA interest-settlement rates were
established in 1984 by the British Bankers' Association (BBA), which represented the banking and financial
services sector. BBA LIBOR, which became the preferred standard interest rate for transactions in interest
rate and currency-based financial dealings between financial institutions at the local and international
levels, was developed in 1986 as a result of further streamlining.

EURIBOR-
The Euro Interbank Offer Rate, also known as Euribor, is a benchmark rate that is created using the
average interest rate at which banks in the eurozone provide unsecured short-term loans on the interbank
market. Loans used to compute Euribor frequently have maturities between one week and one year.

This is the benchmark rate used by banks to lend or borrow excess reserves over brief time frames,
ranging from one week to 12 months. These short-term loans, which frequently take the form of
repurchase agreements (repos), are designed to keep banks liquid and to make sure that extra cash may
earn interest rather than just sitting around.

The Euro Interbank Offer Rate (Euribor) in fact refers to a set of eight money market rates corresponding
to different maturities: the one-week, two-week, one-month, two-month, three-month, six-month, nine-
month, and twelve-month rates. These rates, which are updated daily, represent the average interest rate
that eurozone banks charge each other for uncollateralized loans.

Euribor rates are an important benchmark for a range of euro-denominated financial products, including
mortgages, savings accounts, car loans, and various derivatives securities. Euribor's role in the eurozone is
analogous to LIBOR in Britain and the United States.

Who Contributes to the Euribor Rate?

There are 20 panel banks that contribute to Euribor. These are the financial institutions that handle the
largest volume of eurozone money market transactions.

 Belfius (Belgium)
 BNP Paribas (France)
 HSBC France
 Natixis (France)
 Crédit Agricole (France)
 Société Générale (France)
 Deutsche Bank (Germany)
 DZ Bank (Germany)
 National Bank of Greece
 Intesa Sanpaolo (Italy)
 Monte dei Paschi di Siena (Italy)
 UniCredit (Italy)
 Banque et Caisse d'Épargne de l'État (Luxembourg)
 ING Bank (Netherlands)
 Caixa Geral De Depósitos (Portugal)
 Banco Bilbao Vizcaya Argentaria (Spain)
 Banco Santander (Spain)
 CECABANK (Spain)
 CaixaBank (Spain)
 Barclays (Britain)
 Financial 29
Awareness

CHP 7 Important Financial

Terminologies
Credit Score – A confusing number that nobody truly understands, but everyone frets about more than
they should. It’s a way for lenders to attempt to determine how likely you are to pay them back if they
lend you money. The higher the score, the more likely you are to make on-time payments in full, and
therefore can secure loans with more favourable terms than someone who has a lower credit score.
Like a reputation, it takes time to build and can be destroyed in an instant.

Equity – Ownership of an asset. Stocks are a form of equity in that you are part-owner of the companies
you own stock in.
Also, the difference in the value of an asset minus the outstanding debt on it. If you have a house worth
$500,000 and the mortgage balance is $300,000, you have 40% equity in your house ($200k equity out of
$500k value).

Fixed Income – A fancy term for bonds. Bonds are a fancy term for debt. Debts pay interest, typically
fixed interest (meaning the interest does not change). That income can be viewed as income to the
person on the receiving end. Hence the term fixed income.

Yield – A fancy term for the interest that bonds pay. Bonds paying 5% interest have a 5% yield. For
example, if you pay $1,000 for a bond paying 5% interest, you will receive $50 in interest per year and
then get your $1,000 back when the bond term is up.

Simple Interest – Bonds pay simple interest. Simple interest is calculated as a percentage of the original
value. See the above example.

Compound Interest – Typically how interest is calculated for everything else in the world. The interest
amount complies on top of itself. The interest compounds on itself. Inflation is calculated using compound
interest—credit cards, mortgages, stocks’ growth rate, etc.
For example, let’s pretend you have a credit card with a $10,000 balance and a 20% interest rate. If you
don’t make any payments, after a year, your balance will be $12,000 ($10k + 20% of $10k for interest.
This assumes the interest compounds annually, when most credit cards compound interest monthly, or
even more frequently). If you don’t make any payments on your credit card in year two, the balance will
rise to $14,400 ($12k + 20% of $12k for interest).

Security – a stock, bond, or other tradable assets. It is pretty much the opposite of the more commonly
known definition of ―security,‖ meaning safe and free from danger.

Asset – Another term for equity or something you own.

Liability – Another term for debt or something you owe money on.

Net Worth – What people should use to measure how financially successful they are. The sum of your
assets minus your liabilities. What you own, minus what you owe.

Risk – Carl Richards defines risk as, ―Risk is what’s leftover when you think you’ve thought of everything.‖
If you can plan for something, you can mitigate the downside, and it is not really an issue. If you didn’t
think of it and/or can’t plan for it, then it’s a risk. Who would have thought a silly little virus would have
toppled our entire economy and tipped life as we know it upside down for over a year?

Opportunity Cost – All the things you are giving up to do the thing you are doing now. You could be
having so much fun right now, but instead, you’re reading a book about financial words. Money spent on
one thing is money that can’t be spent on something else. It’s not just the money you are spending; it’s
all the other things you are forgoing that you could be spending that money on instead.

Time Value of Money – The value of a rupee today versus the value of a rupee tomorrow, next month,
next year, next decade, etc. Some might equate it to a bird in the hand is worth more than two in the
bush. The value of a rupee today is worth more than a rupee tomorrow. However, patience is a virtue in
finance – if you are patient, your rupees can potentially grow at a rate faster than inflation from compound
interest.
 Financial
30 Awareness

Bull Market – Stocks have risen in value in the recent past, and many people assume that you can draw
a straight line forever into the future, mapping out the trajectory of stocks moving forward. Envision a
bull running through the streets. There is no stopping it. It will only stop running when it decides to stop.

Bear Market – When the bull stops running, it transforms into a bear and goes into hibernation. Stocks
are no longer running upward. They are asleep at the wheel and falling off a cliff. The consensus is we
are in a bear market when stocks decline by more than 20%.

Currency – An agreed-upon medium in society that can be used universally in exchange for goods and
services.

Pre-Tax – Before taxes. If you earn $100k this year and make a $10k pre-tax deposit into your
retirement account at work, the department only taxes you on $90k of income. However, you have to pay
ordinary income taxes on all the money you withdraw from pre-tax accounts in retirement.

Post-Tax – After taxes. If you earn $100k and make a $10k post-tax deposit into your retirement
account at work, the department still taxes you on $100k of income.

Roth – A special type of post-tax account where you can withdraw the money completely tax-free in
retirement.

Cost Basis – The amount you paid for an asset or investment.

Capital Gains – Money your investment earns for you while you’re sleeping. When you sell an asset or
investment for more than your cost basis, the profit is considered a realized capital gain. You can discuss
your tax implications with the authorities.

Economic Forecasting: – activity economists engage in to make astrology look respectable. Predicting
the future is hard.

Lender- This is either a person or a financial institution, such as a bank or credit union, that loans out
money.

Interests- Interest is the cost of borrowing money, which means you end up paying back more than you
borrowed. Debts such as loans and credit cards have interest, which is paid by the person who borrowed
the money. On the flip side, if you keep your money in a savings account, the bank will pay you interest
for parking your funds in an account with them.

Generational Wealth- Money or valuable things that are passed down from your grandparents to your
parents to you are called generational wealth. This can be in the form of college or university tuition, a
house, the family business, or another type of inheritance. People with generational wealth have a head
start on life when it comes to where they live and what they can afford, while people without it may have
to scrimp and save or take out loans to cover major expenses.

Loan- A loan is a set amount of money lent between people and institutions—usually banks—to pay for a
large purchase that would otherwise be unaffordable up front (like a car or a house). In finance, loans
come in two forms:

 Secured loan: Just like it sounds, this loan has built-in security just in case the borrower can’t
pay it back. Usually high-value items, like a house or car, are used to secure this type of loan. If
the borrower can’t make their payments, they could lose their house or car.
 Unsecured loan: This is money loaned out to someone who, based on factors such as income and
credit score (see above), is likely to pay back their debts. While there’s no risk of losing your
house or other high-value item, an unsecured loan may charge a higher interest rate.
 Question Bank 31

Financial Test 01 8. What is the SENSEX?

1. A measure of inflation
1. What is the primary function of the Securities 2. An index of 30 leading companies on the
and Exchange Board of India (SEBI)? BSE
3. A government bond
1. Regulating the capital markets 4. A foreign exchange index
2. Regulating money markets
3. Providing loans to small businesses 9. Which financial market deals with short-term
4. Managing the foreign exchange instruments?

2. Which financial instrument represents 1. Capital Market 2. Money Market

ownership in a company? 3. Stock Market 4. Forex Market

1. Bonds 2. Debentures 10. What does MIBOR stand for?

3. Equity Shares 4. Treasury Bills
1. Mumbai Interbank Offered Rate
3. Which of the following is a short-term debt 2. Money Interbank Operative Rate
instrument issued by corporations? 3. Market International Bankers Operating
Rate
1. Commercial Papers 4. Monetary Index Based on RBI
2. Certificates of Deposit
3. Treasury Bills 11. What is the primary benefit of issuing Masala
4. Fixed Deposits Bonds for Indian companies?

4. Assertion (A): Zero-coupon bonds do not 1. Exemption from taxation

pay interest. 2. Avoiding currency risk by issuing bonds in
Reason (R): These bonds are issued at a Indian rupees
discount and redeemed at face value. 3. High interest rates
4. Enhanced liquidity
1. Both A and R are true, and R is the correct
explanation of A 12. Which of the following best defines “bear
2. Both A and R are true, but R is not the market”?
correct explanation of A
3. A is true, but R is false 1. A market with rising prices
4. A is false, but R is true 2. A market where stock prices are falling
3. A market with stable prices
5. Which of the following describes a money 4. A market where inflation is high
market instrument?
13. Which financial term refers to the difference
1. Long-term bond between assets and liabilities?
2. Short-term, high-liquidity security
3. Equity share 1. Equity
4. Government bond 2. Net worth
3. Profit margin
6. What is the primary role of the Reserve Bank 4. Return on investment
of India (RBI)?
14. What is a Treasury Bill?
1. Issuing government securities
2. Regulating the banking sector 1. A long-term bond issued by the
3. Offering loans to large businesses government
4. Managing stock exchanges 2. A short-term government security issued
at a discount
7. Which bond does not provide regular interest 3. A corporate bond
payments to the bondholder? 4. A tradable equity security

1. Fixed-rate bond 2. Floating-rate bond 15. Which of the following is a function of the
3. Zero-coupon bond 4. Convertible bond capital market?

1. Facilitating short-term lending

2. Facilitating long-term financing
3. Regulating the money supply
4. Issuing government bonds
 32 Question Bank

16. Which instrument is issued by companies as a 23. Which of the following represents a high-risk,
promise to pay a fixed amount of interest and high-reward investment?
principal?
1. Government bonds 2. Mutual funds
1. Bond 2. Equity Share 3. Equity shares 4. Fixed deposits
3. Mutual Fund 4. Commercial Paper
24. What is the role of a capital market in the
17. What is the primary difference between financial system?
money markets and capital markets?
1. Facilitating long-term borrowing and
1. Money markets deal with long-term lending
finance, while capital markets deal with 2. Managing the currency exchange rates
short-term finance 3. Providing short-term loans to businesses
2. Capital markets deal with long-term 4. Regulating commercial banks
finance, while money markets deal with
short-term finance 25. Which financial term describes the overall
3. Both markets deal only with equity value of all assets minus liabilities?
instruments
4. Both markets deal only with government 1. Net worth 2. Profit margin
bonds 3. Dividend yield 4. Capital gain

18. Which type of market instrument has a fixed

maturity date and pays periodic interest?

1. Equity Shares 2. Bonds

3. Commodities 4. Derivatives

19. Which of the following best describes the

“Repo Rate”?

1. The interest rate at which the RBI lends to

commercial banks
2. The interest rate at which commercial
banks lend to the public
3. The rate at which banks lend to the RBI
4. The return on investment for government
securities

20. Which bond pays interest linked to an

inflation index?

1. Floating rate bond

2. Inflation-linked bond
3. Fixed-rate bond
4. Zero-coupon bond

21. Which rate is determined by the Mumbai

Interbank Offer Rate (MIBOR)?

1. Repo Rate
2. Interest rate at which banks lend to each
other overnight
3. Loan rates to corporate customers
4. Interest rates for government bonds

22. What does a Certificate of Deposit (CD)

represent?

1. A savings account with high interest

2. A short-term, negotiable money market
instrument
3. A loan issued by a bank
4. An equity share
 Question Bank 33

Financial Test 02 9. Which of the following best defines the repo

rate?

1. Which type of bond is issued at a discount 1. The rate at which RBI lends to commercial
and redeemed at face value? banks
2. The rate at which banks lend to each other
1. Fixed-rate bond 2. Floating-rate bond 3. The rate at which commercial banks lend
3. Zero-coupon bond 4. Convertible bond to the public
4. The interest rate on savings deposits
2. What is the role of the International Monetary
Fund (IMF)? 10. What is the primary role of SEBI?

1. Regulate international trade 1. Regulate money markets

2. Provide short-term loans to countries 2. Regulate the stock exchanges and protect
3. Regulate global financial markets investors
4. Provide long-term capital financing 3. Manage foreign exchange reserves
4. Provide long-term loans to banks
3. Which of the following is a characteristic of
money market instruments? 11. Which of the following is a negotiable
instrument?
1. Long-term investment
2. Low liquidity 1. Savings account
3. High risk 2. Certificate of Deposit
4. Short-term maturity 3. Fixed Deposit
4. Loan agreement
4. Which financial market instrument is typically
used by governments for short-term 12. Which financial term refers to spreading the
borrowing? cost of an intangible asset over its useful life?

1. Treasury Bills 2. Bonds 1. Depreciation 2. Amortization

3. Commercial Papers 4. Equity Shares 3. Liquidity 4. Leverage

5. What is the purpose of the Cash Reserve 13. What is a convertible bond?
Ratio (CRR) set by the RBI?
1. A bond that can be converted into equity
1. To manage the liquidity in the banking shares
system 2. A bond with a fixed interest rate
2. To regulate the stock market 3. A bond that is issued by a foreign
3. To manage foreign exchange government
4. To provide loans to the government 4. A bond with no maturity date

6. Which of the following is NOT a capital 14. Which type of loan is backed by collateral?
market instrument?
1. Unsecured loan 2. Personal loan
1. Bonds 2. Equity Shares 3. Secured loan 4. Education loan
3. Commercial Papers 4. Debentures
15. Which of the following financial instruments is
7. What does “SENSEX” represent? issued at a discount and pays no interest?

1. Interest rate on government bonds 1. Treasury Bills 2. Bonds

2. Performance of 30 companies listed on the 3. Equity Shares 4. Mutual Funds
BSE
3. Foreign exchange index 16. What is the main function of the capital
4. Government tax rates market?

8. What is the primary benefit of Treasury Bills 1. Short-term borrowing and lending
(T-bills) for investors? 2. Long-term borrowing and lending
3. Issuing currency notes
1. High returns 4. Facilitating trade between countries
2. Risk-free investment
3. Long-term capital gains
4. High liquidity
 34 Question Bank

17. Which rate is used by banks to lend to their 25. Which of the following best describes the role
most creditworthy customers? of a primary market?

1. Repo rate 1. Buying and selling of existing securities

2. Bank rate 2. Issuance of new securities
3. Prime lending rate 3. Regulating the foreign exchange market
4. Reverse repo rate 4. Managing stock exchanges

18. What is a Commercial Paper?

1. A short-term debt instrument issued by

companies
2. A government bond
3. A stock issued by companies
4. A type of mutual fund

19. What is the primary purpose of a money

market?

1. Long-term investments
2. Short-term lending and borrowing
3. Equity financing
4. Regulating the stock market

20. Which of the following is an example of a

debt instrument?

1. Bonds 2. Equity Shares

3. Derivatives 4. Commodities

21. What does the term "net worth" refer to?

1. The total income of a company

2. The total assets minus liabilities
3. The total liabilities of a company
4. The profit earned in a fiscal year

22. Which of the following best defines inflation-

linked bonds?

1. Bonds that have a fixed rate of interest

2. Bonds that adjust their returns based on
inflation
3. Bonds that are issued by companies in the
stock market
4. Bonds that pay zero interest but are
issued at a discount

23. Which financial term refers to money held in

reserve by banks to meet emergency
withdrawals?

1. Capital reserve 2. Cash reserve

3. Interest rate 4. Risk capital

24. Which of the following is a high-risk, high-

return investment?

1. Bonds 2. Fixed deposits

3. Equity shares 4. Treasury Bills
 Question Bank 35

Financial Test 03 8. Which of the following is NOT a money

market instrument?

1. What does the term "amortization" refer to in 1. Treasury Bills

finance? 2. Commercial Papers
3. Equity Shares
1. Spreading the repayment of a loan over 4. Certificates of Deposit
time
2. Increasing the value of an asset 9. Which rate is used by the RBI to lend to
3. Buying and selling of government bonds commercial banks?
4. Reducing the interest rate on loans
1. Repo rate 2. Prime lending rate
2. Which of the following is a primary function of 3. Reverse repo rate 4. Bank rate
the money market?
10. Which type of bond has a variable interest
1. Long-term financing rate that fluctuates with the market?
2. Short-term borrowing and lending
3. Issuing of equity shares 1. Zero-coupon bond 2. Fixed-rate bond
4. Regulating the bond market 3. Floating-rate bond 4. Convertible bond

3. Which bond is issued at a discount and does 11. Which financial market deals with long-term
not pay interest until maturity? investments?

1. Fixed-rate bond 2. Convertible bond 1. Money market

3. Zero-coupon bond 4. Floating-rate bond 2. Capital market
3. Foreign exchange market
4. What is the main purpose of the Securities 4. Derivatives market
and Exchange Board of India (SEBI)?
12. Which of the following is a function of the
1. Regulate insurance companies Reserve Bank of India (RBI)?
2. Protect investors in the securities market
3. Manage banking transactions 1. Issuing currency
4. Provide financial assistance to businesses 2. Regulating insurance companies
3. Managing the stock exchange
5. What is a Certificate of Deposit (CD)? 4. Providing short-term loans to companies

1. A negotiable money market instrument 13. What is the primary objective of Treasury
issued by banks Bills (T-bills)?
2. A government-issued bond
3. An equity security issued by companies 1. Short-term borrowing by the government
4. A long-term investment instrument 2. Issuance of long-term government bonds
3. Equity financing for companies
6. Which financial term refers to a company's 4. Managing foreign exchange reserves
total liabilities subtracted from its total
assets? 14. Which of the following best describes the
prime lending rate?
1. Net worth
2. Return on investment 1. The interest rate charged by RBI to
3. Capital gain commercial banks
4. Dividend yield 2. The interest rate banks charge their most
creditworthy customers
7. What is the main function of the capital 3. The interest rate on government bonds
market? 4. The rate of return on equity investments

1. Facilitating short-term investments 15. What is the main function of Commercial

2. Issuing government bonds Papers?
3. Providing long-term financing for
businesses and governments 1. Long-term government securities
4. Regulating stock exchanges 2. Short-term corporate debt instruments
3. Equity shares issued by companies
4. Loans offered by the government
 36 Question Bank

16. Which financial term describes an increase in 24. What is the primary purpose of issuing
the value of an asset over time? bonds?

1. Amortization 2. Depreciation 1. To provide equity to investors

3. Appreciation 4. Leverage 2. To raise debt capital
3. To issue short-term loans
17. Which of the following is a key characteristic 4. To finance trade deficits
of the money market?
25. Which type of market is used for trading
1. Long-term borrowing newly issued securities?
2. High risk
3. Short-term lending 1. Secondary market
4. Fixed interest rates 2. Derivatives market
3. Commodity market
18. Which of the following instruments is typically 4. Primary market
issued by corporations to raise short-term
funds?

1. Bonds 2. Commercial Papers

3. Equity Shares 4. Mutual Funds

19. What is the primary difference between

equity and debt?

1. Equity represents ownership, while debt

represents a loan
2. Debt represents ownership, while equity
represents a loan
3. Equity is long-term, and debt is short-term
4. Debt has no maturity, but equity does

20. Which type of bond provides regular interest

payments to bondholders?

1. Zero-coupon bond
2. Convertible bond
3. Fixed-rate bond
4. Inflation-linked bond

21. What does SENSEX measure?

1. The performance of 50 companies on the

NSE
2. The interest rates on government bonds
3. The performance of 30 companies on the
BSE
4. The inflation rate

22. What is the role of the cash reserve ratio

(CRR) set by the RBI?

1. To control inflation
2. To manage liquidity in the banking system
3. To regulate foreign exchange reserves
4. To provide loans to commercial banks

23. Which financial instrument is issued by the

government to raise funds for a short period?

1. Equity Shares
2. Commercial Papers
3. Treasury Bills
4. Mutual Funds
 Question Bank 37

Financial Test 04 8. Which of the following instruments is typically

issued by corporations to raise short-term
funds?
1. What is a convertible bond?
1. Bonds 2. Equity Shares
1. A bond that can be converted into equity 3. Commercial Papers 4. Treasury Bills
shares
2. A bond with a fixed interest rate 9. What does MIBOR stand for?
3. A bond that is issued by a government
4. A bond with no maturity date 1. Money International Banking Operations
Rate
2. Which of the following is NOT a money 2. Mumbai Interbank Offered Rate
market instrument? 3. Market Interest Base Rate
4. Monetary Investment Banking Operations
1. Treasury Bills Rate
2. Commercial Papers
3. Bonds 10. What is the role of SEBI in the financial
4. Certificates of Deposit system?

3. What is the primary role of the capital 1. Regulating money markets

market? 2. Issuing government bonds
3. Regulating the capital market and
1. Facilitating short-term lending protecting investors
2. Facilitating long-term borrowing and 4. Providing long-term loans to companies
lending
3. Regulating the stock exchange 11. Which financial term describes the difference
4. Providing short-term loans to businesses between assets and liabilities?

4. Which of the following is an example of a 1. Net worth

negotiable instrument? 2. Capital gain
3. Return on investment
1. Treasury Bills 4. Depreciation
2. Certificate of Deposit
3. Equity Shares 12. Which type of market instrument is issued by
4. Commercial Papers the government to raise short-term funds?

5. Which financial term refers to the value of an 1. Treasury Bills 2. Commercial Papers
asset that has decreased over time? 3. Bonds 4. Equity Shares

1. Appreciation 2. Depreciation 13. What is the purpose of the cash reserve ratio
3. Amortization 4. Liquidity (CRR)?

6. What does the term “liquidity” mean in 1. To regulate interest rates in the banking
financial markets? system
2. To maintain liquidity in the economy
1. The ease with which an asset can be 3. To ensure banks have sufficient funds to
converted into cash meet liabilities
2. The ability to generate profit from an 4. To encourage lending by commercial
investment banks
3. The capacity to pay off debt
4. The rate of interest on bonds 14. Which financial term refers to spreading the
repayment of a loan over time?
7. What is a zero-coupon bond?
1. Depreciation 2. Amortization
1. A bond that does not pay interest 3. Leverage 4. Appreciation
2. A bond that pays interest at a floating rate
3. A bond that can be converted into equity 15. Which of the following is a function of the
shares capital market?
4. A bond that matures in less than one year
1. Issuing government securities
2. Providing long-term financing
3. Regulating foreign exchange rates
4. Facilitating short-term lending
 38 Question Bank

16. What is a prime lending rate? 24. What does the term "repo rate" refer to?

1. The interest rate at which banks lend to 1. The rate at which the RBI lends money to
their most creditworthy customers commercial banks
2. The interest rate set by the government 2. The rate at which banks lend money to the
for loans to the public RBI
3. The interest rate charged by RBI to 3. The interest rate on equity shares
commercial banks 4. The return on mutual funds
4. The rate of return on mutual funds
25. Which market is used for trading newly
17. Which of the following is a key characteristic issued securities?
of money market instruments?
1. Secondary market 2. Commodity market
1. High liquidity 3. Derivatives market 4. Primary market
2. Long-term maturity
3. High-risk investment
4. Equity financing

18. What does SENSEX measure?

1. The performance of 50 companies on the

NSE
2. The interest rates on government bonds
3. The performance of 30 companies on the
BSE
4. The inflation rate

19. What is the role of a Commercial Paper?

1. A long-term bond issued by the

government
2. A short-term corporate debt instrument
3. An equity share issued by companies
4. A derivative contract

20. Which bond provides regular interest

payments to the bondholder?

1. Zero-coupon bond
2. Convertible bond
3. Fixed-rate bond
4. Inflation-linked bond

21. Which of the following represents ownership

in a company?

1. Bonds
2. Equity Shares
3. Debentures
4. Commercial Papers

22. What is the main purpose of the money

market?

1. Long-term financing for businesses

2. Short-term borrowing and lending
3. Issuing equity shares
4. Providing venture capital

23. Which of the following is a debt instrument?

1. Bonds 2. Equity Shares

3. Derivatives 4. Mutual Funds
 Question Bank 39

Financial Test 05 8. What does the term “liquidity” refer to in

finance?

1. What is a floating-rate bond? 1. The ability of a company to repay long-

term debt
1. A bond with a fixed interest rate 2. The ease with which an asset can be
2. A bond that adjusts its interest rate converted into cash
periodically based on market rates 3. The profitability of a company
3. A bond issued at a discount 4. The return on an investment
4. A bond with no interest payment
9. Which financial instrument is issued by
2. Which of the following is NOT considered a companies to raise short-term funds?
capital market instrument?
1. Bonds 2. Treasury Bills
1. Bonds 2. Equity Shares 3. Commercial Papers 4. Equity Shares
3. Commercial Papers 4. Debentures
10. Which of the following best describes the
3. What is the role of SEBI in the Indian prime lending rate?
financial system?
1. The rate at which RBI lends to commercial
1. Regulating the money supply banks
2. Regulating the capital markets 2. The interest rate charged to the most
3. Issuing currency notes creditworthy customers of a bank
4. Providing short-term loans to businesses 3. The interest rate on long-term government
bonds
4. Which financial term refers to the value of an 4. The interest rate on mutual funds
asset minus its liabilities?
11. What does MIBOR stand for?
1. Net worth
2. Capital gain 1. Mumbai Interbank Offered Rate
3. Return on investment 2. Monetary International Banking Operations
4. Leverage Rate
3. Market Interest Base Rate
5. What is a Certificate of Deposit (CD)? 4. Minimum Investment Banking Operations
Rate
1. A long-term bond issued by the
government 12. Which of the following best defines equity
2. A negotiable short-term instrument issued shares?
by banks
3. An equity security 1. Short-term debt instrument
4. A type of mutual fund 2. Ownership in a company
3. Long-term government bond
6. Which market is used for the issuance of new 4. Fixed deposit
securities?
13. What is the role of the cash reserve ratio
1. Secondary market 2. Derivatives market (CRR)?
3. Commodity market 4. Primary market
1. To control inflation
7. What is a zero-coupon bond? 2. To ensure banks have sufficient funds to
meet withdrawals
1. A bond that pays interest at a fixed rate 3. To regulate government bonds
2. A bond that does not pay interest but is 4. To manage foreign exchange reserves
issued at a discount
3. A bond that can be converted into equity 14. What is the main function of the capital
shares market?
4. A bond with a variable interest rate
1. Short-term lending and borrowing
2. Long-term financing for businesses and
governments
3. Issuing currency notes
4. Providing foreign exchange
 40 Question Bank

15. Which type of bond adjusts its interest rate 23. Which of the following is a negotiable
according to inflation? instrument?

1. Fixed-rate bond 1. Fixed deposit

2. Zero-coupon bond 2. Equity share
3. Inflation-linked bond 3. Certificate of Deposit
4. Convertible bond 4. Mutual fund

16. What is the purpose of Treasury Bills (T- 24. What is the main difference between the
bills)? primary and secondary market?

1. To raise long-term capital 1. The primary market is for issuing new

2. To provide equity financing securities, while the secondary market is
3. To raise short-term funds for the for trading existing securities
government 2. The primary market is for trading
4. To manage foreign exchange reserves government bonds, while the secondary
market is for equity shares
17. Which of the following financial instruments 3. The primary market is for short-term
provides regular interest payments to the securities, while the secondary market is
bondholder? for long-term securities
4. The primary market is for international
1. Zero-coupon bond trade, while the secondary market is for
2. Fixed-rate bond domestic trade
3. Commercial Paper
4. Equity Shares 25. What does the term “repo rate” refer to?

18. What is the SENSEX? 1. The rate at which the RBI lends to
commercial banks
1. A government bond index 2. The rate at which banks lend to each other
2. A measure of inflation 3. The interest rate charged on savings
3. A stock market index of 30 companies accounts
listed on the BSE 4. The interest rate on government bonds
4. A foreign exchange index

19. Which financial term refers to the repayment

of a loan over time?

1. Depreciation 2. Amortization
3. Leverage 4. Dividend yield

20. Which financial market deals with short-term

borrowing and lending?

1. Money market 2. Capital market

3. Stock market 4. Commodity market

21. Which rate is set by RBI to control the money

supply?

1. Repo rate 2. Prime lending rate

3. Reverse repo rate 4. Bank rate

22. Which of the following best describes equity

financing?

1. Issuing bonds to raise debt

2. Raising funds by selling ownership in a
company
3. Borrowing money from banks
4. Issuing commercial papers
 Question Bank 41

Answer Key

Test 01 Test 02 Test 03 Test 04 Test 05

1. 1 1. 3 1. 1 1. 1 1. 2
2. 3 2. 2 2. 2 2. 3 2. 3
3. 1 3. 4 3. 3 3. 2 3. 2
4. 1 4. 1 4. 2 4. 2 4. 1
5. 2 5. 1 5. 1 5. 2 5. 2
6. 2 6. 3 6. 1 6. 1 6. 4
7. 3 7. 2 7. 3 7. 1 7. 2
8. 2 8. 2 8. 3 8. 3 8. 2
9. 2 9. 1 9. 1 9. 2 9. 3
10. 1 10. 2 10. 3 10. 3 10. 2
11. 2 11. 2 11. 2 11. 1 11. 1
12. 2 12. 2 12. 1 12. 1 12. 2
13. 2 13. 1 13. 1 13. 3 13. 2
14. 2 14. 3 14. 2 14. 2 14. 2
15. 2 15. 1 15. 2 15. 2 15. 3
16. 1 16. 2 16. 3 16. 1 16. 3
17. 2 17. 3 17. 3 17. 1 17. 2
18. 2 18. 1 18. 2 18. 3 18. 3
19. 1 19. 2 19. 1 19. 2 19. 2
20. 2 20. 1 20. 3 20. 3 20. 1
21. 2 21. 2 21. 3 21. 2 21. 1
22. 2 22. 2 22. 2 22. 2 22. 2
23. 3 23. 2 23. 3 23. 1 23. 3
24. 1 24. 3 24. 2 24. 1 24. 1
25. 1 25. 2 25. 4 25. 4 25. 1
Economic Awareness
 Basics of Economy 1

BASICS OF ECONOMY
A. INTRODUCTION TO ECONOMICS
Economics as a word comes from the Greek language where ―Oikos‖ means family, household or estate
and ―nomos‖ means management. Thus, household management or management of scarce resources is
the essential meaning of economics. Economics includes production, distribution, trade & consumption of
goods and services. Economics is the study of how societies use scarce resources to produce valuable
products and distribute them among different people.

Branches of economics
a) Micro Economics (Detailed study in depth about individual entity): It examines economic behaviour
of individuals such as consumers, households etc. to understand how decisions are made in the
face of scarcity and what effects they will have on the larger [Link] studying an automobile
firm (TVS show- room in Chandni Chowk Delhi) or studying about a farmer.
b) Macro-Economics (Overview): It studies the economy as a whole and its features like National
income, poverty, overall manufacturing sector, employment etc.

The division of economics into macroeconomics (the study of economic performance, structure, behavior,
and decision-making at the national, regional, or global level) and microeconomics (the study of resource
allocation by households and firms) is fundamentally incomplete and misleading. But there are at least two
other divisions in economics that have been neglected: meso-economics and meta-economics.

Meso-economics studies the institutional aspects of the economy that are not captured by micro or
macroeconomics. By presupposing perfect competition, complete information, and zero transaction costs,
neoclassical economics assumes away the need for institutions like courts, parties, and religions to deal
with the economic problems that people, firms, and countries face.

By contrast, the economists Kurt Dopfer, John Foster, and Jason Potts have developed a Macro-Meso-Micro
theory of evolutionary economics in which ―an economic system is a population of rules, a structure of
rules, and a process of rules.‖ The most important feature of a meso-economic framework is to study the
actual web of contracts, formal or informal, in family, corporate, market, civil, and social institutions.
Doing so provides a natural linkage between micro and macro, because the micro-level rules and
institutions typically imply macro-level consequences.

Meta-economics goes still further, by studying deeper functional aspects of the economy, understood as a
complex, interactive, and holistic living system. It asks questions like why an economy is more competitive
and sustainable than others, how and why institutions‘ governance structures evolve, and how China
developed four global-scale supply chains in manufacturing, infrastructure, finance, and government
services within such a short period of time.

In order to study the deep hidden principles behind human behavior, meta-economics requires us to adopt
an open-minded, systemic, and evolutionary approach, and to recognize the real economy as a complex
living system within other systems. This is difficult, because official statistics mismeasure – or simply miss
– many of the real economy‘s hidden rules and practices.

The British economist Fritz Schumacher understood that human institutions, as complex structures with
dynamic governance, require systemic analysis. He defined meta-economics as the humanizing of
economics by accounting for the imperative of a sustainable environment; thus, he included elements of
moral philosophy, psychology, anthropology, and sociology that transcend the boundaries of profit
maximization and individual rationality.

The framework of ―micro-macro-meso-meta-economics‖ – what we call ―systemnomics‖ – is a more

complete way to analyze human economies, understood as complex living systems evolving within
dynamically changing complex natural systems.

Economics and Economy

Economics- It is a discipline studying economic behaviour of Humans. It is theory. It will come out with
theories of poverty, employment, etc.
Economy- It is the real life picture of it. It is economics in practice. It is the real picture which will come
out after the same theories are practiced. It is economics at play in a certain region.
 2 Basics of Economy

Economy as such means nothing. It gets meaning once it is associated with a particular region or area,
e.g. Indian Economy US Economy.

Definition of Economics by different Economists:

Wealth definition- Adam Smith (1776)

• This Definition was introduced by Adam Smith.
• He is also known as Father of Economics.
• According to this definition —
• Economics is a science of study of wealth only
• It deals with production, distribution and consumption
• This wealth centered definition deals with the causes behind the creation of
wealth, and
• It only considers material wealth.

Adam Smith

“Economics is the science of wealth”

Welfare Definition – Alfred Marshall (1890)

• This Definition was put forward by Alfred Marshall.
• According to Alfred Marshall ―Economics is the study of man in the ordinary
business of life‖.
• It examines how a person gets his income and how he invests it.
• Thus on one side it is a study of wealth and
• On the other most important side, it is a study of well-being (welfare).

Alfred Marshall

“Economics is the study of man in the ordinary business of life”

Scarcity Definition – Lionel Robbins (1932)

• This definition was put forward by Robbins.
• According to him ―Economics is a science which studies human behavior as
a relationship between ends and scarce means which have alternative
uses.
• Features:
• Human wants are unlimited.
• Alternative use of scarce resources.
• Efficient use of resources.
• Need for optimization(best allocation of resources).
Lionel Robbins
 Basics of Economy 3

Economics is the aspect of scarcity in all economic behaviour

Growth Definition – Paul. A. Samuelson (1948)

• This definition was introduced by Paul. A. Samuelson

• According to him-‖Economics is the science which studies human behaviour
as a relationship between ends and scarce means which have alternative
uses‖.
• It analyses costs and benefits of improving patterns of resource allocation.
This definition is the combination of welfare and scarcity definition

Paul. A. Samuelson

Economics is concerned with determining the pattern of employment of scarce resources to produce
commodities „over time‟.

POLITICAL ECONOMY:

Political economy is the study of production and trade and their relations with law, custom and
government; and with the distribution of national income and wealth. As a discipline, political economy
originated in moral philosophy, in the 18th century, to explore the administration of states' wealth. In the
late 19th century, the term "economics" gradually began to replace the term "political economy" with the
rise of mathematical modeling coinciding with the publication of an influential textbook by Alfred Marshall
in 1890

TYPES OF POLITICAL ECONOMIES IN THE WORLD:

The Four Types of Economic Systems

1. Traditional Economic System

2. Command Economic System
3. Market Economic System
4. Mixed Economic System

1. Traditional Economic System

The traditional economic system is the most traditional and ancient types of economies in the world. Vast
portions of the world still function under a traditional economic system. These areas tend to be rural,
second- or third-world, and closely tied to the land, usually through farming.
 4 Basics of Economy

In general, in a traditional economic system, a surplus would be rare. Each member of a traditional
economy has a more specific and pronounced role, and these societies tend to be very close-knit and
socially satisfied. However, they do lack access to technology and advanced medicine.

2. Command Economic System

In a command economic system, a large part of the economic system is controlled by a centralized power.
For example, in the USSR most decisions were made by the central government. This type of economy
was the core of the communist philosophy.
Since the government is such a central feature of the economy, it is often involved in everything from
planning to redistributing resources. A command economy is capable of creating a healthy supply of its
resources, and it rewards its people with affordable prices. This capability also means that the government
usually owns all the critical industries like utilities, aviation, and railroad.
In a command economy, it is theoretically possible for the government to create enough jobs and provide
goods and services at an affordable rate. However, in reality, most command economies tend to focus on
the most valuable resources like oil.
China or D.P.R.K. (North Korea) are examples of command economies.

Advantages of Command Economic Systems

 If executed correctly, the government can mobilize resources on a massive scale. This mobility can
provide jobs for almost all of the citizens.
 The government can focus on the good of society rather than an individual. This focus could lead
to more efficient use of resources.

Disadvantages of Command Economic Systems

 It is hard for central planners to provide for everyone‘s needs. This challenge forces the
government to ration because it cannot calculate demand since it sets prices.
 There is a lack of innovation since there is no need to take any risk. Workers are also forced to
pursue jobs the government deems fit.

3. Market Economic System

In a free-market economy, firms and households act in self-interest to determine how resources get
allocated, what goods get produced and who buys the goods. This is opposite to how a command economy
works, where the central government gets to keep the profits.
There is no government intervention in a pure market economy (―laissez-faire―). However, no truly free
market economy exists in the world. For example, while America is a capitalist nation, our government still
regulates (or attempts to control) fair trade, government programs, honest business, monopolies, etc.
In this type of economy, there is a separation between the government and the market. This separation
prevents the government from becoming too powerful and keeps their interests aligned with that of the
markets.
Historically, Hong Kong is considered an example of a free market society.

Advantages of a Free Market Economy

 Consumers pay the highest price they want to, and businesses only produce profitable goods and
services. There is a lot of incentive for entrepreneurship.
 This competition for resources leads to the most efficient use of the factors of production since
businesses are very competitive.
 Businesses invest heavily in research and development. There is an incentive for constant
innovation as companies compete to provide better products for consumers.

Disadvantages of a Free Market Economy

 Due to the fiercely competitive nature of a free market, businesses will not care for the
disadvantaged like the elderly or disabled. This lack of focus on societal benefit leads to higher
income inequality.
 Since the market is driven solely by self-interest, economic needs have a priority over social and
human needs like providing healthcare for the poor. Consumers can also be exploited by
monopolies.

4. Mixed Economic System

A mixed economy is a combination of different types of economic systems. This economic system is a
cross between a market economy and command economy. In the most common types of mixed
 Basics of Economy 5

economies, the market is more or less free of government ownership except for a few key areas like
transportation or sensitive industries like defense and railroad.

However, the government is also usually involved in the regulation of private businesses. The idea behind
a mixed economy was to use the best of both worlds – incorporate policies that are socialist and capitalist.
To a certain extent, most countries have a mixed economic system. For example, India and France are
mixed economies.

Advantages of Mixed Economies

 There is less government intervention than a command economy. This results in private
businesses that can run more efficiently and cut costs down than a government entity might.
 The government can intervene to correct market failures. For example, most governments will
come in and break up large companies if they abuse monopoly power. Another example could be
the taxation of harmful products like cigarettes to reduce a negative externality of consumption.
 Governments can create safety net programs like healthcare or social security.
 In a mixed economy, governments can use taxation policies to redistribute income and reduce
inequality.

Disadvantages of Mixed Economies

 There are criticisms from both sides arguing that sometimes there is too much government
intervention, and sometimes there isn‘t enough.
 A common problem is that the state run industries are often subsidized by the government and run
into large debts because they are uncompetitive.

SCHOOLS OF ECONOMIC THOUGHT:

In the history of economic thought, a school of economic thought is a group of economic thinkers who
share or shared a common perspective on the way economies work. While economists do not always fit
into particular schools, particularly in modern times, classifying economists into schools of thought is
common.

Economic thought may be roughly divided into three phases: premodern (Greco-Roman, Indian, Persian,
Islamic, and Imperial Chinese), early modern (mercantilist, physiocrats) and modern (beginning with
Adam Smith and classical economics in the late 18th century). Systematic economic theory has been
developed mainly since the beginning of what is termed the modern era.

Mercantilism

Economics is said to begin with Adam Smith in 1776. Prior to that, nobody thought of economics, or
markets, as an object of study. It is not that they didn't pay attention to economic matters, it is simply
that they didn't think of it in any systematic or coherent manner. It was all just off-the-cuff intuition and
policy proposals by a myriad of merchants, government officials & journalists, principally in Britain. It is
common to denote the period before 1776 as "Mercantilism". It wasn't a coherent school of thought, but a
hodge-podge of varying ideas about improving tax revenues, the value & movements of gold and how
nations competed for international commerce & colonies. Mostly protectionist, 'war-minded', and all
haphazardly argued. (the principal features of the Mercantilist school are discussed in our "Gains from
Trade" handout). There was some opposition to Mercantilist doctrines, notably among French and Scottish
thinkers (e.g. Pierre de Boisguilbert, Francois Quesnay, Jacques Turgot and David Hume)

Classical School
The Classical school, which is regarded as the first school of economic thought, is associated with the 18th
Century Scottish economist Adam Smith, and those British economists that followed, such as Robert
Malthus and David Ricardo.

The main idea of the Classical school was that markets work best when they are left alone, and that there
is nothing but the smallest role for government. The approach is firmly one of laissez-faire and a strong
belief in the efficiency of free markets to generate economic development. Markets should be left to work
because the price mechanism acts as a powerful ‗invisible hand‘ to allocate resources to where they are
best employed.

In terms of explaining value, the focus of classical thinking was that it was determined mainly by scarcity
and costs of production.
 6 Basics of Economy

In terms of the macro-economy, the Classical economists assumed that the economy would always return
to the full-employment level of real output through an automatic self-adjustment mechanism.
It is widely recognised that the Classical period lasted until 1870.

Neo-classical
The neo-classical school of economic thought is a wide ranging school of ideas from which modern
economic theory evolved. The method is clearly scientific, with assumptions, and hypothesis and attempts
to derive general rules or principles about the behaviour of firms and consumers.

For example, neo-classical economics assumes that economic agents are rational in their behaviour, and
that consumers look to maximise utility and firms look to maximise profits. The contrasting objectives of
maximising utility and profits form the basis of demand and supply theory. Another important contribution
of neo-classical economics was a focus on marginal values, such as marginal cost and marginal utility.
Neo-classical economics is associated with the work of William Jevons, Carl Menger and Leon Walras.

New classical
New classical macro-economic dates from the 1970s, and is an attempt to explain macro-economic
problems and issues using micro-economic concepts like rational behaviour, and rational expectations.
New classical economics is associated with the work of Chicago economist, Robert Lucas.

Keynesian economics
Keynesian economists broadly follow the main macro-economic ideas of British economist John Maynard
Keynes. Keynes is widely regarded as the most important economist of the 20th Century, despite falling
out of favour during the 1970s and 1980s following the rise of new classical economics.

In essence, Keynesian economists are skeptical that, if left alone, free markets will inevitably move
towards full employment equilibrium.

The Keynesian approach is interventionist, coming from a belief that the self-interest which governs micro-
economic behaviour does not always lead to long run macro-economic development or short run macro-
economic stability. Keynesian economics is essentially a theory of aggregate demand, and how best to
manipulate it through macro-economic policy.

One group, known as the 'Cambridge school' (led by Joan Robinson) proposed to dump all Neoclassical
theory altogether and actually resurrect the old Classical theory to explain the 'micro-level' side, as it
seemed more compatible with Keynesian theory. Another group, known as the Chicago (or 'Monetarist')
school (led by Milton Friedman) proposed to dump Keynesian theory altogether, and let Neoclassicism take
over the macro side again.

Caught in the middle were the 'Synthesis school' (led by no single charismatic figure, but championed by
most leading economists, notably Paul Samuelson, James Tobin, Robert Solow and others). The
Synthesists sought to split the difference, arguing that there is no need to go to extremes or dump
anything. The Synthesists tried to show how the Keynesian ideas were actually deducible from Neoclassical
principles and consequently compatible. As the 1970s wore on, the debates got more furious and the
various sides grew more intractable and bitter. But the ultimate decider turned out not to be the
arguments forwarded, but the intrusion of economic reality. The 1970s saw a great period of 'stagflation'
(high unemployment plus high inflation), a surprising macro-phenomenon which could not be easily
explained by Keynesian theory. After all, Keynesian theory had argued inflation was caused by tight labor
markets, and that mass unemployment should be accompanied by price deflation, not inflation. This stag-
flationary reality of the 1970s diminished the appeal of those who were arguing for a greater role for
Keynesian theory. The Synthesists were embarrassed, Robinson & Co. retreated to the insular world of
Cambridge, while Milton Friedman's Monetarists, feeling vindicated, came roaring to the fore.

Monetarist School
The Monetarist 'victory' in the stagflationary 1970s was both brief and permanent. On the permanent
front, it certainly revolutionized academic thinking, seemingly taking economics off its "two rails" and
reducing it all to one theory: Neoclassicism. In many American universities, a particularly fundamentalist
strain of Monetarism (sometimes called the "New Classical" school, an unfortunately confusing name),
took hold and has remained, on and off, a powerful theoretical force since. The New Classical School is led
by Robert Lucas and fellow faculty members of the University of Chicago. It brooks little or no tolerance
for Keynesian ideas and has expunged most traces of Keynesianism from its analysis. 5 The looser
Monetarists (terribly mislabeled as "New Keynesians") try to make room for some Keynesian results at the
macro level, even though their theoretical tools remain almost wholly Neoclassical, with only some
 Basics of Economy 7

adjustments here and there. Like the New Classicals, they believe Neoclassicism to be absolutely correct,
that all you have to do is allow prices to adjust and the market will fix everything. The difference is that
New Keynesians accept that sometimes prices are "sticky", that is, they don't adjust, or don't adjust
quickly enough. This may be because of monopolistic conditions, transactions costs, information
asymmetries, imperfections, errors, thoughtless government interference or silly regulations. These real-
world imperfections may stop the price system from working properly and prevent adjustment, thereby
leading to prolonged periods of unemployment. As a result, it may be practical to recommend some
degree of active government policy to smooth over these problems and help the economy transition more
quickly to a stable position. The New Keynesian school is not particularly self-conscious nor dogmatic nor
centered anywhere. Popular economists such as Paul Krugman and Joseph Stiglitz are frequently counted
among them, although I am not sure if they would welcome that label.

Liberalism:
Liberalism, political doctrine that takes protecting and enhancing the freedom of the individual to be the
central problem of politics. Liberals typically believe that government is necessary to protect individuals
from being harmed by others, but they also recognize that government itself can pose a threat to liberty.
Liberalism is the culmination of developments in Western society that produced a sense of the importance
of human individuality, liberation of the individual from complete subservience to the group, and a
relaxation of the tight hold of custom, law, and authority.

Neo-Liberalism
Neoliberalism is a policy model—bridging politics, social studies, and economics—that seeks to transfer
control of economic factors to the private sector from the public sector. It tends towards free-market
capitalism and away from government spending, regulation, and public ownership.

Often identified in the 1980s with the conservative governments of Margaret Thatcher and Ronald Reagan,
neoliberalism has more recently been associated with so-called Third Way politics, which seeks a middle
ground between the ideologies of the left and right.

Current world economic order can be termed as neo-capitalism or neo-liberalism order which focuses on
Laissez-faire (market freedom), globalisation, intellectual property rights, and free movement of goods,
services, investment and ideas. India entered the neo-liberalism phase in the post 1991 after LPG policy.

However, over the course of the neoliberal era, economies around the world have become more and more
unequal. Such conditions question neo-capitalism's long term viability as the key driving force of world
economic order.

Issues Related to Neo-liberal Era

 Increasing Inequalities: Social inequalities and the grim problems of stark and continuing poverty
are at the epicenter of the current world order.
 Creation of Monopolies: Despite its alleged commitment to market competition, the neoliberal
economic agenda instead brought the decline of competition and the rise of close to monopoly
power in vast swaths of the economy: pharmaceuticals, telecom, airlines, agriculture, banking,
industrials, and retail.
 Unsustainable Economic Growth: One of the chief characteristics of economic development is the
intensification of energy use. There is an unprecedented concentration of high energy density in all
economic development strategies.
 The bulk of the energy continues to be generated from non-renewable sources.
 The developed world‘s primary objective is to capture energy-generating resources from across
continents and put them to use to push their GDP growth to greater heights.
 This unsustainable economic growth model is against the concept of sustainability, as it
sacrifices the need of future generations for the welfare of present generations.
 Developing Countries at Disadvantage: High consumption of energy by the developed world has
been accompanied by the disposal of residual products (‗e-waste‘) on the shores of many African
and Asian countries.
 As a result, the poor in the developing world are, unwittingly, drawn and exposed to toxic,
hazardous materials like lead, cadmium and arsenic.
 Also, the ‗globalisation‘ phenomenon has led to the exploitation of the developing world, with most
countries being treated as a source of cheap labour and critical raw material.
 Further, high expenses on research and Intellectual Property Rights favour the developed
countries, as it hinders the transfer of technology which may aid sustainable development.
 Moreover, the sustainability of neo-liberal economic order got exposed during the 2007-2008
Global financial crisis due to which the global economy was on the verge of collapse.
 8 Basics of Economy

Way Forward
Improvement in ‗Ease of Doing Business‘ needs to be balanced with the improvement in Human
Development Index.
• The current neo-liberal model can be replaced by ‗Nordic Economic Model‘, which pertains to the
remarkable achievements of the Scandinavian countries comprising Denmark, Finland, Iceland,
Sweden, Norway, and allied territories.

Nordic Economic Model is comprised of:

 Effective welfare safety nets for all.
 Corruption-free governance.
 A fundamental right to tuition-free education, including higher education.
 A fundamental right to good medical care.
 Nordic Countries also shut down the tax havens.
 Also, in Nordic countries, personal and corporate income tax rates are very high, especially on the
very rich.
 They also have large public sector enterprises; extensive and generous universal welfare systems
and considerable state involvement in promoting and upholding welfare states.
 By following this economic model, These nations are among the richest in the world when
measured in terms of GDP per capita.
 UN reports also indicate that the Nordic countries are the happiest countries in the world.
 New Model for the Corporate Sector: A new format has emerged under which a company‘s
performance is measured through four ‗Ps‘.
 The first is ‗P‘ for ‗profit‘.
 The second ‗P‘ is for ‗people‘: How the companies‘ actions impact not only employees but
society as a whole.
 The third ‗P‘ is for ‗planet‘: Companies actions and plans should be sensitive to the
environment.
 The fourth ‗P‘ is for ‗purpose‘: Companies and individuals must develop a larger purpose than
‗business as usual‘.
 Using big data and text analytics, a company‘s performance can be measured in terms of all
the four ‗P‘s and a corporate entity can be thus held accountable.
 Redistribution of wealth and resources is needed to end extreme poverty. This can be done by
taxing wealth, high incomes, and cracking down on loopholes and inadequate global tax rules.
 Apart from these, there is a requirement of global consensus and the will to make the planet more
sustainable, so that all individuals can live with justice and equality.

What Is Development Economics?

Development economics is a branch of economics that focuses on improving fiscal, economic, and social
conditions in developing countries. Development economics considers factors such as health, education,
working conditions, domestic and international policies, and market condition with a focus on improving
conditions in the world's poorest countries. The field also examines both macroeconomic and
microeconomic factors relating to the structure of developing economies, and domestic and international
economic growth. Macroeconomics refers to broadly influencing factors such as interest rates, whereas
microeconomics relates to individual influences. Prominent development economists include Jeffrey Sachs,
Hernando de Soto Polar, and Nobel Laureates Simon Kuznets, Amartya Sen and Joseph Stiglitz. Some
aspects of development economics include determining to what extent rapid population growth helps or
hinders development, the structural transformation of economies, and the role of education and health
care in development. They also include international trade and globalization, sustainable development, the
effect of epidemics such as HIV and AIDS, and the impact of catastrophes on economic and human
development.

What is Behavioral Economics?

Behavioral Economics is the study of psychology as it relates to the economic decision-making processes
of individuals and institutions. The two most important questions in this field are:
1. Are economists' assumptions of utility or profit maximization good approximations of real people's
behavior?
2. Do individuals maximize subjective expected utility?

Behavioral economics is often related with normative economics. Behavioral economics draws on
psychology and economics to explore why people sometimes make irrational decisions, and why and how
their behavior does not follow the predictions of economic models. Decisions such as how much to pay for
a cup of coffee, whether to go to graduate school, whether to pursue a healthy lifestyle, how much to
contribute towards retirement, etc. are the sorts of decisions that most people make at some point in their
 Basics of Economy 9

lives. Behavioral economics seeks to explain why an individual decided to go for choice A, instead of choice
B.

One application of behavioral economics is heuristics, which is the use of rules of thumb or mental
shortcuts to make a quick decision. However, when the decision made leads to error, heuristics can lead to
cognitive bias. Behavioral game theory, an emergent class of game theory, can also be applied to
behavioral economics as game theory runs experiments and analyzes people‘s decisions to make irrational
choices. Another field in which behavioral economics can be applied to is behavioral finance, which seeks
to explain why investors make rash decisions when trading in the capital markets.

Green Economics
A green economy is defined as low carbon, resource efficient and socially inclusive. In a green economy,
growth in employment and income are driven by public and private investment into such economic
activities, infrastructure and assets that allow reduced carbon emissions and pollution, enhanced energy
and resource efficiency, and prevention of the loss of biodiversity and ecosystem services.

Green accounting

 The term Environmental accounting was used for the first time in the year 1980s by Professor
Peter Wood.
 Environmental accounting or green accounting is a new branch of accounting that aims at
accounting for the Environment and its well-being.
 It deals with most important factors-
1. People,
2. Profitability and
3. The planet and
4. Deals with the costs and the advantages or benefits an environment brings to a business
concern.

Steps that are already being taken by India – CSR

 The government of India through the new Companies Act of 2013 made Corporate Social
responsibility (CSR) mandatory for Companies who fall within any of the 3 categories mentioned
below:
1. Companies having net worth of INR 500 crore
2. Companies having turnover of INR 1000 crore or
3. Companies having net profit of INR 5 crore
 It has to spend at least 2% of its average net profits of the last 3 years on CSR activities.
 In addition to these Companies in India also have to disclose particulars relating to conservation of
energy, technology absorption and foreign exchange earnings and outgo.
 10 Basics of Economy

Green GDP

 Green GDP is a term used generally for expressing GDP after adjusting for environmental damage.
 Green GDP means that it accounts the monetized loss of biodiversity, costs caused by climate
change.
 It‘s a measure of how a country is prepared for sustainable economic development.

Green GDP- To account for what GDP does not, economist have created Green GDP
Green GDP = GDP - The value of environmental degradation - P
P = all expenditures resulting from cleaning up pollution, avoiding further environmental damage, and
health care costs of pollution induced illnesses.

Measuring „green GDP‟ of States by India:

• The government will begin a five-year exercise to compute district-level data of the country‘s
environmental wealth starting from 2018.
• The numbers will eventually be used to calculate every State‘s ‗green‘ Gross Domestic Product
(GDP).
• The metric will help with a range of policy decisions, such as compensation to be paid during land
acquisition, calculation of funds required for climate mitigation, and so on.

Green skilling

• The government has launched a ‗green skilling‘ programme.

• Youth, particularly school dropouts, would be trained in a range of ‗green jobs‘— as operators of
scientific instruments used to measure environmental quality, as field staff in nature parks, and as
tourist guides etc.

Green Public Procurement

• Green Public Procurement (GPP) may be simply defined as ―Public procurement for a better
environment―.
• It is a process whereby public authorities seek to procure goods, services and works with a
reduced environmental impact throughout their life cycle when compared to goods, services and
works with the same primary function that would otherwise be procured.

Benefits of Green Public Procurement

• Reducing hazardous substances

• Reducing CO2 emissions
• Improving competitiveness of eco-industry
• Preserving natural resources
• Promoting the update of green products
• Redeeming the money

Importance of GPP:

1. Influencing the market by promoting and using GPP, public authorities can provide industry with
real incentives for developing green materials, technologies and products.
2. It is a strong stimulus for eco-innovation.
3. Conservation of Environment
 Basics of Economy 11

Green Public Procurement that will ensure that procurement decisions take the following key factors into
account when evaluating goods and services:

• Economic: The need to achieve better value for money with the financial resources available
• Environmental: The product, service or work requirements should include environmental
performances following environmentally friendly production methods, higher energy efficiency as
well as maximum use of renewable energy, lower generation of waste and emissions and avoiding
use of non-biodegradable and toxic substances.
• Social: reduction of poverty and inequality: promoting security and social inclusion; improving
working conditions and employee welfare; promoting gender balance.

B. NATIONAL INCOME

National Income:

Final goods and intermediate goods

Final goods are the goods that are consumed by the customer. They are not used in the production of
other goods. Eg.1kg Tomato bought & consumed by making it into a type of chutney. Here tomato is a
final good. Intermediate goods are those goods which are used to make final goods. eg. 1kg tomato
bought by Kissan Sauce Co. The company makes sauce out of it and sells the sauce in the market. Here
tomato is an intermediate good and sauce is final good. Only final goods are included while measuring
national income. If intermediate goods were also included, this would lead to double counting.

GDP (Gross Domestic Product)

It is defined as the market value of all final goods & services produced by the factors of production located
within the boundary of a country during a period of 1 year. In India GDP is calculated by CSO (Central
Statistical Organization), which comes under the ministry of Statistics and Programme Implementation.

How to measure GDP

Three different ways are used:-

 Output Approach Income Approach
 Expenditure Approach
 Output Approach

Above case is an example of output approach. To understand output approach we‘ll have to add the value
of final goods & services and eliminate the value of intermediate goods (Otherwise the value of
intermediate goods would cause double counting and there will be overestimation of value of GDP.
 12 Basics of Economy

In the above case, the farmer sells wheat to the miller at Re.1 (we are assuming the input cost of farmer
as zero).
So value addition done by farmer = value of output (Rs.1) minus value of inputs (Rs.0) = Re.1).
Miller converts the wheat into flour and sells it to the bakery for Rs.1.5 value addition by miller = value of
output (Rs.1.5) minus value of input (Rs.1) = Rs.0.5 Then, bakery converts this flour to cake and sells it
to Mc. Donalds for Rs.2
Value addition by bakery = value of output (Rs.2) minus value of inputs (Rs.1.5) = Rs.0.5
Then Mc. Donalds sells this cake to Virat Kohli for Rs.2.5, who then eats it very happily.
Value addition by Mc. Donalds = value of out- put (Rs.2.5) minus value of inputs (Rs.2) = Rs.0.5 Total
value addition in this whole process is 1 + 0.5 + 0.5 + 0.5 = Rs.2.5

Concept and measurement of “Value Added”

It is defined as the difference between the value of output of a firm and value of inputs bought from other
firms. It is thus the value which the firm concerned has added by its process of production (Basically the
profit margin). Most goods pass through many stages of production.
The value of the final good will is equal to the sum of the value added at each stage of production.
Sum of value added = 1 + 0.5 + 0.5+ 0.5 = 2.5
= Value of the Final Good
GDP contribution = 2.5(1+.5+.5+.5) GDP is sum of value addition at each stage of production and not 1 +
0.5 + 2 + 2.5 = 7
It will not be the sum total of values of outputs at each stage. We won‘t add the value of the intermediate
goods in the GDP but we will add the value addition at each stage. If we add the value of intermediate
goods, we will be counting the value of one good many times (also called double counting of goods).

Income Approach

Here GDP is sum of all factor incomes generated in the production of a good. It is the addition of all fac-
tor incomes generation in the production of goods and services.
 Basics of Economy 13

It includes:-
1. Wages
2. Profit to the owners of the firm [Link] earned by owners of the land
4. Interest earned by the person providing capital

In the above example, while producing wheat, flour, cake and giving services at McDonalds, factor
incomes are generated at each stage .eg. the miller purchases the wheat at Rs.1, converts it into flour and
sells it for [Link] for doing it, he needs a piece of land , for which he pays a rent (10 paise),he
employs a labourer and he gives wages (15 paise) to him ,he has taken a loan from a bank, for which he
has to give interest (10paise) and then whatever is left after paying rent, interest and wages, he gets it as
his profit (15 paise).All this is repeated at every stage. So when we add factor incomes generated at each
stage, we get GDP by In- come Approach.

Expenditure Approach

Here GDP is considered as sum of Expenditure. There are three different types of expenditures:

1. Private Consumption Expenditure (C):

It is the monetary value of goods & services purchased by households or individuals or nonprofit
institutions like gurudwaras during a time period. It is divided in 3 sub categories:
I. Consumer services: e.g. Banking, transport, education etc.
II. Consumer non-durable goods: e.g. Food, Clothes etc., these goods are used in very short span
of time.
III. Consumer durable goods: e.g. Fridge, T.V. etc., they are used for longer period of time. But
durability doesn‘t imply a state of permanence. Durable goods also have a limited period of use
value after which they are discarded. Private consumption expenditure adds up the expenditure of
all the 3 categories above.

2. Investment (I): It includes four categories:

a) Business fixed investment: Amount spent by business units on purchase of new machinery.
b) Inventory investment: Net change in inventories of final goods awaiting sale. These must be
included since they represent currently produced output but are not included in the current sale of
final output. The difference between goods produced and goods sold in a year is called inventory.
c) Residential construction investment: Amount spent on building housing units.
d) Public investment: It includes all capital formation carried by government for the construction of
roads hospitals etc. Total investment will be sum total of all the above investment.

3. Government purchase of goods & services (G):

It includes the government spending on goods & services. e.g. salaries. At the same time
government makes payments to certain categories of people to compensate them. E.g. Pension,
scholarships etc. food coupons, direct benefit transfers. They are called transfer payments or
Government transfers. They aren‘t counted in the GDP because there is no production of goods or
services. Money is just getting transferred from government account to the beneficiary account.

4. Net Exports = Exports (X) – Imports (M)

GDP = C + I + G + (X – M) - Growth, Boom, Slowdown and Recession

Suppose the following figures represent GDP numbers over a period of consecutive years:

Growth: 100 → 105→112→121→135

(Here 100,105 etc. are considered as GDP) i.e. increase in GDP over a period of time

Boom: 100→110→125→150→250 i.e. increase in GDP by leaps and bounds

Slowdown: 100→110→118→120→121 i.e. increase in GDP but at a decreasing rate

Recession: 100→95→85 i.e. fall in GDP Technically speaking, recession is fall in GDP over two
consecutive quarters.

*In Economy all comparisons are made with the previous year. GDP growth will be measured by com
paring GDP of this year with the GDP of previous year. Quarterly GDP growth is calculated by comparing
GDP of a particular quarter with the same quarter of the previous year.
 14 Basics of Economy

Business Cycle

Growth Boom

Govt. intervention

Recovery Recession

An economy moves from growth to boom then to recession then to recovery and then back to growth. It
moves from growth to boom and then to recession itself .i.e. with help of market forces of supply and
demand. But it cannot move out of recession itself. Here there will be requirement of active intervention
by the government in the form of a stimulus package.

A stimulus is an attempt by policymakers to kick- start a sluggish economy through a package of

measures. A monetary stimulus will see the central bank expanding money supply or reducing interest
rates to encourage consumer spending. A fiscal stimulus is one in which the government spends more
from its own pocket or slashes tax rates or gives loan waivers.
Stimulus package puts more money in the hands of consumers and spending goes up – thereby
encouraging demand & growth.

So the package will involve decrease in tax rates, loan waiver, and decrease in interest rates and
increased government spending especially on infrastructure creation.

Stimulus package 2008- After the 2008 Sub-prime crisis India, like many other countries provided a fiscal
stimulus package. It included excise duty cuts, infrastructure financing, government employee pay revision
and big ticket government purchases.

Consequently growth revived from 6.7% in FY09 to 8.9% in FY11. But at the same time, fiscal deficit (will
be discussed in fiscal policy chapter) of the government for FY09 rose to nearly 8% of GDP, from the
projected 2.5%.

GNP (Gross National Product)

It is the value of output produced by the nationals of a country both within the geographical boundary and
outside. Income is calculated as part of GNP on the basis who owns the factors of production rather than
where the production takes places.

The difference between GDP and GNP is that GNP includes net factor income from abroad. Therefore if we
have to get GDP from GNP, we should subtract net factor income from abroad (NFIA) from GNP. Or to
calculate GNP, we add the income of Indians from abroad and subtract the contribution of foreigners in
India‘s GDP.

GNP = GDP + (Factor income earned by the domestic factors of production employed in the rest of the
world) minus (Factor income earned by the factors of production of the rest of the world employed in the
domestic economy).

GNP = GDP + NFIA (net factor income abroad).

The items counted in income from abroad are:

1. Net exports: It is (exports minus imports). In India‘s case, it is negative because we import more than
what we export.

2. Interest of external loans: India takes more loans than it provides to other countries. Therefore,
India gives more interest on external loans takes as compared to the interest what it earns on the loans
given to other countries. So, the interest is overall negative in India‘s case. Net interest = interest taken –
interest given = –ve (India gives more interest)
 Basics of Economy 15

3. Income from entrepreneurship and returns on investments (FDIs/FIIs) like dividends and
interest: Negative in case of India. There are more foreign companies investing in India as compared to
Indian companies investing abroad. Moreover the amount invested by foreign companies is greater
compared to what Indian companies invest abroad. Therefore, the returns on investments of foreign
companies are larger. Net income is equal to Indian companies getting return on investment from abroad
minus foreign companies getting return on investment made in India

4. Private remittances: It is that net outcome (result) of money which inflows and outflows on account
of private transfers by Indians working outside (sending money to India) and foreign nationals working in
India (sending money to their homeland). In India‘s case, it is always positive due to large remittances
(India is the largest receiver of remittances in the world) sent by Indians especially from Gulf region, US,
EU etc. In India, the Balance of above four points comes out to be negative and hence NFIA in India is
negative.
GNP = GDP + NFIA
GNP (India) = GDP (India) – NFIA
GDP (India) > GNP (India)
GNP is the national income according to which IMF ranks the nations of the world.

Net Investment, Depreciation, Net domestic product (NDP)

That part of the final output which comprises of physical capital goods is called gross investment. So
investment is not measured as money put in business or any economic activity but it is basically that
portion of the final output which consists of capital goods. Suppose there is only one factory in a country
which is worth of 1 lakh and is producing consumption goods worth of 700rupees and capital goods worth
of 300 rupees in a particular year. This means the GDP will be Rs. 1000 (which is total production of both
consumption and capital goods) and gross investment in the economy will be Rs. 300 or (Rs. 300/Rs.
1000) 30%, as investment is measured as the percentage of output which consists of capital goods.

If the country imports capital goods worth of Rs. 100, then the gross investment will be Rs. 300 + Rs.100
i.e. Rs. 400 and investment %age will be Rs. 400/Rs/1000 or 40%.This is because Rs.100 worth of capital
goods is added in the economy. But if we also export capital goods worth of Rs. 40, then gross investment
will be (Rs.300 + Rs.100 – Rs.40) i.e. Rs.360 and investment percentage will be 36%. Investment in the
economy is also called Gross Fixed Capital Formation. Which mainly refers to the value of new machinery
and equipment plus the value of new construction activity undertaken during the year? Investment also
includes net acquisition of valuables like precious articles, gems and stones, silver, gold etc.

Now, when the factory runs for a year, then wear and tear happens in the factory which is called
depreciation. Depreciation is also defined as consumption of physical capital. In the above example,
rupees 1lakh worth of capital goods produce Rs. 700 worth consumption goods and Rs.300 capital goods.
But during this production process suppose there is wear and tear of Rs.50 in the factory. This implies that
to produce Rs.700 of consumption goods and Rs.300 of capital goods there is a loss of Rs.50 of capital
goods in the economy i.e. net production of capital goods (investment) in the economy is Rs.300 minus
Rs.50.
Net Investment = Gross Investment- Depreciation = Rs. 300 – Rs. 50 = Rs. 250 Net Domes- tic product
(NDP) = GDP – Depreciation =1000 - 50 = Rs.950

Let us understand depreciation with another example. I bought a car in 2005 for 10 lakhs. It would go up
to 2015. (Life time 10 years).I included 10 lakh in 2005‘s GDP. Each year I‘m taking out 1 lakh from the
GDP. By the end of 10 years, the GDP would be balanced in expenditure.

Unlike intermediate goods, which are consumed entirely in the process of making final goods, the capital
goods are only partially depleted in making final goods. If a steel mill may have a useful life of 50 years,
then in providing steel in one year, only a small portion (1/50th) of the mill is used. This using up of
capital is called Depreciation.

Depreciation is the value of the existing capital stock that has been consumed in the process of producing
output. The inclusion of capital goods (steel mill or cars) in the final product along with the goods (steel
and services, taxi services) produced by them would involve double counting. Therefore it is important to
make provision for depreciation. If every year we deduct from investment (hence from the domestic
product) the amount by which the capital stock has been used up over the years, then over the whole life
span of the capital good we‘d have deducted from the domestic product the whole value of the capital
good.
 16 Basics of Economy

In this way, we will avoid counting in the domestic product both the asset and goods & services produced
by and so shall have avoided double counting.

NDP = GDP – Depreciation NNP = GNP – Depreciation

GDP at Market price and GDP at factor cost Market price refers to the actual transacted price and it
includes indirect taxes like excise duty and custom duty. Factor costs are the actual production cost at
which goods and services are produced by an industry in an economy. They are really the cost of all the
factors of production (Land, Labour, Capital, Entrepreneur).
Market price = factor cost + indirect taxes – subsidies Net Indirect Taxes = Indirect taxes – subsidies
@ M.P means at market prices @ F.C means at factor cost
GDP=GDP + Indirect Taxes – subsides GDP @M.P = GDP@F.C + indirect taxes – subsidies GDP @M.P =
GDP @F.C + Net Indirect Taxes

Nominal GDP and Real GDP

If the GDP or any other related aggregates is measure in terms of current market prices then it is called
nominal GDP.
Nominal GDP includes the influence of inflation on the prices. Nominal GDP will change when either the
overall price level changes or when actual volume of production changes or when both change
simultaneously.

Real GDP is calculated at constant prices i.e., prices of the base year. In this method, the GDP value is
expressed in terms of prices prevailing in a year chosen to be a base year. In the above example, 2015 is
taken as the base year and prices of 2015 are called base prices or constant prices.

Base year is chosen as the year where there isn‘t much fluctuation in internal & external level. When final
goods and services included in GDP are valued at current market prices, i.e., prices prevailing in the year
for which GDP is being measured, it is called GDP at current market prices or Nominal GDP, For example.
Nominal GDP of 2012-13 is the value of output produced in 2012-13 at the market prices that prevail in
2012-13.

On the other hand, when goods and services included in GDP are valued at constant [fixed) prices, i.e.,
prices of the base year, it is called GDP at constant prices or Real GNP. For example real GDP of 2012-13
is the value of output produced in 201213 measured at base year‘s (say 2004-2005) prices. Constant
prices refer to prices prevailing in some carefully chosen year called base year. Mind, a base year is a
normal year devoid of price fluctuations. Presently in India, 2011-12 is taken as the base year for
estimating GDP (or any other related aggregate) at constant prices.
 Basics of Economy 17

Advantages of Real GDP

It is useful in finding out the effect of increased production of goods & services on the real development
capacity of the economy.
It helps to make a year to year comparison of changes in the growth of output of goods and services.
Real GDP is often used in making international comparisons of economic performance across the countries.
The purpose of using constant prices is to eliminate the effect of price changes. Therefore we express the
value of current year‘s GDP (Nominal GDP) in terms of prices prevailing during a reference year in the
past, called the base year. That means the account of the value of current year‘s GNP as if the price level
is same as that of the base year.

National Income = Real NNP@ market price

We can have aggregates like Real GDP @F.C, Real GDP @M.P, Nominal GDP @F.C and Nominal GDP @M.P.
Suppose for the base year 2011-12 ,only 1 fan is produced and its factor cost is 100 [Link] Indirect
taxes for 2011- 12 is Rs.10.
Now in 2017-18, suppose 7 fans are produced and the factor cost of each fan has increased to Rs.700
(due to inflation) and net indirect taxes collected in the year 2017-18 is 80 rupees.
Then, for the year 2017-18; Real GDP @ F.C = 7 x 100 = 700(GDP calculated at base prices without
adding any taxes) Real GDP @M.P = 7 x 100 + 80 = 780(GDP calculated at base prices but adding indirect
taxes of the year 2017-18)
Nominal GDP @FC = 7 x 700 = 4900 (GDP calculated at current prices but without adding any taxes)
Nominal GDP @M.P = 7 x700 + 80 = 4980(GDP calculated at current years prices and also adding current
years collection of net indirect taxes)
So, Real GDP @F.C will increase as compared to previous year only when production increases.
Real GDP @M.P increases compared to previous year if either the production increases or if current year‘s
net indirect tax collection is more as compared to previous year.
Nominal GDP @F.C will increase as com- pared to previous year when production increases or when the
prices increase. Nominal GDP @M.P increase as compared to previous year when production increases or
when the prices increase or when current year‘s net indirect tax collection is more as compared to
previous year.

GDP deflator
It is a comprehensive measure of inflation implicitly derived from National accounts data as the ratio of
nominal GDP to real GDP.
It‘s positive side is that it isn‘t limited to a basket goods as in WPI (wholesale price index) or CPI(-
Consumer price index)(explained in Inflation chapter) but encompasses all the goods produced in the
country.
But its negative aspect is that it is available on annual/ quarterly basis, while WPI or CPI based inflation
data comes out monthly.
GDP deflator = Nominal GDP × 100

Real GDP
e.g. A price deflator of 200 means that the current year price is twice its base year‘s price. That means
GDP deflator is a measure of inflation.

Per Capita Income

It measures the average income earned per person in a given country in a specified year. It is calculated
by dividing the country‘s total income by its total population.

Per capita income = Net National Product at factor cost Population

National Income Current Updates

CSO in January 2015,released the new and revised data of National Accounts, effecting two changes: The
Base Year was revised from 2004-05 to 2011-12 The methodology of calculating the national Accounts has
also been revised in line with the requirements of the System of National Accounts (SNA)-2008,an
internationally accepted standard.

New method (CSO 2015 reforms)

UN, WB, IMF, OECD (Organisation of economically developed countries) and European Commission have
collaborated to give System of National ac- counts (SNA) and have advised the countries to keep their
national accounts in this format. In this method, we calculate GVA and then GDP.
 18 Basics of Economy

Earlier in income method:

Total income = Wages + Profit + Rent + Interest But under the new method, we will add, compensation to
employees + Mixed income / operating surplus (earlier profit) + consumption of fixed capital

Compensation to employees
It includes wages plus any social security benefit given by the employer like Provident fund contribution or
insurance premium paid by the employer.

Operating Surplus/Mixed Income Operating surplus or mixed income: is a measure of the surplus
accruing from processes of production before deducting any explicit or implicit interest charges, rent or
other property incomes payable on the financial assets, land or other natural resources required to carry
on the production. The surplus so arrived in the case of incorporated enterprises is called operating
surplus. The surplus arrived in the case of unincorporated enterprises is called mixed income.

Incorporated enterprises: refer to enterprises that are established as a separate legal entity. A
separate legal entity is an entity which can be treated like a human being. It is capable of entering into
contracts and on failure of its contract it can be sued in a court. eg. Companies and Limited Liability
Partnerships (LLPs) registered under the Companies Act. If the legal entity is not able to repay the
borrowed loan, the investors or promoters of the legal entity is not responsible to repay the loan availed
by the [Link]. For the default of Kingfisher Airlines Ltd., Vijay Mallaya cannot be held responsible
unless it is proved that Vijay Mallaya misused his position and misappropriated the borrowed funds.

Unincorporated enterprises: are enterprises that are not incorporated as separate legal entity. There is
no distinction between the owners/investors and the entities. eg. Proprietorship concerns, partnership
concerns. The proprietorship concerns cannot enter into any contract. They cannot borrow. Everything
should be done in the name and by the owner/investor.

The unincorporated enterprises are owned by house- holds in which the owner(s) or members of the same
household may contribute unpaid labour inputs of a similar kind to those that could be provided by paid
employees. The households do not charge separately for the labour contributed by them for their own
enterprises. They take the entire surplus. The surplus is described as mixed income because it implicitly
contains an element of remuneration for work done by the owner, or other members of the household,
that cannot be separately identified from the return to the owner as entrepreneur. Only workers and
labourers get wages and entrepreneurs get profit but what about the not registered, non-organised agro
and cottage industry.

How will we decide that how much has come from wages and how much Money has come from profit? For
all those companies which don‘t distinguish between wages and profit, concept of mixed income will be
used. For companies which follow standard accounting, operating surplus would be used.

Consumption of fixed capital

It is the decline in the current value of the stock of fixed assets owned and used by a producer as a result
of physical deterioration. The plant and machinery fall under the category of capital assets. It undergoes
wear and tear in the manufacturing process. It is a sort of consumption. It is called consumption of fixed
capital.
GVA @F.C = Compensation to employees + Consumption of fixed capital + (Mixed Income/Operating
Surplus)
GVA@ basic price = GVA @F.C + production taxes – production subsidies

Production Tax and Production Subsidies: They are paid to the government or received by the people
or firms with relation to production and are independent of volume of actual production.
Production taxes are given even if the products are not produced. Eg of production taxes are stamp duty,
land revenue, registration fees, professional tax etc. Production subsidies include subsidies on irrigation,
free electricity to farmers etc.
GDP = GVA @basic price + Product tax – Product subsidy
GDP = GVA @ F.C + production taxes + product taxes – production subsidies – product subsidies
This is same as GDP @M.P
Therefore, India‘s current GDP is Real GDP @M.P and GDP before 2015 reforms, it was Real GDP @F.C
Product taxes are dependent on volume of production. e.g. excise tax, VAT.
Product subsidies are dependent on volume of production. e.g. food subsidy, petroleum subsidy.
Before 2015, CSO was not using market prices to calculate GDP, rather it was using factor cost. But now
as per global best practices, India‘s GDP will be calculated at market prices. So now Real GDP at market
prices is our GDP, while earlier it was Real GDP at factor cost.
 Basics of Economy 19

Purchasing Power Parity

Purchasing Power parity is defined as the number of units of a country‘s currency required to buy the same
basket of goods and services in the domestic market as one dollar would buy in the US.
PPP is an attempt to work out how much currency will be needed to buy the same basket of goods and
services in different countries. It reflects the underlying exchange rate between the two different countries
for buying goods and services, and a more.
Suppose, India‘s GDP is Rs.1000 and market ex- change rate is 1$= 50 Rs. Then in dollar terms, India‘s
GDP is 1000/50 = 20$.
Now suppose, price of 1 apple in USA is 1$ i.e. 1 Apple = 1$
And price of same apple (basket of goods) in India is
Rs.25. i.e 1 Apple = Rs.25.
So 1$ buys same amount of goods in USA as 25 Rs. in India. We can say that purchasing power of 1$ is
equal to purchasing power of 25rupees. i.e. 1$= 25 rupees.
So if we calculate GDP of India at purchasing power parity (parity means equality),it is 1000/25= 40$.
GDP of every country is measured using market ex- change rate and purchasing power exchange rate,
where it is called GDP at PPP (purchasing power parity). The PPP exchange rates help to minimize
misleading international comparisons that can arise with the use of market exchange rates.

Terms that are excluded from GDP measurement

1. Purely Financial transactions:

These are of 3 types:
i. Buying and selling of securities- In financial
markets, people buy and sell financial assets
such as shares. When someone one buys a
share from other person, there‘s only transfer of
ownership. There is no production activity but
only exchange of funds. Hence the value of
shares and bonds is not included in GDP. But the
interest earned on bonds and dividend on shares
is included in GDP.
ii. Government transfer payments Pensions,
Scholarships, ad-hoc assistance in calamities like
floods, subsidies given directly to the beneficiary
are not added in GDP as there is no production
of any good or service. There is only transfer of
funds from government‘s account into the beneficiary‘s account. These payments are called
government transfer payments.
iii. Private transfer payments- e.g. Pocket money.

2. Selling of used goods:

Price of second hand goods is not included in GDP as their price has already been included and adding
their price in GDP would result in double counting.

3. Non market goods and services:

Many final goods and services are not acquired through regular market transactions. e.g., Vegetable
grown in personal garden instead of being bought from supermarket or electrical fault repaired by house
owner himself instead of an electrician.
GDP includes only those transactions that occur through market.
Bartar transactions or production for self-consumption of households aren‘t included in GDP. Value of work
done by housewives isn‘t included in GDP.

4. Illegal activities:
GNP doesn‘t include trade in illegal services. Even though they are final goods and are purchased in
market transactions. e.g. Smuggling, Gambling etc. These illegal activities create an underground
economy or parallel economy wherein production is unreported or unaccounted because either it is
unlawful or those who are involved want to evade the tax net. As a result these illegal and hidden
transactions create a huge volume of unaccounted money called Black Money.

i. Environmental cost GDP estimation doesn‘t account for environmental cost incurred E.g. River
water degradation due to discharge of chemical waste
 20 Basics of Economy

Limitations of GDP as a measure of welfare

 It doesn‘t value intangibles like leisure, quality of life etc.
 Impact of growth can be harmful for the environment.
 It can also cause lifestyle diseases. E.g. Obesity
 It only gives average figures that causes stratification (it makes layers).
 Economic inequality is not revealed by GNP figure.
 Condition of poor is not indicated
 Doesn‘t show gender disparity
 Doesn‘t measure sustainability of growth

Green GNP

GNP (or GDP) does not take into consideration the cost in terms of-
(i) Environmental pollution and,
(ii) Depletion of natural resources caused by production of output. Mere increase in GNP will not reflect
improvement in quality of life if it increases environ- mental pollution or reduces available resources
for future generations. That is why the concept of Green GNP has been introduced. Green GNP is
defined as ―GDP which is an indicator of a sustainable use of natural environment and equitable
distribution of benefits of development.‖

This concept denotes the following characteristics,

(i) Sustainable economic development, i.e.,
development which should not cause environmental
degradation (pollution) and depletion of resources,
(ii) Equitable distribution of benefits of development,
(iii) Promote economic welfare for a long period of time.

World Bank‟s Classification of countries- World

Bank classifies the world‘s economies based on
estimates of Gross National Income/Product (GNI/GNP)
per capita based on nominal exchange rate. The GNI per
capita estimates are also used as input to the world
bank‘s operational classification of economies that
determines lending eligibility.
As per the 2015 data, the following is the classification
of world‘s economies.
High income à GNI per capita > $12475

Middle In- come:

Upper Middle à $4035<GNI per capita<$12475 Lower Middle à$1025<GNI per capita<$4035
Low Income à GNI per capita < $1025 India belongs to the Lower Middle group as its GNI per capita is
$1582 in terms of nominal exchange rate. As per the PPP exchange rate, India‘s GNI per capita is $5350.

IMF‟s Classification of countries

The world Economic Outlook (WEO, IMF) classifies the world into two major groups:
i. Advanced economies
ii. Emerging market and developing economies

The above classification is based on three parameters:

1. PCI (Per capita income) using PPP exchange rate
2. Export diversification
3 .Degree of integration into the global financial system

Least Developed Countries, Developing Countries, and Developed Countries

The least developed countries (LDCs) are countries that, according to the United Nations, exhibit the
lowest indicators of socioeconomic development, with the lowest human development index (HDI) ratings
of all the countries in the world. The concept of LDCs originated in the late 1960s. A country is classified
among the LDCs if it meets three criteria:
 Basics of Economy 21

1. Poverty: An adjustable criterion based on the per capita averaged over three years. As of 2015, a
country must have GNI per capita less than $1035 to be included on the list and over $1242 to
graduate from it.
2. Human resource weakness (based on the indicators of nutrition, health, education, and adult
literacy).
3. Economic vulnerability (based on the instability of agricultural production, instability of exports of
goods and services: economic importance of non-traditional activities, merchandise export
concentration, and the percentage of population displaced by natural disasters).

The LDC criteria is reviewed every 3 years by the Committee for Development Policy (CDP) of the UN
Economic and Social Council (ECOSOC). Countries may graduate out of the LDC classification when
indicators exceed these criteria.

A developing country, also called a less developed country or an under developed county is a nation or a
sovereign state with a less developed industrial base and a low HDI relative to other countries. There are
no universally agreed criteria that make a country developing or developed, although there is general
reference points such as a nation‘s GDP per capita compared to other nations. Less developed country is
general term and should not be confused with the specific term, least developed country. The definition of
least developed country is given by the United Nations. A developed country ,industrialized country, or‗,
more economically developed country`(MEDC), is a sovereign state that has a highly developed economy
and advanced technological infrastructure relative to other less industrialized nations.

Most commonly, the criteria for evaluating the degree of economic development are GDP, per capita
income, level of industrialization, amount of wide- spread infrastructure, and general standard of living.
Criteria are to be applied, and which countries can be classified as being developed are subjects of debate.
Developed countries have postindustrial economies, meaning the service sector provides more wealth than
the industrial sector.

ICOR (Incremental Capital Output Ratio)

Capital output ratio = Capital /Output
ICOR is defined as incremental / additional capital required to produce one additional unit of output. ICOR
is how much extra unit of capital is required to produce one additional unit of output. It represents how
efficiently capital is being used in a country to produce output.
Change in Capital
ICOR 
Change in Output
If ICOR of India is 4, that means India requires Rs.4 of capital goods to produce Rs.1 of additional output.
The higher the ICOR, the lower is the productivity of capital. Thus, a high ICOR can be considered as a
measure of the inefficiency with which capital is used. In India, ICOR is little above 4.
ICOR is influenced by a number of factors such as technology, skill of the labour force, which in turn
depends on the quality of the education sys- tem and ease of doing business. Bureaucratic hurdles, which
impede speedy execution of projects need to be removed. Thus improving the productivity of capital
requires steps at several fronts. Economic growth de- pends on investment rate and ICOR.
In other words, Economic Growth = Investment rate / ICOR If investment rate is 36% and ICOR is 4, then
economic growth = 36%/4 = 9%. But if we decrease the ICOR to 3, then with same investment, we will
get a economic growth of 12%. During the credit boom time (20032008) in India, Investment rate was
around 36% and ICOR was 4.4, so we were growing at around 8%.

C. GROWTH AND DEVELOPMENT

Growth and Development is not the same thing. Neither is necessary for the other. To grow is to increase
in size or number. To develop is to increase one‘s ability and desire to satisfy one‘s own needs and
legitimate desires and those of others. A legitimate desire is one that, when satisfied, does not impede the
development of anyone else. Related to these two terms is Economic Growth and Economic Development
Economic Growth is a narrower concept than economic development. It is an increase in a country's real
level of national output which can be caused by an increase in the quality of resources, increase in the
quantity of resources & improvements in technology or in another way an increase in the value of goods
and services produced by every sector of the economy. Economic Growth can be measured by an increase
in a country's GDP (gross domestic product).

Economic development is a normative concept i.e. it applies in the context of people's sense of morality
(right and wrong, good and bad). The definition of economic development given by Michael Todaro is an
increase in living standards, improvement in self-esteem needs and freedom from oppression as well as a
greater choice. The most accurate method of measuring development is the Human Development Index
 22 Basics of Economy

which takes into account the literacy rates & life expectancy which affects productivity and could lead to
Economic Growth. It also leads to the creation of more opportunities in the sectors of education,
healthcare, employment and the conservation of the environment. It implies to an increase in the per
capita income of every citizen.

Economic Growth does not take into account the size of the informal economy. The informal economy is
also known as the black economy which is the unrecorded economic activity. Development alleviates
people from low standards of living into proper employment with suitable shelter. Economic Growth does
not take into account the depletion of natural resources which might lead to pollution, congestion &
disease. Development however is concerned with sustainability which means meeting the needs of the
present without compromising future needs. These environmental effects are becoming more of a problem
for Governments now that the pressure has increased on them due to Global warming.

 Growth – the quantitative increase in size or throughput of biophysical matter. Daly has argued
economic growth is based on the ―limitless transformation of natural capital into man-made
capital‖.
 Development – the qualitative improvement in economic welfare from increased quality of goods
and services as defined by their ability to increase human wellbeing. This infers promoting
increased economic activity only insofar as it does not exceed the capacity of the ecosystem to
sustain it.

Measuring Development
Although economists were able to articulate the difference between growth and development, it took some
more time when the right method of measuring development could be developed.
The Human Development Index (HDI) is a composite statistics of life expectancy, education, and income
indices to rank countries into four tiers of human development. It was created by economist Mahbub-ul-
Haq, followed by economist Amartya Sen in 1990, and published by the United Nations Development
Programme.

In its 2010 Human Development Report, the UNDP began using a new method of calculating the HDI. The
following three indices are used:
1. Life Expectancy Index
2. Education Index: It includes
 Mean Years of Schooling Index
 Expected Years of Schooling Index
3. Income Index
4. Finally, the HDI is the geometric mean of the above three normalized indices.
Mean years of schooling: Years that a 25-year-old person or older has spent in schools Expected
years of schooling: Years that a 5-year-old child will spend with his education in his whole life
5. Inequality-adjusted HDI:
6. The 2010 Human Development Report was the first to calculate an Inequality-adjusted Human
Development Index (IHDI). The HDI represents a national average of human development
achievements in the three basic dimensions making up the HDI: health, education and income.
Like all averages, it conceals disparities in human development across the population within the
same country. Two countries with different distributions of achievements can have the same
average HDI value. The HDI takes into account not only the average achievements of a country on
health, education and income, but also how those achievements are distributed among its citizens
by ―discounting‖ each dimension‘s average value according to its level of inequality.

Criticism of HDI index

The Human Development Index has been criticized on a number of grounds including alleged ideological
biases towards egalitarianism and so-called ―Western models of development‖, failure to include any
ecological considerations, focus on per capita in- come which depends on GDP only, lack of consideration
of technological development or contributions to the human civilization, focusing exclusively on national
performance and ranking, lack of attention to development from a global perspective, measurement error
of the underlying statistics, and on the UNDP‘s changes in formula which can lead to severe
misclassification in the categorisation of ‗low‘, ‗medium‘, ‗high‘ or ‗very high‘ human development
countries.

GDI (Gender development Index)

Female HDI / male HDI. It is the ratio of female HDI to male HDI. Estonia, Latvia, Russia etc. have
GDI>[Link] means women are more developed in these countries as compared to men.
 Basics of Economy 23

Gender Inequality index

Gender inequality remains a major barrier to human

development. Girls and women have made major strides since
1990, but they have not yet gained gender equity. The
disadvantages facing women and girls are a major source of
inequality. All too often, women and girls are discriminated
against in health, education, political representation, labour
market, etc. with negative repercussions for development of
their capabilities and their freedom of choice.
The GII is an inequality index. It measures gender inequalities
in three important aspects of human development—
1. Reproductive health, measured by maternal mortality
ratio and adolescent birth rates;
2. Empowerment, measured by proportion of parliamentary seats occupied by females and proportion
of adult females and males aged 25 years and older with at least some secondary education;
3. Economic status, expressed as labour market participation and measured by labour force
participation rate of female and male populations aged 15 years and older.
The GII is built on the same framework as the IHDI — to better expose differences in the distribution of
achievements between women and men. It measures the human development costs of gender inequality,
thus the higher the GII value the more disparities between females and males and the more loss to human
development.

Multi-Dimensional Poverty Index

The Global Multidimensional Poverty Index (MPI) was

developed in 2010 by the Oxford Poverty & Human
Development Initiative (OPHI) and the United Nations
Development Programme and uses different factors to
determine poverty beyond income-based lists. It complements
the previous Human Poverty Index. The global MPI is released
annually by OPHI.
The global Multidimensional Poverty Index (MPI) is an
international measure of acute poverty covering over 100
developing countries. It complements traditional income-based
poverty measures by capturing the severe deprivations that each person faces at the same time with
respect to education, health and living standards. The MPI assesses poverty at the individual level. If
someone is deprived in a third or more of ten (weighted) indicators, the global index identifies them as
‗MPI poor‘, and the extent – or intensity – of their poverty is measured by the number of deprivations they
are experiencing. The MPI can be used to create a comprehensive picture of people living in poverty, and
permits comparisons both across countries, regions and the world and with- in countries by ethnic group,
urban/rural location, as well as other key household and community characteristics.
These characteristics make the MPI useful as an analytical tool to identify the most vulnerable people - the
poorest among the poor, revealing poverty patterns within countries and over time, enabling policy
makers to target resources and design policies more effectively.

Indicators

The index uses the same three dimensions as the Hu- man Development Index: health, education, and
standard of living. These are measured using ten indicators.

Dimensions Indicators
Health • Child Mortality
• Nutrition
Education • Years of school
• Children enrolled
Living • Cooking fuel
Standards • Toilet
• Water
• Electricity
• Floor
• Assets
 24 Basics of Economy

Indicators used- The following ten indicators are used to calculate the MPI
• Education (each indicator is weighted equally at 1/6)
1. Years of schooling: deprived if no household member has completed six years of schooling
2. Child school attendance: deprived if any school-aged child is not attending school up to class 8
• Health (each indicator is weighted equally at 1/6)
3. Child mortality: deprived if any child has died in the family in past 5 years
4. Nutrition: deprived if any adult or child for whom there is nutritional information is stunted.
• Standard of Living (each indicator is weighted equally at 1/18)
5. Electricity: deprived if the household has no electricity
6. Sanitation: deprived if the household‘s sanitation facility is not improved (according to MDG
guidelines), or it is improved but shared with other households
7. Drinking water: deprived if the household does not have access to safe drinking water
(according to MDG guidelines) or safe drinking water is more than a 30-minute walk from
home roundtrip
8. Floor: deprived if the household has a dirt, sand or dung floor
9. Cooking fuel: deprived if the household cooks with dung, wood or charcoal
10. Assets ownership: deprived if the household does not own more than one of: radio, TV,
telephone, bike, motorbike or refrigerator and does not own a car or truck

A person is considered poor if he is deprived in at least a third of the weighted indicators. The intensity of
poverty denotes the proportion of indicators in which they are deprived.

Gross National Happiness Index

Gross National Happiness is a term coined by His Majesty the Fourth King of Bhutan, Jigme Singye
Wangchuck in the 1970s. The concept implies that sustainable development should take a holistic
approach towards notions of progress and give equal importance to non-economic aspects of well-being.
GNH is a much richer objective than GDP or economic growth. In GNH, material well-being is important,
but it is also important to enjoy sufficient well-being in things like community, culture, governance,
knowledge and wisdom, health, spirituality and psychological welfare, a balanced use of time, and
harmony with the environment. It has the following parameters viz-
(i) Higher per capita income
(ii) good governance
(iii) environmental protection
(iv) cultural promotion (i.e. inculcation of ethical and spiritual values in life without which a program may
become a curse than a blessing).

Inclusive Development Index

Inclusive Development Index was released recently by the World Economic Forum. It has been developed
as a new metric of national economic performance. The index presents an alternative to GDP as GDP
measures current production of goods and services rather than the extent to which it contributes to broad
socio-economic progress as manifested in median household income, employment opportunity, economic
security and quality of life.
The Index on inclusiveness reflects more closely the criteria by which the people evaluate their countries
‗economic progress.
The index has three pillars of growth for global economies namely:
1. growth and development
2. Inclusion
3. Intergenerational equity and sustainability

Inclusive Growth
The inclusive growth as a strategy of economic development received
attention owing to a rising concern that the benefits of economic growth
have not been equitably shared. Now the agenda of inclusivity and
sustainability has become the focus of policy framework both at national
and international level. The approach of development through
―including‖ the general mass is directed towards a broad based growth,
shared growth, and pro-poor growth. This is the central idea of the
inclusive growth i.e. sharing of fruits of socio-economic development
with all sections of the society. Elimination of the extreme forms of
poverty and participation of the people is encouraged through the idea
of inclusive growth.
 Basics of Economy 25

Inclusive growth basically means making sure everyone is included in growth, regardless of their economic
class, gender and religion. Inclusive growth is economic growth that creates opportunity for all segments
of the population and distributes the dividends of increased prosperity to every section of the society. The
eleventh plan defines inclusive growth to be a growth process that yields broad based benefits and ensures
equality of opportunity for all. It stands for equitable development or growth with social justice. This
concept expands upon tradition- al economic growth models to include focus on the equity of health,
human capital, environment quality, social protection and food security.

Growth is inclusive when it takes place in the sectors in which the poor work(agriculture),occurs in places
where the poor live(undeveloped areas with few resources like slums and rural areas),uses the factors of
production that the poor possess (unskilled labour) and reduces the prices of consumption that the poor
consume(food, fuel, clothing).The equality of opportunity and participation in growth by all with a special
focus on the most vulnerable people of the society are the very basis of inclusive growth.

Inclusive growth refers to both the pace and the pattern of economic growth. There is a difference
between direct income redistribution or shared growth and inclusive growth.

The inclusive growth approach takes a longer term perspective as the focus is on productive employment
rather than on direct income redistribution, as a means of increasing income of excluded groups. In the
short run ,governments could use income redistribution schemes to reduce the negative impacts on the
poor of the policies intended to jump start growth, but transfer schemes cannot be a answer in the long
run and can be problematic also. In poor countries, such schemes can impose significant burden on
already stretched budgets and it is theoretically impossible to reduce poverty through redistribution.
Inclusive growth is therefore supposed to be inherently sustainable as distinct from income redistribution
schemes. While income distribution schemes can allow people to benefit from economic growth in short
run, inclusive growth allows people to contribute to and benefit from economic growth in a sustainable
manner.

The inclusivity involves four attributes. They are opportunity, capability, access and security. The
opportunity attribute focuses on generating more and more opportunities for the people and focusing on
increasing their income. The capability attribute concentrates on providing the means for people to create
or enhance their capabilities in order to exploit available opportunities. The access attribute focuses on
providing the means to bring opportunities and capabilities together. The security attribute provided the
means for people to protect themselves against a permanent or temporary loss of livelihood.

Inclusive growth is a process in which economic growth is measured by a sustained expansion in GDP
which contributes to an enlargement of the scale and scope of all four dimensions.

Rapid and sustained poverty reduction requires inclusive growth that allows people to contribute to and
benefit from economic growth. Rapid pace of growth is unquestionably necessary for substantial poverty
reduction, but for this growth to be sustain- able in the long run, it should be broad based across sectors
and inclusive of the large part of the country‘s labour force.

How can IG be achieved:

• Resource allocation: Without proper resource (financial/natural) allocation, the issues of poverty
and development can‘t be solved. Equitable sharing of resources is required.
• Employment generation: it is the most important strategy to achieve inclusive growth. It will have
to be in organized sector.
• Focus on agriculture:
• Skill building and capacity development
• Decentralization
• Good Governance (Transparency and accountability)
• Financial Inclusion
• CSR (Corporate Social Responsibility)
• Women empowerment
• Access to essential services
• Equality of opportunity of access to market and resources

Challenges to IG
• Defining the poor: Without a proper definition of poverty and Poverty line, policy framework for
inclusive growth can‘t be developed.
• Fiscal Deficit: Welfare schemes by the government will increase the fiscal deficit. Income
redistribution will also transfer the expenditure from Revenue expenditure to capital Expenditure.
 26 Basics of Economy

• Ill effects of LPG: LPG promotes MNCs, which are capital intensive, hence they don‘t create
adequate employment. Moreover MSMEs, which are labour intensive, don't stand a chance against
the MNCs.
• Infrastructure: Most of the infrastructure spending is for the industrial sector, while 55% of people
depend on agriculture. Moreover most of the infrastructure is developed in the urban areas, while
70% people live in the villages.
• Low technology and innovation

Policy approaches towards IG

• Growth oriented policy: can help with the help of trickledown theory
• Direct Intervention: can be done by legislation and credit facilitation. Social security schemes can
be started.
• Capacity building: focusing on skill development, education and health
• Welfare schemes: Food subsidies, PDS
• Public participation: with the help of civil society and encouraging formation of SHGs

Benefits of Inclusive growth

• Broad based and sustainable growth (sustainable at financial and environmental level both)
• Demographic dividend
• Decrease in incidents of violence, theft, naxalism
• Women empowerment
• To achieve the equity objective

TECHNOLOGICAL ACHIEVEMENT INDEX

The Technology Achievement Index is used by the UNDP (United Nations Development Programme) to
measure how well a country is creating and diffusing technology and building a human skill base, reflecting
capacity to participate in the technological innovations of the network age. The TAI focuses on four
dimensions of technological capacity: creation of technology, diffusion of recent innovations, diffusion of
old innovations, human skills.
• Technology creation, measured by the number of patents granted to residents per capita and by
receipts of royalties and license fees from abroad per capita.
• Diffusion of recent innovations measured by the number of Internet hosts per capita and the share
of high-technology and medium-technology exports in total goods exports.
• Diffusion of old innovations, measured by telephones (mainline and cellular) per capita and
electricity consumption per capita.
• Human skills, measured by the mean years of schooling in the population aged 15 and older, and
the gross tertiary science enrolment ratio.

Big Mac Index

1) A British Magazine "The Economist" has been publishing the Big Mac index since 1986. It was
introduced by Pam Woodall.
 Published annually since 1986.

2) What is the purpose of Big Mac Index?

 The Big Mac index compares the price of the Big Mac burger across countries, which helps to
measure purchasing power parity between two currencies.
 It provides a test of the extent to which market exchange rates result in goods costing the
same in different countries.

3) The Big Mac index is used to compare the price of a good across countries.
 The law of one price states that the price of a good sold internationally should converge as
entrepreneurs try to profit from any price discrepancy.

4) Drawback of the Big Mac index:

 Goods that look physically similar to each other may not necessarily be similar in their
economic nature.
5) Index gave rise to the word "burgernomics".

6) Some of the variants of Big Mac index produced on the same theme are:
i) Tall Latte Index: replaced Big Mac burger of Mac Donald's with a cup of Starbucks coffee in Jan
2004.
 Basics of Economy 27

ii) iPod index: Launched in 2007 by an Australian Bank comparing cost of iPod across various
countries but its drawback was that it didn't considered Shipping cost which varies country by
country.
iii) Billy index: Introduced by Bloomberg L.P where they convert local prices of IKEA's Billy
bookshelf into US dollars and compare the prices.
iv) Gold-Mac-Index: The value of the purchasing power for 1g of gold i.e how many burgers one
got for 1g gold.
v) The Chai Latte Global Index: Launched in 2017 by the comparison platform Versus, which
compared Starbucks Chai Latte prices worldwide, by first converting the local prices into USD.

SUSTAINABLE DEVELOPMENT AND GROWTH

Sustainable development (SD) refers to a mode of human development in which resource use aims to
meet human needs while preserving the environment so that these needs can be met not only in the
present, but also for generations to come. The term 'sustainable development' was used by the Brundtl
and Commission which coined what has become the most often-quoted definition of sustainable
development: "development that meets the needs of the present without compromising the ability of
future generations to meet their own needs."

Sustainable development ties together concern for the carrying capacity of natural systems with the social
challenges faced by humanity. As early as the 1970s, "sustainability" was employed to describe an
economy "in equilibrium with basic ecological support systems." Ecologists have pointed to The Limits to
Growth, and presented the alternative of a "steady state economy" in order to address environmental
concerns.
The concept of sustainable development has in the past most often been broken out into three constituent
parts: environmental sustainability, economic sustainability and sociopolitical sustainability.

The United Nations 2005 World Summit Outcome Document refers to the "interdependent and mutually
reinforcing pillars" of sustainable development as economic development, social development, and
environmental protection. Based on the triple bottom line, numerous sustainability standards and
certification systems have been established in recent years.

Green development is generally differentiated from sustainable development in that Green development
prioritizes what its proponents consider to be environmental sustainability over economic and cultural
considerations. Proponents of Sustainable Development argue that it provides a context in which to
improve overall sustainability where cutting edge Green Development is unattainable.

Inclusive green growth is the pathway to sustainable development. It is the only way to reconcile the rapid
growth required to bring developing countries to the level of prosperity to which they aspire, meet the
needs of the more than 1 billion people still living in poverty, and fulfill the global imperative of a better
environment.

D. HISTORY OF INDIAN ECONOMY

A. Gunder Frank has described the changes that took place under British Empire as ―development of
underdevelopment‖. This means that many changes were positive in nature in India under the British
Empire but they were aimed at taking India further towards underdevelopment by turning its growth
subservient to British interests.

The following changes were brought about by the British Empire in India:
 India was turned into a producer and exporter of raw materials and importer of finished goods.
The British wanted a ready market for their machine made goods. After Industrial revolution,
Britain had started producing machine goods in mass quantities. India emerged as a lucrative
market for finished goods produced in Britain‘s factories. The result was that Indian handloom and
handicraft industry was destroyed completely and India was left as a producer of primary products
for Britain‘s factories.
 A large part of India‘s surplus and savings was appropriated by the colonial state and misspent.
Very little was invested back for development of indigenous people. This was termed as ―Drain of
Wealth‖ by Dadabhai Naoroji. It is estimated that 5-10 percent of total national income of India
was unilaterally exported out of the country.
 The British government in India did not try to reduce Corruption in British administration at that
time. High Corruption had a direct impact on Indian lower and middle class but it served the
purpose of British government by looting Indian people and satisfying needs of British Officers in
 28 Basics of Economy

India. Indian posting became a highly lucrative one due to attached opportunities of making
money under the table. This served interests of the British in India but introduced a culture of high
corruption in government departments.
 Commercialization of agriculture- A large part of Indian agriculture was diverted from food crops to
cash crops. These cash crops were used by the British for producing finished goods, which were
then exported to different colonies of the British. Thus, India was reduced as a supplier of cash
crops for the British. This also affected the health of agriculture in food crops category. There were
no investments in using latest technology for food crop generation, which resulted in low yields per
hectare and low volume of food crops available for Indian people.
 Absence of capital goods and machine industries- In 1950, India met 90 percent of its needs of
machine tools through imports. This industrial backwardness was a legacy of the British. The
British Empire did not want to develop any kind of capital industry in India due to its interests in
turning India into an importer of machines made in Britain.
 Although the British laid down a web of roads and railways in India, the purpose of creating
transport infrastructure was to transport raw material from Interiors to the ports and to distribute
British finished goods to interiors of the country.

India‟s Economy at Independence

Indian economy at the time of independence was overwhelmingly rural and agricultural in character with
nearly 85% of population living in villages and deriving their livelihood from agriculture and related
pursuits.

The backwardness of Indian economy is reflected in its unbalanced occupational structure with 72 percent
of working population engaged in agriculture. Even with such a large proportion of working population
dependent on agriculture, India was not self-sufficient in food production.

Agricultural activities contributed nearly 50% to India‘s national income.

Low level of industrialization at independence is clear from the following statistics

Sector Contribution to National Income Employment

Agriculture 50% 72%
Industry 17% 11%
Services 33% 17%

The Agrarian Scene-

 As discussed above, agriculture stagnated and deteriorated during first half of 20th century due to
impact of colonialism.
 Per capita agricultural production (food and non-food) declined at a rate of 0.72% per year during
1911-41.
 Per capita food grain output declined by 29% (1.14% per year) in the period proving the level of
ignorance towards food grain output.
 After Independence, India had to import food grains equivalent to about 10 percent of its domestic
production. Despite having more than 70 percent of working population dependent on agriculture,
India had to rely on imported grains to feed its people.
 The agriculture sector was inflicted by POOR TECHNOLOGY, DRAIN OF CAPITAL AND
MONEYLENDING (zamindari and ryotwari systems)

The Industrial Scene-

 India experienced a long era of ―deindustrialisation‖ resulting in replacement of Indian exports of
handicrafts by imports of capital or producer‘s goods. The ruin of traditional trades and crafts was
a result of British commercial policy. Restrictions were imposed upon Indians exporting to the west
while favors were granted to British exporters who flooded Indian markets.
 At the same time, the capital goods industry was virtually absent in 1950 in India. Indian
industries had to rely almost wholly on imported machinery and machine tools. The ratio of
consumer to capital industries in 1950 was 62:38.
 In 1951, only about 2% of working population was employed in modern industries due to large-
scale illiteracy and deteriorating condition of industries.
 Similarly, modern banking and insurance were grossly underdeveloped. Indian entrepreneurs could
not mobilize resources for their development due to underdeveloped banking and British controlled
banks provided funds mainly to British controlled enterprises.
 Basics of Economy 29

In the absence of industrial revolution in India, introduction of Railways began a commercial

revolution, which further colonialized the Indian economy. Railways were made to promote export
of raw materials and import of finished. goods. It promoted British steel and machine industry by
making it easier to import and distribute the goods in internal parts of India.

Global scenario at the time of Independence:

 When India achieved Independence, the world was recovering from a nuclear World War II. Japan
had been defeated in the war and Hiroshima, Nagasaki were completely destroyed. The Russian
and German forces had damaged European countries immensely. United States was desperately
looking to revive European markets because their trade had been diminished to nothing due to war
ravaged European economy. In order to revive Europe, USA introduced what is called as
MARSHALL PLAN or European Recovery Plan. The objective of Marshall Plan was twofold- First, it
wanted to rebuild Western Europe so that trade between USA and Europe could flourish again.
Second, it wanted to limit the expansion of communism as it was considered a big threat for
capitalist ideology at that time.
 Ineffective International institutions were replaced with new Institutions and many new
Organizations were formed to start an era of economic and political union of the world. League of
Nations was replaced with ―United Nations Organization‖ to promote international co-operation.
 A new ―Nuclear Arms Race‖ started in the world after WW II. The communist bloc realized that it
could face the capitalist bloc only with Nuclear arms in its hands.
 Majority of colonies held by Europe gained Independence after WW II. Indonesia, Philippines, Arab
states and India were the major decolonized states after the end of 2nd WW.

Planning method on the eve of independence:

1. Planning commission was setup in 1950 to make an assessment of material, capital and human
resources of the country and to formulate a plan for most effective and balanced utilization of
these resources. Planning commission made 5 year plans as well as 20 year perspective plans.
2. The idea of creating 5-year plans was taken from Soviet economy. This method of five-year plan
led development was also adopted by other communist nations like China. India decided to adopt
this method of planning under its mixed economy system.
3. The Planning commission was created through an executive decision. This means that neither any
law was passed in the parliament for its creation nor was it mentioned in the constitution of India.
4. The planning commission was formed owing to Nehruvian view (derived from Fabian socialism)
that rapid development can be created by state economic activity and state led planning.
5. Early planning documents regarded the chief barrier to growth as low savings rate in India.
Savings rate were low on the eve of independence due to low earnings of people, widespread
poverty in the country and low growth rate limiting attractive opportunities for investments for
people with considerable income and savings.

Impediments identified by Indian Planners and steps decided for economic development:

Problems with Indian economy-

• Low savings rate- As discussed above, the savings rate in the economy was very low due to
widespread poverty and lack of investment opportunities. In order to direct material capital
towards investment, it was important that incomes are raised so that people can earn, save and
invest their savings towards economic advancement.
Savings can be invested through social security schemes like Pension funds and market
investment methods like Mutual Funds. At the time of Independence, these concepts were non-
existent in the country. Due to this, people with incomes were spending on consumption of
irrelevant material rather than saving for future gains.
• High dependence of population on Agriculture- 72 percent of working population was dependent on
agriculture for their survival. It was identified that agriculture was subject to diminishing returns
whereas industrialization had the potential to provide more productive employment and increasing
returns to scale.
• Little Private Investment- It was found that private investment in terms of entrepreneurship was
limited in nature due to limited funds in the hands of people. Thus, State led planned development
became a necessity to pick up investment in infrastructure, agriculture and industrial development.
• Social services- services like Education, Health, safe drinking water, basic banking services and
other basic needs were absent in the country due to exploitation by the British for two hundred
years. Majority of the population was illiterate, there was not enough food for everyone despite
 30 Basics of Economy

70% of working population being employed in agriculture, health care facilities were almost absent
and mortality rates were very high due to absence of hygienic living facilities.
• Internationally, it was being predicted that India would break apart in smaller states due to such
diversity of religions, ethnicities and cultures. Nowhere in the world had such a diverse country
ever existed as one nation. It was upon the nation-builders to prove this prediction wrong through
a modern, scientific and inclusive model of development.

INDIA between 1947- 70

Growth Experience-

During the first half of 20th century (under British Rule), India experienced a near stagnation in both per
capita income and national income. The reasons have been described in the first chapter as lack of
Investment in the economy, drain of wealth, widespread poverty and illiteracy and lack of modernization.
This trend of low growth was immediately turned around after Independence. India achieved a decent rate
of growth in terms of National income as well as per capita growth after independence. The growth in GDP
was 3.5% per annum on an average between 1950-1980. It picked up after 1980 and touched an average
of 5.6% per annum. The period between 1947- 1980 is often termed as ―Hindu rate of Growth‖ because
the performance of Indian economy in this era is termed as ―disappointing but not bad‖. Different
economists have divided trend of Growth in India differently. While some define the phases of growth as
1947- 1980 and 1980- present, others follow a different division according to policy changes by
segregating phases of growth as 1947-1991 and 1991- present. We will be talking about both divisions in
future chapters.

The following chart summarizes phases of growth in India.

Periodisation of Indian Growth Experience

Period Characterisation GDP Growth GFCF ICOR

(Annual Percentage (Column
Average (Annual Divided b
Average) Column 3)
(1) (2) (3) (4) (5)
1951-52 to 1964-65 The foundation years 4.1 11.6 2.8
1965-66 to 1969-70 The crisis years 3.0 14.2 4.7
1970-71 to 1979-80 The turbulent years 2.9 15.7 5.4
1980-81 - 1990-91 The transitional years 5.6 20.4 3.6
1991-92 - 2002-03 The reform years 5.5 22.9 4.1
2003-04 - 2007-08 The high growth years 8.8 30.2 3.4

The period between 1950–1965 is called as the period of foundational years. In this period, an industry
oriented strategy was followed with the onset of second five year plan. As discussed above, it was
assumed that underdevelopment in India was a factor of limited supply and not limited demand. In order
to overcome that limitation, a large industrial base was planned before second five year plan. It is
important to remember that this period was not marked by nationalization but by fresh public investments
by the government. Private sector was left to grow on its own. This period is called as period of
foundational years because seeds of large public investments were sowed and fruits of these seeds were to
be enjoyed later. Foundations of a capital based economy were laid in this period.

The period of 1965-1970 is the period of crisis due to two consecutive droughts that hit India in 1965 and
1966. After the droughts, the development strategy was changed and focus on agriculture was revived.
With this change in strategy, the green revolution became a reality and India turned self-sufficient in
agriculture production overtime. It is important to understand that this change in strategy in 1965 did not
mean abandonment of industries in India. The older development strategy through industrial development
continued all throughout with a renewed focus on fertilizer sector, which became important post green
revolution.

The crisis period saw the beginning of subsidies (food and fertilizer). While food subsidies entered the
economic landscape due to twin droughts, fertilizer subsidy became important to ensure success of green
revolution.
 Basics of Economy 31

The phase of 1970- 1980 is called as the phase of turbulence because of changes that emerged in 1970.
―Garibi Hatao‖ or ―poverty eradication‖ became the central theme of government. Economic performance
was given a backseat and populist changes became all the more important. Nationalization of banks in
1969, nationalization of Food Grain trade, introduction of differential interest rates in banking system, and
further tightening of MRTP act are some examples, which show that the government wanted to control
everything to make a difference.

Performance of Agriculture-

After Independence, land reforms were considered the most important step in agricultural reforms. It was
widely accepted that land reforms would result in a more productive agriculture system in India and free
agriculture of its evils.

Land reform had 4 important elements:

i. Abolition of intermediaries- zamindari system
ii. Tenancy reforms
iii. Ceiling on landholdings
iv. Consolidation of scattered landholdings

It was assumed that land reforms would make agriculture more productive and would help in redistribution
of land to the poor. It is important to understand that all four elements of land reform are connected to
each other. They were not isolated missions. Also, laws related to agriculture reform were made by states
and not by the centre because agriculture is a state subject. This brought in many variations and
inconsistencies in agriculture policy of states.

i. Abolition of intermediaries-

Before independence, the Indian rural economy was dominated by some big landowners who acted as
intermediaries between the British government and farmers. They could acquire lands by paying some
amount of money to the British government. The intermediaries had no direct connection with land and
agriculture, but they could capture land easily and this had no limit. So the small and marginal farmers
were exploited and forced to transfer land to the big landlords. The Intermediaries did the following to
Indian agriculture:
• They forced the tenants to provide demand free labour (forced labour/ Begari)
• They could evict tenants as per their whims and fancies. This resulted in no security of tenure.
• They enjoyed a lavish lifestyle and did not add anything to agriculture productivity/ development.
Yet, they charged high rent from tenants who worked on the farm

The sharecroppers also lost interest in farming because majority of their produce was taken away by
intermediaries. Under Zamindari system, the tax on land produce was as much as 11/12th of the entire
produce. Such high taxation and exploitation by intermediaries made it important that it be abolished.
After independence when the Government of India started agrarian reform, the main issue was the
abolition of intermediaries. Otherwise redistribution of lands would have been extremely difficult for the
Government. In the process of abolition of intermediaries, the government took the land from
intermediaries and compensated them for giving their land.
Due to the abolition of the intermediate classes not only more than twenty million farmers in India had
been connected directly with the government but also the tax revenue from the rural area increased.
The financial security of the farmers improved and as a result of that, productivity, advancement of
agriculture and rate of employment also increased.

ii. Ceiling on landholdings-

It was decided to put ceiling on how much land one person could hold in his/ her name. The purpose of
putting a ceiling on landholdings was to ensure an egalitarian agricultural system where farmers could own
a decent amount of land for tilling. Before independence, a small number of landowners held a large
amount of land. This gave rise to tenancy farming and also increased inequality within agriculture.
There were two rounds of land reform legislations concerning ceiling on landholdings-one in 1950s and
another in 1970s.
Ceiling on landholdings has been a limited success due to various reasons-
a. People could go over the law by transferring land among their family members and thus complying
with land ceiling
b. Land records are still not properly accounted for. Even after Internet revolution, the country has
failed in putting all land into records. Lack of land records about ownership of land made it
impossible to see who held more land than the land ceiling.
 32 Basics of Economy

iii. Tenancy reforms-

Tenancy reform refers to reforming of the system of tenancy wherein the owner could hire another person
to work the farm/ cultivate the soil and pay him/ her for his work. The produce belonged to the owner of
the land. Problems related to landlessness and poor tenants were highlighted in films made after
independence. Movies like Mother India showcased hardships faced by landless farmers and tenants.
There were 4 sub elements of tenancy reform. They tried to protect both the tenant and the landowner
from any form of exploitation.

a. Landowner‘s right to lease- it was realized that not every landowner can cultivate her land. Many
people owned land as wealth and worked in some other area to feed them. In that case, it was
important to give such landowners certain rights of leasing their land. All states made their own
laws of leasing and provided a regulated and restricted method of leasing to the people.
b. Tenant‘s right against eviction and high rent- there would be exploitation of tenant if he can be
evicted at whims and fancies of the landowner. Tenant‘s right over the cultivated land became an
important part of tenancy reforms. All states formulated their own set of laws to ensure tenant‘s
rights over the cultivated land.
c. Tenant‘s right to surrender- Tenancy reforms also included the provision of giving the right to
tenant to surrender the cultivated land back to the landowner, in case the tenant decides to buy
her own land or shift to another occupation.
d. Tenant‘s right to ownership- Tenancy reforms also wanted to ensure that the tenant could
purchase the land from the landowner with some pre-agreed or standard payment system. For
example, the tenant could purchase the land by paying twice the annual rent to the landowner.
Another example is that a tenant could purchase the land from landowner at market price if he/
she have worked for more than 12 years on the same land. This ensured that tenant‘s interest in
the land is not diminished.

Tenancy reform is still an incomplete process. Many states have completely abolished tenancy while others
have allowed it in a strictly regulated manner. It is important now to look at tenancy through a new lens
so that developments in agriculture over the past 4 decades can be taken into consideration and a more
realistic tenancy reform formula can be built.

iv. Consolidation of landholdings-

After independence, it was realized that one of the main reasons for low productivity is scattered
landholding. People owned too little of land to use modern mechanized methods and improve productivity
from their holding. ―Cooperative Farming‖ was recognized as a viable method of consolidating agricultural
land and also maintaining egalitarianism in agriculture by ensuring land for everyone. However, its failure
was recognized in fourth five-year plan and the programme was stopped after that.
Though many other steps have been taken under agriculture like Green revolution, drip irrigation and
Evergreen revolution, Land reform still remains the toughest and still incomplete reform measure, which
was established right after Independence

Food security before green revolution-

Food grains production in the pregreen revolution was unable to keep pace with population growth. The
droughts of 1965 and 1966 exposed the vulnerable situation of India with respect to food security. The
reason for this failure was ignorance of the need for technological advancement in agriculture and reliance
on the private sector to invest in agriculture. Traditional technology and over-reliance on monsoon made
agriculture highly vulnerable to yearly movements. After twin droughts of 1960s, a major step was taken
towards technology. It was named as Green Revolution.

Performance of Industry-

The Industrial policy resolution 1956 laid the background work for Mahalanobis model of 2nd five-year
plan. The important features of Industrial policy resolution were:

1. Government should actively participate in setting up certain important industries, either directly or
by subscribing shares in such industrial undertakings. This idea was an outcome of the realization
that the private sector does not have required capital to expand industrial base of India to the
level required. It was considered mandatory for the government to participate actively in Industrial
development of the country by investing heavily in capital based industries like steel, power et
cetera
 Basics of Economy 33

2. Licensing- Industrial licensing meant that establishment and operation of an industrial enterprise
in India required direct approvals from the central government. The reason for introducing
industrial licensing was to ensure dispersal of industries and to prevent establishment of excess
capacity in certain industries while abandonment of others. Under Industrial licensing, the
government made sure that industries are well distributed in the country and a limited number of
licenses are granted/ approved in every industry to ensure enough production in every area/ field.
While the original intention of industrial licensing was to promote selected important industries, it
was later used to control almost all industries which resulted in ―over regulation‖ and ―license-raj
permit system‖.

Major licenses required to operate an enterprise were:

a. Approval from the ministry before making an investment or starting an enterprise

b. Approval for importing capital goods/ machinery
c. Approval for importing raw material from outside the country and an approval mentioning that the
particular raw material is not available domestically
d. Approval for foreign collaboration
e. Approval for hitting the capital market to raise funds for the enterprise/ project

This shows the level of difficulty in starting and operating an enterprise during 1950s. The step
was taken due to the fear that high imports of every essential item would break the backbone of
domestic production and in order to develop and support a healthy domestic economy, it was
essential to keep the global market away.
The license raj system resulted in ―red-tapism‖ in the country. Red-tapism is derived from the red
tape, which is placed around files in a government office. Over regulation and immense powers to
bureaucrats resulted in high corruption in government offices and slow movement of files. This
slowed down advancement of domestic economy.

3. The resolution also created a list of industries preserved solely for the public sector with the twin
reason that:

a. These industries could not be developed by the private sector due to heavy investment and lack of
profits,
b. These industries are going to act instrumental in capturing ―commanding heights of the economy‖.
Therefore, they cannot be left to the private sector.

4. Import Substitution- import substitution is a trade and economic policy which advocates replacing
foreign imports with domestic production. Import substitution gained importance worldwide after
WW II as newly independent countries wanted to free themselves from economic clutches of the
west (developed nations). India also adopted the policy of import substitution wherein it aimed at
producing whatever was domestically possible in the country. The policy was supported by
a. Tight foreign exchange laws,
b. Industrial investment by the government in heavy amount,
c. Rigid domestic production rules which supported domestic goods over imported products, and
d. Tax and non-tax advantages to domestic industries in terms of quotas, import duty etc. on
imported products.

The above-mentioned approach towards industry was followed continuously till 1980s. Some minor
changes were made in 1980s, when various committees (Sengupta committee on public sector,
Narsimham committee on fiscal controls and Abid Hussain committee on trade policy) recommended
dilution of controls due to ineffectiveness of the above industrial policy, especially licensing system. Major
breakthroughs were made in 1991 after the new economic policy was adopted by India.
 34 Basics of Economy

INDIA between1970 to 1990:

Growth Experience-

Periodisation of Indian Growth Experience

Period Characterisation GDP Growth GFCF ICOR (Column

(Annual Percentage Divided b
Average (Annual Column 3)
Average)
(1) (2) (3) (4) (5)
1951-52 to 1964-65 The foundation years 4.1 11.6 2.8
1965-66 to 1969-70 The crisis years 3.0 14.2 4.7
1970-71 to 1979-80 The turbulent years 2.9 15.7 5.4
1980-81 - 1990-91 The transitional years 5.6 20.4 3.6
1991-92 - 2002-03 The reform years 5.5 22.9 4.1
2003-04 - 2007-08 The high growth years 8.8 30.2 3.4

As can be seen in the chart, the period of 1965- 70 belong to crisis years. This period provides background
for later years so it will be briefly discussed below. The period of 1970 – 1990 belongs to turbulent and
transitional years.

After the drought of 1965-66 and war with Pakistan, India decided to correct anomalies in its planning
methodology to prevent future occurrence of such disasters. The following were major changes in Indian
government‘s outlook:

1. Background work for green revolution was started. It was realized that food security holds immense
importance for domestic stability and stable growth of other sectors. The green revolution can be
divided into 3 phases, starting in 1966. We shall be discussing all 3 phases in agriculture section.
2. The era of subsidies began. Fertilizer, food and other subsidies were being provided to companies
and the people to ensure a stable domestic environment.
3. Nationalization became a reality. The policy after independence had been one of co-existence of
public and private sector. There was a stark shift in the policy with nationalization of various
companies and banks by the government.
4. ―Populist‖ schemes, slogans and policies became more important than actual work. The slogan of
―Garibi hatao‖ was used directly during 1971 elections by the congress to generate votes on the
premise of removing poverty instantly.
5. There was Liberalization of licensing in agriculture related industries after the droughts of 1965 and
1966. Thus, two contrasting policies were followed in this time period i.e. one of nationalization of
certain industries and liberalization of agriculture industries.

The period between 1970- 1990 is termed as turbulent and transitional period respectively due to many
reasons.

• In the period of 1970- 1980, there was an oil crisis in global arena due to fight of capitalism versus
communism between USA and Soviet Union. The Afghanistan war and spread of communist in the
eastern globe created uncertainty for USA‘s hegemony and resulted in many crisis situations. Oil
crisis was one major impact of geo-political fight.
• The congress government, led by Mrs. Indira Gandhi declared emergency in 1973-74, which took
focus away from development for the government in power. Emergency resulted in centralized
control of all states and forced the states to focus on short-term targets rather than a long-term
vision of development.
• The period of 1965- 1980 saw the worst performance of Indian Economy. Various Governmental
lapses resulted in cost overruns, higher corruption, delays in projects and political upheavals.
• Many substantive changes were made in Rajiv Gandhi‘s administration beginning 1984. Tax rates
were reduced to encourage private sector and capital markets to invest more in the economy.
Public expenditure was raised with a target of providing basic services to the poor so that overall
productivity and standard of living can increase in the country. Computers were introduced to
make administration more efficient. All these and many other constructive changes made this
decade the decade of transition.
• The decade of 1980-1990 experienced expansionary macroeconomic policies, which raised
aggregate demand and resulted in higher output in the economy.
 Basics of Economy 35

Trade liberalization and deregulation in industrial policy in 1980s contributed to higher trade, productivity
increase and economic growth. Import laws for capital goods were liberalized to encourage private
investment in the economy.

Performance of Agriculture-

It is clear from earlier discussions that agriculture held a very important role in Indian economy because it
provided employment to majority of workforce, contributed to national income the most and also served
interests of Industries, without which the industrial advancement was impossible.

The twin droughts in 1965 and 1966 brought the entire economy to a halt. Such was the power of
agricultural stability for India.

Agriculture not only provided food security and employment to the masses, it also contributed towards
industries in the following ways:
• Agriculture acted as supplier of wage goods to the industrial sector
• Agriculture provided raw material to agro based industries
• Agriculture income generated rural demand for industrial goods.

However, it experienced low productivity compared to other advanced countries as well as countries in the
region. The main reasons of low productivity were three fold- General, Institutional and Technical.

General reasons-

• Pressure of population on land- pressure on land in India has increased four- fold from 300 million
to 1.25 billion. With increase in population, per capita cultivated land has consistently declined and
resulted in fragmentation of holdings.

Institutional reasons-

• Land Tenure System- Zamindari system has taken away the enthusiasm of sharecroppers to
invest in development of land. Majority of earnings are taken away by middlemen and not invested
back for adoption of new technologies.
• Uneconomic holdings- majority sharecroppers hold less than 2 hectare land, which is too small
to introduce modern production methods. Reliance on labour intensive and obsolete technologies
has resulted in low productivity.

Technological reasons-

• Obsolete technologies and low irrigation potential

Due to twin droughts of 1965 and 1966, India had become dependent over P L 480 (Public Law 480), also
known as ―food for peace‖ under which United States provided food for overseas aid. To come out of the
humiliating situation, India embarked upon the path of introducing High Yield Variety (HYV) Wheat in the
country. There have been three phases of green revolution in India.

Introduction of Green Revolution- Phase I from 1966- 1972:

Green revolution was launched in India by importing Wheat HYV seeds from Mexico and indigenizing them
to meet Indian needs. The first phase of Green Revolution had two aspects- Introduction of HYV seeds and
adoption of Minimum Support Price (MSP) to incentivize farmers to produce and sell at MSP.

As a result of HYV seeds, production of food grains increased from 74 million tons to 105 million tons in
1971 and India became self-sufficient in food production.

In order to make the revolution successful, subsidies played a very important role. Subsidy in terms of
Fertilizer, irrigation (power), canal water and credit became an important instrument in success of green
revolution. Due to their instrumental role, subsidies gained important role in future agricultural policies in
the country.

Success of Phase I of green revolution reduced poverty in India from 64% to 56% in 1973.
Phase I of green revolution was largely limited to north-western parts of Punjab and Haryana. HYV
technology spread to other areas in phase III of the movement.
 36 Basics of Economy

Phase II- 1973- 1980:

Phase II of green revolution was affected by twin droughts in 1972 and 1973. To tackle the problem,
subsidies on Urea (Fertilizer) were increased and share of groundwater irrigation was also increased from
0.5% to 20% by 1975. HYV seeds were also introduced in Rice under phase II of Green revolution.

Phase III- 1981-1990:

In 1980s, India became a food sufficient country, capable of withstanding prolong drought situations. In
1987, the worst drought of the century hit India, but no lives were lost on account of lack of food in the
market. India‘s food reserves had become sufficient to take on drought years.
During this phase, HYV technology spread eastwards to West Bengal and Bihar.
However, in this phase, India experienced plateauing of HYV technology. Growth of yearly Food grain
production decreased from more than 4% to 2.3% p.a. In order to increase the yearly growth of food
production, the government started increasing subsidies in terms of water, credit and fertilizers.

Performance of Industry-
Major changes in policy of industrial development were made in 1980s under the guidance of Rajiv Gandhi
and V P Singh. The phase of deregulation and de-licensing began and took a strong shape in 1991 when
the new economic policy was launched.
Although barriers to entry were being reduced, the barriers to exit were not paid any attention in 1980s.
Lack of modern laws on Bankruptcy, labour laws, laws of rent control and urban land ceiling laws were
some major impediments in development of industrial sector.

Performance of Services-
• According to Development Economics, development is a three-stage process. Stage 1 is dominated
by agriculture sector in an economy. India was dominated by agriculture sector till 1980 in terms
of contribution to GDP. Stage 2 is dominated by Industrial growth. Industry was provided support
by the government since 1950s but it picked up growth in 1980s after structural changes were
brought about in the sector. Stage 3 is dominated by the services sector. The services sector
picked up growth in 1980s and accelerated in 1990s.
• India has moved directly from agriculture to services, bypassing decades of ―dominance of
industrial sector‖. Although government of India provided support to grow the industrial sector,
various structural and policy based impediments did not allow dominance of this sector. In the
meantime, the new economic policy opened the economy to the world, providing impetus to the
service sector. The private sector took advantage of this opportunity and services saw instant
growth in India. Thus, while India has per capita GDP composition of a low-income economy, due
to dominance of services sector, its sectoral composition of output has come to resemble that of a
middle-income country.

Sectoral Growth Rates

Average growth (In per cent per annum)

1951-1980 1981-1990 1991-200
Agriculture 2.1 4.4 3.1
Industry 5.3 6.8 5.8
Services 4.5 6.6 7.5
GDP 3.5 5.8 5.8

INDIA between 1991- Present:

 The latest changes or movements will be covered separately in ―Schemes of the government‖ and
latest ―Economic Survey‖.
 Financial changes since independence will be covered in ―Indian Financial System‖.
 In this chapter, the focus will be on features and impacts of economic reforms of 1991.

Growth Experience-

Background of Economic Reform:

• After following an inward looking economic policy for 4 decades, India decided to change gears
towards a liberalized economy in 1991 due to various domestic and international compulsions.
 Basics of Economy 37

• The reasons for economic reform in 1991 included factors like

 Collapse of Soviet Union that had emerged as India‘s major trading partner
 The gulf war of 1991 spiked prices of oil and stopped remittances from gulf countries,
increasing India‘s BOP deficit suddenly
 The expansionary policy of 1980s started showing its negative effects. The policy was at fault
because majority of money pumped into the economy was used for expanding consumption
rather than expanding investment in capital goods. As discussed in macroeconomics, the
quality of deficit is determined by its usage in an economy. While deficit incurred for expanding
capital creation capacity of an economy is considered self-correcting, deficit for consumption is
dangerous above a certain level. Unfortunately, India incurred heavy expenditures on
expansion of aggregate consumption of the economy, which resulted in high BoP deficit for the
country. The public debt to GNP ratio increased through 1980s to 60 percent at the end of the
decade, doubling in 10 years time.
 The restrictive trade and industrial licensing framework between 1950-90 resulted in a serious
loss of efficiency as well as competition of public sector enterprises. Return on investment and
growth rate of these enterprises fell in 4 decades till 1991.

The 1991 economic reforms changed the course of Indian economy completely. By the time the crisis
occurred, there was considerable support among key figures for a thorough reform of the economy:

The reforms can be broadly categorized into stabilization policies and structural reform policies. While
stabilization policies were meant to correct the lapses and put the house in order in short term, structural
changes were meant to accelerate economic growth in medium to long term. Changes made through
economic reforms were:
• Fiscal stabilization- to contain growing fiscal deficit
• Internal Liberalization- freedom to private enterprises, both domestic and global
• Integration with global economy- removing various economic and policy level controls to link
domestic economy with the world economy.

Structural Reforms-

• Foreign trade and Investment reforms

• Industrial licensing reforms
• Financial sector reforms

Foreign trade and Investment reforms-

1. Import Licensing policy has been dismantled. All tariff and non- tariff barriers have been phased
out. They are now followed as an exception in emergency like situations. Only consumer goods can
have tariff and non- tariff barriers. Agriculture still has tariffs of as low as 10%. This has been
made to protect Indian agriculture from foreign cheap imports. Foreign Investment norms in India
and outside India have been liberalized. India is now one of the largest recipients of foreign
investment.
2. Rupee has been made fully convertible on current account since 1994.
3. Institutional reform in capital market- SEBI and IRDA have been setup as independent regulators
of Indian capital and insurance market respectively.

Industrial Licensing reforms-

1. New Industrial Policy- The NIP dismantled the industrial approval or licensing system which had
been in place since Independence. The Industrial licensing system demanded approval of the
government at every stage of performance of an enterprise, thus hurting efficiency and
encouraging red-tapism. The NIP allowed industrial licensing in only 14 specified industries. These
were related to environment protection, national security and social well-being. Only 2 industries
are now reserved for the public sector- atomic energy and railway transport.

Financial Sector reforms-

1. Permission to private companies and foreign ventures to set-up banks in India. 3 phases of private
licensing of banks have been carried out till date. The first one was carried out in 1993, second in
the year 2001 and third in the year 2013.
2. The administered interest rate regime has been done away with in phases. Administered interest
rate means that the government decides on the interest rate to be charged by banks to customers.
Due to the policy of administered interest rates, interest rates being charged were lower than cost
of capital to banks and thus pushed banks into losses.
 38 Basics of Economy

3. Cross subsidization of lending rates undermined profits of banking sector. This means that some
sectors were charged very low rates as an incentive at the cost of other sectors and profits of
banks.
4. Government interference in deciding loans was reduced. A greater autonomy to banks and FIs
have made them more efficient and profitable.

Stabilization reforms-
Fiscal deficits of Indian government had increased to 8.2% of GDP in 1980s. In the crisis situation of 1991,
the government aimed at reducing budget deficits to sustainable levels and successfully did it by reducing
deficits to 5% by 1999.
However, there have been criticisms of the way government has reduced its deficits.
• Post 1991 reforms, its fiscal deficit came down from 8% to 5% but its revenue deficit went up to
an unsustainable 4% by 1999. This shows that the government decided to cut back on capital
expenditures but raised its revenue expenditures related to day-to-day administration.
• Expenditures on social sectors such as education, health and poverty reduction have declined in
the post reform period. These sectors are very important for human development. Economic
growth without human development will push India into another crisis, which cannot be tackled
unless human capabilities are developed substantially.
• Tax reforms were brought in to enhance tax collection- tax rates were reduced drastically to
increase tax base and make tax filing a user-friendly phenomena and not a mode of punishment
by the government. Rates on corporate tax were also reduced to encourage setting up and growth
of private enterprises.
Stabilization reforms focused on two things- deficit reduction and inflation control.
The structural and stabilization efforts can also be classified according to the more popular LPG reforms
i.e. Liberalization, Privatization and Globalization. We will be mentioning just points in LPG reforms as all
major points have been explained under structural and stabilization heads.

Liberalization- Liberalization consisted of the following reforms:

• Industrial licensing- removal of licensing requirements

• Export import policy- easier and market oriented exchange methods and liberalization of import
and export rules
• Technology upgradation- opening up of the economy to foreign technology
• Fiscal and financial policy- fiscal reforms through FRBM, tax reforms by reducing tax rates,
financial reforms through SEBI and IRDA, autonomous and powerful RBI
• Foreign exchange and investment policy- FDI and FII allowed in Indian market, currency devalued
and subsequently made floating.

Privatization:
• Disinvestment
• Autonomy to PSUs

Globalization- Integration of domestic economy with global economy. Globalization has resulted in
greater integration and interdependence between India and the world economy.
• Outsourcing- outcome of globalization
• Abiding to WTO rules and laws

Performance of agriculture-

Average GDP Growth Rates - Overall and in Agriculture

(Per cent Per Year at 1999-2000 Prices)

Period Total Agriculture and Crops and

Economy Allied Sectors Livestock
1. Pre-green revolution 1951-152 to 1967-68 3.69 2.54 2.65
2. Green revolution period 1968-69 to 1980-81 3.52 2.44 2.72
3. Wider technology dissemination period 1981-82 to 5.40 3.52 3.65
1990-91
4. Early reforms period 1991-92 to 1996-97 5.69 3.66 3.68
5. Ninth Plan 1997-98 to 2001-02 5.52 2.50 2.49
6. Tenth Plan period 2002-03 to 2006-07 of which 7.77 2.47 2.51
2002-03 to 2004-05 6.60 0.89 0.89
2005-06 to 2006-07 9.51 4.84 4.96
 Basics of Economy 39

The above chart shows that growth rate of agriculture increased drastically from 2.44% to 3.52% in 1990
but started decelerating after economic reforms. The present target of 4% growth in agriculture has not
yet been achieved.

Positive and negative impact of reforms on agriculture:

Positive impacts-

• Following economic reforms, higher rate of economic growth resulted in higher per capita incomes,
which increased food demand by people. Higher food demand meant better prices for agricultural
products. There was also diversification of food demand into non-food grain crops like fruits,
vegetables, meat and eggs. This gave a boost to the Horticulture industry in the country.
• Due to higher profits in agriculture, private investment in primary sector increased drastically.
• Due to higher productivity following more private investment in agriculture, the inverse
relationship between farm size and output per acre has reduced. Technology has made bigger
farms more productive again.
• Institutional credit to farming sector has increased after economic reforms. Many foreign investors
and companies are now investing in agriculture in India.

Negative impacts-

• Fiscal contraction by the government increased rural poverty in the country. The direct positive
impacts of economic reforms were limited to urban areas, thus widening the rural urban income
gap. Rural-urban inequality increased multifold after economic reforms.
• Monoculture became even more prevalent in the country with dominance of wheat over other
crops. While production of other crops has gone down, productivity of wheat has become stagnant
due to reliance on the same technology of fertilizer and HYV based production.
• Due to increasing urbanization following new economic policy and economic reforms, pressure of
land on agriculture has increased. Now there is less available land for agriculture and more
demand for crops.
• Higher pollution, environmental and human health effects of green revolution are now becoming
visible. There is a drive to convert green revolution to ―evergreen revolution‖ by adopting organic
farming practices and focusing on diversity of crop production.

Performance of Manufacturing-

A number of cyclical and structural factors have contributed towards slowdown in manufacturing activity
after 1996 in India.

• Rise in Interest rates for financing projects- Interest rates on loans in India are among the highest
in the world. While it has supported the banking sector, it has been destructive for growth of
manufacturing industry.
• Infrastructure constraints- investment in infrastructure by the government has been on a lower
side since 1991 reforms. Slow development in infrastructure has acted as an impediment for
growth of manufacturing. Transport and warehousing bottlenecks have pushed manufacturing
away from India.
• Lack of skilled employees- there is a severe shortage of skilled employees in manufacturing sector
in India. The impetus for foreign investors to invest in India is lost when they see highly unskilled
employees in the market.
• Laws and rules are anti industries and highly restrictive- laws like bankruptcy act, labour laws etc
are highly restrictive of fast growth for enterprises.
• Ease of entry but difficulties of exit- As per economic survey, industries in India are able to enter
the market easily but their exit options are limited and cumbersome. In such a scenario, many
enterprises decide not to enter the market or if they do, their cost of operation goes up due to
legal impediments.
• Cyclical factors like crisis of 1999 and 2008 have acted as breakers in the growth of manufacturing
in India.
 40 Basics of Economy

E. Economic Planning in India

Economic planning is, ―the making of major economic decisions—what and how much is to be produced
and to whom it is to be allocated by the conscious decision of a determinate authority, on the basis of a
comprehensive survey of the economic system as a whole.

Types of Planning: After the first national planning was started by the Soviet Union, many more
countries followed it, but with variations in their methods and practices. Though there are many variants
of planning the most important one is on the basis of the type of economic organisation (i.e., state
economy, mixed economy).
During the course of evolution, planning has been classified into two types, based upon the type of
economic system prevalent in the country.

1. Imperative Planning- The planning process followed by the state economies (i.e., the socialist or
communist) is known as the imperative planning. Such planning is also called as directive or target
planning.

Basic features of such planning are as under:

(i) Numerical (i.e., quantitative) targets of growth and development are set by the plan. As for
example, five lakh tonnes of steel, two lakh tonnes of cement, 10,000 km of national highways,
5,000 primary schools, etc., will be produced/built in the coming 5 or 6 years.
(ii) As the state controls the ownership rights over the resources, it is very much possible to realise
the above-cited planned targets.
(iii) Almost no role for the market, no price mechanism with all economic decisions to be taken in the
centralised way by the state/government.
(iv) No private participation in the economy, only the state plays the economic role. The Command
Economies followed this kind of planning. That is why such economies are also known as the
Centrally Planned Economies—the USSR, Poland, Hungary, Austria, Romania, etc., and finally
China.

Market Economy

In a market economy, it is the opposite – state has a minimal role in the management of the economy –
production, consumption and distribution decisions are predominantly left to the market. State plays
certain role in redistribution. State is called the laissez faire state here. It is a French phrase literally
meaning ―Let do.‖

2. Indicative Planning- In the following two decades after the soviet planning commenced, the idea
of planning got attention from the democratic world. A time came when some such economies
started national planning. As they were neither state economies nor communist/socialist political
systems, the nature of their planning was different from the command economies. Such planning
has been termed as indicative planning by economists and experts. The identifying features of
indicative planning may be summed up as under:

(i) Every economy following the indicative planning were mixed economies.
(ii) Unlike a centrally planned economy (countries following imperative planning) indicative planning
works through the market (price system) rather than replaces it.
(iii) Side by side setting numerical/quantitative targets (similar to the practice in the imperative
planning) a set of economic policies of indicative nature is also announced by the economies to
realise the plan targets.
(iv) The indicative nature of economic policies, which are announced in such planning, basically
encourage or discourage the private sector in its process of economic decision making.

Difference between Planned Economy and Command Economy

The difference between planned economy and command economy is that in the former there may be
mixed economy and while in the latter Government owns and regulates economy to near monopolistic
limit.
Command economies were set up in China and USSR, mainly for economic growth and social and
economic justice but have been dismantled in the last two decades as they do not create wealth
sustainably and are not conducive for innovation and efficiency. Cuba and North Korea are still command
economies.
 Basics of Economy 41

History of Economic Planning in India

It was the Soviet Union which explored and adopted national planning for the first time in the world. After
a prolonged period of debate and discussion, the First Soviet Plan commenced in 1928 for a period of five
years. But the world outside was not fully aware of the modus operandi of development planning till the
1930s. It was the exodus of the east European economists to Britain and the United States in the 1920s
and 1930s that made the world aware as to what economic/national planning was all about. The whole lot
of colonial world and the democracies of the time were fascinated by the idea of planning as an instrument
of economic progress. The nationalist leaders with socialistic inclination of the erstwhile British colonies
were more influenced by the idea of economic planning. The whole decade of the 1930s is the period in
the Indian history when we see nationalists, capitalists, socialists, democrats and academicians advocating
for the need of economic planning in India at one point or the other. Even if the so-called economic re-
forms started in 1991–92, all the humble suggestions regarding the contours of reforms were very much
outlined by the Planning Commission by then.

By the decade of the 1930s, the idea of planning had already entered the domain of intellectual and
political discussion in India. Many fresh proposals suggesting immediacy of planning in India were put
forward, though the erstwhile British government remained almost immune to them. But these humble
proposals of planning served their purpose once India became independent and decided to adopt a
planned economy.
India being devastated economically after more than two centuries of colonial exploitation resulting in
chronic poverty, was the driving force for the formulation of various models of growth before
independence.
In 1944, leading businessmen and industrialists (including Sir Purshotamdas Thakurdas, JRD Tata, GD
Birla and others) put forward ―A plan of Economic Development for India‖ – popularly known as the
‗Bombay Plan‘.
It saw India‘s future progress based on further expansion of the textile and consumer industries al- ready
flourishing in cities like Bombay and Ahmedabad. It saw an important role for the state in post in-
dependence India: to provide infrastructure, invest in basic industries like steel, and protect Indian
industry from foreign competition.
Visionary engineer Sir Moksh Gundam Vishveshvaraya pointed to the success of Japan and insisted that
‗industries and trade do not grow of themselves, but have to be willed, planned and systematically
developed ‗- in his book titled ―Planned Economy for India‘ (1934). The goal was poverty eradication
through growth.

The Indian National Congress established a Nation- al Planning Committee under the chairmanship of
Jawaharlal Nehru (1938). It stated that objective of planning was to ensure an adequate standard of living
for the masses, in other words, to – get rid of the appalling poverty of the people‖. It advocated heavy
industries that were essential both to build other industries and for Indian self-defence; heavy industries
had to be in public ownership, for both redistributive and security purpose; redistribution of land away
from the big landlords would eliminate rural poverty.

The Gandhian Plan

Espousing the spirit of the Gandhian economic thinking, Shriman Narayan Agarwal formulated The
Gandhian Plan in 1944. The plan laid more emphasis on agriculture. Even if he referred to industrialisation,
it was to the level of promoting cottage and village-level industries, unlike the NPC and the Bombay Plan
which supported a leading role for the heavy and large industries. The plan articulated a ‗decentralised
economic structure‘ for India with ‗self-contained villages‘.

The People‟s Plan

In 1945, yet another plan was formulated by the radical humanist leader [Link], Chairman of the Post-
War Reconstruction Committee of Indian Trade Union. The plan was based on Marxist socialism and
advocated the need of providing the people with the ‗basic necessities of life‘. Agricultural and industrial
sectors, both were equally highlighted by the plan. Many economists have attributed the socialist leanings
in Indian planning to this plan.

The Sarvodaya Plan

After the reports of the NPC were published and the government was set to go for the five-year plans, a
lone blueprint for the planned development of India was formulated by the famous socialist leader
Jayaprakash Narayan .The Sarvodaya Plan was published in January 1950. The plan drew its major
 42 Basics of Economy

inspirations from the Gandhian techniques of constructive works by the community and trusteeship as well
as the Sarvodaya concept of Acharya Vinoba Bhave, the eminent Gandhian constructive worker. Major
ideas of the plan were highly similar to the Gandhian Plan like emphasis on agriculture, agri-based small
and cottage industries, self-reliance and almost no dependence on foreign capital and technology, land
reforms, self-de- pendent villages and decentralised participatory form of planning and economic progress,
to name the major ones.

Main Goals of Indian Planning

After Independence in 1947, India launched the five years plan for rapid growth.

Planning has the following long term goals:

1. Growth
2. Modernization
3. Self – reliance and
4. Social justice

Economic growth is the increase in value of the goods

and services produced by an economy. It is
conventionally measured as the percent rate of increase
in a real gross domestic product, or real GDP – real
means adjusted to inflation. Growth measures
quantitative increase in goods and services.

Economic development refers to growth that includes

redistributive aspects and social justice. GDP shows
growth and not welfare and human development
aspects like education, access to basic amenities,
environmental quality, freedom, or social justice.
Economic growth is necessary for development but not
sufficient.

Growth is expected to spread to all sections and regions; raise resources for the Government to spend on
socio – economic priorities etc. it takes a long time for growth to trickle down to all people and regions.
Therefore, State plans – for an expeditious process of inclusive growth.

Modernization is improvement in technology. It is driven by innovation and investment in Research &

Development. Education is the foundation of modernization. The more modernized the economy, the
greater the value created by it.

Self – reliance means relying on the resources of the country and not depending on the other countries
and the MNCs for investment and growth. India embarked on it partly due to the colonial experience and
partly due to the goal of orienting growth to development and poverty eradication. Nehru – Mahalanobis
mode of growth that closed Indian economy and relied on basic industries is the main plank for self –
reliance.

The term self – reliance should not be confused with self – sufficiency, the former means depending on
resources of the country and avoiding dependence on externals capital and help; the latter means that the
country has all the resources it needs. A country can be self reliant but no country can be self – sufficient.
Social justice means inclusive and equitable growth where inequalities are less and benefits of growth
reach all rural – urban, man – woman; caste divide and interregional divides are reduced.
While the above four are the long term goals of the planning process, each five year plan has specific
objectives and priorities.

Planning in India after Independence

Planning Commission

The Planning Commission of India was set up by a Resolution of the Government of India in March [Link]
was given the function to make five year plans. Objectives of the government while starting PC were the
following:
 Basics of Economy 43

1. Promote a rapid rise in the standard of living of the people by efficient exploitation of the resources
of the country.
2. Increase production.
Offer opportunities to all for employment in the service of the community.

Planning Commission of India (PC)

Prime minister was the ex officio chairman of the planning commission assisted by a deputy chairman. It
included 6 union cabinet ministers as its ex officio members. There was also a member secretary.

The planning commission was an autonomous body, which worked closely with union and state cabinets
and had full knowledge of their policies. Institutionally it was a part of the cabinet organization and the
‗demands for grants‘ for the PC was included in the budget for the cabinet secretariat.

Functions and Responsibilities of the Planning Commission

1. Make assessment of all resources of the country.

2. Augment deficient resources
3. Formulate plans [Five Year Plans (FYP)] for the most effective and balanced utilization of resources
and determining priorities.
4. Determine the stages of plan implementation
5. Determine the nature of machinery required.
6. Indicate the factors which tend to retard economic developments.
7. Monitor and evaluate.

PLANNING OVER THE YEARS:

FIRST FIVE-YEAR PLAN (1951–1956)

The first Indian Prime Minister, Jawaharlal Nehru presented the first five-year plan to the Parliament of
India on December 8, [Link] plan was based on the Harrod Domar model. The plan addressed, mainly,
the agrarian sector, including investments in dams and irrigation. The agricultural sector was hit hardest
by the partition of India and needed urgent attention. The total planned budget of INR 2069 crore was
allocated to seven broad areas: irrigation and energy (27.2 percent), agriculture and community
development (17.4 percent), transport and communications (24 percent), industry (8.4 percent), social
services (16.64 percent), land rehabilitation (4.1 percent), and for other sectors and services (2.5
percent).

The target growth rate was 2.1% annual gross domestic product (GDP) growth; the achieved growth rate
was 3.6%. The net domestic product went up by 15%. The monsoon was good and there were relatively
high crop yields, boosting exchange reserves and the per capita income, which increased by 8%. National
income increased more than the per capita income due to rapid population growth. Many irrigation
projects were initiated during this period, including the Bhakra Dam and Hirakud Dam.

SECOND FIVE-YEAR PLAN (1956–1961

The second five-year plan focused on industry, especially heavy industry. Unlike the First plan, which
focused mainly on agriculture, domestic production of industrial products was encouraged in the Second
plan, particularly in the development of the public sector. The plan followed the Mahalanobis model, an
economic development model developed by the Indian statistician Prasanta Chandra Mahalanobis in 1953.
The plan attempted to determine the optimal allocation of investment between productive sectors in order
to maximise long-run economic growth. It used the prevalent state of art techniques of operations
research and optimization as well as the novel applications of statistical models developed at the Indian
Statistical Institute. The plan assumed a closed economy in which the main trading activity would be
centered on importing capital goods.

Hydroelectric power projects and five steel mills at Bhilai, Durgapur, and Rourkela were established. Coal
production was increased. More railway lines were added in the north east.

The Atomic Energy Commission was formed in 1958 with Homi J. Bhabha as the first chairman. The Tata
Institute of Fundamental Research was established as a research institute. In 1957 a talent search and
scholarship program was begun to find talented young students to train for work in nuclear power.

Target Growth-4.5% Growth achieved:4.0%.

 44 Basics of Economy

THIRD FIVE-YEAR PLAN (1961–1966)

The third plan stressed on agriculture and improvement in the production of wheat, but the brief Sino-
Indian War of 1962 exposed weaknesses in the economy and shifted the focus towards the Defence
industry or Indian army. In 1965–1966, India fought a [Indo-Pak] War with Pakistan. Due to this there
was a severe drought in 1965. The war led to inflation and the priority was shifted to price stabilisation.
The construction of dams continued. Many cement and fertilizer plants were also built. Punjab began
producing an abundance of wheat.

Target Growth: 5.6% Actual Growth: 2.4%.

FOURTH FIVE-YEAR PLAN (1969–1974)

At this time Indira Gandhi was the Prime Minister. The Indira Gandhi government nationalised 14 major
Indian banks and the Green Revolution in India advanced agriculture. In addition, the situation in East
Pakistan (now Bangladesh) was becoming dire as the Indo-Pakistani War of 1971 and Bangladesh
Liberation War took Funds earmarked for the industrial development had to be diverted for the war effort.
India also performed the Smiling Buddha underground nuclear test in 1974, partially in response to the
United States deployment of the Seventh Fleet in the Bay of Bengal. The fleet had been deployed to warn
India against attacking West Pakistan and extending the war.

Target Growth: 5.7% Actual Growth: 3.3%

FIFTH FIVE-YEAR PLAN (1974–1979)

Stress was by laid on employment, poverty alleviation, and justice. The plan also focused on self-reliance
in agricultural production and defence. In 1978 the newly elected Morarji Desai government rejected the
plan. Electricity Supply Act was enacted in 1975, which enabled the Central Government to enter into
power generation and transmission. Target Growth: 4.4% Actual Growth: 5.0

SIXTH FIVE-YEAR PLAN (1980–1985)

The sixth plan also marked the beginning of economic liberalisation. Prize controls were eliminated and
ration shops were closed. This led to an increase in food prices and an increase in the cost of living. This
was the end of Nehruvian Socialism and Indira Gandhi was prime minister during this period.
Family planning was also expanded in order to prevent overpopulation.

Target Growth: 5.2% Actual Growth: 5.4%

SEVENTH FIVE-YEAR PLAN (1985–1990)

The Seventh Plan marked the comeback of the Congress Party to power. The plan laid stress on improving
the productivity level of industries by upgrading of technology.
The main objectives of the 7th five-year plans were to establish growth in areas of increasing economic
productivity, production of food grains, and generating employment.
As an outcome of the sixth five-year plan, there had been steady growth in agriculture, control on rate of
Inflation, and favourable balance of payments which had provided a strong base for the seventh five Year
plan to build on the need for further economic growth. The 7th Plan had strived towards socialism and
energy production at large.

Target Growth: 5.0% Actual Growth: 5.7%

EIGHTH FIVE-YEAR PLAN (1992–1997)

1989–91 was a period of economic instability in India and hence no five-year plan was implemented.
Between 1990 and 1992, there were only Annual Plans. In 1991, India faced a crisis in Foreign Exchange
(Forex) reserves, left with reserves of only about US$1 billion. Thus, under pressure, the country took the
risk of reforming the socialist economy. P.V. Narasimha Rao was the twelfth Prime Minister of the Republic
of India and head of Congress Party, and led one of the most important administrations in India's modern
history overseeing a major economic transformation and several incidents affecting national security. At
that time Dr. Manmohan Singh (currently, Prime Minister of India) launched India's free market reforms
that brought the nearly bankrupt nation back from the edge. It was the beginning of privatisation and
liberalisation in India.
 Basics of Economy 45

Modernization of industries was a major highlight of the Eighth Plan. Under this plan, the gradual opening
of the Indian economy was undertaken to correct the burgeoning deficit and foreign debt. Meanwhile India
became a member of the World Trade Organization on 1 January [Link] plan can be termed as Rao and
Manmohan model of Economic development.

An average annual growth rate of 6.78% against the target 5.6% was achieved.

NINTH FIVE-YEAR PLAN (1997–2002)

Ninth Five Year Plan India runs through the period from 1997 to 2002 with the main aim of attaining
objectives like speedy industrialization, human development, full-scale employment, poverty reduction,
and self-reliance on domestic resources.
During the Ninth Plan period, the growth rate was 5.35 per cent, a percentage point lower than the target
GDP growth of 6.5 per cent.

TENTH FIVE-YEAR PLAN (2002–2007)

• Attain 8% GDP growth per year.

• Reduction of poverty ratio by 5 percentage points by 2007.
• Providing gainful and high-quality employment at least to the addition to the labour force.
• Reduction in gender gaps in literacy and wage rates by at least 50% by 2007.
• 20 point program was introduced.

Target growth: 8% Growth achieved: 7.8%

ELEVENTH FIVE-YEAR PLAN (2007–2012)

The eleventh plan has the following objectives:

Income & Poverty

 Accelerate GDP growth from 8% to 10% and then maintain at 10% in the 12th Plan in order to
double per capita income by 2016–17
 Increase agricultural GDP growth rate to 4% per year to ensure a broader spread of benefits
 Create 70 million new work opportunities.
 Reduce educated unemployment to below 5%.
 Raise real wage rate of unskilled workers by 20 percent.
 Reduce the headcount ratio of consumption poverty by 10 percentage points.

Education

 Reduce dropout rates of children from elementary school from 52.2% in 2003–04 to 20% by
2011–12
 Develop minimum standards of educational attainment in elementary school, and by regular
testing monitor effectiveness of education to ensure quality
 Increase literacy rate for persons of age 7 years or above to 85%
 Lower gender gap in literacy to 10 percentage point
 Increase the percentage of each cohort going to higher education from the present 10% to 15%
by the end of the plan

Health

 Reduce infant mortality rate to 28 and maternal mortality ratio to 1 per 1000 live births
 Reduce Total Fertility Rate to 2.1
 Provide clean drinking water for all by 2009 and ensure that there are no slip-backs
 Reduce malnutrition among children of age group 0–3 to half its present level
 Reduce anaemia among women and girls by 50% by the end of the plan

Women and Children

 Raise the sex ratio for age group 0–6 to 935 by 2011–12 and to 950 by 2016–17
 Ensure that at least 33 percent of the direct and indirect beneficiaries of all government schemes
are women and girl children
 46 Basics of Economy

 Ensure that all children enjoy a safe childhood, without any compulsion to work
 Infrastructure
 Ensure electricity connection to all villages and BPL households by 2009 and round-the-clock
power.
 Ensure all-weather road connection to all habitation with population 1000 and above (500 in hilly
and tribal areas) by 2009, and ensure coverage of all significant habitation by 2015
 Connect every village by telephone by November 2007 and provide broadband connectivity to all
villages by 2012
 Provide homestead sites to all by 2012 and step up the pace of house construction for rural poor to
cover all the poor by 2016–17

Environment

 Increase forest and tree cover by 5 percentage points.

 Attain WHO standards of air quality in all major cities by 2011–12.
 Treat all urban waste water by 2011–12 to clean river waters.
 Increase energy efficiency by 20%

Target growth: 8.4% Growth achieved: 7.9%.

TWELFTH FIVE-YEAR PLAN (2012-2017)

12th five year plan (2012-17) document that seeks to achieve annual average economic growth rate of 8.2
per cent, down from from 9 per cent envisaged earlier, in view of fragile global recovery. 12th five-year
plan is guided by the policy guidelines and principles to revive the following Indian economy, which
registered a growth rate of meagre 5.5 percent in the first quarter of the financial year 2012-13.
The plan aims towards the betterment of the infrastructural projects of the nation avoiding all types of
bottlenecks. The document presented by the planning commission is aimed to attract private investments
of up to US$1 trillion in the infrastructural growth in the 12th five-year plan, which will also ensure a
reduction in subsidy burden of the government to 1.5 percent from 2 percent of the GDP (gross domestic
product). The UID (Unique Identification Number) will act as a platform for cash transfer of the subsidies
in the plan.

The plan aims towards achieving a growth of 4 percent in agriculture and to reduce poverty by 10
percentage points, by 2017.

Critical Evaluation of Planning

1. Lack of „Perspective‟ in Planning: According to experts, if a nation is going for economic planning it
must have ‗perspective‘ element in it. To have perspective in planning, two basic elements need to be
fulfilled, namely
(i) Planning should be evaluation-based, and
(ii) ‗Long-term‘ goals should be followed up besides the ‗short-term‘ goals.

In the Indian content, the succeeding plans have been always commenced without the full evaluation of
the preceding Plan. This was mainly due to the following reasons:
(a) Lack of a nodal body responsible for data collection at the national level;
(b) Federal nature of polity made data collection full of delays and also due to higher dependence on
the states; and
(c) Speedier data delivery was not possible.

2. Failure in Promoting a Balanced Growth and Development: Indian planning is blamed for failing
the objective of a regionally balanced growth and development. Though the Second Plan itself had noticed
this fact, the measures taken were not sufficient or were short-sighted. Economic planning at the national
level has proved to be a highly effective tool of promoting balanced growth. But in the Indian case it
turned out to be the opposite.
To take care of the issue of balanced growth, the planning process has been using the right tools, i.e.,
allocating plan funds on a sectoral (primary, secondary and federal reasons) basis. But due to political
reasons, enough discrepancies cropped up in the method of allocating funds to the states. At the
theoretical level, the governments knew the remedies, but at the practical levels politics dominated the
planning process. Democratic immaturity and politicisation of the planning process is to be blamed for this
 Basics of Economy 47

3. Highly Centralised Nature of Planning: De-centralising the process of planning has been a major
goal of the governments since the 1950s. But after Nehru, with every Plan we see greater tendency of
centralisation in the planning process.

Finally, by early 1990s two constitutional amendments (i.e., the 73rd and the 74th) promoted the cause of
decentralised planning by delegating constitutional powers to the local bodies. With this, a new era of
planning began, but still the planning of local bodies is in a nascent stage due to lack of proper financial
provisions for them. Once the financial pro- visions for local bodies are evolved to the adequate level or
the local bodies are given financial autonomy, the process of decentralised planning will surely get a new
direction and meaning, as the experts believe.

4. Wrong Employment Strategy: Planning in India has been tilted heavily in favour of ‗capital
intensive‘ industries, especially from the Second Plan onwards. Such industries in the public sector could
not generate enough employment. In place of it India should have gone in for ‗labour-intensive‘ industries.

5. Excessive Emphasis on PSUs: Indian planning emphasised on public sector undertakings (PSUs) for
the right reasons, but in the wrong way and for a considerably longer period of time. The state‘s
monopolies in certain areas continued over such a long period that too in losses that there came a
demand-supply gap in the major goods and services produced by the PSUs.

6. Agriculture Overshadowed by the Industry: Promoting the cause of faster industrialisation over
time became so dear to the planning process that the agriculture sector got badly over-shadowed. Though
the Plans were highlighting or prioritising agriculture, the industrial sector and the PSUs were glorified in
such a way that time and resources both were scarce for the agriculture sector. Such a policy always
created a situation of food insecurity (even today) for the country and the masses who depended upon
agriculture for their livelihood and income (still it is 58.2 per cent) could never increase their purchasing
power to a level that the economy could reverse the situation of ‗market failure‘. In India, even today,
industrial growth is badly dependent on agricultural growth.

7. Faulty Industrial Location Policy: There are time-tested theories of ‗industrial location‘ considering
the nearness of raw materials, market, cheaper labour, better transportation and communication, etc. But
the Plans always prioritised setting up of new industrial units (i.e., the PSUs) in the backward regions of
the country, which falsify the theories of industrial location. The government needs to develop all industrial
infrastructures besides setting up certain PSUs. As the PSUs require skilled labour force, the regions failed
to gain any employment from the PSUs too.

8. Wrong Financial Strategy: Mobilising resources to support the highly capital-intensive Plans
(courtesy the PSUs) has always been a challenge for the government. To support the Plans, no stones
were left unturned namely, going for a highly complex and liberal tax structure, nationalising the banks,
etc. Ultimately, tax evasion, the menace of parallel economy and lesser and lesser capital for the private
sector were the bane of India. Expansion of subsidies, salaries and the interest burden every year gave an
upward push to the non-plan expenditure leading to scarcity of funds for plan expenditure.

9. Politicisation of the Planning Process: In a

democratic political system, almost every issue of socio-
political importance is influenced by politics. It is more
correct in the case of lesser matured democracies. The
same stands true for the process of planning in our
country. Greater and greater politicisation of the planning
process culminated in such a design that at times
economic planning served the opposite purpose. For
example, we know that planning is a tool for promoting
regionally balanced growth, but in India in the process of
serving vested political interests of the Centre, it resulted
into promoting an imbalanced growth.
There has been a general anger among the sections of
society regarding coalition politics, scams, etc., in recent years. The Economic Survey 2014–15 rightly
blames coalition politics and the federal structure for tardy decision making in several areas— from oil
subsidy to tax reforms, FDI in retail and free movement of food grains.
 48 Basics of Economy

Planning Commission: Positives and Achievements

1. PC laid emphasis on infrastructure developments and capacity building. As a result, huge
investments were made in education, energy, industry, rail- ways and irrigation.
2. India became self-sufficient in agriculture and made great progress in capital sector goods and
consumer sector goods.
2. PC introduced many remarkable concepts like nationalisation, green revolution etc. and
transformed itself to align with new concepts like liberalisation, privatisation and inclusion.
3. Planning Commission made great emphasis on social justice, governance, employment generation,
poverty alleviation, health and skill development.
The transformation of India from a poor to an emerging economic power is credited to the orderly and
phased manner in which planning was implemented.

Planning Commission: Negatives and Problems There were many issues with planning methods followed
in India.

The drawbacks of the planning adopted via PC includes:

1. No structural mechanism for regular engagement with states.
2. Ineffective forum for the resolution of centre-state and inter-ministerial issues.
3. Inadequate capacity expertise and domain knowledge; weak networks with think tanks and lack of
access to expertise outside government.
4. Failed to implement land reforms.
5. It was a toothless body, was not able to make union/ states/UTs answerable for not achieving the
targets.
6. Designed plans with ‗one size fit for all‘ approach. Hence, many plans failed to show tangible
results.
7. Weak implementation, monitoring and evaluation.
8. Achieved >9% GDP growth-rate during 2005-07, thanks to American boom prior to sub-prime
crisis. But almost all nations of world experienced high growth. So 9% GDP did not come due to
efforts of Planning Commission.
9. Post sub-prime crisis, failed to evoke the ―animal spirit‖ in Indian economy. GDP-fell, inflation rose
during 2008-13 nonstop.
10. Hopes that CAG and Public accounts Committee will take care of accountability part. But PAC too is
pretty much toothless.
11. Failed to implement land reforms. Faulty policies for MSME, industrialization, Factory-labour law
problems.
12. Office manned by Generalist IAS/IES with short tenure; panel members filled with academicians
and NGOs. Need subject specialists with international exposure.
13. They tried to bypass state Governments via NGO-funding, DRDA. Hence States unenthusiastic
about implementing Central-schemes.
14. Only in 2013- reforms done like reducing number of Centrally Sponsored Schemes (CSS), 10%
flexi fund to states, direct transfer of money to state consolidated fun etc. But it‘s too little too
late.
15. There were shortcomings in planning commission, so new bodies sprung up like PM‘s economic
advisory council, PM‘s project monitoring group and so on. More brains were working together
hence more lack of coordination.

Why does India need a change from Planning Commission?

1. The contemporary world is governed by constitutional ethos like federalism rather than
centralisation.
2. India's population has almost tripled to 121 Cr, and many of the Indian states are as big as
European nations.
3. Indian economy has expanded from a GDP of 10,000 crore to 100 lakh crore (at current prices) –
i.e. from a poor nation to one of the largest economies.
4. India ranks 3rd in GDP at purchasing power parity, has surpassed Japan and is now standing just
below the US and China. The new economy needs institutions which can take India forward in a
global competitive environment.
5. Co-operative federalism and fiscal federalism will help to meet the diverse needs of different
states/UTs in which planning commission had failed drastically. Plans have to be formulated by
fulfilling the aspirations of states by tailoring the plans to suit their needs and requirements.
6. The share of agriculture in GDP has been drastically decreasing while the share of the service
sector to GDP is increasing in India. From 1991, as our economy is liberalised, private firms have
been playing a major role in the economy. Today we are living in a globalised world connected by
 Basics of Economy 49

modern transport, media, communications and networked international institutions and markets.
With the increasing levels of development, the aspirations of people have soared from survival to
safety and surplus. So governance systems need to be transformed to keep up with the same.
7. Change in the economic scenario where the government is supposed to be an enabler rather than
a player or provider of first and last. PS: In the next article, let‘s see how the new institution, NITI
Aayog can change the face of Indian Planning.
8. For so many years, Government worked as the ―provider of first and last resort‖. But, today Indian
industry and service sector has reached on global scale, a neo-middle class has emerged.

Times have changed, from being a underdeveloped country in 1950s – India has become a major
economic force. Hence our needs have changed- from mere food security to profitable agriculture. In this
playground, Government needs to become an ―enabler‖ rather than a ―player‖.

NITI AAYOG

The Union Government of India announced the formation of NITI Aayog on 1 January 2015, and the first
meeting was held on 8 February 2015. On 29 May 2014, the Independent Evaluation Office submit- ted an
assessment report to Prime Minister with the recommendation to replace the Planning Commission with a
―control commission.‖ On 13 August 2014, the Union Cabinet scrapped the Planning Commission, to be
replaced with a diluted version of the National Advisory Council (NAC) of India. On 1 January 2015 a
Cabinet resolution was passed to replace the Planning Commission with the newly formed NITI Aayog
(National Institution for Transforming India). The first meeting of NITI Aayog was held on 8 February
2015.
Finance Minister made the following observation on the necessity of creating NITI Aayog, ―The 65 year- old
Planning Commission had become a redundant organisation. It was relevant in a command economy
structure, but not any longer. India is a diversified country and its states are in various phases of
economic development along with their own strengths and weaknesses. In this context, a ‗one size fits all‘
approach to economic planning is obsolete. It cannot make India competitive in today‘s global economy.

What‟s new with NITI Aayog?

The centre-to-state one-way flow of policy, that was the hallmark of the Planning Commission era, is now
sought to be replaced by a genuine and continuing partnership of states.

 NITI Aayog will be more of a ―think tank‖ than a finance distributing agency.
 NITI Aayog will provide Governments at the central and state levels with relevant strategic and
technical advice across the spectrum of key elements of the policy.
 With NITI Aayog, there will be multi- directional flow of policy (from Center to States, from States
to Center, between ministries etc.)
 Better inter-ministry coordination.
 The NITI Aayog will develop mechanisms to formulate credible plans at the village level and
aggregate these progressively at higher levels of government.
 The NITI Aayog will create a knowledge, innovation and entrepreneurial support system through a
collaborative community of national and international experts.
 In NITI Aayog, the state governments have an equal role in nation‘s development process and
NITI Aayog promises the principle of co-operative federalism.
 It‘s a platform for monitoring and implementation of all government policies by bringing together
various ministries at the center and state level.

NITI Aayog: Objectives and Opportunities

NITI Aayog will aim to accomplish the following objectives and opportunities:
 An administration paradigm in which the Government is an ―enabler‖ rather than a ―provider of
first and last resort.
 Progress from ―food security‖ to focus on a mix of agricultural production, as well as actual returns
that farmers get from their produce.
 Ensure that India is an active player in the debates and deliberations on the global commons.
 Leverage India‘s pool of entrepreneurial, scientific and intellectual human capital.
 Incorporate the significant geo-economic and geo-political strength of the Non-Resident Indian
Community.
 Use urbanization as an opportunity to create a wholesome and secure habitat through the use of
modern technology.
 50 Basics of Economy

 Use technology to reduce opacity and potential for misadventures in governance and bring
transparency. Leveraging of India‘s demographic dividend, and realization of the potential of
youth, men and women, through education, skill development, elimination of gender bias, and
employment.
 Redressal of inequalities based on gender bias, caste and economic disparities.
 Ensure that the economically vibrant middle-class remains engaged, and its potential is fully
realized.
 To pay special consideration to the sections of the society that may be at risk of not profiting
satisfactorily from economic progress.
 Policy support to more than 50 million small businesses, which are a major source of employment
creation Safeguarding of our environmental and ecological assets
 To get active participation of States in the light of national objectives and to provide a framework
‗national agenda‘.
 To promote cooperative federalism through well- ordered support initiatives and mechanisms with
the States on an uninterrupted basis.
 To construct methods to formulate a reliable strategy at the village level and aggregate these
gradually at higher levels of government. Integrate villages institutionally into the development
process.
 To grant advice and encourage partnerships between important stakeholders and national-
international Think Tanks, as well as educational and policy research institutions.
 To generate a knowledge, innovation and entrepreneurial support system through a shared
community of national and international experts etc.
 To provide a platform for resolution of inter sectoral and inter-departmental issues in order to
speed up the accomplishment of the progress agenda.
 To pay attention to technology improvement and capacity building for the discharge of programs
and initiatives.

7 pillars of NITI Aayog

The NITI Aayog is based on the 7 pillars of effective Governance. They are:
1. Pro- People: it fulfils the aspirations of society as well as individuals
2. Pro-activity: in anticipation of and response to citizen needs
3. Participation: involvement of citizenry
4. Empowering: Empowering, especially women in all aspects
5. Inclusion of all: inclusion of all people irrespective of caste, creed and gender
6. Equality: Providing equal opportunity to all especially youth
7. Transparency: Making the government visible and responsive

Composition of NITI Aayog

The NITI Aayog will comprise the following:

Prime Minister of India is the Chairperson Governing Council consists of the Chief Ministers of all the States
and Lt. Governors of Union Territories in India.

Regional Councils will be created to address particular issues and possibilities affecting more than one
state. These will be formed for a fixed term. It will be summoned by the Prime Minister. It will consist of
the Chief Ministers of States and Lt. Governors of Union Territories. These will be chaired by the Chair-
person of the NITI Aayog or his nominee.

Special invitees: Eminent experts, specialists with relevant domain knowledge, which will be nominated
by the Prime Minister.

Ex Officio members: Maximum of 4 members of the Council of Ministers which is to be nominated by the
Prime Minister.

Chief Executive Officer: CEO will be appointed by the Prime Minister for a fixed tenure.
He will be of the rank of Secretary to the Government of India.
The Secretariat as deemed necessary.
Strategy and Planning in the NITI Aayog will be anchored from State-level. Regional Councils will be
convened by the Prime Minister for identified priority domains, put under the joint leadership of related
sub-groups of States (grouped around commonalities which could be geographic, economic, social or
otherwise) and Central Ministries.
 Basics of Economy 51

Regional Councils: Have specified tenures, with the mandate to evolve a strategy and oversee
implementation. Be jointly headed by one of the group‘s Chief Ministers (on a rotational basis or
otherwise) and a corresponding Central Minister. Include the sectoral Central Ministers and Secretaries
concerned, as well as State Ministers and Secretaries. It will be linked to corresponding domain experts
and academic institutions.
Have a dedicated support cell in the NITI Aayog Secretariat.
States would thus be empowered to drive the national agenda. As a consequence, deliberation would be
more grass-roots informed, and recommendations would have more ownership, given their joint
formulation.
Special Invitees: experts, specialists and practitioners with relevant domain knowledge as special invitees
nominated by the Prime Minister.

Difference between NITI Aayog and Planning Commission

Organization: Planning Commission – Had deputy chairperson, a member secretary, and full-time
members. Secretaries or member secretaries are appointed by the usual process. NITI Aayog – New posts
of CEO of secretary rank, and Vice-Chairperson will also have five full-time members and two part-time
members. Four cabinet ministers will serve as ex-officio members. CEO is appointed directly by Prime
Minister.

Planning:
Planning commission goes for top-down planning for government with public sector resources.
NITI aayog formulate national development strategy in a market economy integrated with the globalized
world.

Relation with states

The planning commission was a central government institution and no representation of state government.
There was no structural mechanism for interaction with states.
NITI aayog provides a partnership with state governments to promote co-operative federalism. It provides
a platform for structured and regular interaction with states.

Finance
The role of Finance Commission was greatly reduced with the formation of Planning Commission.
Allocation of funds was decided by the Planning Commission.
NITI aayog don‘t any role in fund allocation. Finance ministry to decide the share of taxes to states, fund
allocation to CSS and Union assistance to the state plan.

Constitution and Reporting

Planning Commission- The commission reported to National Development Council that had State Chief
Ministers and Lieutenant governors.
Niti Aayog – Governing Council has State Chief Ministers and Lieutenant Governors.

Action Agenda
After dismantling Planning Commission and taking its place, NITI Aayog has created a 15 years vision
document,7 years strategy document and a 3 year Action Agenda. This set the phasing out of Five Year
plans as a concept completely. The recommendations of Action Agenda are:

Double farmer‟s income

The think tank has proposed enhancing agricultural productivity by introducing new technologies and
shifting from low- to high-value activities such as horticulture, dairying, poultry, piggery, fisheries, and
forestry. Expand the scope of irrigation, increase crop intensity, enhance the seed replacement rate, and
encourage the balanced use of fertilizers.

Jobs, jobs, jobs

The NITI Aayog pegs India‘s unemployment rate at between 5% and 8% currently. But it believes un-
employment isn‘t the real challenge and considers underemployment as a severe problem. A job that one
worker can perform is often performed by two or more. In effect, those in the workforce are employed, but
they are overwhelmingly stuck in low-productivity, low-wage jobs.
Taking a cue from countries such as South Korea, Japan, Singapore, and China, NITI Aayog wants the
government to aggressively push for domestic manufacturing under its Make in India initiative to create
well-paid jobs for low- and semi-skilled labourers. It recommends the setting up of two coastal
employment zones on the lines of the Chinese strategy to promote exports and create jobs.
 52 Basics of Economy

Become a global soft power

Since coming to power three years ago, this government has tried hard to project itself as a regional soft
power.
The think tank now wants government to set up a comprehensive soft power policy that will ―leverage
India‘s cultural and creative strength‖ across the globe. It also recommended the setting up of a
humanitarian assistance and disaster relief agency that could provide assistance to less-developed
countries. It suggests using India‘s highly regarded doctors and healthcare professionals to provide
assistance in Asian and African nations.

Digital India
In line with the government‘s Digital India initiative, the think tank proposes to ramp up digital
infrastructure.
It wants the government to ensure that citizens are trained in the use of the internet through school
curricula and vocational education. Some 69% of Indians don‘t use the internet because they don‘t
understand it, according to NITI Aayog. It has also proposed to speed up government initiatives to bring
wireless and broadband connectivity to millions of villages through fibre cables, both underground and
over power lines.

Regional development
NITI Aayog has divided the country into four key geographies: the
Northeast, coastal areas, Himalayan states, and the desert and
drought-prone areas. In the long-neglected Northeastern states, the
think tank proposes ramping up infrastructure, while also bringing
connectivity to neighbouring countries such as Myanmar. On the coasts,
besides the need for infrastructure, it sees huge potential for tourism.
Meanwhile, across the Himalayan region, it has proposed increasing
forest land and promoting animal husbandry, fruit and timber
plantation, and floriculture.

Government and judiciary

Two of its key recommendations concern the Indian bureaucracy and
judiciary. India‘s bureaucracy, acutely short of officers as it is, has
long been blamed for red tape. Many of its officers are appointed
through a national level examination, leaving the private sector out
of policy making. ―Today, the rising complexity of the economy has
meant that policy-making is a specialised activity,‖ the report said.
―Therefore, it is essential that specialists be inducted into the system
through lateral entry. Such entry will also have the beneficial side
effect of bringing competition to the established career bureaucracy.
‖
Similarly, NITI Aayog proposes to introduce a judicial performance index to track trials and tackle
pendency. Such an index could be established to help high courts and high court chief justices keep a
track of performance and process improvement at the district courts and subordinate levels for reducing
delay.
Over 30 million cases are currently pending even as the courts grapple severe shortage of judges.
Meanwhile, to improve policing, the home ministry has been asked to identify non-core functions that can
be outsourced to private agents or government departments to reduce the police‘s workload.

Skills and welfare

India has become the world‘s youngest country with an average age
of 29 years; by 2030, it will have the world‘s largest working-age
population of 962 million people.
However, India has also been struggling with the quality of school
education. The report has asked the government to focus on
foundational learning, conduct a national-level assessment to
understand the quality of education to suggest corrective measures,
and also give more autonomy to higher-education institutes.
NITI Aayog has proposed setting up an independent authority to
oversee the various skill development programs of the government.
 Basics of Economy 53

Healthy India
The policy think tank has suggested higher spending on health care. India spends about 1% of its GDP on
public health, compared to 3% in China and 8.3% in the US. Over the course of the next three years, the
health care system in the country must prioritise public health and shift from being curative to preventive.
Key goals include reducing the maternal mortality rate to 120 deaths per 100,000 live births from the
current 167, reducing the infant mortality rate to 30 deaths per 1,000 live births, and reducing the
incidence of tuberculosis to 130 from the current 217.

Environment
India has 10 of the world‘s 20 most polluted cities. To fix this problem, NITI Aayog has proposed a slew of
measures, from ramping up public transportation to shifting from petrol and diesel engines to CNG and
subsequently to electric vehicles over the next decade. To tackle the annual smog caused by crop burning
in northern India (as farmers burn residue) it has proposed subsidising the Happy seeder, a machine that
can plant crops using the residue.
NITI Aayog has also listed a roadmap for river linking and afforestation, besides suggesting other
pollution-control measures.

Advantages of the Agenda

Electoral cycles do not synchronise with five-year plans; quite often, this entailed outcome accountability
to rest with a successor government.
But a ―Three Year Action Agenda‖ makes the government in office more directly accountable for the
implementation of its plans.
It gives the government an improved prospect to make corrections and adaptations during its own term in
office.
Augmenting the ―Three Year Action Agenda‖ with a seven-year implementable policy strategy and a 15-
year vision allows adaptation to changing times and exogenous variables.
It enables us to look into the future, particularly at evolving technology, demography and ecology, and
accordingly align our policies.
The 15-year vision is also somewhat coterminous with the Sustainable Development Goals (SDGs) of the
United Nations (UN).
The new format thus combines domestic aspiration with global aims.
The agenda projects three scenarios for nominal GVA (Gross Value Added), namely, low growth, baseline
and high growth.
Relying on the proposals forwarded by the FRBM Review Committee, the action agenda estimates a fall in
the share of non-development revenue expenditure, both as a proportion of total budget expenditure and
GDP.
It rightly emphasises the need for optimal utilisation of resources and regular monitoring of progress.
The agenda rightly points out that a functional classification of public expenditure rather than distinction
between revenue and capital expenditures will prove to be more meaningful.

Loopholes in the agenda

During the last two-and-a-half years, NITI Aayog has worked on several agendas, such as the promotion
of digital payments, reforms in agriculture, education and railways, helping states undertake social sector
reforms.

Autonomy still not available: While all these issues were important, and the suggestions made by NITI
Aayog critical, it appears that the institution‘s agenda and priorities are being set by government diktat
rather than an organic, independent thought process.

Less clarity: For instance, while recognizing the importance of competition, it walked with the
government on promoting digital payments through select entities, and kept mum when government
policies distorted competition.

Work that remains to be done: NITI Aayog is yet to institutionalize checks and balances mechanism to
caution the government about the claims it makes, and apprise policymakers of the ground realities.
The action agenda covers a wide range of issues, including the fiscal framework, agriculture, industry,
services, transport, digital connectivity, public private partnership, energy, science, technology,
governance, taxation, competition, environment, forests and water.

What is actually expected?

When dealing with imminent challenges, such a wide-ranging approach is not expected. For example,
while covering pertinent issues and providing important recommendations such as ―Price Deficiency
 54 Basics of Economy

Payment‖ to remove distortions in the existing minimum support price mechanism in the farm sector,
there is limited clarity on how, by whom, and the timelines within which such suggestions would be
implemented.
The action agenda appears more like a document collating several policy-related recommendations
provided by experts and government formulated committees over the years.
Good ideas would remain on paper- It puts limited or negligible focus on implementation challenges,
bureaucratic reforms and government-citizen interaction, which is core to several good ideas remaining on
paper and being left unimplemented.

What should have been done?

 Rather than focusing on policy-level recommendations, NITI Aayog would have done better had it
dealt with implementation-related challenges.
 Steps that were needed- A clear action agenda on how policies should be implemented, the
creation of a feedback loop, taking into account changes on the ground, and fixing accountability
of babus, would have been welcome.
 It should have focused on process reforms

Niti Aayog: Criticism

 Like planning commission, it‘s also a non-constitutional body which is not responsible to
parliament.
 Dismantled planning commission without consulting the states.
 UTs are represented by Lieutenant Governors, not by chief ministers. This is against the principles
of federalism. Fund allocation to welfare schemes may get affected. For example, there is a 20 %
reduction in gender budgeting.

Hits and Misses of NITI Aayog

1. NITI Aayog is still at infancy. It is trying to find out what its role should be because the role of
think tank is not an easy one. There has to be awareness regarding all the constraints, be in touch
with professional organizations and then decide whether a programme will work or not. Based on
this, it has to give suggestions to the State Governments and Government of India. This role has
not been performed by NITI Aayog, therefore, this body needs some more time. Any think tank
has to be slightly distant from the Government. The members and Vice Chairman of NITI Aayog
have been defending government on all issues which is actually the role of various ministries of the
Government. If that role is taken by the think tank, then there is a conflict between justifying
Government and giving advice to the Government on right issues.
2. The job of NITI Aayog should have been to identify the immediate challenges that the country
faces to realize a vision set rather than writing a manifesto for coming years such as global
environment, consistent poverty in the country, regional inequalities among many others. NITI
Aayog should mobilize the country to address real challenges.
3. It appears that the development monitoring and evaluation office at NITI Aayog is currently
responsible for monitoring and impact evaluation of centrally funded programmes. However, we
are yet to witness significant improvement in this domain.
4. Independent monitoring and evaluation is important but not sufficient to ensure the success of
policy reforms. It aids in identifying implementation-related challenges but falls short of
transforming implementation, which is the need of the hour.

Pros of NITI Aayog

It also came up with indices for measuring states‘ performance in health, education and water
management to help states gauge the results of social programmes and compete with each other and
share best practices and innovations.
It also suggested clubbing various social programmes and centrally-sponsored schemes under 28 umbrella
projects. The panel suggested changes in Swachh Bharat Abhiyan, skill development, poverty
measurement, Atal Innovation Mission.

Impediments to implementation include capacity constraints, inadequate resources, lack of incentives to

perform, no disincentives for non-performance, absence of policy and regulatory clarity among others.
These could differ with sector, geography and demography. Identifying such impediments is a tough ask,
which would require NITI Aayog to have many more eyes and ears on the ground. To this end, NITI Aayog
could leverage available local skills for providing independent inputs and feedback. Similarly, NITI Aayog
will need to design customized solutions depending on the impediment. There could be vertical and
horizontal coordination challenges which would require NITI Aayog to act as catalyst to enhance
implementation capabilities and improving outcomes, rather than merely measuring them.
 Basics of Economy 55

Suggestions for NITI Aayog

 It would be advantageous to constitute a separate parliamentary committee on planning, which
could meaningfully engage with the NITI Aayog‘s policy prescriptions.
 It would also be desirable to create state-level bodies, to be called Sub-National Institutes for
Trans- forming India (SuNITI), in formulating and expediting state-specific policies.
 This should enable state assemblies to discuss state-level plans in sync with the ―Three Year Action
Agenda‖.
 In the notification constituting the NITI Aayog, there is a provision to form ―Regional Councils to
address specific issues impacting more than one state or a region‖.
 This is the right time to implement this enabling mandate. The government needs to realize that a
business-as-usual approach will work no more, and it needs a comprehensive strategy to
transform implementation. Such strategy must comprise working with key stakeholders to identify
implementation-related challenges and design solutions
 It is high time that NITI Aayog realizes that it needs to metamorphose into an organization which
can transform implementation of policy reforms in the country. It should be in a position to garner
avail- able independent expertise and capacity to objectively analyse specific governance or
development challenges in a non-partisan manner, and design and implement solutions at different
levels of governance. Over time, it must create a repository of best practices for dealing with
implementation challenges, based on case studies from around the world. This strategy can aid
NITI Aayog to achieve its objective of transforming India. Surely, the management of NITI Aayog
is capable of rising to these challenges.

Planning Commission Niti Ayog

The planning commission had the power to The Niti Aayog is essentially a think tank and the
allocate funds are allocated by the Finance ministry
funds to Ministries and States
The planning commission formed the central Niti Aayog will not formulate any plans but will
plans and allocated funds for the same contribute ideas in the formation and
implementation of programmes
There was a limited role of States in the The Niti Aayog incorporates all the chief ministers
planning of States and the administrator of union territories
commission era in the Governing Council, which is fundamental to
It followed the top-down approach for policy It emphasizes on the bottom-up approach for policy
making making
There was no specific body to address local There is a regional Council for the purpose of
issues addressing local issues

F. FISCAL POLICY
Fiscal Policy talks about both the quantitative and qualitative aspects of government‘s income and
expenditure. Government implements its fiscal policy with the help of annual budget.
While exercising fiscal policy, the government keeps primarily the following factors in mind.
 Welfare of people
 Financial condition of government
 Inflation level in the economy

Types of fiscal Policy

Contractionary fiscal policy

Government reduces the spending and increases the taxes.

Expansionary fiscal policy

Government increases spending and reduces tax levels.

High Expenditure and Low Revenue Collection

When the government incurs high expenditure on the welfare of people (i.e. higher salaries and pensions,
etc.) and reduces revenue collection (i.e. lower taxes), it has the following effects:
• People‘s standard of living improves.
• Financial condition of the government deteriorates
• Higher expenditure and reduced revenue collection increases money supply and may lead to
inflation.
 56 Basics of Economy

Low Expenditure and High Revenue Collection

When the government incurs less expenditure on the welfare of people (i.e. lower salaries and pensions,
etc.) and increases revenue collection (i.e. higher taxes), it has the following effects:
• The standard of living of people does not improve.
• The financial condition of the government improves.

Less expenditure & high revenue collection reduces money supply in the market and, therefore may lead
to a fall in price.

Exercising Fiscal Policy

While exercising fiscal policy, the government strives to strike a balance between the aforesaid three
factors i.e. standard of living of people, financial condition of government and inflation in economy. The
right balance changes with circumstances as explained below.

When Economic Growth needs to be increased

Let us say that an economy has slowed down, unemployment levels have increased, spending has
reduced, and businesses are not making substantial profits.
In such scenario, the government increases its expenditure and reduces its revenue, which leads to more
funds with people and, consequently, rises in demand, investment, employment and output. However, any
such increase in expenditure and decrease in revenue collection would also depend on the financial
condition of the government.
Pumping money into the economy by decreasing taxation and increasing government spending is known
as ―pump priming‘. Thus, when the economy is slow, the RBI increases the money supply by exercising
monetary policy and the government increases expenditure and reduces tax collection. This is called
stimulus package.

In other words, a stimulus package is a package of economic measures put together by the government to
stimulate a floundering economy. The objective of a stimulus package is to reinvigorate the economy and
prevent or reverse a recession by boosting employment and spending.

When the Economy needs to be Curbed

When inflation is too strong, the economy may need a slowdown. In such a situation the government can
use fiscal policy to increase taxes to suck money out of the economy. Fiscal policy could also dictate a
decrease in government spending and thereby decreases the money in circulation.
Of course, the possible negative effects of such a policy in the long run could be a sluggish economy, less
growth and high unemployment levels.

How the Budget is made?

The budget is made through a consultative process involving the Ministry of Finance, NITI Aayog and
spending ministries. The Budget Division of the Department of Economic Affairs in the Ministry of Finance
is the nodal body responsible for producing the budget. The Finance Ministry issues guidelines on spending
by various ministries. On the basis of these guidelines, various ministries present their demands. In
September, the Budget Division issues a circular to all union ministries, states, union territories,
autonomous bodies, departments, and the defence forces for preparing the estimates for the next year.
After the ministries and departments send their demands, extensive consultations are held between the
union ministries and the Department of Expenditure of the Finance Ministry. At the same time, the
Department of Economic Affairs and the Department of Revenue meet the various interest groups such as
farmers, businesspersons, etc. to take their views. After the pre-budget meetings, a final call on the tax
proposals is taken by the Finance Minister. The proposals are discussed with the Prime Minister before the
budget is finalized.

Budget
It is the Annual financial statement of income & expenditure
of the government. Every budget contains three types of
data:
Budgetary estimates (of the next year), Revised estimates
(of the current year) and Actual Data(of the previous year)
 Basics of Economy 57

Revenue Budget
That part of the budget which deals with income & expenditure of the revenue account of the government.

Revenue Expenditure
This expenditure of the government doesn‘t create assets. It is synonymous with maintenance,
consumption and welfare.

It includes:
Interest paid on loans taken, salaries and pension & Provident Fund contribution, Subsidies, Defence,
account expenditure, Law and order expenditure, Expenditure on social service (Poverty alleviation
schemes)
Grants given by centre to states and other foreign countries.

Revenue Receipts
Government receipts which neither (i) create liabilities nor (ii) reduce assets are called revenue receipts.

Revenue Receipts are of two types:

Tax revenue receipts and non tax revenue receipts

Tax Revenue Receipts are of two types:

Direct Tax & Indirect tax

Non-Tax Revenue Receipts includes the following:

 User charges, bills, penalties, profits and dividends from PSUs (government is the largest
shareholder of PSUs).
 Interest earned on loans given.
 Grants which the government receives, both external (centre receives from World Bank and other
countries) and internal (states receive from centre).
 Service income from Railways, Advertisements and CISF giving protection to MNCs.

Revenue Deficit = Revenue Receipt – Revenue Expenditure

In India, we have Revenue deficit. Revenue deficit is not good as

money is spent for consumption purposes. Incurring Revenue Deficit
is considered a serious crime in management of fiscal policy by the
government. Revenue Deficit implies that government‘s tax
collection is not up to the mark and its maintenance and
consumption expenditure is huge. Therefore, revenue deficit is
criticized and should be kept as low as possible. The best option is
to have revenue surplus, but if that is not possible, then Revenue
Deficit should be minimized.
Government will fill the deficit with the money which could have
been invested in productive areas.

Effective Revenue Deficit

Effective Revenue Deficit = Revenue Deficit– GOCA

GOCA is Grants for creation of Capital Assets Revenue expenditure also includes all those grants which the
centre gives to states and union territories. But some of these grants are used by states to create capital
assets (though these assets are owned by the respective states & UTs and not the centre). As this part of
the revenue expenditure contributes to the growth of the economy so it shouldn‘t be treated as
unproductive in nature. The GOCA includes the Government of India grants to the states and the union
territories for the implementation of centrally sponsored schemes (CSS) eg. JNNURM, NREGA etc.

Capital Budget
 That part of the budget dealing with receipt and expenditure of the capital account by the
government.

Capital Expenditure
 Loans given by centre, both internal (to states, PSUs, UTs) and external (to other countries, or
sovereign bond purchase by India of foreign countries) Loan repayments
 Government expenditure on infrastructure creation.
 58 Basics of Economy

 Capital expenditure on defence eg. purchase of arms, fighter jets from other countries. (Capital
Expenditure comes under revenue as well as capital expenditure)
 Other liabilities of government like repayment of all receipts generated by government eg. PF
liabilities.

Sovereign bond – Debt security issued by a national government. It can be denominated in foreign
currency or domestic currency. Because of default risk, they are offered at a discount. Less developed
countries have difficulty issuing sovereign bonds denominated in their own currency & thus have to
assume debt denominated in foreign currency.

Capital Receipts
Government receipts which either
(i) create liabilities(borrowings) or
(ii) reduce assets (e.g. disinvestment)
It is of two types: Debt creating and non-Debt creating Capital Receipts.
Non debt Creating Capital Receipts include: Loan recovered from states and other countries, Disinvestment
proceeds
Debt creating Capital Receipts are: Borrowings by the government both internal (such as RBI, SBI, LIC
etc.) and external (World Bank, Foreign governments)
Raising of funds from public provident Fund (PPF) and small savings deposits e.g. Indira Vikas Patra, Kisan
Vikas Patra

Fiscal deficit = (Revenue expenditure +capital expenditure) minus (Revenue Receipts+ Non Debt
creating capital receipts) = borrowings of the Government

Budget deficit = (Revenue Receipts + Capital Expenditure) – (Revenue Receipts + Capital Receipts)

Primary deficit = Fiscal Deficit – Interest payments Primary deficit tells us that out of total borrowings of
the country, how much is used in interest payments (debt servicing) and how much is used for
expenditure on the economy.

Deficit financing
It is the process by which government finances/supports its deficit budget. In this process the government
knows in advance that its total expenditure is going to be more than its income and hence follows such
policies so that it can sustain the burden of the deficits proposed by it.

Means of Deficit Financing

Following are the means in order of their preference: -

1) External aid
2) External borrowings

They should be cheaper and for long term. It is considered better than internal borrowings due to two
reasons:
If government borrows from external sources, then banks don‘t have to lend to the government
and can lend to the corporates. Hence crowding out of the corporates doesn‘t take place.
External Borrowings can be used by the government to finance its external expenditure
3) Internal borrowings get the third preference. To finance its deficit, the government borrows more
amounts from the banks and moreover it is borrowed at less rate of interest (the government is
considered most secure, so the rate of interest for it is the least).

Drawbacks of high Fiscal Deficit

 Pushes up interest rates increased government debt burden.
 Burden future generation with high taxation thus disrupting inter-generational parity.
 It may cause Balance of Payment crisis (explained in External Sector chapter)
 Financial repression/crowding out of corporate which can cause growth to come down in future
 High inflation and hence real interest rate would become negative(effect of negative interest rate
explained in inflation chapter)

FRBM Act (Fiscal Responsibility and Budget Management Act) 2003

In the year 2000, the fiscal situation of the government of India had worsened and the fiscal deficit
reached to 6% of GDP. It was argued that, a legislative provision that is applicable to all governments –
present and future – is likely to be effective in keeping the deficits under control. The government of India
 Basics of Economy 59

set up a committee in 2000 to recommend draft legislation for fiscal prudence/responsibility. Based on the
recommendations of the committee, the government of India enacted the FRBM Act 2003, which became
effective from July 2004.

It had the following features:

1. Annual targets of reduction in deficits, government borrowings and debt were given to the
government.
2. Government will annually reduce the Revenue Deficit by 0.5% and Fiscal Deficit by 0.3% beginning
from 2004-2005.
3. Elimination of Revenue Deficit and reduction of Fiscal Deficit to 3% by 31st March 2009
4. RBI can‘t print money to lend to the government. Only in times of calamities can the RBI print
money to give to the centre.

FRBM Amendment Act 2012

The Fiscal Deficit target wasn‘t met due to recession in 2008.

Government gave stimulus packages like loan waiver, decreasing
interest rates, decreasing tax rates and increased government
spending to get India out of slowdown. Hence revenue deficit &
Fiscal Deficit increased.

Current Fiscal Deficit

Revenue Deficit need not be brought to 0% but ERD will be brought
Finance Minister Nirmala Sitharaman said the revised estimate of
the fiscal deficit for FY24 stands at 5.8 per cent while presenting
the Interim Budget 2024-25.

―The Revised Estimate of the fiscal deficit is 5.8 per cent of GDP,
improving on the Budget Estimate, notwithstanding moderation in the nominal growth estimates,‖
Sitharaman said.

She went on to say that the government is committed to reducing the fiscal deficit below 4.5 per cent by
2025-26, adding that the fiscal deficit in 2024-25 is estimated to be 5.1 per cent of GDP.

How much of Fiscal deficit is Right?

Fiscal Deficit is bridged by market borrowings and central bank printing fresh currency, if necessary. To a
limited extent, Fiscal Deficit is important as the Government‘s ability to help growth and welfare increases.
Government can always return the loans when its revenues improve due to tax buoyancy (discussed in
Taxation chapter). However, Fiscal Deficit becomes problematic and even destabilizing when it overshoots
a rational threshold. Sovereign debt crisis in Greece and the fiscal woes of USA are the result of
unsustainable high debt and borrowing.

Therefore, moderation of fiscal deficit is important. Large and persistent fiscal deficits are a cause of
concern, as they pose several risks. Fiscal deficits may cause macroeconomic instability by inflating the
economy as money supply rises.

Corporate sector is crowded out — they are left with inadequate funds in the markets as the government
borrowing requirements increase. Added to that, interest rates will be high as there is pressure on the
available money in the market. If the funding route is through RBI monetization, it means inflation and
instability. Inflation may mean less savings, less investment and eventually it hurts the sustainability of
high growth. Large deficits, even if they do not spill over into macroeconomic instability in the short run,
will require higher taxes in the long term to cover the heavy burden of internal debt. It means, as the
FRBM Act says , inter-generational parity is hurt if debt mounts as future generations will have to pay
higher taxes to help the government repay-the debt. Government liabilities- interest payments- increase
and there is far less for development.
There can be BOP crisis as FDI/FII (Foreign Direct Investment/Foreign Institutional Investment) inflows
may decrease because the credit rating of the country can come down because of high FD.

The above situation is good in normal times, but in abnormal times like slowdown or recession, the FD
may be allowed to go up as the stimulus package is required from the govt. side to get the economy out of
the crisis.
 60 Basics of Economy

NK Singh (FRBM Review) Committee- The FRBM Review Committee headed by former Revenue
Secretary, NK Singh was appointed by the government to review the implementation of FRBM. The
Committee has suggested that a rule based fiscal policy by limiting government debt, fiscal deficit and
revenue deficits to certain targets are good for fiscal consolidation in India.

Why Fiscal Deficit target should be relaxed during downturn of economy?

Banks and financial institutions fund business and others, and it is that credit money which drives the
economy. If, for some reason including reasons like lack of business confidence or rising NPAs, the bank
credit to the economy does not adequately grow, economic growth will suffer due to lack of adequate
money.
That is when the Budget needs to step in, to pump money into the economy by incurring deficit, and, for
the purpose, borrow the money lying with banks or even by printing more money, if that is needed.

Public Debt
It is government‘s debt. It doesn‘t include private debts (of individuals and corporates).

It includes:
Internal debt: Borrowings from SBI, LIC, etc.
Borrowing from RBI External debt: Loans from foreign countries/international financial institutions like
World Bank NRI deposits.
Public debt is justified as the government doesn‘t have adequate resources and taxation cannot be done
beyond a point but it should be done for productive reasons.

External Debt
It is the total external debt of the country. It includes both government and private debt.

It includes:
 NRI deposits
 Bilateral and multilateral loans of the government Trade credit
 ECBs (External Commercial Borrowings). When a corporate (PSU or Private) borrows money from
outside the country in a foreign currency, it is called ECB. They can either take loan from foreign
banks or they can issue bonds/debentures.
 Long term debt forms the bulk of India‘s external debt.

Fiscal Drag

Due to inflation, income comes in higher tax slab without any increase in profit in absolute terms. It
results in increase in income tax hence called fiscal drag. It causes no increase in purchasing power.
This problem arises during period of high inflation. Government gains due to higher tax collection and
economy suffers due to less demand as the prices increase.
In high growth & high inflation (overheated) economies, fiscal drag acts as an automatic stabilizer as it
acts to keep the demand stable.

Crowding in
If the government spends the borrowed money on infrastructure, it can have a multiplier effect on
investment, tax collection and growth. It is called crowding in of corporate.

Tax to GDP Ratio

 The tax to GDP ratio is the ratio of tax collected compared to national gross domestic product
(GDP). Some countries aim to increase the tax-to-GDP ratio by a certain percentage to address
deficiencies in their budgets.
 A tax-to-GDP ratio of 15% or higher is believed to ensure economic growth and, thus, poverty
reduction in the long term, according to the World Bank. The tax-to-GDP ratio in the United States
was 27.7% in 2022.
 Official information on India's direct tax-to-GDP ratio for 2023-24 shows that it increased to 6.6%,
up from 6.1% in 2022-23. This is the highest ratio in the past fifteen years and is expected to be
around 6.7% for the following year.
 2023-24, India's indirect tax-to-GDP ratio stood at 6.86%. Based on the latest GST collections
data, this figure indicates a slight increase from the previous year's ratio of 6.72%.
 The tiny Pacific island nation of Nauru has the highest tax-to-GDP ratio at 48.2%, meaning the
government collects taxes equivalent to roughly half the nation's overall economy. Denmark takes
second place with 35.5%. Third, fourth, and fifth places aren't far behind, with Seychelles
 Basics of Economy 61

(31.5%), Lesotho (30.8%), and Kiribati (30.1%.) Among the top ten highest ratios of taxes to
GDP, three are in Europe (Denmark, the United Kingdom, and Sweden), three are in Africa
(Seychelles, Lesotho, and Namibia), and three are in the Pacific Islands/Australia region (Nauru,
Kiribati, and New Zealand), with Barbados representing the Caribbean.
 The tax-to-GDP ratio gives policymakers and analysts a metric that they can use to compare tax
receipts from year to year. In most cases, because taxes are related to economic activity, the ratio
should stay relatively consistent. Essentially, as the GDP grows, tax revenue should grow as well.
 However, in cases of major shifts in tax law or during serious economic downturns, the ratio can
shift, sometimes dramatically. For example, during the 2000s, Australia‘s tax-to-GDP ratio rose to
a record high of 24.2%, but during the global financial crisis, the ratio fell to 3.7%. Australia
implemented a lot of tax cuts during that period, further depressing the ratio.
 During economic downturns, tax revenues typically fall because consumers earn less and spend
less, paying less property tax and consumption taxes. In addition, property taxes fall as property
values de- crease. However, tax receipts tend to fall at a faster rate than GDP, pushing the ratio
down.

Why is India‟s tax-to-GDP ratio so low?

According to a report by Moody‘s, India‘s tax-to-GDP ratio, at just fewer than 15 percent, is lower than
countries with similar sovereign ratings. There are three key reasons for that.

One, structural factors such as low per capita income keeps tax collections low. Low average incomes and
a high poverty rate result in a very small portion of the labour force being eligible to pay personal income
taxes. As of 2010-11, income taxes accounted for a lower proportion (10 percent) of the general
government‘s revenue than, say, the OECD average (approximately 30 percent).

Two, a large proportion of economic activity is generated by small and medium enterprises (SMEs).
Although these enterprises have enjoyed strong profitability growth over the past decade, the government
has not captured their earnings in tax revenues due to a variety of exemptions and compliance issues, the
ratings agency said.

Three, a lack of policy initiatives has also kept the tax take low. This includes certain tax exemptions on
agriculture related activity and until the mid-nineties, on most services as well. The tax net has been
progressively expanded to include a greater number of services each year, and service tax revenue has
grown the fastest of all revenue sources. Yet, service taxes constitute merely 5 percent of total general
government revenues, although they comprise about 60 per- cent of GDP.

FINANCE COMMISSION

The Finance Commission is a Constitutional body formulated under Article 280 of the Indian Constitution.
It is constituted every five years by the President of India to review the state of finances of the Union and
the States and suggest measures for maintaining a stable and sustainable fiscal environment. It also
makes recommendations regarding the devolution of taxes between the Centre and the States from the
divisible pool which includes all central taxes excluding surcharges and cess which the Centre is
constitutionally mandated to share with the States.

The FFC has submitted its recommendations for the period 2021-26. Some of the major recommendations
are as follows:

Share of states in central taxes

The share of states in the central taxes for the 2021-26 period is recommended to be 41%, same as that
for 2020-21. This is less than the 42% share recommended by the 14th Finance Commission for 2015-20
period. The adjustment of 1% is to provide for the newly formed union territories of Jammu and Kashmir,
and Ladakh from the resources of the centre.

Criteria for devolution

Table 1 below shows the criteria used by the Commission to determine each state‘s share in central taxes,
and the weight assigned to each criterion. The criteria for distribution of central taxes among states for
2021-26 period is same as that for 2020-21. However, the reference period for computing income
distance and tax efforts are different (2015-18 for 2020-21 and 2016-19 for 2021-26), hence, the
individual share of states may still change. The individual share of states in the taxes devolved by the
centre is provided in Table 2 in the annexure.
 62 Basics of Economy

We explain some indicators below.

Criteria for devolution

Criteria 14th FC 2015-20 15th FC 2020-21 15th FC 2021-26

Income Distance 50.0 45.0 45.0
Area 15.0 15.0 15.0
Population (1971) 17.5 - -
Population (2011)# 10.0 15.0 15.0
Demographic Performance - 12.5 12.5
Forest Cover 7.5 - -
Forest and Ecology - 10.0 10.0
Tax and fiscal efforts* - 2.5 2.5
Total 100 100 100

Note: #14th FC used the term ―demographic change‖ which was defined as Population in 2011.
*The report for 2020-21 used the term ―tax effort‖, the definition of the criterion is same.
Sources: Reports of the 14th and 15th Finance Commissions; PRS.

 Income distance: Income distance is the distance of a state‘s income from the state with the
highest income. Income of a state has been computed as average per capita GSDP during the
three-year period between 2016-17 and 2018-19. A state with lower per capita income will have a
higher share to maintain equity among states.

 Demographic performance: The Terms of Reference of the Commission required it to use the
population data of 2011 while making recommendations. Accordingly, the Commission used 2011
population data for its recommendations. The demographic performance criterion has been used to
reward efforts made by states in controlling their population. States with a lower fertility ratio will
be scored higher on this criterion.

 Forest and ecology: This criterion has been arrived at by calculating the share of the dense
forest of each state in the total dense forest of all the states.

 Tax and fiscal efforts: This criterion has been used to reward states with higher tax collection
efficiency. It is measured as the ratio of the average per capita own tax revenue and the average
per capita state GDP during the three years between 2016-17 and 2018-19.

Sixteenth Finance Commission is the Finance Commission constituted by the Government of

India under Article 280 of Constitution. Arvind Panagariya has been appointed as the Chief of
the Commission with the main task of determining revenue sharing between Central
Government and State Government for a period of five years from April 1, 2026.
Grants

Over the 2021-26 period, the following grants will be provided from the centre‘s resources (see Table 3
and 4 in the annexure for more details):

 Revenue deficit grants: 17 states will receive grants worth Rs 2.9 lakh crore to eliminate
revenue deficit.

 Sector-specific grants: Sector-specific grants of Rs 1.3 lakh crore will be given to states for
eight sectors:
(i) Health,
(ii) School education,
(iii) Higher education,
(iv) Implementation of agricultural reforms,
(v) Maintenance of PMGSY roads,
(vi) Judiciary, (vii) statistics, and
(viii) Aspirational districts and blocks.
A portion of these grants will be performance-linked.

 State-specific grants: The Commission recommended state-specific grants of Rs 49,599 crore.

These will be given in the areas of:
 Basics of Economy 63

(i) Social needs,

(ii) Administrative governance and infrastructure,
(iii) Water and sanitation,
(iv) Preservation of culture and historical monuments,
(v) High-cost physical infrastructure, and
(vi) Tourism.
The Commission recommended a high-level committee at state-level to review and monitor
utilisation of state-specific and sector-specific grants.

 Grants to local bodies: The total grants to local bodies will be Rs 4.36 lakh crore (a portion of
grants to be performance-linked) including:
(i) Rs 2.4 lakh crore for rural local bodies,
(ii) Rs 1.2 lakh crore for urban local bodies, and
(iii) Rs 70,051 crore for health grants through local governments.

The grants to local bodies will be made available to all three tiers of Panchayat- village, block, and
district. The health grants will be provided for:
(i) Conversion of rural sub-centres and primary healthcare centres (PHCs) to health and wellness
centres (HWCs),
(ii) Support for diagnostic infrastructure for primary healthcare activities, and
(iii) Support for urban HWCs, sub-centres, PHCs, and public health units at the block level.

Grants to local bodies (other than health grants) will be distributed among states based on
population and area, with 90% and 10% weightage, respectively. The Commission has prescribed
certain conditions for availing these grants (except health grants).
The entry-level criteria include:
(i) Publishing provisional and audited accounts in the public domain and
(ii) Fixation of minimum floor rates for property taxes by states and improvement in the collection
of property taxes (an additional requirement after 2021-22 for urban bodies). No grants will be
released to local bodies of a state after March 2024 if the state does not constitute State Finance
Commission and act upon its recommendations by then.
 Disaster risk management: The Commission recommended retaining the existing cost-sharing
patterns between the centre and states for disaster management funds. The cost-sharing pattern
between centre and states is:
(i) 90:10 for north-eastern and Himalayan states, and
(ii) 75:25 for all other states. State disaster management funds will have a corpus of Rs 1.6 lakh
crore (centre‘s share is Rs 1.2 lakh crore).

Fiscal roadmap

 Fiscal deficit and debt levels: The Commission suggested that the centre bring down fiscal
deficit to 4% of GDP by 2025-26. For states, it recommended the fiscal deficit limit (as % of
GSDP) of:
(i) 4% in 2021-22,
(ii) 3.5% in 2022-23, and
(iii) 3% during 2023-26.
If a state is unable to fully utilise the sanctioned borrowing limit as specified above during the first
four years (2021-25), it can avail the unutilised borrowing amount (calculated in rupees) in
subsequent years (within the 2021-26 period).
Extra annual borrowing worth 0.5% of GSDP will be allowed to states during first four years (2021-
25) upon undertaking power sector reforms including:
(i) Reduction in operational losses,
(ii) Reduction in revenue gap,
(iii) Reduction in payment of cash subsidy by adopting direct benefit transfer, and (iv) reduction in
tariff subsidy as a percentage of revenue.
The Commission observed that the recommended path for fiscal deficit for the centre and states
will result in a reduction of total liabilities of:
(i) The centre from 62.9% of GDP in 2020-21 to 56.6% in 2025-26, and
(ii) The states on aggregate from 33.1% of GDP in 2020-21 to 32.5% by 2025-26.
It recommended forming a high-powered inter-governmental group to:
(i) Review the Fiscal Responsibility and Budget Management Act (FRBM),
(ii) Recommend a new FRBM framework for centre as well as states, and oversee its
implementation.
 64 Basics of Economy

 Revenue mobilisation: Income and asset-based taxation should be strengthened. To reduce

excessive dependence on income tax on salaried incomes, the coverage of provisions related to
tax deduction and collection at source (TDS/TCS) should be expanded. Stamp duty and
registration fees at the state level have large untapped potential. Computerised property records
should be integrated with the registration of transactions, and the market value of properties
should be captured. State governments should streamline the methodology of property valuation.

 GST: The inverted duty structure between intermediate inputs and final outputs present in GST
needs to be resolved. Revenue neutrality of GST rate should be restored which has been
compromised by multiple rate structure and several downward adjustments. Rate structure should
be rationalised by merging the rates of 12% and 18%. States need to step up field efforts for
expanding the GST base and for ensuring compliance.

 Financial management practices: A comprehensive framework for public financial management

should be developed. An independent Fiscal Council should be established with powers to assess
records from the centre as well as states. The Council will only have an advisory role. A time-
bound plan for phased adoption of standard-based accounting and financial reporting for both
centre and states should be prepared while eventual adoption of accrual-based accounting is being
considered. The centre as well as states should not resort to off-budget financing or any other
non-transparent means of financing for any expenditure. A standardised framework for reporting
of contingent liabilities should be devised. Both centre and states should strive to improve the
accuracy and consistency of macroeconomic and fiscal forecasting.
 States should amend their fiscal responsibility legislation to ensure consistency with the centre‘s
legislation, in particular, with the definition of debt. States should have more avenues for short-
term borrowings other than the ways and means advances, and overdraft facility from the Reserve
Bank of India. States may form an independent debt management cell to manage their borrowing
programmes efficiently.

Other recommendations

 Health: States should increase spending on health to more than 8% of their budget by 2022.
Primary healthcare expenditure should be two-thirds of the total health expenditure by 2022.
Centrally sponsored schemes (CSS) in health should be flexible enough to allow states to adapt
and innovate. Focus of CSS in health should be shifted from inputs to outcome. All India Medical
and Health Service should be established.

 Funding of defence and internal security: A dedicated non-lapsable fund called the
Modernisation Fund for Defence and Internal Security (MFDIS) will be constituted to primarily
bridge the gap between budgetary requirements and allocation for capital outlay in defence and
internal security. The fund will have an estimated corpus of Rs 2.4 lakh crore over the five years
(2021-26). Of this, Rs 1.5 lakh crore will be transferred from the Consolidated Fund of India. Rest
of the amount will be generated from measures such as disinvestment of defence public sector
enterprises, and monetisation of defence lands.

 Centrally-sponsored schemes (CSS): A threshold should be fixed for annual allocation to CSS
below which the funding for a CSS should be stopped (to phase out CSS which outlived its utility or
has insignificant outlay). Third-party evaluation of all CSS should be completed within a stipulated
timeframe. Funding pattern should be fixed upfront in a transparent manner and be kept stable.

TYPES OF BUDGETS

Outcome Budget or Performance Budget

It is a shift from traditional budgeting in the sense that it goes

beyond budgeting by inputs (how much can we spend) towards
budgeting by measurable outcomes (what can we achieve with what
we spend).
Outcome based budgeting is a practice of suggesting and listing of
estimated outcomes of each programme or schemes designed.

Outcomes are the end products and results of various Government

initiatives and interventions.
 Basics of Economy 65

An interesting feature of outcome-based budgeting is that the outcomes of programmes are measured not
just in terms of Rupees but also in terms of physical units like Kilowatt of energy produced or tonnes of
steel produced. Also, outcomes are expressed in terms of qualitative targets and achievements to make
the technique more comprehensive. Under outcome budgeting, the document shows physical dimensions
of the financial budget indicating the actual physical performance.
In 2005, India showed its interest in adopting outcome budgeting. India today follows a performance
budgeting framework which tracks outcomes at the level of individual programmes. Consequently, the
government specifies (and monitors) key outcomes for all its key development programmes or initiatives
(say for example, ―number of additional children to be covered under the Mid-Day Meal Scheme‖) together
with the envisaged budgetary outlay for the programme.
The first step in developing an outcome budgeting system involves the process of defining the desired
outcomes (outcomes are essentially more long term and typically are made up of more than one output)
for the concerned ministry, department or function. This is followed by the process of identifying the
interventions required for achieving target outcomes. Finally, the expenditure required for implementing
the identified interventions is estimated, which forms a line item in the budget for that particular year.

Let us explain it with an example. Assuming that the primary outcome being targeted is an increase in
literacy rate from xx% to yy%, the first step would be to identify the various interventions required for
achieving this target. These could include-
a) Augmentation of existing school and associated infrastructure,
b) Implementing special programmes like mid-day meal for attracting children in the target age groups to
school,
c) Undertaking focused community based awareness programmes etc. The final part of the exercise
would involve estimating the expenditure required for implementing the identified interventions.

Almost all developed countries in the world have adopted outcome-based budgeting techniques in their
efforts to provide high quality effective services to their citizens. In fact, even in the developing world,
select countries in Africa are venturing in to this area, with requisite technical support being arranged by
agencies like the World Bank, African Development Bank and others.

Advantages of Outcome budget:

 Better service delivery Decision-making

 Evaluating programme performance and results Communicating programme goals
 Improving programme effectiveness Make budgets cost effective
 Fix accountability
 Better scheme management
 Makes government programmes more result oriented, instead of outlay oriented.

Challenges in Outcome Budget in India

Sadly, limited progress has been made in this area. The slow progress on this front has primarily been due
to two key reasons. Firstly, much of the development interventions in India are routed through the state
governments. Other than a few progressive states, the key line departments and other organizations in
most states are yet to adopt outcome budget. There is there- fore a need for an appropriate Centre-State
institution- al framework to standardize a set of outcome/output indicators at the sector (health, education
etc.) level and put in place systems and processes for collecting and collating outcome related information
together with interventions which are being or are proposed to be used for impacting these outcomes.
Secondly, there exists limited knowledge and understanding on the linkage between specific Government
interventions and the outcomes expected. Moreover, there are multiple programmes operating in the same
sector. Additional statistical analysis based on past data would need to be conducted to understand cause
effect relationships better. There is data on key outcomes in individual sectors for all States, but there is a
need to check the consistency of this data set and the underlying processes used for collection and
collation of data.

Zero Based Budgeting

Zero based budgeting is a practice where all expenditure is allocated and revenue estimates are made for
a new period starting from a zero base. Cleary, as the name indicate, zero-based budgeting starts from a
―zero base‖. Everything including expenditure and receipts are beginning from a scratch under ZBB.
Budget estimates for each Ministries or heads are provided on the basis of what is needed for the
upcoming period, regardless of the budget activity of the previous years.
 66 Basics of Economy

Under ZBB, allocations or funding are based on program efficiency and necessity rather than budget
history. However, ZBB is a time-consuming process that takes much longer time than traditional, cost-
based budgeting.

Traditional Budget calls for incremental increases over previous budgets, such as a 5% increase in
spending, as opposed to the justification of all the expenses required in ZBB. Traditional Budgeting
analyses only new expenditures, while ZBB starts from zero and calls for a justification of old, recurring
expenses in addition to new expenditures.

Zero-base budgeting first rose to prominence in government in the 1970s. Though looked attractive, the
ZBB has lost its utility gradually because of the complexities and costs involved in implementing it. The
large amount of paperwork and data ZBB generates, along with doubts about the method‘s ability to fully
meet its theoretical promises, were some factors that defected the ZBB.
In recent years, the ZBB is making a comeback in the context of fiscal constraints. Many governments
across the world are experiencing the after effects of the worst economic slowdown now and are following
the principles of ZBB in the context of tax revenue short falls.

Gender Responsive Budget

A Gender-Responsive Budget is a budget that acknowledges the gender patterns in society and allocates
the money to implement policies and programs that will change these patterns in a way that moves
towards a more gender equal society. Gender budget initiatives are exercises that aim to move the
country in the direction of a gender-responsive budget. Gender budgeting (GB) is a practice that uses
budgetary measures to support gender commitments. It is a powerful tool for achieving gender
mainstreaming so as to ensure that benefits of development reach women as much as men. It is not just
an accounting exercise but an ongoing process of keeping a gender perspective in policy/ programme
formulation, its implementation and review.
Gender budgeting is an evolving area in India. More and more ministries and departments are contributing
to the development of the practice in the country.
Budgetary resource allocation and the specific expenditure amount for women specific programmes are
separately mentioned as part of gender specific budgeting.

Need of a Gender Budget

The gender budgeting exercise would potentially assist and lead to the following empowering measures:
1. Addressing gap between policy commitment and allocation for women by emphasizing on adequate
re- source allocation.
2. Putting focus on gender sensitive programme formulation and implementation.
3. Mainstreaming gender concerns in public expenditure and policy.
4. Improving women‘s economic equality.
5. Improving effectiveness, efficiency, accountability, and transparency of government budgets.
6. Revealing discrepancies between what a governments says it is doing and the actual impact of
government policies.

Objectives of Gender Budgeting

Objective of gender budgeting was to ensure that pol- icy commitments and financial outlays are made on
gender perspective. Other objectives are to tackle gender imbalances, promote gender equality and
development are identified under gender specific budgeting. Similarly, it also ensures that public resources
were made in the budget in gender specific manner.

Gender Budgeting in India

The first Gender Budget Statement appeared in the Union Budget

2005-06 and included 10 demands for grants. However, in recent
budgets the number of demands of grants have been as high as
[Link] states in India have also introduced gender budgeting but the
lack of a standardised nomenclature for the various schemes has
made it difficult to replicate or assess them.
 Basics of Economy 67

Fugitive Economic Offenders Ordinance

Fugitive Economic Offenders Act, 2018 seeks to confiscate properties of economic offenders who have left
the country to avoid facing criminal prosecution or refuse to return to the country to face prosecution.
Fugitive economic offender (FEO): An FEO is a person against whom an arrest warrant has been issued for
committing any offence listed in the Schedule to the Bill, and the value of the offence is at least Rs 100
crore. Further, the person has left the country and refuses to return, in order to avoid facing prosecution.

Key Features

The ordinance seeks to confiscate properties of economic offenders who have left the country to avoid
facing criminal prosecution. A fugitive economic offender is a person against whom an arrest warrant has
been issued for committing offence like-
i. counterfeiting government stamps or currency, cheque dishonour for insufficiency of funds
ii. money laundering
iii. transactions defrauding creditors.

A fugitive economic offender is one who has left the country to avoid facing prosecution, or refuses to
return to face prosecution.

Provisions

The provisions of the ordinance will apply for economic offenders with following conditions:
i. who refuse to return
ii. Persons against whom an arrest warrant has been issued for a scheduled offence
iii. Wilful bank loan defaulters with outstanding of over Rs.100 crore It provides for confiscating
assets even without a conviction. It also provides for paying off lenders by selling off the fugitive‗s
properties. Such economic offenders will be tried under Prevention of Money Laundering Act
(PMLA).

G. INFLATION
Inflation means a persistent rise in the price of goods and services. Inflation reduces the purchasing power
of money. It hurts the poor more as a greater proportion of their incomes are needed to pay for their
consumption. Inflation reduces savings, pushes up interest rates & dampens investment depending upon
the rate of growth of prices.

Inflation can be of the following types:

Creeping inflation- is a rate of general price increase of 1 to 5 percent a year. Creeping inflation of 3 to
5 percent erodes the purchasing power of money when continued over many years, but it is
―manageable‖. Furthermore, a low creeping inflation could be good for the economy as producers and
traders make reasonable profits encouraging them to invest.

Trotting inflation- is usually defined as a 5 to 10 percent annual rate of increase in the general level of
prices that, if not controlled, might accelerate into a galloping inflation of 10 to 20 percent a year. If it
aggravates, galloping inflation can worsen to ‗runaway‘ inflation which may change into a hyperinflation.
Hyperinflation is inflation that is out of control, a condition in which prices increase rapidly as a currency
loses its value.

Other related concepts are-

 Deflation- when there is a general fall in the level of prices.
 Disinflation- which is the reduction of the rate of inflation.
 Stagflation- which is a combination of inflation and rising unemployment due to recession. It is
called stagnation because the economy is stagnant but there is inflation. It is caused due to supply
side constraints.
 Reflation, which is an attempt to raise prices to counteract deflationary pressures.

GDP Deflator
GDP deflator is a measure of the change in prices of all new, domestically produced, final goods and ser-
vices in an economy. The GDP deflator is not based on a fixed market basket of goods and services but
ap- plies to all goods and services domestically produced.
 68 Basics of Economy

Nominal GDP
GDP deflator = --------------- x 100
Real GDP

Types of inflation according to causes

The major types of inflation are:

Demand – pull inflation: inflation caused by increase in demand due

to increased private and government spending, etc. This is commonly
described as ‗too much money chasing too few goods. Since supplies
will be augmented to adjust to demand, prices will come down. It may
be referred to as ‗growth inflation‘ too. Demand – pull inflation can be
caused by money supply increasing.

Cost push inflation: It is also referred to as ―supply shock inflation,‖

caused by reduced supplies due to increased prices of inputs, for example crude prices globally went up in
2008 causing supply constraints which means higher costs of production and so higher prices. Crude and
food prices shot up in 2008 July. Other examples are higher cost of capital, increases in prices of imported
raw materials.

Structural inflation: A type of persistent inflation caused by

deficiencies in certain conditions in the economy such as a backward
agricultural sector that is unable to respond to people‘s increased
demand for food, inefficient distribution and storage facilities leading
to artificial shortages of goods, and production of some goods
controlled by some people. Food inflation currently being witnessed is
structural in nature as the preference for protein food is far ahead of
its supplies and this is caused due to income rise.

PPI
Producer Price Index (PPI) measures the change in the prices received by a producer. The difference with
the WPI is accounted for by logistics, profits and taxes. Mainly producer price inflation measures the price
pressure due to increase in the costs of raw materials. It may be absorbed by the producers or made up
by increases in productivity or passed on to the consumers. It depends on the market conditions.

WPI
Wholesale Price Index measures the change in price of a selection of goods at wholesale level, prior to
retail sales thus excluding sales taxes. These are very similar to the Producer Price Indices.

CPI
Consumer price index measures the change in prices paid by the consumer at the retail level. It can be for
the whole community or group – specific for example, CPI for industrial workers etc as in India.

Effects of Inflation on various classes of persons

Debtors and creditors: During periods of rising prices, debtors gain and creditors lose. When prices rise,
the value of money falls. Though debtors return the same amount of money, but they pay less in terms of
value of money. Thus, inflation brings about a redistribution of real wealth in favour of debtors at the cost
of creditors.

Salaried persons: Salaried workers such as clerks, teachers, and other white collar persons lose
purchasing power when there is inflation. The reason is that their salaries are slow to adjust to rising price.

Wage earners: Wage earners may gain or lose depending on the speed with which their wages adjust to
rising prices. If their unions are strong, they may get their wages linked to the cost of living index. In this
way, they may be able to protect themselves from the bad effects of inflation.

Fixed-income group: The recipients of transfer payments such as pensions, unemployment insurance,
social security, etc. and recipients of interest and rent, live on fixed incomes. All such persons lose
because they receive fixed payments, while the value of money continues to fall with rising prices.
 Basics of Economy 69

Investors: Persons who hold shares of companies gain during inflation. When prices rise, business
activities expand which increases profits of companies. But those who invest in debentures, securities,
bonds, etc., which carry a fixed interest rate, lose during inflation because they receive a fixed sum while
the purchasing power is falling.

Business persons: Business persons of all types, such as producers, traders, and real estate holders,
gain during periods of rising prices. When prices rise, the value of their inventories (goods in stock) rise in
the same proportion. So they profit more when they sell their stored commodities.
Government: The government as a debtor gains at the expense of households who are its principal
creditors. This is because interest rates on government bonds are fixed and are not raised to offset the
expected rise in prices. With inflation, even the real value of bonds is reduced.

Exporters: Inflation discourages exports as domestic sales

are attractive and BOP problems can be caused. Inflation
may erode the external competitiveness of domestic
products if it leads to higher production costs such as wage
increase, higher interest rate.

Inflation can drag down growth as interest rates are raised

and cost of credit increases. Increasing uncertainly may
discourage investment and saving. The savings pattern is
affected thus: with the declining value of money, people
would be more inclined to spend than save anticipating that
their money can buy even less in the future. Therefore, with
its adverse effect on savings, inflation can also discourage
investment.

Thus, inflation redistributes income from wage earners and fixed-income groups to profit recipients, and
from creditors to debtors. So far as wealth redistributions are concerned, the very poor are more likely to
lose than the middle- and high-income groups. This is because the poor hold wealth in monetary form and
are mostly wage earners. On the other hand, the middle income and rich people are likely to invest in
shares and real estate, which witness price rise during times of inflation. Thus, inflation increases the gap
between rich and poor.

Small Amount of Inflation can be Good

It can be argued that a low level of inflation can be good if it is a result of innovation. New products are
launched at- high prices, which quickly come down through competition. Therefore, there is
encouragement for innovation and the problem is short lived. Also, ‗a small price rise is necessary for‘
wages to go up. It further helps the economy keep off deflation which can otherwise set off a recession.
Besides, inflation at a moderate level is an incentive to the producer. At any rate, small price rises are
inevitable in a growing economy. Some see mild inflation as ―greasing the wheels of commerce‖.

To Control Inflation

There are fiscal, monetary, supply side and administrative measures to control inflation to ideal / optimal
rates.
Fiscal measures include increase in taxes.
Monetary measures include increase in interest rate (Repo rate, reverse repo rate) and increase in re-
serve requirements (SLR, CRR). Open market operations (RBI can sell government securities and suck out
excess liquidity) can stabilize prices under normal conditions also. Sterilization through government bond
transaction as in the case of Market Stabilization Bonds.
Administrative measures include implementation of dishoarding
and anti-black marketing measures. Wage and price controls can
also be used.

Measurement of Inflation

In India, CPI and WPI are two major indices for measuring
inflation. Comparison between WPI and CPI
The WPI was the main index for measurement of inflation in
India till April 2014 when the RBI adopted CPI as the key
measure of inflation.
 70 Basics of Economy

The WPI is computed by the office of the Economic Adviser in the Ministry of Commerce and Industry,
Government of India. CPI is of three types: CPI for industrial workers (IW), CPI for agricultural labourers
(AL)/rural labourers (RL), and CPI (rural/urban/combined). While the first two are compiled and released
by the Labour Bureau in the Ministry of Labour and Employment, the third by the Central Statistics Office
(CSO) in the Ministry of Statistics and Programme Implementation.
Both WPI and CPI are released monthly.
Base year of WPI is 2011-12.
Base year of CPI is 2012-13

Base effect: The consequence of abnormally high or low levels of inflation in the same month of the
previous year distorts headline inflation numbers for the present month. A base effect can make it difficult
to accurately assess the inflation levels. In our example, the base month is November 2015.

Indices of inflation

Changes in the prices levels at the producer, wholesale and retail level are tracked by various price indices
in India viz. PPI, WPI and CPI respectively.
All prices indices use a particular year as a ―base year‖ that means that rise or falls in prices are measured
with reference to the price in that year.

Wholesale Price index

 Government launched a new series of wholesale price index (WPI) with 2011-12 as base. Earlier
2004-05 was used as base year to calculate WPI.
 The new series of WPI has 697 items as against 676 items in the previous series. In all 199 new
items have been added and 146 old items have been dropped.
 Under primary article group of the new WPI, there are 117 items against earlier 102, while fuel
and power category has 16 as compared to 19 earlier, in the new series, there are 564 items of
manufactured products compared to 555 items earlier.
 Manufactured items now have a lesser weight of 64.23 as against 64.97 earlier. The weight for
fuels has also decreased to 13.15 against 14.91 earlier. But for primary articles, the weight has
increases at 22.62 against [Link] decreasing order of three groups of items in terms of
weightage is: manufactured products>primary articles >fuel & power.
 The WPI is published monthly by the Economic Advisor in the Ministry of commerce and Industry,
with a two week lag, tracks the wholesale traded price of 697 items that include agricultural
commodities (such as rice, tea, raw cotton, groundnut Oil seed), industrial commodities such as
‗iron ore, bauxite, coking coal, intermediate products for industry (such as cotton yarn, polyester
fiber, synthetic res- ins, iron & steel, sheet glass), products for consumers (aata, sugar, paper,
electricity, ceiling fans) and energy items (petrol, kerosene, electricity for commercial use). The
weight attached to each item in the index is meant to reflect the volume (by value) of wholesale
trade in that item in the Indian market.
 In the Primary Articles, new vegetables and fruits such as Radish, Carrot, cucumber, Bitter Gourd,
Mosambi, Pomegranate, Jack Fruit, Pear etc have been added. In the mineral group items like
Copper Concentrate, Lead Concentrate and Garnet have been added whereas Copper Ore,
Gypsum, Kaolin, Dolomite, Magnesite have been deleted. Natural Gas has been added as a new
item.
 A new ―Food Index‖ is being compiled combining the ―Food Articles‖ under ―Primary Articles‖ and
―Food Products‖ under ―Manufactured Products‖. Together with the Consumer Food Price Index
released by Central Statistics Office, this would help monitor the price situation of food items
better.
 The WPI Food Index consisting of ‗Food Articles‘ from Primary Articles group and ‗Food Product‘
from Manufactured Products group has 24.38% weightage in WPI.
 In the new series of WPI, prices used for compilation do not include indirect taxes in order to
remove impact of fiscal policy. This is in consonance with international practices and will make the
new WPI conceptually closer to ‗Producer Price Index‘. There are a number of agricultural
commodities, especially, some fruits and vegetables, which are of a seasonal nature. Such
seasonal items are handled in the index in a special manner. When a particular seasonal item
disappears from the market and its prices are not quoted, the index of such an item ceases to get
compiled and its weight is distributed over the remaining items and new seasonal items, if any, in
the concerned sub group.
 Headline inflation in India is measured in terms of WPI.
 In short, the advantage of the WI is that it covers goods; is available with relatively small time lag
of fortnight; is convenient to compile. Disadvantages are that it does not include services like
transport, health, education etc. Wholesale Price Index (WPI) is computed by the Office of the
 Basics of Economy 71

Economic Adviser in Ministry of commerce & Industry, Government of India. It was earlier released
on weekly basis for Primary Articles and Fuel Group. However, since 2012, this practice has been
discontinued. Currently, WPI is released monthly.

Limitation of WPI

The accuracy of WPI is unsatisfactory even after the introduction of the raised series in 2010. Services
such as rail and road transport, health care, postal banking and insurance, for example, are not part of the
WPI basket. Neither are the products of the unorganized sector that are estimated to constitute about 35
percent of the total manufactured output of the country. The index thus falls well short of being a broad
based indicator of the price level even in its construction.

Consumer Price Index

Other than the WPI, India also calculates inflation at the consumer level. Currently we have three different
CPIs, CPI-rural, CPI-urban and CPI-combined.

New Series of CPI for urban areas

CPI (Urban) numbers are compiled at state / UT as well as at all India Level.
For regular price collection, 310 towns have been selected, which include all states UT capital from each
selected town, price data are collected in respect of items consumed by the population of the respective
states / UTs. In all 1,114 price schedule containing an average of 250 items are canvassed every month.
House rent data are also collected as a fixed set of rented dwellings from the select towns by Prices
National Sample Survey Office (NSSO).

New Series of CPI for rural areas

CPI (Rural) numbers are compiled at state / UT and all India levels.
CPI (Rural) would provide the price changes for the entire rural population of the country, a total of 1,181
villages have been selected at all India level. The broad criterion of selection of villages is to have
representation of all the districts within the state/UT and two villages from each district have been selected
randomly from different tensile, however, to provide adequate representation of the total rural population
in some states / UTs, allocated number of villages to the state has been increased or decreased on the
basis of population of the concerned state / UT. Regular prices are collected by the officials of the
Department of Posts.

National CPI

CSO will also compile national CPI by merging CPI (Rural) and CPI (urban) with appropriate weights, as
derived from NS$ 61st round of Consumer Expenditure Survey (2004 - 05) data.

Subgroup Rural Urban Combined

Food and Beverages 54.18 36.29 45.86
Pan and tobacco 3.26 1.36 2.38
Fuel and light 7.94 5.58 6.84
Clothing bedding footwear 7.36 5.57 6.53
Housing 0 21.67 10.07
Miscellaneous 27.26 29.53 28.32

Advantages/Disadvantages of using CPI

Pros

CPI better reflects demand side of the economy and market dynamism. It is closer to what the general
population is effected by, and therefore a better parameter. The revisions in the CPI are way forward. For
ex: weightage for food is down from 47.5% to 45.8%. The weightage for housing and clothing has
increased. These changes reflect the changing consumption pattern. CPI indirectly takes into account the
services sector as reflected in the spending of health, education, transport and communication etc. The
central bank has to maintain the real interest rate and therefore has to target CPI because retail
consumers, their ability to consume and buy goods (especially poor), their investment and savings
decisions etc., are impacted by it.
 72 Basics of Economy

Cons

Distorting: The high weightage for a relatively small consumption basket of food and fuel items if used to
determine the overall cost of funds can be distorting. Volatile sectors like fuel in CPI basket. Fuel prices
depend upon supply chain bottle-necks and disruptions are beyond control of rates set by the RBI.
Changing demand patterns not appropriately reflected in CPI: there is rising demand for the so called
superior foods, because of growing incomes and transfer payments.

Reasons for difference between wholesale and consumer prices

WPI measures price rise at the wholesale level. Wholesale means sale in large quantities and meant for
resale it covers a certain set of goods that are traded at the wholesale level. CPI on the other hand
measures price rise at the retail level. There is a difference between the two. The difference is due to a
number of factors. A substantial portion of the differential is accounted for by the retailer‘s margins which
are built into what the consumer pays. Besides, the way the two indices are calculated differs both in
terms of weight age assigned to products as well as the kind of items included in the basket of products.

While wholesale prices are more or less the same throughout the country, consumer prices or retail prices
vary across regions (rural and urban) and also across cities according to the consumer preferences for
certain products, supplies and purchasing power. Besides, taxes levied by states comprise an important
component of the variation on prices of any products, therefore, give WPI an important place in
government policy as it is more representative; figures come quickly relatively and has an all-India
character.

Difference between CPI and WPI

1. Primary use of WPI is to have inflationary trend in the economy as a whole. However, CPI is used
for adjusting income and expenditure streams for changes in the cost of living.
2. WPI is based on wholesale prices for primary articles, administered prices for fuel items and ex-
factory prices for manufactured products. On the other hand, CPI is based on retail prices, which
include all distribution costs and taxes.
3. Prices for WPI are collected on voluntary basis while price data for CPI are collected by
investigators by visiting markets.
4. CPI covers only consumer goods and consumer services while WPI covers all goods including
intermediate goods transacted in the economy.
5. WPI weights primarily based on national accounts and enterprise survey data and CPI weights are
derived from consumer expenditure survey data.
6. WPI doesn‘t include services while CPI includes services.

Divergence between WPI and CPI

WPI reflects the change in average prices for bulk sale of commodities at the first stage of transaction
while CPI reflects the average change in prices at retail level paid by the consumer. Major difference is in
the baskets of the two indices. The prices used for compilation of WPI are collected at ex-factory level for
manufactured products.

In contrast, retail prices applicable to consumers and collected from various markets are used to com-pile
CPI. The reasons for the divergence between the two indices can also be partly attributed to the difference
in the weight of food group in the two baskets. CPI Food group has a weight of 45.8% as compared to the
combined weight of 24.4% (Food, articles and Manufactured Food products) in WPI basket. Similarly
weights of the major petroleum products such as petroleum and HSD also vary significantly. The CPI
basket consists of services like housing, education, medical care, recreation etc. which are not part of WPI
basket.

A significant proportion of WPI item basket represents manufacturing inputs and intermediate goods like
minerals, basic metals, machinery etc. whose prices are influenced by global factors but these are not
directly consumed by the households and are not part of the CPI item basket. Thus, even significant price
rise or decline in items included in WPI basket need not necessarily translate into CPI in the short run. The
rise or fall in prices at wholesale level spills over to the retail level after a lag. Middlemen and indirect
taxes that add on make the CPI higher. The divergence is likely to get greater as the new WPI series
excludes indirect taxes.
 Basics of Economy 73

Which Index should one use?

The WPI is useful in certain contexts. For example, for industrialists, the costs of setting up a factory over
the course of several years; and further to calculate the costs of production and returns over several
years. The basket of items in the CPI does not include machinery, chemicals, and so on; secondly, the
price of electricity in the CPI is the consumer tariffs, not the industrial tariffs; and so on.

Figures for inflation in the WPI are on the average much lower than those in the CPI indices. There could
be two reasons for these differences in rates be- tween the WPI and CPI first, prices of the items in the
CPI basket might have risen more sharply than the items excluded from it – this would mean that prices of
mass consumption goods have risen more sharply than inputs for production; secondly, the retail prices of
commodities might have grown more sharply than the wholesale prices, indicating that middlemen have
taken a bigger share.

„Core‟ or‟ Underlying Inflation‟

Core or underlying inflation measures the long run trend in the general price level. Temporary effects on
inflation are factored out to calculate core inflation.

For this purpose, certain items are usually excluded from the computation of core inflation. These items
include: changes in the price of fuel and food which are volatile or subject to short-term fluctuations and/
or seasonal in nature like food items. In other words, core or underlying inflation is an alternative measure
of inflation that eliminates transitory effects. These price changes are not within the control of monetary
policy as much as these are supply shocks (price of food and fuel depend on supply and not on demand).
The main argument here is that the central bank should effectively be responding to the movements in
permanent component of the price level rather than temporary deviations. RBI can control core inflation
while it has certain limitations in controlling general inflation.

Inflation Targeting

Inflation targeting focuses mainly achieving price stability as the ultimate objective of monetary policy.
This approach entails the announcement of an inflation target – either a number or a range, that the
central bank promises to achieve over a given time period. The targeted inflation rate will be set jointly by
the RBI and the government, although the responsibility of achieving the target would rest primarily on
the RBI. This would reflect an active government participation in achieving the goal of price stability with
fiscal discipline (not borrowing in excess).

Monetary policy and fiscal policy have to con- verge for achievement of inflation targeting. Advantage is
that it promotes transparency in the conduct of monetary policy. Further, it increases the accountability of
monetary authorities (RBI) to the inflation objective.

Ideal Inflation Rate

Ideal inflation rate is one that takes into consideration human social and economic impact. It is the level of
inflation beyond which the adverse consequences are strong.
However, such a level of inflation cannot be fixed at one level for all times. It depends on growth rate. It
also depends on what the global levels are RBI sees about 5.5% rate of inflation as ‗comfortable‘ neither
does it hurt in human terms nor in growth terms.

Deflation and its remedy

Deflation is a prolonged and widespread decline in prices that causes consumers and businesses to curb
spending as they wait for prices to fall further. It is the opposite of inflation, when prices rise, and should
not be confused with disinflation, which merely describes a slowdown in the rate of inflation.

Deflation occurs when an economy‘s annual headline inflation indicator – typically the consumer price
index – enters negative territory; Deflation is hard to deal with because it is self– reinforcing, put simply,
unless it is stopped early, deflation can breed deflation, leading to what is known as a deflationary spiral.
When an economy has fallen into deflation, demand from businesses and consumers to buy products falls
because they expect to pay less later, as prices fall. But as producers struggle to sell and go bankrupt,
unemployment rises, reducing demand further. That causes deflation to become more pronounced.
It makes it more expensive to service existing debts. This is as true of governments, who have borrowed
trillions of dollars globally to prop up the financial sector, as it is for consumers.
 74 Basics of Economy

As debt becomes more expensive to pay off, the risk of default and bankruptcy rises too, making banks
more wary of lending. This reduces demand and further exacerbates the deflationary problem.

Remedy
• Tax cuts to boost demand from consumers and businesses
• Lowering central bank interest rates to encourage economic activity.
• Printing more currency to boost money supply.
• Capital injections into the banking system.
• Increase government spending on projects that boost the return on private investment.

Philip‟s Curve

The inverse relationship between rate of inflation and rate of

unemployment is shown in the Philips curve. When
unemployment increases inflation decreases and when
unemployment decreases inflation increases.

Open Inflation

When the government does not attempt to prevent a price

rise, inflation is said to be open. Thus, inflation is open
when prices rise without any interruption. In open inflation,
the free-market mechanism is permitted to fulfil its historic
function of rationing the short supply of goods and distribute
them according to consumer‘s ability to pay.

Therefore, the essential characteristics of an open inflation lie in the operating of the price mechanism as
the sole distributing agent.

Repressed inflation

When the government interrupts a price rise, there is a repressed or suppressed inflation. Thus it refers to
those conditions in which price increase are prevented at the present time through an adoption of certain
measures like price controls and rationing by the government. But they rise on the removal of such
controls and rationing. The essential characteristic of repressed inflation, in contrast to open inflation, is
that the former seeks to prevent distribution through price rise under free market mechanism and
substitutes instead a distribution system based on controls. Thus, the administration of controls is an
important feature of suppressed inflation Repressed inflation is criticized as it breeds number of evils like
black market and uneconomic diversion of productive resources from essential industries to non-essential
or less essential goods industries since there is a free price movement in the latter and hence are more
profitable to investors.

Housing Price Index

 The Housing Price Indices (HPIs) are a broad measure of movement of residential property prices
observed within a geographic boundary. The first official housing price index for the country named
‗NHB RESIDEX‘ was launched in July, 2007 by the National Housing Bank (NHB). NHB is not
computing the composite all India housing price index as of now.
 Using population proportion as weights, an all India index as weighted average of city indices has
been computed in-house.
 RESIDEX, covered 26 cities and was published till 2015 on a quarterly basis. It was discontinued
then and has been revived in 2017. The revamped RESIDEX has been expanded to 50 cities
spread over 18 States and UTs. These include 38 smart cities, of which 18 are state capitals.
 NHB RESIDEX enables the policy makers, banks, housing finance companies, builders, developers,
investors, individuals, etc., to track the movement of housing prices across different cities in India
on quarterly basis. NHB RESIDEX helps buyers and sellers to check and compare prices before
entering a transaction. They can also analyze the price trends across different cities.
 The NHB Residex currently offers two sets of quarterly Housing Price Indices (HPIs) across the
cities it tracks. List prices of under-construction property, collated through a survey of developers,
are captured in the `Market HPI‘. Data reported by banks and finance companies that extend
home loans, is collated into the ‗Assessment HPI‘.
 Basics of Economy 75

Growth -Inflation Trade Off

 With high growth, economy overheats.

 Over- heating of the economy means demand overshoots supply and there is pressure on prices.
As growth creates more employment, incomes and demand, prices rise.
 As prices rise, the central bank intervenes and raises rates to cool investment and consumption
demand and so price rise is moderated. Repo rate (the policy rate) is the tool along with CRR and
OMOs available to the central bank as signals to the economy that it is ready to act to soften
prices -partly because the poor suffer disproportionately and partly because inflation can derail the
medium and long term growth.
 Such intervention by the central bank-has a dampening impact on growth as higher interest rates
prevent easy borrowing and thus demand decreases.
 We witnessed the same in India with CRR and repo rates going down from 2009 for one year and
later till 2011 going up in response to inflation in the country. The primary goal of the RBI is to
moderate and stabilize prices as the inflation targeting frame- work of 2015 February mandates.
 Thus, growth and inflation are intimately connected- one being traded for the other depending
upon where the growth situation stands.
 As prices stabilize, growth resumes and a new and higher base is set for the growth process.
Growth and inflation do have a trade-off but that is only in the short term. As Dr. C. Rangarajan
says, growth is a marathon while overheating and slow down are temporary pauses to gain greater
strength.
 Further, unless the RBI raises the policy rates with inflation going up, there is a danger of banks
failing to attract deposits as ‗real interest rates become negative and savings may be diverted to
`unproductive assets like gold with serious consequences-inside and outside for the economy.

H. TAXATION
 Tax is a payment collected from individuals or firms by government. Funds provided by taxation
are used by governments to carry out the functions such as Creation of infrastructure – roads,
ports etc.
 Social infrastructure like education, health etc. Social welfare schemes like NREGA etc.
 Social security measures like pensions for the elderly unemployment benefits
 Defence expenditure Enforcement of law and order
 Redistribution of wealth and decrease inequality

Taxation System in India

India has a well-developed tax structure. Being a federal country, the authority to levy taxes is divided
between the central govt. and the state governments. The central government levies direct taxes such as
income tax and corporate tax, and indirect taxes like customs duties and excise duties. The State imposes
direct taxes like stamp duties, land revenue and indirect taxes like VAT earlier.

Tax Base:
A tax base is defined as the total value of assets, properties or income in a certain area or jurisdiction. For
example, taxable income is the tax base for income tax and assessed value is the tax base for property
taxes.

Tax Rate:
The tax rate is the percentage of an income or an amount of money
that has to be paid as tax.

Laffer Curve
 It was developed by Arthur Laffer.
 The Laffer Curve is a graphic representation of the
relationship between rates of taxation and the resulting
levels of government revenue. According to it, the tax
collection increases as the tax rate increases.
 The theory tries to arrive at an optimal tax rate beyond
which tax revenues for an economy tend to fall.

Progressive Tax: Here the tax rate increases as the taxable amount increases. They reduce inequality in
the society. Direct taxes are progressive in nature.
 76 Basics of Economy

Regressive Tax: The tax as a percentage of income (Tax rate) falls as the income rises. They increase
inequality in the society. Indirect taxes are regressive in nature.

Proportional Tax: The tax as percentage of income is constant over all income level.

Ad Valorem Tax: If a tax is levied as a percentage of the

value of the good regardless of the number of units
produced/sold/imported eg.10% on the value of the car.

Specific Tax: It is a tax that is defined as a fixed amount for

each unit of a good or service sold, such as rupees per
kilogram or rupees per metre. It is thus proportional to the
particular quantity of a product sold, regardless of its price

Negative income Tax: Subsidy is a negative income tax. It is

a taxation system where income subsidies are given to persons or families that are below the poverty line.
Tax Buoyancy: It refers to the percentage change in tax revenue with the growth of national income.
That is, growth-based increase in tax collections.

Tax Elasticity: Tax elasticity is defined as the percentage change in tax revenue in response to the
change in tax rate and buoyancy, on the other hand is the response to economic growth when the base
increases but no change in the rate.

Tax Stability: It means no frequent changes and continuity of policy in a predictable and transparent
manner.

Tax Shelters: Any technique which allows one to legally reduce or avoid tax liabilities. It is a way in which
the taxpayer can invest his income in particular kind of investment giving tax concessions.

Tax Planning
Tax planning refers to the reduction in net tax liability by use of various provisions provided under tax
laws. This is done by taking advantage of the various tax exemptions, deductions, and reliefs permitted
under tax laws.

Tax Avoidance
Tax avoidance refers to the reduction in net tax liability by
exploiting loopholes in tax laws. Tax avoidance involves
deliberately performing an act that helps in avoiding tax while
subsequently adhering to the legal framework.
Tax avoidance includes cases where the intention is to mislead
the law without breaching the boundaries of the law.

Tax Evasion
It is a practice wherein tax payment is avoided either entirely or
partially by breaching provisions of taxation laws. Tax evasion
is illegal and is commonly carried out by not reporting the
income (or reporting less income) or by reporting inflated
expenses. Transactions carried out in cash are often not
disclosed in the books of accounts in order to avoid tax on
them.
Both tax planning and tax avoidance require thorough knowledge of the existing tax laws. While both are
legal, tax planning is regarded as morally appropriate as it uses the advantages offered under tax laws to
reduce the tax burden whereas tax avoidance is immoral as it exploits the various loopholes that are
present in tax laws. On the other hand, tax evasion is an illegal practice which may lead to tax laws
imprisonment, fine, or even both.

Impact of Tax and Incidence of Tax

Impact of a tax is on the person from whom government collects money in the first instance while
incidence of a tax is on the person who finally bears burden of a [Link]. Suppose government levies a tax
on electric goods in India. Tax will be paid to Government in the first instance by manufacturers of electric
goods. Impact of tax is, therefore, on them. If manufacturers of electric goods industries add tax to the
 Basics of Economy 77

price and succeed in selling goods at higher prices of electric goods to consumers then burden of tax is
thus shifted on to consumers.

Direct tax

It is a type of tax where the incidence and impact of taxation

fall on the same entity. In the case of direct tax, the burden
can‘t be shifted by the taxpayer to someone else. These are
largely taxes on income or wealth. Income tax, corporation
tax, property tax, inheritance tax and gift tax are examples of
direct tax.

Merits of Direct taxes

They are progressive in nature and reduce inequality in the

society. They are also elastic i.e. they show quick result when
increased or decreased. They also bring accountability of the
government as they pinch more when paid (unlike indirect taxes which are hid- den taxes and whose value
is included in the final value of goods).Due to which people demand service delivery from the government.
They also have a certainty associated with them, certainty regarding when to pay and where to pay.

Demerits of Direct taxes

Their collection is expensive due to reasons of staff salary, data base management etc. Therefore the tax
base is kept lower so that the cost of tax collection should not get more than the taxes collected. They also
don‘t factor in externalities caused due to a financial [Link] TATA group provides employment to many
people and also pays corporate tax and a film
star promoting pan masala also pays income
tax. But in this case there is negative externality
(impact) to the society. Moreover high level of
direct taxes may lead to tax evasion.

Direct tax of Union:

1. Income tax
2. Corporate tax/MAT on book profit on
companies showing zero profit & hence
not paying corporate tax.
3. Capital gain tax.
4. STT
5. Commodities tax
6. Dividend Distribution Tax

Direct taxes of state:

On income:
1. Agriculture income tax
2. Professional tax (state/ local body upper
limit of 2500 per year F.C recommended
to 12000 per year) on property:
 Land revenue
 Stamp/registration duty.
 Property tax in urban areas.

Indirect Tax

It is a type of tax where the incidence and impact of taxation does not fall on the same entity. Here, the
burden of tax can be shifted by the taxpayer to some- one else. Indirect tax has the effect to raising the
price of the products on which they are imposed. Customs duty, central excise, service tax and value
added tax are examples of indirect tax. Their value is included in the final value of the good. Therefore
they are also called hidden taxes.
 78 Basics of Economy

Merits of Indirect taxes

They are convenient to collect, no extra paper work for the customer. They also have a wider base and
everyone is covered. There is less evasion especially under VAT/GST (invoice credit).They are also elastic.
Government can keep check on harmful consumption. E.g. gold, tobacco etc. by taxing them higher.

Demerits

They are regressive in nature (both rich & poor are taxed equally for the same item. E.g. Excise on bathing
soap. As a result the poor ends up paying larger percentage of the income).

Indirect taxes (union):

 GST
 Excise duty (It is levied on the manufacture of goods) CST (central sales tax is levied on interstate
trade & commerce. The centre collects and gives to the exporter state). Customs Duty (It is levied
on imports and exports of goods)
 Service tax (It is levied on production of services)

Indirect taxes of states:

 Sales tax/ VAT (not on newspaper) Excise on liquor & narcotics for human consumption. But if
alcohol & narcotics used for medicinal & toiletry (deodorant) purpose, then excise by centre.
 Motor vehicle tax, animals, boats, tolls.
 Entertainment tax, electricity tax
 Advertisement tax (not on TV/radio/newspaper E.g. Advertisement on Yojana magazine, on buses
etc.)

GST
Goods and Services Tax (GST) is a comprehensive indirect tax on the manufacture, sale, and consumption
of goods and services throughout India. GST would replace respective taxes levied by the central and state
governments.
 It is a destination-based taxation system.
 It has been established by the 101st Constitutional Amendment Act.
 It is an indirect tax for the whole country on the lines of ―One Nation One Tax‖ to make India a
unified market.
 It is a single tax on the supply of Goods and Services in its entire product cycle or life cycle i.e.
from manufacturer to the consumer.
 It is calculated only in the ―Value addition‖ at any stage of goods or services.
 The final consumer will pay only his part of the tax and not the entire supply chain which was the
case earlier.
 There is a provision of the GST Council to decide upon any matter related to GST whose chairman
in the finance minister of India.

Dividend Distribution Tax

A dividend is a return given by a company to its shareholders out of profits made by it during a particular
year. They are usually given in proportion to the number of shares owned. In India, domestic companies
pay Dividend Distribution Tax, or DDT, which is a levy in addition to income tax chargeable on their total
income in an assessment year.
In India, a company which has declared, distributed or paid any amount as dividend is required to pay a
dividend distribution tax at 15%. The pro- visions of DDT were introduced by the Finance Act 1997. Only a
domestic company is liable for the tax. Domestic companies have to pay the tax even if the company is
not liable to pay any tax on its income.
Income by way of dividend in excess of Rs. 10 lakh would be chargeable at the rate of 10% for individuals,
Hindu Undivided Family, partnership firms and private trusts also.
Budget 2020 abolished the Dividend Distribution Tax (DDT).
 Basics of Economy 79

Securities transaction tax

STT is levied on every purchase or sale of securities that

are listed on the Indian stock exchanges. This would
include shares, derivatives or equity-oriented mutual
funds units.
This tax is payable whether you buy or sell a share and
gets added to the price of the stock at the time the
transaction is made. Since brokers have to automatically
add this tax to the transaction price, there is no way to
avoid it.

Capital gains tax

Capital gains are the rising worth of an investment that makes its current value higher than when it was
originally bought by the owner. So if you bought shares of a company at Rs. 25 lakh in 2008 and the
current value of the shares is Rs. 35 lakh, then the capital gains would be equal to Rs. 10 lakh in 8 years.
However, if you do not sell the shares, then the capital gains are not realized and you make no profit. On
the other hand, if the worth of the investment has depreciated over a period of time, you incur capital loss
if you sell it.
There are two types of capital gains – short-term and long-term.

Short-Term Capital Gains

As per the Income Tax laws of India, if an investor holds an immovable asset for less than 36 months
before selling it, it would be considered a short-term capital gain. But this is not applicable to stocks and
bonds. Stocks, shares and bonds are faster-moving compared to real estate. Because of this, if they are
held for 12 months or less before sale, they fall under short-term capital gains. However, this rule is
applicable only to securities which are listed and traded on the stock exchange. If you are trading in
unlisted or over-the-counter securities, then the 36-month rule applies.

Long-Term Capital Gains

 Income Tax laws in India specify that immovable property held for more than 36 months – or 3
years before sale, fall under long-term capital gains. For stocks, shares and bonds, this period is
more than 12 months instead of 36 months. Unlisted securities, on the other hand, will be
considered as long-term capital gains only if sold after 36 months.
 Prior to the budget of 2018-19, long-term capital gains arising from the transfer of long-term
capital assets, which are held as equity shares is exempt from taxation. However, transactions in
such long- term capital assets are liable to securities transaction tax (STT).

Minimum Alternative Tax: Under the provisions of the Minimum Alternate Tax Act, as per section 115JB,
every company domestic or foreign is required to pay MAT. The rule was put to practice so as to ensure
that no taxpayer with substantial economic income is able to avoid tax liability by use of various
exclusions, deductions and credits. MAT is a tax levied under Income Tax Act of India, 1961.

There are several ―zero tax companies‖ that book high profit but pay almost nil taxes by rolling out
substantial dividends to their shareholders. This nil tax comes as a result of various exemptions,
deductions and incentives provided to them due to several conditions that they meet. However, the aim of
MAT is to ensure that no company which has the ability to pay taxes gets to avoid payment of income tax.

For every company in India, profit is calculated as per two different Acts:
Profit as per income tax act - on which tax is paid Profit as per companies act - from which dividend is
distributed

One would assume that these two profits should be the same; but that‘s not the case. This is because
there are certain differences in the way these are computed (for example: there are different rates of
depreciation, sometimes income tax is levied on receipt of money, but companies act calls it a profit even
before it is received etc.) Since all these differences exist, the two figures are not the same.

Sometimes, the companies can have zero profit as per income tax act and still pay dividend to the
shareholders. Therefore, these companies can pay dividend without paying any tax to the government.
 80 Basics of Economy

Due to these reasons, the government came up with a smart alternative. This is the smart alternative:
Even though your tax liability may be very less, but you will still have to pay at least certain amount of
tax. By doing this -
(1) You will not distribute all the cash to shareholders,
(2) You will continue giving certain amount of money to the government; and
(3) You will not manipulate your book profits

This is the reason why minimum alternate tax (MAT) was introduced.
E.g. suppose a company ABC books a profit of RS.8 lac. After claiming all applicable deductions,
exemptions and depreciation, the gross taxable income comes out to be Rs.4 lac.
Income tax applicable in this case will be 30% of Rs.4 lac = Rs.1,20,000
However, applicable MAT = 18.5% of Rs.8 lac = Rs. 1,48,000
So excess tax payable will be Rs.1,48,000 – Rs. 1,20,000 = Rs.28,000

Cess
A cess imposed by the central government is a tax on tax, levied
by the government for a specific purpose. Generally, cess is
expected to be levied till the time the government gets enough
money for that purpose. Amount collected by imposing a cess for
a particular purpose can be used for that purpose only and not for
any general purpose.

Surcharge

Surcharge is a charge on any tax, charged on the tax already paid. As the name suggests, surcharge is an
additional charge or tax. The main surcharges currently levied are that on personal income tax (on high
income slabs and on super rich) and on corporate income tax. Surcharge is levied as 10% of income tax,
where total income is between Rs. 50 lakhs and Rs.1 crore and it is 15% of income tax, where total
income exceeds Rs.1 crore.

A common feature of both surcharge and cess is that the centre need not share it with states.
Pigovian Tax

The pigovian tax is imposed on bodies that have a negative externality. Externality means impact of one
person‘s actions upon the well being of an outsider (bystander or third party). Example of negative
externality is exhaust fumes from automobiles. Positive externality refers to a good effect on the third
party. For example, restoration of historic buildings, research into new technologies. Carbon tax is one
example of pigovian tax.

Tobin Tax

James Tobin, an economist proposed a worldwide tax on all foreign exchange transactions when foreign
capital enters a country and when it leaves. The aim is to check speculative flows. Long term investment –
generally FDI, will not suffer as it does not invest for speculative (short term) reasons like FIIs.

Tobin justified the tax on two grounds:

First, it would reduce exchange rate volatility and improve macroeconomic performance. Second, the tax
could bring in revenue to support for development effort or exchange rate stabilization.
The defining characteristics of a Tobin Tax are the tax is levied twice-once when one acquires foreign
exchange, and again when one sells the foreign exchange.
Tobin tax can be imposed only if all the countries accept the
proposition. Otherwise, FIIs, can go to countries where the tax is
not imposed.
India does not prefer it as we need foreign inflows as we are CAD
country and don‘t have a surplus.

Tax Havens
Tax haven is a country (legal jurisdiction) that offers foreign
individuals and organizations
1. A minimal tax liability
2. Politically and economically stable environment for
investments
 Basics of Economy 81

3. Secrecy of financial information, i.e. financial information is not shared with foreign tax authorities.
Tax havens do not require individuals to reside in or businesses to operate from their area to
benefit from local tax policies. In other words, tax havens are not tax havens just because they
have low taxes, rather, what makes a tax haven is its opacity of financial information. This is why
tax havens are often more accurately referred to as ―secrecy jurisdictions‖.

Tax havens allow their banks, companies, trusts, or other financial actors to accept money from anywhere
without reporting it to the authorities in the country where it originates or from which it is controlled. In
some cases, it is actually illegal to disclose that information, but in many places, it is simply because the
banks or other entities are not required to disclose it and there is no mechanism to force them to do so.

Shell Companies

Shell Company is a corporate entity without active business operations or significant assets. They are
often created to avoid taxes and many big companies create shell corporations to avoid taxes without
attracting legal actions.
It can‘t be asserted that shell corporations are illegal. They are deliberate financial arrangements to avoid
taxes. Tax avoidance is not illegal, though it is not desirable.

But many shell companies park black money, carryout illegal transactions and sometimes act as facilitators
of money laundering. Often, shell companies remain untraceable and happen to be the vehicle of choice
for money launderers, bribe givers and takers, tax evaders and financiers of terrorism.
Most of the shell companies are registered in tax havens like British Virgin Islands or Cayman Islands. In
many tax havens, registration of a company is very simple- by paying just few hundred dollars, revealing
nothing about the promoters etc. The shell incorporation business is a major financial activity in these tax
havens.

Now, there are increasing attempts globally and nationally from governments to check tax avoidance.
Hence, shell companies are coming under government scanner.
The Financial Action Task Force (FATF), which is an inter-governmental body, gives guidelines in
controlling shell companies.

Black Market

A black market is called so because of its disregard for

the rules and regulations that ―white‘ businesses follow.
Goods sold in the black market can be illegal (such as
weapons, drugs, or stolen goods) or legal goods can be
sold illegally (goods sold without proper license and
without paying any kind of taxes).
In the black market, goods and services are purchased
and sold violating restrictions or by not paying taxes. So
transactions that take place in this market are ―under the
table‖ transactions, which occur outside government-
sanctioned channels.
The black market is also called the underground market,
shadow market or underground economy. The earnings
derived through black market is called black money.

Black Economy or Parallel Economy

Black economy refers to the collection or aggregate of black markets in an economy.

In an economy, there are two types of sub-economies: white and black economy.
White economy refers to businesses carried out according to rules and regulations. On the other hand,
black economy is the economy that does not follow rules and regulations or deals in illegal goods. Black
economy is run on black money. This flow of money in our system, which is beyond the purview of the RBI
and government, is called parallel economy.

Money Laundering

Money Laundering is a process of concealing the source of money usually earned through illegal activities
or is otherwise black money. In other words, illegal money is introduced into the financial system and
made to appear as if It is earned from a legal source.
 82 Basics of Economy

Some Common Methods of Money Laundering

1. Structuring or smurfing is a method whereby cash deposits are made into bank in small amounts.
Small deposits usually defeat suspicion of anti-money laundering agencies.
2. Bulk cash smuggling refers to the transfer of a large amount of money to foreign jurisdiction and
depositing it in a financial institution such as an offshore bank, which follows secrecy norms.
3. Cash-intensive business refers to the fake claim that the business of a person has earned the cash,
which is otherwise derived from a criminal source.
4. Casinos and gambling: Individuals convert cash into chips at casinos and then get chips converted
into cheque amount, which is shown as prize money won by them in the casino.
5. Round tripping refers to the transfer of money to a foreign jurisdiction typically a tax haven, where
the money is subjected to low tax rates and this money is retransferred to domestic territory as
foreign in- vestment. Such foreign investment may be directed back into the self-owned domestic
business.

International Mechanism to Deal with Money Laundering

The Financial Action Task Force (FATF) is an inter-governmental body set up in 1989 to combat money
laundering. The primary functions of the FATF are as follows:

1. Monitors member nations and their organizations‘ progress in anti-money laundering measures.
2. Reviewing and reporting on laundering trends, techniques and counter measures.
3. Promotion and adoption of anti-money laundering measures at the global level

Domestic Mechanism to Deal with Money Laundering

Prevention of Money Laundering Act, 2002

The objective of the act is to prevent money laundering and provide for punishment and confiscation of
property derived from money laundering. Salient features of the act are as follows:
1. The act provides punishment for indulging in money laundering or facilitating money laundering
with rigorous imprisonment from 3 to 7 years and a fine without any upper limit.
2. The property acquired through money laundering shall be confiscated by the Government India.
3. The order of the executive agency under the act can be challenged before an appellate tribunal
and the order of appellate tribunal can further be challenged before a High Court.
4. Burden of proof is on the accused to explain the source of acquired money.

Enforcement Directorate (Directorate General of Economic Enforcement)

The Directorate General of Economic Enforcement is a law-enforcement agency and economic intelligence
agency responsible for enforcing and fighting economic crime in India. It is a part of the Department of
Revenue, Ministry of Finance. It comprises officers of the Indian Revenue Service, Indian Police Service,
and the Indian Administrative Service.

It was set up in 1956 to deal with foreign exchange violations under the Foreign Exchange Regulation Act,
1947. Presently, the prime objective of the Enforcement Directorate is the enforcement of two Key acts of
the Government of India: the Foreign Exchange Management Act (FEMA) 1999 and Prevention of Money
Laundering Act (PMLA) 2002.

HAWALA TRANSACTIONS

In the most basic variant of the hawala system, money is

transferred via a network of hawala brokers or hawaladars. It
is the transfer of money without actually moving it. In fact, a
successful definition of the hawala system is ―money transfer
without actual money movement‖

The figure shows how hawala works: customer (A, left-hand

side) approaches a hawala broker (X) in one city and gives a
sum of money that is to be transferred to a recipient (B, right
hand side) in another, usually foreign city. Along with the
money, he usually specifies something like a password that
will lead to the money being paid out.
 Basics of Economy 83

The hawala broker X calls another hawala broker M in the recipient‘s city and informs M about the agreed
password. Then, the intended recipient (B), who also has been informed by about the password, now
approaches M and tells him the agreed password. If the password is correct, then M releases the sum to B
after deducting a small commission.
X now owes M the money that M has paid out to B; thus M has to trust X‘s promise to settle the debt at a
later date.

Features of Hawala System

1. The unique feature of the system is that the transaction takes place entirely on trust. As the
system does not depend on the legal enforceability of claims, it can operate even in the absence of
a legal and juridical environment. Trust and extensive use of connections, such as family relations
and regional affiliations, are the components that distinguish it from other remittance systems.
2. Informal records are produced of individual transactions and a running tally of the amount owed
by one broker to another is kept. Settlement of debts between hawala brokers can take a variety
of forms such as goods, services, properties, gold, transfer of employees, etc.
3. In addition to commission, hawala brokers often earn their profits through bypassing official
foreign exchange transaction charges. For instance, the funds enter the system in the source
country‘s currency and leave the system in the recipient country‘s currency.
4. Hawala is attractive to customers because it provides a fast and convenient transfer of funds,
usually with a far lower commission than that charged by banks. It is even used to transfer black
money or money used to finance international terrorism.

DTAA (Double Taxation Avoidance Agreement)

 Double taxation is an issue related with taxation of income that crosses boundaries. Here, an
individual or a company may be earning his/ its income in a foreign country. But that income is
transferred to the home country. The issue is that who has the right to tax such an income.
 Definitely, the source country (the country where income has generated, the country where the
company or individual worked) would like to tax the income generated there.
 Similarly, the resident country (where the individual is residing or the company is incorporated) to
which he/it belongs also tries to tax the income. This is because; the income is generated by its
resident. Now if both countries try to tax the person/company, it is double taxation. Double
taxation means taxing the same income twice, once in the home country and again in the host
country.
 Such a double taxation discourages the individual/company to engage in economic activities
overseas. Hence, there should be mechanisms to avoid double taxation. But, there is no
international law to avoid double taxation. So, it is for the countries in the international arena to
solve double taxation problems by preparing bilateral agreements.
 Hence, negotiations are taking place between different countries and as a result, large number of
Double Taxation Avoidance Agreements (DTAAs) are reached to facilitate cross national economic
activities by avoiding double taxation.
 Double taxation avoidance treaties comprise of agreements between two countries, which, by
eliminating international double taxation, promote exchange of goods, persons, services and
investment of capital. These are bilateral economic agreements where the countries concerned
evaluate the sacrifices and advantages which the treaty brings for each contracting state, including
tax forgone and compensating economic advantages.
 The right to tax a particular income, rate of taxes etc are reached after bilateral discussion with
the other country under the DTAA process. This is needed because each country has its own
unique tax laws.

Capital Gains Tax (CGT) & withholding norms (TDS)

Assume a seller wants to sell a company to a buyer at profit of 1000 crore and has to pay 100 crore CGT
to income tax department. In real life, seller himself doesn‘t need to pay 100 Crore CGT to Government.
Buyer will keep aside 100 crores for government, and pay only 1000 – 100 = 900 crores to seller. This is
called withholding norms or Tax deduction at source (TDS). So withholding tax is a tax deducted at source,
especially one levied by some countries on interest or dividends paid to a person resident outside that
country.

Vodafone CGT case

Hutchison (Hongkong) owned a company called CGP Investment holding ltd at (Cayman Island).CGP in-
vestment holding ltd owned 67% shares of Hutch-Essar India. Vodafone (HQ London), tells its subsidiary
 84 Basics of Economy

in Netherland, to purchase CGP Investment from Hutch (Hongkong) for the price of 11 billion dollars
(~55k crore rupee that time).Now Vodafone owns CGP investment holding ltd, therefore, and thus
indirectly owns Hutch-Essar India also

Result → A buyer (Vodafone) has (indirectly) purchased shares (of an Indian company) from a seller
(Hutch). So, does Buyer (Vodafone) have to pay Capital Gains Tax, in India?

Vodafone → We‘ve not purchased ―Hutch Essar‖, we have purchased CGP. CGP is not an Indian company,
so India cannot demand any tax from us.

Income Tax Department → CGP is a post box company in a tax haven. It doesn‘t produce any mobile
phones, then why have you given 55k crores for it? Obviously, to control those 67% shares in Hutch-Essar
India!!! Therefore, CGP‘s valuation is based on Indian asset; hence, we can demand CGT.

Matter goes to Income tax Appellate tribunal (ITAT) and then to court:
2010 – Bombay High Court says government is right, Vodafone wrong. Orders Vodafone to pay the taxes
2012 – Supreme Court says government wrong, Vodafone right. Under the current Income Tax act 1961,
Income tax Department has no jurisdiction in this matter, when companies trade assets outside India

IT Act 1961: Clarification (2012)

Capital gains will be levied on companies outside India, whose value is derived from Indian Assets. Such
companies will be considered located within India. Will apply to all deals from 1962 onwards (hence called
―Retrospective‖) So, even after winning case in Supreme court, Vodafone‘ trouble did not end. Income tax
department again sends notice for the same Capital gains tax.

General Anti-Avoidance Rules (GAAR)

Originally mentioned in Budget 2012, has been implemented from 1/4/2017. IT commissioner can take
action against any business deal made outside India, to avoid taxes. He can send notice to Indian Citizens,
NRIs as well as foreigners, to recover such money even if they‘re living outside India. It will be applicable
even for retrospective deals i.e. deals which happened before GAAR was implemented. It will also be
applicable to deals protected under any Double Taxation Avoidance Agreement treaty. Burden of proof lies
with the party and not IT commissioner i.e. the Company has to explain that their deal is genuine. IT
commissioner has to decide the case within 12 months. Aggrieved party can approach Dispute resolution
Panel (DRP) → Income Tax Appellate Tribunal (ITAT) → High court and finally Supreme Court

Shome Panel on GAAR

IT commissioner should send notices only in rare cases- where he can recover more than 3 crore rupees.
GAAR should not be used for filling revenue short- falls.
For retrospective cases- government should only recover tax dues & should not demand addition- al
penalty and interest on taxable amount. Exempt the buying/selling of company shares from Capital gains
tax. Better just increase the Securities Trans- action Tax (STT) on buying/selling of such shares. Then,
there is no litigation about ―CGT evasion via Post Box Company‖.
Don‘t implement GAAR from 2014. Implement it from April 2016. (But now it has been implemented from
April, 2017)

Transfer Pricing

 Globalization shows that MNCs are operating in different countries by setting up affiliates,
subsidiaries etc. The operation of MNCs indicates that there is greater volume of transactions
within a firm. Firms may be purchasing components and other semi-finished products from their
affiliates. Some estimates say that nearly 60 per cent of international transactions are intra-firm
transactions.
 Transfer pricing is the price paid by a firm for a good or service while purchasing it from a related
entity. It refers to the setting, analysis, documentation, and adjustment of charges made between
related parties for goods, services, or use of property (including intangible property like IPRs).
 When a firm is buying or selling from its relative entity, there are chances that prices may not be
fixed not according to the market principles. Rather price may be decided artificially by the parent
company with a view to get maximum benefits, as well as to avoid tax payments. This artificially
price setting in intra-firm transactions to avoid taxes and to get other benefits is called transfer
mispricing.
 Basics of Economy 85

 Transfer mispricing, or transfer pricing manipulation refers to trade between related parties at
prices meant to manipulate markets or to cheat tax authorities. Often, avoidance of taxes is the
main purpose of transfer mispricing.
 For example, suppose that a Company producing cars has its HQ in Japan, and subsidiary in India.
Besides, imagine that for the year, the Japanese operations have losses whereas the Indian
subsidiary has profits. Here, if the Indian subsidiary purchases a component from Japan parent by
recording it at a high price, it is good for the company as a whole. The profit of the Indian
operations will come down (due to higher price). Hence, its tax outgo will come down. Similarly,
the loss of the Japanese firm declines. The result is that the company as a whole including its
parent and subsidiary has benefited by paying less taxes.
 Governments have also devised many measures to avoid the misuse of transfer pricing. One such
method is the adoption of arms-length principle for intra-firm sale of goods and services. Similarly,
safe harbour rules are designed to eliminate transfer mispricing. Advance pricing agreement is
another measure to check transfer mispricing.

Arm‟s Length Price

It is the price at which two unrelated parties will make a deal. Since these two parties are unrelated,
hence market forces of supply-demand will work, the (share) price will be rational. So, government will get
the full tax it deserves.
But, When MNC giant‘s one subsidiary company makes deal with another subsidiary company- they‘re
related with each other. In this case, deal pricing may not be rational & Government may not get full tax it
deserves. Therefore, government wants to ensure that following two prices are same.

Transfer pricing reforms

APAs and MAP are alternative tax dispute mechanism in matters involving transfer pricing.

Advance Pricing Agreement (APA)

It has been brought to reduce the transfer pricing related litigations, and enhance MNC confidence to
invest in India. It is a contract/agreement between a taxpayer and at least one tax authority (one of the
two countries that have signed the bilateral treaty) specifying the pricing method that the taxpayer will
apply to its related-company transactions. It is signed prior to the transaction taking place.

MAP (Mutual Agreement Procedure)

It is a way by which taxpayer can seek relief in his country of residence when he feels that he is not being
taxed according to the terms of the bilateral treaty between the two countries.
Prior to the recent relaxation, Income Tax Department was open to receiving bilateral APAs and MAP only
in case of existence of ―corresponding adjustment‖ clause in the double tax avoidance agreement (DTAA)
with the concerned countries.
Now, the income tax department will continue to receive applications from companies despite the absence
of ‗corresponding adjustment‘ clause in the double taxation avoidance agreement (DTAA) with the
countries concerned.
The ‗corresponding adjustment‘ clause in transfer pricing matters provides that if tax demand is raised on
a company by a DTAA-signatory country, the revenue authorities in India would reduce the tax liability of
the parent company based in India.

Significance
This move brings India in the line with the commonly accepted practices abroad as outlined by the OECD.
It strengthens the government resolve to establish a non-adversial tax regime and thereby improving
India‘s ease of doing business prospects.
It will open the gates for clearing of many pending transfer pricing cases currently under litigation.

Advance Tax ruling

Suppose a foreign company enters India via Joint Venture / Subsidiary / etc. But India has a complex tax
structure; the foreign company may need clarification in advance, on the Taxes that may apply to it. To
help foreign companies, Government setup a body called Authority for Advance Ruling (AAR). Foreign
company can file application to AAR, to seek clarification on its tax liabilities & AAR has to reply with-in 6
months. AAR is binding on both company (Tax payer) and IT department. IT officials cannot send
notices/raids if AAR already rules in advance that a particular matter is exempted. Even Indian companies
can approach AAR. Thus, AAR provides clarity on tax structure in India, Promotes ―Ease of Doing
business‖, Speedy decisions & Avoids lengthy court litigations.
 86 Basics of Economy

Base Erosion and Profit Shifting (BEPS)

It is a technical term indicating the tax avoidance strategies of MNCs that reduces the tax bases for
countries. The terms base erosion and profit shifting are closely related. Usually, a company has to pay tax
for its profit or income. This profit is the tax base for the government as tax is imposed as a percentage of
this profit. Once profit is shifted to other countries or to tax havens, the tax base is eroded and there is no
tax payment by the company in the concerned country.
In recent years, Multinational Corporations (MNCs) are innovating sophisticated tax planning practices to
avoid taxes by shifting profits to other countries especially to tax havens. This has resulted in the erosion
of tax base.

Governments hence are at the receiving end as their tax revenues are reduced. There is a growing
concern with regards to the significant losses of national tax revenues because of BEPS.
In the same manner, academicians and social activists are criticizing governments for going soft on
companies that are not paying taxes. This has led to the launching of the so called BEPS project by the
OECD. It has designed a fifteen point action plan to tackle the problem of profit shifting.

How profit shifting becomes possible?

There are many ‗gaps and inadequacies‘ of domestic laws, insufficient controlled foreign company rules,
transfer mispricing, double taxation avoidance treaty abuses by MNCs to avoid taxes. The MNCs utilize the
loopholes available with domestic tax laws as well as shifting income to tax havens to minimise taxes.
Hence, tax avoidance is practiced by them to escape from taxes.

What is the BEPS project?

The BEPS (Base Erosion and Profit Shifting) initiative is an OECD effort, approved by the G20, to de- sign a
globally standardized rules to check tax avoidance practices by the MNCs so that there will be no tax base
erosion.
As a part of the BEPS project, OECD has developed an action plan to counter the tax avoidance practices
by corporates. The Action Plan includes fifteen detailed actions that governments can take to reduce the
tax avoidance by MNCs.
Some of the actions will require coordination and information sharing between governments, and
potentially the amendment of existing tax treaties.

PoEM (Place of Effective Management)

There are two types of companies as per tax jurisdiction.
1. Global company (e.g. Walmart): India can tax only its Indian income
2. Indian resident company (eg Infosys): India can tax both its Indian and global Income including
global passive [Link]. Royalty on software or on interests of loan given by ICICI bank. It is
done if incorporated in India or if PoEM is in India.

Place of effective management is a place where key management and commercial decisions for the
business of a company are made. This is the broad definition. There was a need for setting some guiding
principles as to what exactly would be factors to determine the PoEM.

PoEM is checked on the following parameters:

1. Place where the management & commercial decisions of the company are taken
2. BoD location
3. If BoD has delegated powers to other executive panel, then its location
4. Percentage of total assets or employees located in India. It will be implemented from 1st April,
2017.

Limitation of Benefit (LoB) Clause under DTAAs

Taxation of gross national income is complex and is often controversial. In an effort to attract more foreign
investment, developing countries including India extend tax concessions to foreign investors through
Double Taxation Avoidance Agreements (DTAAs).
But a major defect of DTAAs is that companies often exploit the opportunities/loopholes provided in tax
laws of DTAAs to avoid taxes. Several Double Taxation Avoidance Agreements (DTAA) are misused by
cross national investors to reduce tax burden. One classic example is the often-quoted India-Mauritius
DTAA.

Limitation of Benefit Clause (LoB): Under LoB, foreign investors who seek tax exemptions in India should
produce documents that he is a resident of the said foreign country (eg Mauritius). LoB refers to
 Basics of Economy 87

procedural requirements that the concerned beneficiary is a resident of the treaty country. The Limitation
of Benefit (LoB) Clause is attached by the treaty parties in their bilateral DTAAs. The benefit of tax
concession will be limited to such entities that produce the document (for example, the company proving
that its residence is in Mauritius).

Limitation of Benefit (LoB) Clause to fight treaty shopping

The LoB is tailored to check a well-known misutilization by foreign investors called, treaty shopping. Un-
der treaty shopping, foreign companies (of UK, USA etc.) establish some sort of an office in Mauritius or in
any other tax haven and channelize their investment into India to claim the tax concession offered under
the India-Mauritius DTAA or India and the country‘s DTAA through separate Protocols that add LOB
provisions.

Bilateral Investment Treaty

Bilateral Investment Treaties (BITs) are agreements between two countries that establish the legal
framework for investment by investors from one country in the territory of the other.

 These treaties are pivotal in the international investment landscape, providing protection to foreign
investors against unfair treatment and ensuring a level of predictability and security for cross-
border investments.
 BITs are integral to encouraging foreign direct investment (FDI), fostering economic growth, and
developing international economic relationships.
 Initially, India pursued Bilateral Investment Treaties aggressively to attract foreign direct
investment (FDI), signing its first BIT with the United Kingdom in 1994. Over the next two
decades, India entered into more than 80 BITs with countries around the world.
 However, a series of international arbitration cases against India, initiated by foreign investors
under various BITs, led to a reevaluation of its BIT strategy.
 A notable case was brought by Vodafone International Holdings B.V. against the Indian
government, which raised concerns within India about the implications of its existing BIT
framework on its sovereign right to regulate investments for legitimate public welfare objectives.

New Model Bilateral Investment Treaty (BIT)

The government had brought a new Model Bilateral Investment Treaty (BIT) in 2016 and it became
effective from April 2017 onwards. As a result of this change, new investment into the country has to be
treated under the revised guidelines and negotiations should be started with partner countries.
Main reason for bringing the Model BIT was the constant suing of the country by foreign firms. India was
one of the most sued countries during 2015 and 2016.

Gaps in the existing policy

The Prime Minister‘s Office has directed the commerce ministry to review the existing model text of
bilateral investment treaties (BIT) to enhance the ease of doing business.

 Currently, only seven countries have accepted this model, with many developed nations expressing
concerns, particularly regarding dispute resolution provisions.
 These pacts are important as India has earlier lost two international arbitration cases against
British telecom giant Vodafone and Cairn Energy plc of the UK over the retrospective levy of taxes.

GOODS AND SERVICES TAX

It is a destination-based tax on consumption of goods and services. It is levied at all stages right from
manufacture up to final consumption with credit of taxes paid at previous stages available as setoff. Only
value addition is taxed and burden of tax is to be borne by the final consumer
GST means Goods and Service Tax eliminating many indirect taxes like VAT, Central Excise duty, Sales
Tax, Service Tax etc. etc. It is described as one tax for one nation.
GST eliminated the following indirect taxes and introduced new Tax of CGST, IGST and SGST: Service Tax,
Central Excise Tax, Additional Excise Duties, Additional Customs Duty, commonly known as Countervailing
Duty, Special Additional Duty of Customs, Surcharges, and Cesses, VAT / Sales tax, Luxury tax, Taxes on
lottery, betting and gambling, entertainment tax (unless it is levied by the local bodies),State Cesses and
Surcharges in so far as they relate to supply of goods and services, entry tax not in lieu of Octroi.
 88 Basics of Economy

GST Administration in India

Keeping in mind the federal structure of India, there are two components of GST central GST (CGST) and
State GST (SGST). Both Centre and States simultaneously levy GST across the value chain. Tax is levied
on every supply of goods and services. Centre would levy and collect Central Goods and Services Tax
(CGST), and States would levy and collect the State Goods and Services Tax (SGST) on all transactions
within a State. The input tax credit of CGST would be available for discharging the CGST liability on the
output at each stage. Similarly, the credit of SGST paid on inputs would be allowed for paying the SGST on
output. No cross utilization of credit would be permitted.

The Central GST and the State GST would be levied simultaneously on every transaction of supply of
goods and services except on exempted goods and services, goods which are outside the purview of GST
and the transactions which are below the prescribed threshold limits. Further, both would be levied on the
same price or value unlike State VAT which is levied on the value of the goods inclusive of Central Excise.

Inter-State Transactions of Goods and Services

In case of inter-State transactions, the Centre would levy and collect the Integrated Goods and Services
Tax (IGST) on all inter-State supplies of goods and services. The IGST would roughly be equal to CGST
plus SGST.

Need of Constitutional Amendment for GST

The Constitution provides for delineation of power to tax between the Centre and States. While the Centre
is empowered to tax services and goods up to the production stage, the States have the power to tax sale
of goods. The States do not have the powers to levy a tax on supply of services while the Centre does not
have power to levy tax on the sale of goods. Thus, the Constitution does not vest express power either in
the Central or State Government to levy a tax on the ‗supply of goods and services‘. Moreover, the
Constitution also does not empower the States to impose tax on imports. Therefore, it is essential to have
Constitutional Amendments for empowering the Centre to levy tax on sale of goods and States for levy of
service tax and tax on imports and other consequential issues. Hence, the 101st Constitutional Amendment
Act was passed to implement GST.

GST Council

The GST Council is a joint forum of the Centre and the States.

This Council consists of the following members namely:

Union Finance Minister- Chairman
 State Finance Ministers – one of them will be nominated as deputy chairperson Union minister of
State for revenue
 The Council will make recommendations to the Union and the States on important issues related to
GST, like the goods and services that may be subjected or exempted from GST, model GST Laws,
principles that govern Place of Supply, threshold limits, GST rates including the floor rates with
bands, special rates for raising additional resources during natural calamities/ disasters, special
provisions for certain States, etc.

Manner of Functioning
Decisions will be taken by majority vote. Centre has 1/3rd voting rights. All the states together have 2/3rd
of voting powers in GST council. Any decision will be taken in GST council by 3/4th of the majority.

GST Rates

The GST Council has finalized 4 tier Goods and Services Tax
(GST) rate structure with multiple-slab rates, including the
cess for the new indirect tax regime. Thus, GST will be levied
at multiple rates ranging from 0% to 28%. Most of the
commodities and services that are subject to GST have been
categorized under four tax slabs, viz. 5%, 12%, 18%, and
28%. However, GST Rates is not applicable to some goods
and services.
 Basics of Economy 89

Compensation to States
The Parliament had agreed to compensate states for any loss of revenues, on account of change in
taxation system to GST, for a period of 5 years (till 2022). A shift to new taxation system initially reduces
tax compliance among the people and thus in the initial years, the revenue of state governments may
reduce. However, in the long run, GST will lead to increase in the revenue of state governments.

GST Cess

GST cess is a compensation cess levied under The Goods and Services Tax (Compensation to State) Act,
2017. GST cess is levied on intra-state supply of goods or services and inter-state supply of goods or
services to provide compensation to the States for loss of revenue due to implementation of GST in India.
As GST is consumption-based tax, the state in which the consumption of goods and supply happen would
be eligible for the indirect tax revenue. Hence, after GST coming into effect, some states that are net
exporter of goods and/or services are expected to experience a decrease in indirect tax revenue.
To compensate the States for the loss in tax revenue, the GST Compensation Cess has been declared by
the Central Government. As per the Goods and Services Tax (Compensation to State) Act, 2017, GST
compensation cess would be levied for a period of 5 years from GST implementation.

Usage of GST Cess

All the proceeds received from the GST compensation cess would be credited to a non-lapsable fund
known as the Goods and Services Tax Compensation Fund. The funds would then be used for
compensating tax revenue loss to States on account of GST implementation. If any funds are unutilized,
then at the end of the transition period, it would be shared in half by the Central Government and all State
Government. State government‘s share would be distributed in the ratio of their total revenues from the
State tax or the Union territory goods and services tax, in the last year of the transition period.

GST E-Way Bill

The E-way bill is a document required to be carried by a person in charge of the conveyance carrying any
consignment of goods of value exceeding Rs. 50,000 for sales beyond 10 km in the new Goods and
Services Tax (GST) regime, as mandated by the Government in terms of section 68 of the GST Act. It is
generated from the GST Common Portal by the registered persons or transporters before commencement
of movement of goods of consignment.

Objectives
1. Single e-way bill for hassle free movement of goods throughout the country.
2. No need of separate transit pass in each state for movement of goods
3. Shift from departmental policing model to self-declaration model for movement of goods

Other features of E-way bill

1. Reduction in detention time – In case vehicle is detained for more than 30 minutes, transporter
can raise a complaint.
2. Prevents double checking – Tax officials will have the power to scrutinise the e-way bill at any
point during transit to check tax evasion. However, once verified, e-way bill will not be checked
again during movement.
3. Easy tracking – through a unique e-way bill number (EBN) as well as a QR code.
4. Multiple modes for e-way bill generation such as via SMS/Android apps/web browser on laptop,
desktop or phone/third party-based system of Suvidha providers etc. for ease of use.

Benefits
1. Taxpayers/transporters need not visit any tax officers/check post for generation of e-way
bill/movement of goods across states.
2. No waiting time at check posts and faster movement of goods thereby optimum use of vehicles/re-
sources, since there are no check posts in GST regime.
3. User friendly e-way bill system
4. Easy and quick generation of e-way bill
5. Check and balances for smooth tax administration and process simplification for easier verification
of e-way bill by tax officers

Challenges with e-way bill

1. Ensuring that every transporter – especially in the smaller towns – knows how to use the GSTN
portal
 90 Basics of Economy

2. Internet connectivity in India: there is no guarantee that transporters will be able to use the GSTN
portal to address their grievances (If any) while on the road.
3. Use of RFIDs and RFID readers: The idea of an automatic mode of verification for transport
vehicles at major checkpoints seems very ideal, but ensuring this may be difficult.
4. Strict timelines for validity of e-way bills: The validity has been calculated according to the
distance travelled and some industry leaders find it unrealistic.

Way forward
1. Take care of the technological aspects such as internet coverage and e-literacy.
2. Generate awareness to the assesses about the new arrangement. Adequate training should be
given to traders, manufacturers, transporters and other stake- holders.
3. The government will also have to factor in unavoidable delays (say due to natural or man-made
calamities) and list out the rules for expired e-way bills in such cases.

GST Network

The GSTN is a not-for-profit organisation at present. It provides the technological support to the GST. The
government holds a 49% stake, with Centre and states share of 24.5% each. The balance 51% is held by
five non-government institutions. These are LIC Housing Finance, HDFC, HDFC Bank, ICICI Bank and NSE
Strategic Investment Co Ltd.

The finance ministry considers converting the Goods and Services Tax Network (GSTN) into a
government-owned company. The Goods and Services Tax Network handles massive amounts of data. It
deals with crucial data sets such as indirect tax returns and refunds. By now, over 10 million businesses
have already registered on the GSTN portal. GSTN is apparently a repository of sensitive data on business
entities nationwide. It is of strategic importance to the country. The government is thus concerned about
the safety and security of ―sensitive‖ data. It thus considers limiting the ownership to the government.

National Anti-Profiteering Authority (NAA)

Profiteering means unfair profit realized by traders by manipulating prices, tax rate adjustment etc. In the
context of the newly launched GST, profiteering means
that traders are not reducing the prices of the
commodities when the GST Council reduces the tax rates
of commodities and services.
Conventionally, several traders will have a strong
tendency to quickly increase the price of a commodity
whose tax rate has been increased. But on the opposite
side, they may delay the price reduction of a commodity
whose tax rate has been cut by the government. A
delayed or postponed price reduction helps business firms
to make higher profit. The losers here are the consumers.

The Government has approved the constitution of a National Anti-Profiteering Authority (NAA), the
institutional mechanism under the GST law to check the unfair profit-making activities by the trading
community. Union Cabinet chaired by the PM decided for the appointment of a Chairman and Technical
Members of the Authority.
The Authority‘s core function is to ensure that the benefits of the reduction in GST rates on goods or
services made by the GST Council are passed on to the ultimate consumers by way of a reduction in prices
by traders.

Utility of the authority

The Authority‘s main function is to ensure that traders are not realizing unfair profit by charging high price
from the consumers in the name of GST. Traders may charge high price from the consumers by naming
the GST factor. Similarly, they may not make quick and corresponding price reduction when the GST
Council makes tax cut. All these constitute profiteering. The responsibility of the NAA is to examine and
check such profiteering activities and recommend punitive actions including cancellation of licenses.

Benefits of GST

The benefits of GST can be summarized as under:

For business and industry
 Basics of Economy 91

1. Easy compliance: A robust and comprehensive IT system would be the foundation of the GST
regime in India. Therefore, all tax payer services such as registrations, returns, payments, etc.
would be available to the taxpayers online, which would make compliance easy and transparent.
2. Uniformity of tax rates and structures: GST will ensure that indirect tax rates and structures are
common across the country, thereby increasing certainty and ease of doing business. As GST is a
uniform taxation system applicable throughout the country, it will create a uniform market across
the country and make taxation transparent and hassle free. In other words, GST would make
doing business in the country tax neutral, irrespective of the choice of place of doing business.
3. Removal of cascading: A system of seamless tax-credits throughout the value-chain, and across
boundaries of States, would ensure that there is minimal cascading of taxes. This would reduce
hidden costs of doing business.
4. Improved competitiveness: Reduction in transaction costs of doing business would eventually lead
to an improved competitiveness for the trade and industry.
5. Gain to manufacturers and exporters: The subsuming of major Central and State taxes in GST,
complete and comprehensive set-off of input goods and services and phasing out of Central Sales
Tax (CST) would reduce the cost of locally manufactured goods and services. This will increase the
competitiveness of Indian goods and services in the international market and give boost to Indian
exports. The uniformity in tax rates and procedures across the country will also go a long way in
reducing the compliance cost.

For Central and State Governments

1. Simple and easy to administer: Multiple indirect taxes at the Central and State levels are being
replaced by GST. Backed with a robust end-to-end IT system, GST would be simpler and easier to
administer than all other indirect taxes of the Centre and State levied so far.
2. Better controls on leakage: GST will result in better tax compliance due to a robust IT
infrastructure. Due to the seamless transfer of input tax credit from one stage to another in the
chain of value addition, there is an in-built mechanism in the design of GST that would incentivize
tax compliance by traders.
3. Higher revenue efficiency: GST is expected to decrease the cost of collection of tax revenues of
the Government, and will therefore, lead to higher revenue efficiency. The earlier system of
numerous tax departments hampered inter-department coordination and made tax evasion
possible. GST will drastically increase the tax base and reduce tax evasion.

For the consumer

1. Single and transparent tax proportionate to the value of goods and services: Due to multiple
indirect taxes being levied by the Centre and State, with incomplete or no input tax credits
available at progressive stages of value addition, the cost of most goods and services in the
country today are laden with many hidden taxes. Under GST, there would be only one tax from the
manufacturer to the consumer, leading to transparency of taxes paid to the final consumer.
2. Relief in overall tax burden: Because of efficiency gains and prevention of leakages, the overall tax
burden on most commodities will come down, which will benefit consumers.

Reverse Charge Mechanism and Composition Scheme

The Composition scheme under the GST is an easy, low procedure and compliance friendly tax scheme for
small and medium enterprises. Under the scheme, firms under a threshold limit of turnover can pay a
fixed percentage of their turnover as tax. They need to fill only reduced number of returns compared to
normal tax payers under GST.

The low proportion of collections under the scheme indicates poor response as well as large evasions. Most
of the people who have registered have a declared income of less than Rs. 20 lakh a year, suspected
under declarations. To plug the loopholes, the Council is thinking of reverse-charge mechanism (RCM)
under the composition scheme. Unlike the usual practice of sellers depositing the tax to the government,
the buyer does so under the RCM. The reverse-charge levy on purchase from unregistered businesses
could come back for composition dealers, in turn plugging possible tax leakage.

Tax Reforms

A favourite all-time Indian myth is that one must increase tax rates to increase tax revenue and the tax
rate on Indian corporates is too low.
 92 Basics of Economy

History of tax rates

Personal income tax rates were reduced to a three-tier structure (10-20-30%) in 1997. The flat corporate
tax rate was reduced to 35% in 1997 and 30% (where it now stands) in [Link] finance ministry and
budgets have come forth with additional taxes in the form of surcharges and cesses over the years, but
the tax rate has been considered sacrosanct.

Corporate tax rate structure

The existing reality is a tax rate of 30% and an effective tax rate of 25%— the 5% gap between stated
and effective tax is because of exemptions. The Indian corporate sector is one of the most heavily taxed in
the world

Centre of Business Taxation (CBT)

CBT estimates two indicators of taxation — Effective Average Tax Rates (EATR) and Effective Marginal Tax
Rate (EMTR).

NITI Aayog‟s Action Agenda on Taxation Policy

Three broad principles should guide tax policy:

 First, it should be such that it raises the requisite revenue while minimizing evasion and distortion
in the economy.
 Second, it should exhibit horizontal equity in the sense that individuals with equal income are
taxed equally.
 Finally, it should exhibit progressivity in the sense that those with higher incomes are taxed at
higher rates.
 A tax system rests on two legs: a system of tax rates including exemptions, if any, and an
administration system that enforces tax collection at the rates specified.

The tax reform agenda outlined below is based on the following strategic objectives:

1. Eliminating the generation of black money.

Tax reform should be seen as part of a larger government agenda of cleaning up the system so that no
black in- come is generated. A complex tax system accompanied by myriad exemptions breeds rent-
seeking behaviour and presents opportunities for individuals and businesses to evade taxes. Therefore, the
reform aims to simplify substantially the tax structure and dismantle exemptions offered under special
situations.

2. Expanding the tax base.

India‘s tax base is very narrow. Only a small proportion of individuals and businesses are part of the tax
net. This has led to a low tax-to-GDP ratio, which is detrimental to effective governance and delivery of
public services. A larger tax base, achieved through tax reforms, can also al- low reduced across-the-
board tax rates, thereby sup- porting investment, expanding output and enhancing economic growth.

3. Supporting investments through a predictable and stable tax policy.

Transforming the tax administration will help minimise tax-related disputes. We can achieve this by
simplifying tax laws and regulations, and minimizing discretionary powers to the tax authorities provided
by the statutes. There is also a need to improve the interface of tax authorities with the taxpayers,
thereby making the process more tax- payer friendly.
 Basics of Economy 93

I. GOVERNMENT SCHEMES
Central Sector Schemes and Centrally Sponsored

The central schemes are divided into central sector schemes and centrally sponsored schemes (CSS).

Central Sector Schemes

Central sector schemes are schemes with 100% funding by the Central government and implemented by
the Central Government machinery. The central sector schemes are mainly formulated on subjects mainly
from the Union List. In these schemes, the financial resources are not shifted to states

Centrally Sponsored Schemes

Centrally Sponsored Schemes are the schemes by the centre where there is financial contribution from
both the centre and states.
A stipulated percentage of the funding is provided by the States in terms of percentage contribution. The
ratio of state participation may vary in 50:50, 60:40, 70:30, 75:25, or 90:10; showing higher
contributions by the centre. Various central government ministries directly transfer money to the state
governments. Implementation of Centrally Sponsored Scheme is made by State/UT Governments.
Centrally Sponsored Schemes are created on areas that are covered under the State List.

Restructuring of the CSS

The CSS have undergone drastic restructuring after the recommendations of the 14th Finance
Commission. Higher tax share and devolution from centre to states necessitated transfer of several
schemes to the states. In this context, the restructuring of the CSS was a major outcome of the
recommendations of the XIV FC. Similarly, states were given more flexibility on the implementation of
projects. Later, the NITI Aayog‘s created Chief Minister‘s Panel recommended reduction of number of CSS
from 66 to 30. The rationalization of the CSSs would ensure optimum utilization of resources with better
outcomes through area specific interventions. This would also ensure wider reach of the benefits to the
target groups.

The Panel also grouped these schemes under three heads.

1. Core of the core

2. Core and
3. Optional

Restructuring came into effect from 2016-17 budget onwards. In yet another meeting, the sub group of
Chief Ministers, the CSS were reduced to 28. As a follow up, under budget 2017, there were only 28
schemes. Out of these, core of the core was 6, core schemes were 22. A notable development was the
shrinking number of optional schemes as such schemes were shifted to states.

Financing of CSS
Centrally Sponsored Schemes are divided into three: core of the core, core and optional. Though each
scheme envisages financial participation from the states as well, the state share differs for different
schemes. Similarly, geographically difficult states will get higher central share.
Financing of core of the core schemes: These schemes comprise six umbrella schemes. After
restructuring, the Core of the Core schemes will retain their expenditure allocation framework. Most of
these schemes prescribe specific financial participation by states. For example, in the case of MGNREGA,
state governments have to incur 25% material expenditure.

Financing of core schemes: In the case of core schemes, the funding pattern is 60:40 for centre and
states respectively. But for difficult states (NE and Himalayan states), there will be 90:10 pattern.
 94 Basics of Economy

Balance of Payment

 Definition:
 Balance of Payment (BoP) of a country can be defined as a systematic statement of all
economic transactions of a country with the rest of the world during a specific period usually
one year.
 It indicates whether the country has a surplus or a deficit on trade.
 When exports exceed imports, there is a trade surplus and when imports exceed exports there
is a trade deficit.

 Purposes of calculation of BoP:

 Reveals the financial and economic status of a country.
 Can be used as an indicator to determine whether the country‘s currency value is appreciating
or depreciating.
 Helps the Government to decide on fiscal and trade policies.
 Provides important information to analyze and understand the economic dealings of a country
with other countries.

 Components of BoP:
 For preparing BoP accounts, economic transactions between a country and rest of the world
are grouped under - Current account, Capital account and Errors and Omissions. It also shows
changes in Foreign Exchange Reserves.
 Current Account: It shows export and import of visibles (also called merchandise or goods-
represent trade balance) and invisibles (also called non-merchandise).

• Invisibles include services, transfers and income.

 Capital Account: It shows a capital expenditure and income for a country.

• It gives a summary of the net flow of both private and public investment into an economy.
• External Commercial Borrowing (ECB), Foreign Direct Investment, Foreign Portfolio Investment,
etc form a part of capital account.
 Errors and Omissions: Sometimes the balance of payment does not balance. This imbalance is
shown in the BoP as errors and omissions. It reflects the country‘s inability to record all
international transactions accurately.
 Changes in Foreign Exchange Reserves: Movements in the reserves comprises changes in the
foreign currency assets held by the Reserve Bank of India (RBI) and also in Special Drawing
Rights (SDR) balances.
 Basics of Economy 95

What is Balance of Payments Surplus?

The account by which the money coming into a nation is more than the money going out in a particular
time frame.

What is Balance of Payments Deficit?

A balance of payments deficit means the nation imports more commodities, capital and services than it
exports. It must take from other nations to pay for their imports.

The nation could use its reserves of foreign exchange in order to balance any shortfall in its BoP:
 When the foreign exchange is being sold by the reserve bank when there is a deficit, it is known as
official reserve sale.
 The decrease or increase in official reserves is known as the overall balance of payments deficit or
surplus.
 The fundamental hypothesis is that the monetary authorities are the final financiers of any deficit
in the BoP (or the recipients of any surplus).
 Official reserve transactions are relevant under the reign of the fixed exchange rates than when
exchange rates are floating.

Exchange Rates in India

Exchange rate (foreign exchange rate) is the rate at

which domestic currency is traded for a foreign
currency. Similarly, it is the rate that shows the
value of domestic currency in terms of other
currencies. Here, the value of Rupee means the
value measured in terms of other currencies like the
US Dollar.
Exchange rate system refers to the arrangement for
the movement of exchange rate. There are basically
three types of exchange rate systems globally:
flexible or floating exchange rate system, fixed
exchange rate system and managed floating
(intermediate exchange rate system).

(i) Fixed Exchange Rate: It was followed up to March 1992 in India & 1$ was approx. equal to Rs. 40.
The exchange rate was fixed by RBI.

Devaluation: Devaluation is an official lowering of the value of a country‘s currency, by which the RBI
formally sets a new fixed rate with respect to a foreign reference currency .eg. 1$= 40rupees and then
RBI decides that 1$= [Link] earlier 1$ was equal to 40 rupees but not now 1$ is equal to
[Link] 1$ can buy more rupees as compared to earlier, so rupees have become cheaper or rupees
have lost its value as compared to dollar or rupee has been devalued.

Devaluation makes exports cheaper or makes them more competitive. eg. Suppose price of a radio called
ABC is 300rupees and 1$= 50 rupees. So its value in international market is 6$.But if RBI devalues the
rupee from 1$=50rupees to 1$=[Link] its price will be 5$.So exports have become cheaper.
At the same time, devaluation makes imports costly. In the above case, suppose price of crude oil is 100$/
barrel(1 barrel = 159litres) and 1$= 50rupees,so India pays 5000 rupees to buy 1 barrel of crude oil. But
now, RBI devalues the currency to 1$=60 rupees .So Now India will have to pay 6000 rupees for 1 barrel.

Revaluation: It is a calculated upward adjustment to a country‘s official exchange rate relative to a

chosen [Link]. 1$= 50rupees and then RBI decides that 1$= 40rupees. So earlier 1$ was equal to 50
rupees but not now 1$ is equal to [Link] 1$ can buy less rupees as compared to earlier, so rupees
have become costly or rupees have gained its value as compared to dollar or rupee has been revalued.
Revaluation makes exports costly or makes them more competitive. eg. Suppose price of a radio called
ABC is 300rupees and 1$= 60 rupees. So its value in international market is 5$.But if RBI revalues the
rupee from 1$=60rupees to 1$=[Link] its price will be 6$.So exports have become costly.
At the same time, revaluation makes imports cheaper. In the above case, suppose price of crude oil is
100$/barrel (1 barrel = 159litres) and 1$= 60rupees, so India pays 6000 rupees to buy 1 barrel of crude
oil. But now, RBI revalues the currency to 1$=50 rupees. So Now India will have to pay 5000 rupees for 1
barrel.
 96 Basics of Economy

(ii) Floating exchange rate: India is following it since 1993. RBI doesn‘t intervene to control exchange
rate. Free market i.e. supply-demand comes into play to decide the exchange rates. But there is too much
volatility in exchange rate. Hence in real-life countries use ―Managed floating‖ or dirty floating exchange
rate.

Depreciation: It is the decrease in the external value of the domestic currency due to the operation of
market forces. Here exchange rate is moving with demand and supply of dollar. Suppose, there is sudden
increase in militancy in India or there is military coup in India. In that case, all FDIs and FPIs would leave
India. They will give all their rupees to banks and would like to get it converted into dollars. In this case
the demand of dollars will increase in India and demand of rupees will increase. As demand of dollars is
increasing, the price of dollars will also increase and the price of rupees will decrease. Dollar would
appreciate and rupee will depreciate. So if 1$= 40ru- pees, now it will move to 1$=50rupees (just random
figures).

Appreciation and depreciation is relative. If rupee depreciates with respect to dollar, then dollar
appreciates with respect to rupee.
Depreciation of rupee has the same impact on imports and exports as devaluation. It makes exports
cheaper and imports costly.

Appreciation: It is the increase in the external value of the domestic currency due to the operation of
market forces. Here exchange rate is moving with demand and supply of dollar.
Suppose, Indian government brings various economic and political reforms in the country. In that case,
many FDIs and FPIs would like to invest in India. They will give all their dollars to banks and would like to
get it converted into rupees. In this case the demand of rupees will increase in India and demand of dollar
will decrease. As demand of rupees is increasing, the price of rupee will also increase and the price of
dollars will decrease. Rupee would appreciate and dollar will depreciate. So if 1$= 50rupees, now it will
move to 1$=40rupees (just random figures)(Earlier 1$ was able to buy 50 rupees, but now as rupee is
getting costly,1$ will be able to buy less rupees as compared to earlier). Appreciation and depreciation is
relative. If rupee depreciates with respect to dollar, then dollar appreciates with respect to rupee.
Appreciation of rupee has the same impact on imports and exports as revaluation. It makes exports costly
and imports cheaper.

Managed floating Exchange Regime

 India is having this type of exchange rate system. In this hybrid exchange rate system, the
exchange rate is basically determined in the foreign exchange market through the operation of
market forces.
 Market forces mean the selling and buying activities by various individuals and institutions. So far,
the managed floating exchange rate system is similar to the flexible exchange rate system.
 But during extreme fluctuations, the central bank under a managed floating exchange rate system
(like the RBI) intervenes in the foreign exchange market.
 Depreciation is happening because there is sudden outflow of dollars from the Indian market and
there is deficiency of dollars in the Indian market. It has led to appreciation in value of dollar and
depreciation of rupee. If somehow, the supply of dollars in the market is increased, the status quo
will be restored. Therefore, RBI sells dollars in the market and purchases rupees. This causes
appreciation on rupee. But it also leads to decrease in forex reserve of RBI. At the same time, RBI
has sold dollars to the banks and has takes rupees from them. It will lead to decrease in liquidity
in the market and will have a negative impact on the growth.
 To stop appreciation of rupee, RBI should buy dollars from its forex reserve.

 Appreciation is happening because there is sudden inflow of dollars in the Indian market (due to
more inward flow of FDI/FII) and there is increase of dollars in the Indian market. It has led to
depreciation in value of dollar and appreciation of rupee. If somehow, the supply of dollars in the
market is decreased, the status quo will be restored.

 Therefore; RBI buys dollars from the market and sells rupees. This causes depreciation on rupee.
But it also leads to increase in forex reserve of RBI. At the same time, RBI has bought dollars from
the banks and has given rupees to them. It will lead to increase in liquidity in the market and will
cause inflation.
 But RBI doesn‘t interfere on a regular basis and does so when it thinks that situation has gone out
of its comfortable level and now either importer or exporter is getting seriously hurt.
 Basics of Economy 97

Nominal Exchange Rate and Real Exchange Rate

 Nominal exchange rate is the price of one currency in terms of number of units of some other
currency. This is determined by government (RBI in India‘s case) in a fixed rate regime and by
demand and supply for the two currencies in the foreign exchange rate market in a floating rate
regime.
 It is ‗nominal‘ because it measures only the numerical exchange value, and does not say anything
about other aspects such as the purchasing power of that currency. In a floating rate regime, an
increase in the value of the domestic currency against other currencies is called an appreciation,
while a decrease in value is called depreciation. In contrast, an increase in the exchange rate in a
fixed rate regime is called a revaluation (for an increase) and a decrease in the exchange value of
the domestic currency is referred to as devaluation.

Real Exchange Rate

 To incorporate the purchasing power and competitiveness aspect and, therefore, make the
measure more meaningful, real exchange rates are used. The real exchange rates are nothing but
the nominal exchange rates multiplied by the price indices of the two countries. This means the
market price level of goods and services, given by indices of inflation.
 So if the price level in the US is higher than the price level in India, then the real exchange rate of
the rupee versus the dollar will be greater than the nominal exchange rate.
 Suppose the nominal exchange rate is Rs 50 and US prices are greater than Indian prices, a dollar
will buy more in India than what Rs 50 will buy in the US. So the real rupee-dollar exchange rate is
greater than the nominal rate.
 If the real exchange rate is calculated using the price levels of common traded goods, then it gives
a measure of export competitiveness. For example, if both the US and India manufacture the same
(or highly comparable) pharmaceutical drug, and Indian drug prices are lower than US prices, then
the exchange rate in terms of drugs is favourable to India.
 This can be generalized to all the goods manufactured by the two economies that compete in the
export market. If the real rupee-dollar exchange rate based on export-competing goods
depreciates, then Indian exports enjoy an enhanced pricing advantage over US goods. The
converse is true for a real appreciation.

NEER and REER

NEER is the Nominal Effective Exchange Rate, and REER is the Real Effective Exchange Rate. Unlike
nominal and real exchange rates, NEER and REER are not determined for each foreign currency separately.
Rather, each is a single number (usually expressed as an index) that expresses what is happening to the
value of the domestic currency against a whole basket of currencies. These other currencies are picked on
the basis of that country‘s trade with the domestic economy. India trades with a large number of countries
such as the US, EU, Japan and Middle East. With each individual currency, the rupee has a different
nominal exchange value.

NEER
 To calculate NEER we weight the nominal exchange rate of the rupee against the currencies of
these trading partners by their share in India‘s trade. Then, by summing the weighted exchange
rates, we get the NEER. By setting the NEER for some year at 100, we can track changes in the
rupee‘s value as percentage changes over the base year. If NEER has become 110 from 100 of the
base year, then the value of the domestic currency has appreciated over the period with respect to
that basket of currency. It is not good for exports.
 There is 6 currency basket as well as 36 currency basket. NEER and REER are calculated for both 6
currency as well as 36 currency basket.
REER

Similar to the NEER, the REER is the weighted average of

real exchange rates, weighted by the relative importance
of each country in trade with the domestic economy. In
other words, like the NEER, the REER is an index of a
country‘s real exchange rate, a single number which gives
some reference or benchmark about how the currency is
performing in relation to the rest of the world as a whole,
rather than just individual countries. Both these measures
are useful as benchmarks that give an idea of the general
 98 Basics of Economy

movement of the domestic currency against the rest of the world. If the domestic currency becomes more
expensive in terms of other currencies, then exports will become costly and imports will become cheaper.
REER is also set 100 for any particular year and then the progress is tracked. If REER becomes less than
100 over a period of time, (say 90), it is depreciation of currency and will make exports cheaper and
imports costly.

Sterilization

Sterilization refers to the process by which the RBI takes away money from the banking system to
neutralize the fresh money that enters the system.
Suppose the RBI decides to buy US dollars from the market. Now the money held by the RBI does not
form part of the banking system. So if the RBI releases rupees in the market to buy dollars, the money
supply in the banking system increases. This can lead to inflation.
It will reduce (sterilize) liquidity by selling the government bonds that it holds. Thus, sterilization is
possible only to the extent that the RBI holds government bonds in its portfolio.
This process of selling government bonds to reduce liquidity is part of its open market operations.

Convertibility of accounts

Currency convertibility means ―the freedom to convert one currency into other internationally accepted
currencies, wherein the exporters and importers were allowed a free conversion of a rupee. But still, none
was allowed to purchase any assets abroad.

Capital account convertibility

 It means the freedom to convert local financial assets into foreign financial assets and vice versa
at market determined rates of exchange.
 Capital account convertibility means the freedom to convert rupees into foreign currency and back
for capital transactions. It means that rupee can now be freely convertible into any foreign
currencies for the acquisition of assets like shares, properties and assets abroad. Further, the
banks can accept deposits in any currency.
 It helps attract foreign investment. At the same time, capital account convertibility makes it easier
for domestic companies to tap foreign markets.
 It is sometimes referred to as Capital Asset Liberation.
 Capital Account Convertibility is beneficial for a country because inflow of foreign investment
increases. It also provides opportunity to invest in global assets. It will enable Indian enterprises
to borrow from anywhere in the world at the cheapest rates.
 The flip side is that in the case of slowdown in Indian economy, investors would prefer to invest
their money abroad; leading to flight of capital. It can destabilize an economy due to massive
capital flows in and out of the country. It will make the currency more volatile. There can be
sudden inflow and outflow of foreign currency.

Current account convertibility

 Current account convertibility allows free inflows and outflows for all purposes other than for
capital purposes such as investments and loans.
 It means rupee is convertible for current account transactions. In other words, it allows residents
to make and receive trade-related payments — receive dollars (or any other foreign currency) for
export of goods and services and pay dollars for import of goods and services, make sundry
remittances, access foreign currency for travel, studies abroad, medical treatment and gifts, etc.
 India has full current account convertibility but partial capital account convertibility. India has
some restrictions on capital account convertibility.

 The Committee on Capital Account Convertibility (CAC) or Tarapore Committee was constituted by
the Reserve Bank of India for suggesting a roadmap on full convertibility of Rupee on Capital
Account.
 The Tarapore committee observed that the Capital controls can be useful in insulating the economy
of the country from the volatile capital flows during the transitional periods and also in providing
time to the authorities, so that they can pursue discretionary domestic policies to strengthen the
initial conditions.
 The CAC Committee recommended the implementation of Capital Account Convertibility for a 3
year period viz. 1997-98, 1998-99 and 1999-2000 but based on certain conditions like decreasing
fiscal deficit, decreasing NPAs etc.
 Basics of Economy 99

At present the rupee is fully convertible on the current account, but only partially convertible on the capital
account.

Ownership Share and Rights of Foreign Investor

 The ownership share of a foreign investor in an Indian company can range from 0% to 100% of
capital. The rights in a company are subject to the share in capital of the company as mentioned in
the Indian companies Act.
 0% share: Foreign investor is not allowed to invest in a particular sector.
 26% shares: The approval of at least 75% of the shareholders (a special resolution) is required in
order to alter the Memorandum and articles of the company, change the name of the company,
repurchase the company‘s shares, change the registered office or liquidate the company .Thus any
of the above decisions cannot be taken without the consent of foreign investor holding 26% capital
of the company.
 49% shares: The sector is sensitive enough and the foreign investor should not be given majority
control over a company. A 51% stake enables the foreign investor to take many decisions of the
company. Approval of at least 50% of the shareholders (a ordinary resolution) is required for
declaration of dividend, to increase or decrease the number of directors, to re- move directors etc.
 Thus a foreign investor with 49% ownership cannot take the above decisions. A 51% share means
the foreign investor is given incentives to carry on day to day decisions of the company.
 74% shares: It is opposite of 26%.The foreign investor can take most of the decisions for the
company but some special decisions requiring 75% majority can be blocked by 26% shareholders.
 100% shares: Complete ownership and control can be taken.

Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI)

 They are the two important forms of foreign

capital. The real difference between the two is that
while FDI aims to take control of the company in
which investment is made; FPI aims to reap profits
by investing in shares and bonds of the invested
entity without controlling the company.
 Both FDI and FPI are the most well sought type of
foreign capital by the developing world. Usually,
both these are measured in terms of the
percentage of the shares they own in a company
(i.e., 10%, 20% etc.).
 According to the existing regulation by the SEBI,
FPI is investment in shares of a company not
exceeding 10% of the total paid up capital of the
company. Any investment above and equal 10% is FDI as with that size of shareholding, the
foreign investor can exert control in the management of the company.

Foreign Direct Investment (FDI)

 FDI is investment by non-resident entities like MNCs to carryout business operations in India with
management of investment, production of goods or services, employing people and marketing
their products.
 In FDI, both the ownership and control of the firm is with the investor. The foreign investor usually
takes a considerable stake or shareholding in the company and exerts management influences
completely or partially, depending on his shareholding.

Foreign Portfolio Investment (FPI)

 FPI on the other hand is investment in shares, bonds, debentures, etc. According to the IMF,
portfolio investment is defined as cross-border transactions and positions involving debt or equity
securities, other than those included in direct investment or reserve assets. Foreign Portfolio
Investors includes investment groups of Foreign Institutional Investors (FIIs), Qualified Foreign
Investors (QFIs) (Qualified Foreign Investors) and subaccounts etc. NRIs don‘t come under FPI.
 After the new SEBI guidelines, the RBI stipulated that Foreign Portfolio Investors include Asset
Management Companies, Banks, Pension Funds, Mutual Funds, and Investment Trusts as Nominee
Companies, Incorporated / Institutional Portfolio Managers or their Power of Attorney holders,
University Funds, Endowment Foundations, Charitable Trusts and Charitable Societies etc.
Sovereign Wealth Funds are also regulated as FIIs.
100 Basics of Economy

 FII is an institution like a mutual fund, insurance company, pension fund etc. According to SEBI,
―an FII is an institution established or incorporated outside India which proposes to make
investments in India in securities‖. FII is an institution who is registered under the Securities and
Exchange Board of India.
 (Foreign Institutional Investors) Regulations,1995. FIIs comprised of a pension fund, a mutual
fund, investment trust, insurance company or a reinsurance company.

Qualified Foreign Investor

QFI is an individual, group or association which is a resident in a foreign country. The QFI should compliant
with the Financial Action Task Force standard and should be a signatory to the International Organization
of Securities Commission.
The FIIs are big and hence they have the capacity to make large-scale investment. On the other hand,
small investors and individuals under QFI category can‘t match FIIs in terms of business volume. So, often
when we hear about foreign investment in the share market, it is the FIIs who steal the attention.

FDI vs. FPI: of the two, FDI is more desirable

FDI means real investment; whereas FPI is monetary or
financial investment –Here, FDI means the investor makes
investment in buildings and machineries directly in the
company in which he has made the investment. FPI doesn‘t
create such productive asset creation directly. It is just
financial investment. FDI is certain, predictable, takes
production risks, have stabilizing impact on production. It
directly augments employment, output, export etc. The
major merit of FDI is that it is non-debt creating as well as
non-volatile (less fluctuating).
FPI on the other hand is investment aimed at getting profits
from shares, interests from deposits etc. It is otherwise
known as hot money. The portfolio investors keep their
money in the capital market only for a short period of time.
Its destination period is so small and is empirically
considered as fluctuating (often short term) capital. It is highly volatile, a fair weather friend, speculative,
involves exchange risks and may lead to capital flight and currency crisis affecting real economic variables.
It is destabilizing in the foreign exchange market. Fluctuations in the mobility of FPI affects foreign
exchange rate, domestic money supply, value of rupee, call money rates, security market etc. FII (Foreign
Institutional Inflows) inflows depend on two factors: first, return potential of the destination market (host
country) and second availability of risk capital at source geographies (home market; countries like the
US). A change in environment in any of these will result in quick reversal of the flows.
If FDI is certain, long term and less fluctuating, FPI is speculative, highly volatile and un-predictive. Hence,
FDI is superior to FPI.

Mechanism for Entry of FDI- As far as administrative mechanism is concerned; FDI enters India
through two routes:

Automatic Route and Approval Route

Automatic Route: Under the automatic route, there is no requirement of prior approval and the project can
be set up directly. No special clearance is required by the foreign investor to invest in India. The investors
are only required to intimate the regional office of the RBI within 30days of receipt of inward remittance.
Approval route: Some projects are not allowed through automatic route but require specific approval. The
DIPP would consider the proposal.
In India FDI is approved through Automatic route, Government (approval) route and through the
combination of both routes (especially for FDI be- yond 49% and up to 74% or 100%).

J. LAND REFORMS

Colonialism shattered the basis of traditional Indian agriculture. Commercialization of agriculture &
differentiation between the peasantry occurred on a large scale. However unlike independent societies
under- going transition from pre-industrial & pre-capitalist mode of production to capitalist mode of
production, in India, commercialization and differentiation didn‘t mark the shift towards capitalist
commodity production and rise of the capitalist farmer.
 Basics of Economy 101

In India, commercialization of agriculture led to extraction of surplus from the peasantry in the form of
land revenue and the transfer of this surplus from India to Britain by exporting agriculture produce.
Differentiation of peasantry led to the creation of a rent collecting Zamindar (Landlord class) and not the
creation of a capitalist farmer. (A tenant farmer is not a wage worker. He takes land on rent).

Features of Indian Agriculture under British Period

(i) A very high tax demand
(ii) Huge indebtedness of the peasants

Land Reforms

Land Reforms usually refer to redistribution of land from rich to poor. More broadly, it includes regulation
of ownership, operation, leasing, sales and inheritance of land. In an agrarian economy like India with
great scarcity and unequal distribution of land, coupled with a large mass of below poverty line rural
population, there are compelling economic and political arguments for land reform. At the time of
independence, ownership of land was concentrated in the hands of few .This led to the exploitation of the
farmers and was a major hindrance towards the socio economic development of the rural population.
Equal distribution of land was therefore an area of focus of independent India‘s government, and land
reforms were seen as important pillar of a strong and prosperous country. Therefore, it received top
priority on the policy agenda at the time of independence. In the de- cades following independence, India
passed a significant body of land reforms legislation. The constitution of India has left the adoption and
implementation of land and tenancy reforms to state governments. This led to a variation in the
implementation of these reforms across states and time.

Following are the major land reforms introduced in India after independence:

The process of land reforms after independence occurred in 2 phases.

1. Reforms started soon after independence and continued till early 1960s. They were called Institutional
reforms.
They included:
(i) Abolition of intermediaries i.e. Zamindari Abolition
(ii) Tenancy reforms
(iii) Providing security of tenure to tenants
(iv) Decrease in rents
(v) Giving ownership rights to the tenants
(vi) Ceiling on size of land holding
(vii) Cooperativisation

2. Reforms from mid of 1960s. They were called technological reforms. They included green revolution.
The two phases are not to be divided into rigid water tight compartments. In fact they were
complimentary to each other (one enforced the other) and there was a fair degree of overlap in the
program.

Zamindari Abolition

By 1949, Zamindari abolition bills were introduced in a number of provinces but there were wide spread
apprehensions among the congress leaders that the Zamindars could try to stop the acquisition of their
property by going to the court and by raising the issue of violation of the fundamental right to property or
for the excuse of injustice in compensations. Therefore the first constitutional amendment & 4th
amendment were brought to strengthen the hands of state legislature for implementing Zamindari
abolition. In the first amendment, laws related to land reforms & acquisitions were kept in 9th schedule
i.e. beyond judicial review, so that Zamindar couldn‘t go courts. Under these amendments, litigation for
violation of any fundamental right of property or insufficiency of compensation while acquiring land wasn‘t
permitted in the court.

4th amendment: The compensation given to landlord was made beyond judicial review. But the Zamindars
continued to make petitions to the courts to stop taking away of their lands.

Land Reforms Causes: Social Justice, economic development, improve standard of living
1st Constitutional Amendment Act added 3 things to the constitution:-
a. 2 new articles (31A & 31B)
b. 1 schedule (9th)
102 Basics of Economy

Article 31A: State can make laws to acquire any estates/rights related to estates. Courts can‘t declare
such law as void on the ground that it violates Fundamental Rights.
Article 31B: Acts listed in 9th schedule can‘t be challenged in the court.
9th Schedule: 1st constitutional amendment act listed 13 acts in 9th schedule all meant for Zamindari
abolition.

Zamindari Abolition Act: Salient Features. Compensation: ownership & land revenue related rights of
Zamindars were abolished. Land was transferred to tenants & state government gave compensation to
Zamindars.

Common Land: Earlier common land belonged to the Zamindars. They controlled it & charged fees if
someone else wanted to use it. Zamindari Abolition Acts transferred such land to the village panchayat.
Ownership transfer: Land brought under personal cultivation & land revenue was abolished.

Effects of Zamindari abolition/Land reforms

(1) Agricultural production increased

(2) Improvement in the conditions of the tenants
(3) No land revenue was to be paid
(4) Changed rural power structure towards egalitarian society.
(5) Rise of middle class.
(6) Increase in investment in agriculture
(7) Decrease in poverty

By 1956, Zamindari Abolition acts were passed in most of the provinces.

One of the difficulties faced in Zamindari abolition was the absence of land records. Still by the end of
1950s, the Zamindari abolition was almost completed.
This was possible partly because the Zamindar class was isolated socially during the national movement as
they were seen as a part of the imperialist camp. The area under tenancy decreased from 42% in 1950s to
approx 22% by early 1960s. However the decline in tenancy wasn‘t a result of tenants becoming
landowners but also due to the fact that many tenants were evicted by the landowner. Under the
government‘s clause of land to the tiller, a person who cultivates land could keep the land with himself.
Due to this, landowners evicted many tenants and started to cultivate the lands themselves under the
clause of personal cultivation.

The compensation paid to the Zamindar was generally small and varied from state to state depending on:-
• Strength of peasant movement against the British rule.
• The class balance between the landlords and the tenants.
• The ideological composition of the congress leadership and of the legislature as a whole.
However, the payment of compensation stretched over a long period.

Weaknesses in Zamindari Abolition

 Absence of land records was the biggest hurdle. Without land records it could not be found out that
who was cultivating whose land.
 What constituted personal cultivation was very vaguely defined as the Zamindars were allowed to
keep the land under personal cultivation and there was no limit on the land to be declared under
the personal cultivation of the Zamindars. The Zamindars who were earlier absentee landlords
could now keep large amounts of lands with themselves.
 Further in order to declare more land under personal cultivation a large scale eviction of tenants
took place. However, personal cultivation clause had certain positive results too. Many of the
Zamindars who kept the land under personal cultivation, invested in it and moved towards
progressive capitalist farming (this was one of the objectives of land reform movement; to
increase the food grain production).
 The MLAs used every possible method of parliamentary obstruction in the legislatures. The bills
were subjected to long debates and many amendments were proposed. In many states like U.P. &
Bihar, many years passed between the introduction of the bills & the laws being enacted.
 Even after the laws were enacted, the landlords used the judicial system to defer the
implementation of the law. Zamindars refused to hand over their land records to the government,
which forced the government to follow the lengthy procedure of reconstruction the land records!!!
 The implementation of the law was also difficult because of the nexus between the Zamindars and
the lower level revenue official (most of the revenue officials were former rent collecting agents of
the Zamindars).
 Basics of Economy 103

 Despite the resistance of the landlords, the process of Zamindari abolition was completed except in
certain part of the country. The main beneficiaries were the occupancy tenants who now became
land- lords.
 The issue of tenancy continued even after the abolition of Zamindari system. Such tenancy existed
on the lands of former Zamindars. It was called oral tenancy. The lands which the Zamindars
declared to be under personal cultivation were given to tenants. Also the earlier tenant who now
became a landowner gave his land on rent.
 The political and economic conditions in different parts of Indian were so varied that the tenancy
legislation passed by the different states and manner of implementation also varied a lot.

Tenancy Reforms

Objectives of tenancy reforms:-

(1) Guarantee of security of tenure to the tenants who had cultivated a piece of land for a fixed
number of years (number of years varied from state to state).
(2) To reduce the rents paid by tenants to a fair and just level.
(3) The tenant should gain the right to acquire ownership of land he cultivated subject to certain
restrictions. The tenant was expected to pay a price much below the market price (Generally a
multiple of annual rent).
(4) The tenancy legislation tried to bring a balance between the interests of landowners particularly
the small landowners and the tenant.

 The aim of Zamindari Abolition and Tenancy reforms was the same: ―land to the tiller‖.
 The absentee landowner‘s right to resumption of land for personal cultivation was limited. He
couldn‘t cultivate more land than the ceiling prescribed by each state.
 Again the tenants‘ right to acquire the landowners land was restricted by the condition that the
land owner wasn‘t to be deprived of all his land. Also the tenants holding after acquisition of the
land of the Zamindar couldn‘t exceed the ceiling prescribed by each state.
 The economic circumstances of small owners were not so different from that of tenants and the
tenancy legislation worked to their disadvantage. Therefore the second 5 Year plan envisaged that
very small land owners could resume their entire holding for personal cultivation.
 However the actual implementation of the tenancy laws was complicated. Due to the above pro-
visions (protection of small landowners) there was misuse by the larger landlords. They connived
with the revenue officials and transferred their lands in the names of a number of relatives so as to
enter the category of small landowners.
 After this, the landowners evicted the tenants from such lands by exercising the right of
resumption given to small owners.
 Infact the right of resumption and the lose definition of personal cultivation was used for eviction
of tenants on a large scale.
 The process of eviction had begun in anticipation of tenancy legislation coming in near future. The
long delays in enacting the laws created vested interests enabling them to evict potential
beneficiaries before the law came into force.
 Even after the tenant got legal protection against eviction, large scale evictions continued.
 Voluntary surrenders were another excuse for illegal eviction. According to the landlord, the tenant
had voluntarily surrendered the land to the landowner for personal cultivation but in reality the
tenant was threatened to give up the right to land.
 The fourth plan recommended that all surrenders should be in favour of the government, which
would allot such lands to the eligible persons. However, only a few states acted on this
recommendation. In many cases tenancy continued in a hidden form. The tenants were now called
farm servants though in reality they had the same status as that of the tenants. In the early years
of land reforms, tenants were converted to sharecroppers. Share croppers were now treated as
tenants and were not protected under tenancy legislation. Only cash rent payers were treated as
tenant and tenants who paid in kind were called share croppers.
 What contributed to insecurity of tenants was the fact that most tenancies were oral and informal
i.e. they were not recorded and the tenants couldn‘t benefit from the legislation.
 The absence of proper records was a major obstacle in the implementation of the Zamindari
abolition & land reform act. A massive drive was launched by the farmer leader Charan Singh to
get a few mil- lion records corrected.
 In the later years many such drives were started under the power of left forces. The targeted
beneficiaries were no longer the upper or middle level tenants but also the sharecroppers & small
tenants.
 Therefore the only benefit of tenancy legislation was that a substantial portion of tenants acquired
security and permanent occupancy rights.
104 Basics of Economy

Permanent tenant or occupancy tenants: when tenancy rights is permanent, hereditary and passed on
to generations. They have security of tenure and could claim compensation from the landlords for any
improvement done on the land.

Tenant at will: They did not have any security of tenure, made to pay exorbitant rent to the landlords
and could be evicted from the land whenever landlord so desired or were evicted at will.

Subtenant: When tenant gives land to another tenant. The only positive of tenancy reforms was that it
caused positive impact on levels of investment and improvement in productivity and hence brought a
decrease in poverty in the field of such secure tenants

Operation Barga
 It was launched in the state of West Bengal by the left front government with the objective of
registration of share croppers in a time bound period so that they can then proceed to secure for
themselves, their legal rights namely permanent occupancy & heritable rights.
 In operation Barga, the support of the rural poor and especially the targeted beneficiary was
sought in the implementation of the reform measures. It neutralized the lower level revenue
official like Patwaris etc. who often acted as major obstacles in the successful implementation of
government programs.

Reason for stagnation of operation Barga

 It was politically impossible and ethically indefensible as many landlords were cultivators
themselves with holdings only marginally larger than those of the sharecroppers.
 In West Bengal, the majority of the cultivators were small cultivators controlling less than 5 acres.
Therefore a further redistribution was difficult and the government had to balance the interest of
small land- owner and tenants.
 The land man ratio in Bengal was such that the land lord was able to rotate a piece of land among
two or more share croppers. Registering any one of the tenants would permanently remove the
other. Also if the tenants were registered in such a situation the size of the holdings would fall
below the optimum level.

Limitations of tenancy reforms

 The first objective of tenancy legislation was to provide security of tenure to all tenants but it met
with a limited success. The practice of insecure tenancy mostly oral, continued in India on a large
scale.
 The second objective of tenancy legislation was to bring the rent to a fair and just level. But the
presence of so many insecure tenants was the major obstacle in this area. This led to a tenant
getting ready to pay rent higher than the legal and fair rent .The legal and fair rent could only be
enforced in the case of tenants who were registered with the state government. Therefore many
states fixed maximum rent (20 to 30%). In practice however, the market rates of rent were
around 50%. Insecure tenants and the sharecroppers paid the market rent while the secured
tenants paid the legal rent.
 Further the green revolution aggravated the problem. Land rents increased further.
 The third objective of the acquisition of ownership rights by tenants was achieved only partially.
The reasons were right to resumption by landowners, legal and illegal evictions, voluntary
surrenders, shift towards oral or concealed tenancy.
 One of the reasons that the larger number of tenants didn‘t acquire ownership rights was that for
the tenants who had acquired permanent occupancy rights and achieved rent reduction, there was
hardly any motivation to try & acquire full ownership. This process would not only involve raising
capital (lawyer‘s fees) but also legal and other complications.
 The cumulative effect of abolition of Zamindari, tenancy and ceiling legislation was the meeting of
one of the major objectives of land reforms which was creation of progressive cultivators who
would make investment in the land and improve its productivity.
 Abolition of Zamindari led to about 20 million tenants becoming landowners and many absentee
Zamindars turning to direct cultivation in the lands by ―resumed personal cultivation‖.
 The tenants and share croppers got occupancy rights or paid reduced fixed rents (the landless got
the land which was declared surplus over the ceiling limits and the absentee landowners become
direct cultivators)
 All of them had the motivation to become progressive farmers based either on their own resources
or on credit from banks which become increasingly available to the poorer peasants.
 Basics of Economy 105

Ceiling and Bhudaan Movement

Land ceiling
 Another aspect of the land reform movement in India was the imposition of ceilings on the size of
land holdings with the objective of making land distribution more equitable.
 However societal consensus was weak on this question and there was very little success in
implementation of this program. The first plan was in favour of an upper limit on the amount of
land that an individual may hold. However the upper limit was to be decided by each state
separately.
 In the meantime opposition to ceilings was building up in large parts of the country. A threat to the
right to property was perceived by the rural land- owners as well as the urban interest. The
complainers and beneficiaries of Zamindari abolition, the tenants who had now become the
landowners, all came up against the attempt of redistribution of landownership through imposition
of land ceilings. The states also were not in any hurry to enact any land ceiling act.

Weaknesses in land ceiling legislation

 In a situation where more than 70% of the landholdings in India were less than 5 acres the
ceilings fixed by the states were very high.
 In Andhra, it was from 27 to 312 acres, Assam 50 acres, Punjab 30-60 acres etc.
 Moreover in most states the ceilings were imposed on individuals and not on family holdings. It
enabled the land owners to divide up their land for the sake of formality & registering it in the
names of relatives, just to avoid the ceiling. Further in many states the ceiling could be raised too.
 The long delay as well as the legislation ensured that the ceilings had a very little impact & re-
leased little land for redistribution.
 A large number of exemptions to the ceiling limits were permitted by most of the states. According
to the second plan, certain categories of land could be exempted from ceilings e.g Tea, Coffee,
Rubber Plantation, Orchards, farms for cattle breeding etc.
 The intention was to promote progressive or capitalist farming done on a large scale and at the
same time try to end the absentee landlordism.
 However even this method wasn‘t problem free. Many times the exemptions were absurd.
 Criteria such as efficiently managed farm were quite vague. A large number of farmers declared
their lands as efficiently managed and thus evaded the ceilings. Similarly, the exemption to land
held by cooperatives was also misused. Many landlords transferred theirs lands to bogus co-
operatives.
 The only positive of these exemptions was that some landowners shifted to efficient farming in
order to save their lands from being taken of the government under the ceilings act.
 The long delay in bringing the ceiling legislation also defeated its very purpose. The large land
owners had enough time to either sell their excess land or transfer it in the names of relatives.
 The landowners also resorted to mass eviction of tenants, resuming cultivation on their lands at
least up to the ceiling limit and claiming falsely to have shifted to progressive farming under their
direct supervision.
 Thus by the time, the ceiling legislations were in place, there were barely any holdings left above
the ceiling limit. Despite the ceiling legislations were passed by most states by 1961, till the end of
1970 not single acre was declared surplus in large states like Bihar Mysore, Rajasthan, Orissa etc.

Second Spurt of Land Reforms

In the wake of the political and economic crisis of be mid 1960s, a strong agrarian radicalism emerged in
large parts of the country. The naxalite movement led by CPI-ML (Marxist - Leninist) peaked in West
Bengal and parts of Andhra.

West Bengal saw widespread land grab movement by the landless. The poor would come together and
forcible seize the land of the large landowners. The total amount of land seized wasn‘t very significant and
most of it was government waste land, land which was taken over by the government but was not
distributed to the poor.
The movement was suppressed. However despite the very limited success in land seizure and the quick
suppression of the movement, on the whole, it had a significant symbolic effect. The nation‘s attention was
drawn to the agrarian question. This was the context of second spurt of land reforms which occurred in
1960s and early 1970s. The central land reforms committee made a series recommendations.

They were-
(1) Decrease in the level of ceiling limit.
(2) Withdrawal of exemption is favour of efficiently managed or mechanized farms.
106 Basics of Economy

(3) Making ceiling limit applicable to the family as a unit and not to the individuals as was the case
earlier.
(4) In the distribution of surplus land, priority was to be given to landless agricultural workers
especially those belonging to SCs & STs.
(5) Compensation to be paid for surplus land was fixed well below the market price, so as to be within
the budget of new allotees.

Why land ceiling isn‟t possible now

 Given the adverse land man ratio and the fact that very high proportion of population continues to
be dependent on agriculture, the number of competitors for land is very high. Any attempt to
further reduce ceilings to provide land for landless labourers would increase the number of
uneconomic holdings.
 Also it would turn the politically important, the landowning classes under the new farmers
movement against any political party which tries to do so.

New farmers‟ movement

 Prior to independence all farmers were poor but after reforms & especially green revolution, the
farmers became rich and with money came power. Now their demand is not about land. The level
has risen. They now demand for high MSP, free electricity etc.
 Perhaps the only option left for landless labourer is to ensure payment of minimum wages, security
of tenure and fair rents to sharecroppers and tenants. The other solution can be increasing the
nonfarm and non-agricultural employment in rural areas, increasing animal husbandry and other
activities associated with cultivation which does not require land.

Bhudaan Movement

Bhudaan was an attempt at land reform by bringing institutional changes in agriculture like land re-
distribution through a movement and not simply through government legislation. Acharya Vinoba Bhave
launched this movement in early 1950s. He organized an All India Federation of constructive workers
called the Sarvodaya Samaj. It was to take up the task of non-violent social transformation in the country.
He and his followers did Padyatra to persuade the larger land owners to donate at least 1/6 of their lands
as Bhudaan or land gift for distribution among the land- less and the poor.
The target was to get as donation 50 million acres which was 1/6th of the 300 million acres of cultivable
land in India. The movement, though independent of the government, had the support of congress, which
urged its members to participate in the movement.

Limitation of the movement

 In the initial years, the movement achieved considerable success but it soon lost momentum.
 A substantial part of the land donated was unfit for cultivation or was under litigation. Perhaps this
was the one reason that out of the nearly 4.5 million acres of land donated only about 0.6 million
acres was actually distributed.
 Towards the end of 1955, the movement took a new form, that of Gramdaan or donation of
village. It was declared that all the land in the Gramdaan movement was owned collectively or
equally as it didn‘t belong to any one individual. The movement started in Orissa & was most
successful there.
 It is said that this movement was successful mainly in villages where class differentiation had not
yet emerged and there was little disparity in owner- ship of land example.
 Vinoba picked such villages which were mostly inhabited by the tribals for this movement. By the
1960s, the Bhudaan/Gramdaan movement lost its charm despite its original promise. Its creative
potential remained unutilized.
 The Sarvodaya Samaj on the whole failed to make a transition from a local movement to an active
large scale, mass movement.

Positives of Sarvodaya Movement

 It wanted to bring land reform through a movement & not through government legislation. This
was an achievement in itself.
 The potential of the movement was enormous as it was based on the idea of trusteeship or that all
land belong to God and the landlords were first trustees. If the landlords failed to behave as
trustees or equal sharers of prosperity then a Satyagraha in the Gandhian form could be launched.
 The movement made a significant contribution by creating a moral atmosphere which put pressure
on the landlords and created conditions favourable to the landlords.
 Basics of Economy 107

Consolidation of land holdings

Consolidation of land holdings means bringing together the various small plots of land of a farmer
scattered all over the village as one compact block, either through purchase or exchange of land with
others. The average size of holdings in India is very small. The size of the land holdings is decreasing but
number of holdings is increasing over time. This is due to the inheritance laws because of which farms are
being subdivided and fragmented with every passing generation. Subdivision and fragmentation of
holdings results in several disadvantages such as wastage of land, difficulties in land management,
difficulties in land management, difficulty in the adoption of new technology, disputes over boundaries, low
productivity etc.

There were various obstacles to the speedy implementation of the consolidation programme. These were
poor response from the cultivators due to the perceived advantage of having land in fragmented parcels in
the event of floods and other natural calamities or acquisition ,complicated process of land consolidation,
wide variation in the quality of land, lack of enforcing machinery, lack of political will, emotional
attachment of people to their land and reluctance to part away with their land holding, unwritten and
incomplete land records, lack of administrative staff to carry out consolidation of land holdings etc.

Evaluation of consolidation:

Only in Punjab and Haryana, the task of consolidation has been undertaken on a considerable extent. In
some States, consolidation has not at all been undertaken. Overall, consolidation could not be carried out
on account of the following reasons:
1. It is difficult to allot a single land of the same area and of the same quality as was previously held
by the owner.
2. People are emotionally attached to the land and thus, do not part away with the land holdings.
3. Unwritten and incomplete land records hamper consolidation of land holdings and lead to excessive
litigation.
4. There is lack of administrative staff to carry out consolidation of land holdings.
5. It is said that the rich and influential open manage to get fertile and when situated land where as
the poor and non influential get inferior land.
6. Consolidation of land holdings often leads to eviction of tenants.

Co-operatives

Co operative farming refers to a system in which each member farmer remains the owner of his land
individually, but farming is done jointly. Profit is distributed among the member farmers in the ratio of
land owned by them. Wages are distributed among the member farmers according to the number of days
they worked.

In other words, cooperative farming refers to pooling of land and practicing joint agriculture. The
advantages of cooperative farming are as follows:
(1) It resolves the problem of land fragmentation
(2) Allocation of tasks among farmers makes tasks easier.
(3) Agricultural input can be purchased in bulk at cheaper rates
(4) Similarly, agricultural output can be transported to markets in bulk at cheaper rates
(5) Agricultural machinery such as tractors can be shared leading to lower cost of cultivation.

Many national leaders agreed that co-operativisation would lead to major improvement in Indian
agriculture and would particularly benefit the poor. It was also one of the institutional reforms. However
no consensus particularly among the peasantry was made in this question. Further it was made clear that
co-operativisation would done through persuasion, no force will be used as was done in Russia & China.
The first five year plan recommended that small & medium farms should be encouraged and assisted to
form co-operatives & farmer societies.

 The early planners had hoped that the village Panchayats activated by motivated party workers
and helped by the trained workers of CDP (community Development program) would help
implement rural development projects and bring institutional changes in Indian agriculture.

 Further there were high expectations from the institutional changes like co-operatives that they
would help in bringing changes to increase production. The second plan said that it wanted to take
essential steps for the development of co-operative farming so that over a period of ten years or
so, a large portion of agricultural lands are cultivated on co-operative lands.
108 Basics of Economy

 In the meantime news came from china that co-operatives had led to dramatic increase in
agricultural production.

 Indian sent two delegations to China to understand and study the co-operative organization of
China. Both these delegations recommended a bold program of increasing co-operative farming in
India. Nehru started putting pressure on the states to follow the Chinese example.

 The congress in one of its resolutions stated that the organization of the village should be based on
village Panchayats and village co-operatives. Both of them to be given adequate powers &
resources to discharge the functions allotted to them.

 A wave of opposition followed this recommendation. The Chinese repression in Tibet in 1959 and
Chinese attack on India in 1962 made it difficult for the Indian government to follow anything
which had its source in China.

 Therefore the idea of farming co-operatives was discarded and congress tried to set up service co-
operatives. The co-operative farms could be set up voluntarily. The congress decided to set up
training centers for it workers so that they could help in organizing Service Co-operatives.

Two types of farming co-operatives were observed

Bogus Co-operatives

These were formed to evade land reforms & eat up the excess incentives offered by the state. These co-
operatives were formed by influential families who took a number of agricultural labourers or ex tenants as
bogus members. Forming a co-operative helped the influential families to evade the ceiling laws & the
tenancy laws. The lands were tilled by the bogus members who were engaged as wage labourers or
tenants. Moreover by following cooperative farming, these bogus co-operatives, cheap credit could be
taken from the bank. Also these co-operative would get priority in acquiring inputs like fertilizers,
improved seeds etc.

State sponsored co-operative farms

These were in the type of pilot projects where poor and uncultivated land was made available to the
landless harijans, displaced person etc.
The poor quality of land, lack of proper irrigation facility and the fact that these farms were run like
government sponsored projects made them unsuccessful experiments.

Limitations of service co-operatives

They not only reflected the unequal structure of the Indian countryside but also tried to re-enforce it.
Typically the leadership of the co-operatives i.e. president, secretary consisted of the leading family of the
village which not only owned a great deal of land but also controlled trade and money lending. These rich
families would use all the scarce agricultural inputs for themselves. There was exclusion of the landless.
Government had to start special programs to bring these landless and marginal farmers under the ―Garibi
Hatao‖ campaign.

Instead of promoting people‘s participation, a co-operative soon became an over staffed government
department with officials, clerks etc. and replicated at the higher level. This large bureaucracy was
unsympathetic towards principles of co-operative movement & was influenced by local vested interests.
The co-operative credit societies failed to recover their loans and there were many NPAs. The defaulters
were not only the poor farmers but also the well to do rich farmers who didn‘t pay their dues intentionally.
Populist measures like writing off rural debts put a heavy burden on the nation and also eroded the
viability of rural credit institutions.

Positives of co-operatives
(1) They provided cheap credit. Credit was provided to weaker sections as well.
(2) They not only helped in bringing improved seeds, fertilizers etc. to the peasants but also guided
them in using these inputs.
(3) They also helped the farmers to market their produce.
(4) In fact the co-operatives provided a necessary condition for the success of green revolution.
 Basics of Economy 109

Size of agricultural holding (as in 2015-16)

As per Agriculture Census 2015-16, the average size of operational holding has declined to 1.08 hectare in
2015-16 as compared to 1.15 hectare in 2010-11. The small and marginal holdings (<2 ha) now constitute
86%, while the large holdings (>10 ha) are merely 0.57% of the total land holdings.

The reasons for the subdivision and fragmentation of agricultural holdings in India are as follows:
1. Inheritance of land among children
2. Pressure of population on land
3. Decline of joint family system
4. Financial distress causes farmers to sell part of their land
5. Psychological attachment to land leads to a number of small holdings in place of a few large
holdings.

The disadvantages of subdivision and fragmentation are as follows:

1. Wastage of land in making boundaries
2. Difficulties in mechanization
3. Low productivity of land
4. Disguised unemployment as many people are employed on small piece of land
5. Increase in disputes over boundaries

Cooperative farming

Cooperative farming refers to a system in which each member farmer remains the owner of his land
individually, but farming is done jointly. Profit is distributed among the member farmers according to the
number of days they worked.
In other words, cooperative farming refers to pooling of land and practicing joint agriculture. Cooperative
farming is not a new concept in India.
Since ancient times, Indian farmers have been giving mutual help to each other in sowing, harvesting etc.
However, the state push towards cooperative farming has been mainly since independence.

The advantages of cooperative farming are as follows:

1. It resolves the problem of subdivision of land
2. Allocation of tasks among farmers makes tasks easier
3. Agriculture input can be purchased in bulk at cheaper rates
4. Similarly, agricultural output can be transported to markets in bulk at cheaper rates
5. Agricultural Machinery such as tractors can be shared leading to lower cost of cultivation

Critical Evaluation of cooperative farming in India

To promote cooperative farming, the government has offered a number of incentives such as financial
assistance, technical assistance, supply of input etc. However, the progress of cooperative farming has
been extremely slow. Only 0.38% of cultivable land is operated under Cooperative farming.
Cooperative farming has unsuccessful in India due to various reasons such as lack of professional
management of farms, lack of trust among members etc.
The motivation behind the formation of cooperative societies in the farming sector has not been genuine.
Most Cooperative are formed not on the basis of spirit of cooperation but to avoid Government laws and to
gain benefits from the government.

To conclude, land reforms in India have largely been a failure. Apart from the factors mentioned earlier,
other factors are
1. Lack of political will
2. Apathy of bureaucracy
3. Corruption
4. Land owning by Bureaucracy and political class
5. Linkage between bureaucracy, politicians and land owning class

Green Revolution

It is the introduction of new techniques of agriculture which became popular by the name of the Green
Revolution (GR) around the world in early 1960 s – at first for wheat and by the next decade for rice, too,
It revolutionized the very traditional idea of food production by giving a boost by more than 250 percent to
the productivity level. The Green Revolution was centered around the use of the high yielding variety (
110 Basics of Economy

HYV) of seeds developed by the US agro- scientist Norman Borlaug doing research on a British Rocke-
feller foundation scholarship in Mexico by the early 1960s . The new wheat seeds which he developed
claimed to increase its productivity by more than 200 percent. By 1965, the seeds were successfully tested
and were being used by farmers in food deficient countries such as Mexico, Taiwan.

Components of the Green Revolution

The Green Revolution was based on the timely and adequate supply of many inputs / components. A brief
review on the green Revolution is given below

The HYV seeds

They were popularly called the dwarf variety of seeds. With the help of repeated mutation, Mr. Borlaug
was able to develop a seed, in which nutrients would be supplied less to the leaves, stem making the plant
dwarf and more nutrients would flow to the grains resulting into high yield.
These seeds were non-photosynthetic, hence non dependent on sun rays for targeted yields.

Irrigation

For controlled growth of crops and adequate dilution of fertilizer, a controlled means of water supply was
required. It made two important compulsions- firstly the area of such crops should be at least free of
flooding and secondly, artificial water supply should be developed

Chemical pesticides and germicides

As the new seeds were new and non-acclimatized to local pests, germs and diseases than the established
indigenous varieties, use of pesticides and germicides became compulsory for result oriented and secured
yields.

Chemical Herbicides and weedicides

To prevent costlier inputs of fertilizers not being consumed by the herb and the weeds in the farmlands,
herbicides and weedicides were used while sowing the HYV seeds

Credit, storage, marketing / Distribution

For farmers to be capable of using the new and the costlier inputs of the Green Revolution, availability of
easy and cheaper credit was a must. As the farmlands suitable for this new kind of farming was region-
specific (Haryana, Punjab and western utter Pradesh in India) storage of the harvested crops had to be
done in the region itself till they were distributed throughout the country. Again, the countries which went
for the green revolution were food – deficient and needed the new yield to be distributed throughout the
country and a proper chain of marketing, distribution and transport connectivity was necessary. These
entire peripheral infrastructures were developed by the countries going for the green revolution with softer
loans coming from the World Bank - India being the biggest beneficiary.

Chemical Fertilizers

The seeds were could increase productivity provided they got sufficient level of nutrients from the land.
The level of nutrients they required could not be supplied with the traditional manures because they have
low concentration of nutrients content. That is why a high concentration fertilizer was required which
could be given to the targeted seed only. The only option was the chemical fertilizers.

Impact of the Green Revolution

The Green revolution had its positive as well as negative socio- economic and ecological impacts on the
countries around the world. We will study the impacts pertaining to India:

Socio- economic impact

(i) Food production increased (wheat in 1960s and rice by 1970s). India not only became self –
sufficient in food production but later turned into a food exporting country.
It gave a boost to the production of cereals. But it did not cover coarse cereals like maize, jowar,
bajra and ragi. Moreover green revolution never touched pulses.
 Basics of Economy 111

Increase in production of cash crop has taken place here. Earlier the focus was on food security.
There is improvement in oilseeds, potato, cotton etc. But there is no significant increase in
production of jute.
It caused a change in the cropping pattern in favour of wheat and rice putting pulses, oilseeds,
maize, barley on the margins, etc.
No increase in output of pulses and area under pulses remained stagnant. So prices rose of these
goods. Per capita consumption of pulses in 1969 was 69 gm and currently it is 32 gm.
Availability of cereals has increased from 395 per day in 1950 to 460 g/day, 2010 while for pulses
it has come down from 60gms per day to 39 gms per day
Coarse cereals – 116 to 90 g/day
Wheat has replaced coarse cereals
(ii) It increased the income of the farmers and increased their standard of living also.
(iii) It increased the inequality between the large farmers (who benefitted more) and the small
farmers. It also increased the inequality among the states too. The gap between the already
progressive states of Punjab and Haryana and Bihar, West Bengal increased.
(iv) It caused migration from these poor states to the north western states.

Ecological impact

The most devastating negative impact of the green Revolution was the ecological one. The major ones
them may be glanced in their chronological order.

(a) Soil degradation and decrease in fertility(due to the repetitive kind of cropping pattern being
followed by the farmers, excessive exploitation of the land, lack of a suitable crop combination,
intensive agriculture, increased salination of the soil because of excessive irrigation, detioration of
NPK ratio of the soil because of excessive use of urea.)
(b) Water table falling down ( as the new HYV seeds required comparatively very high amount of
water for irrigation )
(c) Eutrophication
(d) Toxic Level in food chain (Bio Magnification): Toxic level in the food chain of India has increased to
such a high level that nothing produced in India is fit for human consumption. Basically, excessive
use of chemical pesticides, fertilizers and weedicides has polluted the land, water and air to such
an alarmingly high level that the whole food chain has been a prey of high toxicity.

New Thrust Areas in Agriculture

(i) Output and area under (Bajra, jowar, ragi) coarse cereals should increase.
(ii) MSP should also increase for coarse cereals. (iii)Research on coarse cereals should be focused.
(iv) If coarse cereals are given in PDS, then demand for coarse cereals is created and naturally if
demand is more, focus would be made on its production.
(v) There should be development of short duration and rainfed varieties of pulses.
(vi) Boost production of edible oils. We are not self-reliant in production of edible oil because we suffer
from low productivity. More area should be brought under irrigation for oil seeds. Modern crop
technologies should be used
(vii) Now strategies of irrigation and water management to be promoted
(viii) Improved water conservation, fertilizer use and credit availability.
(ix) Use of bio fertilizer has to be expanded
(x) Emphasis on dry land farming.

Problems of Farmers

(i) Drought and rain

(ii) Less institutional support
(iii) Capital promotion in agriculture & allied sectors is less
(iv) Increasing indebtedness (consumerism has increased post LPG especially, leading to indebtedness.
(v)Output is affected due to El Nino, climate change and the input is getting very costly. The result
is farmer suicide.
(vi) Chronic malnutrition is high in families without assets & in families with small land holdings without
access to irrigation.
112 Basics of Economy

National mission for sustainable Agriculture (NMSA)

The NMSA launched in 2011-12 aims at enhancing food security and protection of resources such as
lands, water biodiversity and genetic resources by developing strategies to make Indian agriculture more
resilient to climate change. The economic survey 2011-12 discusses the impacts of climate change on
Indian Agriculture in the following points:
(i) Indian agriculture, with two– third rain fed area remains vulnerable to various vagaries of
monsoon, besides facing occurrence of drought and flood in many parts of the country. Natural
calamities such as drought and flood occur frequently in many parts of the country.
(ii) Climate change will aggravate these risks and may considerably affect food security through direct
and indirect effects on crops soils, livestock, fisheries and pests. Building climate resilience,
therefore, is critical.

Potential adaptation strategies to deal with the ad- verse impacts of climate change are:
(a) Developing varieties tolerant to heat, moisture and salinity stresses
(b) Modifying crop management practice & improving water management
(c) Adopting new farm practices such as resources conserving technologies
(d) Crop diversification
(e) Making available timely weather- based advisories
(f) Crop insurance
(g) Harnessing the indigenous technical knowledge of the farmers.

Second green revolution

Use of all eco- friendly means in cultivation is the second green revolution (SGR) or evergreen revolution
or sustainable agriculture. For experts it includes the agricultural practices such as
(1) Replacing chemical fertilizer by bio- fertilizers
(2) In place of chemical pesticides using bio- pesticides
(3) Conserving water,
(4) Balanced cropping pattern,
(5) Proper crop combinations etc.

Second green Revolution in India

The second green Revolution in India is a concept as well the name of a programme. It was suggested as
an idea of sustainable agriculture in mid- 1990s by the agro- scientist as the ongoing GR was not based on
sustainable agricultural practices. When the Indian president, Dr Kalam suggested for the same, he
attached much wider meaning to it. For him it consisted of, crop management, cost education, value
addition, processing and marketing other than the green farming.

In January 2004, the government of India announced a major agricultural programme named the second
green revolution with an initial fund location of Rs 50,000crore. This programme was so exhaustive that it
had hardly left any problem area of Indian agriculture untouched and had every potential of solving all
long standing problems. In a sense it was a complete agricultural policy based on the concept of
sustainable development and well- equipped to fight the challenges posed by the WTO and capable enough
to make Indian agriculture to emerge as a winner in the globalizing economy. As there was a government
change at the centre, the complete details of the programmes were not made available. The present
government at the centre has not been referring to these programmes, but in practice it looks like
promoting the same causes more vigorously. In the meantime, the president has been quoting the needs
for a second green revolution time and again.

Summing up the second green revolution

If we add up the different announcements by the governments time to time and the propositions of
experts we may sum up the idea of the second green revolution in India with the help of the following
parameters:

(1) Increasing Agricultural production. It includes four major things-

(a) Unlike the green revolution which was limited to only five food grains (wheat , rice, jowar
bajra, maize) , the second green revolution includes all agricultural products - cereals , cash
crops, animal husbandry (dairy, goatry, piggery, poultry, etc.) fisheries, sericulture , etc. It is
rightly called the rainbow revolution. Naturally, it is the most ambitious idea in the agriculture
sector of India ever formalized.
 Basics of Economy 113

It deals with suitable kinds of cropping pattern, crop diversification, crop management, plant
protection, checking pre-harvest losses of agricultural products, as well as post – harvest,
integrated pest management, soil conservation, etc. Initiation of sustainable practices in
agriculture is very important parameter of sustainable agriculture.
One very important point should be noted here that India cannot afford to go for only green
farming or organic farming in the name of sustainable agricultural development. As the
replacement of chemical inputs by the organic ones has every chance of reducing production
and with use of costlier inputs, the product of such farming will not be economically accessible
by the poor population of India. That is why cost cutting, is an integral part of this revolution.
And that is why agro- scientists have suggested basing our agriculture on biotechnology. Use
of biotechnology in agricultural does not only open new dimension for it but has every
potential to cut costs of the agricultural products by doing miraculous and unthinkable kind of
research and development. India is very much aware of this reality that without an active
support of biotechnology, sustainable agricultural development is not possible.

(2) Value Addition: Indian agriculture has been lacking the aspect of value addition. That is why the
real potential of Indian agriculture to create gainful employment has never been tapped. This
green revolution has laid increased emphasis upon agro- processing, beverages and drinks
industries.

(3) Strengthening the infrastructural & Institutional Aspects:

(a) We need to strengthen the credit delivery aspects for the agriculture sector- both at the micro
and macro levels (for corporate farming).
(b) The storage facility for agricultural products in India is among the weakest in the world. India
does not have adequate capacity of godowns and cold storage. A beginning has been made
recently by the railways with the initiation of the refrigerated station wagons. Basically, private
sector participation is considered very vital for the growth of this segment.
(c) The country lacks a suitable kind of transport connectivity. Rural connectivity programmes are
today the high priority areas for the government.
(d) The developments of telecommunication with all modern means
(e) The irrigation preparedness of India needs grassroots level approach. Focus should be on
micro irrigation than on flood irrigation. It becomes especially important once the climate has
started showing its vagaries more and more in recent times.
(f) We need to restructure and strengthen agricultural marketing right from the grassroots level
to the national level. Only then can we internationalize (globalize) our agriculture sector.
(g) Low level of farm insurance because of low levels of farm insurance

Impact of Second Green Revolution

The second green has every prospect of revolution sing the agriculture sector of India with
multidimensional positive impact on agriculture in particular and the economy, in general.

(a) As agricultural production will increase, India will be safe from food security concern. This will
provide India physical access to food.
(b) Every Indian will have economic access to food because of increase in production and cost cut due
to genetically modified foods (GMFs) will make food cheaper.
(c) As this is a sustainable kind of agriculture revolution, India will also be able to make its agriculture
sector ecologically safe- the achievement of eco- logical access will become possible.

The surplus agricultural produce will enter the world market and agriculture sector will be able to tap the
benefits of globalization thus, farmer, rural areas and Agri-business will be able to feel the benefits of
economic reforms and globalization.

Horticulture Revolution

Fruits and vegetables give 4-10 times the return from other crops namely cereals, pulses and oilseeds.
Diversification towards horticultural crops is the most powerful factor in raising growth rate of agriculture
GDP. Due to changes in taste, preferences and food habits, the consumption pattern in India has been
shifting towards fruits and vegetables and the per capita intake of fruits and vegetables will keep rising in
coming years. Such changes are also happening globally. Moreover, there is large deficiency of these items
in Indian diet.
114 Basics of Economy

All these indicators suggest that demand side prospects for fruits and vegetables are very bright. However,
area under fruits and vegetables in the country has remained below 10%, despite favourable demand side
factors. Even with 1/10 share in area, fruits & vegetables contribute more than one fourth of earnings
from crop sector in the country.

White Revolution in India offers interesting lessons for harnessing its horticulture potential. Milk and
horticulture have lot of similarities. Both are high value, perishable, labour intensive, and income
augmenting enterprises. Very stable and robust growth in milk production is attributable mainly to three
market factors, namely, institution of milk cooperatives, complete freedom to milk producers and buyers
for sale/purchase of milk throughout the country and de- regulation of dairy sector. With similar market
conditions, India can achieve horticulture revolution in a much shorter period than White Revolution.

Demand side factors and technology are highly favourable for horticulture revolution at small farms. What
is needed is policy support for market liberalization, producer‘s organizations and processing. These
require action both by the states and the Central govt. The onus for freeing market for horticultural
produce rests with the states while support of Central government is crucial for promoting producers‘
organizations (e.g. Small Farmers Agribusiness Consortium (SFAC)) and fruits and vegetable processing).

Growth in horticulture in the recent past: India is the second largest producer of horticulture crops, just
behind China. The horticulture boom is spread across the country, and not limited to the erstwhile food
grains-based green revolution states like Punjab, Haryana and western Uttar Pradesh.

Another positive for horticulture is that since fruits and vegetables are mostly grown by marginal and small
farmers, the resource-poor farmers are likely to have benefitted most from the growth in horticulture
sector. And this sector has thrived even with- out a minimum support price (MSP) to cushion it.

Model Agricultural Land Leasing Act, 2016

The Expert Committee on Land Leasing constituted under the NITI Aayog submitted the model Agricultural
Land Leasing Act, 2016 on March 31, 2016. The model Act seeks to permit and facilitate leasing of
agricultural land to improve access to land by the landless and the marginal farmers. It also provides for
recognition of farmers cultivating the leased land to enable them to access loans through institutional
credit.

Definitions

‗Lease‘ is defined as a contract between the land owner and the cultivator, who uses the land owner‘s land
for agriculture and allied activities for a mutually agreed specified period. ‗Leasing in‘ means taking land
from an owner (who is leasing out his land) for use.

Land lease agreement: The lease agreement between the land owner and cultivator will include
information pertaining to:
(i) The location and area of leased out land,
(ii) The duration of lease,
(iii) The lease amount and the due date by which rent has to be paid, and
(iv) Terms and conditions for the renewal or extension of lease. The lease period and lease amount will
be based on a mutual agreement between the land owner and cultivator. Additionally, the lease
agreement will not confer any protected tenancy right on a cultivator. The lease agreement may or
may not be registered (as mutually agreed), and will also not be entered into any record of rights.

Enforcement of lease agreement:

The tahsildar or a revenue officer of equal rank will be responsible for,

(i) Enforcement of terms of lease, and
(ii) Facilitating return of the leased out agricultural land to the owner on expiry of the lease period.

Rights and responsibilities of land owner: The land owner will give possession of the leased-out land
to the cultivator on the first day of the lease. He will be entitled to automatic possession of the land on the
expiry of the agreed lease period. He can put the leased out land for use such as sale, gift, mortgage, etc.
However, this should not affect the cultivator‘s right to cultivate the land till the end of the lease period.
He will also be responsible to pay all taxes and cess on the land.
 Basics of Economy 115

Rights and responsibilities of cultivator: The cultivator, to whom the land has been leased out, will be
entitled to an undisturbed possession and use of this land. He can use the land only for agriculture and
allied activities. Further, he cannot sub-lease or mortgage the land. He will be eligible to raise loans from
banks and other financial institutions without mortgaging the leased in land. He will be entitled for
compensation from landowner for any improvements or fixtures that he makes on this land. He will also
have the right to surrender land to the land owner within a time period as specified in the lease
agreement.

Termination of lease: The lease agreement may be terminated on grounds including:

(i) Failure of cultivator to pay the lease amount after a grace period of three months,
(ii) Use of land for purposes other than those specified in the agreement,
(iii) Subleasing of land or damage caused to it by the cultivator.

Dispute resolution: The cultivator and the owner can settle disputes between them using third party
mediation, or Gram Panchayat, or Gram Sabha. If the dispute cannot be settled by third party mediation,
either the landowner or the cultivator can file a petition before the Tahsildar, or an equal rank revenue
officer. He will have to adjudicate the dispute within four weeks. In such cases, an appeal can also be
made to the collector or district magistrate.

Special Land Tribunal: State governments will constitute a special Land Tribunal, which will be the final
authority to adjudicate disputes under the model Act. It will be headed by a retired high court or district
court judge. No civil courts will have jurisdiction over disputes under the model Act.

Repeals and savings: The provisions of the model Act will override any other law in force on the
concerned subject from the date of its coming into force. Cases pending under any other law in force will
be governed by the provisions of that particular law. The model Act will not have any retrospective effect.

Land Leasing

A Big Win-Win Reform for the States by Arvind Panagariya, Vice Chairman, NITI Aayog Land leasing laws
relating to rural agricultural land in Indian states were overwhelmingly enacted during decades
immediately following the independence. At the time, the abolition of Zamindari and redistribution of land
to the tiller were the highest policy priorities. Top leadership of the day saw tenancy and sub-tenancy as
integral to the feudal land arrangements that India had inherited from the British. Therefore, tenancy
reform laws that various states adopted sought to not only transfer ownership rights to the tenant but also
either prohibited or heavily discouraged leasing and sub-leasing of land.

Politically influential landowners were successful in subverting the reform, however. As P.S. Appu
documents in his brilliant 1996 book Land Reforms in India, till as late as 1992, ownership rights were
transferred to the cultivator on just 4% of the operated land. Moreover, just seven states, Assam, Gujarat,
Himachal Pradesh, Karnataka, Kerala, Maharashtra, and West Bengal, accounted for some 97% of this
transfer.

In trying to force the transfer of ownership to the cultivator, many states abolished tenancy altogether.
But while resulting in minimal land transfer, the policy had the unintended consequence of ending any
protection tenants might have had and forced future tenants underground. Some states allowed tenancy
but imposed a ceiling on land rent at one-fourth to one-fifth of the produce. But since this rent fell well
below the market rate, contracts became oral in these states as well, with the tenant paying closer to 50%
of the produce in rent.

Many large states including Telengana, Bihar, Karnataka, Madhya Pradesh and Uttar Pradesh banned land
leasing with exceptions granted to land- owners among widows, minors, disabled and defence personnel.
Kerala has for long banned tenancy, per- mitting only recently self-help groups to lease land. Some states
including Punjab, Haryana, Gujarat, Maharashtra and Assam did not ban leasing but the tenant acquires a
right to purchase the leased land from the owner after a specified period of tenancy. This provision too has
the effect of making tenancy agreements oral, leaving the tenant vulnerable. Only the states of Andhra
Pradesh, Tamil Nadu, Rajasthan and West Bengal have liberal tenancy laws with the last one limiting
tenancy to sharecroppers. A large number of states among them Rajasthan and Tamil Nadu, which
otherwise have liberal tenancy laws, do not recognize sharecroppers as tenants.

The original intent of the restrictive tenancy laws no longer holds any relevance. Today, these restrictions
have detrimental effects on not only the tenant for whose protection the laws were originally enacted but
also on the landowner and implementation of public policy. The tenant lacks the security of tenure that she
116 Basics of Economy

would have if laws permitted her and the landowner to freely write transparent contracts. In turn, this
discourages her from making long-term investments in land and also leaves her feeling perpetually
insecure about continuing to maintain cultivation rights. Furthermore, it deprives her of potential access to
credit by virtue of being a cultivator. Land- owner also feels a sense of insecurity when leasing land with
many choosing to leave land fallow. The latter practice is becoming increasingly prevalent with landowners
and their children seeking non-farm employment.

Public policy too faces serious challenges to- day in the absence of transparent land leasing laws. There
are calls for expanded and more effective crop insurance. Recognizing that such insurance is likely to be
highly subsidized, as has been the case with the past programmes, a natural question is how to ensure
that the tenant who bears the bulk of the risk of cultivation receives this benefit. The same problem arises
in the face of a natural calamity; if tenancy is informal, how do we ensure that the actual cultivator
receives disaster relief.

In a similar vein, fertilizer subsidy today is subject to vast leakages and sales of subsidized fertilizer in the
black market. In principle, these leakages could be sharply curtailed by the introduction of direct benefit
transfer (DBT) using Aadhar seeded bank accounts along the lines of the cooking gas subsidy transfer. But
in face of difficulty in identifying the real cultivator and therefore intended beneficiary, DBT cannot be
satisfactorily implemented.

In the context of the difficulties in land acquisition under the 2013 land acquisition law, states wishing to
facilitate industrialization can further benefit from liberal land leasing if they simultaneously liberalize the
use of agricultural land for non-agricultural purposes. Currently, conversion of agricultural land for non-
agricultural use requires permission from the appropriate authority, which can take a long time. State
governments can address this barrier by either an amendment of the law to permit non-agricultural use or
by the introduction of time-bound clearances of applications for the conversion of agricultural land use in
the implementing regulations. The reform opens up another avenue to the provision of land for
industrialization: long-term land leases that allow the owner to retain the ownership while earning rent on
her land. In addition, she will have the right to renegotiate the terms of the lease once the existing lease
expires.

Therefore, the introduction of transparent land leasing laws that allow the potential tenant or sharecropper
to engage in written contracts with the landowner is a win-win reform. The tenant will have an incentive to
make investment in improvement of land, landowner will be able to lease land without fear of losing it to
the tenant and the government will be able to implement its policies efficiently. Simultaneous liberalization
of land use laws will also open up an alternative avenue to the provision of land for industrialization that is
fully within the state‘s jurisdiction and allows the landowner to retain ownership of her land.

A potential hurdle to the land leasing reform laws is that landowners may fear that a future populist
government may use the written tenancy contracts as the basis of transfer of land to the tenant and
therefore would oppose the reform. This is a genuine fear but may be addressed in two alternative ways.
The ideal way would be yet another major reform: giving land- owners indefeasible titles. States such as
Karnataka that have fully digitized land records and the registration system are indeed in a position to
move in this direction. For other states, such titles are a futuristic solution. Therefore, in the interim, they
can opt for the alternative solution of recording the contracts at the level of the Panchayat eschewing
acknowledging the tenant in the revenue records. They may then insert in the relevant implementing
regulations the clause that for purposes of ownership transfer, only the tenancy status in revenue records
would be recognized.

State governments must seriously consider revisiting their leasing (and land use) laws to deter- mine if
they could bring about these simple but powerful changes to enhance productivity and welfare all around.
We, at the NITI Aayog, stand ready to assist them in this Endeavour.
 Basics of Economy 117

K. SECTORS OF ECONOMY
 Economic activities result in the production of goods and services while sectors are the group of
economic activities classified on the basis of some criteria.
 The Indian economy can be classified into various sectors on the basis of ownership, working
conditions and the nature of the activities.
 All economic activity was in the primary sector during early civilisation. After the surplus
production of food, people‘s need for other products increased which led to the development of the
secondary sector.
 The growth of secondary sector spread its influence during the industrial revolution in the
nineteenth century.
 A support system was needed to facilitate the industrial activity. Certain sectors like transport and
finance played an important role in supporting the industrial

Primary Sector
 In Primary sector of economy, activities are undertaken by directly using natural resources.
Agriculture, Mining, Fishing, Forestry, Dairy etc. are some examples of this sector.
 It is called so because it forms the base for all other products. Since most of the natural
products we get are from agriculture, dairy, forestry, fishing, it is also called Agriculture and allied
sector.
 People engaged in primary activities are called red-collar workers due to the outdoor nature of
their work.

Secondary Sector
 It includes the industries where finished products are made from natural materials produced in the
primary sector. Industrial production, cotton fabric, sugar cane production etc. activities come
under this sector.
 Hence its the part of a country's economy that manufactures goods, rather than producing raw
materials
 Since this sector is associated with different kinds of industries, it is also called industrial sector.
 People engaged in secondary activities are called blue collar workers.

Examples of manufacturing sector:

 Small workshops producing pots, artisan production.
 Mills producing textiles,
 Factories producing steel, chemicals, plastic, car.
 Food production such as brewing plants, and food processing.
 Oil refinery.

Core Industries

Eight Core Industries are Electricity, steel, refinery products, crude oil, coal, cement, natural gas and
fertilizers. The Index of Eight Core Industries is a monthly production index, which is also considered as a
lead indicator of the monthly industrial performance. The Index of Eight Core Industries is compiled based
on the monthly production information received from the Source Agencies.
118 Basics of Economy

Tertiary Sector/Service Sector

 This sector‘s activities help in the development of the primary and secondary sectors. By itself,
economic activities in tertiary sector do not produce goods but they are an aid or a support for the
production.
 Goods transported by trucks or trains, banking, insurance, finance etc. come under the sector. It
provides the value addition to a product same as secondary sector.
 This sector jobs are called white collar jobs.

Pink Collar Worker

 Pink-collar worker is one who is employed in a job that is traditionally considered to be women's
work. The term pink-collar worker was used to distinguish female-orientated jobs from the blue-
collar worker, a worker in manual labor, and the white-collar worker, a professional or educated
worker in office positions.
 A pink collar worker need not require as much professional training as white-collar professions.
They do not get equal pay or prestige.
 A pink collar worker is usually a woman. Men rarely work in pink collar jobs. Some examples of
pink collar occupations are baby sitter, florist, day care worker, nurses etc.
 Lately, the pink collar worker is educated or trained. Pink collar workers are educated through
training seminars or classes and they have to continue to strive for advancement in their careers.
 Today, women have more opportunities in traditionally male white-collar jobs and men work in
traditionally female pink-collar jobs.

Sunrise Industry

 Sunrise industry is a term used for a sector that is just in its infancy but shows promise of a
rapid boom.
 The industry is typically characterized by high growth rates, high degree of innovation and
generally has plenty of public awareness about the sector and investors get attracted to its long-
term growth prospects.
 On the other hand Sunrise industry rapid emergence may threaten a competing industry sector
that is already in decline. Because of its dim long-term prospects, such an industry is referred to
as a sunset industry.
 Existing Indian sectors that can be termed as Sunrise sectors and likely to hold us in good stead in
the future in terms of employment generation and business growth are:
 Information Technology
 Telecom Sector
 Healthcare
 Infrastructure Sector
 Retail Sector
 Food Processing Industries
 Fisheries

Why did India shift from primary sector to services sector and not secondary sector?
 The natural economic movement of a country goes from agrarian economy to an industrial
economy to a service economy but India has leapfrogged from an agrarian economy to a service
economy.
 One remarkable feature of India‘s recent growth is diversification into services, with the services
sector dominating GDP.
 India‘s success in software and IT-enables serviced (ITeS) exports has made it a significant
services exporter with its share in world services exports rising from 0.6 per cent in 1990 to 3.3
per cent in 2013.
 Well educated and immense human resources, Fluency in English and availability of cheap labour
are other reasons for rapid growth of service sector in the country. On the other hand low growth
in Secondary sector can be attributed to:
 The license Raj
 Restrictions on foreign investment
 Lack of measures to promote private industry
 Power Deficit
 Stringent Labour laws
 Lack of skilled labour
 Delays in Land Acquisition and environmental clearances
 Import of cheap manufactured goods etc.
 Basics of Economy 119

 Though India ranks low in terms of per capita income, its share of services in GDP is approaching
the global average. Interestingly, however, the contribution of services to employment was
significantly lower than the world average.
 The manufacturing sector tends to be labour intensive, hence renewed emphasis on the
manufacturing through programmes like ‗Make in India‘ will serve to correct this anomaly and raise
employment in proportion with growth in GDP.

Quaternary Activities
 These are specialized tertiary activities in the ‘Knowledge Sector’ which demands a separate
classification.
 The quaternary sector is the intellectual aspect of the economy. It is the process which enables
entrepreneurs to innovate and improve the quality of services offered in the economy.
 Personnel working in office buildings, elementary schools and university classrooms, hospitals and
doctors‘ offices, theatres, accounting and brokerage firms all belong to this category of services.
 Like other tertiary functions, quaternary activities can also be outsourced.

Quinary Activities
 The quinary sector is the part of the economy where the top-level decisions are made. This
includes the government which passes legislation. It also comprises the top decision-makers in
industry, commerce and also the education sector.
 These are services that focus on the creation, re-arrangement and interpretation of new and
existing ideas; data interpretation and the use and evaluation of new technologies.
 Profession under this category often referred as 'gold collar' professions, they represent another
subdivision of the tertiary sector representing special and highly paid skills of senior business
executives, government officials, research scientists, financial and legal consultants, etc.

Organised Sector
 In this sector, employment terms are fixed and regular, and the employees get assured work and
social security.
 It can also be defined as a sector, which is registered with the government and a number of acts
apply to the enterprises. Schools and hospitals are covered under the organised sector.
 Workers in the organised sector enjoy security of employment. They are expected to work only a
fixed number of hours. If they work more, they have to be paid overtime by the employer.

Unorganised Sector
 An unorganised worker is a home-based worker or a self-employed worker or a wage worker in the
unorganized sector and includes a worker in the organized sector who is not covered by any of the
Acts pertaining to welfare Schemes as mentioned in Schedule-II of Unorganized Workers Social
Security Act, 2008.
 In this sector wage-paid labour is largely non-unionised due to casual and seasonal nature of
employment and scattered location of enterprises.
 The sector is marked by low incomes, unstable and irregular employment, and lack of protection
either from legislation or trade unions.
 The unorganised sector uses mainly labour intensive and indigenous technology. The workers in
unorganised sector, are so scattered that the implementation of the Legislation is very inadequate
and ineffective. There are hardly any unions in this sector to act as watch-dogs.
 But the contributions made by the unorganised sector to the national income, is very substantial
as compared to that of the organised sector. It adds more than 60% to the national income while
the contribution of the organised sector is almost half of that depending on the industry.

The Public Sector

 In the sector, government owns most of the assets and it is the part of the economy concerned
with providing various governmental services.
 The purpose of the public sector is not just to earn profits. Governments raise money through
taxes and other ways to meet expenses on the services rendered by it.

The Private Sector

 In the private sector, ownership of assets and delivery of services is in the hands of private
individuals or companies.
 It is sometimes referred as the citizen sector, which is run by private individuals or groups, usually
as a means of enterprise for profit, and is not controlled but regulate by the State.
 Activities in the private sector are guided by the motive to earn profits. To get such services we
have to pay money to these individuals and companies.
120 Basics of Economy

PPP (Public Private Partnership)

 PPP is an arrangement between government and private sector for the provision of public assets
and/or public services.
 In this type of partnership investments being undertaken by the private sector entity, for a
specified period of time.
 As PPP involves full retention of responsibility by the government for providing the services it
doesn‘t amount to privatization.
 There is a well defined allocation of risk between the private sector and the public entity.
 Private entity is chosen on the basis of open competitive bidding and receives performance linked
payments.
 PPP route can be alternative in developing countries where governments faced various constraints
on borrowing money for important projects.
 It can also give required expertise in planning or executing large projects.

L. INDUSTRIES IN INDIA
Most of the western countries have written their success stories of industrialization which led them to
accelerated growth. When India became independent, it needed to rejuvenate its economy. It had many
tasks in front of it like food security, poverty which were calling for immediate attention. The other areas of
attention included industry infrastructure etc.
All these areas of development required heavy capital investment which had been avoided by the British for
the last 150 years. Looking at the pros and cons of available options; India decided that industrial sector
will be the prime moving force for economic development and for its development it brought many policies.

Industrial Policy Resolution, 1948

This was not only the first industrial policy statement of India, but also decided the model of the economic
system (i.e., the mixed economy), too. Thus, it was the first economic policy of the country. The major
highlights of the policy are given below:
(i) India will be a mixed economy.
(ii) Some of the important industries were put under the Central List such as coal, power, railways,
civil aviation, arms and ammunition, defence, etc.
(iii) Some other industries (usually of medium category) were put under a State List such as paper,
medicines, textiles, cycles, rickshaws, two wheelers, etc.
(iv) Rest of the industries (not covered by either the central or the state lists) were left open for private
sector investment—with many of them having the provision of compulsory licensing.
(v) There was a 10 year period for review of the policy.
Industrial Policy Resolution, 1956

The government was encouraged by the impact of the industrial policy of 1948 and it was only after eight
years that the new and more crystallized policies were announced for the Indian industries. The new
industrial policy of 1956 had the following major provisions:

1. Reservation of Industries
A clear-cut classification of industries (also known as the Reservation of Industries) were affected with
three schedules:

(i) Schedule A- This schedule had 17 industrial areas in which the Centre was given complete monopoly.
The industries set up under this provision were known as the Central Public Sector Undertakings (CPSUs)
later getting popularity as ‗PSUs‘. Though the number of industries was only 17, the number of PSUs set
up by the Government of India went to 254 by 1991. These included those industrial units too which were
taken over by the government between 1960 to 1980 under the nationalization drive. These industries
belonged to Schedules B and C (other than Schedule A).

**The nationalization of industrial units allowed the government to enter the unreserved areas, which
consequently increased its industrial presence. Though the nationalization was provided a reason of
greater public benefit, the private sector always doubted it and took it as an insecurity and major unseen
future hurdle in the expansion of private industries in the country.
 Basics of Economy 121

(ii) Schedule B- There were 12 industrial areas put under this schedule in which the state governments
were supposed to take up the initiatives with a more expansive follow up by the private sector. This
schedule also carried the provisions of compulsory licensing. It should be noted here that neither the states
nor the private sector had monopolies in these industries unlike Schedule A, which provided monopoly to
the Centre.

**The central government had always the option to set up an industry in any of these 12 industrial areas.
This happened through nationalization and through joint sector.

(iii) Schedule C- All industrial areas left out of Schedules A and B were put under this in which the private
enterprises had the provisions to set up industries. Many of them had the provisions of licensing and have
necessarily to fit into the framework of the social and economic policy of the state and were subject to
control and regulation. It was this industrial policy in which the then PM Jawaharlal Nehru had termed the
PSUs the ‘temples of modern India’, symbolically pointing to their importance. There was a time soon after
Independence when the PSUs were regarded as the principal instrument for raising savings and growth in
the economy.

2. Provision of Licensing
The provision of compulsory licensing for industries was cemented in this policy. All the schedule B
industries and a number of schedule C industries came under this provision. This provision established the
so-called ‘License-Quota-Permit’ regime (raj) in the economy. These industries which were set up after
taking license from the government had fixed upper limits on their production known as quota and they
needed to procure timely permit i.e. permission for the supply of raw material.

3. Regional Disparity
To tackle the widening regional disparity, the policy committed to set up the upcoming PSUs in the
comparatively backward and underdeveloped regions/areas in the economy. Such a commitment was
totally against the theory of industrial location.

4. Emphasis on Small Industries

There was emphasis on small industries as well as the khadi and village industries.
This is considered as the most important industrial policy of India by the experts as it decided not only the
industrial expansion but structured the very nature and scope of the economy till 1991 with minor
modifications. All the industrial policies were nothing but minor modifications in it except the new industrial
policy of 1991 which affected deeper and structural changes in it with which India started a wider process
of economic reforms.

Industrial Policy Statement, 1969

This was basically a licensing policy which aimed at solving the shortcomings of the licensing policy started
by the Industrial Policy of 1956.
In practice, the licensing policy of 1956 was not serving the above-given purpose properly. A powerful
industrial house was always able to procure fresh licences at the cost of a new budding entrepreneur. The
price regulation policy via licencing was aimed at helping the public by providing cheaper goods, but it
indirectly served the private licenced industries ultimately (as central subsidies were given to the private
companies from where it was to benefit the poor in the form of cheaper goods). Similarly, the older and well
established industrial houses were capable of creating hurdles for the newer ones with the help of different
kinds of trade practices forcing the latter to agree for sell-outs and takeovers.

Finally, it was in 1969 that the new industrial licencing policy was announced which affected the following
major changes in the area:

(i) The Monopolistic and Restrictive Trade Practices (MRTP) Act was passed. The Act intended to
regulate the trading and commercial practices of the firms and checking monopoly and
concentration of economic power.
(ii) The firms with assets of Rs. 25 crore or more were put under obligation of taking permission from
the Government of India before any expansion, greenfield venture and takeover of other firms (as
per the MRTP Act). Such firms came to be known as the ‗MRTP Companies‘. The upper limit (known
as the ‗MRTP limit‘) for such companies was revised upward to Rs. 50 crore in 1980 and Rs. 100
crore in 1985.
(iii) For the redressal of the prohibited and restricted practices of trade, the government did set up an
MRTP Commission.
122 Basics of Economy

The Industrial Policy Statement of 1973

It introduced some new thinking into the economy with major ones being as follows:
(i) A new classificatory term i.e., core-industries were created. The industries which were of
fundamental importance for the development of industries were put in this category such as iron
and steel, cement, coal, crude oil, oil refining and electricity. In the future, these industries came
to be known as basic industries, infrastructure industries in the country.
(ii) Out of the six core industries defined by the pol- icy, the private sector may apply for licences for
the industries which were not a part of schedule A of the Industrial Policy, 1956.
(iii) Some industries were put under the reserved list in which only the small or medium industries
could be set up.
(iv) The concept of ‗joint sector‘ was developed which allowed partnership among the Centre, state and
the private sector while setting up some industries. The governments had the discretionary power
to exit such ventures in future. Here, the government wanted to promote the private sector with
state support.
(v) The Government of India had been facing the foreign exchange crunch during that time. To
regulate foreign exchange the Foreign Exchange Regulation Act (FERA) was passed in
[Link] have called it a ‗draconian‘ Act which hampered the growth and modernisation of
Indian industries.
(vi) A limited permission to foreign investment was given, with the multinational corporations (MNCs)
being allowed to set up subsidiaries in the country. This limited permission was restricted to the
areas where there was a need of foreign capital. Such MNCs entered the Indian Economy with the
help of a partner from India- the partner being the major one with 74% shares in the subsidiaries
set up for by the MNCs. The MNCs invested via technology transfer route. This was a period when
most of the MNCs had the chance to enter India. Once economic reforms started by 1991, many of
them increased their holdings in the Indian subsidiaries with the Indian partner getting the
minority shares or getting total exit.

Industrial Policy Statement, 1977

The Industrial Policy Statement of 1977 was chalked out by a different political set up from the past with a
different political fervor—the dominant voice in the government was having an anti- Indira stance with an
inclination towards the Gandhian socialistic views towards the economy. We see such elements in this
policy statement:
(i) Foreign investment in the unnecessary areas was prohibited (opposite to the IPS of 1973 which
promoted foreign investment via technology transfer in the areas of lack of capital or technology).
In practice, there was a complete ‗no‘ to foreign investment.
(ii) Emphasis on village industries with a redefinition of the small and cottage industries.
(iii) Decentralized industrialization was given attention with the objective of linking the masses to the
process of industrialization.
(iv) Democratic decentralization got emphasized and the khadi and village industries were
restructured.
(v) Serious attention was given on the level of production and the prices of essential commodities of
everyday use.

Industrial Policy Resolution, 1980

The year 1980 saw the return of the same political party at the Centre. The new government revised the
Industrial Policy of 1977 with few exceptions in the Industrial Policy Resolution, 1980. The major initiatives
of the policy were as given below:
(i) Foreign investment via the technology transfer route was allowed again (similar to the provisions
of the IPS, 1973).
(ii) The ‗MRTP Limit‘ was revised upward to Rs. 50 crore to promote setting of bigger companies.
(iii) Industrial licencing was simplified.
(v) Overall liberal attitude followed towards the expansion of private industries.

Industrial Policy Resolution, 1985 & 1986

The industrial policy resolutions announced by the governments in 1985 and 1986 were very much similar
in nature and the latter tried to promote the initiative of the former. The main highlights of the policies are:
(i) Foreign investment was further simplified with more industrial areas being open for their entries.
The dominant method of foreign investment remained as in the past, i.e., technology transfer, but
now the equity holding of the MNCs in the Indian subsidiaries could be up to 49 per cent with the
Indian partner holding the rest of the 51 per cent shares.
 Basics of Economy 123

(ii) The ‗MRTP Limit‘ was revised upward to Rs. 100 crore promoting the idea of bigger companies.
(iii) The provision of industrial licencing was simplified. Compulsory licencing now remained for 64
industries only from 95 earlier.
(iv) High level attention on the sunrise industries such as telecommunication, computerization and
electronics.
(v) Under the overall regime of FERA, some relaxations concerning the use of foreign exchange was
permitted so that essential technology could be assimilated into Indian industries and international
standard could be achieved.
(vi) The agriculture sector was attended with a new scientific approach with many technology missions
being launched by the government.

These industrial policies were mooted out by the government when the developed world was pushing for
the formation of the WTO and a new world economic order looked like a reality. Once the world had
become one market only bigger industrial firms could have managed to cater to such a big market. Side by
side sorting out the historical hurdles to industrial expansion perpetuated by the past industrial policies,
these new industrial policy resolutions were basically a preparation for the globalised future world.
These industrial provisions were attempted at liberalizing the economy without any slogan of ‗economic
reforms‘. The government of the time had the mood and willingness of going for the kind of economic
reforms which India pursued post-1991 but it lacked the required political support.
The industrial policies conjoined with the overall micro-economic policy followed by the government had
one major loophole that it was more dependent on foreign capital with a big part being costlier ones. Once
the economy could not meet industrial performance, it became tough for India to service the external
borrowings—the external events (the Gulf war, 1990–91) vitiated the situation, too. Finally, by the end of
1980s India was in the grip of a severe balance of payment crisis with higher rate of inflation (over 13
percent) and higher fiscal deficit (over 8 per cent). The deep crisis put the economy in a financial crunch,
which made India opt for a new way of economic management in the coming times.

Reasons behind pre 1991 industrial policy

Raw materials such as steel, coal, cement etc. were limited. These raw materials where allocated among
various industries. Thus, the output of industries was restricted because without restrictions, profitable
Industries might produce at the cost of less profitable industries, creating a serious shortage of certain
type of goods.
Also, there was a possibility that resources would be diverted towards luxury industries benefiting small
sections of the society and ignoring essential industries involvement large sections of the society.
As the output of the industries was limited, the demand for the output was high. Consequently, it was
important to regulate the prices of the output.
Moreover, the government was a significant investor in the economy because the private sector lacked
funds. The private sector develops financial capability with industrialization of the economy. However,
under the British rule, India witnessed little industrialization.

Criticism
1. Delay in industrial development: Business approvals were given after a long time period. Moreover,
excessive approvals and regulations hampered industrial development.
2. Concentration of industry in a few hands: People with strong political and administrative links able
to secure licenses.
3. Excessive regulation: Moreover, businesses were required to follow too many regulations.
Inspectors were appointed under these regulations. On account of wide powers enjoyed by the
inspectors, the era was called Inspector Raj.
4. Control over output and prices created black market for commodities. Some good for even sold at
a very high price

Movement towards liberalization

Various liberalization measures were announced under the industrial licensing policies of 1970, 1973 and
1978. Moreover, many measures were taken in the 1980s to liberalize the industry like the limit for
requiring license was enhanced. Most of the industries were exempted from licensing requirements.
Regulations on the use of foreign exchange were also reduced.

Economic reforms: Liberalization Privatization and Globalisation

Liberalisation
Liberalisation of the economy means reduction in restrictions over business organisations in the economy.
It is similar to deregulation.
124 Basics of Economy

It means that the process of decreasing traits of a state economy and increasing traits of a market economy
is liberalization. In India‘s case the term liberalization is used to show the direction of the economic reforms
– with decreasing influence of the state or the planned or the command economy and increasing influence
of the free market or the capitalistic economy.

Need for deregulation

Excessive restrictions increase the cost of business and reduce the opportunity for business. For instance,
license restrictions to approve capacity expansion reduce the opportunity for business. Similarly,
compliance with too many laws also raises the cost of operating business.
Higher cost of functioning makes the business uncompetitive, and loss of opportunities reduces the growth
of business. Growth of the private sector contributes to the overall growth of the economy. Thus, excessive
restrictions hamper the growth of the economy.
India could undertake steps towards liberalization with gradual surplus availability of raw materials such as
steel, cement, coal etc. Moreover, the public sector units were incurring losses and posing heavy burden
on state finances.
It was expected that with liberalization of economy, many private players would enter each industry and
competition among them would lead to availability of good quality products at cheap rates.

Liberalization in India

Pre 1991 liberalization attempts

Attempts were made to liberalize the economy in 1966 and [Link] first attempt was reversed in 1967.
Thereafter, even stronger restrictions were imposed. The second major attempt was in [Link] process
came to a halt in 1987, though 1967 type reversal did not take place. In the 1980s,the government
started reforms in the direction of liberalization.

Economic crisis
Foreign exchange shortages started emerging in 1985, and by the end of 1990, the foreign exchange
reserves had reduced to the point that India could barely finance three weeks‘ of imports. It had to pledge
gold as part of a bailout deal with the International Monetary Fund (IMF). Most of the economic reforms
were forced upon India as part of the IMF bailout. In response, the government initiated the economic
liberalization of 1991. The reforms abolished the Licence Raj in most of the industries, ended public-sector
monopolies in many industries, and reduced restrictions on foreign direct investment in many sectors.

Privatization
Privatization refers to a greater role of the private sector in the economy either through establishment of
new businesses under private ownership or through transfer of existing businesses under the public sector
to the private sector. Liberalization leads to privatization. In other words, fewer regulations facilitate growth
of the private sector in the economy.
The decades of the 1980s and 1990s witnessed a, rolling back, of the state by the government especially in
the USA and the UK under the inspiration of the new right priorities and beliefs. The policies through which
the, roll back of the state was done included deregulation, privatisation and introduction of market reforms
in public services. Privatisation at that time was used as a process under which the state assets were
transferred to the private sectors. But during the period several connotations and meaning of the terms,
privatisation, have developed.

We may see them as follows:

Privatisation in its purest sense and lexically means de-nationalization, i.e. transfer of the state ownership
of the assets to the private sector to the tune of 100 percent.. This route of privatization has been avoided
by almost all democratic system. India never ventured into any such privatization move.

The sense in which privatisation has been used is the process of disinvestment all over the world. This
process includes selling of the shares of the state owned enterprises to the private sector. Disinvestment is
de-nationalisation of less than 100 percent ownership transfer from the state to the private sector.
All the economic policies which directly or indirectly seem to promote the expansion of the private sector or
the market (economy) have been termed by experts and the government as the process of privatisation.
We may cite a few example from Indian de-licensing and dereservation of the industries, cuts in the
subsidies, permission to foreign investment , etc.
Here we may connect liberalization to privatization in India. Liberalisation shows the direction of reform in
India, i.e. inclination towards the dominance of markets. But how will it be achieved? Basically,
privatization will be the path to reform.
 Basics of Economy 125

Globalization

In economic terms, globalization refers to the process of integration of domestic economy with outside
world. It refers to free movement of goods, services, investment, and technology among nations, of the
world.
This globalization lasted from 1800 to almost 1930, interrupted by the great Depression and the two wars
which led to retrenchment and several trade barriers were erected since early 1930s. The concept was
popularized by the organization of economic Cooperation and development (OECD) in the mid- 1980s again
after the wars. The process of liberalization shows movement of the economy toward the markets
economy, privatisation is the path/ route through which it will travel to realize the ultimate, goal, i.e.
globalization.

Impact of globalization

Globalization impacts every aspect of a nation such as economy, society, culture, education, family
system, and state sovereignty (state sovereignty refers to the freedom of a state to manage its affairs). At
present, most of the nations of the world are engaged in integration with other countries. Such integration
is facilitated either through free-trade agreements or by an international body, namely, World Trade
Organization.
Globalization facilitates large scale production and thus facilitates economies of scale
It leads to competition at the global level, which encourages innovation, adoption of best practices and
exchange of learning.

Washington consensus

By the early 1980s, a new development strategy emerged. Though it was not new, it was like the
old idea getting vindicated after failure of a comparatively newer idea. After the world recognized the limits
of a state dominated economy, arguments in favour of the market, i.e. the private sector, was promoted
emphatically. Many countries shifted their economic minimal policy just to the other extreme arguing for a
minimal role of the government in the economy. Government of the socialist or the planned economies
were urged / suggested to privatize and liberalise, to sell off state–owned companies and eliminate
government intervention in the economy. These government were also suggested to take the measures
which could boost the aggregate demand in the economy (macroeconomic stability measures) the broad
outlines of such a development strategy were called as the Washington consensus.

This consensus is broadly termed as the popular meaning of the ‗economic reform‗ followed by almost all the
socialist, communist and planned developing economies during the 1980s in one form or the other – the
term economic reform got currency around the world during this period . The term was usually seen as a
corollary of promoting naked capitalism. Openness in the economies was criticised by the political parties
in the opposition and the critique for being soft to the dictates of the IMF and the WB. And becoming a party
to promote , neo-imperialism. The United Kingdom under Mrs. Thatcher had gone for politically most vocal
privatization moves without any political debates ( the only such example of privatization moves among
the democracies, till date ) It should be noted here that after the great depression of 1929 a strong state
intervention , was suggested ( By J.M Keynes ) and such a policy did really help the Euro – American
countries to mitigate the crisis. The favour for the state intervention in the economy was being reversed
by the Washington consensus. But soon this consensus was also to be replaced by another development
strategy.

Obligatory reform

Similar reform processes started by some other economies since the 1980s were voluntary decisions of the
concerned countries. But in the case of India it was an involuntary decision taken by the government of the
time in the wake of the BOP crisis. Under the extended fund facility (EFF) programmes of the IMF, countries
get external currency support from the fund to mitigate their BOP crisis, but such support have some
obligatory conditionality put on the economy to be fulfilled. The reforms India carried out were neither
formulated by India nor mandated by the public.

The IMF conditions put forth for India were as under:

1. Devaluation of the rupee by 22 percent ( which was effected in two phases and the Indian rupee
fell down from Rs 21 to RS 27 per US dollar)
2. Drastic reduction in the peak imports tariff from the prevailing level of 130 percent to 30 percent (
India completed it by 2000-01 itself and now it is voluntarily cut to the level of15 percent)
126 Basics of Economy

3. Excise duties to be hiked by 20 percent to neutralize the revenue short falls due to the custom cut
(a major tax reform programme was launched to streamline, simplify and modernize the Indian
tax structure which is still going on).
4. All government expenditure to be cut down by 10 percent annually (i.e. cutting the cost of running
the government and denotes interest: pays, pension and PF: subsidies. A pressure on the
government to consolidate the fiscal deficit and go for fiscal prudence).

Though India was able to pay back its IMF dues in time, the structural reform of the economy was
launched to fulfill the above given conditions of the IMF. The ultimate goal of the IMF was to help India
bring about equilibrium in its BOP situation in the short term and go for macroeconomic and structural
adjustment so that in future the economy faces no such crisis.
There was enough scope for the critics to take India‘s economic reforms as prescribed and dictated by the
IMF. The process of economic reforms in India had to face severe criticism, although the reforms were to
boost growth.

Generations of Economic Reforms First generation Reforms (1991-2000)

First generation of reforms may be seen as under:

 Promotion of private sector: This included various liberalizing policy decisions, i.e. de-
reservation and de- licensing of the industries, abolition of the MRTP limit, abolition of the
compulsion of the phased production and conversion of loan into shares, simplifying environmental
laws for the establishment of the industries, etc.

 Public sector Reforms: The steps taken to make the public sector undertakings predictable,
efficient, their disinvestment ( token) their corporatization etc, were major parts of it,

 External sector Reforms: They consisted of policies like- abolishing quantitative restrictions on
import, switching to the floating currency regime of exchange rate, announcing full current account
convertibility, reforms in the capital account, permission to foreign investment ( direct as well as
indirect),promulgation of a liberal foreign Exchange management Act ( the FEMA replacing the
FERA) etc.

 Financial sector reforms: Several reforms initiatives were taken up in the areas of the banking
sector, capital market, insurance, mutual funds, etc.

 Tax reforms: This consisted of all the policy initiatives directed towards simplifying, broad basing
modernizing, checking evasion, etc.
 A major re-direction was ensured by this generation of reforms in the economy - the command
type of the economy moved strongly towards a market – driven economy, private sector (domestic
as well as foreign) to have greater participation in the future.

Second generation Reforms (2000-01 onwards)

The government launched this generation of the reforms in the years 2000-01. Basically, the reforms India
launched in the early 1990s were not taking place as desired and a need for another set of reforms was
felt by the government which were initiated with the title of the second generation of economic reforms.
The reforms of this generation were not only deeper and delicate but required a higher political will power
from the governments. The major components of the reforms are as given below:

 Factor market reforms: It consists of dismantling of the Administered price mechanism (

APM).There were many products in the economy whose prices were fixed/regulated by the
government, viz. petroleum, sugar fertilizer, drugs etc, Though a major section of the products
under the APM were produced by the private sector, they were not sold on market principle which
hindered the profitability of the manufacturers as well the sellers and ultimately the expansion of
the concerned industries leading to a demand- supply gap. Under market reforms these products
were to be brought into the market fold. In the petroleum segment now only kerosene oil and the
LPG remain under the APM while petrol , diesel, lubricants have been phased out. Similarly the
income tax paying families don‘t get sugar from the PDS on subsidies; only urea among the
fertilizers remains under APM. Many drugs have also been phased out of the mechanism.
 Public sector reforms: The second generation of reforms in the public sector especially
emphasizes on the area like greater functional autonomy, freer leverage to the capital market,
international tieups and Greenfield ventures, disinvestment.
 Basics of Economy 127

 Legal sector reforms: Though reforms in the sector were started in the first generation itself ,
now it was to be deepened and newer area were to be included – abolishing outdated and
contradictory laws, reforms in the Indian penal code(IPC)and CrPC, labour laws company law, etc

 Reforms in the critical Areas: The second generation reforms also commit to suitable reforms in
the infrastructure sector( i.e., power, roads, telecom), agriculture, agricultural extension,
education and the healthcare , etc,
 These reforms have two segments. The first segment is similar to the FRMs, while the second
segment pro- vides a broader dimension to the reforms, viz. corporate farming, research and
development in the agriculture sector(which was till now basically taken care of by the government
and needs active participation of the private sector), irrigation, inclusive education and the
healthcare.

 States Role in the Reforms: For the first time, an important role to the states was designed in
the process of economic reforms. All new steps of the reforms were now to be started by the
states with the centre playing a supportive role.

Fiscal consolidation: The FRBM act was passed by the centre and the fiscal responsibility Act (FRA) was
followed by the states.

Greater Tax devolution to the states: There is a visible change in the central policies favouring greater fiscal
leverage to the states, even the process of tax reforms takes the same dimension .Similarly, the finance
commission as well as the planning commission started taking greater fiscal care of the states.
Focusing on the social sector : The social sector (especially the healthcare and education) gets increased
attention by the government with manifold increases in the allocation

Third generation Reforms

 Announcement of the third generation of reforms were made on the margins of the launching of
tenth plan (2002-07 ) This generation of reforms commits to the cause of a fully functional
Panchayati Raj institution (PRIs) so that the benefits of the economic reforms in general , can
reach the grassroots level.
Fourth generation reforms

 Some experts coined this generation of reforms which entail a fully information technology- enabled,
India. They hypothesized a two-way, connection between the economic reforms and the information
technology (IT) –with each one reinforcing the other.

The different generation of economic reforms in India should not be seen as the completion/ ending of the
former and commencement of the later generations of reforms. Basically all generations are going on at
present simultaneously, so that the goal of reforming the economy is objectified, The various generations
of reforms in India also verify the fact that reform, is a continuous process which needs , fine tuning in
accordance with the changed situations. Reforms are not the aim of the economy but reforming the
economy is the aim.

Industrial Policy since 1991

The Industrial policy 1991 was launched to attain faster economic growth through participation of the
private sector. Accordingly, steps were taken towards liberalization, privatization, and globalization.

New Industrial Policy, 1991

The financial support India received from the IMF to fight out the BoP crisis of 1990–91 was having a tag
of conditions to be fulfilled by India. These IMF conditionality required the Indian economy to go for a
structural re-adjustment. As the nature and scope of the economy was moulded by the various industrial
policies India followed till 1990, any desired change in the economic structure had to be induced with the
help of another industrial policy. The new industrial policy, announced by the government in 1991 had
initiated a bigger process of economic reforms in the country and was motivated towards the structural
readjustment obliged to ‗fulfill‘ IMF conditionality. The major highlights of the policy are as follows:

1. De-reservation of the Industries

The industries which were reserved for the Central Government by the IPR, 1956, were cut down to only
eight. In coming years many other industries were also opened for private sector investment. At present
there are only two industries which are fully or partially reserved for the Central Government:
128 Basics of Economy

(i) Atomic energy and nuclear research and other related activities, i.e. mining, use management, fuel
fabrication, export-import, waste management, etc., of radioactive minerals (none of the nuclear
powers in the world have allowed entry of private sector players in these activities, thus no such
attempts look logical in India, too).
(ii) Railways: Many of the functions related to the railways have been allowed private entry, but still the
private sector cannot enter the sector as a full-fledged railway service provider.

2. De-licensing of the Industries

The number of industries put under the compulsory provision of licensing (belonging to Schedules B and C
as per the IPR, 1956) were cut down to only 18. Presently there are only five industries which carry the
burden of compulsory licensing:
(i) Aero space and defence related electronics
(ii) Gun powder, industrial explosives and detonating fuse
(iii) Dangerous chemicals
(iv) Tobacco, cigarette and related products
(v) Alcoholic drinks

3. Abolition of the MRTP Limit

The MRTP limit was Rs. 100 crore so that the mergers, acquisitions and takeovers of the industries could
become possible. In 2002, a Competition Act was passed which has replaced the MRTP Act. In place of the
MRTP commission, the Competition Commission has started functioning.

4. Promotion to Foreign Investment

Functioning as a typical closed economy, the Indian economy had never shown any good faith towards
foreign capital. The new industrial policy was a path breaking step in this regard. Not only the draconian
FERA was committed to be diluted, but the government went to encourage foreign investment (FI) in both
its forms—direct and indirect.

The direct form of FI was called as the foreign direct investment (FDI) under which the MNCs were allowed
to set up their firms in India in the different sectors varying from 26 per cent to 100 per cent ownership
with them—Enron and Coke being the flag-bearers. The FDI started in 1991 itself.

The indirect form of foreign investment (i.e., in the assets owned by the Indian firms in equity capital) was
called the Portfolio Investment Scheme (PIS) in the country, which formally commenced in [Link] the
PIS the Foreign Institutional Investors (FIIs) having good track record are allowed to invest in the Indian
security/stock market. The FIIs need to register themselves as a stock broker with SEBI.

5. FERA replaced by FEMA

The government committed in 1991 itself to replace the draconian FERA with a highly liberal FEMA, which
came into effect in the year 2000–01.

6. Compulsion to Convert Loans into Shares Abolished

The policy of nationalization started by the Government of India in the late 1960s was based on the sound
logic of greater public benefit and had its origin in the idea of welfare state. It was criticized by the victims
and the experts alike. In the early 1970s, the Government of India came with a new idea of it. The major
banks of the country were now fully nationalized (14 in number by that time), which had to mobilize
resources for the purpose of planned development of India. The private companies which had borrowed
capital from these banks (when the banks were privately owned) had to repay loans to the banks. The
government came with a novel provision for the companies which were unable to repay their loans (most of
them were like it)—they could opt to convert their loan amounts into equity shares and hand them over to
the banks. The private companies which opted for this route (this was a compulsory option) ultimately
became a government-owned company as the banks were owned by the Government of India. This was an
indirect route to nationalize private firms. Such a compulsion which hampered the growth and
development of the Indian industries was withdrawn by the government in 1991.

Special Economic Zones

A special economic zone (SEZ) is an area in which business and trade laws are different from the rest of
the country. SEZs are located within a country‘s national borders. They are established with the objective of
promoting exports. The SEZ Act was passed in 2005. According to the act, SEZ units are given the
following benefits:
 Basics of Economy 129

1. Tax holidays for some period. However, the income tax benefits were neutralized by the introduction
of 20% minimum alternate tax (MAT) and the 20% dividend distribution tax (DDT) in 2011-12.
2. These units can attract even 100% FDI from, automatic route. These units are also free from
external commercial borrowing restrictions.
3. Overseas banking units can open branches in SEZs. These branches will not be required to follow
RBI guidelines regarding rate of lending and will be free to borrow from the international market.
These banking units will lend at internationally competent rates to SEZ units.
4. Labour laws are not applicable to SEZ units.
5. Further from domestic units to SEZ units will be considered export and, thus, exempted from taxes.
On other hand, sales from SEZ units to domestic units will be considered import and import duties
will be levied.
6. SEZs have been declared public utility. Under the Land Acquisition Act, the government can
procure land for public utility. Thus, the government can procure land for setting SEZ units.

Possible implications of SEZ policy

At present, the government has already approved a large number of SEZs. Many SEZs are in the process
of setting up.
When all the approved SEZs will become operational, they are expected to rope in huge investment and
create massive jobs, which will give a huge boost to Indian economy. New technology and managerial
capabilities will be introduced in India.
However, there are certain negative repercussions as well on account of relying too much on SEZs for
promotion of exports.
1. Land acquisition for SEZs deprives the poor of their land and occupation. Sometimes
compensations are delayed even inadequate.
2. Lack of recognition of labour rights leads to poor working conditions in SEZs.
3. Many domestic manufacturers may shift their units to SEZ. Thus, the SEZs will benefit on cost of
local industrial base.
4. Tax subsidies given to SEZ units will be a huge loss to government revenues.

Challenges with SEZz

1. It is difficult to gauge the real performance of SEZs, and they highlight the risk that creating islands
of doing business pose.
2. The model‗s excellence is unlikely to generate the kind of allround economic development that
India urgently needs.
3. Political and Social dynamics differ significantly to make Chinese developmental model the least
optimum solution for India.
4. The enthusiasm for SEZs waned considerably once the government imposed the minimum
alternate tax and the dividend distribution tax.

Fourth Industrial Revolution

It is a Collective term embracing a number of contemporary automation, data exchange and manufacturing
technologies and denotes a fundamental change in the way business is being done in the present world. It
is characterized by a wave of innovations and fusion of technologies that is blurring the lines between the
physical, digital, and biological spheres. For example things like driverless cars, smart robotics, tougher and
lighter materials, and a manufacturing process built around 3D printing technology, internet of things and
internet of services.

The characteristic is not just these new innovations but also that it is changing at exponential rates and
disrupting every industry at a pace that is difficult to cope with. New technology, increased connectivity,
artificial intelligence etc. has changed the way any industry functions, the consumer demand and the
competition. ―

Challenges posed by Fourth Industrial Revolution

1. Risk of greater unemployment especially low skilled ones has increased
2. Sustainability of businesses especially small ones is under threat
3. Disruptions in existing industries as new ways of serving needs are coming up.
4. The innovators are improving the quality, speed and price of services at a much faster rate due to
better access to global digital platforms for research, development, marketing, sales, and
distribution.
5. Growing transparency and consumer engagement would demand more adaptation from the
companies.
6. IT security issues.
7. It also affects the governance system as well.
130 Basics of Economy

The accountability of the government has increased due to more citizen engagement.
At the same time governments would gain more technological powers to increase its control over people,
based on pervasive surveillance systems and the ability to control digital infrastructure.
The government‘s dependence on private sector would also increase.
On the whole governments, will increasingly face pressure to change their current approach to public
engagement and policymaking, as their central role of conducting policy diminishes owing to new sources of
competition and the redistribution and decentralization of power that new technologies make possible.
The First Industrial Revolution started in the 18th century with the use of water and steam power to
mechanize production,
The Second in Nineteenth century used electric power to create mass production, the third began in the
1960s and used electronics and information technology to automate production. Now a Fourth Industrial
Revolution is building on the third, that is, the digital revolution.

IIP (Index of Industrial Production)

A measure of industrial performance & is compiled and released every month by CSO. It is a fixed weight
and fixed base index. CSO revised the base year of IIP from 2004-05 to 2011-12. This series has an
enlarged and more representative basket of the industrial sector. IIP comprises 3 components of
industries:
 Mining
 Manufacturing
 Electricity

Core industry
They are eight basic industries and are the backbone of overall economy. Their output is used by various
other industries. Thus the core industries determine the state of overall industrial development of the
economy. They comprise nearly 40.27% of the weight of items included in the IIP. Following are the
industries with their respective weights in core industry (total weight age 100%).
1. Electricity generation: 19.85%
2. Steel production: 17.92%
3. Petroleum refinery production: 28%
4. Crude oil production: 8.98%
5. Coal production: 10.33%
6. Cement production: 5.37%
7. Natural gas production: 6.88%
8. Fertilizer production: 2.63%

Comparing PMI and IIP

While PMI and IIP are both used for gauging the health of the economy, it is prudent to understand what
they actually stand for.

Purchasing Managers Index (PMI)

 PMI is calculated on the basis of information received on a monthly basis from companies on various
factors that represent demand conditions. A standard questionnaire is administered to 500 private
companies (PSUs are excluded) and the comprehensive score is arrived at.
 5 parameters in PMI are - new orders (30% weightage), output (25%), employment (20%),
supplier‗s delivery (15%) and stock of purchases (10%). The respondents can either give a
―Positive, Neutral or Negative response and each response is marked as ―1, 0.5 or 0 on the score
card respectively.
 Hence, if there is unanimous positivity across all parameters, then the PMI score would be 100
(percentage) and an unanimous negative would mean 0.
 While an absolute score of 50 would mean neutrality, anything above it is perceived as an
improvement and less than it would mean deterioration.
 Intuitively, it can be seen that the purpose of the PMI is to indicate some degree of confidence level
in manufacturing based company perspectives.
 Notably, as PMI is a market sentiment tracker that compares the current month with the previous,
it is season sensitive.

Index of Industrial Production (IIP)

IIP measures actual production output across the industrial sector. Significantly, IIP for December 2017
would be reckoned with the same month in 2016, unlike PMI, which is monthly comparison. As it is a
comparison over the previous year, it is season neutral.
Therefore, as the basis of IIP and PMI are different, a comparison between the two is really not
appropriate. However, as the PMI is released on the 1st of every month and the IIP is known on the 12th,
 Basics of Economy 131

the PMI score is assumed to be a precursor to the IIP. But the correlation between PMI and IIP isn‗t strong
and the relationship between the two variables is quite low and insignificant.

Reason for the lack of correlation

A sample of 500 companies for PMI is too small to be representative of what is happening at the aggregate
level. Also, as these companies tend to be the bigger ones, SMEs are under-represented in PMI, whereas
IIP is more comprehensive. Also, even with the PMI new orders increasing, it would not necessarily mean
that output would increase in a subsequent period. Exclusion of the PSUs is another significant aspect as
there is a very high contribution by this segment, especially in capital goods and infra areas.

What is preferable?
Hence, it may be said that the PMI is not a leading indicator of the state of industry which is better
represented by IIP growth. While the IIP growth calculation has its challenges, it is to be noted that the
number is used for GDP calculations to account for the unorganised sector. But nonetheless, there is room
for both concepts in the set of economic indicators that have to be tracked continuously.

PUBLIC SECTOR

Evolution, Reforms and Performance

Since the beginning of socio-economic planning after the Independence, public sector played a pre-eminent
role in India. Commanding heights of the economy were to be in the hands of the public sector — basically
infrastructure and basic industries like heavy engineering, power, metals, etc. PSEs dominated the
Industrial Policy Statement 1948 and IP Resolution 1956 The PSUs were opted for by the Government
partly as the Government wanted to steer the economy towards planning goals rapidly and also because of
pragmatic compulsions like the presence of the private sector in manufacturing was negligible and they
were not willing to take up the unprofitable work of investing in infrastructure.
Public sector units in India are wholly or partly owned and controlled by the government. In a public sector
enterprise, the majority of equity shares is owned by the government directly or indirectly through
governmental institutions and the government has decision making control. Public sector enterprise
normally has various forms of organisational structure like departmental undertakings (Railways etc);
statutory corporations; companies registered under the Companies Act 1956 mainly.

Departmental undertakings are not formed by or with the consent of the legislative authority. These are
set up by the executive actions of government bodies and are charged with the duty of carrying out specially
defined functions. These undertakings are not independent entities. They are subject to budgetary, audit
and other controls of the government and are managed by civil servants. They are financed by annual
budgets which also receives their revenues (CFI).

A departmental undertaking is best suited where the main purpose of the enterprise is to collect revenue
for the state and to provide public utilities and services at fair prices in larger public interest. Some
examples of departmental undertakings are the Railway, Postal Department, All India Radio, Doordarshan,
etc.

Statutory corporations are enterprises normally engaged in economic or manufacturing activities and
are set up by act of legislature. These corporations are legal entities separate from the government and
also the persons who conduct their affairs. ONGC, LIC are some examples.
Shares of such corporations are in the name of the government and these are thus owned and controlled
by the government Statutory corporations enjoy extensive legal autonomy, and their rules, objectives,
functions and duties are defined and specified in the act. Financing statutory corporations is not part of the
Budget and therefore, they can retain their revenues, and also spend as per the rules laid down by the
statute.

Control Boards are set up to manage government projects, for example, the river valley projects. Eg. Bhakra
Management Board.
PSE can be in the form of cooperative society to support cooperative movement- Indian Farmers Fertilizer
Cooperative Ltd (IFFCO), Krishi Bharati Cooperative Ltd (KRIBHCO) etc. Capital of the units is held by the
Central Government.

Government Company is one where the government owns 51% or more of the paid up capital. They are
set up under the Companies Act [Link],HMT. HAL etc.
In India, we have all these types of PSEs.
132 Basics of Economy

Importance of the PSUs are

1. They help to built a self-reliant economy
2. Prevent & reduce concentration of private economic power
3. Establish sound economic infrastructure
4. Set up industries in the backward regions and thus help bring about balanced regional
development
5. Assist in setting up ancillary industries and thus spread the benefits of industrialization
6. Create sufficient levels of employment and set standards in labour welfare
7. Selling goods and services at reasonable prices so as to serve consumer, keep prices affordable
and help non-inflationary growth process.
8. Invest in areas where the private sector would not invest like in roads transport and so on.
9. Supply goods and services like coal, transport, power, irrigation etc.
10. They contribute a substantial portion in government‘s income by way of dividends and profits.
While considering the performance of the PSUs it must be recognized that most of them had
locational disadvantage; sold the product at administered prices; did not have access to the best
of technology; had excess of manpower; operated in areas not meant for profit making like FCI;
were subject to multiple controls and excess of accountability and so on.

Even while sick PSEs are reducing in number, the problems are compounded by : resource crunch, erosion
of net-worth due to continuous losses incurred by the PSUs, reluctance of financial institutions to provide
funds for revival of PSUs, heavy interest burden, old and obsolete plant and machinery, outdated
technology, low capacity utilization, excess manpower, weak marketing strategy, etc. Inadequate autonomy
is one reason. Populism and the absence of rational pricing of goods and services another reason for the
low levels of efficiency in PSUs.

Public Sector and Economic reforms

Economic reforms were, made necessary to post higher growth rates for poverty alleviation on a war
footing. Public sector was in need of competition to unlock its value. Therefore, domestic and foreign
capital was invited to force the PSEs to compete and perform. Government recognized the need for PSE
reform during the 7th FYP (1985-1990).

The New Industrial Policy 1991 made significant changes like de reserving many areas(with only 3 areas
being reserved today) equity disinvestment; managerial revamp with greater autonomy; referring a sick
PSU to the Board-of Industrial and Financial Reconstruction (BIFR)and so on.

The period since 1991 when reforms were launched saw many reforms in the way PSEs should function
1. De-reservation
2. Withdraw them from commercial and other areas like hotels, bakery, cycles etc.
3. Disinvest a portion of the PSE equity for a variety of purposes
4. Strategic sale where a PSE is sold over to a strategic partner who buys majority equity and takes
over management and may extend ownership further in course of time
5. Increasingly they are being subject to market discipline primarily by listing on the stock exchanges
which is the direct outcome of divestment
6. Globalization - liberal FDI norms and import of capital goods, compel the PSUs to perform.
7. The MoU system is being improved with greater weight age being given to the criterion of financial
performance
8. Navaratnas are granted financial and managerial autonomy for global competitiveness
9. Miniratnas were taken up for similar reforms
10. Maharatnas have been recognized since 2011
11. Professionalization of boards

As mentioned above, the reforms have helped the PSUs and the performance has improved.

Navaratna, Miniratna and Maharatna Companies

Navaratnas
Economic reforms subjected PSEs to market competition. Gloablization makes the competition more
intense. To perform in such conditions, PSEs need a level playing field with the private players. Hence, the
Navaratna package that gives autonomy to PSEs.
Government introduced the navaratna concept in 1997. It granted enhanced autonomy to nine selected
PSEs referred to as ―Navaratnas‖. Many more CPSEs were made navaratnas since then.
 Basics of Economy 133

The government has a quantitative system to confer the Status of ―Navaratna‖ on PSE. According to the
system, every PSE is rated on the following 6 parameters:
 Net Profit to Net Worth
 Total Manpower Cost as a Percentage of Total cost of Production
 Profit before Depreciation, interest and Taxes on capital Employed
 PBDIT on turnover
 Earnings per Share &
 Inter-sectoral performance

To gain Navaratna status, a PSE must score at least 60 out of 100 based on these 6 parameters.
Additionally, a company must first be a miniratna and must have four independent directors on its board
before it can be made a navaratna.

These navaratnas, subject to certain guidelines, now have freedom to

 incur capital expenditure
 decide upon joint ventures
 set up subsidiaries/offices abroad
 enter into technological and strategic alliances
 raise funds from capital markets (international and domestic)
 enjoy substantial operational and managerial autonomy
 Boards of these PSEs have been broad-based with induction of nonofficial part-time professional
directors.

Examples of Navratna are MTNL, BEL, HAL etc

Miniratna companies
There are two types of miniratna companies: Type I arid 2. Miniratnas can also enter into joint ventures,
set subsidiary companies and overseas offices but with certain conditions.

Category I Miniratna
They are PSEs that have made profits continuously for the last three years and earned a net profit of Rs 30
crores or more in one of the three years. These miniratnas are granted certain autonomy like incur- ring
capital expenditure without government approval up to Rs 500 crores or equal to their net worth
whichever is lower.

Category-II Miniratna V
This category include those PSEs which have made profits for the last three years continuously and should
have a positive net worth. Category II miniratnas have autonomy to incur the capital expenditure without
government approval up to Rs. 300 crores or up to 50% of their net worth whichever is lower.

Maharatnas
The category of PSEs was created in 2011. To be eligible for the grant of the Maharatna status, the
company should have an average turnover of over Rs 25,000 crore, average annual net worth of more
than Rs 15,000 crore and average annual net profit of over Rs 5,000 crore during the last three years.
Besides, it should be a Navralna firm, should be listed on the Indian Stock Exchange with minimum
prescribed public shareholding under the SEBI regulations and have global presence.
Once a company gets, the Maharatna status, its board would not be required to take the government‘s
permission fat investments up to R 5000 crore in a joint venture project or wholly owned subsidiary. For
the Navratna companies, the limit is Rs 1,000 crore.
The main objective of the Maharatna scheme is to empower mega-Central public sector enterprises to
expand their operations and emerge as global giants.
Eg of Maharatna are BHEL ,Coal India Limited, GAIL, Indian Oil Corporation Limited. NTP- C,ONGC,
SAIL,BPCL

Ad-hoc Group of Experts (AGE) Report

The Report on Empowerment of Central Public Sector Enterprises, prepared by a group of experts headed
by Arjun Sengupta, recommended greater autonomy for Public Sector Units. It also made the following
recommendations:
1. Central PSUs to have truly independent boards. It has recommended empowering the PSU boards
to take decisions about mergers, joint ventures, pricing, exports, appointments, selection of
dealers, promotion and transfer of employees, and so on.
134 Basics of Economy

2. The ministry concerned should not review the PSU more than twice a year. Supervision should be
done by sector specific supervisory boards.
3. Ministries should not interfere with the functioning of the PSIJs under them. Their managements
should be accountable to the board and not to the ministry
4. Government should be given flexibility to divest its stake in PSUs. As long as the government‘s
stake remains above 51 per cent, it should not requite Parliament‘s permission to divest its shares
— even in navratnas, miniratnas, and consistently profit-making PSUs. This can be done through a
board decision.
5. Supplementary audit by the Comptroller and Auditor General of India of the PSEs should be an
exception rather than rule, as it delays the publishing of audited accounts as required by SEBI.
6. Reworking of the accountability of the PSEs to Parliament so that the questions raised on their
functioning do hot compromise sensitive trade data and work as an impediment in functioning as
commercial enterprises

The Government accepted some of the recommendations of AGE relating to enhancement of financial
powers of Navratna, Miniratna and other profit-making CPSES.

MOU

MOU is a freely negotiated agreement between the public enterprise and the administrative ministry. Under
the agreement, the enterprises undertake to achieve the targets set in the agreement at the beginning of the
year. The MOU covers both financial performance as well as non-financial performance. Under this system
performance of the company is categorized into five categories namely: excellent, very good, good, fair,
and. poor.
The MOU system has been adopted as it was felt that PSEs are unable to perform at efficient levels because
of multipoint accountability. Also, there was no clarity of objectives. Absence of functional autonomy also
hampered their performance.
The objectives of the MOIJ system are to improve the performance of public enterprises by increasing
autonomy and accountability of the management; remove the fuzziness in the goals and objectives the
enterprise is to pursue through clearly laid down performance targets at the beginning of the year enable
the evaluation of managerial performance through objective criteria and provide a mechanism to reward
good performance through performance incentives to stimulate improved performance.

Disinvestment and Privatization

Government classified the Public Sector Enterprises into strategic and non-strategic areas for the purpose
of disinvestment. It was decided that the Strategic Public Sector Enterprises would be those in the areas
of:
1. Arms and ammunitions and the allied items of defence equipment, defence aircrafts and warships;
2. Atomic energy (except in the areas related to the generation of nuclear power and applications of
radiation and radio isotopes to agriculture, medicine and non-strategic industries);
3. Railway transport.

All other Public Sector Enterprises were to be considered non-strategic.

Token Disinvestment

Disinvestment started in India with a high political caution in a symbolic way known as the ‗token‘
disinvestment (presently being called as ‗minority state sale‘). The general policy was to sell the shares of
the PSUs maximum up to the 49 per cent (i.e., maintaining government ownership of the companies). But
in practice, shares were sold to the tune of 5–10 per cent only. This phase of disinvestment though brought
some extra funds to the government (which were used to fill up the fiscal deficit considering the proceeds
as the ‗capital receipts‘) it could not initiate any new element to the PSUs, which could enhance their
efficiency. It remained the major criticism of this type of disinvestment, and experts around the world
started suggesting the government to go for it in the way that the ownership could be transferred from the
government to the private sector.
Disinvestment is the sale of shares of the Government to the retail public or employees or mutual funds or
the FIIs. In other words, in disinvestment (divestment), there is no change in the management from
public to private hands because either the government holds majority equity (51%) or even if the
government holds less than 51% of equity, rest of it is sold to various individuals and institutions none of
whom holds enough to take over management. It is essentially money-raising exercise with some
accompanying benefits.
 Basics of Economy 135

Strategic Disinvestment

In order to make disinvestment a process by which efficiency of the PSUs could be enhanced and the
government could deburden itself of the activities in which the private sector has developed better
efficiency (so that the government could concentrate on the areas which have no attraction for the private
sector such as social sector support for the poor masses), the government initiated the process of strategic
disinvestment. The government classifying the PSUs into ‘strategic‘ and ‗non-strategic‘ announced in 1999
that it will generally reduce its stake (share-holding) in the ‘nonstrategic‘ public sector enterprises (PSEs)
to 26 per cent or below if necessary and in the ‗strategic‘ PSEs (i.e., arms and ammunition; atomic energy
and related activities; and railways) it will retain its majority holding. There was a major shift in the
disinvestment policy from selling small lots of share in the profit-making PSUs (i.e., token disinvestment)
to the strategic sale with change in management control both in profit and loss making enterprises. The
essence of the strategic disinvestment was—
(i) The minimum shares to be divested will be 51 per cent, and
(ii) the wholesale sale of shares will be done to a ‘strategic partner’ having international class
experience and expertise in the sector.

 If the Government sells chunk of equity to a single buyer- 26% or 51% or more to whom the
management is also handed over, it is called strategic sale and the buyer is called strategic
partner. It is a case of privatization. The buyer is one who has presence-in- the sector and can add
value to the unit. For example, IPCL being sold to Reliance Industries Ltd( RIL) and Balco is sold to
Sterlite.
 Government may also sell off a unit to a strategic buyer entire equity.
 Strategic buyer is one who not only buys the chunk of entire equity in one tranche or more but also
takes over management. .That is the ‗strategic‘ part of the sale. It is unlike disinvestment where
sale of shares is unaccompanied by management control transfer. The strategic partner gives
higher price for the shares as he gets management control along with it( management premium).
Also, running of the unit improves. Privatization and strategic sale are the same.
 As mentioned above, disinvestment can be for less than 50% stake sale in which case the
company remains a Government company.
 The advantages with strategic sale (privatization) are that it gets investment. The strategic
partner with management control will invest further for diversification and technological
improvement; market perception will improve as it is no longer a government company; and
shareholder value will increase. With the improvement of the functioning of the company, workers‘
protection will also be guaranteed.
 The transfer of shares by Government may not necessarily be such that more than 51% of the
total equity goes to the Strategic Partner for the transfer of management to take place. In the case
of PSUs, in order that the company no longer has the character of a Government company, the
transfer of shares involves bringing down Governments shareholding below 51%. In fact, it must
be remembered that Companies Act, 1956 only defines a ‗Government Company‘, which in
common parlance, is a company in which Government holds more that 51%. PSU is not defined in
the Act. Once the Governments shareholding goes below 51%, it ceases to be a Government
company and hence, it requires changes in the Articles of Association of the company especially in
relation to the Presidential directives etc. The Strategic Partner, after the transaction, may hold
less percentage of shares than the Government but the control of management would be with him.

In case of strategic sale of PSUs, Government typically has affirmative rights on several issues, which are
much wider in scope than what is provided in Company Law for special resolutions. In fact, the Agreements
can be structured such that these rights are exercisable even when Government holding goes below 26%.
The other critical number one encounters in Company Law are 10% shareholding, below which one loses
voting rights unless specially provided.
Disinvestment in India is seen connected to three major interrelated areas, namely:
(i) A tool of public sector reforms
(ii) A part of the economic reforms started in mid 1991. It has to be done as a complementary part of
the ‗de-reservation of industries‘. The de reservation of industries had allowed the private sector to
enter the areas hitherto reserved for the central Government. It means in the coming times in the
unreserved areas the PSUs were going to face the international class competitiveness posed by the
new private companies. To face the challenges, the existing PSUs needed new kind of
technological, managerial and marketing strategies (similar to the private companies).For all such
preparations there was a requirement of huge capital. The government thought to partly fund the
required capital out of the proceeds of disinvestment of the PSUs. In this way disinvestment should
be viewed in India as a way of increasing investment in the disinvested PSUs.
136 Basics of Economy

(iii) Initially motivated by the need to raise resources for budgetary allocations. (Right since 1991 when
disinvestment began, governments have been using the disinvestment proceeds to manage fiscal
deficits in the budget at least up to [Link] 2000-01 to 2002-03 some of the proceeds went
for some social sector reforms or for labour security. After 2003, India established national
investment fund to which the proceeds of divestment automatically flow).

The Department of Disinvestment has been renamed as Department of Investment and Public Asset
Management (DIPAM) by the government. Aim of the renamed department is proper management of
Central government‘s investments in equity and also its disinvestment proceeds in central public sector
undertakings (PSUs). DIPAM will work under Union Finance Ministry.

Functions:
1. It has been mandated to advise the Union Government in the matters of financial restructuring of
PSUs and also for attracting investment through capital markets.
2. It will deal with all matters relating to sale of Union Government‘s equity through private
placement or offer for sale or any other mode in the erstwhile Central PSUs.

DIFFERENT TYPES OF GOODS IN ECONOMY

Normal good
A normal good means an increase in income causes
an increase in demand. It has a positive income
elasticity of demand YED. Note a normal good can
be income elastic or income inelastic.

Luxury good
A luxury good means an increase in income causes
a bigger percentage increase in demand. It means
that the income elasticity of demand is greater than
one. For example, HD TV‘s would be a luxury good.
When income rises, people spend a higher
percentage of their income on the luxury good.

YED calculations
In the above example of a luxury good, income
rises (500-550) 10%, demand rises 100/800 –
12.5% YED = 12.5/10 = 1.125
In the above example of a normal good, income
rises (500-700) 40%, demand rises 100/800 –
12.5% YED – 12.5/40 = 0.3125

Note: a luxury good is also a normal good, but a

normal good isn‘t necessarily a luxury good.
 Basics of Economy 137

Inferior good
An inferior good means an increase in income causes a fall in demand. It is a good with a negative income
elasticity of demand (YED). An example of an inferior good is Tesco value bread. When your income rises
you buy less Tesco value bread and more high quality, organic bread.

Examples of different types of good

Luxury good – Superfast broadband, organic luxury coffee, Netflix tv, Porsche, a foreign holiday to Bali
Normal good – ordinary broadband, ordinary tv license, Ford Focus car, holiday to somewhere close to
where you live
Inferior good – Supermarket own brand coffee, bus travel, a day out at theme park.
Other types of goods

Necessity good – something needed for basic human existence, e.g. food, water, housing, electricity.
Though this becomes a subjective term, is electricity a necessity? Is broadband internet a necessity?

Comfort good – a good which isn‘t a necessity, but gives enjoyment/utility, e.g. subscription to netflix or
take-away food. A comfort good may become a luxury.

Complementary Goods- Goods which are used together, e.g. TV and DVD player.

Substitute goods- Goods which are alternatives, e.g. Pepsi and Coca-cola.

Giffen good- A rare type of good, where an increase in price causes an increase in demand. The reason is
that the income effect of a rise in the price causes you to buy more of this cheap good because you can‘t
afford more expensive goods. For example, if the price of wheat rises, a poor peasant may not be able to
afford meat anymore, so has to buy more wheat.

Possible examples of Giffen good – rice, potatoes, bread.

Veblen / Snob good- A good where an increase in price encourages people to buy more of it. This is
because they think more expensive goods are better.

Example of Veblen / Snob good – some forms of art, designer clothes.

Market Failure

 Public goods – goods with characteristics of non-rivalry and non-excludability, e.g. national
defence.
 Quasi-public good – goods which have some of the characteristics of non-rivalry and non-
excludability, but not 100%. For example, interest is mostly very cheap to access. Once provided,
you can access most website – though some websites may charge to view (e.g. newspapers).
 Merit goods- Goods which people may underestimate benefits of. Also often have positive
externalities, e.g. education.
 Demerit goods- Goods where people may underestimate the costs of consuming it. Often have
negative externalities, e.g. smoking, drugs.
 Private goods – goods which do have rivalry and excludability, the opposite of a public good.
 Free goods – A good with no opportunity cost, e.g. breathing air.

Capital Goods industry in India

The Capital Goods industry is one of the key contributors to value added manufacturing in India. Capital
goods include plant machinery, equipment and accessories required for manufacture or production of
goods or for rendering services, either directly or indirectly. Currently, the Capital goods sector is
contributing 12% to manufacturing sector which translates to around 2% of GDP. It employs around 15
Lakh people across various sub-sectors. The sector also plays an important role in improving India‘s trade
balance.

Problems in Capital Goods industry

India‘s 1956 industrial policy was in favour of domestic production of capital goods particularly machine
tools. This created a strong capital goods sector in India. But the growth was not sustained on continuous
basis because of the protection and support from the government was incomplete. The policy from 1980‘s
started dismantling the structure of import protection and public sector investment in the capital goods
industry. This led to the weakening of the domestic industry and growth of the imports and foreign firm
production in India.
138 Basics of Economy

For last many years, the capital goods sector is witnessing slow growth. The growth over the past 3 years
has been a mere 0.3% annually. Imports contribute around 45% of capital goods demand and domestic
capacity utilisation across its sub-sectors is only around 60%-70%. Local manufacturers have not been
able to effectively tap the global market. Delay in implementation of approved projects retarded the
growth of the sector.

Main issues in Capital Goods Sector

 Inadequate growth of domestic market for capital goods.
 Falling share of domestic production in total domestic consumption and growth of more imports.
This can be attributed to the underutilisation of domestic capacity and slowdown in domestic
capacity creation.
 India failed to make a mark in the global market for capital goods, with its share in global exports
placed at less than one per cent.
 There is inadequate capacity expansion in infrastructure and power industries, and institutional
issues such as inadequate inter-ministerial coordination.
 Contractual clauses in public procurement policy inhibited the domestic production and have a
―limited positive bias‖ in favour of domestic value addition.
 Permission to import second-hand machinery discouraged the domestic production. The provision
of a zero import duty concession for several items imported under the ―project imports‖ category
has put the domestic industry at a disadvantage position.
 Free Trade agreements (FTAs) with several countries that have a comparative advantage over
India in capital goods production as opposed to those with respect to which India has strong
export potential.
 ―Skewed tax and duty structure‖ has adversely affected the cost structure and competitiveness of
the industry. In certain category of imports ―inverted duty structure‖ is still prevalent. Inverted
duty structure means lower import duty on finished products than on raw materials and
components.
 Low technology depth is a critical problem with current levels ranging ―from basic to intermediate‖.
This is the result of policy failure; with R&D spend in India, at 0.9 per cent of GDP which is low
when compared to countries like South Korea and Japan.
 In India Capital goods industry is fragmented with many small units operating at uneconomic scale
capacities. This made India uncompetitive in global market.
 Other issues are related low level of skill development and non-availability of long term finance to
the sector.

National Capital Goods Policy, 2016

To unlock the potential for this promising sector and to establish India as a global manufacturing
powerhouse under Make in India initiative, Government has unveiled a National Capital Goods Policy 2016.
A draft policy was released earlier in November 2015.
The policy seeks to address some of the key issues including availability of finance, raw material,
productivity, quality and environment friendly manufacturing practices, innovation and technology,
creating domestic demand and promoting exports.

Key features of Policy

 Increasing Exports
 The National Capital Goods Policy 2016 aims at increasing exports to 40 percent of production,
from the current 27 percent.

 Push to Domestic Production

 The policy aims to increase the share or domestic production in the country‘s demand to 80
percent from 60 per cent, potentially making India net exporter of capital goods.

 Technological Improvement
 The policy aims to facilitate improvement in technology depth across subsectors, increase skill
availability, ensure mandatory standards and promote growth and capacity building of MSMEs.

 HIEMDA Scheme
 The policy seeks to enhance Indian made capital goods export through a ‗Heavy Industry Export &
Market Development Assistance Scheme (HIEMDA)‘.
 Basics of Economy 139

 Increased Budgetary Allocation

 This includes strengthening existing scheme of DHI (Department of Heavy Industry) on
enhancement of competitiveness of Capital Goods sector by increasing budgetary allocation.

 Technology Development Fund

 The policy advocates launching a Technology Development Fund under the public-private
partnership (PPP) model to fund technology acquisition, transfer of technology, purchase or JPRs,
designs and drawings as well as commercialisation of such capital goods technologies.

 Integration with subsectors

 The policy looks to integrate key capital goods sub-sectors. It also seeks to make standards
mandatory in order to reduce sub-standard machine imports and provide opportunity to local
manufacturing units and launch scheme of skill development for Capital Goods sector.

 Start-up Center
 The policy also suggests creation of a ‗Start-up Center‘ for capital goods sector‘ to provide an array
of technical, business and financial support sources and services to promising start-ups in
manufacturing and services.

 Standardization
 The policy also calls for mandatory standardisation, which includes defining minimum acceptable
standards for the industry and adoption of International Organization for Standardization norms.

This is for the first time that government in India has come up with a national policy for capital goods
sector. The implementation of the above recommendations both in letter and spirit may usher a new phase
in capital goods industry in India.

M. AGRICULTURE

Agriculture remains the most important sector of the Indian economy. The share of agriculture sector in the
economic remains at 15% of the GDP(world‘s average is 6%). In the fiscal 1950-51 agriculture accounted
for 55.4% in the GDP. Now 47% (as per labour bureau) of the population lives with only 15% of the total
income of the Indian economy. This fact clearly substantiates the reason why people who depend on
agriculture are poor. In the developed economies such as the USA, France, Norway, the and Japan,
agriculture contributes only 2% of their GDP with only 2% people dependent on this sector for their
livelihood.

In a developing country like India, agriculture sector and rural economy have a significant role in providing
livelihoods, ensuring food security and providing impetus to the growth of industries and service sectors.

Agriculture is the biggest unorganized sector of the economy accounting for more than 90% share in the
total unorganized labour force (93% of the total labour force of the economy is employed in the
unorganized sector).

Agriculture is deeply related to industrial growth and the national income in India. A 1% increase in the
agricultural growth leads to 0.5% increase in industrial output (growth) and 0.7% increase in the national
income of India.

Kharif & Rabi

The Indian cropping season is classified into two main seasons

1. Kharif Season: It is from July to October during the south–west/summer monsoon. The Kharif
crops include rice, maize, sorghum, pearl millet/ bajra, finger millet/ragi (cereals, Arhar (pulses),
soybean, groundnut (oilseeds) cotton, etc.
2. Rabi Season: It is from October to march (north– east/Returning/winter monsoon).The rabi crop
include wheat, barley, oats (cereals) , chickpea/gram(- pulses), linseed, mustard (oilseeds) etc.

Along with these two we have another sea- son at some parts of the country, which is called Zaid season.
Zaid crops are grown on irrigated lands and they don‘t have to wait for the monsoons. They are grown in
the short duration between rabi and kharif crop, mainly from March to June. They require warm dry
weather for major growth period. Main produce is seasonal fruits and vegetables eg. Cucumber, musk
melon, water melon etc.
140 Basics of Economy

Cropping Pattern in India

Cropping Pattern means the proportion of area under different crops at a point of time.

Factors Determining Cropping Pattern in India

1. Natural factors: climate, soil, rainfall etc.
2. Government Policies: MSP, export policy, subsidy
3. Economic factors: input prices, income, size of
4. land holdings, demand of the crop
5. Social factors: customs, traditions, social environment

Cropping Systems/ Combinations

 Mono cropping- Mono cropping is when the field is used to grow only one crop season after
season eg. planting wheat year after year in the same field. The disadvantage is that it can reduce
the soil fertility and damage the soil structure. It encourages pests, diseases and weeds.

 Crop Rotation-Crop Rotation means changing the type of crops grown in the field each season or
each year (or changing from crops to fallow). Eg. Planting maize one year, and beans the next.
Crop rotation is a key principle of agriculture conservation because it improves the soil structure
and fertility and helps in controlling weeds, pests and diseases.

 Sequential Cropping-Sequential Cropping involves growing two crops in sequence within a crop
year. One crop being sown after the harvest of the other. In some places, the rainy season is long
enough to grow two crops: either two main crops or one main crop followed by a cover crop.

 Intercropping-Inter cropping means growing two or more crops in the same field at the same
time eg. planting alternate rows of maize and beans, or growing a cover crop in between the cereal
rows.

Agriculture Subsidies in India

Green Revolution in the mid-1960s necessitated a high priority to supplying quality inputs like irrigation,
water, fertilizers and electricity to the Indian farmers. To ensure that these inputs are accessible to all
farmers at all the times the government decided to subsidize these inputs.

How Subsidy Works

There are two most common ways of subsidizing agriculture; First, government supplies the inputs below
the market price. Second, governments may pay much higher prices for the agricultural products
(outputs) than what the farmers can obtain under free market environment.

Major subsidies on Agricultural Inputs

1. Power subsidy is provided by the state governments. It is granted on power that is used to draw
groundwater for irrigation. Power subsidy is the difference between the price paid by the farmer
for the usage of electricity and the actual cost of generating and distributing the electricity.
The sustainability of the power subsidies has come under a lot of stress in recent years mainly
because of the bad health of State electricity boards‘ finances. The states like Punjab and Tamil
Nadu have provided electricity to the farmers free of cost which has led to its wastage and
financial losses to the state electricity boards. Moreover excessive pumping of water has led to the
fall in level of the ground water level.
2. Irrigation subsidy it is also provided by the state government. It is the subsidy provided on the
usage of government provided canal water. Irrigation subsidy is the difference between the
operation and the maintenance cost of irrigation infrastructure in the state and irrigation charges
recovered from farmers.
Irrigation subsidies have become unsustainable mainly because the states have failed to device a
rational pricing model for the canal water. Estimates suggest that the pricing of the canal water did
not recover more than 20 percent of the operational and maintenance expense of the canals.
3. Fertilizer subsidy: Discussed later in detail.
4. Seed Subsidy: Seed subsidy is granted through the distribution of quality seeds at a price that is
less than the market price of the seeds.
5. Credit Subsidy: It is the difference between interest charged from the farmers, and actual cost of
providing credit. It also includes other costs such as loan waiver. Availability of credit is a major
problem for poor farmers. They are cash strapped and cannot approach the credit market because
they do not have the collateral needed for loans. To carry out production activities, they approach
 Basics of Economy 141

the local money lenders. Taking advantage of the helplessness of the poor farmers the lenders
charge exorbitantly high rates of interest.
Many times, even the farmers who have some collateral cannot avail loans because banking
institutions are largely urban based and many times they do not indulge in agricultural credit
operations, which is considered to be risky by the banks.

Benefits of giving Agricultural subsidies

1. From a situation of massive food shortage, India has emerged as a food grain surplus country and
food security has been attained at the national level.
2. Prices of basic food items have remained relatively stable.
3. There is a positive impact on farm income and has led to increase in standard of living of the
farmers especially in the irrigated regions.

Negative Impacts of Agriculture Subsidies

1. Rising subsidies has lead to revenue and fiscal deficits and created fiscal imbalances at the centre
and state level.
2. Pressure from WTO under Agreement on Agriculture to reduce subsidies as they are considered to
create trade distortion.
3. Inefficient use of natural resources like water (by giving power subsidy) has led to environment
degradation.
4. Excessive use of fertilizers has led to degradation of soil.
5. Benefits of agricultural subsidies are mostly accrued to the rich farmers.
6. Increase in the stock piles of food grains which are then left in the warehouses to rot.
7. Change in consumption pattern as area under wheat and rice has increased and decreased for
coarse cereals and pulses.
8. Failure to take into account the changing consumption pattern of Indian customer has led to food
inflation especially in pulses and vegetables.
However, the issue of agriculture subsidies should not be examined only from the perspective of
fiscal imbalances, but from a much wider perspective of ensuring food and nutritional security for
billions and income security for poor and marginal farmers and ensuring that they do not get
wiped out from the market.

Need of Government intervention in food grain markets

1. To achieve the goal of price stability at the time of bumper harvest or below normal production
(intervention by MSP).
2. To provide a guaranteed price to producer farmers.
3. To supply food to vulnerable and poor sections at a lower price (By PDS).

The government has been carrying out procurement and storage of food grains in India since 1960‘s
through mainly two institutions:
1. The Commission for Agriculture Cost and Prices (CACP)
2. The Food Corporation of India (FCI)

The CACP is entrusted with the task of suggesting the Minimum Support Prices. The FCI is entrusted the
task of procurement and storage of food grains.

Irrigation and water security

For maximum crop productivity, it is very essential to supply the optimum quantity of irrigation water at
proper timing. Irrigation water ensures better utilization of chemical fertilizers and maintains optimum
temperature around the plant environment.

Irrigation is necessary for the following reasons:

1. Scanty Rainfall
2. Non-Uniform Rainfall
3. Increasing Yield in Dry Farming
4. To practice Crop Rotation
5. Nutrient and moisture carrier

The disadvantages of excessive irrigation may be listed as follows:

1. Wasteful use of water
2. Water logging
3. Soil degradation in irrigated areas
142 Basics of Economy

4. Contamination of water with harmful substances

5. Damp climate and ecological imbalances
6. Mosquitoes breeding
7. Decreasing underground water level

Types of Irrigation

Conventional and recognized means of irrigation are wells, tanks and canals.

 Wells: The important well-irrigated states are Uttar Pradesh, Punjab, Tamil Nadu and Maharashtra.
In these states water-level is high and the soil is soft. Therefore, wells are easily sunk.

 Tube wells: They are worked by electricity or diesel oil and thus, they relieve our cattle of much of
the strain. They are mostly present in Uttar Pradesh, Bihar, Haryana and Punjab. This is because
these states have ample sub-soil water.

 Wells and tube wells account for about 48% of the total irrigation in India. Due to excessive use of
tube wells, underground water level is going down in Punjab and Haryana.

 Tanks: They are of considerable importance in central and southern India, esp. in Andhra Pradesh
and Tamil Nadu. About 8% of total irrigated area is irrigated by tanks. Canals: Some canals were
constructed by the early Hindu and Mohammedan Kings. Most of the canals however, are the
products of the British rule. At present, canals irrigate about 39% of the total irrigated area of
India. Most of the canals of the country are found in Uttar Pradesh and Punjab.

Localized irrigation

Drip Irrigation
Drip irrigation also known as trickle irrigation, functions as its name suggests. In this system water falls
drop by drop just at the position of roots. This method can be the most water-efficient method of irrigation,
if managed properly, since evaporation and runoff are minimized. It is more economical for orchard crops
than for other crops and vegetables since in the orchard, plants as well as rows are widely spaced.

Fertigation is the application of fertilizers, soil amendments, or other water soluble products through an
irrigation system. It is a method of fertilizer application in which fertilizer is incorporated within the
irrigation water by the drip system. In this method, liquid fertilizers as well as water soluble fertilizers are
used. In this system fertilizer solution is distributed evenly in irrigation. The availability of nutrients is very
high therefore the efficiency is more.

Benefits of Fertigation
1. Increased nutrient absorption by plants.
2. Reduction in fertilizer and chemicals needed.
3. Reduced leaching to the water label.
4. Reduction in water usage
5. Application of nutrients at the precise time they are needed and at the rate they are utilized.

Disadvantage of Fertigation
1. Concentration of solution decreases as fertilizers dissolves, leading to poor nutrient placement.
2. Results in pressure loss in main irrigation line.
3. Use of chemical fertilizers of low-sustainability, instead of organic fertilizers.
4. Dependent on water supply.

Sprinkler system

In sprinkler system or overhead irrigation, water is piped to one central location within the field and
distributed by overhead high pressure sprinklers or guns. The pump unit is usually a centrifugal pump
which takes water from a source and provides adequate pressure for delivery. Sprinkler irrigation has high
efficiency. It however, varies according to climatic condition; 60% in warm climate; 70 % in moderate
climate and 80% in humid or cool climate.
 Basics of Economy 143

CADP (Command Area Development Programme)-

In all five year plans, considerable importance was given to the creation of additional irrigation potential.
However, the potential actually utilized was much below. The irrigation potential created over the years in
major and medium works was not being fully utilized and the gap between the potential created and the
actual utilisation was widening. This non-utilization occurred mainly because there was a delay in
construction of the field channels and drains.

In 1974-75, the Government of India launched the Command Area Development programme to bridge /
narrow the gap between irrigation potential created and actually utilized in major and medium irrigation
schemes. This scheme was supposed to develop adequate delivery of the irrigation water up to the fields.
It had the following components: construction of field channels and field drains, land shaping and
introduction of rotational supply of water to ensure equitable and assured distribution to individual farm
holdings.

AIBP (Accelerated Irrigation Benefits Programme)-

The Central Government launched the Accelerated Irrigation Benefit Programme (AIBP) from 1996-97
for extending loan assistance to states for the completion of near complete irrigation schemes.
AIBP was specifically started because a large number of river valley projects had spilled from plan to plan,
mainly because of financial constraints of state governments. Some of these projects were in an advanced
stage of construction and could provide irrigation benefits in four or five agricultural seasons. The
completion of these projects, however, was beyond the resources capability of the State Governments.
The assistance provided by the Centre was entirely in the form of loan in the beginning but later a grant
component was also added in 2005.

Seeds
India is the fifth largest seed market across the globe. The seed market is majorly contributed by non-
vegetable seeds such as corn, cotton, paddy, wheat, sorghum, sunflower and millets.
Direct contribution of quality seed to the total production can be raised up to 45% with efficient
management of other inputs.

Hybrid Seeds
Hybrid seeds are obtained by cross pollination of different varieties of related plants. These seeds were
instrumental in green revolution. These seeds combine desirable properties of two related plants. One
drawback is that these seeds don‘t regenerate seeds of same quality. So every time farmers have to buy
new seeds. In case of conventional seeds farmers can use reproduced seeds by current crop. In that sense
hybrid seeds push up input costs for the farmers.

Genetically Modified Varieties

These varieties of seeds are developed in laboratories by genetic engineering technologies. In these
technologies, genes of different species of organisms (like bacteria genes with plants) are integrated to
modify DNA to get desired characteristic. This plant will be protected from pests and will give increased
yields. In USA, GM crops are allowed and contribute about 85% of the consumption, whereas in Europe it
is largely banned as of now. In India, it is allowed for commercial production of cotton and for food crops
field trials are going on. Main concern of the farmer community is that, companies like Monsanto will
exploit their monopolies as seeds are expensive and are not regenerative.

Issues Involved

The issues in seed sector involve multiple stakeholders such as:

a. Seed Companies
1. The research investment by private companies remains at a meager 3-4% of revenue against
the international norm of 10-12%, due to complex and weak IPR regime.
2. Moreover, existing technology providers in GM Crop seed, continue to enjoy close to monopoly
status.
b. Government
1. Regulatory failure in preventing the rampant illegal sale and planting of seeds based on an
unapproved GM crop has been reported in Maharashtra and Telangana.
2. Various agricultural economists argue that the policies for seed sector lack visionary approach
and rest on fragmented actions.
c. Farmers

Seed replacement rate continues to remain below the desired level of 20 per cent for most crops.
144 Basics of Economy

Seed Replacement Ratio (SRR) It is a measure of how much of the total cropped area was sown with
certified seeds in comparison to farm saved seeds. It represents the access of farmers to quality seed and
directly proportional to productivity of farming.

Steps that can be taken

1. An action framework is needed in collaboration with state governments to identify and take over
fields where illegal GM cotton is being grown.
2. Focus on GM technology: National policy on GM crops to define the exact areas where GM is
required by the country and where the government will encourage public and private investment in
GM technology.
3. Quick resolution: of the conflicts between the different IPR laws that are affecting this industry and
clearly defining how the government wants to encourage research and investment with assured IP
protection in this important sector.
4. Incentives: to private sectors should be provided for production of low value high volume seeds.
5. Regulatory mechanism: Strengthening the regulatory mechanism for the seed and biotech industry
to bring more transparency.
6. Integrated Approach: Efforts should be made towards improvement of Seed Replacement Rate.
There should be distribution of quality seeds appropriate to agro-climatic zone along with a
determined effort to address general and region-specific constraints.

Seed industry is the crucial apparatus for sound agricultural health of the economy.
Legislative Frameworks for Seeds in India

 Historically, the seed industry in India has been governed by several legislative & policy
frameworks such as Seed Act (1966), Seed Rules (1968), Seed (Control) Order (1983), New Policy
on Seed Development (1988), Plants, Fruits & Seeds (Regulation of Import into India) Order
(1989), Protection of Plant Varieties and Farmers’ Right Act (2001), and the Essential
Commodities Act, 1955 including Seeds (1955), National Seed Policy (2002), and Seed Bill
(2004).
 All of these legislations were passed to take care of seeds right from the production level
to marking, labeling, and marketing levels so as to maintain the quality standards as
prescribed by the Central Seed Committee (formed under the Seed Act, 1966).
 These laws make quality seeds and planting material available to a common farmer and
provide him a mechanism to approach concerned authority for justice.
 The Seed Bill (2004) was proposed to replace the Seed Act (1966), however, owing to several
shortcomings it was not passed. The 2019 draft version tries to overcome the drawbacks of the
2004 Bill.

Highlights of the Seed Bill- 2019

 It is an important legislation to ensure the supply of modern, high-quality, cutting-edge seed
technologies to the farmers which will help them in enhancing their productivity and profitability.
 Formation of Seed Committee
 The Bill authorizes the Central government to reconstitute a Central Seed Committee (based
in New Delhi) that will be responsible for the effective implementation of its provisions.
 Registration of Seed Varieties
 Draft Bill Provision: All varieties of seeds for sale have to be registered and are required to
meet certain prescribed minimum standards. For instance, for transgenic varieties of seeds,
registration is to be obtained under the Environment (Protection) Act, 1986. This can
bring greater accountability to seed companies.
 Industry Recommendation: Make the registration process time-bound.
 Exemptions
 Bill: Exempt farmers from obtaining registration for varieties developed by them. However, if
the farmer sells such seeds for a monetary consideration, then that sale needs to be
registered. This is to protect the interests of other farmers who buy seeds from such a farmer.
 Also, farmers are allowed to sow, exchange or sell their farm seeds and planting material without
having to conform to the prescribed minimum limits of germination, physical purity and genetic
purity (as required by registered seeds). However, farmers cannot sell any seed under a brand
name.
 Recommendation: Exemption of export-oriented varieties from registration has been made.
This will encourage custom production of seeds in India.
 Research-based Companies
 Basics of Economy 145

 Bill: In the proposed Bill, there is a differentiation between the seed producer, seed processor
and seed dealer for the purpose of licensing. However, there is no recognition of National
Level Integrated Seed Companies with R&D capabilities.
 Recommendation: There must be a system of accreditation of national level research-based
companies with integrated facilities for research, product testing, data analytics, seed
production, seed quality control, seed processing, farmer extension and marketing. These
companies need to be given a national licence that can be renewed at regular intervals based
on fresh inspections and track record.
 Truthfully labeled seeds
 Bill: Currently, a large percentage of seed is sold under a self-certification programme called
Truthfully Labeled (TL) seeds. The certification process has been kept voluntary.
 Recommendation: TL seeds category must continue, as the mandatory registration of seed
varieties eliminates the risk of misuse of TL provision. The TL certification has helped the
industry to grow and facilitated the supply of high-quality seeds to the farmer in the last 30
years.
 Nurseries
 Bill: Licences/ registration of fruit nurseries.
 Recommendation: Apply this provision to all nurseries and not just fruit nurseries.
 Price Control
 Bill: Empowers the government to fix prices of selected varieties in case of ‗emergent‘
situations such as seed shortage, abnormal increase in price, monopolistic pricing,
profiteering, etc. which is open to subjective interpretation.
 Recommendation: The industry opposes any kind of price control, as it can stifle innovation
and result in a scale back of research investments.
 Review of complaints
 Bill: Consumer Protection Act, 1986 to be used to deal with complaints related to the non-
performance of seed.
 Recommendation: Seed performance is dependent on several agro-climatic and biological
factors and is not always related to the quality of the seed. Hence, this aspect must be kept in
mind while reviewing a complaint.
 Penal Provisions
 Bill: Differentiates the agronomic performance of the seed, its physical quality and the supply
of spurious seed, and consequently penalizes the offences and prescribes punishment.
 Recommendation: All offences are not criminal. Minor offences (unintended offences) and
major offences (made intentionally) should be differentiated. The minor offences in the Bill
must be made as compoundable.

Agricultural credit in India

Agricultural credit system is significant because for most of the Indian rural families, savings are
inadequate to finance farming and other economic activities. Moreover, there is a time lag between income
realization and expenditure in agriculture. Also the non-institutional lenders exploit the illiterate and poor
families. Thus, the institutional credit system is necessary to support agriculture.

In India, a multi agency approach comprising cooperative banks, scheduled commercial banks and
regional rural banks (RRBs) is used to facilitate credit to the agriculture sector.

Types of Agriculture Credit

According to purpose of agriculture credit, it can be categorized into two types:
1. Productive: Productive loans are the loans that are used to support agricultural production, for
example purchase of tractor, land, seeds etc
2. Unproductive: Unproductive credit is used for personal consumption, for example loan for
e x p e n diture on marriages, religious ceremonies etc.

Source of Agricultural Credit in India

There are two broad sources of agricultural credit in India: non-institutional sources and institutional
sources.

Non-institutional sources
The non-institutional sources constitute around 40% of the total rural credit in India.
The important sources of non-institutional credit are as allows:
1. Money lenders: Money lenders charge a huge rate of interest and mortgage the property of the
cultivators and in some cases even the peasants and the members of his family are taken as
collateral.
146 Basics of Economy

2. Traders, landlords and commission agents: They give credit on the hypothecation of crops. These
crops when harvested are used to repay loans
3. Credit from relatives: This credit is generally used for meeting personal expenditure.

Institutional sources
The government policy for agricultural credit has been to enhance institutionalization of rural credit.
NABARD is an apex institution established for rural credit in India. It does not lend directly to farmers and
to other rural people. It does indirect lending through banks. The institutional sources for agriculture credit
are :
1. Scheduled Commercial Banks (SCBs)
2. Regional Rural banks (RRBs)
3. Cooperative Banks
4. Micro finance Institutions MFIs

Interest Subvention Scheme

It is the scheme for farmers to provide concession of 2% per annum for crop loans of up to Rs.3 lakh by
providing loans at 7% rate of interest. An additional interest subvention of 3 per cent per annum is
available to the ―prompt payee farmers.
Recently, RBI has clarified that the farmers will continue to get crop loan under Interest Subvention
Scheme.

Negotiable Warehousing Receipts

Warehouse Receipts are documents issued by warehouses to depositors against the commodities
deposited in the warehouses, for which the warehouse is the bailee. Warehouse Receipts may be either
non-negotiable or negotiable. NWRs can be traded, sold, swapped and used as collateral to support
borrowing.
The government has launched negotiable warehousing receipts in electronic format that farmers can use
to avail of bank credit easily and without fear of losing or misusing it.

Weaknesses in Rural Credit Structure

Despite a large network of institutional credit system, it has not been able to adequately penetrate.
Informal rural financial markets and non-institutional sources continue to play a dominant role in meeting
the credit needs of the people residing in rural areas. The weaknesses are:
1. Lack of guidance to farmers: While finance is a very important factor, it should be complemented
with the extension of services in the form of guidance, expertise and counseling on agricultural
issues.
2. Multiplicity of institutions: There is a lack of coordination among the multiple agencies providing
credit, and thus, the commercial viability of these agencies is adversely affected in this scenario.
3. Lack of motivation: There is a pressure on banks to improve their financial position and so these
banks are now concentrating on selected large borrowers.
4. Poor recovery: Banks avoid rural financing mainly because of poor recoveries. It is ironical that the
recovery position is adverse among rich farmers than among small farmers. The political decisions
of waiving off loans are further putting pressures on the financial system.
5. Procedural delays: There is a problem of considerable delays in the processing of loan applications
and collaterals. Thus, farmers continue to rely on non-institutional sources.

There is a trend of actual loan disbursements to the farm sector outstripping the liberally hiked annual
targets year after year. Yet agrarian distress and farmers‘ dependence on moneylenders are showing no
signs of easing.

Organic Farming and Paramparagat Krishi Vikas Yojana

Organic farming is a form of agriculture that relies on techniques such as crop rotation, green manure, and
biological pest control. It is a method of farming system which primarily aims at cultivating the land and
raising crops in such a way, as to keep the soil alive and in good health by use of organic wastes and other
biological materials along with beneficial microbes (bio fertilizers) to release nutrients to crops for increased
sustainable production in an eco friendly pollution free environment.

Advantages of Organic farming

1. It discourages environmental exposure to pesticides and chemicals
2. It builds healthy soil and will help in combating soil erosion.
3. It decreases toxin levels in food
4. It encourages biodiversity.
5. It fights the effects of global farming on soil
 Basics of Economy 147

6. Supports water conservation and water health

7. Discourages algal bloom
8. Supports animal health and welfare
9. It will decrease refusal of Indian food exports on the grounds of SPS under WTO

To boost organic farming in India, Paramparagat Krishi Vikas Yojana (PKVY) was launched in 2015-16. It is
an elaborated component of Soil Health Management (SHM) of major project National Mission of
Sustainable Agriculture (NMSA). Its objectives are-
1. To support and promote organic farming and thereby improving soil health.
2. Reduce farmer‘s dependence on fertilizers and agricultural chemicals to improve yields.
3. Motivate the farmers for natural resource mobilization for input production.
4. Plans to form around 10 thousand clusters in three years and cover an area of 5 Lakh hectares
under organic farming.

Scope & Challenges

Organic farming can be used to revive traditional farming practices and methods to save the soil and
agricultural produce from contamination caused by the chemical inputs.
It is a proven fact that productivity of organic cultivation will be far lower and that more organic re-
sources will be required to ensure there is no substantial decline in productivity. Hence, organic farmers
will be forced to sell their produces at premium prices which will be unbearable to the common man.
Organic farming may not be practical for large scale cultivation essential for feeding a country with a
population of 128 crore people. India‘s arable land is 2.4% of the total arable land in the world while US‘s
share is 6% and India‘s population is 16% of the world‘s population while the US population is just around
2%. The US can completely go organic, if they want, but India will have to take a balanced approach that
makes a judicious blend of organic methods and science & technology both.

Limitations with Organic Farming

 Manure - Huge quantities of manure would be needed to replace the chemical fertilizers. Notably,
tribal farmers do not own plots large enough to keep cattle.
 Impact of green revolution- The practices employed as a result of Green Revolution has delved
deeper into the agricultural system. Certainly, it has now become harder for true traditional
farming because the country‘s agricultural system is engulfed in high-input agriculture.
 However, it is felt that traditional farming would thrive, if subsidies offered for high-input
agriculture is graded down. This can probably help the small-scale farmers to be self-contained
with the traditional, non-chemical agriculture.
 Consumers- Organic produce in the markets along with the non-organic produce make their
prices highly unaffordable for many. It is thus still uncertain if customers are willing to spend more,
for organic farming to be taken on a large scale.

Zero Budget Natural Farming in India

Zero Budget Natural Farming (ZBNF) is a set of farming methods, and also a grassroots peasant movement,
which has spread to various states in India. It has attained wide success in southern India, especially the
southern Indian state of Karnataka where it first evolved.
The neo-liberalization of the Indian economy led to a deep agrarian crisis that is making small scale
farming an unviable vocation. Privatized seeds, inputs, and markets are inaccessible and expensive for
peasants. Indian farmers increasingly find themselves in a vicious cycle of debt, because of the high
production costs, high interest rates for credit, the volatile market prices of crops, the rising costs of fossil
fuel-based inputs, and private seeds. Debt is a problem for farmers of all sizes in India. Under such
conditions, ‗zero budget‘ farming promises to end a reliance on loans and drastically cut production costs,
ending the debt cycle for desperate farmers. The word ‗budget‘ refers to credit and expenses, thus the
phrase ‗Zero Budget‘ means without using any credit, and without spending any money on purchased
inputs. ‗Natural farming‘ means farming with Nature and without chemicals.

The four-wheels of zero budget natural farming

1. Soil aeration
2. Seed treatment with cow dung and urine-based formulations
3. Mulching: Activities to ensure favorable micro-climate in the soil)
4. Ensure soil fertility through cow dung and cow urine-based concoctions without any use of
fertilizers and pesticides

Economic benefits of ZBNF over conventional farming practices

1. Low input cost- Agriculture in its prevailing form requires farmers to rely heavily on inorganic
external chemical inputs such as fertilisers and pesticides. Zero budget farming promises to end a
148 Basics of Economy

reliance on loans and drastically cut production costs, ending the debt cycle for desperate farmers.
2. Higher yield- Besides reduced input cost, farmers practising ZBNF gets higher yields. In AP Yields
of five crops (paddy, groundnut, black gram, maize and chillies) have increased by 8-32 percent
for ZBNF farmers. Farmers are able to get five quintals of red gram under ZBNF compared to
three quintals under non-ZBNF. Farmers use bio fertilizers and that make the soil fertile, thus
giving higher yields.
3. It has the ability to solve the food and farm crisis in the country by cutting the cost of production
and doubling productivity and production.
4. Net income raised-There will be increase in net income for farmers and will improve the cash flow
of poor and vulnerable farmers, and may enhance their ability to deal with economic shock. Crop
cutting experiments from 2016 and 2017 indicate that ZBNF farmers in AP earn better net
incomes and can raise their disposable incomes. Farmers vulnerable to economic shocks have an
important safety net against short-term shocks.
5. Food and nutritional security:As a result of increased crop yields, ZBNF farmers may be able to
improve food and nutritional security for their families. The practice of intercropping growing
multiple crops in proximity to each other is encouraged under ZBNF as it ensures vulnerable
communities access to a suite of nutritional sources and income generating crops throughout the
year. In the long-run, due to the use of local inputs, the project is likely to contribute to
maintaining the genetic diversity of seeds and crops.

Environmental benefits
1. It is free from health hazards, as no chemical or organic materials are used for farming
2. Prevailing agricultural practices such as mono-cropping decrease soil moisture content, causing
tremendous stress on water resources. Zero budget natural farming requires only 10 per cent
water and 10 per cent electricity than what is required under chemical and organic farming.
3. It utilizes only natural resources as inputs. It also increases the fertility of the soil.
4. Fertilisers and pesticides have been shown to have adverse impacts on farmers as well as
consumers. Farmers are exposed to contaminants when applying chemical inputs to their crops.
By replacing such external inputs with locally made natural concoctions, inoculums, and
decoctions, the project could help in reducing the incidence of non-communicable diseases
5. ZBNF can help prevent over-extraction of groundwater, enable aquifer recharge, and eventually
contribute to increasing water table levels.
6. ZBNF might help farmers build resilience against extreme climate events by improving the fertility
and strength of the soil.
7. ZBNF farmers have shown that crop losses due to droughts, floods and other extreme events have
been lower than in non-ZBNF farms.
8. By reducing the need for irrigation and eliminating external chemical inputs, ZBNF could reduce
the material footprint per capita and material footprint per unit of value added in agriculture.
9. Wide-scale adoption of ZBNF would help reduce the release of harmful chemicals to the air, water
and soil.
10. Zero budget natural farming eliminates chemical fertilisers and pesticides, and would help reduce
ocean acidification and marine pollution from land-based activities. It might help to reduce the
leaching of nitrogen and phosphorous from the soil into groundwater or surface water, and
eventually into rivers and oceans.
11. High concentration of ammonium nitrates in fertilisers, and hazardous chemical pollutants from
pesticides which run-off into rivers and oceans can severely impact aquatic life. The use of natural
concoctions in ZBNF will help to reduce the contamination and degradation of rivers and oceans.
12. By eliminating the use of chemical fertilisers and pesticides, ZBNF will vastly reduce the need for,
and use of energy along their value chain.
13. By restoring the quality of soil and water-related ecosystems, it decouples agricultural productivity
and growth from ecosystem degradation and biodiversity loss. This decoupling of growth and
resource use provides a sustainable livelihood to farmers and allied value chain actors.
14. Globally, as few as 30 crops constitute 90 per cent of the calorie intake of people. ZBNF may
improve the potential of crops to adapt to and be produced for evolving climatic conditions.

Organic Food
FSSAI issued regulation on organic food in country. It has given definitions and brought guidelines
regarding organic food in India.

a. FSSAI has defined

Organic Agriculture: A system of farm design and management to create an ecosystem of
agriculture production without the use of synthetic external inputs such as chemicals, fertilisers,
pesticides and synthetic hormones or genetically modified organisms.
 Basics of Economy 149

b. Organic Farm Produce: the produce obtained from organic agriculture.

c. Organic Food Means: Food products that have been produced in accordance with specified
standards for organic production.
d. Mandatory labeling of Organic food Approval authority: Organic food products should carry a
certification mark or a quality assurance mark given by National Programme for Organic
Production (NPOP) or Participatory Guarantee System for India (PGS-I India). There should be a
voluntary logo from the FSSAI that marks the produce as ‗organic.‘

Food Safety and Standards Act, 2006 was enacted to:

Consolidate multiple laws in the country relating to food safety.
Establish a single point reference system. Establish the Food Safety and Standards Authority of India
(FSSAI) which formulates standards for food and regulates their manufacture, storage, and distribution,
among others. Ministry of Health & Family Welfare (MoHFW) is the administrative Ministry for the
implementation of FSSAI. The FSSAI along with the State Food Safety Authorities is responsible for
monitoring and verifying the relevant requirements under the Act and its enforcement.

Minimum Support Price and related issues

 The policy to announce MSP was started in 1960s as a safety net for farmers. The MSP is the rate
at which the government buys grains from farmers.
 Reason behind the idea of MSP is to counter price volatility of agricultural commodities due to the
factors like variation in their supply, lack of market integration and information asymmetry.
 Fixation of MSP: The MSP is fixed on the recommendations of the Commission for Agricultural
Costs and Prices (CACP).
 Factors taken into consideration for fixing MSP include:
 Demand and supply,
 Cost of production (A2 + FL method),
 Price trends in the market, both domestic and international,
 Inter-crop price parity,
 Terms of trade between agriculture and non-agriculture,
 A minimum of 50% as the margin over cost of production, and
 Likely implications of MSP on consumers of that product.
 The Commission also makes visits to states for on-the-spot assessment of the various constraints
that farmers face in marketing their produce, or even raising the productivity levels of their
crops.
 Based on all these inputs, the Commission then finalizes its recommendations/reports, which are
then submitted to the government.
 The government, in turn, circulates the CACP reports to state governments and concerned
Central Ministries for their comments.
 After receiving the feedback from them, the Cabinet Committee on Economic Affairs (CCEA) of
the Union government takes a final decision on the level of MSPs and other recommendations
made by the CACP.
 Procurement: The Food Corporation of India (FCI), the nodal central agency of the Government
of India, along with other State Agencies undertakes procurement of crops.
 MSP Calculation: This MSP is usually estimated based on three types of calculation methods.
 A2: Under this, MSP is set 50% higher than the amount farmers spend on farming including
spending on seeds, fertilisers, pesticides, and labour.
 A2+FL: It includes A2 plus an assigned value of unpaid family labour.
 C2: Under C2, the estimated land rent and the cost of interest on the money taken for
farming are added on top of A2+FL.
 The Central government had set up the National Commission on Farmers (NCF) in 2004 to address
the issues of farmers in India including that of calculation of MSP.

National Commission on Farmers: Swaminathan Committee

 On 18th November, 2004, the Union government constituted this committee with MS
Swaminathan as its chairman.
 The main aim of the committee was to come up with a sustainable farming system, make farm
commodities cost-competitive and more profitable.
 The commission, in 2006, recommended that MSPs must be at least 50% more than the cost of
production and recommended the C2 method for MSP calculation.
 However, the government calculates its MSP based on the A2+FL method.
150 Basics of Economy

Commission for Agricultural Costs and Prices

 The CACP is an attached office of the Ministry of Agriculture and Farmers Welfare, formed in 1965.
It is a statutory body.
 Currently, the Commission comprises a Chairman, Member Secretary, one Member (Official) and
two Members (Non-Official).
 The non-official members are representatives of the farming community and usually have
an active association with the farming community.
 It is mandated to recommend Minimum Support Prices (MSPs) to incentivize the cultivators to
adopt modern technology, and raise productivity and overall grain production.
 CACP submits separate reports recommending prices for Kharif and Rabi seasons.

Agricultural Marketing, APMC (Agricultural Produce and Market Committee) Act and Related
Issues

Agriculture is a state subject and almost all state governments enacted APMC act in 1950s or so, to bring
transparency and end discretion of traders in the marketing of agriculture products.
Under the APMC acts, states are geographically divided in markets which are headed by market
committees and any production in that area shall be brought to a market committee for sale. Any
wholesale level of sale and purchase of agricultural produce will take place at APMC only.

Working of the APMC

 The Act is implemented and enforced by APMCs established under it.

 It mandates that the sale/purchase of agricultural commodities notified under it are to be
carried out in specified market areas, yards or sub-yards. These markets are required to have
the proper infra- structure for sale of farmers‘ produce.
 Prices in them are to be determined by open auction, conducted in a transparent manner in the
presence of an official of the market committee.
 Market charges for various agencies, such as commissions for commission agents (arhtiyas);
statutory charges, such as market fees and taxes; and produce-handling charges, such as for
cleaning of produce, and loading and unloading, are clearly defined, and no other deduction can be
made from the sale proceeds of farmers. Market charges, costs, and taxes vary across states and
commodities.
 This is applicable to ‗notified agricultural products‘ which differs from state to state and generally
includes most of the important cereals, vegetables and other horticulture products. Notified
products are meant to be brought to the market committee and auctioned in presence of the
farmer. States have been asked by the centre to deregulate the marketing of fruits and vegetables
and keep them out of APMC Acts.
 In this market committee (popularly called mandi) there are commissions agents (called
arhatiyas) who hold license and are allotted a shop in the market. Farmer and buyer have
discretion to go to any agent in this market. There are huge numbers of commission agents in a
particular APMC dealing in same crop, which result in constant price discovery and adjustments for
that particular crop.
 At same time buyers, which may be rice mills, flour mills, cotton ginning mill owners, come to
procure these products. They make their bids and if these bids are fair, will give return to farmers.
But unfortunately, this is not so.
 Basics of Economy 151

National Agricultural Market

National Agricultural Market is an online platform with physical markets or mandis at the backend. NAM
is not a parallel marketing structure but rather an instrument to create a national network of physical
mandis which can be accessed online. NAM seeks to leverage the physical infrastructure of mandis
through an online trading portal, enabling buyers situated even outside the State to participate in
trading at the local level.

Technology Missions in India

The technological missions in India was initiated in 1987 by the Rajiv Gandhi led Congress government.
Rajiv Gandhi had chosen his close aid Sam Pitroda to lead the Mission. The mission had the task to cover
five critical areas which were considered very important for the development of the Indian economy and
society.
The Core Focus areas were:
1. Drinking water
2. Immunization
3. Literacy
4. Oilseeds
5. Telecommunications

The Specific Goals of the Technology missions were:

1. To make drinking water available to most backward villages.
2. Immunize pregnant women and 20 million children per year.
3. To teach people in the age group 18-35 to read and write.
4. Increase oil seeds production manifold to eliminate India‘s imports of edible oils.
5. Improve service, dependability and accessibility of telecommunications across the country,
including rural areas.
6. Increase dairy production to attain self-sufficiency, increase dairy employment and income of
dairy farmers.
152 Basics of Economy

Public Distribution System

The Timeline of the PDS in India

PDS was introduced around World War II as a war time rationing measure. Before the 1960s, distribution
through PDS was generally dependent on imports of food grains. It was expanded in the 1960sas a
response to the food shortages of the time.
Subsequently the government set up the Agriculture Prices Commission (now CACP) and FCI to improve
domestic procurement and storage of food grains for PDS.
By the 1970s, PDS had evolved into a universal scheme for the distribution of subsidized food. In the
1990s, the scheme was revamped to improve access of food grains to people in hilly and inaccessible
areas and to target the poor.
Subsequently, in 1997, the government launched the TPDS (Targeted public distribution system) with a
focus on the poor. In 2013, government enacted the national food security Act. It relies largely on the
existing TPDS to deliver food grains as legal entitlements to poor households. This marks a shift by making
the right to food a justiciable right.

The Working of the PDS

 The existing structure of the PDS works in a Cooperative Federalist system in which both Centre
and State share the responsibility.
 The Central Government is responsible for buying food grains from farmers at MSP. The Central
Government than allocates the grains to each state on the basis of a pre-determined formula.
 The State Government is responsible for identifying the poor and eligible households in the states.
The Centre transports the food grains to the Central depots (FCI) in each state. After that, the
state government is responsible for delivering the food grains from the centre depots to the ration
shops. The Ration shops are the ultimate end points from where the food grains are sold to PDS
beneficiaries.

Targeted Public Distribution System (TPDS)

In June, 1997, the Government of India launched the Targeted Public Distribution System (TPDS) with
focus on the poor. Under the TPDS, States were required to formulate and make arrangements for the
identification of the poor for delivery of food grains and for its distribution in a transparent and
accountable manner at the FPS level.
The scheme, when introduced, was intended to benefit about 6 crore poor families annually. The
identification of the poor under the scheme is done by the States as per State-wise poverty estimates of
the Planning Commission for 1993-94 based on the methodology of the Lakdawala committee. The
allocation of food grains to the States/UTs was made on the basis of average consumption in the past i.e.
average annual off-take of food grains under the PDS during the past ten years at the time of introduction
of TPDS.
The quantum of food grains in excess of the requirement of Below Poverty Line (BPL) families was
provided to the State as ‗transitory allocation‘.

Identification of BPL families under TPDS

To work out the population below the poverty line under the TPDS the methodology used by the expert
group set up by the Planning Commission under the Chairmanship of Late Prof. Lakadawala has been
used.
Guidelines for implementing the TPDS were issued in which the State Governments had been advised to
identify the BPL families by involving the Gram Panchayats and Nagar Palikas. While doing so the thrust
was to include the really poor and vulnerable sections of the society such as landless agricultural laborers,
marginal farmers, rural artisans/crafts- men such as potters, tappers, weavers, black-smith, carpenters
etc. in the rural areas and slum dwellers and persons earning their livelihood on daily basis in the
informal sector like potters, rickshaw-pullers, cart-pullers, fruit and flower sellers on the pavement, etc. in
urban areas. The Gram Panchayats and Gram- Sabhas would also be involved in the identification of
eligible families.

Alternatives to the PDS

1. Universal PDS
Under the Universal PDS the grains are provided to every household of the state irrespective of the
income level. The non-classification of the households eliminates the risk of inclusion and exclusion errors.
It also reduced the cost of running the scheme as it reduced the administrative cost of identifying the poor
and cost of monitoring the scheme.
 Basics of Economy 153

2. Food Coupons
Food Coupons are another alternative to PDS. Beneficiaries are provided with food coupons which are
equivalent to money. The food coupons are used to buy grains from local markets and grocery stores.
Retailers or grocery shop owners take these coupons to the local bank and are reimbursed with money.
According to the Economic Survey 2009- 10 reports, such a system will reduce administrative costs. Food
coupons also decrease the scope for corruption since the store owner gets the same price from all buyers
and has no incentive to turn the poor buyers away. Moreover, BPL customers have more choice; they can
avoid stores that try to sell them poor-quality grain.

3. Direct Benefit Transfer

DBT provides for cash transfers to the poor. Under DBT, beneficiaries will be given money by the
government in their respective bank accounts which can be used to buy grains from the open markets.
Under the DBT system the government will provide money directly to the target group usually poor
households. The identification of the poor households are much easier under the DBT system, since the
bank accounts are linked with Aadhaar and can be easily monitored.
Some of the potential advantages of these programmes include: (i) reduced administrative costs,
(ii) expanded choices for beneficiaries, and (iii) competitive pricing among grocery stores.

In PDS leakage arises due to ghost ration cards. Under DBT ―the identity of a person is known and ration
cards will be Aadhaar-verified, due to which, only the right beneficiaries will get the subsidy.

N. FOOD PROCESSING

Food Processing is the transformation of raw ingredients into food or of food into other forms. Food
processing typically takes clean, harvested crops or butchered animal products and uses these to produce
attractive, marketable and often long shelf life [Link] milk to butter, cheese, ghee or various pickles
etc. It includes items pertaining to the following two processes:

1. Manufactured Processes: If any raw product of agriculture, animal husbandry or fisheries is

transformed through a process involving employees, power machines or money in such a way
what its original physical properties undergo a change and if the transformed product is edible and
has commercial value, then it comes within the domain of Food Processing Industries.
2. Other Value – Added Processes: If there is significant value addition (increased shelf life,
shelled and ready for consumption etc.) such produce also comes under food processing, even if it
does not undergo manufacturing processes.
3. Items constituting the Food Processing Industries in India Food processing is a large sector
that covers activities such as agriculture, horticulture, plantation, animal husbandry and fisheries.
It also includes other industries that use agriculture inputs for manufacturing of edible products.
Based on International Standard Industrial Classification, it has been assumed that the factories
listed below constitute Food Processing Industries:
 Production, Processing and Preservation of Meat, Fish, Fruits, Vegetables, Oils and Fats
 Manufacturing of Dairy Products.
 Manufacture of Grain Mill Products, Starch products and prepared animal feeds.
 Manufacture of Other Food Products
 Manufacture of Beverages

Supply Chain

A supply chain is a system of organizations, people, activities, information and resources involved in
moving a product or service from supplier to customer. Supply chain activities transform natural resources,
raw materials and components into a finished product that is delivered to the customer. Supply chain
management is an integrating function with primary responsibility for linking major business functions and
business processes within and across companies into a cohesive and high performing business model. It
includes all the logistics management activities, manufacturing processes and operations, channel partners
which can be suppliers, intermediaries, third party service providers and customers. Supply chain
management requires coordination of processes and activities with and across marketing, sales, product
design, finance and information technology.
A supply chain is dynamic and involves the constant flow of information, product and funds between
different stages. The information regarding availability, pricing and funds flow is also part of supply chain.
So, a typical supply chain may involve a variety of stages viz. customers, retailers, wholesalers/
distributors, manufacturer and raw material supplier.
154 Basics of Economy

Supply Chain of the Food Processing Sector and the Backward and Forward integration across
the supply chain

Primary Processing relates to conversion of raw agricultural produce, milk, meat and fish into a commodity
that is fit for human consumption. It involves steps such as cleaning, grading sorting, packing etc.
Secondary and Tertiary Processing Industries usually deal with higher levels of processing where new or
modified food products are manufactured.
The generic value chain of the food processing industry is from raw materials to retail to the consumer.
Traditionally, different players across the value chain play different roles and work more or less
independently. Recently, the trend has been towards increasing integration and collaboration across
players in the value chain, to garner mutual benefits. Such integration is being driven by the
manufacturers, who are looking to integrate backward and forward chains; and establish linkages with both
raw material producers (farmers) and aggressors/logistics providers. These links have led to new models
emerging in the sector – Contract Farming

Backward Linkage – Raw Material Supply

Backward linkage refers to transactions of farmers with food processing industry. The concept of backward
linkage between farmers and industry is promoted to encourage and enable farmers to grow products of
appropriate quality. This helps the poorest of the poor farmers as well as marginal and medium farmers
fetch appropriate and remunerative return for their produce. The scheme of providing assistance is already
in operation but needs to be strengthened further to cover majority of farmers/producers.
The existing institutions like local bodies, cooperatives and self – help groups, which have been in
operation for over decades in different context, can be utilized to strengthen the backward linkage. This
way the skill and expertise acquired by this institution would be constructively used, while this mechanism
would help quickly create the bridge of trust between farmers and processors. This would ensure smooth
supply of raw material to the processors and help the famers (poor, marginal and big) in getting
remunerative prices for their products. Thus, a complete network of farmers and processors will be
created cutting across their status.

Forward Linkage – Marketing

It refers to transactions between food processing industry and customers. There is an urgent need to
develop forward linkages for fresh and processed food. Presently, there are a large number of
intermediaries operating between the farmers/processors and the consumers, resulting in high cost to the
latter and low return to the former. The efforts to cut intermediaries need to be made in such a way that
special skill and expertise required to operate the intermediate links in the system like transportation and
market distribution are not jeopardized. To achieve this, attempts are required to be made to provide
appropriate tax incentives and holidays for setting up food processing industries, taking care of expanses
on market promotion and ancillary activities.
Special attention is to be laid towards setting up regulated markets with the primary objective to improve
market efficiency and achieve equitable distribution of benefits between producers, traders and consumers.
This will be possible by evolving strategies to strengthen regulated market yields and equipping them with
grading, cleaning and packaging facilities, along with market information systems.
Efforts are to be made to develop packaging technologies, for individual products to increase their shelf
life and improve consumer acceptance, both in the domestic and international markets.
Efforts are to be made to harmonize food laws to encourage production of high quality products with
minimum intervention from regulatory authorities. The complexity of multiple administering authorities for
food processing enterprises is also required to be simplified by developing an integrated system.
 Basics of Economy 155

O. SOCIO-ECONOMIC PROBLEMS

POVERTY:
Poverty is deprivation of basic needs that determine the quality of life- food, clothing, shelter, safe
deprivation of opportunities to health, education, skill, employment etc. Reasons for poverty in India:
Historical factors, for example imperialism and colonialism.

Over population
 Growth is not fast enough to eradicate poverty Models of growth may be unsuitable for poverty
alleviation. For example, capital-intense growth in a labour surplus country. Poverty itself
preventing investment and development.
 Widespread reliance on traditional methods of agriculture. About 55% of the population
depends on agriculture whereas the contribution of a GOP is 15%. While services are growing
in double digit figures, agriculture growth rate has been around 4.8% to 2% Geographic
factors, for example lack of fertile land and access to natural resources.
 Anti-poverty schemes not being effective due to institutional and other inadequacies
 War, including civil war, genocide Lack of education and skills Gender discrimination

Headcount ratio

 It is described as the percentage of the population whose per capita income is below the poverty
line, that is, the population which is not able to buy a basic basket of items. It is also called
poverty rate or incidence of poverty or number of people who are below the poverty line or BPL.

Poverty Gap

 Poverty Gap is a measure of the intensity of

poverty among the poor. It is the difference
between the mean income of the poor and the
poverty line. This indicator measures the
magnitude of poverty as well as its intensity
i.e. Number of poor and how poor they are.
The Poverty Gap Index is the combined
measurement of incidence of poverty and
depth of poverty. PG is also called the foster
index.

Poverty Line in India: Its Meaning, Concept and Evolution

It should be noted that determination of poverty line and identification of poor/beneficiary are almost
different things. Poverty line is (or was) determined by planning commission on the basis of data provided
by national sample survey organization (NSSO). NSSO conducts a survey at 5 year interval of a mere
sample to capture consumption patterns of various sections of society. It is taken care that the sample
size represents character of the nation (or a state) as a whole. This gives us data about various classes of
consumption in the sample size (for eg say how many people out of sample size consume what food? How
many calories/ nutrients they get? What is there expenditure on food and nonfood items such as clothes?
What people eat most within food- cereals pulses,
fruits?) What are the patterns? And so on. This is
goldmine of information that planning commission
seeks.
Planning commission quantifies (in terms of money)
the calorific / nutritional needs for a basic minimum
living by taking an ideal, poverty line basket. This
ideal basket includes food and nonfood items which
are recommended by expert groups (among other
things) which are constituted from time to time. So
we will have a monetary figure (Rs 16/25/32 etc)
which that expert panel considers benchmark poverty
line. Then this poverty line is adopted by Planning
Commission .For determination of this figure, reliance
is obviously placed on data provided by NSSO.
156 Basics of Economy

Now we have poverty line figure based on a minor sample and we need to determine number of poor in
the country i.e. people whose consumption expenditure is below this poverty line. For this ratio of poor to
the total sample size is replicated on to total population of the country. For e.g. if sample survey size was
of 2,00,000 households and 50000 households are found to be consuming below the poverty line figure
then 25% of total population of country will be considered below poverty line.
As we can see, in a given course of determination of poverty line and estimation of number of poor there
is no identification of particular households. Number of poor below poverty line in this sense is just a tool
to measure effectiveness of government policies and make interstate, international or temporal
comparison. Other product of this exercise is poverty line. And it might be (or not be) used for actual
identification of poor/ beneficiaries.
Ministry of rural development is conducting BPL census for rural poor since 1992 on the basis on which
rural poor are actually identified. In case of urban poor there no uniform mechanism in place and state
government / UT administration adopt their own methodology for identification.

Absolute poverty VS Relative poverty

Under absolute poverty certain minimum basic standards of living are defined and people living below
theses standards are termed in policy as poor or below poverty line. This is done by determining a poverty
line basket and calculating monetary figure of that basket (as in India) which varies across countries.
In contrast relative poverty is measured in relation to rich people of the country. In this method, certain
percentage of economically bottom population is always considered below poverty line. In these countries,
BPL people may have all basic amenities and reasonable standard of living, but as their income is far
below national per capita income they are considered as BPL.

Poverty line basket

Determining composition of the basket is one of the most debated parts of the issue. To make a living,
people consume innumerable items. Apart from food, housing, fuel, health, education, communication,
transport, entertainment/recreations are the things which are important. But whether they should be
included or not in the basket and if included then what should be their respective weights is always in the
debate. Whether health should get preference over housing or whether expenditure on recreation should
be included in the basket are the toughest questions to be answered. Problem is that these are qualitative
aspects and they need to be quantified in monetary terms. Further, consumption varies as per age groups,
occupation, region, cultures and gender, this variation is hard to capture.
Historically focus of India‘s poverty like basket policy has been on consumption of calories which was first
adopted in 1970s on recommendation of Alagh committee. It was believed that 2400 calories in rural areas
and 2100 calories in urban areas were sufficient to give good nutritious health to citizen. In this sense,
number or percentage of people below poverty line and those of under or malnutrition people should be
roughly same. But it is known that under nutrition is more rampant and widespread than poverty and
outscores ratio of BPL people by huge margin .This forced our policy makers to look for other determinants
of nutritional status and they found that pre natal/ birth health of mother, post natal care of babies,
sanitation, open defecation, health and educational infrastructure has decisive impact on nutritional status
of people. Lack ( or presence ) of many these things has pushed significant numbers of people towards
under nutrition , even when they consumed more than needed calories. These issues were taken into
account by Tendulkar committee to some extent.

Reference period

During the survey, NSSO workers will ask certain questions to the people. Period covered by these
questions is called reference period, care has to be taken that this period is representative of general
pattern of consumption. If we take poverty line basket it will cover food and nonfood items. In case of
food, expenditure is routine and a particular month‘s consumption can give us data which represents
general pattern. If we take consumption pattern of nonfood items such clothes or footwear, we find that in
normal households, these are once or twice in year expenditure. If we take a reference period of 30 days
for these products, we will find that in majority of households no expenditure at all. So reference period
should be different for different category items.

Income Based Poverty Line versus Consumption Based Poverty Line

We have seen that NSSO captures consumption expenditure which is used by planning commission to
determine poverty line. An alternative way of calculation of poverty line can be one based on income of
the population, but till now all committees have favored consumption based poverty line due to the
following factors-Huge majority of population has irregular income. Most of them are in informal sector
 Basics of Economy 157

which consists of self-employed people daily wage laborers etc. Income of this group is variable both
temporally and spatially, while consumption pattern are comparatively much stable.
Even in case of regular wage earners, there are additional side incomes in many cases, which is difficult to
account. For e.g. MGNREGA provides employment for about 100 days, for rest the time too people will
earn something.
NSSO sample based surveys use a reference period (say 30 days) .They will ask households under survey
about their consumption in last 30 days. Thus they take a representative of general consumption of those
households. This is not possible in case of income.
So we can conclude that in absence of reliable data income based approach cannot be relied upon.

Evolution of poverty line in India

One of the earliest estimations of poverty was done by Dababhai Nairoji in his book, ‗poverty and the un-
British rule in India‘. He formulated a poverty line ranging from RS 16 to RS 35 per capita per year based
on 1867-68 prices. The poverty line proposed by him was based on the cost of a subsistence diet
consisting of rice or flour, dhal, mutton, vegetables, ghee, vegetable oil and salt.

Working group of planning commission 1962

This was first created by planning commission to

determine desirable minimum level of expenditure
required to make a living.
It recommended national minimum consumption
expenditure for households of rural- Rs 100/Month (Rs
20/ person) urban – Rs 125/ Month (Rs25/person). It
excluded health and educational expenditure on
assuming that it is provided by state. It used
recommendation on balanced diet by Indian council of
medical research.

Task force of 1979 under Dr. Alagh

Poverty line of 1962 was used during 1960s and 1970s at both national and state level. But it attracted
intense debate for its low figures. In response taskforce under Dr. Y.K Alagh was created to revisit poverty
line.
Average calorie requirement was estimated, separately for the all India rural and urban areas on the
recommendation of nutrition expert group. This resulted in different poverty line basket for urban and
rural areas. The estimated calorie norm was 2400 cal per capita per day in rural areas and 2100 cal per
capita in urban areas.
Now these calorie requirements needed some monetary value which can be determined by ascertaining
quantity of consumption and ‗price/value‘ of that quantity. Data relating to quantity and value was
provided by NSSO survey.
It was estimated that on an average, consumer expenditure ( food and non-food) of Rs 49.09 per capita
per month was associated with a calorie intake of 2400 capita per day in rural areas and Rs 56.64 per
capita per month with a calorie intake of 2100 per day in urban areas . This monthly per capita
expenditure was termed as poverty line. This poverty line was used for upcoming years after adjusting for
rise in prices.

Expert group 1993 (Lakdawala)

This panel didn‘t redefine poverty line and retained

mechanism defined by Alagh expert group but with
some changes.
Instead it disaggregated all India poverty line to
state specific poverty line (using fisher index) for
base year 1973-74.
For latter periods these rural and urban poverty lines
of states were updated by taking into account
(a) consumer price index-agricultural labor, for rural
state specific poverty line and
(b) CPI – industrial workers for urban state specific
poverty line.
158 Basics of Economy

Then all India poverty ratio (rural and urban) was derived through population based weighted average of
poverty ratios of various states.
Hence, poverty line of India is converted in to state poverty lines while poverty ratio of states was
aggregated to all India poverty ratios.
Poverty line is based on consumption expenditure which gets affected by inflation. So for latter years
poverty lines are increased using CPI- AL/IW. They won't calculate new poverty line every year. CPI AL
doesn‘t include housing component, but CPIIW includes it. Group was able to give state specific poverty
lines of only 18 states as in other states adequate data was not available. For these remaining states
poverty line was determined by equating them with one of the 18 states on basis of physical contiguity
and similarity of economic profile of those states. This mechanism was adopted by planning commission
and was used till 2011 when recommendations of Tendulkar expert group were adopted.

Expert group 2005(Tendulkar)

Largely it adopted the same poverty line as given by

Lakdawala committee and major departures were:
It adopted ‗mixed reference period‘ in place of ‗uniform
reference period‘. During previous methodologies, a uniform
reference period was used that included 30 days just before
the survey for all food and non food items , but Tendulkar
group changed ‗reference period‘ to past one year for 5
nonfood items viz, clothing, footwear, durable goods,
education and institutional medical expenses. For other
items 30 day reference period was retained, this is called
mixed reference period.
Further, it recommended a shift away from basing the poverty line basket (PLB) in caloric intake and
towards target nutritional outcomes.
It called for an explicit provision in the poverty line baskets to account for private expenditure in health
and education.
Alagh committee in 1979 had adopted separate PLB for urban and rural areas, but Tendulkar committee
ended this practice by using a uniform basket (for both rural and urban) based on previous urban poverty
line basket. These changes were made for base year 2004-05 and ahead, these rendered past poverty
lines incomparable with new one as they were based on URP and separate baskets for rural and urban
India. Poverty line was in form of Rs per capita per month. National poverty lines (in Rs per capita per
month) for the years 2004-05, 2009-10 and 2011-12 were:

Year urban Rural

2004-05 578.8 446.7
2009-10 859.6 672.8
2011-12 1000.0 816.0

As per the expert group, these expenditures were sufficient to cover food and nonfood expenditure,
including that on health and education. This created furor in public and government was forced to appoint
a new expert group under Dr. Rangarajan.
It is often said that Tendulkar poverty line is equivalent to World Bank‘s $1 or $ 1.25 in BP terms. This is
purely incidental and poverty line calculated by Tendulkar had nothing to do with world bank
methodologies , but government often defended poverty line claiming that it is as per global standards.

Expert group, 2012 (Rangarajan)

Expert group submitted its report in 2014 giving per capita monthly expenditure as Rs 972 in rural areas
and Rs 1407 in urban areas as poverty line. It preferred to use monthly expenditure of households of five
for poverty line purpose which came out to be RS 4860 in rural areas and RS 7035 in urban areas. It
argued that considering expenditure of household is more appropriate than of individuals. Living together
brings down expenditure and expenses such as house rent, electricity etc. gets divided into 5 members.
 Basics of Economy 159

Other major recommendations were:

It reverted to old system of separate poverty line basket for
rural & urban areas, which was unified by Tendulkar group.

Instead of mixed reference period it recommended modified

mixed reference period in which reference period for
different items were taken as:

365 days for clothing, footwear, education, institutional

medical care and durable goods, 7 days for edible oil, egg
and fish and meat ,vegetables, fruits, spices, beverages,
refreshment , processed food, pan, tobacco and intoxicant
and 30 days for remaining food items such as fuel and light,
miscellaneous goods and including non-institutional medical expenses, rent and taxes.
As per these estimates the 30.9% of the rural population and 26.4% of the urban population was below
the poverty line in 2011-12.

World Bank’s poverty line

The approach of poverty estimation by the World Bank is similar

to that employed in India in most of the developing countries.
The international poverty line is set at $2.15 per person per day
using 2017 prices.

Current Status: Arvind Panagariya Task Force

The discussion about Lakdawala Formula, Suresh Tendulkar

Committee and Rangarajan Committee make it clear that
defining a poverty line in India has been a controversial issue
since 1970s. The latest poverty line was defined was by
Rangarajan Formula. However, this report also did not assuage
the critics. The new NDA Government turned down this report also.
To define the poverty line, The NDA Government constituted a 14-member task force under NITI Aayog‘s
Vice-chairman Arvind Panagariya to come out with recommendations for a realistic poverty line. After one
and half years work, this task force also failed to reach a consensus on poverty line. In September 2016, it
suggested to the government that another panel of specialists should be asked to do this job of defining
poverty line. Informally, this committee supported the poverty line as suggested by Tendulkar Committee.
Why defining poverty line is a controversial issue? Most of the governments have mothballed the reports of
committees and panels because this issue is not only politically sensitive but also has deeper fiscal
ramifications. If the poverty line is low, it may leave out many needed people; while if it is high, then it
would be bad for fiscal health of the government. Third, there is a lack of consensus among states too. We
note that some states such as Odisha and West Bengal supported the Tendulkar Poverty Line while others
such as Delhi, Jharkhand, Mizoram etc. supported Rangarajan Line. Thus, no one, including NITI Aayog
wants to bell the cat when it comes to count number of poor in the country.

Global Multidimensional Poverty Index

 The Multi-dimensional Poverty Index (MPI) defines poor not only on the basis of income but on
other indicators, including poor health, poor quality of work and the threat of violence. MPI is
composed of ten indicators spread across:
 Education: years of schooling and child enrollment.
 Health: child mortality and nutrition.
 Standard of living: Electricity, flooring, drinking water,
 The MPI captures both the incidence and intensity of poverty and tracks 109 countries on
deprivations across ten indicators in health, education, and standard of living.

Index is developed by the Oxford Poverty and Human Development Initiative (OPHI) and
the United Nations Development Programme (UNDP).

As per report a single measure is not a sufficient guide to both inequality and multidimensional poverty,
and studies such as the MPI, Human Development Index, and the Gini coefficient (which measures
countries wealth- income distribution), can contribute important and distinctive information for policy
action to effectively reduce poverty.
160 Basics of Economy

Increasing Inequality
In spite of rising incomes, the inequalities have also been
widening which is a major challenge to inclusive growth. The
income disparities between the poorest and the richest in both
rural & urban areas and between urban & rural population are
on the rise. In urban India, this inequality has widened much
faster.

Lorenz curve
It was developed by Max O. Lorenz as a graphical
representation of income inequality.
The Lorenz curve is used to calculate the Gini coefficient which
is the numerical indicator or inequality

Gini Coefficient
To compute the Gini Coefficient, we first measure the area between the Lorenz Curve and the 45 degree
equality line. This area is divided by the entire area below 45 degree line (which is always exactly one
half). The quotient is the Gini coefficient, a measure of inequality.
For a perfect equality, there would be no area between the 45 degree line and the Lorenz curve - a Gini
coefficient of zero. For complete inequality, in which only one person has any income (if that were
possible).The Gini coefficient of most of the economies stays between zero and one.

Adverse impact of inequality

Growing inequalities can dampen growth due to potential instability; weaken social cohesion.
Urban-dominated growth in India has caused social friction as a result of the high levels of migration to
cities and a shortage of foreign investment in more isolated areas.
In societies where wealth is concentrated in the hands of a few, there is danger of policy levers being
captured by the rich for their own benefit and a weakening of the institutional foundations of the growth
process.

Kuznets Curve
Economist Simon Kuznets had hypothesized that as an economy develops, inequality increases but later
reduces. In other words, the shape of the Kuznets curve is like an inverted U. Japan, Germany and some
other social democracies in Europe support the hypothesis.

Kuznets Curve and Thomas Piketty

Kuznets Curve says that the natural progression of development is towards industrialization and
urbanization. Initially, this leads to increased inequality in society, as capitalists get richer and the influx of
rural labour holds wages down. But as employment opportunities grow and the flow of cheap rural labour
is no longer there, wages rise and an equalization tendency appears, which gets stronger over time. Thus,
if we plot inequality against time, we get an inverted U or bell-shaped curve.
The recent work of Thomas Piketty, ‗Capital in the Twenty-First Century‘, questions the Kuznets Curve.
Piketty show‘s that since 1980, there has been a sharp rise ―in inequality in the US, Japan and Europe. His
data shows a U-curve in the trends of inequality in the advanced nations - US, Japan, Germany, France
and Great Britain - the exact opposite of the Kuznets Curve. Inequality grows sharply after having fallen
initially for a few years.
Piketty shows that there is nothing natural or automatic about declining inequality under market system. It
is the destruction of war, the policies of a Keynesian welfare state and a strong, labour movement that led
to a decline in inequality in the 60-year period (1914-1974). The trend shifted towards greater market
forces and so inequality rose again since the 1980‘s and the result is the rise in inequality.

RISING INEQUALITIES IN INDIA

These designs along with accumulated inheritances has consequently, seen the share of the poorer lot dip
continuously in the wealth matrix.

Regional divergence: Differential wealth between states existed even before independence and the
Indian planning process had aimed to undo this. But the outcome has not been as expected as income
inequality between states has been found to be continuously increasing over time.
Hence, the rise in inequality in India is due to growing income divergence between states and increasing
unequal income distribution within states.
 Basics of Economy 161

Caste Groups - Among various social groupings, SCs continue to remain the most disadvantaged, with a
significantly lower per-capita income share. Also, declining trend in the income shares for the ST group,
with a corresponding increase in the share of others has been deciphered.

Religion - Religious identities too has been found to be significant for an individual‘s access to basic
services, and his ability to mobilize resources. In some cases, these may cause isolation, exclusion, and
stereotyping of communities, which can impact jobs and livelihood opportunities.
Significantly, smaller minorities such as Christians, Parsis and Jains have a larger share of
income/consumption than their population share.
But for Muslim populations, this is not the case and they even seem to fare worse than SC and STs in
urban areas. The share of Muslims in national income (per-capita), has also indicated a decline over a
period of time, both in rural and urban areas.
Constitutional Provision

Enforcement of Constitutional Guarantee of equality as enshrined in fundamental rights. Articles 14, 15

and 16 form part of a scheme of the Constitutional Right to Equality. Article 15 and 16 are incidents of
guarantees of Equality, and gives effect to Article 14.
 Taxation - Measures undertaken to improve tax compliance include SAHAJ forms, Aykar setu
mobile app etc.
 Black Money Act - to penalize non-disclosure of assets/ income and to provide for the imposition
of tax thereon. This would be instrumental in augmenting tax revenues.
 Demonetization followed by digitization of the economy helped in formalizing transactions, thus
improving tax collections
 The launch of Skill India Mission, PM Kaushal Vikas Yojana - to enhance the employability of youth
and thereby improve their income.
 Make in India, Start-up India etc. - to create employment opportunities.
 eNAM, PM Krishi Sinchai Yojana, Soil Health Card etc. with a vision to double farm incomes. The
launch of SAMPADA scheme to promote food processing industries to generate low skill-intensive
jobs.

Do the recently proposed policies live up to the Indian inequality challenge?

On 8-9th January 2019, the Indian Parliament reached a consensus on the 124th Constitutional
Amendment Bill (the so-called 10% reservation bill). The law proposed a 10% reservation for the
economically weaker section (EWS) of society, who till then were not included in any existing reservation.
Accordingly, the 103rd Constitutional Amendment Act was passed and the reservation was
implemented.

Thresholds defining Economically Weaker Sections for eligibility of reservation

Category Threshold
Annual Household <Rs.800,000
Income
Agricultural Land <5 acres
Residential House Area <1000 Sq. ft.
Residential Plot <900 [Link]. – Notified municipality
<1800 [Link]. – Notified municipality

 Using available household income data, we find that only 7% of the households are above this
threshold, implying 93% are eligible for the reservation.
 Consequently, 96% of households are currently eligible for the reservation under these criteria
alone. If we consider only the Indian rural population, 92% of the households are eligible with the
current threshold.
 If one tinkers the threshold to target precisely the Bottom 50% (based on agricultural land area)
of the population for reservation policies, the threshold should be set at 0 acres or households with
no agricultural land at all India level
 Households owning more than 1000 sq. ft. of residential house area are excluded from the new
reservation policy. There are currently about 20% of the households (within non-reserved class)
owning more than 1000 sq. ft. of house area. In order to target the Bottom 50% 5 of the
population based on a housing criterion, the threshold should be reduced by half and set at 500
sq. ft.
 Economic reservation stands out more as a political stunt than an inequality reduction policy:
under many of the thresholds that have been proposed, most of the population would benefit from
the policy, which makes it difficult to call it an economic reservation policy at all.
162 Basics of Economy

 In Rural areas, applying the threshold of agricultural land area and building residential area
simultaneously makes 77% of the rural population eligible for reservation. In urban areas, if a
stricter threshold on residential land plot (i.e. less than 900 sq. ft.) was applied, 66% of the urban
population would be eligible. This shows that the combined thresholds would not do much in order
to better target the socio-economically more deprived groups.

Eligibility by combined threshold

Within Non Reserved class

% of households eligible for reservation
Rural Urban Urban
Agricultural Agri Land Area Building Building Building Building
Land Area + Building Residential Residential Residential Residential
Residential Area Area + Land Area Area + Land
Area Plot residential Plot residential
(<900 sq ft) (<1800 [Link])
92.6 77 79 66.4 79 73.6

Key: In rural area 77% of households and in urban area 74% of households are eligible.

Unemployment
It is a situation in which individuals are ready & willing to work at the prevailing rate of wages but are not
able to get work.
NSSO defines unemployment as a situation in which all those, owing to lack of work, are not working but
either seek work & express their willingness or availability for work under the prevailing condition of work
and remuneration.

Amount of Unemployment = Labour Force – Work force

Where, work force = working or being engaged in economic activity and labour force = work force + not
engaged in economic activity and are making tangible efforts to seek work or being available for ‗work‘ if
the work is available.

Labour Force: It consists of the people aged 15 and up to 59 years, who are employed and unemployed
(people who don‘t have jobs but are looking for work) and those who are in this age group but not looking
for work (like students).

Work Force: That part of labour force which is employed.

Employment elasticity: percentage change in employment induced by changes in G.D.P. Hence,

elasticity of employment seeks to capture the responsiveness of labour market to changes in macro
economic conditions as represented by G.D.P growth.

Employment Rate: Ratio of employed to (employed+ unemployed)

Unemployment is referred as the percentage of number of unemployed people to that of the labour force.

Unemployment % = Unemployed people x 100%

Labour Force

Measuring Unemployment- Currently, the National Sample Survey Office (NSSO) is the principal source
of data on employment and survey rounds of sample populations are done once in five year. Recently the
Ministry of Statistics and Programme Implementation, has decided to conduct quarterly and annual
surveys of employment.

National Sample Survey Organization (NSSO), uses three different concepts to estimate the rate of
unemployment.

Chronic or Usual Principal Status- Here the reference period is one year. It is measured in number of
persons, that is, persons who remained employed/ unemployed for a major part of the year. A person is
considered employed/unemployed/not in the labour force if he was working/not working but was either
seeking or was available for work/not working and also not available for work for a relatively longer time
throughout the reference year.
 Basics of Economy 163

Here we classify persons into number of ‗employed‘, ‘unemployed‘ and ‗not in the labour force‘ category
and we do not measure the intensity of employment or unemployment.
This measure is more appropriate for those who are in search of regular employment, e.g. educated and
skilled persons.
The estimates are made in terms of the average number of persons per year in each activity status; say
10 lakh persons/year.

Current Weekly Status

Here the reference period is one week. A person is considered employed/unemployed/not in the labour
force if he has worked at least one hour during the reference period/not worked even one hour but was
seeking or was available for work/not working and also not available for work.
If a person is employed even for an hour in a week, he is considered employed.
164 Basics of Economy

Here we classify persons into number of employed and unemployed category and we do not measure the
intensity of employment or unemployment. The estimates are made in terms of the average number of
persons per week in each activity status, say 10 lakh persons per week.

Current Daily Status

Here also, the reference period is one week like the Current Weekly Status. Current daily Status records
the activity status of a person for each day in the seven days preceding the week of survey.
Each day of the reference week is looked upon as consisting of either two ‗half days‘ or one ‗full day‘ for
assigning the activity status.

A person is considered ‗working‘ (employed) for the entire day if he had worked for 4 hours or more during
the day.

If the person had worked for 1 hour or more but less than 4 hours, he is considered ‗working‘ (employed)
for half day. In the balance half day, if seeking or available for work, but is not getting it, he is considered
as unemployed for half day. If neither seeking nor available for work, then he is considered as not in the
labour force for half day.

If a person was not engaged in ‗work‘ even for 1 hour in a day but was seeking/available for work for 4
hours or more, he is considered ‗unemployed‘ for one full day.

If a person was ‗seeking/available for work‘ for more than 1 hour and less than 4 hours only, he is
considered ‗unemployed‘ for half day and ‗not in labour force‘ for the other half of the day.

A person who neither had any work to do nor was available for work even for half a day(even for 1 hour),
was considered not in labour force for the entire day.

Here, the number of days a person worked and number of days not worked is clearly recorded. It is more
than mere classification of employed and unemployed worker. That is, the intensity of employment and
unemployment is also measured. It is measured in person days or person years, say 10 lakh person days
of employment. Here it does not mean that 10 lakh persons are employed. This 10 lakh person days of
employment may be of 1 lakh workers for 10 days.

It is considered to be a comprehensive mea- sure of unemployment, as it measures chronic unemployment

as well as under employment on weekly basis.

Types of Unemployment

Cyclical Unemployment: It comes around due to the business

cycle itself. It increases during periods of recession (during
down phase of the cycle) and falls during periods of economic
growth (up phase of the economic cycle). In the aftermath of
USA sub-prime crisis, many people lost their jobs. This was a
case of cyclical unemployment.

Frictional Unemployment: This kind of unemployment occurs

when a person leaves/loses a job and starts looking for another
one. This search for a job may take a considerable amount of
time resulting in frictional unemployment.

Seasonal Unemployment: This kind of unemployment is expected to occur at certain parts of the year.
For example, the people at hill stations may experience seasonal unemployment during the winter months
because less people will visit these areas during this time. Another case could be the seasonal
unemployment in agriculture.

Structural Unemployment: This kind of unemployment happens when the structure of an economy
changes. It essentially occurs because there exists a mismatch of skills between the skills of the
unemployed and skills needed for the job. Eg when computers came, the people who worked on type
writers became unemployed.
 Basics of Economy 165

Underemployment: this term can be used in multiple

connotations but one of the major usages is to showcase a
situation where a person with high skills works in low wage
and low skills [Link] a Ph.D scholar working as a peon.

Disguised Unemployment: It occurs when people are

employed in a job where their presence or absence does not
make any difference to the output of the economy. It is a
special kind of case. Here people are apparently employed
but their marginal product is zero (contribution to
production is nil).Marginal product here refers to the
produce added to the existing production due to addition of a new employee/ worker. e.g., if 4 persons are
employed in a factory and they produce 17 units and fifth person is added and the production increases to
19 units, the addition- al 2 units is marginal product. Here, we can consider the fifth person as employed.
If there is no increase in production, the marginal product is zero and he is disguisedly unemployed. Even
if he is removed from the activity, there will be no decline in production.
Such type of unemployment is quite common in the agricultural sector in India. Because of the large
families in the rural areas several people work on farms and at time, the work of 2-3 people is done by 4-5
people because otherwise it would result in unemployment. But in reality this is nothing but a case of
disguised unemployment.

Voluntary Unemployment: One is classified as voluntary unemployed, if he or she is not employed and
is not willing to join the workforce. It is mostly because people choose not to work below a certain income
level after ‗investing‘ in education. There has been a dramatic rise of voluntary unemployment across the
country

Open unemployment: This refers to a situation when there are some workers who have absolutely no
work to do. They are willing to work at the prevailing wage rate, but they are forced to remain
unemployed in the absence of work. These workers are completely idle. Such unemployment is clearly
visible as the number of such persons can be clearly counted and therefore it is known as open
unemployment.

Reasons for Unemployment

1. Defective education system – Failing education system that creates thousands of unemployable
graduates. Aspiring minds latest National Employability Report reveals that there is no massive
progress on the employability on Indian engineers as over 80 percent continue to be
unemployable.
2. Slow economic growth – Inadequate job creation (the non-farm sector eg. Manufacturing sector
needs to be encouraged as land is limited and can create only limited jobs and also agriculture is
seasonal)
3. Lack of infrastructural development which creates job and facilities job creation.
4. Rapid population growth – making large addition in the labour force.
5. Inadequate employment planning by government in companies to the growth. For e.g. skilling
missions were fragmented across different ministries earlier.

Organized and Unorganized Sectors

Sectors of economy are majorly divided into three categories: primary, secondary and tertiary. Based on
the employment conditions, these are further classified as organized and unorganized sectors

Organized sector: The sector that is registered with the government is called an organized sector. In this
sector, the employment terms are fixed and regular. A number of acts apply to enterprises covered under
the organized sector. In this sector, employment terms are fixed and employees have assured work. This
sector is governed by various acts such as Factories Act, Bonus Act, Provident Fund Act, Minimum Wages
Act, etc. Usually monthly salary is given.
166 Basics of Economy

Benefits of being in the organized formal sector

 Workforce gets regular income

 Government, through its labour laws, enable them to protect their rights in various ways
 This section of the workforce has trade unions and has ability to bargain with employers for better
wages and other working conditions etc.
 The formal sector enjoys social security benefits
 Earn more than those in the informal sector. Wages are, on average, more than 20 times higher in
the formal sector.

Formal sector jobs also score better on some non – pecuniary grounds. For example, they allow workers to
build employment history which is important for gaining access to cheaper formal credit.

Unorganized sector

 The sector that is not registered with the government and whose terms of employment are not
fixed and regular is considered an unorganized sector. In this sector, no government rules and
regulations are followed. The sector that comprises small-scale terms enterprises or units which
are not registered with the government. It is not governed by any act. Here remuneration is
mostly in daily wages.

Indian Context: Nearly 93% of the Indian workforce is in the unorganized sector and only 7% is in the
organized sector. Almost all the workforce in the primary sector is part of the unorganized sector. The
unorganized sector is not covered under various laws and thus lacks bare minimum social security benefits
such as pension, insurance, etc.
 Question Bank 167

Economy Test 01 6. In the context of Indian economy, consider

the following statements :

1. Which of the following gives ‗Global Gender A. The growth rate of GDP has steadily
Gap Index‘ ranking to the countries of the increased in the last five years.
world? B. The growth rate in per capita income has
steadily increased in the last five years.
1. World Economic Forum
2. UN Human Rights Council Which of the statements given above is/are
3. UN Women correct?
4. World Health Organization
1. A only 2. B only
2. Which of the following is/are the 3. Both A and B 4. Neither A nor B
indicator/indicators used by IFPRI to compute
the Global Hunger Index Report? 7. Which of the following can aid in furthering
the Government‘s objective of inclusive
A. Undernourishment growth?
B. Child stunting
C. Child mortality A. Promoting Self-Help Groups
B. Promoting Micro, Small and Medium
Select the correct answer using the code Enterprises
given below. C. Implementing the Right to Education Act

1. A only 2. B and C only Select the correct answer using the codes
3. A, B and C 4. A and C only given below:

3. Economic growth in country X will necessarily 1. A only 2. A and B only

have to occur if 3. B and C only 4. A, B and C

1. there is technical progress in the world 8. Economic growth is usually coupled with
Economy
2. there is population growth in X 1. Deflation 2. Inflation
3. there is capital formation in X 3. Stagflation 4. Hyperinflation
4. the volume of trade grows in the world
Economy 9. Consider the following countries:

4. The national income of a country for a given A. Brazil B. Mexico C. South Africa
period is equal to the
According to UNCTAD, which of the above
1. Total value of goods and services is/are categorized as ―Emerging Economies‖?
produced by the nationals.
2. Sum of total consumption and investment 1. A only 2. A and C only
expenditure. 3. B and C only 4. A, B and C
3. Sum of personal income of all individuals.
4. Money value of final goods and services 10. In the context of Indian economy, consider
produced. the following pairs:

5. The Multi-dimensional Poverty Index Term Most appropriate

developed by Oxford Poverty and Human description
Development Initiative with UNDP support A. Melt down Fall in stock prices
covers which of the following? B. Recession Fall in growth rate
C. Slow down Fall in GDP
A. Deprivation of education, health, assets
and services at household level
Which of the pairs given above is/are
B. Purchasing power parity at national level
correctly matched?
C. Extent of budget deficit and GDP growth
rate at national level
1. A only 2. B and C only
3. A and C only 4. A, B and C
Select the correct answer using the codes
given below:

1. A only 2. B and C only

3. A and C only 4. A, B and C
168 Question Bank

11. With reference to BRIC countries, consider 15. Which of the following pairs about India‘s
the following statements: economic indicator and agricultural
production (all in rounded figures) are
A. At present, China‘s GDP is more than the correctly matched?
combined GDP of all the three other
countries. A. GDP per capita (current prices): 37,000
B. China‘s population is more than the B. Rice: 180 million tons
combined population of any two other C. Wheat: 75 million tons
countries.
Select the correct answer using the code
Which of the statements given above is/are given below:
correct?
1. A, B and C 2. A and B only
1. A only 2. B only 3. B and C only 4. A and C only
3. Both A and B 4. Neither A nor B
16. Which one among the following countries has
12. Stiglitz Commission established by the the lowest GDP per capita?
President of the United Nations General
Assembly was in the international news. The 1. China 2. India
commission was supposed to deal with 3. Indonesia 4. Sri Lanka

1. The challenges posed by the impending 17. As per the Human Development Index given
global climate change and prepare a road by UNDP, which one of the following
map sequences of South Asian countries is
2. The workings of the global financial correct, in the order of higher to lower
systems and to explore ways and means development?
to secure a more sustainable global order
3. Global terrorism and prepare a global 1. India—Sri Lanka–Pakistan—Maldives
action plan for the mitigation of terrorism 2. Maldives—Sri Lanka—India—Pakistan
4. Expansion of the United Nations Security 3. Sri Lanka—Maldives—India—Pakistan
Council in the present global scenario 4. Maldives—India—Pakistan—Sri Lanka

13. Inclusive growth as enunciated in the 18. With reference to the Indian economy,
Eleventh Five Year Plan does not include one consider the following activities:
of the following:
A. Agriculture, Forestry and Fishing
B. Manufacturing
1. Reduction of poverty
C. Trade, Hotels, Transport and
2. Extension of employment opportunities
Communication
3. Strengthening of capital market
D. Financing, Insurance, Real Estate and
4. Reduction of gender inequality
Business services
14. With reference to Indian economy, consider
The decreasing order of the contribution of
the following statements:
these sectors to the Gross Domestic Product
(GDP) at factor cost at constant prices
A. The Gross Domestic Product (GDP) has
(2000–01) is
increased by four times in the last 10
years.
1. C, A, B, D 2. A, C, D, B
B. The percentage share of Public Sector in
3. C, D, A, B 4. A, C, B, D
GDP has declined in the last 10 years.
19. Consider the following states:
Which of the statements given above is/are
correct?
A. Gujarat B. Karnataka
C. Maharashtra D. Tamil Nadu
1. A only 2. B only
3. Both A and B 4. Neither A nor B
The descending order of these states with
reference to their level of per capita Net
State Domestic Product is

1. A, C, D, B 2. C, A, B, D
3. A, C, B, D 4. C, A, D, B
 Question Bank 169

20. The most appropriate measure of a country‘s

economic growth is its
Economy Test 02
1. Gross Domestic Product 1. Consider the following statements:
2. Net Domestic Product
3. Net National Product A. The Fiscal Responsibility and Budget
4. Per Capita Real Income Management (FRBM) Review Committee
Report has recommended a debt to GDP
21. The term National Income represents ratio of 60% for the general (combined)
government by 2023, comprising 40% for
1. Gross national product at market prices the Central Government and 20% for the
minus depreciation State Governments.
2. Gross national product at market prices B. The Central Government has domestic
minus depreciation plus net factor income liabilities of 21% of GDP as compared to
from abroad that of 49% of GDP of the State
3. Gross national product at market prices Governments.
minus depreciation and indirect taxes plus C. As per the Constitution of India, it is
subsidies mandatory for a State to take the Central
4. Gross national product at market prices Government‘s consent for raising any loan
minus net factor income from abroad if the former owes any outstanding
liabilities to the latter.
22. The growth rate of per capita income at
current prices is higher than that of per Which of the statements given above is/are
capita income at constant prices, because the correct?
latter takes into account the rate of
1. A only 2. B and C only
1. growth of population 3. A and C only 4. A, B and C
2. increase in price level
3. growth of money supply 2. With reference to digital payments, consider
4. increase in the wage rate the following statements:

23. Indian Human Development Report does not A. BHIM app allows the user to transfer
give for each sample village money to anyone with a UPI-enabled bank
account.
1. Infrastructure and Amenities Index B. While a chip-pin debit card has four
2. Education Related Index factors authentication, BHIM app has only
3. Health Related Index two factors of authentication.
4. Unemployment Related Index
Which of the statements given above is/are
24. In an open economy, the national income (Y) correct?
of the economy is:
(C, I, G, X, M stand for Consumption, 1. A only 2. B only
Investment, Govt. Expenditure, total exports 3. Both A and B 4. Neither A nor B
and total imports respectively)
3. With reference to the ‗Prohibition of Benami
1. Y = C + I+G+X Property Transactions Act, 1988 (PBPT Act)‘,
2. Y = C + I+G–X+M consider the following statements:
3. Y = C + I + G + (X – M)
4. Y = C + I–G + X – M A. A property transaction is not treated as a
benami transaction if the owner of the
25. The first Indian state to have its Human property is not aware of the transaction.
Development Report prepared and released B. Properties held benami are liable for
by Amartya Kumar Sen in Delhi is confiscation by the Government.
C. The Act provides for three authorities for
1. West Bengal 2. Kerala investigations but does not provide for any
3. Madhya Pradesh 4. Andhra Pradesh appellate mechanism.

Which of the statements given above is/are

correct?

1. A only 2. B only
3. A and C only 4. B and C only
170 Question Bank

4. India‘s ranking in the ‗Ease of Doing Business Select the correct answer using the code
Index‘ is sometimes seen in the news. Which given below.
of the following has declared that ranking?
1. A only 2. B and C only
1. Organization for Economic Cooperation 3. A and C only 4. A, B and C
and Development (OECD)
2. World Economic Forum 9. With Reference to the Fourteenth Finance
3. World Bank Commission, which of the following
4. World Trade Organization (WTO) statements is/are correct?

5. With reference to ‗Financial Stability and A. It has increased the share of States in the
Development Council‘, consider the following central divisible pool from 32% to 42%
statements: B. It has made recommendations concerning
sector specific grants
1. It is an organ of NITI Aayog.
2. It is headed by the Union Finance Minister. Select the correct answer using the code
3. It monitors macro-prudential supervision given below.
of the economy.
Which of the statements given above is/are 1. A only 2. B only
correct? 3. Both A and B 4. Neither A nor B

1. A and B only 2. C only 10. With reference to Union Budget, which of the
3. B and C only 4. A, B and C following is/are covered under Non-Plan
Expenditure?
6. What is/are the purpose/purposes of
Government‘s ‗Sovereign Gold Bond Scheme‘ A. Defence expenditure
and ‗Gold Monetization Scheme‘? B. Interest payments
C. Salaries and pensions
A. To bring the idle gold lying with Indian D. Subsidies
house-holds into the economy
B. To promote FDI in the gold and jewellery Select the correct answer using the code
sector given below.
C. To reduce India‘s dependence on gold
imports 1. A only 2. B and C only
Select the correct answer using the code 3. A, B, C and D 4. None
given below:
11. In India, deficit financing is used for raising
1. A only 2. B and C only resources for
3. A and C only 4. A, B and C
1. economic development
7. There has been a persistent deficit budget 2. redemption of public debt
year after year. Which action/actions of the 3. adjusting the balance of payments
following can be taken by the Government to 4. reducing the foreign debt
reduce the deficit?
12. Which of the following is /are among the
A. Reducing revenue expenditure notice-able features of the recommendations
B. Introducing new welfare schemes of the Thirteenth Finance Commission?
C. Rationalizing subsidies
D. Reducing import duty A. A design for the Goods and Services Tax,
Select the correct answer using the code and a compensation package linked to
given below. adherence to the proposed design
B. A design for the creation of lakhs of jobs
1. A only 2. B and C only in the next ten years in consonance with
3. A and C only 4. A, B, C and D India‘s demographic dividend
C. Devolution of a specified share of central
8. Which of the following is/are included in the taxes to local bodies as grants Select the
capital budget of the Government of India? correct answer using the codes given
below :
A. Expenditure on acquisition of assets like
roads, buildings, machinery, etc. 1. A only 2. B and C only
B. Loans received from foreign governments 3. A and C only 4. A, B and C
C. Loans and advances granted to the States
and Union Territories
 Question Bank 171

13. In the Union Budget, a full exemption from 17. Which one of the following was not stipulated
the basic customs duty was extended to the in the Fiscal Responsibility and Budget
bio-based asphalt (bioasphalt). What is the Management Act, 2003?
importance of this material?
1. Elimination of revenue deficit by the end
A. Unlike traditional asphalt, bio-asphalt is of the fiscal year 2007–08.
not based on fossil fuels. 2. Non-borrowing by the central government
B. Bioasphalt can be made from from Reserve Bank of India except under
nonrenewable resources. certain circumstances.
C. Bioasphalt can be made from organic 3. Elimination of primary deficit by the end of
waste materials. the fiscal year 2008–09.
D. It is eco-friendly to use bioasphalt for 4. Fixing government guarantees in any
surfacing of the roads. financial year as a percentage of GDP.

Which of the statements given above are 18. Consider the following actions by the
correct? Government:

1. A, B and C only 2. A, C and D only A. Cutting the tax rates

3. B and D only 4. A, B, C and D B. Increasing the government spending
C. Abolishing the subsidies
14. Which one of the following statements
appropriately describes the ―fiscal, stimulus‖? In the context of economic recession, which
of the above actions can be considered a part
1. It is a massive investment by the of the ―fiscal stimulus‖ package?
Government in manufacturing sector to
ensure the supply of goods to meet the 1. A and B only 2. B only
demand surge caused by rapid economic 3. A and C only 4. A, B and C
growth.
2. It is an intense affirmative action of the 19. Which one of the following statements is
Government to boost economic activity in correct? Fiscal Responsibility and Budget
the country. Management Act (FRBMA) concerns
3. It is Government‘s intensive action on
financial institutions to ensure 1. fiscal deficit only
disbursement of loans to agriculture and 2. revenue deficit only
allied sectors to promote greater food 3. both fiscal and revenue deficit
production and contain food inflation. 4. neither fiscal deficit nor revenue deficit
4. It is an extreme affirmative action by the
Government to pursue its policy of 20. With reference to the Indian Public Finance,
financial inclusion. consider the following statements.

15. The authorization for the withdrawal of funds A. External liabilities reported in the Union
from the Consolidated Fund of India must Budget are based on historical exchange
come from rates.
B. The continued high borrowing has kept the
1. The President of India real interest rates high in the economy.
2. The Parliament of India C. The upward trend in the ratio of Fiscal
3. The Prime. Minister of India Deficit to GDP in recent years has an
4. The Union Finance, Minister adverse effect on private investments
D. Interest payments are the single largest
16. When the annual Union Budget is not passed component of the non-plan revenue
by the Lok Sabha, expenditure of the Union Government.
Which of these statements are correct?
1. the Budget is modified and presented
again 1. A, B and C 2. A and D
2. the Budget is referred to the Rajya Sabha 3. B, C and D 4. A, B, C and D
for suggestions
3. the Union Finance Minister is asked to 21. Consider the following:
resign
4. the Prime Minister submits the resignation A. Market borrowing
of Council of Ministers B. Treasury bills
C. Special securities issued to RBI
172 Question Bank

Which of these is/are component(s) of 25. With reference to India economy, consider
internal debt? the following:

1. A only 2. A and B A. Bank rate

3. B only 4. A, B and C B. Open market operations
C. Public debt
22. Which of the following statements is/are D. Public revenue
correct regarding the Monetary Policy
Committee (MPC)? Which of the above is / are component /
components of Monetary Policy?
A. It decides the RBI‘s benchmark interest
rates. 1. A only 2. B, C and D
B. It is a 12-member body including the 3. A and B 4. A, C and D
Governor of RBI and is reconstituted every
year.
C. It functions under the chairmanship of the
Union Finance Minister.

Select the correct answer using the code

given below:

1. A only 2. A and B only

3. C only 4. B and C only

23. What is/are the purpose/purposes of the

`Marginal Cost of Funds based Lending Rate
(MCLR)‘ announced by RBI?

A. These guidelines help improve the

transparency in the methodology followed
by banks for determining the interest
rates on advances.
B. These guidelines help ensure availability of
bank credit at interest rates which are fair
to the borrowers as well as the banks.

Select the correct answer using the code

given below.

1. A only 2. B only
3. Both A and B 4. Neither A nor B

24. With reference to ‗Bitcoins‘, sometimes seen

in the news, which of the following
statements is/are correct?

A. Bitcoins are tracked by the Central Banks

of the countries.
B. Anyone with a Bitcoin address can send
and receive Bitcoins from anyone else with
a Bitcoin address.
C. Online payments can be sent without
either side knowing the identity of the
other.

Select the correct answer using the code

given below.

1. A and B only 2. B and C only

3. C only 4. A, B and C
 Question Bank 173

Economy Test 03 The correct sequence of these assets in the

de- creasing order of liquidity is

1. When the Reserve Bank of India reduces the 1. A-D-C-B 2. D-C-B-A

Statutory Liquidity by 50 basis points, which 3. B-C-A-D 4. D-A-C-B
of the following is likely to happen?
6. In the context of Indian economy, ‗Open
1. India‘s GDP growth rate increases Market Operations‘ refers to
drastically
2. Foreign Institutional Investors may bring 1. borrowing by scheduled banks from the
more capital into our country RBI
3. Scheduled Commercial Banks may cut 2. lending by commercial banks to industry
their lending rates and trade
4. It may drastically reduce the liquidity to 3. purchase and sale of government
the banking system. securities by the RBI
4. None of the above
2. The terms ‗Marginal Standing Facility Rate‘
and ‗Net Demand and Time Liabilities‘, 7. An increase in the Bank Rate generally
sometimes appearing in news, are used in indicates that the
relation to
1. Market rate of interest is likely to fall
1. banking operations
2. Central Bank is no longer making loans to
2. communication networking
commercial banks.
3. military strategies
3. Central Bank is following an easy money
4. supply and demand of agricultural
policy
products
4. Central Bank is following a tight money
Policy
3. In the context of Indian economy, which of
the following is/are the purpose/purposes of
8. The Reserve Bank of India (RBI) acts as a
‗Statutory Reserve Requirements‘?
bankers‘ bank. This would imply which of the
following?
A. To enable the Central Bank to control the
amount of advances the banks can create
A. Other banks retain their deposits with the
B. To make the people‘s deposits with banks
RBI.
safe and liquid.
B. The RBI lends funds to the commercial
C. To prevent the commercial banks from
banks in times of need.
making excessive profits.
C. The RBI advises the commercial banks on
D. To force the banks to have sufficient vault
monetary matters. Select the correct
cash to meet their day-to-day
answer using the codes given below:
requirements

Select the correct answer using the code 1. B and C only 2. A and B only
given below. 3. A and C only 4. A, B and C

1. A only 2. A and B only 9. Why is the offering of ―teaser loans‖ by

3. B and C only 4. A, B, C and D commercial banks a cause of economic
concern?
4. If the interest rate is decreased in an
economy, it will A. The teaser loans are considered to be an
aspect of sub-prime lending and banks
1. decrease the consumption expenditure in may be exposed to the risk of defaulters
the economy in future.
2. increase the tax collection of the B. In India, the teaser loans are mostly given
Government to inexperienced entrepreneurs to set up
3. increase the investment expenditure in manufacturing or export units.
the economy
4. increase the total savings in the economy Which of the statements given above is/are
correct?
5. Consider the following liquid assets:
1. A only 2. B only
A. Demand deposits with the banks 3. Both A and B 4. Neither A nor B
B. Time deposits with the banks
C. Savings deposits with the banks
D. Currency
174 Question Bank

10. The lowering of Bank Rate by the Reserve Which of the statements given above is/are
Bank of India leads to correct?

1. More liquidity in the market 1. A only 2. B only

2. Less liquidity in the market 3. Both A and B 4. Neither A nor B
3. No change in the liquidity in the market
4. Mobilization of more deposits by 16. What is/are the most likely advantages of
commercial banks implementing ‗Goods and Services Tax
(GST)‘?
11. Which of the following terms indicates a
mechanism used by commercial banks for A. It will replace multiple taxes collected by
providing credit to the government? multiple authorities and will thus create a
single market in India.
1. Cash Credit Ratio B. It will drastically reduce the ‗Current
2. Debt Service Obligation Account Deficit‘ of India and will enable it
3. Liquidity Adjustment Facility to increase its foreign exchange reserves.
4. Statutory Liquidity Ratio C. It will enormously increase the growth and
size of economy of India and will enable it
12. In India, the interest rate on savings to overtake China in the near future.
accounts in all the nationalized commercial
banks is fixed by Select the correct answer using the code
given below:
1. Union Ministry of Finance
2. Union Finance Commission 1. A only 2. B and C only
3. Indian Banks‘ Association 3. A and C only 4. A, B and C
4. None of the above
17. Consider the following statements:
13. When the Reserve Bank of India announces
an increase of the Cash Reserve Ratio, what A. Tax revenue as a percent of GDP of India
does it mean? has steadily increased in the last decade.
B. Fiscal deficit as a percent of GDP of India
1. The commercial banks will have less has steadily increased in the last decade.
money to lend.
2. The Reserve Bank of India will have less Which of the statements given above is/are
money to lend. correct?
3. The Union Government will have less
money to lend. 1. A only 2. B only
4. The commercial banks will have more 3. Both A and B 4. Neither A nor B
money to lend.
18. The term ‗Base Erosion and Profit Shifting‘ is
14. Consider the following statements: sometimes seen in the news in the context of

A. The repo rate is the rate at which other 1. mining operation by multinational
banks borrow from the Reserve Bank of companies in resource-rich but backward
India. areas
B. A value of 1 for Gini Coefficient in a 2. curbing of the tax evasion by multinational
country implies that there is perfectly companies
equal income for everyone in its 3. exploitation of genetic resources of a
population. country by multinational companies
4. lack of consideration of environmental
Which of the statements given above is/are costs in the planning and implementation
correct? of developmental projects

1. A only 2. B only 19. There has been a persistent deficit budget

3. Both A and B 4. Neither A nor B year after year. Which of the following
actions can be taken by the government to
15. Consider the following statements: reduce the deficit?
A. Reserve Bank of India was nationalized on
1. Reducing revenue expenditure
26 January, 1950.
2. Introducing new welfare scheme
B. The borrowing programme of the
3. Rationalizing subsidies
Government of India is handled by the
4. Expanding industries
Department of Expenditure, Ministry of
Finance.
 Question Bank 175

Select the correct answer using the code 23. Which one of the following is not a feature of
given below: ―Value Added Tax‖?

1. A and C only 2. B and C only 1. It is a multi-point destination-based

3. A only 4. A, B, C and D system of taxation
2. It is a tax levied on value addition at each
20. A decrease in tax to GDP ratio of a country stage of transaction in the production
indicates which of the following? distribution chain
3. It is a tax on the final consumption of
A. Slowing economic growth rates goods or services and must ultimately be
B. Less equitable distribution of national borne by the consumer
income 4. It is basically a subject of the Central
Government and the State Governments
Select the correct answer using the code are only a facilitator for its successful
given below: implementation.

1. A only 2. B only 24. In India, the tax proceeds of which one of the
3. Both A and B 4. Neither A nor B following as a percentage of gross tax
revenue has significantly declined in the last
21. Under which of the following circumstances five years?
may ‗capital gains‘ arise?
1. Service tax
A. When there is an increase in the sales of a 2. Personal income tax
product 3. Excise duty
B. When there is a. natural increase in the 4. Corporation tax
value of the property owned
C. When you purchase a painting and there is 25. Consider the following statements:
a growth in its value due to increase in its
popularity. In India, taxes on transactions in Stock
Exchanges and Futures Markets are
Select the correct answer using the codes
given below : A. levied by the Union
B. collected by the State
1. A only 2. B and C only
3. B only 4. A, B and C Which of the statements given above is/are
correct?
22. Which of the following measures would result
in an increase in the money supply in the 1. A only 2. B only
economy? 3. Both A and B 4. Neither A nor B

A. Purchase of government securities from

the public by the Central Bank
B. Deposit of currency in commercial banks
by the public
C. Borrowing by the government from the
Central Bank
D. Sale of government securities to the public
by the Central Bank.

Select the correct answer using the codes

given below:

1. A only 2. B and D only

3. A and C 4. B, C and D
176 Question Bank

Economy Test 04 6. Which one of the following statements

regarding the levying, collecting and
distribution of Income Tax is correct?
1. Consider the following:
1. The Union levies, collects and distributes
1. Fringe Benefit Tax the proceeds of income tax between itself
2. Interest Tax and the states.
3. Securities Transaction Tax 2. The Union levies, collects and keeps all
the proceeds of income tax to itself.
Which of the above is/are Direct Tax/Taxes? 3. The Union levies and collects the tax but
all the proceeds are distributed among the
1. A only 2. A and C only states.
3. B and C only 4. A, B and C 4. Only the surcharge levied on income tax is
shared between the Union and the states.
2. Which one of the following are the correct
statements? Service tax is a/an 7. What is the purpose of setting up of Small
Finance Banks (SFBs) in India?
1. direct tax levied by the Central
Government A. To supply credit to small business units
2. indirect tax levied by the Central B. To supply credit to small and marginal
Government farmers
3. direct tax levied by the State Government C. To encourage young entrepreneurs to set
4. indirect tax levied by the State up business particularly in rural areas.
Government
Select the correct answer using the code
3. Which of the following is not a given below:
recommendation of ‗the task force on direct
taxes under the chairmanship of Dr. Vijay L. 1. A and B only 2. B and C only
Kelkar in the year 2002? 3. A and C only 4. A, B and C

1. Abolition of Wealth Tax. 8. Which of the following is a most likely

2. Increase in the exemption limit of consequence of implementing the ‗Unified
personal in- come to 1.20 lakh for widows. Payments Interface (UPI)‘?
3. Elimination of standard deduction.
4. Exemption from tax on dividends and 1. Mobile wallets will not be necessary for
capital gains from the listed equity. online payments.
2. Digital currency will totally replace the
4. The Kelkar proposals which were in the news physical currency in about two decades.
recently were the: 3. FDI inflows will drastically increase.
4. Direct transfer of subsidies to poor people
1. recommendations for reforms in the power will become very effective.
sector
2. recommendations for tax reforms. 9. Which of the following statements best
3. guidelines for the privatization of public describes the term ‗Scheme for Sustainable
sector undertakings. Structuring of Stressed Assets (S4A)‘,
4. guidelines for reducing vehicular pollution, recently seen in the news?
and the promotion of CNG use.
1. It is a procedure for considering ecological
5. Consider the following taxes: costs of developmental schemes
formulated by the Government.
A. Corporation tax B. Customs duty 2. It is a scheme of RBI for reworking the
C. Wealth tax D. Excise duty financial structure of big corporate entities
facing genuine difficulties.
Which of these is/are indirect taxes? 3. It is a disinvestment plan of the
Government regarding Central Public
1. A only 2. B and D Sector Undertakings.
3. A and C 4. B and C 4. It is an important provision in ‗The
Insolvency and Bankruptcy Code‘ recently
implemented by the Government.
 Question Bank 177

10. Consider the following statements: 3. reduce the greenhouse gas emissions but
places a heavier burden on developed
A. National Payments Corporation of India countries
(NPCI) helps in promoting financial 4. transfer technology from developed
inclusion in the country. Countries to poor countries to enable
B. NPCI has launched RuPay, a card payment them to replace the use of
scheme. Which of the statements given chlorofluorocarbons in refrigeration with
above is/are correct? harmless chemicals

1. A only 2. B only 14. Pradhan Mantri Jan Dhan Yojana has been
3. Both A and B 4. Neither A nor B launched for

11. The establishment of ‗Payment Banks‘ is 1. providing housing loan to poor people at
being allowed in India to promote financial cheaper interest rates
inclusion. Which of the following statements 2. Promoting women‘s Self Help Groups in
is/are correct in this context? back- ward areas
3. Promoting financial inclusion in the
A. Mobile telephone companies and country
supermarket chains that are owned and 4. Providing financial help to marginalised
controlled by residents are eligible to be communities.
promoters of Payment Banks.
B. Payment Banks can issue both credit cards 15. What is/are the facility/facilities the
and debit cards. beneficiaries can get from the services of
C. Payment Banks cannot undertake lending Business Correspondent (Bank Saathi) in
activities. Select the correct answer using branchless areas?
the code given below.
A. It enables the beneficiaries to draw their
1. A and B only 2. A and C only subsidies and social security benefits in
3. B only 4. A, B and C their villages.
B. It enables the beneficiaries in the rural
12. The term ‗Core Banking Solutions‘ is areas to make deposits and withdrawals.
sometimes seen in the news. Which of the
following statements best describes/describe Select the correct answer using the code
this term? given below.

A. It is a networking of a bank‘s branches 1. A only 2. B only

which enables customers to operate their 3. Both A and B 4. Neither A nor B
accounts from any branch of the bank on
its network regardless of where they open 16. Which of the following grants/grant direct
their accounts. credit assistance to rural households?
B. It is an effort to increase RBI‘s control
over commercial banks through A. Regional Rural Banks
computerization. B. National Bank for Agriculture and Rural
C. It is a detailed procedure by which a bank Development.
with huge non- performing assets is taken C. Land Development Banks.
over by another bank.
1. A and B only 2. B only
Select the correct answer using the code 3. A and C only 4. A, B and C
given below.
17. The Reserve Bank of India regulates the
1. A only 2. B and C only commercial banks in matters of
3. A and C only 4. A, B and C
A. liquidity of assets
13. ‗Basel III Accord‘ or simply ‗Basel III‘, often B. branch expansion
seen in the news, seeks to C. merger of banks
D. winding-up of banks
1. develop national strategies for the
conservation and sustainable use of Select the correct code:
biological diversity
2. improve banking sector‘s ability to deal 1. A and D only 2. B, C and D only
with financial and economic stress and 3. A, B and C only 4. A, B, C and D
improve risk management
178 Question Bank

18. Priority Sector Lending by banks in India 23. With reference to India, consider the
constitutes the lending to following:

1. agriculture A. Nationalization of Banks

2. micro and small enterprises B. Formation of Regional Rural Banks
3. weaker sections C. Adoption of villages by Bank Branches
4. All of the above
Which of the above can be considered as
19. The basic aim of Lead Bank Scheme is that steps taken to achieve the ―financial
inclusion‖ in India?
1. big banks should try to open offices in
each district. 1. A and B only 2. B and C only
2. there should be stiff competition among 3. C only 4. A, B and C
the various nationalized banks
3. individual banks should adopt particular 24. Consider the following statements:
districts for intensive development
4. all the banks should make intensive The functions of commercial banks in India
efforts to mobilize deposits include

20. Microfinance is the provision of financial A. Purchase and sale of shares and securities
services to people of low-income groups. This on behalf of customers.
includes both the consumers and the self- B. Acting as executors and trustees of wills.
employed. The service/ services rendered
under micro-finance is/are: Which of the statements given above is/are
correct?
A. Credit facilities
B. Savings facilities 1. A only 2. B only
C. Insurance facilities 3. Both A and B 4. Neither A nor B
D. Fund Transfer facilities
25. Consider the following pairs:
1. A only 2. A and D only
3. B and C only 4. A, B, C and D Large Bank Country of Origin
A. ABN Amro Bank USA
21. With reference to the Non-banking Financial B. Barclays Bank UK
Companies (NBFCs) in India, consider the C. Kookmin Bank Japan
following statements:
Which of the above pairs is/are correctly
A. They cannot engage in the acquisition of matched?
securities issued by the government.
B. They cannot accept demand deposits like 1. A only 2. B only
Savings Account. 3. A and B 4. B and C

Which of the statements given above is/are

correct?

1. A only 2. B only
3. Both A and B 4. Neither A nor B

22. With reference to the institution of Banking

Ombudsman in India, which one of the
statements is not correct?

1. The Banking Ombudsman is appointed by

the Reserve Bank of India.
2. The Banking Ombudsman can consider
complaints from Non-Resident Indians
having accounts in India.
3. The orders passed by the Banking
Ombudsman, are final and binding on the
parties concerned.
4. The service provided by the Banking
Ombudsman is free of any fee.
 Question Bank 179

Economy Test 05 Which of the statements given above is/are

correct?

1. A only 2. B only
1. In the context of independent India‘s
3. Both A and B 4. Neither A nor B
economy, which one of the following was the
earliest event to take place?
7. Consider the following statements:
1. Nationalization of Insurance companies
A. The National Housing Bank the apex
2. Nationalization of State Bank of India
institution of housing finance in India, was
3. Enactment of Banking Regulation Act
set up as a wholly-owned subsidiary of the
4. Introduction of First Five-Year Plan
Reserve Bank of India.
B. The Small Industries Development Bank of
2. Basel II relates to which one of the following?
India was established as a wholly owned
subsidiary of the Industrial Development
1. International standards for safety in civil
Bank of India.
aviation
2. Measures against cyber crimes
Which of the statements given above is/are
3. Measures against drug abuse by
correct?
sportspersons
4. International standards for measuring the
1. A only 2. B only
adequacy of a bank‘s capital
3. Both A and B 4. Neither A nor B
3. The National Housing Bank was set up in
8. What does venture capital mean?
India as a wholly-owned subsidiary of which
one of the following?
1. A short-term capital provided to industries
2. A long-term start-up capital provided to
1. State Bank of India
new entrepreneurs
2. Reserve Bank of India
3. Funds provided to industries at times of
3. ICICI Bank
incurring losses
4. Life Insurance Corporation of India
4. Funds provided for replacement and
renovation of industries.
4. Which one of the following Indian banks is
not a nationalized bank?
9. In the parlance of financial investments, the
term ‗bear‘ denotes
1. Corporation Bank 2. Dena Bank
3. Federal bank 4. Vijaya Bank
1. An investor who feels that the price of a
particular security is going to fall.
5. Consider the following statements:
2. An investor who expects the price of
particular shares to rise.
A. Life Insurance Corporation of India is the
3. A shareholder or a bondholder who has an
oldest insurance company in India.
interest in a company, financial or
B. National Insurance Company Limited was
otherwise.
nationalized in the year 1972 and made a
4. Any lender whether by making a loan or
subsidiary of General Insurance
buying a bond
Corporation of India.
C. Headquarters of United India Insurance
10. In India, which of the following is regulated
Company Limited are located at Chennai.
by the Forward Markets Commission?
Which of the statements given above are
correct? 1. Currency Futures Trading
2. Commodities Futures Trading
1. A, B and C 2. A and B only 3. Equity Futures Trading
3. B and C only 4. A and C only 4. Both Commodities Futures and Financial
Futures Trading
6. Consider the following statements:
11. Which one of the following pairs is not
A. Global Trust Bank has been amalgamated correctly matched?
with the Punjab National Bank.
B. The second report of the Kelkar 1. Japan : Nikkei
Committee dealing with direct and indirect 2. Singapore : Shcomp
taxes has maintained its original 3. UK : FTSE
recommendations including the abolition 4. USA : Nasdaq
of exemptions relating to housing loans.
180 Question Bank

12. What does S&P 500 relate to? 18. A rise in ‗SENSEX‘ means

1. Supercomputer 1. a rise in prices of shares of all companies

2. A new technique in e-business registered with Bombay Stock Exchange
3. A new technique in bridge building 2. a rise in prices of shares of all companies
4. An index of stocks of large companies registered with National Stock Exchange
3. an overall rise in prices of shares of group
13. Participatory Notes (PNs) are associated with of companies registered with Bombay
which one of the following? Stock Exchange
4. a rise in prices of shares of all companies
1. Consolidated Fund of India belonging to a group of companies
2. Foreign Institutional Investors registered with Bombay Stock Exchange
3. United Nations Development Programme
4. Kyoto Protocol 19. Gilt-edged market means

14. What is Indo Next which was launched in the 1. bullion market
year 2005? 2. market of Government securities
3. market of guns
1. A new scheme to promote Indian tourism 4. market of pure metals
2. A new scheme to promote export of Indian
handicrafts 20. Which of the following best describes the
3. An association of the Non-Resident term ‗import cover‘, sometimes seen in the
Indians to organize Pravasi Bhartiya Divas news?
every year in India
4. An alternative trading platform being 1. It is the ratio of value of imports to the
promoted by the Bombay Stock Exchange Gross Domestic Product of a country
and Regional Stock Exchanges 2. It is the total value of imports of a country
in a year
15. Consider the following statements: 3. It is the ratio between the value of exports
and that of imports between two countries
A. Sensex is based on 50 of the most 4. It is the number of months of imports that
important stocks available on the Bombay could be paid for by a country‘s
Stock Exchange (BSE). international reserves
B. For calculating the Sensex, all the Sensex
stocks are assigned proportional 21. The problem of international liquidity is
weightage. related to the non-availability of
C. New York Stock Exchange is the oldest
stock exchange in the world 1. goods and services
2. gold and silver
Which of the statements given above is/are 3. dollars and other hard currencies
correct? 4. exportable surplus

1. B only 2. A and C 3. B and C 4. None 22. Convertibility of rupee implies:

16. Debenture holders of a company are its 1. being able to convert rupee notes into
gold
1. Shareholders 2. Creditors 2. allowing the value of rupee to be fixed by
3. Debtors 4. Directors market forces
3. freely permitting the conversion of rupee
17. Among the following major stock exchanges to other currencies and vice versa
of India, the exchange which recorded 4. developing an international market for
highest turn- over during the year 2000–01 currencies in India
is
23. With reference to Balance of Payments,
1. Bombay Stock Exchange which of the following constitutes / constitute
2. Calcutta Stock Exchange the Current Account?
3. Delhi Stock Exchange
4. National Stock Exchange 1. Balance of trade
2. Foreign assets
3. Balance of invisibles
4. Special Drawing Rights
 Question Bank 181

Select the correct answer using the code

given below.
Economy Test 06
1. A only 2. B and C 1. The balance of payments of a country is a
3. A and C 4. A, B and D systematic record of

24. Which one of the following groups of items is 1. all import and export transactions of a
included in India‘s foreign – exchange country during a given period of time,
reserves? normally a year
2. goods exported from a country during a
1. Foreign currency assets, Special Drawing year
Rights (SDRs) and loans from foreign 3. economic transaction between the
countries government of one country to another
2. Foreign currency assets, gold holdings of 4. capital movements from one country to
the RBI and SDRs Another
3. Foreign currency assets, loans from the
World Bank and SDRs 2. Which of the following would include Foreign
4. Foreign currency assets, gold holdings of Direct Investment in India?
the RBI and loans from the World Bank
A. Subsidiaries of companies in India
25. Which of the following constitute Capital B. Majority foreign equity holding in Indian
Account? companies
C. Companies exclusively financed by foreign
A. Foreign Loans companies
B. Foreign Direct Investment D. Portfolio investment
C. Private Remittances Select the correct answer using the codes
D. Portfolio Investment given below:

Select the correct answer using the codes 1. A, B, C and D 2. B and D only
given below 3. A and C only 4. A, B and C only

1. A, B and C 2. A, B and D 3. Consider the following statements:

3. B, C and D 4. A, C and D The price of any currency in international
market is decided by the

A. World Bank
B. demand for goods/services provided by
the country concerned
C. stability of the government of the
concerned country
D. economic potential of the country in
question

Which of the statements given above are

correct?

1. A, B, C and D 2. B and C only

3. C and D only 4. A and D only

4. In terms of economy, the visit by foreign

nationals to witness the XIX Common Wealth
Games in India amounted to

1. Export 2. Import
3. Production 4. Consumption

5. Consider the following actions which the

Government can take:

A. Devaluing the domestic currency.

B. Reduction in the export subsidy.
C. Adopting suitable policies which attract
greater FDI and more funds from FIIs.
182 Question Bank

Which of the above action/actions can help in 10. Assertion (A): ‗Balance of Payments‘
reducing the current account deficit? represents a better picture of a country‘s
economic transactions with the rest of the
1. A and B 2. B and C world than the ‗Balance of Trade‘.
3. C only 4. A and C Reason (R): ‗Balance of Payments‘ takes
into account the exchange of both visible and
6. A ―closed economy‖ is an economy in which invisible items whereas ‗Balance of Trade‘
does not
1. the money supply is fully controlled
2. deficit financing takes place 1. Both A and R are true and R is the correct
3. only exports take place explanation of A.
4. neither exports nor imports take place 2. Both A and R are true but R is NOT the
correct explanation of A.
7. Both Foreign Direct Investment (FDI) and 3. A is true but R is false.
Foreign Institutional Investor (FII) are 4. A is false but R is true
related to investment in a country. Which one
of the following statements best represents 11. Consider the following statements:
an important difference between the two?
A. In India, during the financial year 2004–
1. FII helps bring better management skills 2005, an increase of below 10% over the
and technology, while FDI only brings in value of exports (in rupee terms) in the
Capital financial year 2003–2004 was reported.
2. FII helps in increasing capital availability B. According to the WTO, India‘s share in the
in general, while FDI only targets specific world merchandise exports crossed 2% in
sectors the year 2005. Which of the statements
3. FDI flows only into the secondary market, given above is/are correct?
while FII targets primary market
4. FII is considered to be more stable than 1. A only 2. B only
FDI 3. Both A and B 4. Neither A nor B

8. A great deal of Foreign Direct Investment 12. Consider the following statements:
(FDI) to India comes from Mauritius than
from many major and mature economies like A. During the year 2004, India‘s foreign
UK and France. Why? exchange reserves did not exceed the 125
billion U.S. Dollar mark.
1. India has preference for certain countries B. The series of index numbers of wholesale
as regards receiving FDI. prices introduced from April, 2000 has the
2. India has double taxation avoidance year 1993–94 as base year.
agreement with Mauritius.
3. Most citizens of Mauritius have ethnic Which of the statements given above is/are
identity with India and so they feel secure correct?
to invest in India.
4. Impending dangers of global climatic 1. A only 2. B only
change prompt Mauritius to make huge 3. Both A and B 4. Neither A nor B
investments in India.
13. In the last one decade, which one among the
9. Tarapore Committee was associated with following sectors has attracted the highest
which one of the following? Foreign Direct Investment inflows into India?

1. Special Economic Zones 1. Chemicals other than fertilizers

2. Fuller capital account convertibility 2. Services sector
3. Foreign exchange reserves 3. Food processing
4. Effect of oil-prices on the Indian economy 4. Telecommunication

Directions: The following items consists of two 14. Among the following commodities imported
statements, one labeled as the ‗Assertion (A)‘ and by India during the year 2000– 01, which one
the other as ‗Reason (R)‘. You are to examine was the highest in terms of Rupee value?
these two statements carefully and select the
answers to these items using the code given 1. Edible oil
below: 2. Fertilizers
3. Organic and inorganic chemicals
4. Pearls, precious and semi-precious stones
 Question Bank 183

15. Consider the following statements: 21. Consider the following statements:
Full convertibility of the rupee may mean
A. The maximum limit of shareholding of
Indian promoters in private sector banks A. its free float with other international
in India is 49 per cent of the paid up currencies.
capital. B. its direct exchange with any other
B. Foreign Direct Investment up to 49 per international currency at any prescribed
cent from all sources is permitted in place inside and outside the country.
private sector banks in India under the C. it acts just like any other international
automatic route. currency.

Which of these statements is/are correct? Which of these statements are correct?

1. Only A 2. Only B 1. A and B 2. A and C

3. Both A and B 4. Neither A nor B 3. B and C 4. A, B and C

16. In which year was Mid-day meal program 22. India has the maximum volume of foreign
was launched in India? trade with

1. 1992 2. 1995 3. 1996 4. 2000 1. USA 2. Japan

3. Germany 4. UAE
17. Which Indian city is known as the healthcare
capital of India? 23. When was VAT introduced in India?

1. Chennai 2. Mumbai 1. 2001 2. 2005 3. 2004 4. 2007

3. Hyderabad 4. Pune
24. Global capital-flows to developing countries
18. Which one of the following statements is increased significantly during the nineties. In
correct with reference to FEMA in India? view of the East Asian financial crisis and
Latin American experience, which type of
1. The Foreign Exchange Regulating Act inflow is good for the host country?
(FERA) was replaced by Foreign Exchange
Management Act (FEMA) in the year 2001. 1. Commercial loans
2. FERA was given a sunset clause of one 2. Foreign Direct Investment
year till 31st May, 2002 to enable 3. Foreign Portfolio Investment
Enforcement Directorate to complete the 4. External Commercial Borrowings
investigation of pending issues.
3. Under FEMA, violation of foreign exchange 25. Who releases the Business-to-Consumer
rules has ceased to be a criminal offence. (B2C) e-commerce Index?
4. As per the new dispensation, Enforcement
Directorate can arrest and prosecute the 1. World economic forum
people for the violation of foreign 2. United Nations Conference on Trade and
exchange rules Development
3. NITI Aayog
19. What is Participatory Notes? 4. None of the above

1. Bonds to raise funds locally

2. Bonds to raise funds from abroad
3. Bonds by government to raise funds
4. None

20. A country is said to be in a debt trap if

1. it has to abide by the conditionalities

imposed by the IMF
2. it has to borrow to make interest
payments on outstanding loans
3. it has been refused loans or aid by
creditors abroad
4. the World Bank charges a very high rate
of interest on outstanding as well as new
Loans.
184 Question Bank

Economy Test 07 Which of the statements given above is/are

correct?

1. Consider the following statements: The 1. A only 2. B only

Indian rupee is fully convertible 3. Both A and B 4. Neither A nor B

A. in respect of Current Account of Balance of 7. Five Year Plan in India is finally approved by
Payment
B. in respect of Capital Account of Balance of 1. Union Cabinet
Payment 2. President on the advice of Prime Minister
C. into gold 3. Planning Commission
4. National Development Council
Which of these statements is/are correct?
8. Consider the following statements:
1. A only 2. C only
3. A and B 4. A, B and C A. The food safety and standards Act, 2006
replaced the Prevention of Food
2. The Government of India has established Adulteration Act,1954.
NITI Aayog to replace the B. The Food Safety and Standards Authority
of India (FSSAI) is under the charge of
1. Human Rights Commission Director General of Health Services in the
2. Finance Commission Union Ministry of Health and Family
3. Law Commission Welfare.
4. Planning Commission
Which of the statements given above is/are
3. Which of the following are associated with correct?
‗Planning‘ in India?
1. A only 2. B only
A. The Finance Commission 3. Both A and B 4. Neither A nor B
B. The National Development Council
C. The Union Ministry of Rural Development 9. What is/are the advantage/advantages of
D. The Union Ministry of Urban Development implementing the ‗National Agriculture
E. The Parliament Market‘ scheme?

Select the correct answer using the code A. It is a pan-India electronic trading portal
given below: for agricultural commodities.
B. It provides the farmers access to
1. A, B and E only 2. A, C and D only nationwide market, with prices
3. B and E only 4. A, B, C, D and E commensurate with the quality of their
produce.
4. The main objective of the 12th Five- Year Select the correct answer using the code
Plan is given below:

1. inclusive growth and poverty reduction. 1. A only 2. B only

2. inclusive and sustainable growth 3. Both A and B 4. Neither A nor B
3. sustainable and inclusive growth to reduce
un- employment 10. With reference to agriculture in India, how
4. faster, sustainable and more inclusive can the technique of `genome sequencing‘,
growth. often seen in the news, be used in the
immediate future?
5. During which Five Year Plan was the
Emergency clamped, new elections took A. Genome sequencing can be used to
place and the Janata Party was elected? identify genetic markers for disease
resistance and drought tolerance in
1. Third 2. Fourth 3. Fifth 4. Sixth various crop plants.
B. This technique helps in reducing the time
6. Consider the following statements regarding required to develop new varieties of crop
Indian Planning: plants.
C. It can be used to decipher the host-
A. the Second Five-Year Plan emphasized on
pathogen relationships in crops.
the establishment of heavy industries.
B. The Third Five-Year Plan introduced the
1. A only 2. B and C only
concept of import substitution as a
3. A and C only 4. A, B and C
strategy for industrialization.
 Question Bank 185

11. Which of the following practices can help in Select the correct answer using the code
water conservation in agriculture? given below.

A. Reduced or zero tillage of the land 1. A and C only 2. B only

B. Applying gypsum before irrigating the field 3. B and C only 4. A, B and C
C. Allowing crop residue to remain in the field
15. With reference to ‗Initiative for Nutritional
1. A and B only 2. C only Security through Intensive Millets Promotion‘,
3. A and C only 4. A, B and C which of the following statements is/are
correct?
12. Consider the following statements:
The nation-wide ‗Soil Health Card Scheme‘ A. This initiative aims to demonstrate the
aims at improved production and post-harvest
technologies, and to demonstrate value
A. Expanding the cultivable area under addition techniques, in an integrated
irrigation. manner, with cluster approach.
B. Enabling the banks to assess the quantum B. Poor, small, marginal and tribal farmers
of loans to be granted to farmers on the have larger stake in this scheme.
basis of soil quality. C. An important objective of the scheme is to
C. Checking the overuse of fertilizers in encourage farmers of commercial crops to
farmlands. shift to millet cultivation by offering them
free kits of critical inputs of nutrients and
1. A and B only 2. C only micro-irrigation equipment.
3. B and C only 4. A, B and C
1. A only 2. B and C only
13. With reference to pre-packaged items in 3. A and B only 4. A, B and C
India, it is mandatory to the manufacturer to
put which of the following information on the 16. Which of the following is/are the advantage
main label, as per the Food Safety and /advantages of practising drip irrigation?
Standards (Packaging and Labelling)
Regulations, 2011? A. Reduction in weed
B. Reduction in soil salinity
A. List of ingredients including additives C. Reduction in soil erosion
B. Nutrition information
C. Recommendations, if any, made by the Which code is correct?
medical profession about the possibility of
any allergic reactions 1. A and B only 2. C only
D. Vegetarian/non-vegetarian 3. A and C only 4. None of the above

1. A, B and C 2. B, C and D 17. With reference to ‗Pradhan Mantri Fasal Bima

3. A, B and D 4. A and D only Yojana‘, consider the following statements:

14. The FAO accords the status of ‗Globally A. Under this scheme, farmers will have to
Important Agricultural Heritage System pay a uniform premium of two percent for
(GIAHS)‘ to traditional agricultural systems. any crop they cultivate in any season of
What is the overall goal of this initiative? the year.
B. This scheme covers post-harvest losses
A. To provide modern technology, training in arising out of cyclones and unseasonal
modern farming methods and financial rains. Which of the statements given
support to local communities of identified above is/are correct?
GIAHS so as to greatly enhance their
agricultural productivity 1. A only 2. B only
B. To identify and safeguard eco-friendly 3. Both A and B 4. Neither A nor B
traditional farm practices and their
associated landscapers, agricultural 18. Why does the Government of India promote
biodiversity and knowledge systems of the the use of Neem-coated Urea‘ in agriculture?
local communities
C. To provide Geographical Indication status 1. Release of Neem oil in the soil increases
to all the varieties of agricultural produce nitrogen fixation by the soil
in such identified GIAHS microorganisms
2. Neem coating slows down the rate of
dissolution of urea in the soil
186 Question Bank

3. Nitrous oxide, which is a greenhouse gas, 23. What can be the impact of
is not at all released into atmosphere by excessive/inappropriate use of nitrogenous
crop fields fertilizers in agriculture?
4. It is a combination of a weedicide and a
fertilizer for particular crops A. Proliferation of nitrogen-fixing
microorganisms in soil can occur.
19. Consider the following statements: B. Increase in the acidity of soil can take
place
A. The Accelerated Irrigation Benefits C. Leaching of nitrate to the ground-water
Programme was launched during 1996-97 can occur.
to provide loan assistance to poor
farmers. Select the correct code:
B. The Command Area Development
Programme was launched in 1974-75 for 1. A and C only 2. B only
the development of water-use efficiency. 3. B and C only 4. A, B and C

Which of the statements given above is/are 24. The Fair and Remunerative Price of
correct? Sugarcane is approved by the

1. A only 2. B only 1. Cabinet Committee on Economic Affairs

3. Both A and B 4. Neither A nor B 2. Commission for Agricultural Costs and
Prices
20. The Genetic Engineering Appraisal Committee 3. Directorate of Marketing and Inspection,
is constituted under the Ministry of Agriculture
4. Agricultural Produce Marketing Committee
1. Food Safety and Standards Act, 2006
2. Geographical Indications of Goods 25. In India, markets in agricultural products are
(Registration and Protection) Act, 1999 regulated under the
3. Environment (Protection) Act, 1986
4. Wildlife (Protection) Act, 1972 1. Essential Commodities Act, 1955
2. Agricultural Produce Market Committee
21. The substitution of steel for wooden ploughs Act enacted by States
in agricultural production is an example of 3. Agricultural Produce (Grading and
Marking) Act, 1937
1. labour-augmenting technological progress 4. Food Products Order, 1956 and Meat and
2. capital-augmenting technological progress Food Products Order, 1973
3. capital-reducing technological progress
4. None of the above

22. Which one of the following best describes the

main objective of ‗Seed Village Concept?

1. Encouraging the farmers to use their own

farm seeds and discouraging them to buy
the seeds from others
2. Involving the farmers for training in
quality seed production and thereby to
make available quality seeds to others at
appropriate time and affordable cost
3. Earmarking some villages exclusively for
the production of certified seeds
4. Identifying the entrepreneurs in village
and providing them technology and
finance to set up seed companies
 Question Bank 187

Economy Test 08 5. Consider the following statements:

A. The Commission for Agricultural Costs and

1. What are the significances of a practical Prices recommends the Minimum Support
approach to sugarcane production known as Prices for 32 crops.
‗Sustainable Sugarcane Initiative‘? B. The Union Ministry of Consumer Affairs,
Food and Public Distribution has launched
A. Seed cost is very low in this compared to the National Food Security Mission.
the conventional method of cultivation.
B. Drip irrigation can be practiced very Which of the statements given above is/are
effectively in this. correct?
C. There is no application of
chemical/inorganic fertilizers at all in this. 1. A only 2. B only
D. The scope for intercropping is more in this 3. Both A and B 4. Neither A nor B
compared to the conventional method of
cultivation. Select the correct answer 6. Consider the following statements:
using the code given below.
A. Regarding the procurement of food grains,
1. A and C only 2. A, B and D only Government of India follows a
3. B, C and D only 4. A, B, C and D procurement target rather than an open
ended procurement policy.
2. In India, which of the following have the B. Government of India announces minimum
highest share in the disbursement of credit to support prices only for cereals.
agriculture and allied activities? C. For distribution under Targeted Public
Distribution System (TPDS), wheat and
1. Commercial Banks rice are issued by the Government of India
2. Cooperative Banks at uniform central issue prices to the
3. Regional Rural Banks States/Union Territories.
4. Microfinance Institutions
Which of the statements given above is/are
3. An objective of the National Food Security correct?
Mission is to increase the production of
certain crops through area expansion and 1. A and B 2. B only
productivity enhancement in a sustainable 3. A and C 4. C only
manner in the identified districts of the
country. What are those crops? 7. Consider the following statements:
India continues to be dependent on imports
1. Rice and wheat only to meet the requirement of oilseeds in the
2. Rice, wheat and pulses only country because
3. Rice, wheat, pulses and oil seeds only
4. Rice, wheat, pulses, oil seeds and A. farmers prefer to grow food grains with
Vegetables highly remunerative support prices
B. most of the cultivation of oilseed crops
4. Consider the following statements: continues to be dependent on rainfall
C. oils from the seeds of tree origin and rice
A. The Union Government fixes the Statutory bran have remained unexploited
Minimum Price of sugarcane for each D. it is far cheaper to import oilseeds than to
sugar season. cultivate the oilseed crops
B. Sugar and sugarcane are essential
commodities under the Essential Select the correct code?
Commodities Act.
1. A and B 2. A, B and C
Which of the statements given above is/are 3. C and D 4. A, B, C and D
correct?
8. The prices at which the government
1. A only 2. B only purchases food grains for maintaining the
3. Both A and B 4. Neither A nor B public distribution system and for building up
buffer - stocks is known as

1. minimum support prices

2. procurement prices
3. issue prices
4. ceiling prices
188 Question Bank

9. Consider the following statements: 14. Which one of the following issues the ―Global
Economic Prospects‖ report periodically?
A. New Development Bank has been set up
by APEC. 1. The Asian Development Bank
B. The headquarters of New Development 2. The European Bank for Reconstruction and
Bank is in Shanghai. Which of the Development
statements given above is/are correct? 3. The US Federal Reserve Bank
4. The World Bank
1. A only 2. B only
3. Both A and B 4. Neither A nor B 15. Which of the following organizations brings
out the publication known as ‗World
10. ‗Global Financial Stability Report‘ is prepared Economic Out- look‘?
by the
1. The International Monetary Fund
A. European Central Bank 2. The United Nations Development
B. International Monetary Fund Programme
C. International Bank for Reconstruction and 3. The World Economic Forum
Development 4. The World Bank
D. Organization for Economic Cooperation
and Development 16. Regarding international Monetary Fund,
which one of the following statements is
11. With reference to `IFC Masala Bonds‘, correct?
sometimes seen in the news, which of the
statements given below is/are correct? 1. It can grant loans to any country
2. It can grant loans to only developed
A. The International Finance Corporation, countries
which offers these bonds, is an arm of the 3. It grants loans to only member countries
World Bank. 4. It can grant loans to the central bank of a
B. They are the rupee-denominated bonds Country
and are a source of debt financing for the
public and private sector. 17. Which of the following is/are treated as
artificial currency?
1. A only 2. B only
3. Both A and B 4. Neither A nor B 1. ADR 2. GDR
3. SDR 4. Both A and C
12. Recently, which one of the following
currencies has been proposed to be added to 18. Who among the following is the founder of
the basket of IMF‘s SDR? World Economic Forum?

1. Rouble 2. Rand 1. Klaus Schwab

3. Indian Rupee 4. Renminbi 2. John Kenneth Galbraith
3. Robert Zoellick
13. With reference to the International Monetary 4. Paul Krugman
and Financial Committee (IMFC), consider the
following statements: 19. Who among the following served as the Chief
Economist of the Inter-national Monetary
A. IMFC discusses matters of concern Fund?
affecting the global economy, and advises
the International Monetary Fund (IMF) on 1. Ashok Lahiri 2. Sumantra Ghoshal
the direction of its work. 3. Saumitra Chaudhuri 4. Raghuram Rajan
B. The World Bank participates as observer in
IMFC‘s meetings. 20. Consider the following statements:

A. Poverty Reduction and Growth Facility

Which of the statements given above is/are
(PRGF) has been established by the
correct?
International Development Association
(IDA) to provide further assistance to low
1. A only 2. B only
income countries facing high level of
3. Both A and B 4. Neither A nor B
indebtedness.
B. Singapore Regional Training Institute
(STI) is one of the institutes that provide
training in macroeconomic analysis and
policy, and related subjects as a part of
programme of the IMF Institute.
 Question Bank 189

Which of the statements given above is/are 25. Consider the following statements:
correct?
A. India has ratified the Trade Facilitation
1. A only 2. B only Agreement (TFA) of WTO.
3. Both A and B 4. Neither A nor B B. TFA is a part of WTO‘s Bali Ministerial
Package of 2013.
21. ―World Development Report‖ is an annual C. TFA came into force in January 2016.
publication of:
1. A and B only 2. A and C only
1. United Nations Development Programme 3. B and C only 4. A, B and C
2. International Bank of Reconstruction and
Development
3. World Trade Organisation
4. International Monetary Fund

22. Consider the following organisations

1. International Bank for Reconstruction and

Development.
2. International Finance Corporation.
3. International Fund for Agricultural
Development.
4. International Monetary Fund.

Which of these are agencies of the United

Nations?

1. A and B 2. B and C
3. C and D 4. A, B, C and D

23. The term ‗Domestic Content Requirement‘ is

sometimes seen in the news with reference
to

1. Developing solar power production in our

country
2. Granting licences to foreign T.V. channels
in our country
3. Exporting our food products to other
countries
4. Permitting foreign educational institutions
to set up their campuses in our country

24. With reference to the ‗National Intellectual

Property Rights Policy‘, consider the following
statements:

A. It reiterates India‘s commitment to the

Doha Development Agenda and the TRIPS
Agreement.
B. Department of Industrial Policy and
Promotion is the nodal agency for
regulating intellectual property rights in
India.

1. A only 2. B only
3. Both A and B 4. Neither A nor B
190 Question Bank

Economy Test 09 6. In order to comply with TRIPS Agreement,

India enacted the Geographical Indications of
Goods (Registration & Protection) Act, 1999.
1. With reference to the ‗Trans-Pacific The difference/differences between a ―Trade
Partnership‘, consider the following Mark‖ and a Geographical Indication is/are:
statements:
A. A Trade Mark is an individual or a
A. It is an agreement among all the Pacific company‘s right whereas a Geographical
Rim countries except China and Russia. Indication is a community‘s right.
B. It is a strategic alliance for the purpose of B. A Trade Mark can be licensed whereas a
maritime security only. Geographical Indication cannot be
licensed.
Which of the statements given above is/are C. A Trade Mark is assigned to the
correct? manufactured goods whereas the
Geographical Indication is as- signed to
1. A only 2. B only the agricultural goods/products and
3. Both A and B 4. Neither A nor B handicrafts only.

2. In the context of which of the following do Which of the statements given above is/are
you sometimes find the terms `amber box, correct?
blue box and green box‘ in the news?
1. A only 2. A and B only
1. WTO affairs 3. B and C only 4. A, B and C
2. SAARC affairs
3. UNFCCC affairs 7. As regards the use of international food
4. India-EU negotiations on FTA safety standards as reference point for the
dispute settlements, which one of the
3. Which of the following has/have been following does WTO collaborate with?
accorded ‗Geographical Indication‘ status?
A. Codex Alimentarius Commission
A. Banaras Brocades and Sarees B. International Federation of Standards
B. Rajasthani Daal-Bati-Churma Users
C. Tirupathi Laddu C. International Organization for
Standardization
1. A only 2. B and C only D. World Standards Cooperation
3. A only C only 4. A, B and C
8. In the context of bilateral trade negotiations
4. The terms ‗Agreement on Agriculture‘, between India and European Union, what is
‗Agreement on the Application of Sanitary the difference between European Commission
and Phytosanitary Measures‘ and Peace and European Council?
Clause‘ appear in the news frequently in the
context of the affairs of the: A. European Commission represents the EU
in trade negotiations whereas European
1. Food and Agriculture Organization Council participates in the legislation of
2. United Nations Framework Conference on matters pertaining to economic policies of
Climate Change the European Union.
3. World Trade Organization B. European Commission comprises the
4. United Nations Environment Programme Heads of State or government of member
countries whereas the European Council
5. In the context of the affairs of which of the comprises of the persons nominated by
following is the phrase ―Special Safeguard European Parliament.
Mechanisms‖ mentioned in the news
frequently? Which of the statements given above is/are
correct?
1. United Nations Environment Programme
2. World Trade Organisation 1. A only 2. B only
3. ASEAN—India Free Trade Agreement 3. Both A and B 4. Neither A nor B
4. G-20 Summits
 Question Bank 191

9. NAMA-11 (Nama-11) group of countries 14. The Global Infrastructure Facility is a/an
frequently appears in the news in the context
of the affairs of which one of the following? 1. ASEAN initiative to upgrade infrastructure
in Asia and financed by credit from the
1. Nuclear Suppliers Group Asian Development Bank.
2. World Bank 2. World Bank collaboration that facilitates
3. World Economic forum the preparation and structuring of
4. World Trade Organization complex infrastructure Public-Private
Partnerships (PPPs) to enable mobilization
10. Consider the following statements: of private sector and institutional investor
capital.
A. The agreement on South Asian Free Trade 3. Collaboration among the major banks of
Area (SAFTA) came into effect from 1st the world working with the OECD and
December, 2005. focused on expanding the set of
B. As per SAFTA agreement terms, India, infrastructure projects that have the
Pakistan and Sri Lanka have to decrease potential to mobilize private investment.
their custom duties to the level of 0 to 5 4. UNCTAD funded initiative that seeks to
percent by the year 2013. finance and facilitate infrastructure
development in the world.
Which of the statements given above is/are
correct? 15. ‗Net metering‘ is sometimes seen in the news
in the context of promoting the
1. A only 2. B only
3. Both A and B 4. Neither A nor B 1. production and use of solar energy by the
house- holds/consumers
11. Consider the following statements: 2. use of piped natural gas in the kitchens of
house- holds
A. The World Intellectual Property 3. installation of CNG kits in motor-cars
Organisation (WIPO) is a specialized 4. installation of water meters in urban
agency of United Nations System of households
Organisations.
B. WIPO has its headquarters at Rome. 16. Which one of the following is a purpose of
C. The Trade Related Aspects of Intellectual `UDAY‘, a scheme of the Government?
Property Rights (TRIPS) Agreement is
binding on all WTO members. 1. Providing technical and financial
D. Least developed country members of WTO assistance to start-up entrepreneurs in the
are not required to apply the provisions of field of renewable sources of energy
TRIPS Agreement for a period of 20 years 2. Providing electricity to every household in
from the general date of application of the the country by 2018
Agreement. 3. Replacing the coal-based power plants
with natural gas, nuclear, solar, wind and
Which of these statements are correct? tidal power plants over a period of time
4. Providing for financial turnaround and
1. A, B, C and D 2. B, C and D revival of power distribution companies
3. A, B and D 4. A and C
17. With reference to the Indian Renewable
12. The earlier name of WTO was Energy Development Agency Limited
(IREDA), which of the following statements
1. UNCTAD 2. GATT 3. UNIDO 4. OECD is/are correct?

13. With reference to ‗National Investment and A. It is a Public Limited Government

Infrastructure Fund‘, which of the following Company.
statements is/are correct? B. It is a Non-Banking Financial Company.

A. It is an organ of NITI Aayog. Select the correct answer using the code
B. It has a corpus of Rs. 4, 00,000 crore at given below.
present. Select the correct answer using
the code given below: 1. A only 2. B only
3. Both A and B 4. Neither A or B
1. A only 2. B only
3. Both A and B 4. Neither A nor B
192 Question Bank

18. Which among the following are the 24. Consider the following statements:
components of the poultry development
scheme? A. Appellate Tribunal for Electricity has been
established by each State Government in
A. Assistance to State Poultry Farms India.
B. Rural Backward Poultry Development B. One of the components of the Accelerated
C. Poultry Estates Power Development and Reforms
Programme (APDRP) is upgradation of
Choose the correct option from the codes sub-transmission and distribution system
given below: for electricity in India.

1. A and B only 2. B and C only Which of the statements given above is/are
3. A, B and C 4. None of the above correct?

19. In the context of global oil prices, ―Brent 1. A only 2. B only

crude oil‖ is frequently referred to in the 3. Both A and B 4. Neither A nor B
news. What does this term imply?
25. Consider the following statements:
1. It is a major classification of crude oil.
2. It is sourced from North Sea. A. The Oil Pool Account of Government of
3. It does not contain sulphur. India was dismantled with effect from 1-4-
2002.
Which of the statements given above is/are B. Subsidies on PDS kerosene and domestic
correct? LPG are borne by Consolidated Fund of
India.
1. B only 2. A and B only C. An expert committee headed by Dr. R. A.
3. A and C only 4. A, B and C Mashelkar to formulate a national auto
fuel policy recommended that Bharat
20. Among other things, which one of the Stage — II Emission Norms should be
following was the purpose for which the applied throughout the country by 1 April,
Deepak Parekh Committee was constituted? 2004.

1. To study the current socio-economic Which of the statements given above are
conditions of certain minority communities correct?
2. To suggest measures for financing the
development of infrastructure 1. A and B 2. B and C
3. To frame a policy on the production of 3. A and C 4. A, B and C
genetically modified organisms
4. To suggest measures to reduce the fiscal
deficit in the Union Budget

21. Which one of the following brings out the

publication called ―Energy Statistics‖ from
time to time?

1. Central Power Research Institute

2. Planning Commission
3. Power Finance Corporation Ltd.
4. Central Statistical Organization

22. With which one of the following has the B.K.

Chaturvedi Committee dealt?

1. Review of Centre-State relations

2. Review of Delimitation Act
3. Tax reforms and measures to increase
revenues
4. Price reforms in the oil sector

23. In which year was Small Farmers‘ Agri-

Business Consortium(SFAC) was established?

1. 1991 2. 1994 3. 1995 4. 1996

 Question Bank 193

Economy Test 10 8. Shankar-6 or Sankar-6 is a variety of which

of the following commodities?

1. With reference to Power Sector in India, 1. Mustard 2. Cotton

consider the following statements: 3. Groundnut 4. Soyabean

A. Rural electrification has been treated as a 9. Which among the following organizations
Basic Minimum Service under the Prime releases from time to time the publication
Minister‘s Gramodaya Yojana. titled ―Database on Indian Economy‖?
B. 100 percent Foreign Direct Investment in
power is allowed without upper limit. 1. Central Statistical organization
C. The Union Ministry of Power has signed a 2. National Sample Survey Organization
Memorandum of Understanding with 14 3. Department of Economic Affairs
States. 4. Reserve Bank of India

Which of these statements is/are correct? 10. For how many years, the Banks have been
directed by the Reserve bank of India to
1. A only 2. A and B 3. B and C 4. C only maintain records relating to suspicious
transactions?
2. Who heads the Cabinet Committee on
Economic Affairs in India? 1. 5 years 2. 8 years
3. 10 years 4. 15 years
1. Finance Minister 2. Commerce Minister
3. Prime Minister 4. Cabinet Secretary 11. Since which year, Reserve bank of India is
using the Selective Credit Control measures
3. Which among the following is the main to control the amount of bank advances
feature of Democratic planning? against the commodities having limited
supply ?
1. Inducement 2. Government
3. Direction 4. Flexibility 1. 1950 2. 1953 3. 1956 4. 1960

4. In which plan Integrated Handloom 12. The ―Service area Approach‖ was an strategy
Development Scheme was initiated? launched to improve which of the following?

1. 9th 2. 10th 3. 11th 4. 12th 1. Micro, Small and medium Enterprising

2. Unorganized Sector
5. In which year Statutory Liquidity Ratio was 3. Rural lending
first imposed on banks? 4. Urban Industrial Lending

1. 1947 2. 1949 3. 1950 4. 1991 13. If we consider that BSE Index has increased
from 17000 to 17170 today, it would mean
6. Who among the following declared the First that __________?
Industrial Policy in the Post-Independence
Period? 1. Total Value of the Share market securities
has gone up by 1%
1. Jawahar lal Nehru 2. Total value of the share market securities
2. Syama Prasad Mookerjee has gone up by 170 Crore Rupees
3. Bayya Suryanarayana Murthy 3. Total value of the securities which
4. Rafi Ahmed Kidwai constitute the index has increased 1%
4. Total value of the securities which
7. The Sick Industrial Companies Act of 1985 constitute the index has increased by 170
was enacted following the recommendation of Crore Rupees
which of the following committees?
14. What is the number of digits in the MICR
1. Tiwari Committee Magnetic Ink Character Recognition code
2. Gadgil Committee mentioned on the white strip at the bottom of
3. Hazari Committee the cheque just after the cheque number?
4. Marathe Committee
1. 6 2. 7 3. 8 4. 9
194 Question Bank

15. The targets from fifth five year plan are set 22. Which among the following is NOT an
with respect to which of the following instrument of qualitative control in India?
parameters?
1. Regulation of the Consumer Credit
1. National Income 2. Rationing of the Credit
2. Net Domestic Product 3. Margin Requirements
3. Gross Domestic Product at Factor Cost 4. Variable Costs and Reserves
4. Gross Domestic Product at Market Cost
23. Which among the following is a qualitative
16. In which of the following five year plans in tool of monetary policy?
India, the actual expenditure on the Rural
Development was almost double than the 1. Bank Rate 2. Credit Ceiling
plan outlay? 3. Credit rationing 4. Cash Reserve Ratio

1. 5th Five year Plan 2. 6th Five year Plan 24. Which among the following was not
3. 7th Five year Plan 4. 8th Five year Plan stipulated in the Fiscal Responsibility And
Budget Management Act 2003?
17. India‘s first operational special economic
zone (SEZ) is located at? 1. Elimination of revenue deficit
2. Elimination of primary deficit
1. Ahmedabad 2. Surat 3. Non-borrowing by the central government
3. Jaipur 4. Indore from RBI except in certain situations
4. Fixing government guarantees in any
18. Which among the following alternative financial year as a percentage of GDP
exchange Rate Regime is most popular in the
world today? 25. Which among the following was the first bank
purely managed by Indians?
1. Free Float
2. Managed Float 1. Oudh Commercial Bank
3. Crawling Peg 2. Punjab National Bank
4. Fixed-but-Adjustable Exchange Rate 3. Bank of India
4. Allahabad bank
19. Which of the following Union Territories are
included in the National Horticulture Mission?

1. Andaman & Nicobar Island and

Pondicherry
2. Andaman & Nicobar Island & Lakshadweep
3. Andaman & Nicobar Island and Daman &
Diu
4. Andaman & Nicobar Island, Pondicherry
and Lakshadweep

20. Which among the following is the most

reasonable idea behind issuing the ―sweat
equity‖ by the companies now days?

1. To provide more profits to the retail

investors
2. To provide more profits to the corporate
investors
3. To retain the best employees
4. To save tax

21. Asian Financial Crisis of 1997 started from

which of the following countries?

1. Myanmar 2. Thailand
3. Cambodia 4. Malaysia
 Question Bank 195

Answer Key

Test 01 Test 02 Test 03 Test 04 Test 05

1. 1 1. 3 1. 3 1. 4 1. 3
2. 3 2. 1 2. 1 2. 2 2. 4
3. 3 3. 2 3. 2 3. 2 3. 2
4. 4 4. 3 4. 2 4. 2 4. 3
5. 1 5. 3 5. 4 5. 2 5. 3
6. 2 6. 3 6. 3 6. 1 6. 2
7. 4 7. 3 7. 4 7. 1 7. 3
8. 2 8. 4 8. 4 8. 1 8. 2
9. 4 9. 1 9. 3 9. 2 9. 1
10. 1 10. 3 10. 1 10. 3 10. 2
11. 1 11. 1 11. 4 11. 2 11. 2
12. 2 12. 1 12. 4 12. 1 12. 4
13. 3 13. 2 13. 1 13. 2 13. 2
14. 2 14. 2 14. 1 14. 3 14. 4
15. 4 15. 2 15. 4 15. 3 15. 2
16. 2 16. 4 16. 1 16. 3 16. 2
17. 3 17. 3 17. 4 17. 4 17. 1
18. 3 18. 1 18. 2 18. 4 18. 3
19. 2 19. 3 19. 1 19. 3 19. 2
20. 4 20. 3 20. 4 20. 4 20. 4
21. 3 21. 4 21. 2 21. 2 21. 3
22. 2 22. 1 22. 3 22. 3 22. 3
23. 4 23. 3 23. 4 23. 4 23. 3
24. 3 24. 2 24. 3 24. 3 24. 2
25. 3 25. 3 25. 1 25. 2 25. 2

Test 06 Test 07 Test 08 Test 09 Test 10

1. 1 1. 1 1. 2 1. 4 1. 2
2. 4 2. 4 2. 1 2. 1 2. 3
3. 2 3. 3 3. 2 3. 3 3. 4
4. 1 4. 4 4. 3 4. 3 4. 3
5. 1 5. 3 5. 4 5. 2 5. 2
6. 4 6. 3 6. 3 6. 2 6. 2
7. 2 7. 4 7. 2 7. 1 7. 1
8. 2 8. 1 8. 2 8. 4 8. 2
9. 2 9. 3 9. 2 9. 4 9. 4
10. 1 10. 4 10. 2 10. 2 10. 3
11. 4 11. 4 11. 3 11. 4 11. 3
12. 2 12. 2 12. 4 12. 2 12. 3
13. 2 13. 3 13. 3 13. 4 13. 3
14. 4 14. 2 14. 4 14. 2 14. 4
15. 2 15. 3 15. 1 15. 1 15. 3
16. 2 16. 3 16. 3 16. 4 16. 3
17. 1 17. 2 17. 3 17. 3 17. 4
18. 3 18. 2 18. 1 18. 3 18. 4
19. 2 19. 2 19. 4 19. 2 19. 4
20. 2 20. 3 20. 2 20. 2 20. 3
21. 1 21. 2 21. 2 21. 4 21. 2
22. 1 22. 2 22. 4 22. 4 22. 4
23. 2 23. 3 23. 1 23. 2 23. 3
24. 2 24. 1 24. 3 24. 2 24. 2
25. 2 25. 2 25. 1 25. 1 25. 2
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