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Introduction to Economy
1. Economics
1.1 Evolution of Economics
1.2 Defining economics
1.3 The role of economics
1.4 Types of Economics
1.4.1 Microeconomics
1.4.2 Macroeconomics
2. Economics vs Economy
3. Type of Economic Systems
3.1 Capitalist Economy
3.2 Socialist Economy
3.3 Mixed Economy
4. Sectors of Economy
4.1 Primary Sector
4.2 Secondary Sector
4.3 Tertiary Sector
5. Economies based on the shares of the particular sector in the total production of an economy and the ratio of the
dependent population
5.1 Agrarian Economy
5.2 Industrial Economy
5.3 Service Economy
6. Why did India shi from the primary sector to services and not the secondary sector?
7. Uniqueness of the Indian Economy
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1. Economics
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The word 'economics' comes from two Greek words, 'eco' meaning home and 'nomos' meaning accounts.
●
The subject has developed from being about how to keep the family accounts into the wide-ranging subject
of today.
1.1. Evolution of Economics
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Economics has grown in scope, very slowly up to the 19th century, but at an accelerating rate ever since.
●
Today it has many of the features of a language.
●
It has linguistic roots, grammatical rules, good and bad constructions, dialects and a wide vocabulary which
grows and changes over time.
●
You may already have studied economics and there is the danger that the language that you learnt has
changed, so be careful! Also, there are different ways of learning economics.
1.2. Defining economics
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One of the founding fathers of economics, Alfred Marshall, advised as follows:
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Every short statement about economics is misleading, nevertheless, definitions are a useful place to begin. A
standard definition of economics could describe it as:
❏ a social science directed at the satisfaction of needs and wants through the allocation of
scarce resources which have alternative uses
●
We can go further to state that:
❏ economics is about the study of scarcity and choice
❏ economics finds ways of reconciling unlimited wants with limited resources
❏ economics explains the problems of living in communities in terms of the underlying resource
costs and consumer benefits
❏ economics is about the coordination of activities which result from specialisation
●
By extension of our basic definition, economics, as applied to agricultural and environmental issues, is
concerned with the efficient allocation of natural resources to maximise the welfare of society.
●
There is an obvious need to understand the economics behind the decisions facing the individual farmer, firm
or resource owner, but it is also important to have an appreciation of the bigger picture in terms of agriculture
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and the environment's impact on the domestic economy as a whole, as well as its impact in an international
context.
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The economics of the individual agent's decisions about resources is referred to as microeconomics, while
macroeconomics studies the interactions in the economy as a whole.
1.3. The role of economics
●
Resources are finite, and people and governments must make choices. By studying the way that people make
choices, the better choices we make!
●
Economics has quite an extensive role to play in a multitude of contexts, particularly in solving agricultural
and environmental problems.
●
For example, it has much to contribute to improved policies for the efficient targeting of agricultural subsidies,
the control of pollution and the depletion of natural resources.
1.4. Type of economics
Economics is usually divided into two main branches.
1.4.1 Microeconomics
●
Microeconomics focuses on the actions of individual agents within the economy, like households, workers,
and businesses
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For example - the question of what price limit will make people switch from buying onions to spring onion falls
under microeconomics, as do questions of whether the certain interest rate will cause firms to expand
production.
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1.4.2. Macroeconomics
●
Macroeconomics looks at the economy as a whole.
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It focuses on broad issues such as the growth of production, the number of unemployed people, the
inflationary increase in prices, government deficits, and levels of exports and imports.
●
Macroeconomics tries to understand what drives the business cycle from boom to bust, or from growth to the
recession, and what controls economics indicators such as gross domestic product, unemployment, inflation.
These two are linked closely as the behaviour of household or consumer or firm depends upon the state of national
as well as the global economy and vice versa. For example - business sentiments depend on the state of the economy.
2. Economics vs Economy
Basis of Comparison
Economics
Economy
Meaning
Economics is the science of decision
When a country or a region is
making regarding the use of scarce defined
resources.
in
the
context
of
its
economic activities, it is called the
Economy.
What is it?
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Theory or Principle
Practical application of Economics.
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3. Type of Economic Systems
There are three types of economic systems found in the world.
3.1. Capitalist Economy
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Before understanding the Capitalist Economy, we need to understand the concept of “Capitalism”
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Capitalism is o en thought of as an economic system in which private actors own and control property in
accord with their interests, and demand and supply freely set prices in markets in a way that can serve the best
interests of society.
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The essential feature of capitalism is the motive to make a profit.
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As Adam Smith, the 18th-century philosopher and father of modern economics said: “It is not from the
benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their
own interest.”
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Both parties to a voluntary exchange transaction have their own interest in the outcome, but neither can
obtain what he or she wants without addressing what the other wants. It is this rational self-interest that can
lead to economic prosperity.
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In a capitalist economy, capital assets—such as factories, mines, and railroads—can be privately owned and
controlled, labour is purchased for money wages, capital gains accrue to private owners, and prices allocate
capital and labour between competing uses
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The government's role in such an economy is limited to management and control measures.
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This means that only the free market will determine the supply, demand, and the prices of the product. There
is no direct government intervention other than controlling a monopolistic practice in the economy.
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Examples of Capitalist Economy - USA, UK, Germany, Singapore etc.
3.2. Socialist Economy
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In a Socialist Economy, all the factors of production are under the ownership and control of the community,
indicated by State. So all the factories, machinery, plants, capital etc is owned by a community indicated by
State.
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All the citizens get the benefits from the production of goods and services on the basis of equal rights. Hence
this type of economy is also known as Command Economy.
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This theory emerged from the political document ‘The Communist Manifesto’ written by Karl Marx with
Fredric Engels.
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The countries which adopted the Socialist economy are China, Poland, Yugoslavia.
3.3 Mixed Economy
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Mixed Economy is a combination of a capitalistic and socialistic economy, wherein both the market and
government decide the allocation of resources.
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While market forces decide the price, demand, supply etc., there is some government oversight to prevent
monopolization and discrimination so there is a co-existence of both private and public sector in the economy.
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The mixed form of economy has its origin in the famous work of John Maynard Keynes in his work ‘The
General Theory of Employment, Interest and Money.
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India follows the mixed economy system.
4. Sectors of Economy
The economic activity is broadly classified into 3 broad categories which are known as the three-sector of the
economy.
4.1. Primary Sector
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It includes all those economic activities where there is direct use of natural resources as agriculture, forestry,
fishing, minerals etc.
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The services in this sector are entirely dependent on the availability of the natural resource in order to keep
day to day operations running.
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In India, the primary sector is termed as the agricultural sector.
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In India, the primary sector provides employment to almost 53% of the entire workforce currently working
and its contribution to GDP is 17%.
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4.2. Secondary Sector
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Secondary Sector adds value to natural resources by transforming the raw material into valuable products.
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This sector is also called the manufacturing or industrial sector.
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In India, the secondary sector provides employment of almost 18% of the entire workforce currently working
and its contribution to GDP is 29%.
4.3. Tertiary Sector
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This sector includes all those economic activities where different services are produced such as education,
banking, insurance, transportation, tourism etc.
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This sector is also known as the Service sector.
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In India, the tertiary sector contribution is the largest in terms of share of GDP at 54% and it employs 29% of
the total workforce.
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The contribution of all three sectors in the GDP of India can be understood through the following graph
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5. Economies based on the shares of the particular sector in the total production of an economy and the ratio of
the dependent population
5.1. Agrarian Economy
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An economy is called agrarian if the share of its primary sector is 50 % or more in the total output (GDP) of
the economy.
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At the time of independence, India was Agrarian an economy.
5.2. Industrial Economy
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If the secondary sector contributes 50% or more to the total output(GDP) of the economy, it is an industrial
economy.
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Higher the contribution, the higher the level of industrialisation.
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5.3. Service Economy
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If the service sector contributes 50% or more to the total output(GDP) of the economy, it is a Service
Economy.
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India is a Service economy in terms of contribution in GDP but Agrarian economy in terms of dependency.
6. Why did India shi from the primary sector to services and not the secondary sector?
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The natural economic movement for a country is to go from agrarian economy to an industrial economy to a
service economy but India has leapfrogged from an agrarian economy to a service economy.
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Following reasons can be attributed to this shi :
❏ India with educational investment toward secondary and higher education produced a group of highly
educated workers who have largely worked in the service sector.
❏ Well educated human resource, Fluent in English and availability of cheap labour are some of the
reasons for the rapid growth of the service sector in the country.
❏ On the other hand, low growth in the Secondary sector can be contributed to
License Raj, Restriction on foreign investment, Stringent labour laws, lack of skilled labour.
7. Uniqueness of the Indian Economy ●
The contribution of the primary sector in the GDP has fallen down to 17% which is sufficient to conclude that
India is no longer an agrarian economy but Indian Economy is characterised by too much dependency on
agriculture.
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The rapid growth of population coupled with inadequate growth of secondary and tertiary occupations are
responsible for the occurrence of chronic unemployment and under-employment problem. In India,
unemployment is a structural one, unlike in developed countries, which is of cyclical type.
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Inequality in the distribution of wealth.
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India has been basically the first case which directly migrated from the primary sector to the service sector. It
means India jumped the stage of being a fully-developed industrial economy.
Without fully realising the industrial potential, and directly converting into the service economy, has created a tougher
macro and micro challenges for policymakers in India.
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Microeconomics
1. Demand
1.1 Demand Function
1.2 Law of Demand
1.3 Ceteris paribus assumption
1.4 Determinants of demand
1.4.1 Price of commodity
1.4.2 Income of consumer
1.4.2.1 Normal Goods
1.4.2.2 Inferior Goods
1.4.2.3 Giffen Goods
1.4.2.4 Veblen Goods
1.4.3 Price of related goods and services
1.4.3.1 Complementary goods
1.4.3.2 Substitute goods
1.4.4 Taste and Preferences
1.4.5 Expectations
1.4.6 Number of buyers in the market
1.5 Quantity demanded
1.6 Difference between Demand and Quantity Demanded
1.7 Utility
1.7.1 Types of utility
1.7.1.1 Marginal Utility
1.7.1.1.1 Law of diminishing Marginal Utility
1.7.1.2 Total Utility
1.8 Price Elasticity of demand
1.8.1 Type of Price Elasticity of Demand
1.8.1.1 Perfectly Inelastic Demand
1.8.1.2 Inelastic Demand
1.8.1.3 Unit Elastic
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1.8.1.4 Elastic demand
1.8.1.5 Perfectly Elastic Demand
1.8.2 Determinant of Elasticity of Demand
1.8.2.1 Nature of goods
1.8.2.2 Availability of close substitute
1.8.2.3 Income level of consumer
1.8.3 Practical application of elasticity
1.8.3.1 Prices of Agricultural commodities are volatile
1.8.3.2 Paradox of poverty of farmers
1.9 Income elasticity of Demand
1.9.1 Income Elastic demand
1.9.2 Income inelastic demand
1.9.3 Perfectly Income Inelastic demand
2. Supply
2.1 Law of supply
2.2 Determinants of Supply
2.2.1 Price of Goods/Services
2.2.2 Cost of production
2.2.3 Government policy
2.2.4 Technology
2.2.5 Other Factors
3. Market equilibrium
4. Market mechanism
4.1 Impact of change in demand
4.2 Impact of change in supply
5. Budget Line
6. Indifference Curve
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6.1 Properties of Indifference Curve
7. Consumer Equilibrium
8. Producer’s Equilibrium
9. Marginal Cost
10. Marginal Revenue
11. Type of market
11.1 Perfect competition
11.2 Monopolistic competition
11.3 Oligopoly competition
11.4 Monopoly
12. Supply-Demand application
12.1 Price ceiling
12.2 Price Floor
13. Resource allocation by market mechanism
13.1 Positives
13.2 Negatives
14. Market Failure
14.1. Externality
14.1.1.Positive Externality
14.1.2.Negative Externality
14.1.3. Private solutions to externalities
14.1.3.1. Coase Theorem
14.2. Public Good
14.2.1. The Free-Rider Problem
14.3. Information Asymmetry
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14.4. Monopoly/ Imperfect Competition
14.5. Government response to market failures
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1. Demand
●
Demand refers to a consumer’s desire to purchase goods and services and willingness to pay a price for the
same.
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Demand drives economic growth. Without demand, no business would produce anything.
1.1. Demand function
●
The demand function shows the relation between the quantity demanded of a commodity by the
consumers and the price of the product.
●
For example - Suresh buys a biscuit for Rs 10, suppose another day price of biscuit falls to Rs 5. Now Suresh
will be able to buy two biscuits for the same price. Hence the demand for biscuit changes with its price.
●
The graphical representation of the demand function is the demand curve.
●
While many variables determine the quantity consumers purchases in a market, the price of the commodity is
perhaps the most important one.
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In the above graph, when the price of a good is P2 consumer is able to buy Q2 quantity of good. With the
decrease in the price of the good to P1, the consumer is able to buy more quantity of good i.e Q1.
●
Demand curve may be of any shape.
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1.2. Law of Demand
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Law of Demand refers to the inverse relationship between the price of a good and the quantity demanded.
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This observed regularity means that the law of demand is an empirical (statistical) law.
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The law of demand states that other factors being constant (ceteris paribus), price and quantity, the demand
for any goods and services are inversely related to each other.
❏ As price falls, there will be an expansion of demand (more demand for a good).
❏ As price rises, there will be a contraction of demand(less demand for a good).
●
The above diagram shows the demand curve is downward sloping.
●
When the price of the commodity increases from P3 to P2, then its quantity demanded comes down from Q3 to
Q2 and vice versa.
1.3. Ceteris paribus assumption
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Many factors affect demand. When drawing a demand curve, the economist assumes all the factors are held
constant except one - the price of the product itself.
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1.4. Determinants of demand
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Some of the important determinants of demand are as follows-
1.4.1. Price of commodity
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The law of demand states that with an increase in the price there is a decrease in demand, and with
decrease in price there is an increase in demand.
●
In figure 1, when the price of a commodity increases, the quantity that consumer wishes to buy decreases.
In figure 2, when the price of a commodity decreases, the quantity that consumer wishes to buy increases.
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Demand expands or contracts respectively with a fall or rise in price. This quality of demand by virtue of which
it changes (increases or decreases) when price changes (decreases or increases) is called Elasticity of
Demand.
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1.4.2. Income of consumer
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With an increase in income, the consumer's purchasing power increases, because now the consumer has got
more income to buy goods. Consequently, the consumer's demand for goods increases.
1.4.2.1. Normal Goods
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Normal Goods are those goods whose demand shows a direct relationship with the consumer's income.
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That is when the demand for goods increases with an increase in income, and the demand for goods
decreases with decreases in income.
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The consumer demand for a normal good is proportional to his income.
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Whole wheat, organic pasta noodles are an example of a normal good.
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Demand for normal goods rises from Q to Q1 due to an increase in the income from Y to Y1.
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Demand curve of normal good shi s toward the right from DD to D1D1 due to increase in income because at
the same price now the customer is able to buy more goods.
1.4.2.2. Inferior Goods
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Inferior Goods are those goods whose demand shows an inverse relationship with the consumer’s income.
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That is when the demand for goods decreases with an increase in income and the demand for goods increases
with decreases in income.
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The demand for the goods moves in the opposite direction with the income of the consumer.
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Example of inferior goods includes low-quality food items like coarse cereals.
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Demand for an inferior good falls from Q to Q1 due to the increase in income from Y to Y1.
●
Demand curve of the inferior good shi toward le from DD to D1D1 due to increase in income at the same
price since customer will now buy goods of higher quality and demand for low-quality food will decrease.
1.4.2.3. Giffen Goods
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Giffen Goods are those inferior goods
whose demand increases with an increase
in the price and vice versa.
●
This results in an upward-sloping demand
curve, contrary to the fundamental law of
demand which creates a downward sloping
demand curve.
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The concept of Giffen goods is limited to
very poor communities with a very limited
choice of goods. If the price of basic foodstuffs (like pulse) increases, then the poor cannot afford more
expensive alternative food (like meat) therefore, they end up buying more pulse because it is the only thing
they can afford.
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1.4.2.4. Veblen Goods
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Veblen Goods are types of luxury goods for which the quantity demanded increases as the price increases
because people feel their higher prices reflect greater status.
●
These goods are associated with social prestige. For example - expensive diamonds, rare articles, branded
clothes etc.
●
Veblen Goods like Giffen good result in an upward-sloping demand curve, contrary to the fundamental law
of demand which create a downward sloping demand curve.
1.4.3. Price of related goods and services
●
Price of related goods and services affect demand. This can be studied through complementary goods and
substitute goods.
1.4.3.1. Complementary goods
●
Goods that are consumed together are called complementary
goods.
●
For example - Tea & Sugar, Shoe & socks, Pen & Ink etc.
❏ Price of Sugar ↓ tea consumption ↑
❏ Price of Sugar ↑ tea consumption ↓
●
The demand for goods moves in the opposite direction of the
price of its complementary goods.
●
Demand curve for tea shi toward le from DD to D1D1 due to
increase in the price of complementary good (sugar) at the
same price.
1.4.3.2. Substitute goods
●
Substitute products offer consumers choices by providing equally good alternatives.
●
An increase in the price of one product will cause an increase in the demand for a substitute product.
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For example- Tea & Coffee are not consumed together they are
a substitute for each other.
●
❏ Price of tea ↑
consumption of coffee ↑
❏ Price of tea ↓
consumption of coffee ↓
The demand for a good usually moves in the direction of the price of
the substitute.
●
Demand curve for tea shi toward the right from DD to D1D1 due to
the increase in the price of a Substitute good (Coffee) at the same
price P.
1.4.4. Taste and Preferences
●
When the public preference change for a product, so does the quantity.
●
The demand curve for such a good shi rightward.
●
For example - the demand curve of ice-cream is likely to shi rightward in summer because of preference for
ice-creams goes up in summer.
●
On the other hand, the demand curve shi s le ward due to unfavourable change in the preferences of the
consumer.
●
For example - Revelation of the fact that Noodles contains harmful ingredient can lead to change in preference
to noodles resulting in a le ward shi in the demand curve.
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1.4.5. Expectations
●
Expectations of an increase in the prices of goods will lead to an increase in the quantity demanded. Similarly,
the expectation of lowering in prices of goods will decrease the quantity demanded.
1.4.6. Number of buyers in the market
●
The number of consumers affects the overall demand. As more buyers enter the market, demand rises.
Furthermore, this is true irrespective of changes in the price of the commodities.
1.5. Quantity demanded
●
Quantity demanded is the quantity of a
commodity that people are willing to buy at a
particular price.
●
For example - At the price of Rs 5 per cup of tea,
consumers buy two cups of tea per day; the
quantity demanded is two. If vendors decide to
increase the price of tea to Rs 6, then consumers
only purchase one cup of tea per day.
●
A change in quantity demanded refers to a
movement along the demand curve, which is
caused only by a change in price.
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1.6. Difference between Demand and Quantity Demanded
●
To understand the difference between demand and quantity demanded we take the condition in which there
is an increase in both demand and quantity demanded.
●
The same concept can be applied to a decrease in demand and quantity demanded.
Basis
Increase in demand
Increase in Quantity
Demanded
Cause
Demand Curve
It is the increase in demand due to
It is the increase in demand due to
change in factors other than price
the change in price
The
demand
‘rightwards’
curve
shi s The
quantity
downward
demanded moves
along
the
demand
curve
Diagram
●
The difference between demand and quantity demanded helps in identifying the movement in the demand
curve.
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1.7. Utility
●
Utility is the satisfaction that a person derives from the consumption of a good or service.
●
Utility is a measure of how much one enjoys a movie, favourite food, or other goods.
●
According to classical economists, utility can be measured in the same way as weight or height is measured.
But, there was no standard unit for measuring utility. So, the economists derived an imaginary measure,
known as ‘Util’.
●
Utils are imaginary and psychological units which are used to measure satisfaction (utility) obtained from the
consumption of a certain quantity of a product.
●
Utility is the basis of consumer demand.
●
For example - A consumer who is fond of apples may find high utility in apples in comparison to the consumer
who has a liking for oranges.
1.7.1. Types of utility
●
There are two types of utility
❏ Marginal Utility.
❏ Total Utility.
1.7.1.1. Marginal Utility
●
Marginal utility is the satisfaction derived from the consumption of an additional unit of a specific
commodity.
●
Marginal utility always declines for each successive quantity consumed of a particular good.
●
For example - Suppose Suresh is consuming cake and he takes 5 cakes.
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Marginal Utility Table
●
Number of Cakes
Marginal Utility
Kind of Marginal Utility
1
20
Positive Utility
2
16
Positive Utility
3
12
Positive Utility
4
8
Positive Utility
5
4
Positive Utility
6
0
Zero Utility
7
-4
Negative Utility
From this table, it is clear that up to the
consumption of 5th cake we will receive positive
utility, 6th unit is the unit of full satisfaction i.e
utility derives from this unit is zero. From the 7th
unit, the utility received will be a negative
utility(we start feeling ill)
1.7.1.1.1. Law of diminishing Marginal Utility
●
The law of diminishing marginal utility is comprehensively explained by Alfred Marshall.
●
According to his definition of the law of diminishing marginal utility, the following happens:
During the course of consumption, as more and more units of a commodity are used, every successive unit
gives utility with a diminishing rate, provided other things remaining the same, although the total utility
increases.
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For example, an individual might buy a certain type of chocolate. Soon, they may buy less of that chocolate
and choose another type of chocolate or buy cookies instead because the satisfaction they were initially
getting from that chocolate is diminishing.
●
It is the basis for the law of demand i.e there is an inverse relationship between price and demand for a
commodity.
1.7.1.2. Total Utility
●
Total utility is the total satisfaction obtained from the consumption of all the units of a good or service.
●
Every unit of a commodity has its marginal utility and total utility is the sum of all these individual marginal
utilities.
●
Total utility is a core concept studied when seeking to analyze consumer behaviours by looking at the way he
spends his income on different goods and services to attain maximum satisfaction.
Total Utility Table
Number of Cakes
Marginal Utility
Total Utility
1
20
20
2
16
36 = (20+16)
3
12
48 = (36+12)
4
8
56 = (48+8)
5
4
60 = (56+4)
Total = 60*
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1.8. Price Elasticity of demand
●
Price Elasticity of Demand is the ratio of change in the quantity demanded of a product to the change in its
price.
Ed
= Change in quantity Demanded
Change in Price
●
Price-Elasticity of Demand(PED) is used in economics while discussing price responsiveness.
●
Price-Elasticity of Demand is a negative number and it does not depend on the units in which the price of
the good and the quantity of goods are measured.
●
Price-Elasticity of Demand is used by the economist to understand how supply or demand changes. For
example, to forecast the impact of change in price on sales volume.
1.8.1. Type of Price Elasticity of Demand
●
The extent of responsiveness of demand with the change in the price is not always the same.
●
The demand for a product can be elastic or inelastic, depending on the rate of change in the demand with
respect to change in the price of a product.
●
Elastic demand is the one when the response of demand is greater with a small proportionate change in the
price.
●
On the other hand, inelastic demand is the one when there is relatively less change in the demand with a
greater change in the price.
1.8.1.1. Perfectly Inelastic Demand (PED= 0)
●
When the price elasticity of demand is zero, then the
demand is perfectly inelastic.
●
That is there is no change in the quantity demanded in
response to the change in the price. The demand
remains constant for any value of price.
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Demand for essential good (for example - Lifesaving Medicine) if the price of essential good increases there
will not be any change in its quantity. Hence it is perfectly inelastic.
●
The demand curve is represented as a straight line.
1.8.1.2. Inelastic Demand (PED is between 0 and 1)
●
If the percentage change in demand is less than the
percentage change in the price, then the demand is inelastic.
●
For example - if the price of the product increases by 10% and
then demand for the product decreases by 15%, then the
demand would be inelastic.
●
The demand for goods of daily consumption such as rice, salt,
etc. is said to be inelastic.
●
The demand curve of the inelastic demand is rapidly sloping.
1.8.1.3. Unit Elastic ( PED = 1)
●
When the percentage change in demand is the same as the
percentage change in the price, then the demand is unit
elastic.
●
In such a type of demand, a 1% change in price leads to
exactly 1% change in quantity demanded.
●
This type of demand is rarely applicable in our practical
life.
Note- This graph can also be a straight line as mentioned in
the earlier section that demand curve can be a curve or a
straight line.
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1.8.1.4. Elastic demand (PED is between 1 and ∞)
●
If the percentage of demand is more than the
percentage change in price, then the demand is elastic
demand.
●
For example - If the price falls by 5% and the demand
rises by more than 5% (say 10%), then it is a case of
elastic demand.
●
The demand for luxurious goods such as cars, television,
furniture, etc. is considered to be elastic.
●
The demand curve is gradual sloping.
1.8.1.5. Perfectly Elastic Demand (PED = ∞)
●
If demand is perfectly elastic, it means that at a certain price
demand is infinite.
●
It does not have practical importance as it is rarely found in real
life.
●
In a perfectly elastic demand, the demand curve is represented as
a horizontal straight line.
1.8.2. Determinant of Elasticity of Demand
●
The price elasticity of demand for a good depends on many factors like -
1.8.2.1. Nature of goods
●
The elasticity of demand depends on the nature of the commodity. The product can be categorized as luxury
goods, necessary goods etc
●
The demand for necessities goods, such as food and clothing is inelastic as their demand cannot be
postponed.
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●
If a good is a necessity (eg. food), consumers will continue to buy it regardless of changes in price, hence its
price is inelastic.
●
Whereas the demand for luxury goods is said to be highly elastic because even with a slight change in its
price the demand changes significantly.
●
If a good is a luxury good, an increase in price might cause consumers to stop buying the good. Hence, the
demand for luxury goods tends to be price elastic.
1.8.2.2. Availability of close substitute
●
Of all the factors determining the price elasticity of demand, the availability of the number and kinds of
substitutes for a commodity is the most important factor.
●
If for a commodity, close substitutes are available, its demand tends to be elastic.
●
If the price of such a commodity goes up, the people will shi to its close substitutes and as a result, the
demand for that commodity will greatly decline.
●
For instance, if the prices of Noodles were to increase, many consumers would turn to other kinds of snacks,
and as a result, the quantity demanded of Noodles will decline very much. On the other hand, if the price of
Noodles falls, many consumers will change from other snacks to Noodles. Thus, the demand for Noodles is
elastic.
●
If for a commodity, substitutes are not available, people will have to buy it even when its price rises, and
therefore its demand would tend to be inelastic.
●
If the price of sugar rises slightly, then people would consume almost the same quantity of sugar as before
since good substitutes are not available. The demand for sugar is inelastic.
1.8.2.3. Income level of consumer
●
The income of the consumer also affects the elasticity of demand.
●
For high-income groups, the demand is said to be less elastic as the rise or fall in the price will not have
much effect on the demand for a product.
●
For example - The demand for salt, sugar etc tends to be highly inelastic because the households spend a
small part of their income on them. When the price of such a commodity rises, it will not make much
difference in consumers’ budget and therefore they will continue to buy the same good and its demand will be
inelastic.
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●
Whereas in the case of the low-income groups, the demand is said to be elastic and rise and fall in the price
have a significant effect on the quantity demanded.
●
For example- The demand for jewellery tends to be elastic since households spend a major chunk of their
income on jewellery. If the price of jewellery falls, it will lead to saving for households and therefore they will
tend to increase the quantity demanded of the jewellery. On the other hand, if the price of jewellery rises,
many households will not afford to buy the same quantity of jewellery as before, and therefore, the quantity
demanded of jewellery will fall.
1.8.3. Practical application of elasticity
1.8.3.1. Prices of Agricultural commodities are volatile
●
Prices of agricultural commodities are very volatile. Their demand and supply are inelastic.
●
When demand is inelastic, a drop in price leads to more quantity being sold but the increase in quantity does
not make up for the revenue loss due to the lower price hence it results in lower profit for the producer.
●
As seen in the figure, the decrease in the price of
agricultural goods leads to an increase in the quantity
of agricultural goods(from Q1 to Q2) but that increase
in the quantity of agricultural goods is less than the
increase in the quantity of other products( from Q1 to
Q3) due to decrease in their prices.
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1.8.3.2. Paradox of poverty of farmers
●
Since agricultural products, particularly food grains, have inelastic demand, when there is a bumper crop, it
can be sold only by cutting prices substantially.
●
Hence, the total income of farmers will be lower in
spite of a bigger crop and farmers may remain poor
despite a bumper crop.
●
As shown in the figure, A farmer produces 1000kg
of foodgrain which he sold it for Rs 10 per kg.
Hence his total sale will be equal to 10*1000 = Rs
10000.
●
Due to bumper production of 1400kg of foodgrain,
the price falls and it is sold for Rs 2 per kg. Now his
total sale will be equal to 6*1400 =Rs 8400.
●
Hence bumper crop production could not increase
revenue for the farmer.
1.9. Income elasticity of Demand
●
It is the responsiveness of the quantity demanded of a commodity to the change in the income of the
consumer.
●
It is represented by Ey.
Ey = Change in Quantity Demanded
Change in Income
1.9.1. Income Elastic demand (Ey > 1)
●
If the percentage change in demand is more than the percentage change in income then it is income elastic
demand.
●
Luxury goods come in this category.
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1.9.2. Income inelastic demand (Ey <1)
●
If the percentage change in demand is less than the percentage change in income then it is income inelastic
demand.
●
Necessity goods fall in this category.
1.9.3. Perfectly Income Inelastic demand (Ey=0 )
●
If there is no change in the quantity demanded in response to the change in the income, then it is perfectly
income inelastic demand.
●
Cheap necessity goods like salt fall in this category.
●
For normal goods Ey>0 and for inferior goods Ey< 0.
2. Supply
●
Supply refers to the amount of goods or services a producer is
willing to supply at a particular price.
●
Supply is what is offered for sale and not what is finally sold.
●
The supply curve slopes upward(i.e direct relation between
price and quantity) as we go from le to right. This means that as
the prices rise, more is being offered for sale and vice versa.
●
The shape of supply curves will vary i.e steeper, flatter, straighter,
or curved.
●
All the supply curves, however, share a basic similarity:
❏ Slope up from le to right and
❏ Illustrate the law of supply.
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2.1. Law of supply
●
Law of supply states that other factors remaining constant, price and quantity supplied of a good are
directly related to each other.
●
In other words, when the price paid by buyers for a good rise, then supplier increases the supply of that good
in the market.
●
For example, a business will make more cricket kit if the price of cricket kit increases. The opposite is true if
the price of cricket kit decreases.
2.2. Determinants of Supply
●
The determinants of supply are the factors which influence the quantity of a product or service supplied.
●
Following are the major determinants of supply:
2.2.1. Price of Goods/Services
●
The most important factor that influences the supply of a commodity is its own price.
●
If the price of goods increases or decreases, the quantity supplied of it will also increase or decrease,
respectively.
2.2.2. Cost of production
●
Production of a good involves many costs. If there is a rise in the price of a particular factor of production(i.e
land, labour, capital, entrepreneur) then the cost of production will increase.
●
Consequently, profit will tend to decline. Seeing an unprofitable situation, a firm will reduce the supply of a
commodity and will try to switch over to the production of another commodity which is still not unprofitable.
2.2.3. Government policy
●
Commodity taxes like GST, import duties etc can affect the supply of a commodity.
●
As these tax increases costs, firms reduce supplies. Similarly, subsidies may be given to firms so as to
encourage them to produce some goods.
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2.2.4. Technology
●
Technological innovations and inventions tend to make it possible to produce better quality and/or quantity of
good using the same resources.
●
Therefore, the state of technology can increase or decrease the supply of certain goods.
2.2.5. Other Factors
●
There are many other factors affecting the supply of goods and services like natural factors (rainfall,
earthquakes etc), infrastructure, market structure, etc.
●
The decrease in supply leads to a le ward shi in the supply curve, whereas the increase in supply leads to
a rightward shi in the supply curve.
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3. Market equilibrium
●
When the supply and demand curves intersect, the market is in equilibrium. This is where the quantity
demanded and quantity supplied are equal.
●
When the market is in equilibrium, there is no tendency for price to change.
Quantity Demanded = Quantity Supplied
●
The price at which the supply is equal to demand in the market is called the equilibrium price of a good or
service.
●
If the market price is above the equilibrium price,
the quantity supplied is greater than quantity
demanded, creating a surplus hence market price
will fall.
●
If the market price is below the equilibrium price,
the quantity supplied is less than quantity demanded,
creating a shortage hence market price will rise.
●
In the diagram, the equilibrium price is Px. The
equilibrium quantity is Qx.
●
For example - Suresh sells Apple. During summer
there is a great demand and equal supply, hence the market is at equilibrium. Post-summer season, the supply
will start falling while the demand remains the same. Thus creating a shortage. Suresh to take advantage will
increase the price. Once the prices are high, the demand will slowly drop, bringing the markets again to
equilibrium.
4. Market mechanism
●
Market Mechanism is a term used to describe the manner in which the producer and consumer eventually
determine the price of the goods that are produced.
●
In the market mechanism, everyone is free to make decisions regarding buying and selling.
●
Adam Smith used this freedom to formulate the notion of an ‘invisible’ hand.
●
‘Invisible hand’ refers to the individual actions/decisions of economic agents(buyer/seller) that lead to
maximum welfare for the economy.
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●
These decisions are collectively referred to as the market mechanism.
●
Thus, the market mechanism ensures that the benefits/welfare for the whole group of economic agents is
maximum.
●
Market Mechanism can exist in the Free market economy, Planned economy, Mixed economy.
4.1. Impact of change in demand
●
Initially, the market equilibrium is at E. Due to the shi in demand to the right, the new equilibrium is at G as
shown above. With the rightward shi , the equilibrium quantity and price increases.
●
In the second diagram, due to the le ward shi , the new equilibrium is at F, resulting in, equilibrium quantity
and price decreases.
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4.2 Impact of change in supply
●
Initially, the market equilibrium is at E. Due to the shi in the supply curve to the le , the new equilibrium
point is at G as shown above, with the le ward shi , equilibrium quantity decreases and price increases.
●
With the rightward shi , the new equilibrium point is at F, with the rightward shi , the equilibrium quantity
increases and price decreases.
5. Budget Line
●
A budget line shows all the combinations of two products that a consumer can afford to buy with a given
income – using all of their available budget.
●
For example - Suresh has to buy cakes for Rs 50.
●
Budget line slopes downwards as more of one good(Vanilla Cake) can be bought by decreasing some units of
the other good(Chocolate Cake).
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Combination
Vanilla Cake
Chocolate Cake
(@ Rs 10 per packet)
(@ Rs 5 per packet)
A
0
10
10*0 + 5*10 = 50
B
1
8
10*1 + 5*8 = 50
C
2
6
10*2 + 5*6 = 50
D
3
4
10 *3 + 5*4 = 50
E
4
2
10*4 + 5*2 = 50
F
5
0
10*5 + 5*0 = 50
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Budget Allocation
29
6. Indifference Curve
●
Indifference Curve is a curve which represents all the combinations of goods that gives the same satisfaction
to the consumer. Since all the combinations give the same level of satisfaction, the consumer prefers them
equally.
●
Indifference curve analysis is simplified by assuming that the consumer spends all her/his money on 2
products.
●
For example - Suresh has 1 unit of Cake and 12 units of Biscuit. Now, Suresh is asked how many units of Biscuit
he is willing to give up in exchange for an additional unit of Cake so that his level of satisfaction remains
unchanged.
●
Suresh agrees to give 6 units of Biscuit for an additional unit of Cake. Similarly, we get various combinations
like as follows:
Combination
Cakes
Biscuit
A
1
12
B
2
6
C
3
4
D
4
3
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6.1 Properties of Indifference Curve
●
Indifference curves are downward sloping. The slope
signifies that when the quantity of one commodity is
increased, the other commodity reduces.
●
Indifference curves are convex to the origin.
●
Higher the
Indifference curve shows a higher level of
satisfaction. IC3 shows higher satisfaction than IC1.
●
Indifference curve never intersects each other. This is
because each indifference curve provides a particular level of
satisfaction or utility to the particular consumer. No two
indifference curves can give the same utility to the consumer
7. Consumer Equilibrium
●
Consumer Equilibrium refers to a situation in which a consumer spends his/her given income on the
commodities in such a way that provides him/her the maximum possible satisfaction.
●
On an indifference map (a collection of indifference curves), higher indifference curve represents a higher level
of satisfaction than any lower indifference curve. So, a
consumer always tries to remain at the highest possible
indifference curve, subject to his budget constraint.
●
In the following figure, we depict an indifference map with
3 indifference curves – IC1, IC2, IC3 along with the budget
line for good X and good Y.
●
From the figure, we can see that the combinations R, S, Q
cost the same to the consumer. In order to maximize his
level of satisfaction, the consumer will try to reach the
highest indifference curve. Since we have assumed a
budget constraint, he will be forced to remain on the
budget line.
●
Q is the point for consumer equilibrium.
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8. Producer’s Equilibrium
●
It is the situation in which a firm produces that level of output which maximize its profit.
9. Marginal Cost
●
Marginal Cost is the additional cost incurred in the production of one more unit of a good or services.
●
The marginal cost is calculated by dividing the change in the total cost by the change in quantity.
Marginal Cost = Change in Total Cost
Change in Quantity
●
It is also known as incremental cost and is based on production expenses like labour, materials, and
equipment.
●
The purpose of marginal cost is to determine the point where the firm reaches its economies of scale.
●
Understanding a product’s marginal cost helps a company
assess its profitability and make informed decisions
related to the product, including pricing.
●
Marginal Cost curve is a U shaped curve, which shows that
cost starts at a higher point and decline with the increase
in the production.
●
The cost decline with the increase in the level of output
because of economies of scale(i.e saving in costs due to
the increase in the level of production).
●
But a er some time, the marginal costs start rising, this is
because the curve reaches the point where diseconomies
of scale persist( cost disadvantage due to the increase in
organisation size).
●
The costs rise because the resources from the current source might have completely exhausted and the firm
purchases raw materials from other sources at a relatively higher price, hire more management, buy more
machines and equipment, etc.
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10. Marginal Revenue
●
Marginal Revenue is the increase in revenue that results from the sale of one additional unit of output.
●
The formula for Marginal Revenue is the change in total revenue divided by the change in quantity.
Marginal Revenue = Change in Total Revenue
Change in Quantity
11. Type of market
●
There are a variety of market structures that characterize an economy. Such market structures essentially refer
to the degree of competition in a market.
11.1. Perfect competition
●
In a perfect competition market structure, there are a large number of buyers and sellers. All the sellers of
the market are small sellers in competition with each other. There is no one big seller with any significant
influence on the market.
●
There are certain assumptions when discussing the perfect competition. This is the reason a perfect
competition market is pretty much a theoretical concept.
●
These assumptions are as follows :
❏ The products on the market are homogeneous, i.e. they are completely identical.
❏ All firms only have the motive of profit maximization.
❏ There is free entry and exit from the market.
❏ No concept of consumer preference.
11.2. Monopolistic competition
●
In monopolistic competition, there are still a large number of buyers as well as sellers. But they all do not sell
homogeneous products.
●
The products are similar but all sellers sell slightly differentiated products.
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●
This kind of structure is more commonly visible.
●
Monopolistic competition builds on the following assumptions:
❏ All firms only have the motive of profit maximization.
❏ There is free entry and exit to the market.
❏ Firms sell differentiated products.
❏ Consumers may prefer one product over the other.
●
For example, the market for Noodles is monopolistic competition. The products are all similar but slightly
differentiated in terms of taste and flavours
11.3. Oligopoly competition
●
An oligopoly describes a market structure which is dominated by only a small number of firms. That results
in a state of limited competition.
●
The firms can either compete against each other or collaborate. By doing so, they can use their collective
market power to drive up prices and earn more profit.
●
The oligopolistic market structure builds on the following assumptions:
❏ All firms only have the motive of profit maximization.
❏ Oligopolies can set prices.
❏ There are barriers to entry and exit in the market.
❏ Products may be homogeneous or differentiated.
❏ There are only a few firms that dominate the market.
●
For example, the market for the operating system. This market is dominated by two powerful companies:
Microso and Apple. That leaves all of them with a significant amount of market power.
11.4. Monopoly
●
A monopoly refers to a market structure where a single firm controls the entire market.
●
In this scenario, the firm has the highest level of market power, as consumers do not have any alternatives.
●
As a result, monopolies o en reduce output to increase prices and earn more profit.
●
Monopolies are extremely undesirable. Here the consumer loses all their power and market forces become
irrelevant.
●
The following assumptions are made when we talk about monopolies:
❏ Firms only have the motive of profit maximization.
❏ It can set the price.
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❏ There are high barriers to entry and exit.
❏ There is only one firm that dominates the entire market.
Characteristics of Different Types of Markets
Nature of firms
Perfect
Monopolistic
Oligopoly
Monopoly
Competition
Competition
Very Large number
Many
Few
One
Differentiated
Standardized
of firms
Product
Standardized
or
Unique
differentiated
Control
No Control
Slight Control
Considerable Control Considerable if not
regulated
Entry Barriers
No barrier
No barrier
High Barrier
High Barrier
12. Supply-Demand application
●
Government intervention to regulate the prices of certain goods and services when their prices are either too
high or too low in comparison to the desired level.
12.1 Price ceiling
●
When the government imposes an upper limit on
the price of the goods or services it is called a price
ceiling.
●
The price ceiling is generally imposed on necessary
items like wheat, rice, kerosene, sugar etc. and it is
fixed below the market-determined price since at
the market-determined price some section of the
population will not be able to afford these goods.
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●
The equilibrium price and quantity are P and Q respectively. The imposition of price ceiling at P1 gives rise to
excess demand(Q2) in the market.
12.2 Price Floor
●
When the government imposes a lower limit on the price that may be charged for a particular good or service
is called price floor.
●
For certain goods and services, fall in price below a particular
level is not desirable and hence the government sets floors or
minimum prices for these goods and services.
●
Most well-known examples of imposition of price floor are
agricultural price support programmes and the minimum wage
legislation.
●
The market equilibrium is at P2Q2. The imposition of price floor
at P1 give rise to excess supply(Q3) in the market.
13. Resource allocation by market mechanism
●
In a market, resources are allocated based on the demand/supply in which prices plays a signalling function as
it allocates resources to the production of different types of goods.
13.1 Positive
●
Market allocate resources optimally because resources are allocated on the basis of collective wishes of
society.
●
Market can ensure productivity because the market can operate under competitive conditions under which
inefficient firm cannot survive.
●
Under this, economic activities are undertaken by the private sector which is motivated by self-interest i.e
production is profit induced.
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13.2 Negative
●
Market can fill the gap between demand and supply but not the gap between need and supply.
●
Market cannot ensure social justice that is reducing poverty, unemployment, inequalities.
●
Market cannot resolve the macroeconomic problem of the economy like long term economic growth,
environmental conservation, price stabilisation etc.
●
Market fails to allocate resources optimally in the presence of ‘externalities’. Externalities refer to the impact of
one economic activity on another activity or spillover effect
14. Market Failure
●
Market failure is the economic situation defined by an inefficient distribution of goods and services in the
free market.
●
In traditional microeconomics, this can be seen as a steady-state disequilibrium in which the quantity
supplied is not equal to the quantity demanded.
●
Reasons for market failure:
❏ Externality
❏ Public Good
❏ Information Asymmetry
❏ Monopoly(Imperfect Competition)
14.1. Externality
●
An Externality refers to the uncompensated impact of one person’s action on the well being of a bystander
(another person).
●
Externalities cause markets to be inefficient,and thus fail to maximize total surplus.
●
Externalities can be positive and negative.
14.1.1.Positive Externality
●
When the impact on the bystander is beneficial, the externality is called a positive externality.
●
A positive externality is a positive spillover that results from the consumption or production of a good
or service.
●
Positive externalities lead markets to consume quantity less than what is socially desirable.
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●
For example, public education not only affect students and schools, but an educated population may
provide positive effects on society as a whole
●
The intersection of the supply curve and the
social-value curve determines the optimal
output level.
●
The optimal output level is more than the
equilibrium quantity.
●
The market produces a smaller quantity than is
socially desirable.
●
The social value of the good exceeds the
private value of the good.
●
Positive
externalities
lead
markets
to
consume a quantity less than what is socially
desirable.
●
Internalizing Positive Externalities:
❏
❏
Subsidies
Industrial Policy - Government intervention in the economy that aims to promote
technology-enhancing industries. For Example - Patent laws are a form of technology policy
that give the individual (or firm) with patent protection a property right over its invention.
14.1.2.Negative Externality
●
When the impact on the bystander is adverse, the externality is called a negative externality.
●
A negative externality is a negative spillover
effect on third parties.
●
Negative externalities lead markets to
produce a larger quantity than is socially
desirable.
●
For Example - When aluminum factories
emit pollution,then the cost to society of
producing aluminum is larger than the cost
to
aluminum
producers.
Because
aluminum producers may not consider the
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costs that pollution imposes on the health of people.
●
Internalizing an externality involves altering incentives so that people take account of the external
effects of their actions.
●
Government uses Corrective taxes to correct the effects of a negative externality. These taxes are called
Pigovian taxes.
14.1.3. Private solutions to externalities
●
Government action is not always needed to solve the problem of externalities.
●
Types of Private Solutions :
❏ Moral codes and social sanctions
❏ Charitable organizations
❏ Integrating different types of businesses
14.1.3.1. Coase Theorem
●
The Coase Theorem argues that under the right conditions parties to a dispute over property rights will be
able to negotiate an economically optimal solution, regardless of the initial distribution of the property rights.
●
The Coase Theorem offers a potentially useful way to think about how to best resolve conflicts between
competing business or other economic uses of limited resources.
●
In order for the Coase Theorem to apply fully, the conditions of efficient, competitive markets, and most
importantly zero transactions costs, must occur.
14.2. Public Good
●
When goods are available free of charge, the market forces that normally allocate resources in our economy
are absent.
●
Public goods are consumed by a large number of the population, and their cost does not increase with the
increase in the number of consumers.
●
Example: National Defense , Basic Research , Light house etc.
●
Lighthouse has a fixed cost of production that is the same, whether one ship or one hundred ships use its light.
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●
Public goods create market failures if a section of the population that consumes the goods fails to pay but
continues using the goods as actual payers. This is known as the Free-Rider Problem.
14.2.1. The Free-Rider Problem
●
Since people cannot be excluded from enjoying the benefits of a public good, individuals may
withhold paying for the good hoping that others will pay for it.
●
The free-rider problem prevents private markets from supplying public goods.
●
Solving the Free-Rider Problem :
❏ The government can decide to provide the public good if the total benefits exceed the costs.
❏ The government can make everyone better off by providing the public good and paying for it
with tax revenue.
14.3. Information Asymmetry
●
Information Asymmetry occurs when decision makers do not have access to the same information which leads
to different definitions, boundaries, and solutions to problems to be solved and social outcomes.
●
Examples: Insurance companies encounter the probability of extreme loss due to a risk that was not divulged
by the insurance holder at the time of a policy's purchase.
●
How do Markets respond to Asymmetric Information?
❏ Signaling - It refers to an action taken by an informed party to reveal private information to an
uninformed party.
❏ Screening - It occurs when an action taken by an uniformed party induces an informed party to reveal
information.
14.4. Monopoly/ Imperfect Competition
●
This form of market failure arises due to restriction to competition.
●
Since a monopoly charges a price above marginal cost, not all consumers who value the good at more than its
cost buy it.
●
Thus, the quantity produced and sold by a monopoly is below the socially efficient level and there is a
deadweight loss for the society(lack of equilibrium between supply and demand).
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Producer surplus + Consumer surplus ⇏ Social Welfare
●
Policymakers in the government can respond to the problem of monopoly in the following ways:
❏ By trying to make monopolized industries more competitive.
❏ By regulating the behavior of the monopolies.
❏ By turning some private monopolies into public enterprises.
❏ Prohibit cartelization through a strong regulatory system. Example: Competition Commission of India.
14.5. Government response to market failures
●
❏
❏
❏
❏
❏
❏
Measures taken by government in response to market failures are as follow:
State provision
Extension of property rights
Prohibition
Consumer protection legislation
Patents
Positive discrimination
© Coursavy
❏
❏
❏
❏
❏
Regulation
Taxation
Subsidies
Mandatory disclosures
Polluter Pays principle
41
National Income Accounting
1. National Income Accounting
2. Gross Domestic Product (GDP)
2.1 What is Domestic territory
2.2 Goods
2.2.1 Final Goods
2.2.1.1 Consumption/Consumer Goods
2.2.1.2 Capital/Producer Goods
2.2.2 Intermediate Goods
2.3 Why only final goods are counted?
2.4 Financial/Fiscal/Accounting Year
2.5 Different uses of the concept of GDP
3. Net Domestic Product(NDP)
3.1 Different uses of the concept of NDP
4. Depreciation
5. Gross National Product(GNP)
5.1 Normal Resident
5.2 Different uses of the concept of GNP
6. Difference between GDP and GNP
7. Net National Product(NNP)
8. Cost
8.1 Factor Cost
8.2 Market Cost
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9. Current Price vs Constant Price
10. Nominal GDP
11. Real GDP
12. GDP Deflator
13. Income
13.1 National Income
13.2 Personal Income
13.3 Personal Disposable Income
13.4 National Disposable Income
13.5 Private Income
14. Base Year
14.1 Criteria for selection of base year
15. Data Collection Agency in India
15.1 CSO
16. New GDP Series 2015
16.1 Production taxes
16.2 Production Subsidies
16.3 Product Tax
16.4 Product subsidies
16.5 Criticism of New Methodology
16.6 Positives of New Methodology
17. Measurement of National Income
17.1 Product or Value Added Method
17.2 Income method
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17.3 Expenditure Method
18. Items not included in National Income
19. Facts regarding National Income
20. Domestic Income
21. Closed Economy vs Open Economy
22. GDP and Welfare
22.1 Distribution of GDP is not uniform
22.2 Non-Monetary Exchange
22.3 Externalities
23. Previous Years Question
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1. National Income Accounting
●
National income accounting is a book-keeping system that a government uses to measure the level of the
country's economic activity in a given time period.
●
Although national income accounting is not an exact science, it provides useful insight into how well an
economy is functioning, and where the money is generated and spent.
●
Some of the metrics calculated by using national income accounting include Gross Domestic Product (GDP),
Gross National Product (GNP) and Gross National Income (GNI) etc.
●
The information collected through national income accounting can be used for a variety of purposes, such
as assessing the current standard of living, the distribution of income within a population, comparing
activities within different sectors in an economy, as well as changes within those sectors over time. A thorough
analysis can assist in determining overall economic stability within a nation.
●
The quantitative information associated with national income accounting can be used to determine the
effect of various economic policies.
2. Gross Domestic Product(GDP)
●
Gross Domestic Product is the value of all final goods and services produced in the domestic territory of the
country during a financial year.
●
The modern concept of GDP was first developed by Simon Kuznets for the US Congress in 1934.
●
GDP is calculated for a specific period of time, usually a year or a quarter of a year.
●
GDP includes only purchases of newly-produced goods and services and does not include sale or resale of
goods.
●
"Gross" (in "Gross Domestic Product") indicates that products are counted regardless of their use.
●
Measuring GDP tells us how a nation is doing. If the GDP is rising, it means that income is rising, and
consumers are purchasing more which means a growing economy.
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2.1. What is Domestic territory?
●
It includes political/geographical boundaries of the country including territorial waters and airspace
●
Ships and aircra owned and operated by residents between two or more countries. For example - Air India
flight between Japan and China is part of the domestic territory of India
●
Fishing vessels, oil and natural gas rigs and floating platforms operated by a resident of a country in the
international waters. For example - Fishing boat operated by Indian fishermen in the international waters of
the Indian Ocean.
●
Embassies, Consulate and Military establishments of a country located abroad.
2.2. Goods
●
Goods are material things that satisfy human's needs.
●
Goods can be classified as
❏ Final Goods - Final Goods can be further classified as :
❖ Consumption/Consumer Goods
❖ Capital/ Producer Goods
❏
Intermediate Goods
2.2.1. Final Goods
●
Such Goods that are meant for final use and will not pass through any more stages of production or
transformation.
●
A final good is a product that the consumer finally uses.
●
For example - shirt is a final good.
2.2.1.1. Consumption/Consumer Goods
●
Consumer goods are those final goods which are bought for consumption by consumers.
●
For example- Food, Clothing etc.
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2.2.1.2. Capital/Producer Goods
●
Capital goods are those final goods which help in the production of other goods.
●
They do not get transformed during the production process rather they make production possible
●
For example - tools, machinery, vehicle etc.
2.2.2. Intermediate Goods
●
Intermediate goods are goods that are used as a raw material or input for the production of final goods
●
For example - copper used for making utensils, steel sheets used for making automobiles, etc.
2.3. Why only final goods are counted?
●
The value of final goods already includes the value of the intermediate goods that have entered into the
production process as inputs.
●
Counting them separately will lead to the error of double counting.
●
For example - Suppose in a year a farmer produces 100 rupees worth of potato. A Chips Company had to buy
Rs 50 worth of potato to produce Chips worth of Rs 200.
Farmer
Chips company
Production Value
100
200
Intermediate Good Used
0
50
Value added
(Production Value Intermediate Good)
100-0= 100
200-50 = 150
Total GDP when intermediate
goods are included
100 + 200 = 300
( here we can see the value of potato i.e Rs 50 is counted twice first in
Farmer’s case then for Chips Company, hence GDP value is increased to
300 )
Total GDP when only Final good
is counted
100 + 150 = 250
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2.4. Financial/Fiscal/Accounting Year
●
Financial Year is a period of 12 months, used by government, business, and other organizations in order to
calculate budget, profit, losses, etc.
●
In India, this 1 year period starts from 1st April and ends on 31st March. So for the year starting 1st April 2019
and ending on 31st March 2020 this period is called Financial Year 2019-20.
●
One financial year is divided into 4 quarters.
Q1 = 1st April - 30 June.
Q2 = 1st July - 30 September.
Q3 = 1st October - 31st December.
Q4 = 1st January - 31 March.
2.5. Different uses of the concept of GDP
●
To determine the growth rate of an economy. The growth rate of 6% means that the size of the economy has
increased by 6% from last year.
●
It is a quantitative concept and its volume indicate the ‘strength’ of the economy. But it does not tell
anything about the ‘qualitative’ aspects of the economy. For example, GDP will tell about the number of
goods that a country produces but it will not tell about the quality of goods produced by the country.
●
It is used for the comparative analysis by International organizations like IMF etc.
3. Net Domestic Product (NDP)
●
Net Domestic Product(NDP) is the annual measure of the economic output of a nation that is adjusted to
account for depreciation.
NDP = GDP - Depreciation
●
NDP of an economy has to be always lower than GDP since there is no way to cut depreciation to zero.
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3.1. Different uses of the concept of NDP
●
It is used to understand and analyse the loss due to depreciation to the economy.
●
It is also used to show the achievement of the economy in the area of research and development in reducing
loss due to depreciation.
4. Depreciation
●
The monetary value of an asset decreases over time due to use, wear and tear. This decrease in value is
called depreciation.
●
It is an annual allowance for wear and tear of a capital good.
●
In other words, it is the cost of the good divided by the number of years of its useful life.
●
For Example - If a Car is purchased with a cost of Rs. 100,000 and the expected usage of the Car is for 5 years,
then Car will depreciate at Rs. 20,000 every year for a period of 5 years.
●
Ministry of Commerce and Industry in India announces the rate at which assets depreciate.
5. GNP/GNI
●
Gross National Product/Gross National Income(GNP/GNI) is the monetary value of all final goods and services
produced by the normal resident(explained below) of the country in a financial year regardless of
production location.
●
Residence, rather than citizenship, is the criterion for determining nationality in GNP calculations, as long
as the residents spend their income within the country.
GNP = GDP + Net Factor Income from Abroad
GNP = GDP + Money flowing from foreign countries - Money flowing to foreign countries
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●
The items which are included in Net Factor Income from abroad are -
a. Trade Balance
❏ The Net outcome of total import and export (i.e Export-Import) of a country in a year.
❏ For India, it is Negative (Since For India Import > Export).
b. Interest on external loans
❏ The Net outcome of the inflow of interest payment (on money lent out) and the outflow of interest
payment (on the money borrowed)
i.e Inflow of interest payment - Outflow of interest payment.
❏ For India, it has been always Negative (Since For India Outflow of Interest Payment > inflow of Interest
Payment).
c. Private Remittances
❏ The Net outcome of the money inflow and outflow by Indian national working outside and the foreign
national working in India.
❏ For India, it is Positive since India is the largest recipient of remittances in the world.
●
For example, Suresh who works in Dubai sends money back to his family in India, Hence that money will be
included in private remittance while calculating GNI.
In the case of India, GNP is Negative hence India’s GNP is always lower than its GDP.
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5.1. Normal Resident
●
It refers to the individual who usually resides in a country, whose economic interest lies in that country.
●
Normal Resident include ❏ Citizens and Non-Citizens ( residing for more than 1 year)
❏ Institutions.
●
For example - Lisa who is an American National works in a so ware company in Delhi for past five years is a
Normal Resident since her economic interest lies in India and her stay in India has been for more than 1 year.
5.2. Different uses of the concept of GNP
●
GNP is preferred to GDP by organizations such as the World Bank because it indicates both internal as well as
external strength of the economy.
●
That is both quantitative as well as qualitative aspects of goods and services produced by a country.
A- Income earned by the normal resident from the domestic territory.
B- Income earned by the normal resident from abroad.
C- Income earned by the non-resident from the domestic territory of the country.
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6. Difference between GDP and GNP
GDP
GNP
It measures the market value of all final goods and
services produced within the domestic territory of a
country.
It measures the market value of all final goods and
services produced regardless of production location.
The focus on GDP is on domestic production.
The focus on GNP is on production by citizens.
It highlights the strength of the country's economy.
It highlights how the resident of the country contributes
to the economy.
7. Net National Product (NNP)
●
Net National Product(NNP) is the (Gross National Product(GNP) minus depreciation.
NNP = GNP - Depreciation
●
NNP is used to find Per Capita Income(PCI) of the country.
PCI = NNP/total population of a nation.
●
It is the purest form of Income as is expressed in terms of the domestic currency of a country.
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8. Cost
●
Cost is the value of money that has been used up to produce something or to deliver a service.
●
The value of total produced goods and services can be calculated at either at factor cost or market cost.
8.1. Factor Cost
●
It is the input cost that the producer has to incur in producing goods and services.
●
Factor cost includes all factors of production used in producing a good or service.
●
The factors of production include land, labour, entrepreneurship, and capital.
●
It is the price of the commodity from the producer side.
●
It is used for determining economic growth.
8.2. Market Cost
●
It is the cost at which the goods are sold in the market.
●
It is derived by adding the Net Indirect tax (E.g. GST) to factor cost.
Market cost = Factor Cost + Net Indirect Tax(Indirect tax - Subsidy)
●
Market cost is used for determining actual GDP transaction i.e GDPMP = GDPFC + Indirect Taxes - Subsidy.
●
For example - Ramesh sell 100 cakes. The cost of production of cake is Rs 9, Ramesh sells 100 products.
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Years
Number of Factor
Tax
Products
Cost
2014-15
100
9
2
2015-16
100
9
3
Subsidies
Net Indirect Market
GDPMP
GDPFC
Tax
Price
1
2-1 = 1
10
1000
900
1
2-1 = 1
11
1100
900
**
●
From January 2015 Government of India started estimating GDP at market price.
●
In general, they are also called ‘factor price’ and ‘market price’.
●
Generally, factor costs are used to measure economic growth whereas market prices are used for actual
transactions.
9. Current Price vs Constant Price
●
Current Price - Goods and Services are valued at the price of their year of production.
Used for measuring actual transactions.
GDP@Current Price gives us Nominal GDP.
●
Constant Price- Goods and Services are valued at Base year price.
Used in Estimating economic growth.
GDP@Constant Price gives us Real GDP.
10. Nominal GDP
●
Nominal GDP is GDP calculated at current market prices.
●
All goods and services counted in nominal GDP are valued at the prices that they are sold.
●
Nominal GDP will include all the changes in market prices that have occurred during the current year due to
inflation or deflation.
●
Because Nominal GDP is measured in current prices, growing nominal GDP might reflect a rise in prices as
opposed to growth in the number of goods and services produced. Hence the nominal GDP presents a
distorted picture of the actual growth.
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11. Real GDP
●
Real GDP is GDP calculated at the market prices at base year.
●
If we are comparing the GDP growth between the two periods, the nominal GDP growth might overestimate
due to inflation.
●
Therefore Economists use the prices of goods from a base year to act as a reference point when comparing
GDP from one year to another.
●
For example, if 2011 were chosen as the base year, then real GDP for 2019 is calculated by taking the
quantities of all goods and services purchased in 2019 and multiplying them by their 2011 prices.
●
Nominal GDP > Real GDP.
●
According to Economic Survey wedge between Real and Nominal GDP has narrowed.
12. GDP Deflator
●
The difference in prices from the base year to the current year is called the GDP deflator.
●
GDP deflator measures the impact of inflation on the gross domestic product(GDP) i.e how much a change
in GDP relies on changes in the price level.
●
It is calculated by dividing nominal GDP by real GDP and then multiplying by 100.
GDP Deflator
=
Nominal GDP x 100
Real GDP
●
The GDP deflator can be viewed as a conversion factor that transforms real GDP into nominal GDP.
●
For example - Table below shows the relation between Nominal GDP, real GDP and GDP deflator.
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14
Years
Number
Current
Base Year
GDP@
GDP@
GDP
Real GDP =
of
Price
Price
current
constant
deflator
(Nominal
price
price
Products
GDP/GDP
deflator) * 100
2011-12
100
10
10
1000
1000
100
1000
2012-13
100
15
10
1500
1000
150
1000
2013-14
100
22.5
15
2250
1500
150
1500
13. Income
●
The income of a person has three forms.
13.1. National Income or NNP at Factor Cost
●
National Income at factor cost = NNP at market price - Indirect tax + Subsidies.
13.2. Personal Income (PI)
●
Personal Income is the part of the National Income received by the household.
●
PI = NI - Undistributed profits - Net interest payments made by the households - Corporate Tax +
Transfer Payment to the household from the government and firms.
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13.3. Personal Disposable Income (PDI)
●
It is the income le with the individuals a er the payment of direct taxes from personal income.
●
It is the actual income which can be spent on consumption by the household.
PDI = Personal Income(PI) - Personal tax payment - Non tax payment
13.4. National Disposable Income(NDI)
●
It is the total income which is available for use with all the resident of a country during a financial year.
NDI = NNP MP + Other current transfer from the rest of the world
NDI = NI + Net Indirect taxes + Transfer payment from the rest of the world
●
NDI gives the idea of what is the maximum amount of goods and services the domestic economy has at its
disposal
13.5. Private Income
●
It is the total income (earned as well as unearned) of the private sector during the financial year.
Private Income = Earned income of private sector + Unearned income of the private sector
[ e.g. transfer payment]
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14. Base Year
●
Base year is a year which is used as a basis for comparison by a price index such as GDP growth, CPI etc.
●
The base year is allocated the value of 100 in an index.
●
For example, to find the rate of inflation between 2013 and 2018, 2013 is the base year or the first year in the
time set.
●
The base year is changed periodically to take into account new goods and services in the economy.
14.1. Criteria for selection of base year
●
A base year has to be a normal year without large fluctuations in trade, prices of commodities and variable
should be on an average.
●
The base year chosen should not be very old (so as to better reflect the basket of items to be measured)
●
Moreover, the year chosen should have data available for all the necessary variables.
15. Data Collection Agency in India
15.1. Central Statistical Office (CSO)
●
Central Statistical Office(CSO) in the Ministry of Statistics and Programme Implementation(MoSPI)
is responsible for macroeconomic data gathering and record keeping.
●
Release estimates of GDP, NI, GNP, NDP, Per Capita Income, CPI, IIP etc.
●
The CSO coordinate with the various state government and organizations to collect and compile data
required to calculate GDP and other statistics.
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●
For example - At State level, State Directorates of Economics and Statistics(DESs) compile their
respective State Domestic Product and other indicators.
●
All the required data is collected and aggregated by CSO and used to arrive at the final numbers.
16. “New GDP Series” 2015
●
The Central Statistical Office(CSO) came out with the new series of national account with 2011-12 as the base
year for computing National Account Statistics like GDP, GNP etc.
●
The New GDP Series will expand the size of the economy by broadening its base in the farm, corporates, and
unorganised sectors.
●
The growth rate of the economy will now be measured by GDP at market price which will be called as GDP as
they are practised internationally.
Earlier
Now
GDP at factor cost
●
GDP at market price
The sector-wise estimate of Gross Value Added is calculated at the basic price instead of factor cost.
GVAbasic price = GVAFC +
(Production Taxes - Production Subsidies)
{above term is Direct Tax on Production(DPT) [ which is practically negligible]}
GVAMP
=
GVAbasic price + (Product taxes - Product Subsidies)
{above term is Net Indirect Tax(NIT)}
Earlier
Now
GVAMP = GVAFC + NIT
GVAbasic price = GVAFC + DPT
GVAMP = GVAbasic price + NIT
GVAMP = GVAFC +DPT + NIT
●
In the current series, the data for corporate income is collected from the Ministry of Corporate Affairs MCA-21
records which allow information even for small level firms.
© Coursavy
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●
It covers data of financial sector from stock exchanges, financial institutions and from various regulators like
SEBI etc.
16.1. Production taxes
●
These taxes are imposed on production and are independent of the volume of actual production.
●
These are direct taxes.
●
For example - Stamp duty, Registration fees, Professional tax.
16.2. Production Subsidies
●
These are paid by the government in relation to production and are independent of actual production.
●
For example - Subsidies to railways, Input Subsidies to farmers etc.
16.3. Product Tax
●
Product Tax is paid on per unit of Output.
●
These are Indirect tax.
●
For example - Sales tax, Excise tax, Service tax etc.
16.4. Product subsidies
●
These are paid by the government on per unit of Output.
●
For example - Food, Petroleum, Fertilizer subsidies to farmers etc.
16.5. Criticism of New Methodology
●
The 2011-12 series used for the first time used, an untested MCA21 database of Ministry of Corporate Affairs
●
Doubtful GDP numbers - The GDP growth for FY17 (-the year of demonetisation) was raised to 8.1%, the
highest in the decade, and for FY18- the year of GST introduction from 6.7% to 7.2%, but these two events
have been described by the expert as twin shock to the economy and it is difficult to see how an economic
growth rate could accelerate in such scenario.
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16.6. Positives of New Methodology
●
It confirms to international standards i.e based on the convention of IMF.
●
It is based on more sources of data.
●
The growth rate as per the new methodology is in consonance with the growth rate of the Indian economy as
estimated by IMF, WB etc.
17. Measurement of National Income
●
National Income(NI) is the total income earned by the normal resident of a country during the financial year.
●
There are 3 methods for the measurement of National Income.
17.1. Product or Value Added Method
●
In this method, NI is estimated by adding up value addition of each firm for all three sectors namely Primary,
Secondary and Tertiary Sector.
●
For example - Suppose a year a farmer produces 100 rupees worth of wheat for which he does not need any
assistance of any input. Therefore the entire amount of Rs 100 is the contribution of the farmer. The baker had
to buy Rs 50 worth of wheat to produce bread worth of Rs 200.
© Coursavy
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Farmer
Baker
Total production Value
100
200
Intermediate Goods Used
0
50
100
200-50 = 150
GVA
(Gross
Value
Added)
=
(Production value - Intermediate
Good)
17.2. Income method
●
In this method, NI is calculated by adding the income of all factors of production within the domestic
territory in terms of rent, royalties, interest, profit, wages, salaries, etc.
GDP = W + In + P + R
W = Wage and salaries.
In = Interest Payments.
P = Gross Profit.
R = Rent.
17.3. Expenditure Method
●
In this method, all the expenditure on consumer goods and investment which are produced within the
domestic territory incurred by the household, government, firms are summed up to get NI.
GDP = C + I + G + (X-M)
●
C = Private final consumption expenditure.
●
G = Government final consumption expenditure.
●
I = Expenditure on final Goods [ Investment or Capital Formation]
●
X = Exports
© Coursavy
M= Imports
X-M = Net Exports
21
18. Items not included in National Income
●
The items that are not included in the calculation of National Income are ❏ Intermediary Goods = to avoid double counting.
❏ Transfer Payments like gi s, scholarships, remittances.
❏ Sale/Purchase of Old/Second-hand goods (but the broker commission is included).
❏ Black Money.
❏ Capital Gains.
❏ Household Services (only housewives services if paid is counted).
19. Facts regarding National Income
●
1st estimate of National Income(NI) in India was made by Dadabhai Naoroji for the year 1867-68. It was
published in his book titled ‘Poverty and British Rule in India’.
●
1st scientific estimate of National Income (NI) was made by Professor V.K.R Rao for the year 1931-32.
●
The first official estimate of National Income(NI) was made by the Ministry of Commerce for the year 1948-49.
●
In 1949 the government established the National Income Committee under the Chairmanship of Dr P.C
Mahalanobis.
●
Since 1956, the Central Statistical Organisation has been estimating National Income(NI) and related
aggregates. These are published in the report titled ‘National Accounts Statistics’.
20. Domestic Income
●
It is the total income earned in the domestic territory during a financial year.
DI = NDPFC
NDPFC = GDPFC - Depreciation
●
Domestic Income can be calculated both at current (Nominal DI) and constant(Real DI).
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21. Closed Economy vs Open Economy
Closed Economy
●
Closed Economy is an economy that has no economic relations with other countries of the world.
●
A closed economy does not enter into the following activities.
❏ It neither exports goods and services to foreign countries nor imports goods and services from
foreign countries.
❏ It neither borrows from foreign countries nor lends to foreign countries.
●
Due to all these reasons, Gross Domestic Product and Gross National Product are the same in a closed
economy.
Open Economy
●
Open Economy is an economy that has economic relations with other countries of the world.
●
An open economy involves itself in the following activities.
❏ It exports goods and services to foreign countries and also imports goods and services from
foreign countries.
❏ It borrows from foreign countries and lends to foreign countries.
●
Due to all these reasons, Gross Domestic Product and Gross National Product are not the same in an open
economy.
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23
22. GDP and Welfare
●
Economic growth is generally taken as the measure of improvement in the standard of living of the citizen’s of
that country.
●
Countries with higher GDP o en have a high score in various development and welfare index.
●
However, there are limitations to the usefulness of GDP as the measure of welfare -
22.1. Distribution of GDP is not uniform
●
If the GDP of the country is rising the welfare may not rise as a consequence. This is because the rise in GDP
may be concentrated in the hands of very few individuals or firms. Economic inequality is not revealed by the
GDP figures.
22.2. Non-Monetary Exchange
●
Many activities in the economy are not estimated in monetary terms. For example, the domestic services
women perform at home are not paid for. In developing countries, where many remote regions are
underdeveloped, the exchange takes place as barter exchange which is not registered as part of economic
activity. This is the case of underestimation of GDP.
22.3. Externalities
●
Externalities refer to the benefits(or harm) a firm or individual causes to another for which they are not paid(or
penalised). The impact of economic activity on the environment is not measured by GDP.
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23. UPSC CSE PRELIMS Previous Years Questions
●
Now, let's check how many questions can you attempt?
Q.1) In terms of economy, the visit by foreign nationals to witness the XIX Common Wealth Games in India
amounted to
(2011)
[A] Export
[B] Import
[C] Production
[D] Consumption
Ans.1) Explanation: (a)
●
The income was from “tourism” and that is an invisible export.
Q.2) A “closed economy” is an economy in which -
(2011)
[A] the money supply is fully controlled
[B] deficit financing takes place
[C] only exports take place
[D] neither exports nor imports take place
Ans.2) Explanation: (d)
●
A closed economy is one that has no trade activity with outside economies.
●
A closed economy is self-sufficient, which means no imports come into the country and no exports leave the
country.
●
A closed economy's intent is to provide domestic consumers with everything they need from within the
country's borders.
© Coursavy
25
Q.3) The National income of a country for a given period is equal to the:
(2013)
[A] The total value of goods and services produced by the nationals
[B] Sum of total consumption and investment expenditure
[C] Sum of personal income of all individuals
[D] Money value of final goods and services produced
Ans.3) Explanation: (a)
●
National income of a country is defined as the sum of total factor income accruing to the residents of that
country from the production activity performed by them both within and outside the economic territory in a
year.
Q.4) A decrease in tax to GDP ratio of a country indicates which of the following?
(2015)
1. Slowing economic growth rates
2. Less equitable distribution of national income
[A] 1 only
[B] 2 only
[C] Both 1 and 2
[D] Neither 1 nor 2
Ans.4) Explanation: (b)
●
Note: This question you will be able to solve effectively a er taxation module.
●
Tax GDP ratio shows the tax revenue for a country measured in terms of GDP.
●
For example, if India’s tax GDP ratio is 16%, it means that the government gets 16% of its GDP as tax
contribution from the public and entities.
© Coursavy
26
●
Here, Tax GDP ratio shows the richness of the government’s exchequer.
●
The government’s ability to spend on socio-economic development programs, military, salary, pension heads
etc, depends on tax GDP ratio.
●
Lower tax GDP ratio indicates a less equitable distribution of national income.
Q.5) With reference to the India economy, consider the following statements:
(2015)
1. The rate of growth of real Gross Domestic Product has steadily increased in the last decade.
2. The Gross Domestic Product at market prices (in rupees) has steadily increased in the last decade
Which of the statements given above is/are correct?
[A] 1 only
[B] 2 only
[C] Both 1 and 2
[D] Neither 1 nor 2
Ans.5) Explanation: (b)
Note: This you can solve by reading and understanding the Eco Survey.
The rate of growth of real Gross Domestic Product has fluctuated over the decade.
But, The Gross Domestic Product at market prices (in rupees) has steadily increased in the last decade
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Economic Growth and Development
1. Economic growth
2. Economic development
3. Difference between Economic growth and development
4. Indicator of Economic Development
4.1 Net Economic Welfare
4.2 Real per capita Income
4.3 Physical Quality of Life Index
4.4 HDI
5. Human Development Index
5.1 Classification of countries based on HDI
5.2 Changes in HDR 2010
5.2.1 Inequality-adjusted HDI
5.2.2 Multidimensional Poverty Index
5.2.3 Gender Inequality Index
5.2.4 Gender Development Index
5.3 India and HDR
6. Has development delivered happiness?
7. Indicator of Happiness
7.1 GNI
7.2 World Happiness Index
7.2.1 World Happiness Report 2019
7.3. Indian State’s Initiatives
7.3.1 Madhya Pradesh
7.3.2 Andhra Pradesh
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7.3.3 Maharashtra
8. Social Progress Index
9. Environmental Performance Index
10. Purchasing power parity
10.1 Difference between Market Exchange Rate & PPP
11. Least Developed Countries(LDC)
12. Millennium Development Goals( MDG)
12.1 India achievement in MDG
13. What is Sustainable Development?
13.1 Dimensions of Sustainable Development
13.2 Indicators of Sustainable development
13.2.1 Green GDP
13.2.2 Genuine Saving
14. Sustainable Development Goals(SDG)
14.1 Why do we need Sustainable Development Goals(SDG)
14.2 Challenges in achieving SDG
15. Classification of countries
15.1 First world countries
15.2 Second world countries
15.3 Third world countries
15.4 Fourth world countries
16. Previous Year Questions
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Is a person’s well-being solely dependent on his economic well being? Are people of countries with a higher Economic
growth happier? What is the difference between economic growth and development? Very o en these two words are
mistakenly understood the same. But in 1960s economist made a distinction between Economic Growth and
Economic Development.
1. Economic Growth
●
An increase in an economic variable (like GDP etc) over a period of time is called Economic growth.
●
Concept of Economic growth is applicable both for an individual ( increase in Income) and for Nation ( with an
increase in goods and services produced by it over a period of time).
●
Economic Growth focuses on the quantitative growth of the economy like GDP, NDP.
2. Economic Development
●
Economic development refers to the process of economic growth which is accompanied by an improvement in
the well being of the people.
●
It indicates a progressive change in socio-economic structure in the economy and focuses on both
quantitative and qualitative growth of the economy.
●
It measures all aspects like Wealth, Health, Education, etc.
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3. Difference between Economic growth and development
Economic Growth
Economic Development
Economic growth is a narrower concept.
Economic development is a much broader concept.
It refers to an increase in the production of goods and
Economic development = Economic growth + Social
services by a country.
Welfare.
Economic growth is considered one dimensional since it Economic development is a Multidimensional concept
only focuses on income.
since it only focuses on income as well as social welfare.
It is a Quantitative Concept
It is both Quantitative and Qualitative Concept.
It can be achieved without Economic development.
It cannot be achieved without Economic growth.
It is a short term process.
It is a long term process.
Economic growth is related to developed countries of
Economic development is related to under-developed
the world.
countries and developing countries of the world.
Indicators are - Real GDP, Real per capita income etc.
Indicators are literacy rate, poverty ratio etc.
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4. Indicator of Economic development
●
There are various indicators to measure the level of economic development of a nation are as follows -
4.1 Net Economic Welfare (NEW)
●
Net economic welfare(NEW) is a broader concept than GNP to measure economic welfare.
●
It adjusts GNP by adding the value of beneficial non-market activities such as Value of leisure and Subtracting
from it ‘bads’ such as pollution.
NEW = GNP +
Value of Housewives Services +
Value of leisure Expenditure on defence Cost of Environment Degradation
●
It is given by Paul Samuelson.
●
It is a theoretical concept which highlights limitations of GDP.
4.2. Real per capita Income
●
Real GDP per capita is a Real GDP divided by the number of people.
●
It is used to compare the standard of living between countries and expressed in terms of a commonly used
international currency such as the Dollar, Euro etc.
●
Real GDP helps to ascertain the country's development status.
●
Real GDP is not a satisfactory measure of economic development because ❏ It is based on National Income which itself is not a satisfactory indicator of economic development.
❏ It is based on the value but does not take into account its various sector composition( agriculture,
secondary or tertiary Sector).
❏ It does not take into account the distribution of National income i.e Inequalities.
❏ It is silent on welfare dimension of economic development namely reduction in poverty, political
liberty, literacy etc.
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Real per capita income was used earlier, because of the lack of any satisfactory quantitative indicator of
economic development.
4.3 Physical Quality of Life Index (PQLI)
●
Physical Quality of Life Index (PQLI) attempts to measure national well being using social indicators.
●
These indicators are :
❏ Life Expectancy at birth
❏ Infant mortality rate
❏ Literacy Rate
●
All three indicator is measured on a scale which ranges from 1 to 100 where 1 represents the worst
performance and 100 is the best performance.
●
The average value of three-component is PQLI.
●
The Physical Quality of Life Index (PQLI) was developed by economist Morris David Morris.
4.4. HDI
●
The Human Development Index (HDI) is used to measure a country's overall achievement in its social and
economic dimensions.
●
The concept of HDI is discussed in detail in the next section.
5. Human Development Index
●
Human Development Index(HDI) was introduced by the United Nations Development Programme(UNDP) in
World Human Development Report in 1990 to measure well being.
●
HDI was developed by economist Mahbub ul Haq.
●
HDI measures the achievement of a Nation in three basic dimensions of human development.
❏ A long and healthy life - measured by life expectancy
❏ Access to Education - measured by the adult literacy rate and enrolment ratio.
❏ Decent Standard of living - measured by Gross National Income(GNI) per capita adjusted for
the price level of the country
●
The HDI helps the United Nations determine which countries need assistance, specifically Least Developed
Countries(LDC).
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From 2010 UNDP began using a new method for calculating HDI. It used the following three index ❏ Life expectancy index (LEI) - Measures life expectancy.
❏ Education Index(EI) -
It is average of Mean years of schooling and Expected years of
schooling.
❏ Income Index (II) - Measure GNI per capita.
Dimension
Indicators
Values
Min
Long & healthy life
Life expectancy at birth
20 year
Dimension Index
Max
85 year
Life
Expectancy
Index(LEI)
Knowledge
a. Mean
year
of 0 year
15 year
Education Index(EI)
schooling
b. Expected year_of
schooling
Standard of living
GNI per capita
0 year
18 year
$100
$75,000
Income Index(II)
($ PPP)
●
HDI is a geometric means of three indices i.e
√LEI
3
* EI * I I .
Terms Life expectancy ●
The number of years a newborn child is expected to live if similar socio-economic conditions prevail
throughout the child's life.
Means years of schooling ●
It is the average number of years of education received by people aged 25 and above during their lifetime.
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Expected years of schooling ●
Number of years of schooling that a child of school entrance age expects to receive if the prevailing pattern of
age-specific enrolment rates persists throughout the child's life.
Gross National Income(GNI) per capita ●
It is calculated by dividing Gross National Income(GNI) with a total population of the country.
●
UNDP shi ed from adopting GDP per capita to GNI per capita because GNI per capita is suitable to consider the
well being of people rather than the income of the country.
5.1. Classification of countries on the basis of HDI
●
HDI is ranked on a scale from 0 to 1.
❏ A score of 0 - 0.49 means low development - for example, Mali.
❏ A score of 0.5 - 0.69 means medium development - for example, India
❏ A score of 0.7 - 0.79 means high development - for example, China
❏ Above 0.8 means very high development - for example, Norway
5.2. Changes in Human development Report
●
UNDP introduced three new indices in the year 2010.
5.2.1.Inequality-adjusted Human Development Index (IHDI)
●
The IHDI is the HDI(Human Development Index) adjusted for inequalities in the distribution of
achievements in each of the three dimensions of the HDI (health, education, and income).
●
The IHDI will be equal to the HDI value when there is no inequality but falls below the HDI value as
inequality rises.
●
The difference between the HDI and the IHDI represents the ‘loss’ in potential human development
due to inequality and can be expressed as a percentage.
●
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Atkinson index is used to measure income inequality.
8
5.2.2. Multidimensional Poverty Index ●
Multidimensional Poverty Index(MPI) measures poverty on the basis of deprivation at household and
individual level in health, education, and standard of living.
●
It is developed by UNDP and Oxford Poverty & Human Development Initiative (OPHI) and it
replaced the Human Poverty Index(HPI).
●
The poverty line is defined as the deprivation score is more than 33.3 %.
●
MPI is calculated as follows MPI = H* A
H = Percentage of people who are MPI poor.
A = Intensity of poverty ( average number of deprivations a poor person suffers).
●
The MPI goes beyond income as the sole indicator for poverty, by exploring the ways in which people
experience poverty in their health, education, and standard of living.
5.2.3. Gender Inequality Index(GII) ●
Gender Inequality Index is an index for measurement of gender disparity.
●
It uses the following three dimensions to measure gender disparity Reproductive health - It is measured by two indicators
❏ Maternal Mortality Rate(MMR)
❏ Adolescent Fertility Rate(AFR)
Empowerment - It is measured by two indicators
❏ Proportion of parliamentary seats occupied by females.
❏ Proportion of adult females and males aged 25 years and older with at least some
secondary education.
Labour market participation ❏ Women’s participation in the workforce.
●
GII is a composite measure to quantify the loss of achievement within a country due to gender
inequality.
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5.2.4. Gender-related Development Index (GDI)
●
Gender-related Development Index is an index to measure gender disparities with respect to three
dimensions of HDI i.e Health, Knowledge and Standard of living.
GDI = HDI (females)
HDI (males)
●
It addresses gender-gaps in life expectancy, education, and incomes.
●
More than GDI value, lesser the gender disparity.
5.3. India and HDR 2019
●
India is ranked 129th out of 189 countries on the 2019 Human Development Index (HDI) released by the
United Nations Development Programme (UNDP).
●
Norway tops the list and Niger is the least developed country in the world.
●
India's HDI score is 0.647.
❏ Health - Life expectancy at birth is 69.4.
❏ Education - Mean years of schooling is 12.3 years.
❏ Income - GNI per capita(PPP $) is 6,829.
●
India has an Inequality-adjusted Human Development Index(IHDI) value of 0.538 ranking it 129 of 189
countries.
●
India has a GII value of 0.501, ranking it 122 out of 162 countries.
●
In India, 11.7% of Parliamentary seats are held by women and 39 % of adult women have reached at least a
secondary level of education.
●
Switzerland tops the Gender Inequality Index, whereas Yemen is ranked at the bottom.
●
India has a Gender development index(GDI) value of 0.829 ranking it 129 of 189 countries on the 2018
gender inequality index.
●
The 2019 Multidimensional Poverty Index(MPI) states that Across 101 countries, 1.3 billion people are
multidimensionally poor.
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India MPI value is 0.123 and India accounts for 28 per cent of the 1.3 billion multi-dimensional poor in the
world.
●
India managed to li 27.1 crores, people, out of poverty from 2005-06 to 2015-16, recording the fastest
reduction in the MPI value during the period.
●
Above figure shows India’s comparison with the world in various indexes.
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India performance in HDI over the years
●
Between 1990 and 2018, India’s HDI value increased by 50 percentage (from 0.431 to 0.647), which places it
above the average for countries in the medium human development group (0.634) and above the average for
other South Asian countries (0.642).
●
The report states that ‘as the gap in basic standards is narrowing, with an unprecedented number of people
escaping poverty, hunger and disease. The next generation of inequalities is opening up, particularly around
technology, education, and the climate crisis. These inequalities are a roadblock to achieving the 2030 agenda
for sustainable development.
6. Has development delivered Happiness?
●
For past decades, the world has chased GDP growth to bring ‘posterity’ and ‘happiness’. We have succeeded in
growing global economic output. Yet ‘wellbeing’ and ‘happiness’ indices have largely remained flat, inequality
has increased, natural resources have been degraded.
●
Our focus on GDP growth to achieve happiness hasn’t worked in delivering happiness.
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7. Indicator of Happiness
●
There are various indicators to measure the level of happiness of a nation are as follow-
7.1. Gross National Happiness
●
Gross National Happiness index is used to measure the collective happiness and well being of a population.
●
The term Gross National Income was coined in 1972 by the then king of Bhutan, Jigme Singye Wangchuck.
●
Gross National Happiness is based on four dimensionsSustainable Economic Development
Good Governance
Preservation of Cultural Values
Conservation of environment
●
The objective of GNH is to achieve a balanced development in all facets of life that are essential for happiness.
7.2. World Happiness Report
●
World Happiness Report is a measure of happiness, published by the United Nations Sustainable
Development Solutions Network(UN SDSN) since 2012.
●
It was developed by Helliwell, Layard, and Sachs.
●
The report measures the happiness and well-being of a country and helps to guide public policy on the basis
of the following six parameters ❏ Real GDP per capita (at PPP)
❏ Healthy Life expectancy
❏ Social Support
❏ Freedom to make life choices
❏ Generosity
❏ Perception of Corruption
●
The report uses data from the Gallup World Poll.
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7.2.1. World Happiness Report 2019
●
This is the seventh annual World Happiness Report, which ranks the world’s 156 countries.
●
The focus of the report was - Happiness and Community.
●
The report was topped by Finland.
●
India is ranked 140th place compared to 133rd place in 2018. India is among the five countries that had the
largest drop since 2008.
●
People in war-torn South Sudan are the most unhappy.
7.3. Indian State’s Happiness Initiative
7.3.1.Madhya Pradesh
●
Madhya Pradesh became the first state to announce its happiness department.
●
Madhya Pradesh in collaboration with Indian Institute of Technology(IIT) Kharagpur to develop a
happiness index for measuring the well being of the people.
7.3.2. Andhra Pradesh
●
Andhra Pradesh is the second state in the country a er Madhya Pradesh to start happiness Index
Department.
●
Its ‘Sunrise AP Vision 2029’ has taken Bhutan as a model to focus on matters including health, time
use, education etc.
7.3.3. Maharashtra
●
Maharashtra government is contemplating to introduce a separate 'happiness ministry' to encourage
positivity in society.
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8. Social Progress Index
●
The Social Progress Index (SPI) measures the extent to which countries fulfil the social and environmental
needs of their citizens.
●
The index is based on a range of social and environmental indicators that capture three dimensions of social
progress:
❏ Basic Human Needs,
❏ Foundations of Wellbeing,
❏ Opportunity.
●
The 2019 Social Progress Index includes data from 149 countries on 51 indicators.
●
The index is published by Social Progress Imperative and is based on the writing of Amartya Sen, Douglas
North and Joseph Stiglitz.
●
Norway tops the 2019 SPI ranking, India is ranked 102nd out of 149 countries.
9. Environmental Performance Index
●
Environmental Performance Index is used to measure the environmental performance of a country.
●
EPI highlights leaders, best practices and provides guidance for other countries that want to be leaders in
environmental sustainability.
●
The index is prepared by Yale University, Columbia University in collaboration with World Economic
Forum(WEF).
●
The First Environmental Performance Index report was published in the year 2006.
●
The 2018 Environmental Performance Index ranks 180 countries on 24 performance indicators across
10 issues covering environmental health and ecosystem vitality.
●
India is ranked at 177 places out of 180 countries in the Environment Performance Index-2018.
●
Switzerland topped the index and Burundi was in the bottom of the index.
●
Low scores on the EPI suggests the need for national sustainability efforts on a number of fronts, especially
cleaning up air quality, protecting biodiversity, and reducing GHG emissions.
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10. Purchasing Power Parity(PPP)
●
When making comparisons between countries which use different currencies it is necessary to convert values,
such as national income (GDP), to a common currency. This is done through purchasing power parity.
●
Purchasing Power Parity states that the expenditure on a similar commodity must be the same in both
currencies when accounted for the exchange rate.
Purchasing Power Parity = Cost of Good X in currency in 1
Cost of Good Y in currency 2
●
For Example - Suppose the cost of cake in India is Rs 250, and the cost of the same cake in the USA is $ 10.
Therefore purchasing power parity will be 250/10 = Rs 25 per dollar.
●
Purchasing Power Parity(PPP) is very important and is used to compare the national income and standard of
living.
●
The World Bank every three years compares countries in terms of PPP and the US dollar.
●
India is ranked third in the world on the basis of GDP(PPP) behind China and the USA.
10.1. Difference between Market Exchange Rate & PPP
●
The market exchange rate is the market price of one currency in terms of another currency.
●
Thus, the present market exchange rate for Indian rupees is in the range of 65 to 70 rupees per U.S. dollar.
●
The market exchange rate depends on the demand and supply of these currencies in the open market.
●
PPP exchange rate measures the relative purchasing power of different currencies.
●
India ranks third when GDP is compared in terms of purchasing power parity at $11.40 trillion.
●
Whereas India is the fi h-largest economy, with a nominal GDP of $2.936 trillion.
●
For Example- GDP calculation at market price, India’s economy is well behind Japan. However, price levels in
Japan are much higher than that of India.
●
So when the national income of the two countries is adjusted in terms of PPP exchange rates using the US
dollar, Indian economy surpasses Japan economy because of lower prices.
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11. Least developed countries(LDC)
●
The Least Developed Countries (LDCs) is a list of developing countries that, according to the United Nations,
are at the bottom of the Human Development Index ratings.
●
The classification of the least developed country was introduced by the Economic and Social
Council(ECOSOC) of UNO in 1971.
●
Countries are classified as LDCs on the basis of the following criteria :
❏ Low-income criteria A country must have GNI per capita less than the $1025 to be included on the LDC list.
❏ Human asset Index
It is a composite index of education and health used as an identification criterion for LDCs.
❏ Economic Vulnerability Index(EVI)
The Economic Vulnerability Index is a composition of the following eight indicators:
1) Population size,
2) Remoteness,
3) Merchandise export,
4) Share of agriculture in the Gross Domestic Product(GDP),
5) Homelessness owing to natural disasters,
6) Instability of agricultural production,
7) Instability of exports of goods and services,
8) Share of the population living in low elevation coastal zone.
●
At present 47 countries are in the Least Developed countries(LDC) list.
●
Various international Organisation give special assistance to LDCs.
●
LDC criteria are reviewed every three years by the Economic and Social Council(ECOSOC).
●
Countries may "graduate" out of the LDC classification when indicators exceed these criteria in two
consecutive reviews.
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12. Millennium Development Goal (MDG)
●
The United Nations Millennium Development Goals(MDG) are eight goals that all 191 UN members had agreed
to achieve by the year 2015.
●
The Eight Millennium Development Goals are ❏ to eradicate extreme poverty and hunger;
❏ to achieve universal primary education;
❏ to promote gender equality and empower women;
❏ to reduce child mortality;
❏ to improve maternal health;
❏ to combat HIV/AIDS, malaria, and other diseases;
❏ to ensure environmental sustainability;
❏ to develop a global partnership for development.
12.1. India’s achievement in MDG
●
India is a signatory to the Millennium Declaration adopted at the United Nations General Assembly in
September 2000 and has made its commitment towards the eight development goals.
●
The targets of the MDGs converge with India’s own development goals to reduce poverty, child mortality
and other concerns.
●
India has witnessed significant progress towards the MDGs, with some targets having been met ahead
of the 2015 deadline, however, progress has been inconsistent.
●
For instance, according to official national estimates, India has achieved the target for reducing poverty by
half, but it is falling short of achieving the target for reducing hunger.
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13. What is Sustainable Development?
●
UN World Commission on Environment and Development(UNWCED) defines it as “ the development
that meets the needs of the present generation without compromising the needs of future generations to
meet their own needs.
●
It is related to Carrying Capacity which refers to the capacity of the environment to absorb the adverse
impact of human activity.
●
Sustainable Development offers a framework to generate economic growth, achieve social justice, and
preserve environmental sustainability.
●
It recognises that growth must be both inclusive and environmentally sound to reduce poverty and meets
the needs of the future generation.
13.1. Dimension of Sustainable Development
●
There are 3 dimensions of Sustainable Development ❏ Economic Dimension - Economic Dimension deals with encouraging business and organisation to
increase investment, efficiency in production, economic growth.
❏ Social Dimension- It deals with encouraging people to participate in environmental sustainability
❏ Environmental Dimension- It defines how to protect ecosystems, air quality, focuses on the
elements that place stress on the environment.
13.2. Indicator of Sustainable development
13.2.1. Green GDP
●
Green Gross Domestic Product( Green GDP) is an index of economic growth where the environmental
consequences of growth are factored in while calculating conventional GDP of a nation.
●
The economic cost of water pollution, land degradation is not incorporated in the GDP.
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For example - WWF’s ‘Living Planet’ report, which finds that “25% of India’s total land is undergoing
desertification. This will have a direct impact on the future food production thus affecting our agrarian
economy as the country could see a decrease in crop production.
●
Ministry of Statistics and Programme Implementation (MOSPI) set up an expert group in 2011 led by
Partha Dasgupta, to work out a framework for a green national account in India. The process is not yet
completed.
13.2.2. Genuine Saving
●
Genuine Saving measures the sustainability of economic development.
●
Genuine Saving = Gross Saving Depreciation in man-made capital Depreciation in Natural capital
●
Natural Capital includes world stock of all-natural assets like soil, air, water etc.
●
Man-Made Capital includes goods and services that are used to produce other goods and services, such as
machines, tools etc it can also include ‘financial capital’ like money.
●
Genuine Savings has emerged as the leading economic indicator of sustainable economic development.
14. Sustainable Development Goal(SDG)
●
The Sustainable Development Goals (SDGs) are a universal set of goals, targets and indicators that UN member
will be expected to use to frame their nation’s policies over the next 15 years.
●
Sustainable Development Goals (SDGs) follow Millennium Development Goals which expire in 2015.
●
The United Nations adopted the 2030 Agenda for Sustainable Development which includes 17 Sustainable
Development Goals (SDG), associated 169 targets and 304 indicators.
●
The table below highlight 17 Sustainable Development Goals(SDG) and India’s effort toward achieving each of
them
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Goals
Goal-1
Objective
No poverty
Description
India Efforts
BY 2030, End poverty in all its forms everywhere
Mahatma Gandhi National Rural
Employment
Guarantee
Scheme(MGNREGA)
National
Social
Assistance
Programme(NSAP)
Goal-2
Zero Hunger
End hunger, achieve food security and improved
Targeted
public
distribution
nutrition by 2030.
system(PDS), National Nutrition
Mission(NNM),
National Food Security Act(NFSA)
Goal -3
Goal-4
Good Health and
Ensure healthy lives and promote well being for
National Health Mission(NHM)
Well-being
all at all stages
Ayushman Bharat
Quality Education
Ensure that all girls and boys complete free,
Sarva Shiksha Abhiyan(SSA)
equitable and quality primary and secondary National Education Policy
education by 2030
Goal-5
Goal-6
Gender Equality
Goal-8
Sukanya Samridhi Yojana
women and girls
Janani Suraksha Yojana
Clean Water and Ensure
Sanitation
Goal-7
To achieve gender equality and empower all
Affordable
and
availability
and
sustainable Swachh Bharat Abhiyan.
management of water and sanitation for all by
National Rural Drinking Water
2030.
Programme.
Ensure
access
to
affordable,
reliable, National Solar Mission.
Clean Energy
sustainable and modern energy for all by 2030.
Decent Work and
Promote sustained, inclusive and sustainable
National
Economic Growth
economic growth.
Mission,
Skill
Development
Deendayal Upadhyaya Antodaya
Yojana,
Atal Innovation Mission
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Goal-9
Industry,
Build resilient infrastructure, promote inclusive
Innovation
Goal-10
and &
sustainable
Make in India
industrialization and foster Start-Up India
Infrastructure
innovation by 2030.
Reduced Inequality
Reduce inequality within and among countries
National
by 2030.
Empowerment of Women Rajiv
Mission
Gandhi
for
Scheme
Empowerment
of
for
Adolescent
Girls (SABLA)
Kasturba Gandhi Balika Vidyalay
(KGBV)
Goal-11
Sustainable
Cities Make cities and human settlements inclusive,
and Communities
safe, resilient and sustainable.
Smart Cities Mission,
Atal Mission for Rejuvenation and
Urban Transformation(AMRUT)
Pradhan
Mantri
Awas
Yojana(PMAY)
Goal-12
Responsible
Ensure
sustainable
Consumption_and
production patterns.
consumption
and National Policy on Biofuels for
managing the efficient use of
Production
Goal-13
Goal-14
Goal-15
Climate Action
Life Below Water
Life on Land
natural resources.
Take urgent action to combat climate change
National Action Plan on Climate
and its impacts
Change
Conserve and sustainably use the oceans, seas
National
and
Conservation
marine
resources
for
sustainable
development.
Eco-systems
Protect, restore and promote sustainable use of
National
terrestrial ecosystems, combat desertification
Programme,
and halt biodiversity loss.
Project Tiger,
Plan
for
of
the
Aquatic
Afforestation
Project Elephant
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Goal-16
Peace and Justice Promote peaceful and inclusive societies for
Strong Institutions
Development of Infrastructure
sustainable development; provide access to Facilities for the Judiciary
justice for all
Goal-17
Partnerships
Achieve the Goal
to
Strengthen the means of implementation and India’s
membership
in
revitalize the global partnership for sustainable
institutions like the Shanghai
development.
Cooperation Organization, BRICS
and its New Development Bank.
14.1. Why do we need Sustainable Development Goals(SDG)
●
SDG carry forward the unfinished agenda of MDG.
●
MDGs were drawn up by a group of experts, whereas SDGs were dra ed a er a long and extensive
consultative process hence are more comprehensive.
●
MDG was focused only on 8 goals, 21 targets and 63 indicators, while SDG includes 17 goals with 169
targets.
●
MDGs had adopted baseline data for the year 1990, while for the SDGs, the baseline is from 2015
estimates.
14.2. Challenges in achieving SDG
●
Financing SDG - Cost for implementing SDG is huge, which for a developing country like India puts
pressure on existing resources.
●
Defining Indicators- A number of target in SDG are not quantified, Hence measurement of progress in
those indicators will depend on the availability of data.
●
Accountability- There was a lack of accountability for inputs into MDG. This challenge needs to be
addressed in SDGs.
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15. Classification of countries -
●
Countries are classified on the basis of the state of development that the country is in:
15.1. First World Country -
●
First world countries are western developed countries. These refer to developed, capitalist, and industrial
countries.
●
First World countries were the most industrialized countries.
●
During World War II, these countries aligned with the United States of America.
15.2. Second world Country
●
Second world countries refer to former communist-socialist countries.
●
These countries were controlled by the Soviet Union.
●
Since the Soviet Union does not exist anymore, the term of the Third World country is not used anymore.
15.3. Third World Country
●
Third World Countries refer to developing countries.
●
Third World countries included nations that were not aligned with either the United States or the Soviet
Union.
●
Third World includes capitalist, communist (e.g., North Korea), Rich (e.g., UAE) as well as very poor (e.g.,
Mali) countries.
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15.4. Fourth World Country
●
Fourth World Country refers to the poorest of the poor countries.
●
These countries have low GNI per capita and high dependence on foreign aid
●
The nations classified as Fourth World are labelled by the United Nations as the Least Developed Countries
or LDCs.
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16. UPSC CSE PRELIMS Previous Years Questions
●
Now, let's check how many questions can you attempt?
Q.1) Consider the following specific stages of demographic transition associated with economic development:
2012
1. Low birth rate with a low death rate
2. High birthrate with a high death rate
3. High birthrate with a low death rate
Select the correct order of the above stages using the codes given below :
[A] 1 2 3
[B] 2 1 3
[C] 2 3 1
[D] 3 2 1
Ans.1) Correct Option: (c)
Explanation:
●
This is a very easy question. Economic Development means improved living conditions.
●
Improved living conditions means a low birth rate and low death rate.
●
For example, we can say that India has achieved impressive demographic transition owing to the decline of
crude birth rate, crude death rate, total fertility rate and infant mortality rate.
Q.2) Economic growth in country X will necessarily have to occur if
2013
[A] there is technical progress in the world economy
[B] there is population growth in X
[C] there is a capital formation in X
[D] the volume of trade grows in the world economy
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Ans.2) Correct Option : (C)
Explanation:
Note : This you will be able to clearly understand when we will study the Indian Industries Module.
●
Internally capital formation takes place when a country does not spend all its current income and
consumption, but saves a part of it and uses it for investment for increasing further production.
●
This act of saving and investment is described as capital accumulation or capital formation.
Q.3) Increase in absolute and per capita real GNP do not connote a higher level of economic development, if 2018
[A] industrial output fails to keep pace with agricultural output.
[B] agricultural output fails to keep pace with industrial output.
[C] poverty and unemployment increase.
[D] imports grow faster than exports
Ans.3) Correct Option (c)
Explanation:
Per capita, GNP is the total value of all the goods and services produced by a country in a year, including income
from foreign investments, divided by the number of people living there.
●
For countries which have a lot of foreign investments, GNP per capita is a more accurate economic
indicator.
●
GNP = GDP + Net income inflow from abroad – Net income outflow to foreign countries.
●
As the question clearly mentions effects on development, we must take into account the impact of poverty
and unemployment of economic growth despite having good parameters of progress in growth, per capita
income etc.
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Q.4) Consider the following statements:
2019
1. Purchasing Power Parity (PPP) exchange rates are calculated by comparing the prices of the same basket of goods
and services in different countries.
2. In terms of PPP dollars, India is the sixth largest economy in the world.
Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
Ans.4) Correct Option: (a)
Explanation:
●
PPP is an economic theory that compares different countries' currencies through a "basket of goods"
approach.
●
According to this concept, two currencies are in equilibrium—known as the currencies being at par—when a
basket of goods is priced the same in both countries, taking into account the exchange rates.
●
By purchasing power parity (PPP), an exercise that seeks to find the ‘true’ value of a currency vis-à-vis the
dollar, India’s rank is third, behind the US and China.
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Money Supply
1. Money
1.1 Need for money.
1.1.1 Barter system of exchange
1.1.2 Limitations of Barter System
1.2 Functions of Money
1.3 Properties of Money
1.4 Types of Money
1.4.1 Full bodied money
1.4.2 Token money
1.4.3 Representative full bodied money
1.4.4 Legal Tender
1.4.5 Non-legal tender
1.4.6 Fiduciary Money
1.4.7 Fiat Money
1.4.8 Near Money
1.4.9 Plastic Money
1.4.10 Digital Money
1.5 Evolution of Money
1.6 Gresham’s Law
2. Money Supply
3. Bank deposit
3.1 Types
3.1.1. Current account demand deposit
3.1.2. Saving account demand deposit
3.1.3. Fixed account Deposit
3.1.4 Recurring account Deposit
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4. Cryptocurrency
4.1. Blockchain Technology
4.2. How can one get cryptocurrency?
4.3. Bitcoin
4.4. Cryptocurrency around the world
4.4.1. Venezuela
4.4.2. Marshall Island
4.5. India and Cryptocurrency
4.6. Advantages of Cryptocurrency
4.7. Disadvantages of Cryptocurrency
5. UPSC CSE PRELIMS Previous Years Questions
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1. Money
●
Money is an economic unit that is recognized as a medium of exchange for transactional purposes.
●
The main functions of money are distinguished as:
❏ a store of value
❏ a store of value (act as the standard measure for trade)
❏ a standard of deferred payment( it is used to settle debt).
1.1 Need for Money
●
The need for money arose because of the inefficiency of the Barter system.
1.1.1. Barter System of exchange
●
Barter System is a system of exchange where participants in a transaction directly exchange goods
or services for other goods or services in return.
●
For example - Onion can be exchanged for potato, rice for pulses, etc.
● Barter System can be bilateral or multilateral.
●
Bartering doesn't involve money, a person can buy items by exchanging an item.
1.1.2 Limitations of Barter System
●
Lack of Double coincidence of wants - For barter to occur between two parties, both parties need to
have what the other wants.
●
Lack of common measure of value - In a monetary economy, money plays the role of a measure of
the value of all goods, so their values can be assessed against each other; this role may be absent in
the barter economy.
●
Indivisibility of certain goods - The barter system of exchange was not applicable in case of goods
that lose their value if divided into parts.
For example, the value of one cow is equal to two goats. This implies that if an individual wants one
goat in exchange for the cow, then he/she has to sacrifice half of his/her cow.
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●
Lack of standards for deferred payments - Deferred payment are those payments that are made in
the future( like loans, interest). Since commodities are used as the medium of exchange in a barter
system it is difficult to make the deferred payment since there is no standard for making such
payments.
●
Difficulty in storing wealth - If a society relies exclusively on perishable goods, storing wealth for the
future may be impractical.
1.2 Functions of Money
●
The main functions of money are distinguished as:
❏ Medium of Exchange - Money is used as a medium of exchange to facilitate the transactions. It
eliminates the inefficiencies of the barter system, such as the "coincidence of wants".
❏ Unit of account - Money acts as a standard measure and common denomination of trade. Money is
used to measure the value of goods or services produced and also record financial transactions.
❏
Store of Value - Money can be used for current consumption and it can also be held over a period of
time and can be used for future payments.
❏ Standard of deferred payment - Money plays an important role in lending and borrowing. This
function of money allows to defer payment from preset to a future date.
1.3. Properties of Money
●
To fulfill its various functions, money should have certain properties:
❏ Fungibility - its individual units must be capable of mutual substitution (i.e., interchangeability).
❏ Durability - able to withstand repeated use.
❏ Portability - easily carried and transported.
❏ Divisible - it can be broken down into smaller denomination.
❏ Stability of value - its value should not fluctuate.
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4. Types of Money
I.
Full-bodied money - Full Bodied money is one whose value in money is the same as the value in the
commodity.
For Example - In present-day, A Rs 10 coin has value only because it is guaranteed by the government, coin by
virtue does not have any value if we sell the coin in the market without its value no one will buy it hence it is
not full bodied money. But if we use Gold in Rs 10 coin, it will have value irrespective of value Gold coin, silver
coin etc.
II.
Token money - Token Money is one whose value in money is much more than its value as a commodity.
It is also called as paper money.
For Example - Indian currencies.
III.
Representative full bodied money - It is a type of token money issued against an equivalent amount of
bullions (gold and silver) with Central Banks/governments.
IV.
Legal Tender - It is a medium of payment recognized by law as a means for meeting a financial obligation.
❏ Usually, coins and paper currencies are legal tenders but the definitions vary from jurisdiction to
jurisdiction.
For Example - personal cheques, credit cards etc. may not be a legal tender in every jurisdiction.
❏ Legal tender can be limited or unlimited in character.
In India, coins function as limited legal tender. Therefore, 50 paise coins can be offered as legal
tender for dues up to ₹10 and smaller coins for dues up to ₹1000.
Currency notes are unlimited legal tender and can be offered as payment for dues of any size.
V.
Non-legal tender - It is a medium of payment that is not necessary to be accepted.
For Example - personal cheques, credit cards etc.
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VI.
Fiduciary Money - It is the money that is used for transactions on the basis of trust between the payer and
payee.
For Example - Cheque is not a compulsorily accepted mode of payment but the transactions on the trust are
based on the mutual trust of the parties involved.
VII.
Fiat Money - It is Government-issued currency without intrinsic value that is not backed by a physical
commodity like gold etc.
❏ Fiat money does not have a use-value, and it has value only because a government maintains its value.
For Example - U.S.Dollar, Indian Rupee etc.
❏ Fiat money gives governments' central banks greater control over the economy because they control
how much currency is printed.
❏ Fiat money is inconvertible and cannot be redeemed.
❏ Since fiat money is not linked to physical reserves, it risks losing value due to inflation or even
becoming worthless in the event of hyperinflation.
VIII.
IX.
Near Money - Near Money is highly liquid non-cash assets like cheques, demand dra ,s etc.
Plastic Money - Plastic Money usually refers to the debit and credit cards and are considered alternatives to
cash for everyday payments.
X.
Digital Money - It is a currency available in digital form and is a money balance recorded electronically on a
stored-value card or other devices.
It is also called electronic money or electronic currency.
They may be centralized (Eg. digital wallets, debit cards, etc.) or decentralized (cryptocurrency).
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1.5. Evolution of Money
I.
●
Money went through a long evolution before moving to the modern banking system.
●
Some of the major stages through which money has evolved are as follow:
Commodity Money
❏ In the earliest period some commodities, for their use, were more sought than others.
❏ Such commodity assumed the role of currency and used as a medium for exchange.
❏ People used salt, rice, wheat, cow as Commodity Money.
❏ The inadequacy of commodity money led to the evolution of Metallic Money.
II.
Metallic Money
❏ With the discovery of metal, it was used as the main standard of value because of its advantage like
divisibility, easy transportation, etc.
❏ The problem of uniformity of weight and purity of metals lead to the evolution of Paper Money.
III.
Paper Money
❏ The invention of Paper Money was a very important stage in the evolution of Money.
❏ Paper Money is printed and regulated by Central Banks of the country (In India’s case it is RBI).
❏ Use of Paper Money has become universal along with Coins.
IV.
Bank Deposit
❏ People Keep a part of cash into bank deposits which they can withdraw in the future through cheque.
❏ Cheque( has replaced Paper Money for the major portion of commercial transactions.
❏ A cheque is not money as it is an instruction from a bank deposit holder to transfer the required
money in another person’s account.
❏ Hence cheque itself is not money, it performs the functions as money.
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V.
Plastic Money
❏
The latest type of Money is Plastic Money.
❏ Plastic Money usually refers to the debit and credit cards and are considered alternatives to cash for
everyday payments.
❏ They aim at removing the need to carry cash for everyday payment.
VI.
Digital Money
❏ The latest type of Money is Digital Money.
❏ It is a currency available in digital/electronic form.
❏ Digital Money can be transferred with the help of technologies like smartphones, internet.
1.6 Gresham’s Law
●
Gresham’s Law state that “bad money drives out good money”.
●
Whenever coins containing precious metals have been used along with metal coins of the same denomination,
both acting as legal tender, the more valuable commodity(precious metal) will gradually disappear from
circulation.
●
Good Money is the money that shows little difference between nominal value and its commodity value( value
of a commodity like gold etc).
●
Bad Money is the money whose commodity value is lower than the nominal value.
●
Gresham’s Law is named a er Sir Thomas Gresham, an English financer during the Tudor Dynasty.
●
For example - A discounted product of inferior quality may drive out non-discounted product of good quality
in the price-sensitive market like India.
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2. Money Supply
●
Money Supply is the total stock of all types of money (currency, deposit) held by the public at any specific
point of time.
●
It is important to note that the term public includes all the economic entities except government and
banking system (this money is not in actual circulation in the economy hence not part of the money supply).
●
The money supply can include cash, coins, and the balances held in checking and savings accounts, and other
near money substitutes.
●
Money Supply is only that part of the total stock of money which is held by the public at a particular point of
time.
●
It measures the total purchasing power in the economy.
2.1. Change in the money supply
●
Change in the money supply has long been considered to be a key factor in driving macroeconomic
performance and business cycles.
●
An increase in the supply of money typically lowers interest rates(since more money leads to more
opportunity to get loans hence lower interest rates), which in turn, generates more investment and puts
more money in the hands of consumers, thereby stimulating spending. Businesses respond by ordering
more raw materials and increasing production. The increased business activity raises the demand for
labour. The opposite can occur if the money supply falls or when its growth rate declines.
●
Macroeconomic schools of thought that focus heavily on the role of money supply include Irving Fisher's
Quantity Theory of Money and Monetarism.
●
Historically, measuring the money supply has shown that relationships exist between Money Supply, inflation
and price levels.
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2.2. Velocity of Money
●
The velocity of money is the rate at which money is exchanged in an economy.
●
It is the number of times that money moves from one transaction to another. Simply put, it's the rate at which
people spend money.
●
For Example - Consider an economy consisting of two individuals, farmer and seed supplier, they have ₹100
between them in a year.
Farmer buys seed from seed supplier for Rs 100.
Seed Supplier buys wheat from the farmer for Rs 80.
Seed Supplier spends the remaining on transportation Rs 20.
●
In a course of time, Rs 200 changed the hands, even though the size of the economy was Rs 100.
●
This multiplication in the value of goods and services exchanged is made possible through the velocity of
money in an economy.
●
The equation for GDP = Money Supply * Velocity of Money.
●
As the equation illustrates, GDP cannot be controlled through money supply alone. If the money supply is
increased, but velocity decreases, GDP may stay the same or even decline. If the money supply is decreased
but velocity increases, GDP could increase.
●
In the above example GDP = 200, Money supply = 100.
●
Hence the Velocity of Money is 2/year.
2.3. Monetary aggregates
●
Money is used as a medium of exchange, a unit of account, and as a ready store of value. Its different functions
are associated with different empirical measures of the money supply. There is no single "correct" measure
of the money supply. Instead, there are several measures, classified along a spectrum or continuum
between narrow and broad monetary aggregates.
●
Narrow money aggregates include only the most liquid assets, the ones most easily used to spend
(currency, checkable deposits).
●
Broad money aggregates include less liquid types of assets (certificates of deposit, etc.).
●
This continuum corresponds to the way that different types of money are more or less controlled by monetary
policy. Narrow measures include those more directly affected and controlled by monetary policy, whereas
broader measures are less closely related to monetary-policy actions.
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●
It is a matter of perennial debate as to whether narrower or broader versions of the money supply have a more
predictable link to nominal GDP.
●
The different types of money are typically classified as "M"s.
●
The "M"s usually range from M1 (narrowest) to M3 (broadest) but which "M"s are actually focused on in
policy formulation depends on the country's central bank.
●
The Reserve Bank of India defines the monetary aggregates as:
Reserve Money (M0) =
❏ The other name of the Reserve Money is “High Powered Money” and also Monetary Base.
❏ It is the total liability of RBI.
Currency in circulation + Bankers' deposits with the RBI + 'Other' deposits with the RBI
❏ Currency in circulation includes Notes in Circulation, Coins.
❏ Banker’s deposit with RBI is Banks current account deposit with RBI.
❏ Other deposits include balance in the account of foreign Central Banks and Government, the account
of international agencies such as IMF, etc.
❏ It can also be written as
Net RBI credit to the Government + RBI credit to the commercial sector + RBI's claims on banks + RBI's net foreign
assets + Government's currency liabilities to the public – RBI's net non-monetary liabilities.
M1 (Narrow Money) =
Currency with the public + Deposit money of the public (Demand deposits with the banking system) + 'Other'
deposits with the RBI
M2 =
M1 + Savings deposits with Post office savings banks
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M3 (broad money) =
M1+ Time deposits with the banking system
❏ It can also be written as
Net bank credit to the Government + Bank credit to the commercial sector + Net foreign exchange assets of the
banking sector + Government's currency liabilities to the public – Net non-monetary liabilities of the banking sector
(Other than Time Deposits)
M4 =
M3 + All deposits with post office savings banks (excluding National Savings Certificates)
2.4. Liquidity
●
Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market at a
price reflecting its intrinsic value.
●
In other words: the ease of converting it to cash.
●
Cash is universally considered the most liquid asset, while tangible assets, such as real estate, fine art, etc
are all relatively less liquid.
●
Other financial assets, ranging from equities to partnership units, fall at various places on the liquidity
spectrum.
●
The liquidity of these measures are in order M1>M2>M3>M4 i.e. M1 is most liquid and M4 is least liquid.
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2.5. Money Multiplier
●
Money Multiplier is the ratio of the Broad Money (M3) to Reserve Money (M0).
Money Multiplier = M3
M0
●
It shows the relationship between the monetary base and money supply in the economy.
●
It can also be considered as the amount of money that banks generate with each unit of money.
3. Bank Deposit
●
Bank deposit is money kept in banking institutions for future use.
●
Bank deposit refers to liability owned by the bank to the depositor.
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3.1. Types of Bank Deposit
●
Bank offers two types of kinds of deposit account.
❏ Demand Deposit - Demand Deposit account consists of funds that can be withdrawn at any time.
There are two types of demand deposit accounts ❖ Current Account Demand Deposit.
❖ Saving Account Demand Deposit.
❏ Term Deposit /Time Deposit - Term deposit account is used to hold money for a fixed period
Money deposited in term deposit cannot be withdrawn before its maturity that is fixed a particular
time.
There are two types of term deposit account ❖ Fixed Deposit.
❖ Recurring Deposit.
3.1.1. Current account demand deposit
●
The money in the current account is available for immediate access.
●
The current account deposit is used by businesses to conduct their business transactions since there is no
restriction on the number of transactions in a day.
●
Bank does not offer interest rates in the current account demand deposit.
3.1.2. Saving account demand deposit
●
Saving account unlike Current account has restrictions on the number of withdrawals as well as the amount of
withdrawal in a specific period.
●
Bank offers fixed interest rates for saving account demand deposit.
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3.1.3. Fixed account Deposit
●
A fixed account demand deposit allows a deposit to be made for a specified period.
●
Banks offer deposit holder with a fixed interest rate at a regular rate which is higher than the Saving account.
3.1.4. Recurring account Deposit
●
In the Recurring deposit, a fixed amount is deposited at regular intervals for a fixed term.
●
The total deposit along with interest is payable on maturity by the bank.
●
The rate of interest offered by the bank on this deposit is higher than saving account but less than fixed
account deposit.
4. Cryptocurrency
●
Cryptocurrency is a digital or virtual currency that is created, stored and transacted using blockchain
technology.
●
The word ‘Cryptocurrency’ is derived from an encryption technique that is used to secure the decentralized
network.
●
The most important feature of Cryptocurrency is that it is not controlled by any central authority( like central
banking system) instead it uses decentralized control.
●
Example of cryptocurrency is Bitcoin, Digicoin, Litecoin, SOV etc.
4.1. Blockchain Technology
●
Blockchain technology is also known as a distributed ledger technology wherein the data of any of the
individuals are saved as blocks.
●
The information related to the addition of the block is shared with everyone on the blockchain and which
makes modification or hacking of the information difficult.
●
A simple analogy to understand blockchain technology is Google Drive. When we create a folder in Google
drive we share it with other people, the folder is distributed instead of copied or transferred. This creates a
decentralized network that gives everyone access to the folder at the same time. Anyone who has access can
make changes in the folder with all the changes recorded in real-time.
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4.2. How can one get cryptocurrency?
●
Cryptocurrency can be obtained in three ways:
❏ Mining - It is the process of adding the transaction to the public ledger known as the blockchain.
It is done using special so ware and high-speed computers.
❏
Payment - By selling goods to a person who owns the cryptocurrency or the person who is involved in
the process of mining.
❏
Purchasing - Purchasing cryptocurrency by using currency.
4.3. Bitcoin
●
Bitcoin is one of the most famous and used cryptocurrency in the world.
●
Bitcoin was invented by Satoshi Nakomoto in the year 2009.
●
The smallest unit to be recorded in the blockchain of the bitcoin is known as satoshi.
●
Satoshi is one hundred millionth of a bitcoin i.e 1 bitcoin = 100 million satoshi.
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4.4. Cryptocurrency around the world
4.4.1. Venezuela
❏ Venezuela adopted Petro Cryptocurrency in year 2018.
❏ Venezuela adopted Petro cryptocurrency because Venezuela is facing hyperinflation.
4.4.2. Marshall Island
❏ Marshall Island adopted SOV or Digital Sovereign in the year 2018.
❏ SOV is used as legal tender and provides Marshall Island with its own currency reducing its
dependence on the US dollar.
4.5. India and Cryptocurrency
●
India is necessarily a cash-based economy but the ‘Digital India’ initiatives of the government have increased
emphasis on digital currency.
●
In 2017, the government of India formed a committee headed by Subhas Chandra Garg to study issues related
to virtual currencies.
●
The committee recommendation is as follows :
❏ Banning of cryptocurrency - Due to risk and volatility associated with cryptocurrency.
❏ Digital Ledger Technology - Report highlight the positive of Digital Ledger Technology(DLT) .
DLT based system can be used by banks and other financial firms for the process like fraud detection,
loan issuance, etc.
❏ Other proposals - Committee suggested that the government should keep an eye for ‘official digital
currency’ as RBI Act 1943 permits the government to approve Digital Currency.
●
The reasons as stated by the Subhash Committee for banning cryptocurrency are as follows:
❏ Volatile nature of cryptocurrencies (however, other investments are also volatile and this should be
le to the investors).
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❏ These are used for transactions between criminal groups and for criminal activities.
❏ No government backing.
4.6. Advantages of Cryptocurrency
●
Easy to use - Since cryptocurrency uses modern technology like the internet, smartphones etc. Funds can be
transferred directly between the parties without the involvement of third parties like banks.
●
Low transaction cost - Since cryptocurrency remove the third party like banks in the transaction it lower
transaction cost in comparison to the conventional banking system.
●
Transparency - In cryptocurrency, every transaction is recorded on the blockchain. Blockchain keeps the
information about every transaction.
●
Decentralization - Since blockchain does not store any information in a central location. Information is
distributed across networks of computers making it difficult to tamper with.
4.7. Disadvantages of Cryptocurrency
●
Lack of knowledge - Most people do not know what cryptocurrency is and how to use cryptocurrency.
●
Volatility - Since Cryptocurrency is not regulated hence its prices vary greatly from one day to another.
●
Technology Cost - Cryptocurrency saves transaction cost, but for the transaction to make happen it require a
computer, electricity making its adaptability difficult for a country like India.
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5. UPSC CSE PRELIMS Previous Year Questions
●
Now, let's check how many questions can you attempt?
Q.1) Which of the following measures would result in an increase in the money supply in the economy?
2012
1. Purchase of government securities from the public by the Central Bank
2. Deposit of currency in commercial banks by the public
3. Borrowing by the government from the Central Bank
4. Sale of government securities to the public by the Central Bank
Select the correct answer using the codes given below :
[A] 1 only
[B] 2 and 4 only
[C] 1 and 3
[D] 2, 3 and 4
Ans.1) Correct Option: (c)
Explanation:
Note: This question you will be able to do a er reading “Money Market module”.
Ways to increase the money supply
●
Print more money – Usually, this is done by the Central Bank, though in some countries governments can
dictate the money supply. For example in Zimbabwe 2000s – the government printed more money to pay
wages.
●
Reducing interest rates- Lower interest rates reduce the cost of borrowing. This makes investment relatively
more profitable, and so encourages economic activity. Consumers will also see cheaper interest payments
leading to higher disposable income.
●
Central Bank buying government securities- If the Central Bank buy Government securities people who
were holding the bonds have more money to spend. Therefore, in certain circumstances, this can lead to an
increase in the money supply.
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Q.2) Consider the following liquid assets:
2013
1. Demand deposits with the banks
2. Time deposits with the banks
3. Savings deposits with the banks
4. Currency
The correct sequence of these decreasing order of Liquidity is
[A] 1-4-3-2
[B] 4-3-2-1
[C] 2-3-1-4
[D] 4-1-3-2
Ans.2) Correct Option : (d)
Explanation:
●
Most liquid assets are the currency assets since they can be used anytime
●
The least liquid assets are the time deposits, which are the deposits for a fixed time period and can only be
used upon their maturity.
●
Demand deposits are more liquid than saving deposits because they can be demanded by the holder from the
bank at any time.
Q.3) Supply of money remaining the same when there is an increase in demand for money, there will be:
2013
[A] a fall in the level of prices
[B] an increase in the rate of interest
[C] a decrease in the rate of interest
[D] an increase in the level of income and employment
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Ans.3) Correct Option: (b)
Explanation:
●
With an increase in demand for money, people will deposit less money in banks. Hence, banks will increase
the rate of interest to attract people to deposit money in the bank.
●
Let’s understand this through an example Supply of money is constant and demand of money is increasing, it
means more people are willing to loan from banks, but the supply of money is constant, so the bank will
increase its rate of interest at which loan is given.
Q.4) The problem of international liquidity is related to the non-availability of -
2015
[A] goods and services
[B] gold and silver
[C] dollars and other hard currencies
[D] exportable surplus
Ans.4) Correct Option: (c)
Explanation:
Note: This question you will be able to do a er reading “Foreign Investment and trade module”
●
The concept of international liquidity is associated with international payments. These payments arise out
of international trade in goods and services and also in connection with capital movements between one
country and another.
●
International liquidity refers to the generally accepted official means of settling imbalances in international
payments which is basically dollars and hard currencies.
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Q.5) With reference to ‘Bitcoins’ sometimes seen in the news, which of the following statements is/are correct?
2016
1. Bitcoins are tracked by the Central Banks of the countries.
2. Anyone with a Bitcoin address can send and receive Bitcoins from anyone else with a Bitcoin address.
3. Online payments can be sent without either side knowing the identity of the other.
Select the correct answer using the code given below.
[A] 1 and 2 only
[B] 2 and 3 only
[C] 3 only
[D] 1, 2 and 3
Ans.5) Correct Option: (b)
Explanation:
●
Bitcoin is a decentralized digital currency without a central bank or single administrator that can be sent
from user to user on the peer-to-peer bitcoin network without the need for intermediaries
●
Transactions are verified by network nodes through cryptography and recorded in a public distributed ledger
called a blockchain.
Q.6) Which one of the following statements correctly describes the meaning of legal tender money?
2018
[A] The money which is tendered in courts of law to defray the fee of legal cases
[B] The money which a creditor is under compulsion to accept in settlement of his claims
[C] The bank money in the form of cheques, dra s, bills of exchange, etc.
[D] The metallic money in circulation in a country
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Ans.6) Correct Option: (b)
Explanation:
●
Legal tender money is a type of payment that is protected by law.
●
Legal tender is also known as a forced tender which is very secure and it is impossible to deny the legal tender
while subsiding a debt which is assigned in the same medium of exchange. In other words, we can say that the
term legal tender does not represent the money itself, rather it is a kind of status which can be bestowed on
certain types of money.
●
The options given in the Question does not properly explain the definition of legal tender money. So, therefore
the most suitable answer is b.
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BANKING
Part I
1. What is a Bank?
2.Evolution of Banking
3. Nationalisation of Bank
3.1 Objective of Nationalisation
3.2 State Bank of India
3.3 Banking Nationalisation Act of 1969
4. Reserve Bank of India(RBI)
4.1 Functions of RBI
5. Credit and Monetary Policy
5.1 Quantitative Instrument
5.1.1 Cash Reserve Ratio(CRR)
5.1.2 Statutory Liquidity Ratio (SLR)
5.1.3. Difference between CRR and SLR
5.1.4. How changes in CRR and SLR affect Money Supply
5.1.5. Bank Rate
5.1.6. Repo Rate (Ready Forward Contract)
5.1.6.1. Types of Repo Rate
5.1.7. Reverse Repo
5.1.8. Liquidity Adjustment Facility(LAF)
5.1.9. How repo rate controls inflation
5.1.10. Marginal Standing Facility (MSF)
5.1.11. Open Market Operations (OMOs)
5.2 Qualitative Instrument
5.2.1. Margin Requirement
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5.2.2. Rationing of credit
5.2.3. Moral Suasion
5.2.4. Direct Actions
6. Urijit Patel Committee
7. Monetary Policy Committee
8. Monetary Policy Transmission
9. Marginal Cost of Funds Based Lending Rate (MCLR)
10. Base Rate
11. Base Rate vs MCLR
12. Limitation of Monetary Policy
13. Banking Sector Reform
13.1 Committee on Financial System(CFS)
13.2. Narasimham Committee II
14. UPSC CSE PRELIMS Previous Year Questions
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1. What is a bank
●
A bank is a financial institution that provides banking and other financial services to its customers.
●
Banking Services provided by banks include accepting deposits and giving loans.
●
Banks also provide many financial services like currency exchange, wealth management, etc.
●
Banking Sector is one of the key drivers of the economy. It provides liquidity to the economy which helps to
create demand. For Example - Car loans provided by banks create demand for the Car hence drive the
automobile sector.
●
Due to the importance of bank for the financial stability of the economy, Banks are highly regulated in most
countries.
●
Banking System is a group or network of institutions which provide financial services to people. Banking
System controls the money supply in the economy.
2. Evolution of Bank in India
●
The first bank of India was The General Bank of India, established in 1786.
●
East India Company established three individual banks which were called as Presidency Bank.
❏ Bank of Calcutta (1809)
❏ Bank of Bombay (1840)
❏ Bank of Madras (1843)
●
Bank of Hindustan was established in 1870.
●
Allahabad Bank (1865) was the first bank that was completely run by Indians.
●
Punjab National Bank Ltd was set up in 1894. It the oldest existing bank by Indian.
●
Central Bank established in 1911 became 1st bank to be owned and managed by Indians.
●
In 1921, all the Presidency Bank were merged to form Imperial Bank of India.
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3. Nationalisation of Bank
●
Nationalisation is the process of transferring private assets to public control by bringing them under the
control of the government.
3.1. Objectives of Nationalisation
●
At the time of independence, there was a large number of small banks in India. One of the reasons was to
streamline the functioning of banks.
●
The government needed financial resources to provide basic amenities to people.
●
To provide access to banking service to the masses and reduce inequalities.
●
To provide social orientation to the banking sector i.e to ensure adequate credit flow in agriculture and rural
sectors.
3.2.State Bank of India
●
In 1955, the Government of India nationalised Imperial Bank of Indian and was given the name “ State Bank of
India”.
●
State Bank of India was established under the SBI Act 1955.
●
In the year 1959, the Government passed the SBI(Associates) Act 1959 to nationalise eight private banks with
good regional presence and named them Associate of the SBI.
●
On 1st April 2017, the Government of India merged 5 Associate Bank and Bhartiya Mahila Bank with SBI.
●
Five associate banks which were merged are State Bank of Bikaner and Jaipur, State Bank of Hyderabad, State
Bank of Mysore, State Bank of Patiala, State Bank of Travancore.
●
Following this merger, SBI became the largest bank of India and one of the top 50 largest banks in the world.
3.3. Banking Nationalisation Act of 1969
●
In 1969, the Government of India nationalised 14 major Indian Commercial Banks with a deposit of more than
50 crores.
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❏ Allahabad Bank
❏ Dena Bank
❏ Bank of India
❏ Indian Overseas Bank
❏ Punjab National Bank
❏ Indian Bank
❏ Bank of Baroda
❏ United Bank
❏ Bank of Maharastra
❏ Syndicate Bank
❏ Central Bank of India
❏ Union Bank of India
❏ Canara Bank
❏ UCO Bank
●
Six more banks with deposits greater than 200 crores were nationalised in 1980.
●
These banks were ❏ Andhra Pradesh
❏ Corporation Bank
❏ New Bank of India
❏ Oriental Bank of Commerce
❏ Punjab & Sind Bank
❏ Vijaya Bank
●
The nationalisation of Bank in 1980 became important to ensure that priority sector lending reaches the poor
through a wide branch network.
●
At present, the number of nationalised banks in India is 20 including SBI.
●
These banks are -
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❏ SBI
❏ Vijaya Bank
❏ Allahabad Bank
❏ Andhra Pradesh
❏ Bank of Baroda
❏ Bank of India
❏ Bank of Maharashtra
❏ Canara Bank
❏ Central bank of India
❏ Corporation Bank
❏ Dena Bank
❏ Indian Bank
❏ Indian Overseas Bank
❏ Oriental Bank of Commerce
❏ Punjab National Bank
❏ Syndicate Bank
❏ Union Bank of India
❏ United Bank
❏ Punjab & Sind Bank
❏ UCO Bank
5
4. Reserve Bank Of India
●
Reserve Bank of India is the Central Bank of India, it is the regulator of the entire Banking System of India.
●
Reserve Bank of India was established on 1st April 1935 following the enactment of the RBI Act 1934.
●
The purpose of the RBI Act 1934 was to issue notes and maintain reserves but the Act did not cover Banking
Regulation.
●
Reserve Bank of India was a privately owned Bank but it was nationalised in 1949.
●
Banking Regulation Act 1949, conferred on RBI a wide range of regulatory and supervisory power with the
objective to develop the banking system of India.
4.1. Functions of RBI
●
The issuer of Currency - RBI is the sole Agency in the country that can issue currency and coins in India
except for one rupee coin and note both which is issued by the Finance Ministry.
RBI print, distribute currency and also regulate the flow of currency in the economy.
●
Banker of Government - RBI provides Banking services to both Central and State governments.
These services include deposits, loans, etc.
●
Bankers to the Banks - RBI as a Central Bank of India supervise also the Commercial Banks of the country.
RBI provides various services to these banks like loans to meet short and long term liabilities, issue license to
Banks, Lender of last resort( RBI stand behind commercial banks if they face any solvency issue. This role of
RBI is called lender of last resort).
●
Inflation targeting - RBI is tasked with the function of stabilizing the rate of Inflation.
●
Regulator of Foreign Exchange - RBI stabilizes the value of Indian currency in the global economy. RBI
manages India’s foreign currency assets and gold reserve.
●
Developmental Functions - RBI ensure credit availability to productive sectors, promote financial inclusion,
set up various institutions like SIDBI, NABARD etc.
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●
Other Functions - RBI act as an agent of the government of India at IMF, controls credit and monetary policy,
publishes monetary and banking data, etc.
5. Credit and Monetary Policy
●
Monetary policy refers to the policy of the Central Bank through which the desired level of money supply and
demand is regulated in the economy.
●
The primary goal of the monetary policy is to maintain price stability while keeping in mind the objective of
growth.
●
Credit Policy is a part of monetary policy. It refers to the set of principles that determines who and how much
and at what rate money is lend.
●
RBI has the right to announce monetary policy from time to time depending upon the state of the economy.
●
There are many tools through which RBI achieves the desired level of credit and monetary policy.
●
These tools are❏ Quantitative Instrument - Quantitative instrument deals with the quantity/volume of the money
supply. These instruments regulate or control the total volume of bank credit.
❖ Cash reserve ratio (CRR)
❖ Statutory Liquidity Ratio(SLR)
❖ Bank Rate
❖ Repo Rate
❖ Reverse Repo Rate
❖ Marginal Standing Facility(MSF)
❖ Open Market Operation
❏
Qualitative Instrument - Qualitative Instrument does not regulate the volume of credit but regulates
bad credit which creates economic instability.
❖ Margin Requirement
❖ Moral Suasion
❖ Direct Action
❖ Rationing of credit
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5.1.1. Cash Reserve Ratio(CRR)
●
Cash Reserve Ratio(CRR) refers to the percentage of total deposits that commercial banks are required to
keep it in the form of cash with the RBI.
●
Banks are not allowed to use this fund for their commercial purposes, and no interest is paid by the RBI on
CRR balance kept by Banks with the RBI.
●
One of the main aim of CRR is to remove excess cash from the economy.
●
Cash Reserve Ratio(CRR) is determined by RBI. Current CRR is 4%.
5.1.2. Statutory Liquidity Ratio (SLR)
●
Statutory Liquidity Ratio(SLR) refers to the percentage of total deposits {includes demand and time liability
(NDTL) } of a bank which is to be maintained by the bank with them in the form of liquid asset (non-cash form)
in addition to cash reserve ratio.
●
Liquid assets are assets that are readily converted into cash. For example -Gold, Government securities, etc.
●
The main aim of SLR is to regulate bank credit, ensure banks invest in government securities, and prevent
banks from facing insolvency issues.
●
SLR is determined by RBI. Current SLR is 18.25%.
NoteIf the Bank fails to meet with the CRR and SLR requirement, a penalty at a rate of 3% per annum above the bank rate is
imposed.
5.1.3. Difference between CRR and SLR
CRR
SLR
Banks are required to maintain CRR in cash only.
Banks are required to maintain SLR in liquid assets
(government securities, gold, etc).
In CRR, the cash reserve is kept with RBI
IN SLR, securities are kept with the bank themselves.
Bank’s don’t earn interest on CRR
Banks earn interest on the SLR.
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5.1.4. How CRR and SLR changes affect Money Supply
●
CRR and SLR changes affect the money supply in the economy.
●
For Example - Suppose there is a bank XYZ. CRR fixed by RBI is 5% and SLR is 25%.
●
●
Total Deposit of bank XYZ (Net Demand and Time
Liability )
100 cr
CRR( at 5%)
5cr
SLR (at 25%)
25cr
Money Le with XYZ
100-5-25 = 70cr
Now Suppose RBI, increases CRR to 10% and SLR to 40%.
Total Deposit of bank XYZ (Net Demand and Time
Liability )
100 cr
CRR( at 10%)
10cr
SLR (at 40%)
40cr
Money Le with XYZ
100-10-40 = 50cr
As shown in the above Example, When RBI increases CRR and SLR. Money le with the bank has decreased
from 70cr to 50cr.
5.1.5. Bank Rate
●
Bank Rate is the interest rate charged by the RBI for long term lending to commercial banks and other
financial institution.
●
Central Banks, State governments, financial institutions also use Bank rate to borrow funds from RBI to meet
their long term requirements.
●
Bank rate influences the lending rate of commercial banks. Higher the Bank rate higher will be the interest rate
charged by the banks.
●
RBI aligned Bank rate with the Marginal Standing Facility(MSF) (discussed in below section) in 2012.
●
RBI can use Bank rate to curb excess liquidity from the economy and vice versa.
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5.1.6. Repo Rate (Ready Forward Contract)
●
Repo Rate or Repurchase Rate is the interest rate charged by RBI for short term lending to commercial
banks.
●
Bank borrows funds from RBI by selling securities with an agreement to repurchase the securities on a
mutually agreed future date at an agreed price.
●
Securities used in Repo Rate can be Government securities, Corporate Securities, or any other securities which
Government permits for the transaction.
●
Bank usually uses this route to fulfil short term liquidity crunch.
●
Repo Rate is also known as Policy Rate. A change in the policy rate will alter all other short term interest rate
in the economy, thereby influencing the level of economic growth and inflation.
●
The graph shows changes in Repo rate over 5 year time. Repo rate is fixed by RBI taking into consideration the
economic growth prospects.
5.1.6.1 Types of Repo Rate
●
Repo rate is of two types based on maturity ❏ Overnight Repo - It refers to Repo with single-day maturity.
Indian Repo market is dominated by the overnight repo market.
❏
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Term Repo - It refers to Repo that has a fixed maturity longer than one day.
10
5.1.7. Reverse Repo
●
Reverse Repo is the rate of interest RBI pays to commercial banks when RBI borrows funds from the banks.
●
Reverse Repo is used to absorb excess liquidity from the economy.
●
Reverse Repo rate allows banks to park excess funds with the RBI to earn interest rate. This serves two
purposes.
❏ One reduces excess liquidity from the economy
❏ Second lower loan disbursal by banks hence prevent bank losses due to NPA.
●
An increase in Reverse repo will decrease money supply since it will encourage banks to park their funds with
RBI to earn interest and vice versa.
5.1.8. Liquidity Adjustment Facility(LAF)
●
Liquidity Adjustment Facility(LAF) is a facility extended by the RBI, to scheduled commercial banks that allow
banks to borrow money through repo or park excess funds with RBI through reverse repo.
●
Liquidity Adjustment Facility(LAF) is the mechanism used by RBI for managing the liquidity needs of
commercial banking.
●
LAF is used to aid banks in adjusting the day to day mismatches in liquidity.
●
Components of LAF are❏ Repo
❏ Reverse Repo
❏ Term Repo (for 14 and 7 days)
❏ Overnight Repo
❏ Overnight Reverse Repo
●
The introduction of the Liquidity facility in India was on the basis of the recommendation of the Narsimham
Committee on banking sector reform.
●
It was introduced by RBI in the year 2000.
●
Under LAF, the Minimum credit limit is Rs 5 crore.
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5.1.9. How Repo Rate controls inflation
●
High Repo Rate and Reverse Repo Rate leave less money available with banks, to lend. Less availability of loan
will restrict money supply in the economy. This is important when inflation is high and there is a need to cut
rising price level. But the decrease in Rates decreases the level of economic activity.
Repo Rate ↑ → Interest Rate ↑ → Consumption, Investment ↓ → Growth ↓
●
On the other hand, when inflation is under control, and economic growth is slow. RBI cut Repo Rate and
Reverse Repo Rate this leave with more money with banks. More availability of loans will increase the money
supply in the economy. This is important to increase the level of economic activity in the economy.
Repo Rate ↓ → Interest Rate ↓ → Consumption, Investment ↑ → Growth ↑
Combat Inflation(increase in price)
Combat Deflation(decrease in price)
CRR, SLR
↑
↓
Repo Rate
↑
↓
Bank Rate
↑
↓
OMO (explained later )
RBI will Sell government securities
Purchase/Buy government securities
●
Above table, shows the changes in monetary policy instrument to combat inflation and deflation in the
economy by RBI.
5.1.10. Marginal Standing Facility (MSF)
●
Marginal Standing Facility is the penal rate at which banks can borrow money from the RBI over and above
what is available to banks through the LAF window.
●
Under MSF, banks can overnight borrow up to 1% of their Net Demand and Time Liabilities(NDTL) at the
interest rate of 1%.
●
MSF would be last resort for banks once they exhaust all the borrowing options including Liquidity
Adjustment Facility(LAF).
●
Bank offer Government Securities to RBI within the limits of the statutory liquidity ratio(SLR).
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●
The scheme has been introduced by RBI with the main aim of reducing volatility in the overnight lending rates
in the inter-bank market.
●
The minimum amount which can be accessed through MSF is Rs.1 crore and in multiples of Rs.1 crore.
●
Since MSF is penal rate MSF is always fixed above the Repo Rate.
●
Thus MSF is now placed at .25% above the Repo Rate. Bank Rate is aligned to the MSF rate.
●
Repo rate will be in the middle, the Reverse Repo Rate will be 25 basis points below it and the MSF rate 25
basis points above it.
●
Current Rates are as follows:
Reverse Repo Rate - 4.90%
Repo Rate - 5.15%
Bank Rate - 5.40%
MSF- 5.40%
(These rates are not constant but are fixed by RBI based on the requirement of the economy)
Bank Rate = MSF > Repo Rate > Reverse Repo
5.1.11. Open Market Operation (OMOs)
●
Open Market Operation is the sale and purchase of government securities in the open market by the RBI.
●
The main aim of the Open Market Operation is to regulate money supply in the economy.
●
Purchase of Government Securities by the RBI will increase the money supply in the economy, whereas Sale of
Government Securities absorbs excess liquidity from the economy.
●
Open Market Operations changes the proportion of Securities held by RBI, Commercial Banks while
maintaining the total stock of securities the same.
●
RBI carries Open Market operations through commercial banks and does not directly deal with the public.
●
For example - Let’s take an example where XYZ bank, buys and sell government securities.
Total Deposit of Bank XYZ
OMO(Open Market
Operation)
100
Government Securities
with Bank XYZ
Money le
30 cr
70cr
100
RBI sells government
securities worth Rs 20cr, and
Banks XYZ buy it
30cr + 20cr =50 cr
50cr
100
RBI buys government
securities worth Rs 20cr
30cr - 20cr = 10cr
90cr
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●
As seen in the above example when RBI sells Government Securities in the market it reduces money supply
from 70cr to 50cr. Similarly, When RBI buys Government Securities it increases the money supply from 70cr to
90 cr.
5.2. Qualitative Instrument
5.2.1. Margin Requirement
●
Banks keep aside some proportion of loan(margin) whenever banks lend to some specified sectors for safety.
●
If the margin requirement for a particular sector is increased it will reduce the flow of credit in that sector. If
the Margin requirement for a particular sector is decreased it will increase the flow of credit in that sector.
●
For Example - Suppose a loan of Rs 100 is needed in Rural sector and the margin requirement is 20% which is
equal to 20% of 100 = 20. Hence maximum loan that banks can give is 100-20= 80.
●
RBI can increase the flow of credit in the above example by increasing or decreasing margin requirement.
5.2.2. Rationing of credit
●
Rationing of credit is a method through which RBI set the limit on the amount of loans, that can be made in a
particular sector.
●
Credit Rationing is used by RBI to regulate credit flow, particularly in case of speculative activities.
5.2.3. Moral Suasion
●
Moral Suasion refers to the persuasion by RBI on scheduled commercial Banks to follow certain policy without
any strict action.
●
Under Moral Suasion, RBI can issue suggestions, guidelines etc for scheduled commercial banks regarding
particular policy.
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5.2.4. Direct Actions
●
Direct Actions refers to strict actions taken by RBI against a scheduled commercial bank.
●
Under Banking Regulation Act, RBI has authority to take strict actions against any scheduled commercial bank
which does not adhere to the direction of the RBI.
6. Urijit Patel Committee
●
An expert committee was appointed to examine the monetary policy framework of the RBI in 2014.
●
The committee was headed by Urijit Patel, with the aim to revise and strengthen and the Monetary Policy
Framework.
●
The main recommendation of the committee are❏
RBI should adopt new CPI( Consumer Price Index) to measure inflation and anchor monetary
policy.
❏ RBI should target CPI at 4%, + 2% [range is between 2% to 6%].
❏ Monetary Policy should be done by the Monetary Policy Committee (MPC), which is 5 members
Committee.
❖ Governor
❖ Deputy Governor in charge of monetary policy
❖ RBI Executive Director in charge of monetary policy.
❖ Two External Members
❏ Government debt and management must be taken by the government’s Debt Management Office, with
the Market Stabilisation Scheme(MSS) and Cash Management Bill should be phased out.
❏ Open Market Operation(OMO) should be used for liquidity management, and not used to manage
yields on government securities.
❏ All sector specific refinance should be phased out as committed to Asian Development Bank in 1992.
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7. Monetary Policy Committee
●
Monetary Policy Committee is entrusted with the task of setting policy interest rate(repo rate) to contain
inflation within the defined target level.
●
Contrary to the recommendation of the Urijit Patel Committee(where RBI was to set inflation target), the
Finance Ministry has set an inflation target for RBI.
●
The Reserve Bank of India and the Government of India signed the Monetary Policy Framework Agreement in
2015.
●
In 2016 Government gave statutory backing to Monetary Policy Committee with the amendment in RBI Act
1934.
●
Functions of MPC ❏ RBI will be responsible for containing inflation targets at 4% (with a deviation of 2%).
❏ MPC will have six members ❖ RBI Governor (Chairperson)
❖ RBI Deputy Governor in charge of monetary policy,
❖ One official nominated by the RBI Board
❖ Three members would be nominated by Government of India [committee headed by
Cabinet Secretary]
❏ Members of MPC will hold the office for 4 years, and not eligible for reappointment.
❏ Not eligible for MPC selection ❖ Members of Parliament / Legislature / Public servant / or anyone having a conflict of
interest with RBI.
❖ Anyone above the age of 70.
❏ The MPC takes decisions based on a majority vote (by those who are present and voting).
❏ In case of a tie, the RBI governor will have the second or casting vote.
❏ The decision of the Committee would be binding on the RBI.
❏ The quorum for the meeting shall be 4, at least one of whom shall be the Governor, in his
presence Deputy Governor.
❏ RBI is mandated to publish a Monetary Policy Report every six months, explaining the sources
of inflation and the forecasts of inflation for the coming period of six to eighteen months.
❏ If RBI fails to meet the inflation target, RBI will give an explanation in the form of a report to
the Central Government.
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❏ In the report RBI, give reasons for failure, remedial actions as well as estimated time within
which the inflation target shall be achieved.
●
The MPC replaces the previous system where the RBI governor, with the aid and advice of his advisory
committee, RBI governor has complete control over monetary policy decisions.
●
The history of suggestions for setting up an MPC can be tracked back to 2002 when the Y. V. Reddy Committee
recommended for an MPC to decide policy actions. Subsequently, suggestions were made to set up an MPC in
2006 by the Tarapore Committee, in 2007 by the Percy Mistry Committee, in 2009 by the Raghuram Rajan
Committee and then in 2013, both in the report of the Financial Sector Legislative Reform Commission (FSLRC)
and the Urijit Patel Committee.
●
With the introduction of the monetary policy committee, the RBI will follow a system similar to the one
followed by most global central banks.
8. Monetary Policy Transmission
●
Monetary Policy transmission refers to the process by which a central bank’s monetary policy changes(repo
rate) is passed through the financial system to affect the public.
●
Monetary Policy transmission is dependent on Repo Rate. How far changes in Repo Rate can bring change in
banks’ interest will depend on Monetary Policy Transmission. The passing of rate changes by MPC is crucial for
regulating inflation, growth etc.
●
To improve Monetary Policy Transmission, RBI introduced the Marginal Cost of Funds Based Lending
Rate(MCLR) system in 2016.
9. Marginal Cost of Funds Based Lending Rate (MCLR)
●
The marginal cost of funds based lending rate (MCLR) refers to the minimum interest rate of a bank below
which it cannot lend, except in some cases allowed by the RBI.
●
This new methodology replaces the base rate system introduced in July 2010.
●
RBI decided to shi from base rate to MCLR because the rates based on marginal cost of funds are more
sensitive to changes in the policy rates. This is very essential for the effective implementation of monetary
policy.
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10. Base Rate
●
Base Rate is the minimum rate of interest set by RBI below which banks are not allowed to lends to its
customer.
11. Base Rate vs MCLR
●
Base rate calculation is based on the cost of funds, a minimum rate of return, operating expenses and cost of
maintaining cash reserve ratio.
●
MCLR is based on the marginal cost of funds, tenor premium, operating expenses and cost of maintaining
cash reserve ratio.
12. Limitation of Monetary Policy
●
Large Non-Monetized Economy - In Rural Economy, many transactions are barter in nature. Hence monetary
policy fails to influence this large section of people.
●
Lack of financial Inclusion - Non-bank financial intermediaries like moneylenders etc operate in large
numbers, they are not under the regulation of RBI. This limit the effective transmission of monetary policy
changes.
●
Natural Factors - Many natural factors like a cyclone, floods, unseasonal rains etc affect crop production
hence inflation. For Example - Rising prices of onion cannot be controlled by monetary policy.
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13. Banking Sector Reform
13.1 Committee on Financial System(CFS)
●
Government of India, in 1991 constituted a nine-member committee headed by M.Narasimham.
●
The Narasimham Committee 1, was constituted with the aim to bring out “ operational flexibility” and
“functional autonomy” to enhance efficiency, productivity, and profitability.
●
The major recommendation of Narasimham Committee 1 are as follow❏ Establishment of a four-tier hierarchy for the banking structure consisting of three to four large banks
with SBI at the top.
❏ The private sector banks should be treated equally with the public sector banks. The ban on setting
new banks in the private sector should be li ed and the licensing policy in the branch expansion must
be abolished.
❏ Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) should be progressively brought down
from 1991-92 levels.
❏ The priority sector should be redefined to comprise small and marginal farmers, tiny industrial sector,
small traders and weaker sections.
❏ The government’s share of public sector banks should be disinvested to a certain percentage.
❏ Interest rates should be deregulated to suit the market conditions
❏ The govt has to be more liberal in the expansion of foreign bank branches and also foreign operations
of Indian banks should be rationalized.
❏ The RBI should be the primary authority for the regulation of the banking system in the country.
13.2. Narasimham Committee II
●
Government of India, in 1998 constituted a committee on Banking Sector Reforms (BSR) under the
chairmanship of M. Narasimham.
●
The Narasimham Committee 2, was constituted with the aim to initiate the second generation of financial
sector reforms.
●
Narasimham committee report II has focused on structural changes so as to strengthen the banking system to
make it more stable.
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●
The major recommendations of the Narasimham Committee Report II are mentioned below❏ Merger among strong public sector banks and closure of weaker banks if their rehabilitation is not
possible.
❏ The committee recommended the idea of setting up an asset reconstruction fund to tackle the
problem of huge non-performing assets (NPAs) of public sector banks.
❏ Competition between the public sector and private sector banks should be enhanced.
❏ Formation of asset reconstruction fund to tackle the problem of huge non-performing assets of public
sector banks.
❏ Capital adequacy norms should be enhanced from the present level of 8 % but did not specify the
amount to which it should be raised.
❏ The Banking Sector Reform Committee further suggested that the existence of healthy competition
between public sector banks and private sector banks was essential.
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14. UPSC CSE PRELIMS Previous Year Questions
●
Now, let's check how many questions can you attempt?
Q.1) The lowering of Bank Rate by the Reserve Bank of India leads to -
2011
[A] More liquidity in the market
[B] Less liquidity in the market
[C] No change in the liquidity in the market
[D] Mobilization of more deposits by commercial banks
Ans.1) Correct Option: A
Explanation:
●
A bank rate is the interest rate at which a nation's central bank lends money to domestic banks, o en in the
form of very short-term loans. Managing the bank rate is a method by which central banks affect economic
activity.
●
Lower bank rates can help to expand the economy by lowering the cost of funds for borrowers, and
higher bank rates help to reign in the economy when inflation is higher than desired.
●
In order to curb liquidity, the central bank can resort to raising the bank rate and vice versa.
Q.2) The Reserve Bank of India (RBI) acts as a bankers’ bank. This would imply which of the following?
2012
1. Other banks retain their deposits with the RBI.
2. The RBI lends funds to the commercial banks in times of need.
3. The RBI advises the commercial banks on monetary matters.
Select the correct answer using the codes given below :
[A] 2 and 3 only
[B] 1 and 2 only
[C] 1 and 3 only
[D] 1, 2 and 3
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Ans.2) Correct Option: d
Explanation:
●
As bankers’ bank, the RBI holds a part of the cash reserves of banks, lends them funds for short periods, and
provides them with centralised clearing and cheap and quick remittance facilities.
●
In the early stages of the development of central banking, banks used to keep some of their cash reserves
voluntarily with a leading bank which gradually took over the role of a central bank.
●
Under the Reserve Bank of India Act, 1934 and the Banking Regulation Act, 1949 (as amended from time to
time), the RBI enjoys extensive powers of supervision, regulation, and control over commercial and
co-operative banks.
●
The Bank’s regulatory functions relating to banks cover their establishment (i.e. licensing), branch expansion,
the liquidity of their assets, management and methods of working, amalgamation, reconstruction and
liquidation.
●
The control by the Bank is exercised through periodic inspection of banks and follow-up action and by calling
for returns and other information from them.
●
The objective of such supervision and control is to ensure the development of a sound banking system in the
country.
Q.3) The Reserve Bank of India regulates the commercial banks in matters of -
2013
1. Liquidity of assets
2. Branch expansion
3. Merger of banks
4. Winding-up of banks
Select the correct answer using the codes given below.
[A] 1 and 4 only
[B] 1 and 2 only
[C] 2, 3 and 4 only
[D] 1, 2, 3 and 4
Ans.3)Correct Option: D
Explanation:
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●
The Reserve Bank of India (RBI) is the central bank of India, which was established on April 1, 1935, under
the Reserve Bank of India Act.
●
The Reserve Bank of India uses monetary policy to create financial stability in India, and it is charged with
regulating the country's currency and credit systems.
●
The main purpose of the RBI is to conduct consolidated supervision of the financial sector in India, which is
made up of commercial banks, financial institutions and non-banking finance firms. Initiatives adopted by the
RBI include restructuring bank inspections, introducing off-site surveillance of banks and financial
institutions and strengthening the role of auditors.
Q.4) An increase in the Bank Rate generally indicates that the:
2013
[A] market rate of interest is likely to fall
[B] Central Bank is no longer making loans to commercial banks
[C] Central Bank is following an easy money policy
[D] Central Bank is following a tight money policy
Ans.4)Correct Option: D
Explanation:
●
Bank rate is the rate charged by the central bank for lending funds to commercial banks.
●
Bank rates influence lending rates of commercial banks.
●
Higher bank rate will translate to higher lending rates by the banks.
●
In order to curb liquidity, the central bank can resort to raising the bank rate and vice versa.
●
In India, the Reserve Bank of India determines the bank rate, which is the rate at which it makes loans to
commercial banks with no collateral (RBI Act 1934 sec.49 ) The Reserve Bank of India also provides short term
loans to its clients (keeping collateral) at what is called the repo rate.
●
This rate is revised periodically.
●
However, there is no predetermined schedule.
●
The repo rates are changed reactively depending on the economy.
●
As in other countries, repo rates affect the money flow into the nation's economy and affect the inflation and
commercial banks' lending or interest rate.
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Q5) In the context of Indian economy, Open Market Operations’ refers to:
2013
[A] Borrowing by scheduled banks from the RBI
[B] Lending by commercial banks to industry and trade
[C] Purchase and sale of government securities by the RBI
[D] None of the above
Ans.5) Correct Option : C
Explanation:
●
An open market operation (OMO) is an activity by a central bank to give (or take) liquidity in its currency to
(or from) a bank.
●
A central bank uses OMO as the primary means of implementing monetary policy.
●
The aim of open market operations is— supplying commercial banks with liquidity and sometimes taking
surplus liquidity from commercial banks.
●
Monetary targets, such as inflation, interest rates, or exchange rates, are used to guide this implementation.
Q.6) The terms ‘Marginal Standing Facility Rate’ and ‘Net Demand and Time Liabilities’, sometimes appearing in
the news, are used in relation to
2014
[A] banking operations
[B] communication networking
[C] military strategies
[D] supply and demand of agricultural products
Ans.6) Correct Option : A
Explanation:
●
Marginal Standing Facility (MSF) is a new scheme announced by the Reserve Bank of India (RBI) in its Monetary
Policy (2011-12) and refers to the penal rate at which banks can borrow money from the central bank over
and above what is available to them through the LAF window.
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Q.7) If the interest rate is decreased in an economy, it will
2014
[A] decrease the consumption expenditure in the economy
[B] increase the tax collection of the Government
[C] increase the investment expenditure in the economy
[D] increase the total savings in the economy
Ans.7) Correct Option: C
Explanation:
●
Lower Interest rates encourage additional investment spending, which gives the economy a boost in times of
slow economic growth.
●
Changes in interest rates affect the public's demand for goods and services and, thus, aggregate investment
spending.
●
A decrease in interest rates lowers the cost of borrowing, which encourages businesses to increase investment
spending.
●
Lower interest rates also give banks more incentive to lend to businesses and households, allowing them to
spend more.
Q.8) In the context of Indian economy which of the following is/are the purpose/purposes of ‘Statutory Reserve
Requirements’?
2014
1. To enable the Central Bank to control the amount of advances the banks can create
2. To make the people’s deposits with banks safe and liquid
3. To prevent commercial banks from making excessive profits
4. To force the banks to have sufficient vault cash to meet their day-to-day requirements
Select the correct answer using the code given below.
[A] 1 only
[B] 1 and 2 only
[C] 2 and 3 only
[D] 1, 2, 3 and 4
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Ans.9) Correct Option: B
Explanation
●
Statutory liquidity ratio (SLR) refers to reserve requirement that the commercial banks in India are
required to maintain in the form of cash, gold reserves, RBI approved securities before providing credit to
the customers.
●
Statutory liquidity ratio is determined by the Reserve Bank of India maintained by banks. The SLR is
determined by a percentage of total demand and time liabilities.
●
When there is a rise in the SLR, a bank is also restricted in terms of its leverage position. Hence, this decrease
in the SLR will enable a bank to release more funds into the economy and in turn, contribute towards the
overall development of the economy and vice-versa.
Q.10) When the Reserve Bank of India reduces the Statutory Liquidity by 50 basis points, which of the following
is likely to happen?
2015
[A] India’s GDP growth rate increases drastically
[B] Foreign Institutional Investors may bring more capital into our country
[C] Scheduled Commercial Banks may cut their lending rates
[D] it may drastically reduce the liquidity to the banking system.
Ans.10)Correct Option: C
Explanation:
●
SLR cut means more liquidity which may prompt the banks to lower the lending rates.
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Q.11) With reference to Indian economy, consider the following :
2015
1. Bank rate
2. Open market operations
3. Public debt
4. Public revenue
Which of the above is/are component/components of Monetary Policy?
[A] 1 only
[B] 2, 3 and 4
[C] 1 and 2
[D] 1, 3 and 4
Ans.11) Correct Option: C
Explanation
●
Public debt is not part of Monetary Policy (it’s a part of Fiscal policy) and OMOs together with CRR, SLR,
Repo, Reverse Repo by RBI are certainly a part of their monetary policy.
●
So the answer should be the option C.
Q.12) What is/are the purpose/purposes of the ‘Marginal Cost of Funds based Lending Rate (MCLR)’ announced
by RBI?
2016
1. These guidelines help improve the transparency in the methodology followed by banks for determining the
interest rates on advances
2. These guidelines help ensure availability of bank credit & interest rates which are fair to the borrowers as well
as the banks
Select the correct answer using the code given below:
[A] 1 only
[B] 2 only
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[C] Both 1 and 2
[D] Neither 1 nor 2
Ans.12) Correct Option: C
Explanation:
❏ The marginal cost of funds based lending rate (MCLR) refers to the minimum interest rate of a bank below
which it cannot lend, except in some cases allowed by the RBI.
❏ Reasons for introducing MCLR :
❏ RBI decided to shi from base rate to MCLR because the rates based on marginal cost of funds are
more sensitive to changes in the policy rates. This is very essential for the effective implementation of
monetary policy.
Q.13) Which of the following statements is/are correct regarding the Monetary Policy Committee (MPC)?
2017
1. It decides the RBI’s benchmark interest rates.
2. It is a 12-member body including the Governor of RBI and is reconstituted every year.
3. It functions under the chairmanship of the Union Finance Minister.
Select the correct answer using the code given below :
[A] 1 only
[B] 1 and 2 only
[C] 3 only
[D] 2 and 3 only
Ans.13)Correct Option: A
Explanation:
●
●
●
The Monetary Policy Committee of India is responsible for fixing the benchmark interest rate in India.
The meetings of the Monetary Policy Committee are held at least 4 times a year and it publishes its decisions
a er each such meeting.
The committee comprises six members - three officials of the Reserve Bank of India and three external
members nominated by the Government of India.
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●
●
●
●
●
●
●
They need to observe a "silent period" seven days before and a er the rate decision for "utmost
confidentiality".
The Governor of Reserve Bank of India is the chairperson ex officio of the committee.
Decisions are taken by the majority with the Governor having the casting vote in case of a tie.
The current mandate of the committee is to maintain 4% annual inflation until March 31, 2021, with an
upper tolerance of 6% and a lower tolerance of 2%
The committee was created in 2016 to bring transparency and accountability in fixing India's Monetary Policy.
The monetary policy is published a er every meeting with each member explaining his opinions.
The committee is answerable to the Government of India if the inflation exceeds the range prescribed for three
consecutive months.
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BANKING
Part II
1. Why Banks are important for the Economy?
2. Capital Adequacy Ratio(CAR)
2.1 Tier 1 Capital
2.2 Tier II Capital
3. Basel Norms
3.1 Basel I
3.2 Basel II
3.3 Basel III
3.4 Buffers introduced in Basel III Norms
3.4.1 Capital Conservation Buffer(CCB)
3.4.2 Counter-Cyclical Buffer (CCCB)
3.5. Challenges in the Implementation of Basel III Norms
3.6. Basel Norm Criteria
4. Non-Performing Asset(NPA)
4.1 Categories of NPA
4.2 Indian Banks and NPA
4.3 Cause of increase in NPA
4.4. Impact of NPA on Indian Economy
4.5. What is being done to address the problem of growing NPAs?
4.5.1. Insolvency and Bankruptcy Code (IBC)
4.5.2. SARFAESI Act 2002
4.5.3. Prompt Corrective Action (PCA)
5. Other important RBI Committee
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5.1 PJ Nayak Committee
5.2 Nachiket Mor Committee
6. Mission Indradhanush
7. Types of Bank
7.1. Scheduled Banks
7.2. Non Schedule Banks
8. Types Of ATM
9. Types of Non-Resident Deposit
9.1.FCNR(B) account
9.2.NRE account
9.3.NRO account
10. Licensing Policy of Bank
11. Priority Sector Lending(PSL)
12. Digital Initiative
12.1 National Payments Corporation of India (NPCI)
a. RuPay
b. Unified Payment Interface(UPI)
c. BHIM
d. Bharat Bill Payment System(BBPS)
e. Aadhaar Enabled Payment System (AePS)
f. National Financial Switch
13. Core Banking Solution (CBS)
14. UPSC CSE PRELIMS Previous Years Questions
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1. Why Bank is important for the Economy?
●
Banks play an important role in the economy by offering a service to people to save, provide finance to
businesses for investment and expansion.
●
Bank loans to businesses are important for enabling economic growth.
●
Loans provided by Banks to business has a certain amount of risk associated with it, of non-payment of loans.
●
Central Banks of the world have adopted various tools to minimize the risk.
●
Some of the tools are ❏ Cash Reserve Ratio (CRR)
❏ Statutory Liquidity Ratio (SLR)
❏ Capital Adequacy Ratio(CAR)
2. Capital Adequacy Ration(CAR)
●
Capital Adequacy Ratio is the percentage of total capital to total risk-weighted assets.
CAR =
Total Capital
* 100 = Tier 1 Capital + Tier 2 Capital * 100
Risk-Weighted Assets
Risk-Weighted Assets
●
CAR is the parameter to measure the financial soundness of the Bank.
●
CAR ensures that banks have enough capital to cover the risk of potential loss and to protect the depositor and
general creditors against losses.
●
It is also known as Capital to Risk-weighted Asset Ratio(CRAR).
●
Risk Weighted Assets(RWA) means assets with different risk profiles. For example, an asset-backed by
collateral would carry lesser risks as compared to loans, which have no collateral.
●
For example - Let’s take an example of a bank XYZ, it has a Capital Reserve of Rs 1cr.
XYZ Capital Reserve= Rs 1crore.
Deposit of XYZ = Rs 100 crore
Loan given by XYZ = Rs 70 crore [Rest Rs 30crore kept as CRR & SLR]
Suppose there is Loss = Rs 5 crore
●
But since the Bank has only Rs 1 cr in Capital rest Rs 4 crore will be shared among depositors which are unjust.
●
Therefore Central banks are instructing the banks to increase capital. More the capital by owners of banks, the
more will be the capability of the banks to overcome the crisis.
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●
RBI introduced the Capital to Risk-Weighted Assets Ratio(CRAR) systems for Indian Banks in the year 1992.
2.1. Tier 1 Capital
●
Tier 1 Capital / Core Capital is the capital that can absorb losses without bank required to cease operation.
●
Tier 1 Capital is the primary indicator to measure a bank's financial strength.
●
Tier 1 capital is disclosed reserves that appear on the bank's financial statements. These include
❏ Share Capital
❏ Undistributed Profit
❏ Preference Share Capital
●
Most of the tier 1 capital will be in the form of equities.
2.2 Tier 2 Capital
●
Tier 2 Capital / Supplementary Capital is the capital that can absorb losses in the event of winding-up of
bank and therefore provide a lesser degree of protection to depositors.
●
Tier 2 capital, includes undisclosed funds that do not appear on a bank's financial statements.
●
Tier 2 capital include
❏ Subordinate Debt
❏ Revaluation Reserve
❏ General loan-loss reserves,
❏ Hybrid (debt/equity) capital instruments
●
Tier 2 capital is more in the form of reserves, debts, etc.
3. Basel Norms
●
Basel Norms are standards set by the Basel Committee on Banking Supervision(BCBS).
●
The Basel Committee on Banking Supervision (BCBS) is an international committee formed with an aim to
develop standards for banking regulation.
●
In 2019, the BCBS has 45 members from 28 Jurisdictions, consisting of Central Banks and authorities with
responsibility of banking regulation.
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●
Basel Norms are agreed upon at Basel, Switzerland at the meeting of the Bank of International
Settlement(BIS).
●
BIS encourages cooperation among central banks with a common goal of ensuring financial stability and
common standards of banking regulations across the globe.
●
Basel Committee’s decisions have no legal force neither it is a multilateral organization. The committee
formulates supervisory standards and guidelines and recommends best practices in banking regulations.
3.1. Basel I
●
Basel I norms was agreed in the year 1998, hence minimum capital requirement was imposed on banks.
●
The minimum capital requirement was fixed at 8% of Risk-Weighted Assets.
●
Basel I norms focussed entirely on credit risk(risk of default on loan).
●
India adopted Basel I guidelines in 1999.
3.2. Basel II
●
Basel II norms were introduced in the year 2004 and were reformed version of Basel I norm.
●
Basel II norms focus on three mains pillars-
❏
Minimum Capital Requirement - Banks should maintain a minimum capital adequacy requirement of
8% of risk assets.
❏
Supervisory Review - Banks are needed to develop and use better risk management techniques in
monitoring and managing all the three types of risks that a bank faces, viz. Credit risk, market risk,
and operational risks.
❏
●
Market Discipline - Banks need to mandatory disclose their risk exposure to the central bank.
Presently Indian banking system follows Basel II norms.
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3.3. Basel III
●
Basel III guidelines were released in the year 2010 in response to the financial crisis of 2008.
●
Basel III aims at❏ Improving Banking sector ability to absorb shock arising from financial and economic instability.
❏ Improve Risk Management and Governance of the banking sector.
❏ Strengthen transparency and Disclosure.
●
The minimum requirement for common equity has been raised under Basel III from 2% to 4.5% of total
Risk-Weighted Assets(RWA).
3.4. Buffers introduced in Basel III Norms
3.4.1 Capital Conservation Buffer(CCB)
●
It is a mandatory capital that financial institutions are required to hold in addition to another
minimum capital requirement.
●
In India, the minimum capital requirement is 9%.
●
The CCB would be 2.5% over and above the minimum capital requirement.
●
It is maintained in the form of common equity Tier 1 Capital.
3.4.2 Counter-Cyclical Buffer (CCCB)
●
Counter-Cyclical Capital buffer is the capital to be kept by a bank to meet business cycle related risks.
●
These are an additional provision that banks are expected to make during good times to provide for
capital erosion during bad business periods.
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The buffer may vary from zero to 2.5% of the total risk-weighted assets(RWA) of banks.
●
It is maintained in the form of common equity Tier 1 Capital.
6
3.5. Challenges in the Implementation of Basel III Norms
a. Higher capital requirement for bank
●
The public sector banks (PSBs) in India will require large capital requirements under Basel III. This will
be difficult for the banks, because of the large number of bad loans on their books.
b. Mounting Pile of Stressed Assets
●
The banking sector in India is facing challenges due to low credit growth, deteriorating asset quality
and low profitability.
c. Economic and policy changes
●
The banking sector is facing headwinds due to policy and economic regulations such as
demonetisation, GST Real Estate (Regulation and Development) Act (RERA).
●
This could slow the process for implementation of global risk norms under Basel III.
3.6. Basel Norm Criteria
Basel II
Basel III
RBI
Common Equity
2%
4.5%
5.5%
Tier 1 Capital
4%
6%
7%
Total Capital
8%
8%
9%
(Tier 1 + 2 + 3)
(Tier 1 + 2)
**
Tier 3 capital is tertiary capital, which many banks hold to support their market risk, commodities risk, and foreign
currency risk. Tier 3 capital includes a greater variety of debt than tier 1 and tier 2 capitals.
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4. Non-Performing Asset(NPA)
●
An asset becomes non-performing when it ceases to generate income for the bank i.e when the borrower
pays neither the interest or principal a er a certain period of time.
●
Non-performing Asset (NPA) shall be an advance(loan) where
❏ Interest and/ or instalment of principal remain overdue for a period of more than 90 days in respect of
a term loan.
❏ interest and/or instalment 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.
❏ any amount to be received remains overdue for a period of more than 90 days in respect of other
accounts.
4.1 Categories of NPAs
●
Banks are required to classify non-performing assets further into the following three categories based on the
period for which the asset has remained non-performing:
❏ Sub-standard Assets
❖ Sub-Standard asset is one, which has remained NPA for a period less than or equal to 12
months.
❏ Doubtful Assets
❖ An asset is to be classified as doubtful if it has remained NPA for a period exceeding 12 months.
❏ Loss Assets
❖ A loss asset is one where loss has been identified by the bank or internal or external auditors or
the RBI inspection but the amount has not been written off wholly.
❖ In other words, such an asset is considered uncollectible.
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4.2. Indian Banks and NPA
●
Data on NPAs is regularly published by RBI as part of its Financial Stability Reports.
●
As per RBI provisional data on global operations, as on 31.3.2019, the aggregate amount of gross NPAs of PSBs
and Scheduled Commercial Banks (SCBs) was Rs. 8,06,412 crore and Rs. 9,49,279 crore respectively.
●
Escalating NPAs require a bank to make higher provisions for losses in their books. The banks set aside more
funds to pay for anticipated future losses; and this, along with several structural issues, leads to low
profitability.
●
Declining profitability of the banks makes them vulnerable to adverse economic shocks and consequently
putting consumer deposits at risk.
4.3. Cause of increase in NPA
●
Excess expansion of corporate during the boom period. But as economic growth stagnated following the
global financial crisis of 2008, the repayment capability of these corporations decreased. This contributed to
what is now known as India’s Twin Balance Sheet problem, where both the banking sector (that gives loans)
and the corporate sector (that takes and has to repay these loans) have come under financial stress.
●
Domestic and economic slowdown.
●
Long delays and gestation periods of several infrastructure projects
●
External Factors, such as decreases in global commodity prices leading to slower exports.
4.4. Impact of NPA on Indian Economy
●
The problem of NPAs in the Indian banking system is one of the foremost and the most formidable problems
that had impacted the entire banking system.
❏ Profitability
❖ NPAs impact profitability, banks stop to earn income on one hand and attract higher
provisioning (set aside an amount in an organization's account) compared to standard assets
on the other hand.
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❏ Capital Adequacy
❖ As per Basel norms, banks are required to maintain adequate capital on risk-weighted assets.
❖ Every increase in the NPA level adds to risk-weighted assets which require banks to increase
their capital.
❏ Liability Management
❖
In the light of high NPAs, Banks tend to lower the interest rates on deposits on one hand and
likely to levy higher interest rates on advances. This may hinder economic growth.
❏ Public confidence
❖ The credibility of the banking system is also affected greatly due to higher level NPAs because
it shakes the confidence of the general public in the soundness of the banking system.
4.5. What is being done to address the problem of growing NPAs?
●
The measures taken to resolve and prevent NPAs can broadly be classified into two kinds – first, regulatory
means of resolving NPAs with various laws (like the Insolvency and Bankruptcy Code), and second, remedial
measures for banks prescribed and regulated by the RBI for the internal restructuring of stressed assets.
4.5.1. Insolvency and Bankruptcy Code (IBC)
●
IBC provides a time-bound process to resolve insolvency in companies and among individuals. Insolvency
is a situation where individuals or companies are unable to repay their outstanding debt.
●
When a default in repayment occurs, creditors( gain control over the debtor's(who owes money) assets and
must take decisions to resolve insolvency within a 180-day period.
●
Under the Code, a financial creditor may file an application before the National Company Law Tribunal (NCLT)
for initiating the insolvency resolution process. The NCLT must find the existence of default within 14 days.
●
A Committee of Creditors (CoC) consisting of financial creditors will be constituted for taking decisions
regarding insolvency resolution. The CoC may either decide to restructure the debtor’s debt by preparing a
resolution plan or liquidate the debtor’s assets.
●
The CoC will appoint a resolution professional who will present a resolution plan to the CoC. The CoC must
approve a resolution plan, and the resolution process must be completed within 180 days. This may be
extended by a period of up to 90 days if the extension is approved by NCLT.
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●
If the resolution plan is rejected by the CoC, the debtor will go into liquidation.
●
The Bill adds that the resolution process must be completed within 330 days. This includes time for any
extension granted and the time taken in legal proceedings in relation to the process.
●
Debt Recovery Tribunal is the Adjudicating Authority with jurisdiction over individuals and unlimited
liability partnership firms. Appeals from the order of DRT shall lie to the Debt Recovery Appellate Tribunal
(DRAT)
●
National Company Law Tribunal (NCLT) shall be the Adjudicating Authority with jurisdiction over
companies, limited liability entities. Appeals from the order of NCLT shall lie to the National Company Law
Appellate Tribunal (NCLAT).
●
The administration of the Insolvency and Bankruptcy Code, 2016 has been transferred to the Ministry of
Corporate Affairs.
4.5.2. SARFAESI Act 2002
●
Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002, was
framed to address the problem of NPA (Non-Performing Assets) or bad assets.
●
The SARFAESI Act allows banks and other financial institution to auction residential or commercial
properties to recover loans.
●
In case of loan default, banks can seize the collateral/securities(except agricultural land) without the
intervention of the court.
●
The law does not apply to
❏ Unsecured loans,
❏ Loans below ₹100,000
❏ Where the remaining debt is below 20% of the original principal.
●
The SARFAESI Act provides for the establishment of Asset Reconstruction Companies (ARCs) which are to
be regulated by RBI.
●
Banks/Financial Institution can sell securities to Asset Reconstruction Companies (ARCs).
●
Government has amended the SARFAESI Act in 2016 to empower the Asset Reconstruction Companies(ARC).
**
An Asset Reconstruction Company is a specialized financial institution that buys the NPAs or bad assets from
banks and financial institutions so that the latter can clean up their balance sheets.
ARCs are registered under the RBI and regulated under the SARFAESI Act, 2002.
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4.5.3. Prompt Corrective Action (PCA)
●
To ensure that Commercial banks do not go bust, RBI has put in place some trigger points to assess, monitor,
control and take corrective actions on banks which are weak and troubled. The process or mechanism under
which such actions are taken is known as Prompt Corrective Action( PCA).
●
The PCA framework deems banks as risky if they slip below certain norms on three parameters — Capital
Ratios, Asset Quality and Profitability.
❏ It has three risk threshold levels (1 being the lowest and 3 the highest) based on where a bank stands
on these ratios.
❖ Banks with capital to risk-weighted assets ratio (CRAR) of less than 10.25% but more than
7.75 % fall under threshold 1.
❖ Those with CRAR of more than 6.25 % but less than 7.75 % fall in the second threshold.
❖ In case a bank’s common equity Tier 1 (the bare minimum capital under CRAR) falls below
3.625 %, it gets categorised under the third threshold level.
❏ Banks that have a Net NPA of 6% or more but less than 9% fall under threshold 1, and those with 12
per cent or more fall under the third threshold level.
❏ On profitability, banks with a negative return on assets for two, three and four consecutive years fall
under threshold 1, threshold 2 and threshold 3, respectively.
●
Once the PCA is imposed, Banks are not allowed to renew or access costly deposits or take steps to increase
their fee-based income. Banks will also have to launch a special drive to reduce the stock of NPAs and contain
generation of fresh NPAs.
●
They will also not be allowed to enter into new lines of business. RBI will also impose restrictions on the bank
on borrowings, mergers, etc from the interbank market.
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5. Other important RBI Committee
5.1. PJ Nayak Committee
●
RBI constituted the P.J. Nayak committee In 2014 to review the governance of Board of Banks in India.
●
The Committee was chaired by P J Nayak and its major recommendations are ❏ Repeal the Bank Nationalisation Act (1970, 1980), the SBI Act and the SBI Subsidiaries Act. This is
because these acts require the government to have above 50% share in the banks.
❏ The Government should set up a Bank Investment Company (BIC)as a core investment company to
hold equity stakes in banks which are presently held by the Government. BIC should be incorporated
under the Companies Act 2013.
❏ The government to transfer its share in the banks to this BIC. Thus, the BIC would become the
parent holding company of all these national banks, and bank would become subsidiaries of BIC. BIC
will be an autonomous body and will have the power to appoint the Board of Directors and make
other policy decisions.
❏ Until the BIC is formed, a temporary body called the Bank Boards Bureau (BBB) will be formed to do
the functions of the BIC. Once BIC is formed, the BBB will be dissolved.
❏ The BBB will advice on appointments to the board, banks’ chairman and other executive
directors.
❏ The Government should consider reducing its holding in public sector banks to less than 50 per cent,
in order that there is a restoration of a level playing field for public sector banks
5.2. Nachiket Mor committee
●
The “Committee on Comprehensive Financial Services for Small Businesses and Low Income
Households” was set up by the RBI under the chairmanship of Nachiket Mor.
●
The committee was tasked for framing a clear vision for financial inclusion and financial deepening in India.
●
Committee has outlined six vision statements for full financial inclusion and financial deepening in India:
❏ Universal Electronic Bank Account (UEBA):
❖ Each Indian resident, above the age of eighteen years, would have an individual, full-service,
safe, and secure electronic bank account.
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❏ Ubiquitous Access to Payment Services and Deposit Products at Reasonable Charges:
❖ The Committee envisions that every resident in India would be within a fi een-minute walking
distance of a payment access point.
❏ Sufficient Access to Affordable Formal Credit:
❖ Each low-income household and small-business would have access to a formally regulated
lender that is capable of assessing and meeting their credit needs.
❖ Such a lender must also be able to offer them a full range of suitable credit products at an
affordable price.
❏ Universal Access to a Range of Deposit and Investment Products at Reasonable Charges:
❖ Each low-income household and small-business would have access to providers that can offer
them suitable investment and deposit products.
❖ Such services must be available to them at reasonable charges.
❏ Universal Access to a Range of Insurance and Risk Management Products at Reasonable Charges:
❖ Each low-income household and small business would have access to providers that have the
ability to offer them suitable insurance and risk management products.
❖ These products must at minimum allow them to manage risks related to
(a) commodity price movements;
(c) death of livestock;
(b) longevity, disability, and death of human beings;
(d) rainfall;
(e) damage to property.
❏ Right to Suitability:
❖ Each low-income household and small-business would have a legally protected right to be
offered only suitable financial services.
❖ She will have the right to seek legal redress if she feels that due process to establish Suitability
was not followed or that there was gross negligence.
●
The main recommendation of the committee are as follow:
❏ Aadhaar will be the prime driver towards rapid expansion in the number of bank accounts.
Monitoring at the district level such as deposits and advance.
❏ Monitoring at the district level such as deposits and advances as a percentage of gross domestic
product (GDP).
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❏ Adjusted 50 per cent priority sector lending target with adjustments for sectors and regions based on
difficulty in lending.
6. Mission Indradhanush
●
The government of India, in order to resolve the issues faced by the Public Sector Banks launched a 7 pronged
plan called “Mission Indradhanush”.
●
Mission Indradhanush aims at revamping the functioning of the Public Sector Banks in order to enable
them to compete with the Private Sector Banks.
●
The seven components include ❏ Appointments
❖ Separation of the posts of Chief Executive Officer(CEO) and the Managing Director(MD)
concentration of power and smooth functioning of the banks.
❖ Induction of talent from the Private Sector into public banks.
❏ Bank Boards Bureau
❖ The Appointments Board of the Public Sector Banks would be replaced by the Bank Board
Bureau (BBB).
❖ It would advice Banks in the matters of raising funds, mergers and acquisitions etc.
❖ The bureau will have three ex-officio members and three expert members in addition to the
chairman.
❏ Capitalisation:
❖ Due to the high NPAs and the need to meet the provisions of the Basel III norms, capitalization
of banks by inducing Rs. 70,000 crore in next 4 years.
❏ De-stressing
❖ Solving issues arising in the infrastructure sector in order to check the stressed assets in the
banks.
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❏ Empowerment
❖ Providing greater flexibility and autonomy to PSBs in hiring manpower.
❏ Framework of Accountability
❖ The assessment of the banks would be based on new performance indicators.
❖ Quantitative Parameters such as Non-Performing Assets Management, growth, diversification,
return on capital, financial inclusion.
❖ Qualitative Parameters such as steps taken in improving asset quality, human resources
initiatives etc.
❏
Governance Reforms
❖ Gyan Sangam conferences between the bankers and the government officials for resolving the
banking sector issues and deciding the future course of action.
7. Types of Bank in India
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7.1. Scheduled Banks
●
Any bank which is listed in the 2nd schedule of the Reserve Bank of India Act, 1934 is considered a
scheduled bank.
●
To qualify as a scheduled bank
❏ The paid-up capital and collected funds of the bank must not be less than Rs5 lakh.
❏ Any activity of the bank will not adversely affect the interests of the depositors.
●
Scheduled bank include State Bank of India, Nationalised Banks, Regional Rural Banks, Foreign Banks,
Private Sector Banks.
●
Scheduled Banks are eligible for obtaining debts/loans on bank rate from the RBI and are given
membership to clearing houses.
7.2. Non Scheduled Banks
●
Non-scheduled banks are those which are not listed in the 2nd schedule of the RBI Act, 1934.
●
Non-scheduled banks are not entitled to borrow from the RBI for normal banking purposes, except in
emergency circumstances." Jammu & Kashmir Bank is an example of a non-scheduled commercial
bank.
**
Note: All other types of banks willl be covered in financial inclusion module.
8. Types of ATM
A. Bank’s own ATM
❖ These are owned and operated by the bank and carry the bank logo.
B. Brown Label ATM
❖ These ATMs are owned and maintained by the service provider but the bank manages the cash and
connectivity to the bank network.
❖ They carry the logo of the bank which outsource their services.
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C. White Label ATM
❖ These are owned and operated by a third party(non-banking firm).
❖ To aid financial inclusion and ATM penetration in the country, the RBI has permitted the launch of
White Labelled ATMs.
❖ These white label ATMs will not display the logo of any particular bank.
❖ TATA launched the first white label ATM in India under the brand name of Indicash.
9. Non Resident Indian Deposit
●
Foreign Exchange Management (Deposit) Regulations, 2000 permits Non-Resident Indians (NRIs) to have
deposit accounts with authorized dealers and with banks authorized by the Reserve Bank of India (RBI). These
accounts include:
❏ Foreign Currency Non-Resident (Bank) account (FCNR(B) account)
❏ Non-Resident External Account (NRE account)
❏ Non-Resident Ordinary Rupee Account (NRO account)
9.1.FCNR(B) account
●
FCNR(B) accounts can be opened by NRIs and Overseas Corporate Bodies (OCBs) with an authorized
dealer.
●
The accounts can be opened in the form of term deposits.
●
Deposits of funds are allowed in Pound Sterling, US Dollar, Japanese Yen and Euro.
●
Rate of interest applicable to these accounts are in accordance with the directives issued by RBI.
9.2.NRE account
●
NRE accounts can be opened by NRIs and OCBs with authorized dealers and with banks authorized by
RBI.
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These can be in the form of savings, current, recurring or fixed deposit accounts.
●
Deposits are allowed in any permitted currency.
●
Rate of interest applicable to these accounts is in accordance with the directives issued by RBI.
18
9.3.NRO account
●
NRO accounts can be opened by any person resident outside India with an authorized dealer or an
authorized bank for collecting their funds from local bonafide transactions in Indian Rupees.
●
When a resident becomes an NRI, his existing Rupee accounts are designated as NRO.
●
These accounts can be in the form of current, savings, recurring or fixed deposit accounts.
10. Licensing policy of Bank
●
RBI guidelines for granting of license to commercial banks are ❏ Individual/Group resident in India confirming to fit an proper criteria, can promote/establish new
banks with the following criteria❖ Sound Credential and integrity
❖ Sufficient finances
❖ Successful business track record of at least 10 years.
●
A New Bank could be established only through a Non- Operative Financial Holding Company(NOFHC),
which would be registered with RBI as an NBFC. Its objective is to separate the business activities of the
promoter group from the new bank. The NOFHC would be holding company of all the financial business of the
promoter group.
●
The paid-up capital should be at least Rs 500 crore. Out of which, the NOHFC has to invest at least 40%
which would be locked in for 5 years. However, the NOHFC has to reduce its shareholding in the new bank to
15% or less over the 12 years from the establishment of the bank.
●
At least 50% of the directors of New bank should be independent directors( Director who do not have any
vested interest in the company)
●
The foreign investment ceiling in New bank would be 49% [ ceiling for an existing bank is 74%].
●
Within 1 year of licensing, banks should be established and within 3 years, banks should be listed in the stock
exchange.
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11. Priority Sector Lending(PSL)
●
Lending by a commercial bank for certain sectors which are identified as “priority sector” by the central
bank (Reserve Bank of India) is called priority sector lending.
●
The objective of priority sector lending is to ensure that adequate institutional credit flows into vulnerable
sectors of the economy.
●
Priority Sector includes the following categories:
(i) Agriculture
(ii) Micro, Small and Medium Enterprises
(iii) Export Credit
(iv) Education ( Loans to individuals for educational purposes up to Rs. 10 lakh )
(v) Housing ( Housing loans to individuals loan upto Rs.28 Lakh in Metros, Rs.20 Lakh in other
centres)
(vi) Social Infrastructure ( Loans up to ₹5 crores per borrower for building social infrastructure )
(vii) Renewable Energy ( Individual households, the loan limit will be ₹10 lakh per borrower,
Loan up to Rs.15 crore for purposes like solar-based power generators etc)
(viii) Others
●
The targets and sub-targets for banks under priority sector are as follows:
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Categories
Domestic scheduled commercial banks and Foreign banks with less than 20 branches
Foreign banks with 20 branches and above
Total Priority Sector
40% of Adjusted Net Bank Credit or Credit 40% of Adjusted Net Bank Credit or Credit
Equivalent Amount of Off-Balance Sheet Equivalent Amount of Off-Balance Sheet Exposure,
Exposure, whichever is higher.
whichever is higher, to be achieved in a phased
manner by 2020.
Agriculture
18% of ANBC.
Not applicable
Within the 18% target for agriculture, a target
of 8% is prescribed for Small and Marginal
Farmers.
Micro Enterprises
Advances
to
7.5% of ANBC.
Weaker 10% of ANBC.
Not applicable
Not applicable
Sections
PSL does not apply to Regional Rural Banks(RRB) and Small Finance Banks (SFB) because these banks are already working in
the sector which are defined in PSL norms .
●
The rate of interest for bank loans under priority sector will be decided by RBI.
●
If the Banks fails to meet its PSL target, then banks may be required to invest in the Rural Infrastructure
Development Fund (RIDF).
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12. Digital Initiative
12.1. National Payments Corporation of India(NPCI)
●
National Payments Corporation of India is the umbrella organisation for all retail payment systems in India.
●
It 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.
●
Founded in 2008, the NPCI is not-for-profit organisation registered under the Companies Act 2013.
●
Product of NPCI are as follows:
a. RuPay
❏ RuPay is the first-of-its-kind domestic Debit and Credit Card payment network of India.
❏ RuPay fulfils RBI’s vision of initiating a ‘less-cash’ economy.
❏ Singapore will be the first country to issue RuPay cards in the country.
❏ RuPay card has been introduced in the following countries Bhutan, Maldives, UAE, Bahrain,
Saudia Arabia.
b. Unified Payment Interface(UPI)
❏ UPI is a real-time interbank payment system for sending or receiving money.
❏ UPI uses existing systems, such as Immediate Payment Service (IMPS) and Aadhaar Enabled
Payment System (AEPS), to ensure seamless settlement across accounts.
❏ In 2018, UPI 2.0 was launched which enabled users to link their Overdra accounts to a UPI.
c. BHIM
❏ Bharat Interface for Money (BHIM) is a mobile payment app that allows users to make quick
transactions using Unified Payments Interface (UPI).
❏ It is named a er B.R. Ambedkar launched in 2016.
❏ Minimum amount - ₹1, Maximum Number of Transactions/day - 10.
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❏ Maximum Fund transfer limit - ₹20,000/ transaction, Maximum - ₹40,000 in a 24-hour
period.
d. Bharat Bill Payment System(BBPS)
❏ BBPS is an interoperable platform that enables a customer to pay bills such as telephone,
water, gas, direct-to-home (DTH) and electricity at a single location—electronic or physical.
e. Aadhaar Enabled Payment System (AePS)
❏ It allows people to carry out financial transactions on a Micro-ATM using the Aadhaar
authentication.
❏ The only inputs required for a customer to do a transaction are:❖ IIN (Identifying the Bank to which the customer is associated)
❖ Aadhaar Number
❖ Fingerprint captured during their enrollment
f.
National Financial Switch
❏ NFS is the largest domestic ATM network in India.
❏ NFS is designed, developed and deployed by the Institute for Development and Research in
Banking Technology (IDRBT).
❏ NFS facilitates routing of ATM transactions through inter-connectivity between the Bank’s
Switches, such that the transactions made at any ATM could be routed to the connected banks.
13. Core Banking Solution (CBS)
●
Core banking solution refers to a centralized system established by a bank which allows its customers to
conduct their business from any branch of the Bank, regardless of where he maintains his account.
●
CORE is an acronym for "Centralized Online Real-time Exchange".
●
Example - E-Kuber is the Core Banking Solution of Reserve Bank of India.
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14. UPSC CSE PRELIMS Previous Years Questions
●
Now, let’s check how many questions you can attempt?
Q.1) Priority Sector Lending by banks in India constitutes the lending to:
2013
[A] Agriculture
[B] Micro and small enterprises
[C] Weaker Sections
[D] All of the above
Ans.1)Correct Answer: (d)
Explanation:
●
Priority Sector Lending is an important role given by the Reserve Bank of India (RBI) to the banks for providing
a specified portion of the bank lending to a few specific sectors like agriculture and allied activities, micro and
small enterprises, poor people for housing, students for education and other low income groups and weaker
sections. This is essentially meant for all-round development of the economy as opposed to focusing only on
the financial sector
Q.2) ‘Basel III Accord’ or simply ‘Basel III’, o en seen in the news, seeks to -
2015
[A] develop national strategies for the conservation and sustainable use of biological diversity
[B] improve the banking sector’s ability to deal with financial and economic stress and improve risk management
[C] reduce greenhouse gas emissions but places a heavier burden on developed countries
[D] transfer technology from developed Countries to poor countries to enable them to replace the use of
chlorofluorocarbons in refrigeration with harmless chemicals
Ans.2)Correct Option : (b)
Explanation:
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●
Basel III is an international regulatory accord that introduced a set of reforms designed to improve the
regulation, supervision and risk management within the banking sector.
●
The Basel Committee on Banking Supervision published the first version of Basel III in late 2009, giving banks
approximately three years to satisfy all requirements.
●
Largely in response to the credit crisis, banks are required to maintain proper leverage ratios and meet certain
minimum capital requirements.
Q.3) The term ‘Core Banking Solution’ is sometimes seen in the news. Which of the following statements best
describes/describe this term?
2016
1. It is networking of a bank’s branches which enables customers to operate their accounts from any branch of
the bank on its network regardless of where they open their accounts.
2. It is an effort to increase RBI’s control over commercial banks through computerization.
3. It is a detailed procedure by which a bank with huge non-performing assets is taken over by another bank.
Select the correct answer using the code given below:
[A] 1 only
[B] 2 and 3 only
[C] 1 and 3 only
[D] 1, 2 and 3
Ans.3) Correct Option: (a)
Explanation:
●
Core Banking Solution (CBS) is the networking of branches, which enables Customers to operate their
accounts, and avail banking services from any branch of the Bank on CBS network, regardless of where he
maintains his account.
●
Another interesting fact regarding CBS is that all CBS branches are inter-connected with each other.
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●
Therefore, Customers of CBS branches can avail various banking facilities from any other CBS branch located
anywhere in the world.
Q.4) Consider the following statements:
2017
1. National Payments Corporation of India (NPCI) helps in promoting financial inclusion in the country.
2. NPCI has launched RuPay, a card payment scheme.
Which of the statements given above is/are correct?
[A] 1 only
[B] 2 only
[C] Both 1 and 2
[D] Neither 1 nor 2
Ans.4) Correct Option: (c)
Explanation:
●
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
●
NPCI facilitate an affordable payment mechanism to benefit the common man across the country and finally
helps in fulfilling goal of financial inclusion.
●
Considering the utility nature of the objects of NPCI, it has been incorporated as a “Not for Profit” Company
under the provisions of Section 25 of Companies Act 1956 (now Section 8 of Companies Act 2013), with an
intention to provide infrastructure to the entire Banking system in India for physical as well as electronic
payment and settlement systems. The Company is focused on bringing innovations in the retail payment
systems through the use of technology for achieving greater efficiency in operations and widening the reach of
payment systems.
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Q.5) Which of the following is the most likely consequence of implementing the ‘Unified Payments Interface
(UPI)’?
2017
[A] Mobile wallets will not be necessary for online payments.
[B] Digital currency will totally replace the physical currency in about two decades.
[C] FDI inflows will drastically increase.
[D] Direct transfer of subsidies to poor people will become very effective.
Ans.5) Correct Option: (a)
Explanation:
●
Unified Payments Interface (UPI) is an instant real-time payment system developed by National Payments
Corporation of India facilitating inter-bank transactions.
●
The interface is regulated by the Reserve Bank of India and works by instantly transferring funds between two
bank accounts on a mobile platform.
●
Unified Payments Interface (UPI) is a system that powers multiple bank accounts into a single mobile
application (of any participating bank), merging several banking features, seamless fund routing & merchant
payments into one hood.
●
It also caters to the “Peer to Peer” collect request which can be scheduled and paid as per requirement and
convenience.
●
Each Bank provides its own UPI App for Android, Windows and iOS mobile platform(s).
●
On August 16, 2018, UPI 2.0 was launched which enabled users to link their Overdra accounts to a UPI handle.
●
Users were also able to pre-authorize transactions by issuing a mandate for a specific merchant. 2.0 version
included a feature to view and store the invoice for the transactions.
Q.6) Which one of the following links all the ATMs in India?
2018
[A] Indian banks' Association
[B] National Securities Depository Limited
[C] National Payments Corporation of India
[D] Reserve Bank of India
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Ans.6) Correct Option: (c)
Explanation:
●
National Financial Switch (NFS) is the largest network of shared automated teller machines (ATMs) in India. It
was designed, developed and deployed by the Institute for Development and Research in Banking Technology
(IDRBT) in 2004, with the goal of inter-connecting the ATMs in the country and facilitating convenience
banking.
●
It is run by the National Payments Corporation of India (NPCI). National Payments Corporation of India (NPCI)
is an umbrella organization for all retail payments in India.
●
It was set up with the guidance and support of the Reserve Bank of India (RBI) and Indian Banks Association
(IBA).
Q.7) Consider the following statements:
2018
1. Capital Adequacy Ratio (CAR) is the amount that banks have to maintain in the form of their own funds to offset any
loss that banks incur if the account-holders fail to repay dues.
2. CAR is decided by each individual bank.
Which of the statements given above is/are correct?
[A] 1 only
[B] 2 only
[C] Both 1 and 2
[D] Neither 1 nor 2
Ans.7) Correct Option: (a)
Explanation:
●
Capital Adequacy Ratio (CAR) is also known as Capital to Risk (Weighted) Assets Ratio (CRAR).
●
It is the ratio of a bank's capital in relation to its risk-weighted assets and current liabilities.
●
It is a measure of a bank's capital.
●
It is expressed as a percentage of a bank's risk-weighted credit exposures. CAR is not decided by each
individual bank but by RBI on the basis of Basel Committee recommendations.
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Q.8) The Chairman of public sector banks are selected by the
2019
(a) Banks Board Bureau
(b) Reserve Bank of India
(c) Union Ministry of Finance
(d) Management of concerned bank
Ans.8) Correct Option: (a)
Explanation:
Banks Board Bureau (BBB) is an autonomous body of the Government of India. It is tasked to improve the governance
of Public Sector Banks, recommend the selection of chiefs of government owned banks and financial institutions and
to help banks in developing strategies and capital raising plans.
Q.9) Which of the following is not included in the assets of a commercial bank in India?
2019
(a) Advances
(b) Deposits
(c) Investments
(d) Money at call and short notice
Ans.9) Correct Option: B
Explanation:
●
Deposits of banks are a liability not assets
●
Commercial Banks hold their assets largely in the form of (i) loans and advances and bills discounted and purchased, together constituting bank credit,
(ii) investment, and
(iii) cash.
●
Money at Call at Short Notice:
❏ It is money lent to other banks, stock brokers, and other financial institutions for a very short period
varying from 1 to 14 days.
❏ Banks place their surplus cash in such loans to earn some interest without straining their liquidity.
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❏ If cash position continues to be comfortable, call loans may be renewed day a er day.
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INFLATION
1. Inflation
3
2. Types of Inflation
3
2.1. Demand-Pull Inflation
4
2.2.Cost-Push Inflation
5
2.3. Low Inflation
5
2.4. Galloping Inflation
5
2.5. HyperInflation
5
3. Measures to Control Inflation
6
3.1. Monetary Policy
6
3.2. Fiscal Policy
6
3.3. Supply Management Measures
6
4. Constraints Faced by the Government in controlling inflation
7
5. Impact of Inflation
7
5.1. Positive Impact
7
5.2. Negative/Adverse Impact
7
6. Measurement of Inflation
8
6.1. Wholesale Price Index (WPI)
8
6.1.2. Key Highlights of WPI with 2011-12 as base year
10
6.2. Consumer Price Index (CPI)
10
6.2.1. CPI for Industrial workers CPI(IW)
11
6.2.2. CPI for Urban Non-Manual Employees(UNME)
12
6.2.3. CPI for Agricultural Labourers CPI(AL)
12
6.2.4. CPI for Rural Labourers CPI(RL)
12
6.2.5. Revision in CPI
13
6.3. WPI vs CPI
14
7. Trends in Inflation
15
8. Inflation Targeting in India
17
9. Food Prices Indices
17
9.1. WPI food index
17
9.2. Consumer Food Price Index(CFPI)
18
10. Other Index
18
10.1. Producer Price Index(PPI)
18
10.1.1. PPI vs WPI
18
10.2. NHB RESIDEX
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1
10.3. Housing Price Index of RBI
19
10.4. Service Price Index
19
11. Effects of Inflation
20
12. Other variants of inflation
21
12.1 Structural Inflation/Bottleneck Inflation
21
12.2. Headline Inflation
21
12.3. Core Inflation
21
12.4. Open Inflation
22
12.5. Suppressed/Repressed Inflation
22
13. Terms
13.1. Reflation
22
13.2. Stagflation
22
13.3. Skewflation
22
13.4. Misery Index
23
13.5. Inflationary Gap
23
13.6. Defationary Gap
23
13.7. Agriflation
23
13.8. Disinflation
23
13.9. Deflation
23
13.10. Phillips Curve
24
13.11. GDP Deflator
24
14. Base Effect
25
15. Inflation Indexed Bond(IIB)
26
16. UPSC CSE PRELIMS Previous Years Questions
27
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2
1. Inflation
●
Inflation refers to a sustained increase in the general price level of goods and services in an economy over a
period of time.
●
If the price of one good increases, it is not inflation but if the price of most of the goods increases then only it is
inflation.
●
Rate of inflation is the rate of change of general price level which is measured as follows:
Rate of inflation (year X) = Price (year X) - Price (year X-1) * 100
Price (year X-1 )
●
Consider a bar of chocolate is priced at ₹100 in 2019. If all the other factors are constant and the same
chocolate is priced at ₹110 in 2020, the inflation rate is 10% per annum.
Rate of inflation (year 2020) = Price (year 2020) - Price (year 2019) * 100 = 110-100 * 100 = 10%
Price (year 2019)
●
100
When the general price level increases, each unit of currency buys fewer goods and services; consequently,
inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium
of exchange and unit of account within the economy.
●
Suppose one ₹100 note buys 10 litres of petrol in 1980. In the year 2020, the same ₹100 buys 2 litres of petrol.
This shows that although ₹100 note did not lose its value over time, it has lost its purchasing power over this
time of 30 years. This example explains how money loses its value over time when prices rise.
●
It is measured on a year-on-year basis (or month/week basis). The rate of change in the price level in a given
month vis a vis corresponding month of last year is known as point to point inflation.
2. Types of Inflation
●
Depending upon the rate of increase in price, based on cause inflation can be classified as
●
Based on Cause of Inflation:
❏ Demand-Pull Inflation
❏ Cost-Push Inflation
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3
●
Based on rate of increase in price:
❏ Low Inflation
❏ Galloping Inflation
❏ Hyperinflation
2.1. Demand-Pull Inflation
●
Demand-pull inflation occurs when the overall demand for goods and services in an economy increases more
rapidly than the economy's production capacity.
●
It creates a demand-supply gap with higher
demand and same supply, which results in higher
prices.
●
For instance, during the sowing season demand
for fertilizer increases. It leads to higher demand,
which results in price rises and contributes to
inflation.
●
An increase in money supply in an economy also
leads to inflation. With more money available to
individuals, positive consumer sentiment leads to
higher spending. This increases demand and
leads to price rises.
●
In all such cases of demand increase, the money loses its purchasing power.
●
As shown in the graph as demand increases from AD to AD1 price increases.
●
Causes of Demand-Pull Inflation are:
© Coursavy
❏ Increase in Money Supply.
❏ Increase in Government Expenditure/Public Expenditure
❏ Decrease in Direct Taxes.
❏ Increase in Exports
❏ Increase in Population
❏ Decrease in Imports
4
2.2.Cost-Push Inflation
●
Cost Push Inflation is inflation caused by an increase in prices of factors of production like labour, raw
material, etc.
●
The increased price of the factors of production leads to a
decreased supply of goods.
●
Causes of Cost-Push Inflation are:
❏
❏
❏
❏
❏
❏
●
Increase in Cost of Production
Decrease in Output
Hoarding and Speculation
Increase in Indirect Taxes
Defective Supply Chain
Increase in price of imported Commodity(like oil)
As shown in the graph, as the cost of production rises, the
aggregate supply decreases from AS to AS1, causing an
increase in the price level.
2.3. Low Inflation
●
Low Inflation used to describe a period of time when prices are rising slowly. Such Inflation is slow and on
predictable lines.
●
This type of Inflation is also called Creeping Inflation.
●
If the prices increase by 3% or less annually, then such inflation is creeping inflation.
2.4. Galloping Inflation
●
Galloping Inflation refers to a type of inflation that occurs when the prices of goods and services increase at a
double-digit (i.e 15% etc) or triple-digit (i.e 100% etc) rate per annum.
●
Galloping inflation is also known as jumping inflation/Running Inflation.
2.5. HyperInflation
●
Hyperinflation occurs when the rate of increase in prices is extremely high and that increase in price takes
place in a short span of time.
●
In other words, hyperinflation takes place when the increase in prices is more than three-digit rate annually.
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●
Germany had witnessed hyperinflation a er the First World War in the 1920s.
3. Measures to Control Inflation
●
The government adopt various measures to control the increase in the price of goods and services.
3.1. Monetary Policy
●
Monetary Policy aims to decrease the money supply in the economy thereby impacting the aggregate
demand in the market. This policy is called a contractionary monetary policy.
●
Rates like CRR, SLR, Repo Rate and Reverse Repo Rate are increased to impact the money supply in the
economy by the RBI to control inflation.
3.2. Fiscal Policy
●
Fiscal Policy refers to the revenue and expenditure policy of the government.
●
The government Increase taxes (such as Income tax, GST etc) and Cut Government spending. This
reduces money supply and hence demand in the economy.
●
For example, if Income tax is increased, the total disposable income would reduce. As a result, the
total spending of individuals decreases, which, in turn, reduces the money supply in the market.
●
Some of the fiscal policy measures taken are as follows:
❏ Reducing Import Duties
❏ Banning exports or Imposing minimum export prices.
❏ Suspending the futures trading of commodities.
❏ Raising the stock limit for the commodities
3.3. Supply Management Measures
●
Supply Management Measures aims to increase the competitiveness and efficiency of the supply
chain, putting downward pressure on long-term costs.
●
Some of the supply management measures taken are as follows:
❏ Restricting exports of commodities in short supply and increasing their imports.
❏ Effective implementation of the Essential Commodities Act, 1952 to prevent hoarding and
speculation
❏ Incentivising the increase in production of commodities through tax concessions, subsidies,
institutional support etc.
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6
❏ Higher MSP has been announced so as to incentivize production and thereby enhance the
availability of food items which may help moderate prices.
❏ Fixing the ceiling prices of the commodities and taking measures to control the black
marketing of those goods
❏ Reforming the supply chain through infrastructure development, foreign investments etc.
4. Constraints Faced by the Government in controlling inflation
●
India imports more than 80 per cent of its oil requirements. Oil prices are volatile owing to the various
geopolitical and economic events in the international arena
●
Long overdue supply-side reforms.
●
Inefficiencies in the monetary policy transmission
●
Limited control of Government and RBI in controlling rupee depreciation
●
Political compulsion in reducing expenditure and fiscal deficit.
●
Populist measures of the government.
5. Impact of Inflation
5.1. Positive Impact
●
A moderate level of inflations stimulates economic growth because it increases profit margins of firms that
encourage them to increase production and supply.
●
It indicates that there is no deficiency of demand in the economy which improves profitability expectation
which encourages firms to invest and increases production capacity.
5.2. Negative/Adverse Impact
●
It deteriorates the standard of living of people as it reduces income at their disposable.
●
It is regressive, i.e it affects poor relatively more because the marginal utility of money for them is relatively
high.
●
High inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will
increase in the future.
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7
●
High inflation retards economic growth as it induces the government to adopt contractionary fiscal and
monetary policies.
●
It deteriorates the balance of payments situation of the country. It discourages export and encourages import
which widens creates a deficit and tends to reduce forex reserves.
6. Measurement of Inflation
●
There are two main set of inflation indices for measuring price level changes in India
❏ Wholesale Price Index (WPI)
❏ Consumer Price Index (CPI)
6.1. Wholesale Price Index (WPI)
●
Wholesale Price Index(WPI) measures the changes in the prices of goods sold and traded in bulk by
wholesale businesses to other businesses instead of consumers.
●
The index basket of the WPI covers commodities falling under the three major groups namely Primary
Articles, Fuel & Power and Manufactured Products.
●
The index basket of the present 2011-12 series has a total of 697 items
❏ Primary Articles - 117 items ❏ Fuel & Power - 16 items
❏ Manufactured Products - 564 items
●
The prices tracked are ex-factory price for manufactured products, mandi price for agricultural commodities
and ex-mines prices for minerals.
●
Weights given to each commodity covered in the WPI basket is based on the value of production adjusted for
net imports.
●
WPI basket does not cover services.
●
In India, the Office of Economic Advisor (OEA), Department of Industrial Policy and Promotion, Ministry
of Commerce and Industry calculates the WPI.
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8
●
The main uses of WPI are the following:
a. To provide estimates of inflation at the wholesale transaction level for the economy as a whole. This
helps in timely intervention by the Government to check inflation in particular, in essential
commodities, before the price increase spill over to retail prices.
b. Global investors also track WPI as one of the key macro indicators for their investment decisions.
●
The Government periodically reviews and revises the base year of the WPI as a regular exercise to capture
structural changes in the economy and improve the quality, coverage and representativeness of the indices.
●
The base year of All-India WPI has been revised from 2004-05 to 2011-12 in 2017 to align it with the base
year of other macroeconomic indicators like the Gross Domestic Product (GDP) and Index of Industrial
Production (IIP).
●
The new series with base 2011-12=100 was based on the recommendations of the Working Group which was
constituted in 2012 under the chairmanship of Late Dr. Saumitra Chaudhuri.
●
Wholesale price index calculated with 2011-12 base year does not include taxes in order to remove the
impact of fiscal policy.
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9
6.1.2. Key Highlights of WPI with 2011-12 as base year
●
In the new and presently running WPI series, significant improvement in concept, coverage and methodology
has been made.
●
In the updated WPI basket, the number of items has been increased from 676 to 697.
●
New definition of Wholesale Price Index(WPI) does not include taxes in order to remove the impact of fiscal
policy. This also brings new WPI series closer to Producer Price Index and is in consonance with the global
practices.
●
The indices are being compiled based on Geometric Mean as compared to Arithmetic Mean used in the WPI
2004-05 series.
6.2. Consumer Price Index (CPI)
●
Consumer Price Index(CPI) measures the change in the price paid by the consumer at retail level.
●
Consumer Price Index(CPI) is a measure of change in retail prices of goods and services consumed by people in
a given area with reference to a base year.
●
The main uses of CPI are the following:
a. It is widely considered as a barometer of inflation
b. Tool for monitoring price stability
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10
●
The formula for calculating Consumer Price Index is Laspeyres index which is measured as follows:
Total cost of a fixed basket of goods and services in the current period * 100
Total cost of the same basket in the base period
●
The Reserve Bank of India (RBI) has started using CPI(Combined) as the sole inflation measure for the
purpose of monetary policy.
●
As per the agreement on Monetary Policy Framework between the Government and the RBI in 2015 the sole
objective of the RBI is price stability and a target is set for inflation as measured by the Consumer Price
Index(Combined).
●
Consumer Price Index compiled for four groups of consumers in India
❏ CPI for Industrial workers CPI(IW)
❏ Consumer Price Index for Urban Non-Manual Employees(UNME)
❏ CPI for Agricultural Labourers CPI(AL)
❏ CPI for Rural Labourers CPI(RL)
6.2.1. CPI for Industrial workers CPI(IW)
●
This index is the oldest among the CPI indices as its dissemination started as early as in 1946.
●
Consumer Price Index Numbers for Industrial workers measure a change over time in prices of a fixed
basket of goods and services consumed by Industrial Workers.
●
The target group is an average working-class family belonging to any of the seven sectors of the
economy- factories, mines, plantation, motor transport, port, railways and electricity generation and
distribution.
●
CPI (IW) is currently calculated at base 2001=100.
●
It is used for wage indexation and fixation of dearness allowance for government employees.
●
The retail prices used in the compilation of CPI(IW) are collected by the Labour Bureau in the Ministry
of Labour.
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11
6.2.2. CPI for Urban Non-Manual Employees(UNME)
●
This index depicts the changes in the level of average retail prices of goods and services consumed by
the urban segment of the population. The target group of this index was urban families who derived a
major portion of their income from non-manual occupations in the non-agricultural sector.
●
The index was being released by CSO with a time lag of about two weeks
●
Some of the State Governments, public and private sector undertakings, foreign embassies, etc. are
making use of this index for purposes of regulating Dearness Allowance.
●
The release of all-India linked CPI(UNME) has been discontinued since January 2011.
6.2.3. CPI for Agricultural Labourers CPI(AL)
●
CPI for Agricultural labourers (AL) measures the extent of change in the retail prices of goods and
services consumed by the agricultural labourers.
●
CPI (AL) is currently calculated at base 1986-87=100.
●
CPI-AL is basically used for revising minimum wages for agricultural labour in different States.
●
CPI(AL) is compiled by the Labour Bureau in the Ministry of Labour.
6.2.4. CPI for Rural Labourers CPI(RL)
●
CPI for Rural labourers (RL) measures the extent of change in the retail prices of goods and services
consumed by the Rural labourers.
●
CPI (RL) is currently calculated at base 1986-87=100.
●
CPI(RL) is compiled by the Labour Bureau in the Ministry of Labour.
**
Note: The Labour Bureau has started the process of revising the base year for Consumer Price Index for Agricultural
and Rural Labourers CPI(AL/RL) to 2019-20, from 1986-87.
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12
6.2.5. Revision in CPI
●
The CPI(IW) and CPI(Al & RL) pertain to specific segments of the population. Since these indices do not cover
all segments of the population, it is difficult to ascertain the true variations in the price level.
●
To overcome this problem, government announced a new index with wider coverage,
❏ CPI(Urban) - representative of the entire Urban population
❏ CPI(Rural) - representative of the entire Rural population
❏
●
CPI(Combined)
It is compiled by the Central Statistics Office(CSO) under the Ministry of Statistics and Programme
Implementation(MOSPI).
●
The base year was also revised from 2004-05 to 2010-11.
●
In 2015, CPI was again revised by CSO.
❏ The base year was revised from 2010 to 2012=100.
❏ The number of group was increased to six in the new series i.e
Groups
Rural
Urban
Combined
Food and beverages
34.18
36.29
45.86
and 3.26
1.36
2.35
and
7.36
5.57
6.53
Housing
-----
21.67
10.07
Fuel and Light
7.94
5.50
6.84
Miscellaneous
27.26
29.53
28.32
Total
100
100
100
Pan,
tobacco
intoxicants
(newly added )
Clothing
Footwear
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13
❏ Consumer Food Price Index(CFPI) will be compiled as the weighted average of the following indices:
❖ CFPI(Rural)
❖ CFPI(Urban)
❖ CFPI(Combined)
❏
The indices are now being computed using Geometric Means(GM) in place of Arithmetic Mean(AM)
used for the old series.
Indices
Nov.2019 (Provisional)
Oct 2019
Rural
Urban
Combined
Rural
Urban
Combined
CPI(General)
5.27
5.76
5.54
4.29
5.11
4.62
CFPI
8.83
12.26
10.01
6.42
10.47
7.89
6.3. WPI vs CPI
Wholesale Price Index (WPI)
Consumer Price Index(CPI)
WPI keeps track of the wholesale price of
CPI measures the average price that households pay for a basket of
goods
different goods and services
The prices used for WPI are collected at
Retail prices applicable to consumers and collected from various
ex-factory level for manufactured products,
markets are used to compile CPI
at ex-mine level for mineral products and
mandi level for agricultural products.
Compiled by Office of Economic Advisor
Compiled by Central Statistics Office (Ministry of Statistics and
(Ministry of Commerce & Industry)
Programme Implementation)
Goods only
Goods and Services both
WPI basket weight of 24.4% (Food articles
CPI Food group has a weight of 39.1%
and Manufactured Food products)
Price paid by Manufacturers and wholesalers
© Coursavy
Price paid by Consumer
14
7. Trends in Inflation
●
India’s experience of inflation has been a mixed bag. There were years when the annual rate of inflation was
high (due to supply-side shortfalls caused by drought, price rise of crude oil), while in other years it was
negative.
●
Decadal inflation in India has been as follows:
Above graph, shows inflation trends since independence
●
Between 2009-13, the inflation remained high due to:
❏ Food inflation due to the shi in dietary habit to protein-rich food.
❏ Increased wages ( due to schemes like MGNREGA etc)
❏ Increase in prices of the commodity in the global market.
●
Since 2014 inflation started moderating due to a decrease in global crude oil prices, so ening in global food
prices, RBI tight monetary policy.
●
In December 2019, Retail inflation rose to five and a half year to 7.35% primarily on the account of rising
vegetable and food prices. Food items make up almost 46 per cent of the inflation basket.
© Coursavy
15
●
According to the National Statistical Office (NSO), retail inflation based on the Consumer Price Index(CPI) was
only 2.11% in December 2018 and 5.54% in November 2019.
●
Onion prices were above the Rs 100 per kg mark in many major cities due to fall in production. Along with rise
in the price of vegetables, high prices of pulses, meat and fish contributed to the spike.
●
The government of India has mandated the Reserve Bank of India to keep inflation in the range of 2-6 per cent.
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8. Inflation Targeting in India
●
Inflation targeting is a monetary policy strategy used by Central Banks(RBI) for maintaining price level at a
certain level or within a range.
●
Inflation targeting brings in more predictability and transparency in deciding monetary policy. If the central
banks could ensure price stability, households and companies can plan ahead, negotiating wages on the basis
of expecting low and stable inflation.
●
The Reserve Bank of India and Government of India signed a Monetary Policy Framework Agreement in 2015.
As per terms of the agreement, the objective of monetary policy framework would be primarily to maintain
price stability, while keeping in mind the objective of growth.
●
The monetary policy framework would be operated by the RBI. RBI would aim to contain consumer price
inflation within 4 per cent with a band of (+/-) 2 per cent.
●
The central bank would be seen as failing to meet the targets if retail inflation is more than 6 per cent for three
consecutive quarters and less than 2 per cent for three consecutive quarters. If this happens, RBI will have to
explain the reason for its failure to meet as well as give a timeframe within which it will achieve it.
●
The RBI will also be required to bring a document every six months to explain the sources of inflation and
forecast for inflation for the next 6-18 months.
9. Food Prices Indices
9.1. WPI food index
●
WPI food index is a new Food price Index launched in 2017 as part of a revised WPI series with base
year 2011-12.
●
WPI food index measures the changes in prices of food items at the level of producers.
●
The WPI Food index is compiled by taking the aggregate of WPI for “Food Products” under
“Manufacture Products” and “Food Articles” from “Primary Article” using weighted arithmetic mean.
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17
9.2. Consumer Food Price Index(CFPI)
●
Consumer Food Price Index (CFPI) is a measure of change in retail prices of food products
consumed by a defined population group in a given area with reference to a base year.
●
The Central Statistics Office (CSO), Ministry of Statistics and Programme Implementation (MOSPI)
started releasing Consumer Food Price Indices (CFPI) for three categories -rural, urban and combined separately on an all India basis with effect from May 2014.
●
Like Consumer Price Index (CPI), the CFPI is also calculated on a monthly basis and methodology
remains the same as CPI.
●
The base year presently used is 2012.
***
Note: Globally, the food price index is being released by the Food and Agriculture Organization of the United Nations.
The FAO Food Price Index is a measure of the monthly change in international prices of a basket of food
commodities. It consists of the average of five commodity group price indices (Cereal, Vegetable Oil, Dairy, Meat and
Sugar) weighted with the average export shares of each of the groups for 2002-2004.
10. Other Index
10.1. Producer Price Index(PPI)
●
Producer Price Index measures the price of goods as they are sold to the wholesalers by the producers.
●
Producer Price Index measure price change from the perspective of the producers.
●
Government has set up a committee under the chairmanship of B.N Goldar to advise methodology for
introducing PPI in the country.
10.1.1. PPI vs WPI
PPI
WPI
PPI measures the average change in prices received by
the producer and excludes indirect taxes.
WPI captures the price changes at the point of bulk
transactions and may include some taxes levied and
distribution costs up to the stage of wholesale
transactions.
PPI includes Services
WPI does not cover Services
PPI weights are derived from Supply Use Table
Weight of an item in WPI is based on Net Traded Value
© Coursavy
18
10.2. NHB RESIDEX
●
NHB RESIDEX, India’s first official housing price index, was an initiative of the National Housing Bank
(NHB) was launched in 2007 covering 26 cities.
●
NHB RESIDEX is designed to track changes in housing prices at neighbourhood, city and national levels. Price
changes will be measured over time and across cities and various locations within cities.
●
NHB RESIDEX was published till March 2015 on a quarterly basis. Therea er revamped NHB RESIDEX with a
larger scope and wider geographical coverage was published.
●
NHB RESIDEX is computed taking base year = 2012-13.
●
The NHB Residex currently offers two sets of quarterly Housing Price Indices (HPIs).
●
The HPI represents the price changes in residential housing properties. At present, the geographical coverage
consists of 50 cities in India including 18 State/UT capitals and 37 smart cities, which will progressively be
expanded to over 100 cities including all State/UT capitals and smart cities.
●
Like HPI, NHB RESIDEX will also track the movement in housing rental prices over a period of time using
market data through Housing Rental Index(HRI).
10.3. Housing Price Index of RBI
●
Reserve Bank compiles the quarterly house price index (HPI) (base: 2010-11=100) for ten major cities i.e
Mumbai, Delhi, Chennai, Kolkata, Bengaluru, Lucknow, Ahmedabad, Jaipur, Kanpur and Kochi.
●
HPI is based on transactions data received from housing registration authorities in ten major cities.
●
RBI started compiling HPI in 2007 for Mumbai.
10.4.Service Price Index
●
Service Price Index would capture the movement of prices in various services like insurance, banking,
transport, communication.
●
Service Price Index was recommended by Abhijit Sen Committee.
●
The tertiary sector contributes about 60 per cent in the country’s gross domestic product (GDP), the need for
this index is important because of the growing dominance of the tertiary sector.
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19
11. Effects of Inflation
On Creditor
Effect
Reason
Loss
The interest rate charged by the bank is nominal interest rate(NIR), which is
not same as the Real interest rate(RIR) paid by the borrower.
RIR = NIR - Inflation
ON Debtor
Profit
Real interest rate is always lower than the Nominal interest rate if inflation is
taking place.
On Demand
Increases
Since money supply increases it increases the demand for commodity
On Investment
Increases
Inflation in the short-run boost investment since it indicates higher
demand, industries increase production to match demand.
On Saving
Reduces
Inflation reflects a reduction in the purchasing power per unit of money i.e
each unit of currency buys fewer goods and services.
That is why people try to keep the least money with themselves and hold
maximum in the bank.
On Indirect Tax
Increases
As indirect tax is imposed on the value of products, with an increase in price
of the product, people pay more. Hence indirect tax increases.
On Direct Tax
Increases
Due to Inflation, tax-payer income increases, due to which, tax-payer is
moved in a higher income tax slab. Hence direct tax burden increases.
On Exchange
Rate
Depreciate
Due to inflation currency of the economy loses its values.
For example - $1 = Rs50 a er inflation $1 = Rs 60
On Export
Increases
Export will increase in volume but will decrease in value.
On Import
Decrease
Because of the increase in the costs of imported products, hence the
volume of import decreases.
On Employment
Increases
Inflation increases employment in the short run. But in long term, as costs
rise it may substitute labour with other factors, such as new technology.
On Salary
Increases
Inflation increases the nominal value of the wages while their real wages(
adjusted for inflation) falls.
On Economy
© Coursavy
If inflation is in the specified range than it is healthy for the economy, otherwise not good.
20
12. Other variants of inflation
12.1 Structural Inflation/Bottleneck Inflation
●
Structural inflation is inflation that results from changes in the structure of demand and supply.
●
This inflation takes place when the supply falls drastically and the demand remains at the same level. Such
situations arise due to supply-side hurdles, hazards or mismanagement.
●
For example - Recent prices of onion prices rise in recent days because of unseasonal rains, affecting supply
whereas demand remained the same.
12.2. Headline Inflation
●
Headline Inflation reflects the rate of change in prices of all goods and services in an economy over a period of
time.
●
It includes price rise in food, fuel and all other commodities.
●
In India, headline inflation is measured through the CPI as it reflects the prices of essential consumption
goods.
●
The headline CPI inflation in India tends to increase whenever there is a surge in food and fuel prices.
12.3. Core Inflation
●
Core Inflation is also known as underlying inflation, is a measure of inflation which excludes items that face
volatile price movement, notably food and energy.
●
In other words, Core Inflation is nothing but Headline Inflation minus inflation that is contributed by food and
energy commodities.
●
To understand the concept in a better way we can say that food and fuel prices may go up in the short run due
to some disturbance in the agriculture sector or oil economy. However, over the long term they tend to revert
back to their normal trend growth. On the other hand, prices of other commodities do not fluctuate as
regularly as food and fuel – as such an increase in their prices could be taken relatively to be much more of a
permanent nature.
●
Reserve Bank of India (RBI) and Central Banks around the World always keep an eye on the core inflation.
Whenever core inflation rises, Central Banks increase their key policy rates to suck excess liquidity from the
market and vice versa. It is, therefore, a preferred tool for framing long-term policy.
© Coursavy
21
12.4. Open Inflation
●
It is the situation in which price level increases without any price suppressive measure by the government.
●
Government does not suppress inflation with subsidies and monetary policy.
12.5. Suppressed/Repressed Inflation
●
The situation in
which aggregate demand is greater than aggregate supply in the economy but the
government prevents price level from rising through direct price control measures like ceiling price etc.
●
Repressed inflation refers to the state of a set of markets or an economy in which there is persistent excess
demand for goods and services.
●
Governments in India are not effective in suppressing inflation because the supply chain is highly unorganised.
13. Terms
13.1. Reflation
●
Reflation is a situation in which price level increases along with an increase in output, employment etc when
an economy moves from recession/depression.
●
Reflation refers to the combination of monetary and fiscal policy initiatives aimed to combat lower economic
growth and is usually done by increasing the money supply, lowering interest rates and tax rate cuts.
13.2. Stagflation
●
Stagflation is defined as a combination of economic phenomenon where there is high inflation along with
rising unemployment and relatively slow economic growth or recession.
●
It is caused due to cost-push inflation.
●
Stagflation is a combination of high inflation and low growth.
●
In the 1970s there was an oil shock and there was stagflation in the world.
13.3. Skewflation
●
Skewflation refers to price rise of one or a small group of commodities over a sustained period of time.
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●
In India, food prices rose steadily during the last months of 2009 and the early months of 2010, even though
the prices of non-food items continued to be relatively stable. As this somewhat unusual phenomenon
Skewflation appeared in the Economic Survey 2009-10, Government of India, Ministry of Finance.
13.4. Misery Index
●
Misery Index is the summation of the inflation rate and unemployment rate.
13.5. Inflationary Gap
●
The situation in which aggregate demand is more than the productive capacity of the economy.
Aggregate Demand >Aggregate SupplyFull employment
●
Inflation Gap leads to excess demand which leads to inflation.
13.6. Defationary Gap
●
The situation in which aggregate demand is less than the productive capacity of the economy.
Aggregate Demand <Aggregate SupplyFull employment
●
Deflation Gap leads to deflation and recession.
13.7. Agriflation
●
Increase in the price of agricultural products.
13.8. Disinflation
●
Reduction in the rate of inflation. It is a situation where price level reduces without any adverse impact on
output, national income, employment etc.
13.9. Deflation
●
A persistent decrease in price level i.e negative inflation. It is the situation in which price level reduces
along with the reduction in the output
●
It leads to recession (which is never desirable), employment etc.
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●
Central banks aim to keep the overall price level stable by avoiding situations of severe deflation/inflation.
They may infuse a higher money supply into the economy to counterbalance the deflationary impact.
●
Deflation is different from disinflation as the disinflation implies a decrease in the level of inflation
whereas on the other hand deflation implies negative inflation.
13.10. Phillips Curve
●
It is a graphic curve which advocates the relationship between inflation and unemployment in an economy.
●
Phillips Curve states that there is an inverse
relationship between inflation and unemployment.
●
That is when inflation is high, unemployment is
less in shorter terms and higher the inflation lower
the unemployment.
●
However, the implications of Phillips curve have
been found to be true only in the short term. Phillips
curve fails to justify the situations of stagflation
when
both inflation and unemployment are
alarmingly high
●
This concept was given by A.W. Philips.
13.11. GDP Deflator
●
GDP deflator measures the impact of inflation on the gross domestic product(GDP) i.e how much a change
in GDP relies on changes in the price level.
●
It is calculated by dividing nominal GDP by real GDP and then multiplying by 100.
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24
GDP Deflator
WPI
GDP deflator reflects the prices of all domestically
WPI is based on a limited basket of goods and
produced goods and services in the economy
services, thereby not representing the entire
economy
GDP deflator also includes the prices of investment
WPI (at present) has no representation of the
goods, government services and exports, and
services sector
excludes the price of imports
14. Base Effect
●
The base effect refers to the impact of the rise in the price level (i.e. last year’s inflation) in the previous year
over the corresponding rise in price levels in the current year (i.e., current inflation).
●
If the inflation rate was too low in the corresponding period of the previous year, even a relatively smaller rise
in the Price Index will arithmetically give a high rate of current inflation.
●
For example :
Price Index
April
●
Inflation
2007
2008
2009
2010
2008
2009
2010
100
120
140
160
(120-100) *100= 20%
100
(140-120)= 16.67%
120
14.29
The index has increased by 20 points in all the three years – 2008, 2009, 2010. However, the inflation rate
(calculated on a year-on-year basis) tends to decline over the three years from 20% in 2008 to 14.29% in 2010.
This is because the absolute increase of 20 points in the price index in each year increases the base year price
index by an equivalent amount, while the absolute increase in price index remains the same.
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15. Inflation Indexed Bond(IIB)
●
Inflation-Indexed Bond (IIB) is a bond issued by the RBI, which provides the investor a constant return
irrespective of the level of inflation in the economy.
●
The main objective of Inflation-Indexed Bonds is to provide a hedge and to safeguard the investor against
macroeconomic risks in an economy.
●
In the Indian context, inflation was one of the major macroeconomic concerns of the economy during the
period 2008-2013 where real interest rates were consistently negative.
●
This leads to huge investment in the alternate instrument – gold – by the households, necessitating heavy
import of gold. In order to reduce the attractiveness of gold for investment and reduce the CAD, the
Government of India launched Inflation-indexed bonds (IIB) in 2013.
●
The Reserve Bank of India auctioned its first tranche, linking to Wholesale Price Index (WPI) inflation, as WPI
headline inflation was then used as the key measure of inflation by RBI.
●
Over time, IIB bonds lost its attractiveness, as there has been significant moderation in inflation since 2014-15
●
Since April 2014, RBI adopted Consumer Price Index (CPI combined) as the key measure of inflation for its
monetary policy stance.
●
In case RBI issues new IIB bonds in the near future, it would be based on CPI, as CPI (combined) has been
accepted by RBI as the key measure of inflation for its monetary policy stance, since 2014.
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16. UPSC CSE PRELIMS Previous Years Questions
●
Now, let's check how many questions can you attempt?
Q.1) India has experienced persistent and high food inflation in the recent past. What could be the reason? 2011
1. Due to a gradual switchover to the cultivation of commercial crops, the area under cultivation of food grains
has steadily decreased in the last five years by about 30%.
2. As a consequence of increasing incomes, the consumption patterns of the people have undergone a significant
change.
3. The food supply chain has structural constraints.
Which of the statements given above are correct?
[A] 1 and 2 only
[B] 2 and 3 only
[C] 1 and 3 only
[D] 1, 2 and 3
Ans.1) Correct Option: (b)
Explanation:
●
According to the statement of RBI: Notwithstanding some moderation, food price inflation has remained
persistently elevated for over a year now, reflecting in part the structural demand-supply mismatches in
several commodities.
●
The trend of food inflation was pointing at not only structural demand-supply mismatches in commodities
comprises the essential consumption basket but also at changing consumption patterns.
Q.2) A rapid increase in the rate of inflation is sometimes attributed to the “base effect”. What is “base effect”?
[A] It is the impact of drastic deficiency in supply due to the failure of crops
[B] It is the impact of the surge in demand due to rapid economic growth
[C] It is the impact of the price levels of the previous year on the calculation of inflation rate
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[D] None of the statements
2011
Ans.2) Correct Option: (c)
Explanation:
●
The base effect refers to the impact of the rise in the price level (i.e. last year’s inflation) in the previous year
over the corresponding rise in price levels in the current year (i.e., current inflation).
Q.3) A rise in the general level of prices may be caused by:
2013
1. an increase in the money supply
2. a decrease in the aggregate level of output
3. an increase in the effective demand
Select the correct answer using the codes given below.
[A] 1 only
[B] 1 and 2 only
[C] 2 and 3 only
[D] 1, 2 and 3
Ans.3) Correct Option: (d)
Explanation:
●
All the statements are correct.
Q.4) Which reference to inflation in India, which of the following statements is correct?
2015
[A] Controlling the inflation in India is the responsibility of the Government of India only
[B] The Reserve Bank of India has no role in controlling the inflation
[C] Decreased money circulation helps in controlling the inflation
[D] Increased money circulation helps in controlling the inflation
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Ans.4)Correct Option: (c)
Explanation:
●
RBI plays a key/primary role in controlling inflation through its monetary policy.
●
So option (a) and (b) are out.
●
Now increased money supply shall only add fuel to the fire and send inflation skyrocketing.
●
So the answer should be the option (c).
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1. Financial Market
4
2. Functions of Financial Market
4
3. Types of Financial Market
4
3.1. Money Market vs Capital Market
5
3.2. Money Market Instruments
6
3.2.1. Commercial Paper
6
3.2.2. Commercial Bill
7
3.2.3. Certificate of Deposit
7
3.2.4. Call Money Market
7
3.2.5. Government Security (G-Sec)
8
3.2.5.1.Treasury Bills (T-bills)
8
3.2.5.2.Cash Management Bills (CMBs)
8
3.2.6. Repo (Ready Forward Contract)
8
3.2.7. Discount and Finance House of India(DFHI)
9
3.2.8. LIBOR( London Interbank Offered Rate)
9
3.2.9. MIBOR and MIBID
9
3.2.10. Hundi
9
4. Capital Market
10
4.1. Means of raising fund in the primary market
11
4.1.1. Initial Public Offer(IPO)
11
4.1.2. Follow on Public Offer(FPO)
11
4.1.3. Right Issue
11
4.1.4. Referential Issue
11
4.1.5. Bonus Issue
11
4.1.6. Private Placement
11
4.1.7. Sweat Equity
12
5. Means of Raising Funds in Secondary Market
12
5.1. Stock Exchange
12
5.2. Over the counter Exchange(OTC)
12
6. Stock Exchanges in India
13
6.1. Bombay Stock Exchange (BSE)
13
6.2. National Stock Exchange (NSE)
13
7. Stock Exchange and Indices
14
8. Important Terms of Stock Exchange
14
8.1. Bear and Bull
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14
1
8.2. Speculation
14
8.3. Arbitrage
15
8.4. Stag
15
8.5. Buyback of Share
15
8.6.Short Selling
15
8.7. Insider Trading
15
8.8. Algorithm Trading
15
9.Stock Exchange Regulator
16
9.1. SEBI (Security Exchange Board of India)
16
10. Capital Market Reforms
16
10.1. Circuit Breakers
16
10.2. Dematerialization/Demat Trading
16
10.3. Depository Participants(DP)
17
10.5. Corporatization
17
10.6.Demutualization
17
10.7.Investor Protection and Education Fund(IPEF)
18
10.8. Introduction of Forward/Derivative Trading
18
10.9. Financial Stability and Development Council(FSDC)
18
11. Derivative Trading
19
11.1 Derivative
19
11.2. Forward Market
19
11.3. Forward
19
11.4. Future
20
11.5. Difference of Forward vs Future
20
11.6. Options
20
11.7. Swaps
21
12. Commodity Exchange in India
21
13. Spot Market
21
13.1. Spot Exchanges in India
21
14. Depository Receipt
22
15. Participatory Note(PN, P-note)
23
15.1. Concerns are raised related to Participatory Notes?
24
16. Credit Default Swap(CDS)
24
17. Financial Sector Legislative Reforms Commission
24
18.Public Debt Management Agency (PDMA)
26
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19. RBI Autonomy
19.2. Argument against RBI autonomy
27
27
20. Venture Capital
27
21. Angel funds
28
22. External Commercial Borrowing (ECB)
28
23. Terms
29
23.1. Mutual Fund
29
23.2. Exchange-Traded Fund(ETF)
29
23.3. Greenshoe Option
29
23.4. Employee Stock Ownership Plan (ESOP)
30
23.5. Debenture
30
24. UPSC CSE PRELIMS Previous Years Questions
31
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1. Financial Market
●
Financial Market refers to the system consisting of the financial institute(banks etc), instruments(bonds and
shares), organization (stock exchange ) and regulatory bodies(RBI, SEBI etc) which facilitates the flow of equity
and debt capital.
●
The financial market provides a platform to the buyers and sellers for trading assets at a price determined by
the demand and supply forces.
2. Functions of Financial Market
●
It facilitates mobilization of savings, where an investor can invest their saving according to risk and choice
assessment.
●
It helps in determining the price of financial commodities on the basis of demand and supply.
●
It provides liquidity to the financial commodities i.e investors can sell their financial commodities and convert
them to cash in a very short period.
●
It saves the time, money and efforts of investors. The financial market provides a platform where both the
buyers and sellers can find each other easily.
3. Types of Financial Market
●
There are two types of Financial Markets
❏ Money Market
Money Market is the market which fulfils the requirements of funds for the period ranging from
overnight to one year.
❏
Capital Market
Capital Market is the market which fulfils the requirements of funds for the period above one year.
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3.1. Money Market vs Capital Market
Money Market
Capital Market
It deals with short term financial transactions
It deals with medium and long term financial
transactions
It is the source of working capital finance for firms
It finances capital equipment to firms i.e it promotes
capital formation
It deals with bonds. Example- commercial papers,
commercial bills, certificate of deposit, treasury bill etc
It deals with both bonds and equities.
Usually, it deals with high volume transaction
It deals with both low and high volume transaction
In India, the participation of the general public is limited
People participation is significant
Participation is confined to banks
All types of Financial Instrument participate actively
RBI is the prime regulator
SEBI is the prime regulator
It consists of both organised and unorganised sector
It is mainly confined to organised sector
3.2. Money Market Instruments
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5
3.2.1. Commercial Paper
●
Commercial Paper (CP) is a short-term unsecured money market instrument issued in the form of a
promissory note(legal instrument)
●
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.
●
Commercial Paper can be issued by
❏ Corporates (tangible net worth is not less than Rs. 4 crores)
❏ Primary Dealers (PDs) and the
❏ All-India Financial Institutions (FIs)
●
CP can be issued for maturities between a minimum of 7 days and a maximum of up to one year from the
date of issue.
●
CP can be issued in denominations of Rs.5 lakh or multiples thereof.
3.2.2. Commercial Bill
●
It is unsecured security issued by one merchant firm to another against a credit transaction.
●
These are issued at a discount (investors pay a price lower than the face value).
●
Its maturity ranges between 14 days to 1 year.
●
It's a source of working capital finance for small corporations.
●
For example: Suppose there are two firms A and B. Firm B needs to buy raw material from A worth Rs 1 Lakh.
But firm B does not have the money to buy raw material. So firm B will issue a commercial bill to Firm A as per
the guideline of RBI. Firm A will give the raw material of less than Rs 1 Lakh. Firm B is liable to pay Firm A.
3.2.3. Certificate of Deposit
●
It is the bond/security issued by a bank to the depositor of the fund.
●
Certificate of deposit is an agreement to deposit money for a fixed period with a bank that will pay interest.
●
These are issued in multiples of Rs 1 lakh subject to a minimum value of Rs 25 lakh.
●
These are issued at a discount.
●
These are similar to fixed deposits but are negotiable and tradable in the money market.
●
CDs can be issued by
❏ Scheduled commercial banks {excluding Regional Rural Banks and Local Area Banks}
❏ Select All-India Financial Institutions (FIs) that have been permitted by RBI
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●
Certificates of Deposits can also be issued to Non-Resident Indians(NRI).
3.2.4. Call Money Market
●
It deals with day to day lending and borrowing transactions of banks amongst themselves.
●
It deals in very short loans that have maturity ranging between 1 - 14 days.
●
Its objective is to provide liquidity to banks.
●
The interest rate charged on such transactions is called ‘call money rate’ which is based on market demand.
●
It is a very competitive market that reflects the liquidity position of banks.
●
Banks
Average Daily Withdrawal
Cash Available
ICICI
50 Lakh
1 Crore
SBI
1 Crore
2 Crore
For Example - If a person comes and withdraws 90 Lakh from ICICI, it cannot give withdrawal to other
customers on that day. So ICICI will borrow some huge amounts from SBI and may return in 2- 3 days (should
not take more than 14 days). The interest may vary from bank to bank.
3.2.5. Government Security (G-Sec)
●
Government Security (G-Sec) is a tradable instrument issued by the Central Government or the State
Governments.
●
It acknowledges the Government’s debt obligation.
●
Such securities are short term (usually called treasury bills, with original maturities of less than one year) or
long term (usually called Government bonds or dated securities with an original maturity of one year or
more).
●
G-Secs carry practically no risk of default and, hence, are called risk-free gilt-edged instruments.
●
Short term government securities are :
3.2.5.1.Treasury Bills (T-bills)
●
Treasury bills or T-bills are short term debt instruments issued by the Government of India and are
presently issued in three tenors, namely, 91 days, 182 days and 364 days.
●
Treasury bills are zero-coupon securities and pay no interest. Instead, they are issued at a discount
and redeemed at the face value at maturity.
© Coursavy
7
●
For example, a 91 day Treasury bill of ₹100/- (face value) may be issued at say ₹ 98.20, that is, at a
discount of say, ₹1.80 and would be redeemed at the face value of ₹100/-.
3.2.5.2.Cash Management Bills (CMBs)
●
In 2010, the Government of India, in consultation with the RBI introduced a new short-term
instrument, known as Cash Management Bills (CMBs), to meet the temporary mismatches in the
cash flow of the Government of India.
●
The CMBs have the generic character of T-bills but are issued for maturities less than 91 days.
3.2.6. Repo (Ready Forward Contract)
●
Repo allows the bank and other financial institutions to borrow money from the RBI for the short term.
●
The rate at which the RBI lends money to commercial banks is called the Repo rate.
3.2.7. Discount and Finance House of India(DFHI)
●
DFHI was set up by RBI in 1998 to strengthen the money market and provide liquidity to money market
instruments.
●
It was set up based on the recommendation of the Vaghul committee.
●
The main objective of DFHI is to develop an active secondary market for the money market instruments.
●
DFHI participates in transactions in all the market segments like treasury bills, call money market etc.
●
In 2004, RBI transferred its total holding to SBI Giltz Limited. Its new name is SBI DFHI.
3.2.8. LIBOR( London Interbank Offered Rate)
●
The London Interbank Offered Rate (LIBOR) is an interest rate at which major global banks lend to one another
in the international interbank market for short-term loans.
●
LIBOR is administered by the Intercontinental Exchange or ICE.
●
It is computed for five currencies Swiss franc, euro, pound sterling, Japanese yen and US dollar.
3.2.9. MIBOR and MIBID
●
Mumbai Interbank Offer Rate (MIBOR) and Mumbai Interbank Bid Rate (MIBID) are the benchmark rates at
which Indian banks lend and borrow money to each other.
●
These rates reflect the short term funding costs of major banks.
© Coursavy
8
●
MIBID is the rate at which banks would like to borrow from other banks and MIBOR is the rate at which banks
are willing to lend to other banks.
3.2.10. Hundi
●
Hundi is an unconditional order in writing made by a person directing another to pay a certain sum of money
to a person named in the order.
●
Hundis, being a part of the informal system have no legal status and are not covered under the Negotiable
Instruments Act, 1881.
4. Capital Market
●
Capital Market refers to the market where long term capital is raised via both debt and equity instruments
such as equity share, preference share, debenture, etc.
●
The demand for long term capital comes from both the government and the private sector.
●
Every Capital Market has two complementary market
❏ Primary Market ❖ Deals with the issuance and sale of the instrument of capital market to investors directly
by the issuer
❖ When a company issues stock or bonds for the first time and sells those securities directly to
investors, that transaction occurs on the primary market
❏
Secondary Market ❖ The market where instruments of the capital market are being traded among the primary
instrument holders.
❖ Any transactions on the secondary market occur between investors, and the proceeds of each
sale go to the selling investor, not to the company that issued the stock.
❖ Such transactions need a platform for their trading, stock exchange provides the platform for
the secondary market.
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4.1. Means of raising fund in the primary market
●
Companies raise capital in the primary market in the following ways:
4.1.1. Initial Public Offer(IPO)
●
Initial Public Offer refers to the process of offering its new securities to the public/investor for the
first time through the issue of prospectus.
●
It is issued only by the unlisted company.
4.1.2. Follow on Public Offer(FPO)
●
Follow on Public Offer(FPO) refers to the process where already listed company offers its securities
to the public/investor to an offer for sale.
●
A follow-on offering is the issuance of additional shares made by a company a er an initial public
offering (IPO).
4.1.3. Right Issue
●
A listed company offers its new securities only to the existing shareholders in proportion to their
existing shareholding.
●
In the Right Issue, shares are issued at a discount.
4.1.4. Referential Issue
●
Under this, a listed company offers its new securities only to a selected class of shareholders.
4.1.5. Bonus Issue
●
Bonus shares are additional shares given to the existing shareholders without any additional cost,
in the proportion of their shareholding in lieu of distribution of dividend.
4.1.6. Private Placement
© Coursavy
●
Raising capital by selling the share to a select group of investors, or individual.
●
The advantage of the private placement is saving in marketing expenses.
●
Under this number of investors who are issued shares cannot be more than 50.
10
4.1.7. Sweat Equity
●
Under this, the share is allotted to top management like directors of a company at a highly
discounted price in recognition of their outstanding contribution.
5. Means of Raising Funds in Secondary Market
●
Companies raise capital in the secondary market in the following ways:
5.1. Stock Exchange
●
A physical institutional set-up where capital market instruments(shares, debenture, etc) are traded.
●
It performs the following major functions:
❏
Efficient price discovery: A stock exchange determines the process of price discovery via
constant valuation of all the securities.
❏
Liquidity: Stock Market ensures high liquidity. The securities can be sold at a short notice and
be converted to cash.
❏
Investor Protection: The government regulates stock exchanges. This provides the investor
with assurances to transact in securities.
5.2. Over the counter Exchange(OTC)
●
Over the Counter Exchange refers to the process of how securities are traded by companies that are
not listed on a formal exchange like BSE etc.
●
Securities that are traded over-the-counter are traded via a broker-dealer network as opposed to on a
centralized exchange.
●
These securities do not meet the requirements to have a listing on a standard market exchange
●
Example of OTC - Over the Counter Exchange of India Limited established in 1999. It facilitates trade-in
companies having paid-up capital of Rs 30 Lakh or more.
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11
6. Stock Exchanges in India
●
Major stock exchange in India are:
6.1. Bombay Stock Exchange (BSE)
●
Bombay Stock Exchange was established in 1875 and is the oldest stock exchange in Asia.
●
On August 31, 1957, the BSE became the first stock exchange to be recognized by the Indian Government
under the Securities Contracts Regulation Act.
●
Around 5500 companies are listed on BSE, the largest number of companies listed in the world(but not the
largest stock exchange in the world).
●
It introduced BOLT (BSE online trading system) in 1995 to promote transparency and eliminate any errors.
●
Presently there are four Indices connected with BSE:
❏ Sensex - Sensex is the stock market index of 30 well established and financially sound companies
listed in Bombay Stock Exchange.
❏
❏
❏
BSE 100 - An index of 100 stocks.
BSE 500 - This index represents major industries and many sub-sector of the economy.
BSE 200 - This is the 200 stock share index of the BSE.
6.2. National Stock Exchange (NSE)
●
NSE was established in 1992 and started trading in 1994.
●
NSE was established on the basis on the recommendation of “Phirwani Committee” as the most modern
stock exchange of the country.
●
NSE is ranked as the largest stock exchange in India in terms of total and average daily turnover for equity
shares.
●
Presently there are two Indices connected with NSE:
❏
❏
© Coursavy
S&P CNX 50 (Ni y Fi y)
S&P CNX 500
12
7. Stock Exchange and Indices
Stock Exchange
Indices
New York Stock Exchange
Dow Jones
NASDAQ
NASDAQ Index
National Stock Exchange(NSE)
NIFTY
Korean Stock Exchange
Kospi
Shanghai Stock Exchange
Composite Index
Bombay Stock Exchange(BSE)
Sensex
London Stock Exchange
FTSE-100
Hongkong Stock Exchange
Hang Seng Index
Singapore Stock Exchange
Straits Times Index
Tokyo Stock Exchange
Nikkei
8. Important Terms of Stock Exchange
8.1. Bear and Bull
●
Bull market refers to a market that is on the rise. It is a sustained increase in market share prices. In such
times, investors o en have faith that the uptrend will continue over the long term
●
Bear market refers to a market that is on the decline. Share prices are continuously dropping, resulting in a
downward trend.
8.2. Speculation
●
Speculation refers to buying a commodity/currency/security with the intention of selling it in the near future
at a higher price to make a profit.
© Coursavy
13
●
Here the sole intention is just to sell when the price goes up and not to purchase.
●
Moderate speculation is good as it checks prices from going up.
8.3. Arbitrage
●
It refers to buying a commodity/security from a cheaper market and selling it immediately in another market
at a higher price.
●
It is a trade that profits by exploiting the price differences of identical or similar financial instruments on
different markets or in different forms.
●
Arbitrage exists as a result of market inefficiencies and would therefore not exist if all markets were perfectly
efficient.
8.4. Stag
●
It refers to a speculator who purchases security from the primary market like IPO for selling them in the
secondary market.
8.5. Buyback of Share
●
Under Buyback, a company purchases its own shares from the investor.
●
It reduces the number of outstanding shares of the company.
●
It increases the dividend per share.
8.6.Short Selling
●
Under this, an investor sells security which is not possessed by him/her but such an investor has to purchase
that security within a specified period time.
●
Short sellers gain with fall in the price of a security.
8.7. Insider Trading
●
It refers to buying or selling shares of a company on the basis of unpublished price sensitive information.
●
It is a criminal offense.
8.8. Algorithm Trading
●
Under this, securities are traded on the basis of inference from advanced mathematical models.
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●
Algorithmic trading makes use of complex formulas, combined with mathematical models and human
oversight, to make decisions to buy or sell financial securities on an exchange.
●
Algorithmic trading can be used in a wide variety of situations including order execution, arbitrage etc.
9.Stock Exchange Regulator
9.1. SEBI (Security Exchange Board of India)
●
SEBI was established in 1988 as a non-statutory body to deal with all the matters relating to regulation and
development of the capital market.
●
It was granted statutory status under the SEBI Act 1992 on the recommendation of the Narasimham
Committee.
●
Functions of SEBI are:
❏ Regulation of Capital Market(both in the primary and secondary markets).
❏ To register and regulate intermediaries in the capital market like brokers, sub-brokers, trustees,
underwriters, mutual funds.
❏ To check malpractice in the securities market particularly in the Stock Exchange.
❏ To promote investor education and awareness.
❏ To protect the interest of the investor.
10. Capital Market Reforms
●
The stock exchange scam of 1992(Harshad Mehta) and Ketan Parekh scam in 2000 led to various measures to
protect the interest of the investor.
10.1. Circuit Breakers
●
It is a mechanism under which trading in a stock exchange is halted for a specified period of time, in
case of deviation in the index of Stock Exchange( or share price) beyond a certain limit.
10.2. Dematerialization/Demat Trading
●
Under this computer record of a Stock Exchange are maintained instead of issuing shares/security
certificate in the physical form.
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●
At present two public sector depositories are functioning in India:
❏
❏
NSDL(National Securities Depositories Limited)
CDSL(Central Depositories Services Limited)
10.3. Depository Participants(DP)
●
These are agents of depositories that provide demand service/online security trading services to the
investors.
●
Example: India Infoline, ICICI Direct, Axis Direct etc.
10.4. Rolling Settlement
●
Badla System: Under this, a spot market transaction in a stock exchange could be postponed by the
buyers. It leads to over speculation and defaults in the stock exchange transaction. So it was replaced
by rolling settlement.
●
Under Rolling Settlement, a spot market transaction in the stock market must be completed within a
specified period i.e settlement period cannot be shi ed.
●
It is on the basis of the T+2 system ( T= transaction day T+2= transaction day + 2 working day).
10.5. Corporatization
●
Historically, the stock exchange was formed as a mutual organization i.e formed by trading members
themselves for their common benefits.
●
They mainly focus on the interest of members instead of investors. The Government of India
introduced corporatization of stock exchange, by which ownership, management and trading
membership of stock exchange would be separated from each other.
●
Objective of corporatisation of stock exchange:
❏ To reduce the scope of manipulation by brokers.
❏ To enable the stock exchange to raise funds from the public through IPO
modernization.
10.6.Demutualization
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It refers to separation of ownership, Management and brokerage rights in the stock exchange.
●
The 1st stock exchange to be corporatized and demutualized in India was BSE in 2005.
16
❏ Ownership = Shareholder
❏ Management = Directors(Board of Directors)
❏ Brokerage = Open to all
10.7.Investor Protection and Education Fund(IPEF)
●
It was established in 2001 by SEBI and the central government for promoting investor’s awareness and
to protect the interest of investors, especially small investors.
10.8. Introduction of Forward/Derivative Trading
●
To enable investors to hedge (using financial instruments to offset the risk of any adverse price
movements) market risks.
10.9. Financial Stability and Development Council(FSDC)
●
FSDC was established on the recommendation of G-20 in 2010.
●
The mandate of FSDC Council :
❏ To monitor macro-prudential supervision of the economy, including the functioning of
large financial conglomerates.
❏ It will address inter-regulatory coordination issues and thus spur financial sector
development.
❏ It will also focus on financial literacy and financial inclusion.
●
The Chairman of the FSDC is the Finance Minister of India.
●
Members include the
❏ Heads of the financial sector regulatory authorities (i.e, SEBI, IRDA, RBI, PFRDA and FMC)
❏ Finance Secretary
❏ Secretary, Department of Economic Affairs (Ministry of Finance)
❏ Secretary, (Department of Financial Services, Ministry of Finance)
❏ Chief Economic Adviser
●
A sub-committee of FSDC has also been set up under the chairmanship of Governor RBI.
●
Sub-Committee discusses and decides on a range of issues relating to financial sector development
and stability including substantive issues relating to inter-regulatory coordination.
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11. Derivative Trading
●
Derivative Trading refers to contracts/transactions of a forward contract.
11.1 Derivative
●
A derivative is a financial instrument whose value is derived from the value of one or more underlying,
which can be commodities, precious metals, currency, bonds, stocks, stocks indices, etc.
●
Four most common examples of derivative instruments are Forwards, Futures, Options, and Swaps.
11.2. Forward Market
●
In this market, contracts are made to buy/sell a financial instrument at a predetermined price and date(i.e
in future).
11.3. Forward
●
A forward is a mutual/bilateral contract between two parties, where settlement takes place on a specific date
in the future at a price agreed today.
●
The main features of forward contracts are :
❏ They are bilateral contracts and hence exposed to counterparty risk.
❏ Each contract is custom designed and hence is unique in terms of contract size, expiration date, and
the asset type and quality.
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❏ The contract has to be settled by delivery of the asset on the expiration date.
●
Benefits of forward are :
❏ It tends to stabilize the prevailing spot market prices, as it provides future reference price.
❏ It enables farmers, producers, exporters to hedge marketing risk.
11.4. Future
●
Futures are exchange-traded contracts to sell or buy financial instruments or physical commodities for future
delivery at an agreed price.
●
There is an agreement to buy or sell a specified quantity of financial instrument commodity in a designated
future month at a price agreed upon by the buyer and seller.
11.5. Difference of Forward vs Future
Basis
Futures
Forward
Nature
Traded on an organized exchange
Over the Counter
Contract Terms
Standardized
Customized
Liquidity
More liquid
Less liquid
Settlement
Follows daily settlement
At the end of the period.
Margin Payments
Requires margin payments
Not required
11.6. Options
●
These are standardized exchange-traded contracts that provide options/rights(not the obligation) to an
investor to buy and sell a commodity at a predetermined date and rate in the future against the payment of
options premium.
●
They are two types of options:
❏ Call option - Option to buy
❏ Put Option - Option to sell
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11.7. Swaps
●
These are contracts bilateral/exchange trade to exchange a commodity/security with another at a
predetermined date and rate.
●
The instruments can be almost anything but most swaps involve cash based on a notional principal amount.
●
Swaps are primarily over-the-counter contracts between companies or financial institutions.
12. Commodity Exchange in India
●
Commodity Exchange provides a platform for trading in commodities.
●
It determines and enforces rules and procedures for trading standardized commodity contracts and related
investment products.
●
Commodity Exchange was first regulated by Forward Market Commission(FMC) but with the merger of FMC
with SEBI in 2015 it is now regulated by SEBI.
●
Commodity Exchange in India are as follow:
❏ MCX(Multi Commodity Exchange) - Largest Exchange in India
❏ NCDEX(National Commodities and Derivative Exchange)
❏ NMCE(National Multi-Commodity Exchange)
❏ ICE (Indian Commodity Exchange Limited)
❏ UCX(Universal Commodity Exchange)
❏ ACE Derivatives & Commodity Exchange Ltd. (ACE)
13. Spot Market
●
In this market, trading is done at the prevailing price and transactions are done on the spot.
13.1. Spot Exchanges in India
●
Spot Exchanges refer to electronic trading platforms which facilitate purchase and sale of specified
commodities, including agricultural commodities, metals, and bullion by providing spot delivery
contracts(provides for the delivery of goods and the payment of the price) in these commodities.
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●
There are four-spot exchanges currently operating in the country. These exchanges are:
❏ National Spot Exchange Ltd (NSEL) - Largest spot exchange in India
❏ NCDEX Spot Exchange Limited
❏ Reliance Spot Exchange Limited
❏ Indian Bullion Spot Exchange Limited
●
Advantage of Spot Exchange:
❏ Creates a National Market
❏ Shows overall demand-supply of commodity
❏ Eliminate Middle Man
14. Depository Receipt
●
A Depository Receipt (DR) is a financial instrument representing certain securities (eg. shares, bonds, etc.)
issued by a company/entity in a foreign jurisdiction.
●
DR constitutes an important mechanism through which issuers can raise funds outside their home
jurisdiction.
●
DR is issued for tapping foreign investors who otherwise may not be able to participate directly in the
domestic market.
●
Securities of a firm are deposited with a domestic custodian in the firm’s domestic jurisdiction, and a
corresponding “depository receipt” is issued abroad, which can be purchased by foreign investors.
●
For investors, depository receipt is a way of diversifying the risk, by getting exposure to a foreign market, but
without the exchange rate risk as they are foreign currency denominated. Further, they feel safer to invest from
their home location.
●
Depending on the location in which these receipts are issued Depository Receipt (DR) are classified as:
14.1. American Depository Receipts(ADRs)/Global Depository Receipt(GDR)
❏ If Depository Receipts are issued outside India on the basis of the shares/securities of the domestic
(say Indian) company it is ADR.
❏ Thus, ADR or GDR are issued outside India by a foreign depository on the back of Indian security
deposited with a domestic Indian custodian(SEBI) in India.
❏ In India, any company - whether private limited or public limited or listed or unlisted - can issue
DR.
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`
14.2. Indian Depository Receipts(IDR)
❏ If Depository Receipts are issued in India on the basis of the shares/securities of the foreign company.
❏ Standard Chartered issued the first IDR in India.
15. Participatory Note(PN, P-note)
●
Participatory Notes (P-Notes) are instruments used by foreign funds and investors not registered with the
SEBI to invest in Indian securities.
●
The underlying Indian security instrument may be equity, debt, derivatives or may even be an index.
●
PN allows foreign investors to buy stocks listed on Indian exchanges without being registered. The
instrument gained popularity as FIIs, to avoid the formalities of registering and to remain anonymous, started
betting on stocks through this route.
●
PN is also known as Overseas Derivative Instruments, Equity Linked Notes, Capped Return Notes, and
Participating Return Notes, etc.
●
The investor in PN does not own the underlying Indian security, which is held by the FII(Foreign Institutional
Investor)who issues the PN.
●
Thus the investors in PN derive the economic benefits of investing in the security without actually holding it.
They benefit from fluctuations in the price of the underlying security since the value of the PN is linked with
the value of the underlying Indian security.
●
The PN holder also does not enjoy any voting rights in relation to security/shares referenced by the PN.
●
One of the primary reasons for the emergence of an Off-shore Derivative market is the restrictions on foreign
investments like capital account convertibility, entry barrier etc.
●
Advantage of PN are:
❏ Reduces transactions cost
❏ Lower financing costs
❏ Enhance portfolio yields
15.1. Concerns are raised related to Participatory Notes?
●
Being derivative instruments and freely tradable, PNs can be easily transferred, creating multiple layers,
thereby obfuscating the real beneficial owner. It is in this respect that concerns about the identity of the
ultimate beneficial owner and the source of funds arise.
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●
Instruments are issued outside India, these transactions are outside the purview of SEBI surveillance.
●
There are also concerns that some of the money coming into the market via PNs could be the unaccounted
wealth camouflaged under the guise of FII investment. However, this has not been proved so far
●
SEBI has indeed been successful in taking action against FIIs who are non-compliant and those who have
misreported offshore derivatives.
●
From January 2011, FIIs have had to follow KYC norms and submit details of transactions.
●
In 2014, new rules on foreign portfolio investors (FPIs) made it mandatory for those issuing P-Notes to submit
a monthly report disclosing their portfolios.
16. Credit Default Swap(CDS)
●
A credit default swap (CDS) is a financial derivative or contract that allows an investor to offset his or her
credit risk with that of another investor.
●
For example, if a lender is worried that a borrower is going to default on a loan, the lender buys a CDS from
another investor who agrees to reimburse the lender in the case the borrower defaults.
●
The buyer of the CDS makes a series of payments to the seller and, in exchange, may expect to receive
compensation if the asset defaults.
●
From the seller’s perspective, CDS provides a source of easy money if there is no credit event.
●
In 2011, India allowed the introduction of CDS contracts in the Indian financial market, but alongside a strict
set of guidelines created by the Reserve Bank of India.
17. Financial Sector Legislative Reforms Commission
●
Financial Sector Legislative Reforms Commission (FSLRC) was set up by the Indian Government in pursuance
of the announcement made in Union Budget 2010-11, to help to rewrite and to harmonize the financial sector
legislation, rules and regulations so as to address the contemporaneous requirements of the sector.
●
The Commission was chaired by Supreme Court Justice (Retired) B. N. Srikrishna and had ten members
with expertise in the fields of finance, economics, law and other relevant fields.
●
The recommendations of the Commission can broadly be divided into two parts
❏
❏
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Legislative aspects
Non-legislative aspects.
23
●
The legislative aspects of the recommendations relate to revamping the legislative framework of the financial
sector regulatory architecture by a non- sectoral, principle-based approach and by restructuring existing
regulatory agencies and creating new agencies wherever needed.
●
To this effect, the Commission has recommended a seven agency regulatory architecture, namely, Reserve
Bank of India, Unified Financial Agency, Financial Sector Appellate Tribunal, Resolution Corporation, Financial
Redress Agency, Public Debt Management Agency and Financial Stability and Development Council in the
Dra law- Indian Financial Code to replace a number of existing laws.
●
The non-legislative aspects of the FSLRC recommendations are broadly in the nature of governance enhancing
principles for enhanced consumer protection, greater transparency in the functioning of financial sector
regulators.
FSLRC’s regulatory architecture
Present
Proposed
Functions
RBI
RBI
Monetary policy; regulation and
supervision of banks; regulation and
supervision of payments system.
SEBI, FMC, IRDA, PFRDA
United financial agency (UFA)
Regulation and supervision of all
non-bank and payments related
markets.
Securities Appellate Tribunal (SAT)
FSAT
Hear appeals against RBI, the UFA and
FRA.
Deposit Insurance and Credit
Guarantee Corporation (DICGC)
Resolution Corporation
Resolution work across the entire
financial system.
Financial Stability Development
Council (FSDC)
FSDC
Statutory agency for systemic risk and
development.
New entities
Debt Management Agency
An independent debt management
agency.
Financial Redressal Agency (FRA)
Consumer complaints.
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18.Public Debt Management Agency (PDMA)
●
Public Debt Management Agency (PDMA) is a specialized independent agency that manages the internal
and external liabilities of the Central Government in a holistic manner and advises on such matters in
return for a fee.
●
PDMA was proposed to be established in India through the Finance Bill, 2015.
●
However, the creation of PDMA was put on hold due to the difference of opinion on the matter and the
relevant clauses were dropped from the Finance Bill, 2015.
●
Argument in favor of PDMA:
❏ Fragmented jurisdiction in public debt management: RBI manages the market borrowing programs of
Central and State Governments. On the other hand, external debt was managed directly by the Central
Government. Establishing a debt management office would consolidate all debt management
functions in a single agency and bring in holistic management of the internal and external liabilities.
❏ It is considered as an internationally accepted best practice that debt management should be
disaggregated from monetary policy, and taken out of the realm of the central bank. Most advanced
economies have dedicated debt management offices.
❏ It was recommended by various committees like the Percy Mistry committee, Raghurajan
committee and FSLRC.
❏ There is a severe conflict of interest between setting the short term interest rate (i.e. the task of
monetary policy) and selling bonds for the government. If the Central Bank tries to be an effective debt
manager, it would lean towards selling bonds at high prices, i.e. keeping interest rates low. This leads
to an inflationary bias in monetary policy.
●
Argument against PDMA :
❏ The scope of conflict of interest has significantly reduced considerably as FRBM 2003 has prohibited
RBI from participating in the primary auction of the government securities (as it would lead to printing
money).
❏ The RBI has been handling multiple tasks very efficiently. It has ensured transparency in managing
public debt in a cost-effective manner (low cost of raising funds for the government).
❏ The function of debt management lies at the crossroad of fiscal and monetary policies so it requires
some coordinated approach.
❏ Some countries like Denmark and Iceland have reverted the debt management function back to the
central bank.
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19. RBI Autonomy
●
Constitutionally RBI is not autonomous but practically the government has given it significantly
autonomy/conventional autonomy.
●
Aspect of autonomy:
❏ Objective Autonomy
❖ To fix goals inflation/GDP growth.
❖ The government has already given inflation target power to the RBI which is not desirable as
the government is democratically elected and it has the right to fix goals.
❏
Instrument autonomy
❖ Use of instrument of monetary policy. For example - Repo rate etc.
❖ In general, this is the autonomy of the RBI. Due to political factors, the government can not do
this work.
19.1 Argument in favor of RBI autonomy
●
Expertise and professionalism in decision making would reduce political interference.
●
Monetary stability is essential for the efficient functioning of the economic system which can be
achieved if a professional central bank with a long term perspective is given charge.
19.2. Argument against RBI autonomy
●
The RBI lacks political legitimacy.
●
It may lead to political friction between the government and the central bank affecting the
coordination between fiscal and monetary policies.
●
Full autonomy of RBI is not desirable as accountability would be compromised.
20. Venture Capital
●
Venture capital funds are investment funds that manage the money of investors who seek private equity
stakes in startup and small- to medium-sized enterprises with strong growth potential. These
investments are generally characterized as high-risk/high-return opportunities.
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●
Venture capital is a type of equity financing that gives entrepreneurial or other small companies the ability to
raise funding.
●
Venture capital seeks to invest in firms that have high-risk/high-return profiles, based on a company's size,
assets, and stage of product development.
●
The money provided by VCF is termed as Venture Capital.
●
In India, the VCF is regulated by the SEBI.
21. Angel funds
●
Angel funds refer to a money pool created by high net worth individuals or companies (generally called angel
investors), for investing in business start-ups.
●
They are a subcategory of venture capital funds with a strict focus on startups, while venture capital funds
generally invest at a later stage of development of the investee company.
●
Angel funds can raise funds only by way of issue of units to angel investors and should have a corpus of at least
ten crore rupees.
●
In India, the term Angel Funds is defined in SEBI (Alternative Investment Funds) (Amendment) Regulations,
2013.
●
Here, Angel fund is defined as a sub-category of Venture Capital Fund under Category I- Alternative
Investment Fund (AIF) that raises funds from angel investors.
●
Angel funds can make investments only in investee companies that:
i.
are incorporated in India and are not more than 3 years old
ii. have a turnover not exceeding Rs 25 crore
iii. are unlisted
iv. has no family connection with the investors proposing to invest in the company
22. External Commercial Borrowing (ECB)
●
An external commercial borrowing (ECB) is an instrument used in India to facilitate Indian companies to
raise money outside the country in foreign currency.
●
ECB is basically a loan availed by an Indian entity from a non-resident lender.
●
Most of these loans are provided by foreign commercial banks and other institutions.
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●
Indian corporations can raise money via ECB for expansion of existing capacity as well as for fresh
investments.
●
ECB can be availed by either automatic route or by approval route.
❏ Automatic route - If a company passes all the prescribed norms specified by the government, it can
raise money without any prior approval.
❏ Approval route - For specific sectors, the borrowers have to take the permission of the government
before borrowing through ECB.
●
Advantage of ECB are as follow:
❏ ECB provides an opportunity to borrow a large volume of funds for long term.
❏ The cost of funds is usually cheaper if borrowed from economies with a lower rate of interest.
❏ ECB allows the borrower to diversify the investor base.
23. Terms
23.1. Mutual Fund
●
It is a professionally managed trust that collects money from a number of investors to invest in securities like
stocks, bonds, money market instruments, and other assets.
●
A mutual fund is run by a group of qualified people who form a company, called an asset management
company (AMC) and the operations of the AMC are under the guidance of another group of people, called
trustees.
●
Mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI).
23.2. Exchange-Traded Fund(ETF)
●
An exchange-traded fund (ETF) is a type of security that involves a collection of securities (stocks,
commodities, etc) and o en tracks an underlying index such as a stock index or bond index.
●
ETFs are in many ways similar to mutual funds; however, they are listed on exchanges and ETF shares trade
throughout the day just like an ordinary share.
23.3. Greenshoe Option
●
A greenshoe option is an over-allotment option.
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●
Under this company can issue shares for the first time(IPO) is allowed to sell some additional shares to the
public.
●
Greenshoe Option gets its name from USA Green Shoe Company which was allowed such an option.
23.4. Employee Stock Ownership Plan (ESOP)
●
An employee stock ownership plan (ESOP) is an employee benefit plan that gives workers ownership
interest in the company.
●
Under these plans, the employer gives certain stocks of the company to the employee for negligible or less
costs.
●
These plans are aimed at improving the performance of the company and increasing the value of the shares by
involving stockholders, who are also the employees, in the working of the company.
23.5. Debenture
●
Debentures are a debt instrument used by companies and the government to issue the loan.
●
Debentures typically are issued to raise capital to meet the expenses of an upcoming project or to pay for a
planned expansion in business.
●
The important features of debentures are as follows:
❏ A debenture is redeemed a er a fixed period of time.
❏ Debentures may be either secured or unsecured.
❏ Debenture holders do not enjoy any voting rights.
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24. UPSC CSE PRELIMS Previous Years Questions
●
Now, let's check how many questions can you attempt?
Q.1) What does venture capital mean?
2014
[A] A short-term capital provided to industries
[B] A long-term start-up capital provided to new entrepreneurs
[C] Funds provided to industries at times of incurring losses
[D] Funds provided for replacement and renovation of industries
Ans.1) Correct Option: B
Explanation:
●
Venture capital is financing that investors provide to startup companies and small businesses that are believed
to have long-term growth potential.
●
Venture capital generally comes from well-off investors, investment banks and other financial institutions.
Q.2) With reference to ‘Financial Stability and Development Council’, consider the following statements: 2016
1. It is an organ of NITI Aayog.
2. It is headed by the Union Finance Minister.
3. It monitors the macro-prudential supervision of the economy.
Which of the statements given above is/are correct?
[A] 1 and 2 only
[B] 3 Only
[C] 2 and 3 only
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[D] 1, 2 and 3
Ans.2) Correct Option: C
Explanation:
●
Financial Stability and Development Council (FSDC) is an apex-level body constituted by the government of
India and the chairman of the council is the Finance Minister.
●
The idea to create such a super-regulatory body was first mooted by Raghuram Rajan Committee in 2008.
●
Finally, in 2010, the then Finance Minister of India, Pranab Mukherjee, decided to set up such an autonomous
body dealing with macroprudential and financial regularities in the entire financial sector of India.
●
The new body envisages to strengthen and institutionalize the mechanism of maintaining financial
stability, financial sector development, inter-regulatory coordination along with monitoring
macro-prudential regulation of the economy.
●
No funds are separately allocated to the council for undertaking its activities
Q.3) Which of the following is issued by registered foreign portfolio investors to overseas investors who want to
be part of the Indian stock market without registering themselves directly?
2019
(a) Certificate of Deposit
(b) Commercial Paper
(c) Promissory Note
(d) Participatory Note
Ans.3) Correct Option: D
Explanation:
●
P-Notes or Participatory Notes are Overseas Derivative Instruments that have Indian stocks as their underlying
assets.
●
They allow foreign investors to buy stocks listed on Indian exchanges through FIIs without being registered.
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32
1. Tax
3
2. Type of Tax
3
2.1. Direct Tax
3
2.2. Indirect Tax
3
3. Direct Tax vs Indirect Tax
4
4. Method of Taxation
4
4.1. Progressive Taxation
4
4.2. Regressive Taxation
5
4.3. Proportional Taxation
5
5. Value Added Tax(VAT)
6
5.1. Advantage of VAT
7
5.2. Limitation of VAT
8
6. Goods and Service Tax (GST)
8
6.1. Salient Features of GST
9
6.2. Taxes subsumed in GST
10
6.3. Advantages of GST
11
6.3.1. Advantages for the government
11
6.3.2. Advantages to Trade and Industry
12
6.3.3. Advantages to Consumer
12
6.3.4. Advantages to States
12
6.4. GST and Revenue Neutral Rate(RNR)
13
6.5. GST and Fiscal Autonomy of State
13
6.6. GST Council
14
6.7. GSTN
15
6.8. GST Tax Slab
15
7. GST Tax System vs Non-GST Tax System
16
8. Direct Tax
17
8.1. Personal Income Tax
17
8.2. Corporate Tax
17
8.3. Dividend Distribution Tax
17
8.4. Minimum Alternate Tax
17
8.5. Alternate Minimum Tax
17
8.6. Capital Gain Tax
18
8.7. Securities Transaction Tax (STT)
18
8.8. Commodity Transaction Tax (CTT)
18
9. Direct Tax Code(DTC)
18
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10. General anti-avoidance rule (GAAR)
19
10.1. Why GAAR?
19
10.2. Advantage of GAAR
19
10.3. Disadvantage of GAAR
19
10.4. Parthasarathi Shome Panel
20
11. Tax Administration Reform Commission(TARC)
20
12. Tax Reform Committee
21
13. Tax Force on Tax Reform
22
14. Double Taxation Avoidance Agreement(DTAA)
22
14.1.Objective of DTAA?
23
14.2. India and DTAA?
23
15. Tax to GDP Ratio
23
16. Feature of Indian Taxation System.
24
17. Terms
25
18. Base erosion and profit shifting (BEPS)
29
19. Advance Pricing Agreement(APA)
30
20. Tax Regulation Authority in India
30
20.1. Central Board of Direct Taxes(CBDT)
30
20.2.Central Board of Indirect Taxes and Customs(CBIC)
30
21. UPSC CSE PRELIMS Previous Years Questions
32
© Coursavy
2
1. Tax
●
A tax is a compulsory financial payment imposed upon a taxpayer (an individual or legal entity) by a
government in order to fund various public expenditures.
●
Taxes are the primary source of revenue for most governments and works as a tool for income distribution.
●
For Example: Suppose a Government impose a rate of income tax i.e 20%.
Person
Income
A
40,000
Income disparity
before
Income a er paying
tax
32,000
10,000
B
50,000
●
Income Disparity
a er tax
8,000
40,000
As shown in the table, the difference between their income before tax was Rs 10,000. But a er Tax is imposed
at 20% income difference reduced to Rs 8,000.
●
Hence with the imposition of income tax reduces income disparity between both A and B.
2. Type of Tax
2.1. Direct Tax
●
A direct tax is paid directly by an individual or organization to the government.
●
Direct taxes are computed based on the ability of the taxpayer to pay, which means that the higher
their capability of paying is, the higher their taxes are(the higher the salary higher the tax).
●
Examples of Direct Tax are income tax, poll tax, land tax, and personal property tax.
2.2. Indirect Tax
●
It is a tax levied by the Government on goods and services and not on the income, profit etc of an
individual.
●
It is usually imposed on a manufacturer or supplier who then passes on the tax to the consumer.
●
Examples of Indirect Tax are Customs duty, central excise, service tax and value-added tax.
●
For Example - Suppose you buy Shirt from an online website priced at Rs 500. At the time of the
payment additional tax is imposed on the price of the Shirt.
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3. Direct Tax vs Indirect Tax
Direct Tax
Indirect Tax
Direct tax is paid directly to the government
Indirect tax is paid indirectly to government
Imposed on income or profits
Imposed on goods and services
The burden falls directly on the individual
The burden is shi ed to the consumer by the manufacturer or
service provider
Direct taxes are calculated based on the paying capacity
Indirect Tax does not look at the consumer’s ability to pay but
of the individual.
is the same for everyone who buys the goods or services.
Direct taxes can be evaded in the absence of proper
Indirect taxes cannot be escaped from because they are
collection administration.
charged automatically on goods and services.
Example - Income Tax, Wealth Tax, Corporate Tax etc
Example - GST (Goods and Services Tax), Sales Tax etc
4. Method of Taxation
●
There are three methods of taxation prevalent in economies:
4.1. Progressive Taxation
●
A progressive tax imposes a higher percentage of tax
on people with higher incomes.
●
It means that the more a person earns, the higher his
rate of tax will be.
●
For example - Income Tax increases with an increase in
personal income. A person earning below is Rs 5 Lakh is
charged 5% income tax and the person earning above
Rs 5 Lakh is charged 20% Income tax.
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●
Progressive Taxation discourages more earning by the individual/organisation i.e poor is rewarded while rich is
punished.
●
The aim of a progressive tax is to help reduce inequality – taking lower average levels of tax from low wage
earners, and taking more from higher wage earners.
●
This is the most popular taxation method in the world.
4.2. Regressive Taxation
●
A regressive tax is a tax which takes a higher percentage of tax
revenue from those with low incomes.
●
In a regressive taxation method, the individuals with lower
incomes pay a higher proportion of their income as tax than
individuals with higher incomes.
●
Regressive Taxation can be used to promote certain sectorsfor increasing production etc.
●
For Example - Sin Taxes (Product that is harmful to society) is
added to the prices of goods like alcohol and tobacco in order
to prevent people from using them.
●
Sin Tax is regressive because they are more burdensome to
low-income earners rather than their high-income counterparts.
4.3. Proportional Taxation
●
A proportional tax is a tax wherein all taxpayers are
taxed at the same percentage rate, no matter how
high or low their income.
●
A proportional tax applies the same tax rate across
low, middle, and high-income taxpayers.
●
Proportional Tax is generally not used as an
independent method of Taxation. It is used as a
complementary method with either progressive or
regressive taxation method.
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It is used as a complementary method because if progressive tax is not converted into proportional tax it will
●
go on increasing and similarly regressive tax will decrease to zero.
The table shows the change in the tax rate in different taxation system.
●
Taxable Income `
Proportional Tax(%)
Progressive Tax(%)
Regressive Tax(%)
10,000
15
10
20
20,000
15
15
16
30,000
15
20
12
40,000
15
25
8
5. Value Added Tax(VAT)
●
Value Added Tax(VAT) is a tax collection method( it is also the name of tax) which is imposed on each stage
of value addition on each stage of economic activity.
●
Every commodity passes through different stages of production and distribution before finally reaching the
consumer. Some value is added at each stage of the production and distribution chain for example, a metal
tool is more valuable than metal.
●
Since VAT method of tax collection is imposed and collected at a different stage of value addition that is why it
is Multipoint tax collection.
●
It is a consumption tax because it is borne ultimately by the final consumer. The tax paid by the dealer is
passed on to the buyer. VAT is based on a taxpayer's consumption rather than their income.
●
It is a destination-based tax as its effective burden is on the final consumer.
●
VAT is calculated by deducting input tax(charged to the customer by a dealer) from output tax (tax paid by the
dealer for purchases).
VAT = Output Tax - Input Tax
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Stages of
value
addition
Firm/
Producer
Product
Value of
Input
Input
Tax
(10%)
Value
of
Output
Output
Tax
(10%)
Value
addition
VAT
(Output TaxInput Tax)
Non VAT
Method
(For
1
Farmer
Wheat
10
1
30
3
20
2
3
2
Mill
Flour
30
3
40
4
10
1
4
3
Baker
Cake
40
4
90
9
50
5
9
4
Retailer
Sale
90
9
100
10
10
1
10
Total
170
17
260
26
90
9
26
●
Above table shows, stages of value addition from farmer to retailer i.e Wheat → Flour → Cake → Sale.
●
Value Addition at each stage of production is the value of output - value of the input.
●
Suppose VAT is calculated at 10%. Total VAT calculated is Rs 9, whereas if we follow Non-VAT method( which is
calculated at the value of output) the total tax payment is Rs 26.
●
Hence VAT does not have the ‘cascading effect’ on the price of goods it does not increase inflation and is,
therefore, more suitable for developing economy like India.
5.1. Advantage of VAT
●
It reduces tax evasion because it enables tax officials to cross-check records of various firms (since purchase
receipt/invoice is a must). In sale tax accounting is not possible which encourages firms to reduce tax liability.
●
It eliminates the cascading burden of multiple taxations i.e under VAT each commodity is taxed only once.
●
It unifies the indirect taxation system across the state/throughout the country. So it creates a single
/national/common market in the country.
●
It enables allocation of resources on the basis of comparative advantage of various states/region that is each
state/region would specialize in the production of those commodities, whose production is most.
●
For example - Andhra Pradesh imposes a higher tax for the same commodity compared to Tamil Nadu where
the cost of production is higher as compared to Andhra Pradesh. This can lead to distortion of resources due to
more tax.
Cost
Tax
Market Price
Andhra Pradesh
9
4
13
Tamil Nadu
10
1
11
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5.2. Limitation of VAT
●
It is highly resource-intensive that it requires computerization to maintain records of firms in a specified
format, centralised record of indirect tax, trained officials etc.
●
The process of estimation of VAT is quite complex.
6. Goods and Service Tax (GST)
●
Goods and Services Tax (GST) refers to the single unified tax created by amalgamating a large number of
Central and State taxes presently applicable in India.
●
Most of the domestic indirect taxes like excise tax, service tax, entertainment tax etc would be merged into
one.
●
GST is proposed to be a dual levy where the
❏ Central Government will levy and collect Central GST (CGST)
❏ State Government will levy and collect State GST (SGST) on intra-state supply of goods/ services.
❏ Centre Government will levy and collect Integrated GST (IGST) on inter-state supply of goods/ services.
●
The 101st Constitution Amendment Act in September 2016 inserted a definition of GST in Article 366 of the
constitution by inserting a sub-clause 12A.
●
Since then the GST Council came into existence as the Constitutional body to decide issues relating to GST.
●
Under GST firms have to pay taxes on the basis of their value of output. But the taxes paid on the input would
be offset(reimbursed) in the form of Input Tax Credit(ITC).
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6.1. Salient Features of GST
●
The salient features of GST are as under:
❏ GST comes under the broad spectrum of what is known as Value Added Tax which provides for input
credits and taxes only on the value addition that happened in the process of production of
good/service.
❏ GST would be applicable on supply of goods/services as against the previous concept of tax on the
manufacture or on sale of goods or on provision of services.
❏ GST is a destination-based tax as against the previous concept of origin based tax. i.e, tax is imposed
at the point of consumption.
❏ CGST and SGST would be levied at rates to be mutually agreed upon by the Centre and the States.
❏ All goods and services, except alcoholic liquor for human consumption, will be brought under the
purview of GST (to include alcoholic liquor, which is a major source of revenue for the states, another
constitution amendment would be required).
❏ Crude Petroleum and some petroleum products have also been Constitutionally brought under GST.
However, it is provided that petroleum and petroleum products shall not be subject to the levy of GST
till notified at a future date on the recommendation of the GST Council.
❏ Exports would be zero-rated. The exporter shall have an option to either pay tax for his output and
claim its refund or export under bond without tax and claim refund of Input Tax Credit.
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❏ Import of goods or services would be treated as inter-State supplies and therefore, would be subject to
IGST in addition to the applicable customs duties.
❏ A Goods & Services Tax Council which will be a joint forum of the Centre and the States will be
created.
❏ The Union Government cannot impose surcharges on articles which are covered under GST laws.
❏ Centre Government will compensate States for loss of revenue arising on account of
implementation of the GST for a period up to five years. The compensation will be on a tapering basis:
❖ First three years - 100%.
❖ Fourth-year - 75%.
❖ Fi h-year - 50%.
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6.2. Taxes subsumed in GST
●
GST would replace the following taxes currently levied and collected by the Centre and State.
Centre Tax Subsumed
State Tax Subsumed
●
Central Excise duty
●
State VAT/ Sales Tax
●
Excise Duty levied under the Medicinal and Toilet
●
Central Sales Tax (levied by the Center and
Preparations (Excise Duties) Act 1955,
●
●
●
collected by the States)
Additional Excise Duties (Goods of Special
●
Luxury Tax
Importance)
●
Octroi
Additional Excise Duties (Textiles and Textile
●
Entry Tax i.e, taxes on the entry of goods into a
Products)
local area for consumption, use or sale therein.
Additional Customs Duty ( known as
(other than those in lieu of octroi)
Countervailing duties or CVD)
●
Purchase Tax
●
Special Additional Duty of Customs (SAD)
●
Entertainment Tax which is not levied by the
●
Service Tax
●
Cesses and surcharges in so far as they relate to
●
Taxes on general advertisements
the supply of goods and services
●
Taxes on lotteries, betting and gambling
Taxes on the sale or purchase of newspapers and
●
State cesses and surcharges insofar as they
●
on advertisements published.
local bodies.
relate to the supply of goods or services
6.3. Advantages of GST
6.3.1. Advantages for the government
●
Will help to create a unified common national market for India, giving a boost to foreign investment
and “Make in India” campaign.
●
Harmonization of laws, procedures and rates of tax between Centre and States and across States.
●
Improved environment for compliance as all returns are to be filed online, input credits to be verified
online, encouraging more paper trail of transactions at each level of the supply chain.
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●
Greater use of IT will reduce human interface between the taxpayer and the tax administration, which
will go a long way in reducing corruption.
●
Common procedures for registration of taxpayers, refund of taxes, uniform formats of tax return,
common tax base, common system of classification of goods and services will lend greater certainty to
the taxation system.
6.3.2. Advantages to Trade and Industry
●
Reduction in multiplicity of taxes that were present governing our indirect tax system leading to
simplification and uniformity.
●
Elimination of double taxation on certain sectors like works contract, so ware, hospitality sector;
●
Increased ease of doing business - Simplified and automated procedures for various processes such as
registration, returns, refunds, tax payments, etc.
●
Reduction in compliance costs - No multiple record-keeping for a variety of taxes - so lesser
investment of resources and manpower in maintaining records.
6.3.3. Advantages to Consumer
●
Reduction in prices of commodities and goods in the long run due to reduction in cascading impact of
taxation.
●
Final price of goods is expected to be transparent due to the seamless flow of input tax credit between
the manufacturer, retailer and service supplier.
●
Poverty eradication by generating more employment and more financial resources.
6.3.4. Advantages to States
●
Expansion of the tax base as they will be able to tax the entire supply chain from manufacturing to
retail.
●
Power to tax services, which was hitherto with the Central Government only, will boost revenue and
give States access to the fastest-growing sector of the economy.
●
Improve the overall investment climate in the country which will naturally benefit the development in
the States
●
Improved Compliance levels of the taxpayers will contribute greatly to improving the revenue
collection of the States.
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6.4. GST and Revenue Neutral Rate(RNR)
●
Revenue Neutral Rate(RNR) refers to that single rate, which preserves revenue at desired (current) levels.
●
RNR is the rate of GST at which the amount of taxes currently collected by the government and the amount
collected by the government in the pre-GST regime remains the same i.e it does not lead to revenue loss or
gain.
●
The Government of India constituted a committee under Arvind Subramanian which suggested the RNR to
be from 15% to 15.50%.
●
The RNR is kept slightly high to ensure no loss in the revenue generation.
●
Currently, the RNR under GST is 15.5%.
6.5. GST and Fiscal Autonomy of State
●
States primarily depend on two sources for their revenue – their own revenue and central transfers.
●
The former indicates revenue generated by states on their own, while the latter consists of receipts from
devolution of Union taxes and grants-in-aid from the Centre.
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●
With the introduction of GST, many indirect taxes levied by the states have been replaced.
●
While these taxes were completely under the control of each state, GST rates are now decided by the GST
Council.
●
This implies that states have limited flexibility in making decisions regarding tax rates on goods and services.
●
Therefore, higher reliance on GST receipts for revenue reduces states’ autonomy as these receipts depend on
tax rates decided by the GST Council.
6.6. GST Council
●
Goods & Services Tax Council is a constitutional body for making recommendations to the Union and State
Government on issues related to Goods and Service Tax.
●
As per Article 279A of the amended Constitution, the GST Council which will be a joint forum of the Centre
and the States, shall consist of the following members:
Chairman - Union Finance Minister
Members - Ministers in charge of Finance/Revenue or
Minister nominated by each of the States & UTs with Legislatures
●
Members have differential voting powers with votes of the central government having 1/3rd weightage and
rest 2/3rd with states.
●
Decisions can be taken only if it has more than 3/4th majority and such decisions will be immune from the
deficiencies in the constitution of the GST council or appointment of its members or any procedural
irregularity.
●
Functions of GST Council: As per Article 279A (4), the Council will make recommendations to the Union and
the States on important issues related to GST, like
❏ Taxes, cesses, and surcharges to be subsumed under the GST;
❏ Goods and services which may be subject to, or exempt from GST
❏ The threshold limit of turnover for application of GST;
❏ Rates of GST;
❏ Model GST laws, principles of levy, apportionment of IGST and principles related to place of
supply;
❏ Special provisions with respect to the eight northeastern states, Himachal Pradesh, Jammu
and Kashmir, and Uttarakhand;
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❏ Other related matters.
6.7. GSTN
●
Goods and Services Tax Network (GSTN) is a not for profit companies, non-Government, private limited
company.
●
It was incorporated in 2013.
●
The Government of India holds 24.5% equity in GSTN and
●
All States of the Indian Union, including NCT of Delhi and Puducherry, and the Empowered Committee of State
Finance Ministers (EC), together hold another 24.5%.
●
Balance 51% equity is with non-Government financial institutions.
●
The Company has been set up primarily to provide IT infrastructure and services to the Central and State
Governments, taxpayers and other stakeholders for implementation of the Goods and Services Tax (GST).
6.8. GST Tax Slab
●
GST is currently levied on every product in five slabs of 0,5, 12, 18 and 28 per cent.
Essential Goods
0%
(For example, cereals, fresh fruits, and vegetables, salt,
natural honey, milk, human blood etc.)
Commonly used Goods and Services
5%
Standard Goods and Services fall under 1st slab
12%
(computer and processed food)
Standard Goods and Services fall under 2nd Slab
18%
(capital goods and industrial
intermediaries are covered in this slab)
Special category of Goods and Services including luxury
28%
(Luxury items such as small cars, premium cars,
cigarettes and aerated drinks)
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●
Further, a cess would be levied on certain goods such as luxury cars, aerated drinks, pan masala and tobacco
products, over and above the rate of 28% for payment of compensation to the States.
●
97.5 per cent articles covered by 18 per cent or lower GST slab.
●
Some of the products are not covered under GST. These are:
❏ Alcohol for human consumption
❏ Tobacco
❏ Electricity
❏ Petroleum Product
7. GST Tax System vs Non-GST Tax System
●
Non-GST Tax System
❏ Imagine a T-Shirt manufacturer. He buys raw material worth Rs 5,000, for which he pays a sales tax of
10% i.e Rs.500.
❏ He manufactures shirts by adding the value of Rs.1000 including profit.
❏ For the total cost, the manufacturer will include 5,000 + 1000 + 500 and fix the price as 6,500.
❏ The customer buying will pay the final cost of 7,150 (6,500 + 10% sales tax i.e 650).
❏ So the total tax collected by the government is 500 + 650 = 1,150.
●
GST Tax System
❏ Imagine a T-Shirt manufacturer. He buys raw material worth Rs 5,000, for which he pays a tax at 10% i.e
Rs.500.
❏ He manufactures shirts by adding the value of Rs.1000 including profit.
❏ For the total cost, the manufacturer will include 5,000 + 1,000 and fix the price as 6,000.
❏ Manufacturer leaves out 500 paid as a tax because it will be reimbursed by the government as input
tax credit.
❏ The customer buying will pay the final cost of 6,600 (6,000 + 10% tax i.e 600).
❏ So the total tax collected by the government is 600.
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8. Direct Tax
●
Different types of direct taxes are:
8.1. Personal Income Tax
●
An income tax is a tax that governments impose on individuals within their jurisdiction.
8.2. Corporate Tax
●
Corporation tax is a tax imposed on the net income of the company.
●
Companies, both private and public which are registered in India under the Companies Act 1956, are liable to
pay corporate tax.
8.3. Dividend Distribution Tax
●
The Dividend Distribution Tax is a tax levied on dividends that a company pays to its shareholders out of its
profits.
8.4. Minimum Alternate Tax
●
Minimum Alternate Tax (MAT) is a tax effectively introduced in India by the Finance Act of 1987,to facilitate the
taxation of ‘zero tax companies’ i.e., those companies which show zero or negligible income to avoid tax.
●
Under MAT, such companies are made liable to pay to the government, by deeming a certain percentage of
their book profit as taxable income.
●
MAT is an attempt to reduce tax avoidance; it was introduced to contain the practices followed by certain
companies to avoid the payment of income tax, even though they had the “ability to pay”
●
MAT is applicable to all corporate entities, whether public or private.
●
It does not apply to
❏ Any income accruing or arising to a company from the life insurance business.
❏ Shipping income liable to tonnage taxation
8.5. Alternate Minimum Tax
●
An alternative minimum tax (AMT) is a tax that ensures that taxpayers pay at least the minimum amount of tax.
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8.6. Capital Gain Tax
●
Capital gain can be defined as any profit that is received through the sale of a capital asset(Land, building,
house property etc).
●
The tax that is paid on that profit is called capital gains tax.
●
Capital gain tax can either be long term ( individuals own an asset for a duration of more than 36 months) or
short term (In case assets are held for a duration of 36 months or less).
8.7. Securities Transaction Tax (STT)
●
Securities Transaction Tax (STT) is a type of financial transaction tax levied in India on transactions done on
the domestic stock exchanges.
●
The rates of STT are prescribed by the Central / Union Government through its Budget from time to time.
●
It is categorised as a direct tax.
8.8. Commodity Transaction Tax (CTT)
●
Commodities transaction tax (CTT) is a tax similar to Securities Transaction Tax (STT), levied in India, on
transactions done on the domestic commodity derivatives exchanges.
●
The concept of CTT was first introduced in the Union Budget 2008-09.
●
CTT aims at discouraging excessive speculation, which is detrimental to the market.
9. Direct Tax Code(DTC)
●
DTC is the proposed legislative reform of the direct taxation system.
●
It seeks to simplify and consolidate all the direct tax of the central government like income tax, gi tax,
wealth tax etc.
●
It seeks to increase tax revenue by broadening the tax base.
●
Features of DTDC are:
❏ Tax laws will be rewritten in simple and unambiguous language to reduce the scope of
misinterpretation.
❏ Reduce exemption- deduction debate to reduce their scope of misuse.
❏ Flexible tax system to make changes in tax provision without amendment in tax law.
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●
In 2017 the Government set up an expert committee under Akhilesh Ranjan to dra a new Direct Taxes Code.
The task force submitted its report in 2019 which is not made public.
10. General anti-avoidance rule (GAAR)
●
It is a provision under direct tax law which seeks to check tax avoidance i.e misuse of exemption, ambiguous
language, loophole in tax laws etc.
●
It provides discretionary power to deny any tax benefit to a firm in case it made an arrangement solely for the
purpose of tax avoidance i.e if there is no commercial substance.
●
A transaction that disguises the value, location, source, ownership or control of funds would also be deemed
to lack commercial substance.
●
It empowers tax officials to override certain provision of domestic tax law as well as Double Taxation
Avoidance Agreement (DTAA) a bilateral agreement.
●
The provision of GAAR is to codify the doctrine of ‘substance over form’ where the real intention of the
parties and purpose of an arrangement is taken into account for determining the tax consequences,
irrespective of the legal structure of the concerned transaction or arrangement.
●
India’s general anti-avoidance rule (GAAR) came into effect on 1 April 2017 for the assessment year 2018-19.
10.1. Why GAAR?
●
GAAR was introduced to address tax avoidance and ensure that those in different tax brackets are taxed the
correct amount.
●
In many instances of tax avoidance, arrangements may take place with the sole intention of gaining a tax
advantage while complying with the law.
10.2. Advantage of GAAR
●
To check tax avoidance.
●
It would plug loopholes in the taxation system.
●
It would also check misuse of DTAA.
10.3. Disadvantage of GAAR
●
It may increase the scope of corruption as it provides discretionary power to tax officials.
●
It may adversely affect domestic and foreign investment as it creates uncertainty regarding the interpretation
of tax provision.
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10.4. Parthasarathi Shome Panel
●
The Parthasarathi Shome Panel was set up in 2012 for drawing up the final guidelines on GAAR.
●
Recommendation of the committee are:
❏ GAAR should be deferred for three years to 1st April 2016 with safeguard, consultation from investors,
training to tax officials
❏ It should be invoked by the approving panel with 5 members.
❖ Head - High Court Judge
❖ Two Member - Income Tax Department
❖ Two Member - Non- government Members
❏ The focus of GAAR should be to check the misuse of tax provision rather than increase tax revenue.
❏ It should be imposed only if the sole objective of an arrangement is tax avoidance.
❏ The application of GAAR should be clarified through an appropriate illustration.
❏ Firms should be permitted to clarify the applicability of GAAR before making investment/transactions
i.e advanced ruling.
❏ The threshold limit for applicability of GAAR should be fixed at tax avoidance of at least Rs 3 crore or
more.
❏ It should not be used to assess the genuineness of tax residency certificate issued under DTAA even by
tax havens.
❏ It should not be applied in the case where Special Anti-Avoidance Rules(SAAR) are applicable.
11. Tax Administration Reform Commission(TARC)
●
The Tax Administration Reforms Commission (TARC) under the Chairmanship of Dr Parthasarathi Shome
was appointed in 2013 by the Government of India for giving recommendations for reviewing the public Tax
Administration system of India.
●
TARC made the following recommendations:
❏ Consumer Focus:
❖ A minimum of 10% of the tax administration’s budget must be spent on taxpayer services.
❖ The decision of the Ombudsman with regard to redressing taxpayer grievances should be
binding on tax officers.
❖ Pre-filled tax returns should be provided to all individuals. The taxpayer will have the option
of accepting the tax return or modifying it.
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❏ Structure and Governance:
❖ CBDT and CBEC should be fully integrated in 10 years. Within the next 5 years, they should
move towards a unified management structure under the Central Board of Direct and Indirect
Taxes.
❖ The post of Revenue Secretary should be abolished and its functions should be assigned to the
two Boards.
❏ Human Resource Development:
❖ There should be a focus on specialisation, including lateral entry of specialists in the Boards.
Indian Revenue Service (IRS) officers should specialise in particular tax administration areas.
❖ The Central Vigilance Commission should have a Member who has been an IRS officer.
❏ Dispute Resolution and Management:
❖ Retrospective legislation should be avoided.
❖ Both Boards should start a special drive for review and liquidation of cases currently clogging
the system by setting up dedicated task forces.
❏ Internal Processes:
❖ The Permanent Account Number (PAN) should be developed as a Common Business
Identification Number (CBIN), to be used by other departments such as customs, excise, etc.
12. Tax Reform Committee
●
The government of India Constituted a tax reform committee under Raja.J.Chelliah, Director of National
Institute of Public Finance and Policy(NIPFP) in 1991.
●
The major recommendation of the committee are as follows:
❏ Reforming the personal taxation system by reducing the tax rates.
❏ Reduction in corporate tax rates.
❏ Reducing the cost of imported inputs by lowering customs duties
❏ Integration of excise duties with a Value-Added Tax (VAT) system.
❏ Bringing the services sector within a VAT system.
❏ Broadening of the tax base.
❏ Improving the quality of tax administration.
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13. Tax Force on Tax Reform
●
The Government of India set up a Task Force on Tax Reform under Vijay Kelkar with the objective of
rationalizing cumbersome tax structure so as to reverse the deteriorating trend in public GDP finances,
improve tax-ratio by making the tax administration simple and meaningful and also to make the tax base wide
with low rates.
❏ Administration of Direct Tax
❖ The taxpayer services should be extended both in quality and quantity and taxpayers should
get easy access through the internet and email.
❖ PAN (Permanent Account Number) should be expanded and it should cover all citizens.
❖ The government should establish a Tax Information Network to modernize, simplify and
rationalize tax collection, particular TDS and TCS.
❖ Empower CBDT with appropriate administrative and financial powers.
❏ Personal income tax
❖ Rationalize income tax slabs, eliminate surcharge on personal income tax.
❖ Exemption for senior citizens and widows.
❖ Increase deduction under Section 80CCC for contribution to pension funds.
❏ Corporate Tax
❖ The listed companies should be exempted from tax on dividends and capital gains.
❖ Increase rate of depreciation for plants and machinery.
❖ Abolish Minimum Alternate Tax.
❏ Wealth Tax
❖ Abolition of wealth tax.
14. Double Taxation Avoidance Agreement(DTAA)
●
Double taxation is the levy of tax by two or more countries on the same declared income, asset or financial
transaction.
●
When such income is taxed in two countries, the aggregate of the tax liability will form a substantial part of
total income.
●
This double liability is mitigated in many ways, one of them being a tax treaty between the countries in
question.
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●
Double Taxation Avoidance Agreement(DTAA) is a tax treaty signed between two or more countries with the
aim to help taxpayers avoid paying double taxes on the same income.
●
This means that there are agreed rates of tax and jurisdiction on specified types of income arising in a country.
●
A DTAA is applicable in cases where a taxpayer is a resident of one nation but earns income in another country.
●
For Example - Suppose an NRIs earn income both in India and the country of current residence, the income
earned in India would be taxed both in India and the country of residence. If India has a DTAA in place with that
country, NRIs can either avoid paying tax twice or pay a lower rate of tax.
14.1.Objective of DTAA?
●
To prevent tax avoidance, evasion, grant relief.
●
To improve the cooperation between two countries taxing authorities.
●
To attract foreign investments by providing relief from double taxation.
●
To prevent discrimination between taxpayers.
14.2. India and DTAA?
●
India presently has DTAA with 80+ countries. This means that there are agreed rates of tax and jurisdiction
on specified types of income arising in a country to a tax resident of another country.
●
Some of the countries with which it has comprehensive agreements include Australia, Canada, the United
Arab Emirates, Germany, Mauritius, Singapore, the United Kingdom and the United States of America.
15. Tax to GDP Ratio
●
Tax to GDP ratio shows the tax revenue for a country measured in terms of GDP.
●
For example, if India’s tax to GDP ratio is 15%, it means that the government earns 15% of its GDP as tax
revenue from the public.
●
Taxes and GDP are generally related. The higher the GDP, the more tax a nation collects. Conversely, countries
with lower taxes produce a lower GDP.
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●
Tax to GDP ratio has risen consistently in the past 10 years which can be seen in the above graph.
●
Reasons for the low tax to GDP ratio in India:
❏ Tax GDP ratio is lower because of the narrow tax base.
❏ There are large scale tax evasion and tax avoidance
❏ Weaknesses in tax administration.
16. Feature of Indian Taxation System.
●
Indian taxation system follows a progressive method of taxation.
●
Indian taxation system is complex and prone to tax evasion.
●
It includes multiple exemptions, deduction and rebates.
●
Moderately high tax rate (despite a significant reduction in tax rate).
●
Narrow tax base and low tax to GDP ratio.
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17. Terms
17.1. Surcharge
●
Surcharge is an additional charge and not an additional tax.
●
A surcharge of 10% on a tax rate of 30% effectively raises the combined tax burden to 33%.
●
Objective of Surcharge is :
❏ To increase the tax revenue temporarily (additional fund mobilisation).
❏ To make the tax system more progressive.
17.2. Cess
●
It is an additional charge (Tax on Tax) which is imposed to finance a specific activity.
●
Cess is not a permanent source of revenue for the government, and it is discontinued when the purpose for
which it is levied is fulfilled.
●
It can be levied on both indirect and direct taxes.
●
For Example - Education Cess, Swachh Bharat Cess, Clean Energy Cess etc.
●
The government can impose any one of the surcharge or cess or both.
17.3. Deduction
●
Tax Deduction is the reduction in tax obligation. Under this amount of deduction is subtracted from the total
income to estimate taxable income.
●
It reduces taxable income.
●
For Example - Under Section 80C up to Rs 1.5 Lakh can be saved. If a person income is Rs 7 Lakh and he invests
Rs 1.5 Lakh under Section 80C now his taxable income reduces to Rs 5.5 Lakh (7 Lakh - 1.5 Lakh).
17.4. Exemption
●
Tax Exemption refers to expenditure, income or investment on which no tax is levied.
●
So, if a particular income is exempt from tax, it will not be included in the total revenue for tax purposes. This
reduces the total taxable income of a taxpayer.
●
For Example - House Rent Allowance(HRA), Leave Travel Allowance(LTA) etc.
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●
Income tax exemptions are provided on particular sources of income and not on the total income.
17.5. Tax Rebate
●
Tax rebate is a refund to the taxpayer when the taxpayer pays more tax than he is supposed to.
●
Tax rebate helps to lower the tax burden on the low-income bracket individuals.
●
Income tax rebates are supposed to be claimed from the total tax payable.
17.6. Incidence of Tax
●
It refers to the point of the imposition of tax i.e on person or firm on which tax is imposed.
●
The impact of a tax is on the person on whom it is imposed first.
17.7. Impact of Tax
●
The incidence of a tax refers to the extent to which an individual or organisation suffers from the imposition of
a tax.
●
The tax incidence depicts the distribution of the tax obligations, which must be covered by the buyer and
seller.
●
Impact refers to the initial burden of the tax, while incidence refers to the ultimate burden of the tax.
●
For Direct tax impact and incidence is both at the same point.
●
For Indirect tax impact and incidence is at a different point.
17.8. Tax Expenditure
●
Tax Expenditure is special provisions such as exclusions, deductions, deferrals, credits etc given to the
taxpayers.
●
Tax expenditures indicate how much more revenue could have been collected by the Government if not
for such measures.
●
It shows the extent of indirect subsidy enjoyed by the taxpayers in the country.
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17.9. Laffer Curve
●
Laffer Curve is a graphic representation of the relationship between rates of taxation and the resulting
levels of government revenue.
●
The shape of the Laffer curve implies that as tax rates rise, tax
revenues will also increase. However, these increased tax revenues
will only increase until a peak, and a er which, the tax revenues begin
to decline.
●
The Laffer curve was developed in 1979 by economist Arthur Laffer.
●
The Laffer curve is typically represented as a graph that starts at 0%
tax with zero revenue, rises to a maximum rate of revenue at an
intermediate rate of taxation, and then falls again to zero revenue at a
100% tax rate.
●
The shape of the Laffer curve is uncertain.
17.10. Tobin Tax
●
A Tobin tax is a tax on financial transactions associated with currency exchange.
●
The aim of a Tobin tax was to generate stability in currency markets.
●
Tobin tax are imposed by many countries to discourage short term capital flows.
●
The Tobin tax, proposed by James Tobin in 1972.
17.11. Pigouvian Tax
●
A Pigouvian tax is a government tax on activities that create socially harmful externalities.
●
Pollution is a negative externality. For example - the driver of a non-compliant vehicle doesn't necessarily
suffer immediately from the exhaust released from the vehicle but as the vehicle drives down the road,
everyone behind the vehicle may suffer. Their exhaust may also increase pollution for everyone in the
community.
●
The government imposes a Pigouvian tax on non-compliant vehicles to make the driver take on more of the
cost of the suffering they may cause.
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17.12. Tax Haven
●
A tax haven is defined as a country or place with very low "effective" rates of taxation for foreign investors.
●
Tax havens also share limited or no financial information with foreign tax authorities.
●
Tax havens do not typically require residency or business presence for individuals and businesses to benefit
from their tax policies.
●
A list of some of the most popular tax haven countries includes the Bahamas, Bermuda, the British Virgin
Islands, the Cayman Islands, Hong Kong, Mauritius, Lichtenstein, Monaco, Panama, St. Kitts, and Nevis.
17.13. Round Tripping
●
It refers to the transfer of illegitimate money through a foreign company(through tax haven) to invest back to
the home country.
●
The objective of round-tripping is the conversion of black/illegal money to white/legitimate money.
17.14. Ad Valorem Tax
●
An ad valorem tax (Latin for "according to value") is a tax whose amount is based on the value of a
transaction or of property.
●
It is imposed at the time of a transaction, as in the case of a value-added tax (VAT).
●
The most common ad valorem taxes are property taxes levied on real estate.
17.15. Specific Tax
●
Specific tax is a tax that is defined as a fixed amount for each unit of a good or service sold.
17.16. Tax Buoyancy
●
It refers to the responsiveness of tax revenue growth to changes in GDP.
●
It is the relationship between the changes in the government’s tax revenue growth and the changes in GDP.
●
It is calculated by dividing the change in tax collection with GDP growth.
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Tax buoyancy
=
Change in tax revenue
Change in GDP
●
A tax is buoyant when revenues increase for example by more than 5 per cent for a 5 per cent increase in GDP.
17.17. Tax Elasticity
●
Tax elasticity refers to changes in tax revenue in response to changes in tax rate.
18. Base erosion and profit shi ing (BEPS)
●
Base erosion and profit shi ing (BEPS) refers to tax planning strategies used by multinational enterprises
that exploit gaps and mismatches in tax rules to avoid paying tax.
●
BEPS is of major significance for developing countries due to their heavy reliance on corporate income tax,
particularly from multinational enterprises.
●
In recent times, MNCs are developing sophisticated tax planning practices to avoid tax by shi ing their
incomes/profits across borders by exploiting gaps and mismatches in tax rules, to take advantage of lower tax
rates and, thus, not paying taxes to in the country where the profit is made.
●
The OECD, under the authority of the Group of 20 countries, has considered ways to revise tax treaties, tighten
rules, and to share more government tax information under the BEPS project, and has issued action plans.
●
The BEPS Package provides 15 Actions that equip governments with the domestic and international
instruments needed to tackle tax avoidance.
18.1. India and BEPS
●
India’s involvement in the BEPS initiative has been intensive. India has played an active part in devising action
plans, and also part of various working groups, committees and task forces that were set up for examining
different aspects of these action plans.
●
Union Budget 2016 announced an ‘equalisation levy’ of 6 per cent on payments exceeding over Rs 1 lakh to
online ad services from non-resident entities.
●
This affected multinational companies with Indian subsidiaries, like Facebook and Google.
●
India is the first country to impose such a levy, post the OECD action plan.
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●
A tax panel has recommended expanding the ambit of this levy to cover a wide gamut of transactions
including online marketing, cloud computing, website designing, hosting and maintenance, platforms for sale
of goods and services, and online use of or download of so ware and applications.
19. Advance Pricing Agreement(APA)
●
An APA is an agreement, usually for multiple years, between a taxpayer and CBDT specifying the transfer
pricing methodology to decide the pricing of future international transactions of the taxpayer.
●
Transfer price is the price at which transactions are carried out between companies part of the same group.
●
The primary objective of an APA is to provide certainty to taxpayers so that predictable and foreseeable
conditions can be expected regarding transfer pricing practices.
●
India has created a legal framework providing for a legally binding agreement between the taxpayer and the
CBDT.
●
The Finance Act, 2012, inserted sections 92CC and 92 CD in the ITA to provide the legal basis for APA in India.
●
These statutory provisions, effective from 1 July 2012, empowered the CBDT to enter an agreement with
any person, with the approval of Central Government, determining or specifying the manner of determination
of transfer pricing in relation to an international transaction.
20. Tax Regulation Authority in India
20.1. Central Board of Direct Taxes(CBDT)
●
The Central Board of Direct Taxes is a statutory authority functioning under the Central Board of Revenue Act,
1963.
●
The Central Board of Direct Taxes (CBDT) is a part of the Department of Revenue in the Ministry of Finance.
●
CBDT provides essential inputs for policy and planning of direct taxes in India, at the same time it is also
responsible for the administration of direct tax laws through the Income Tax Department.
20.2.Central Board of Indirect Taxes and Customs(CBIC)
●
Central Board of Indirect Taxes and Customs (erstwhile Central Board of Excise & Customs) is a part of the
Department of Revenue under the Ministry of Finance, Government of India.
●
It deals with the tasks of
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❏ Formulation of policy concerning levy and collection of Customs, Central Excise duties, Central Goods
& Services Tax and IGST.
❏ Prevention of smuggling and administration of matters relating to Customs, Central Excise, Central
Goods & Services Tax, IGST and Narcotics to the extent under CIBC's purview.
●
The Board is the administrative authority for its subordinate organizations, including Custom Houses, Central
Excise and Central GST Commissionerates and the Central Revenues Control Laboratory.
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21. UPSC CSE PRELIMS Previous Years Questions
●
Now, let’s check how many questions you can attempt?
Q.1) Which one of the following is not a feature of “Value Added Tax”?
2011
[A] It is a multi-point destination-based system of taxation
[B] It is a tax levied on value addition at each stage of the transaction in the production-distribution chain
[C] It is a tax on the final consumption of goods or services and must ultimately be borne by the consumer
[D] It is basically a subject of the Central Government and the State Governments are only a facilitator for its successful
implementation
Ans.1) Correct Option: (c)
Explanation:
VAT
●
The value-added tax was introduced as an indirect tax into the Indian taxation system from 1 April 2005.
●
The existing General Sales Tax Laws were replaced with the Value Added Tax Act (2005) and associated VAT
Rules.
●
Haryana became the first State in the country that had adopted the taxation on 1 April 2003.
Q.2) Under which of the following circumstances may ‘capital gains’ arise?
2012
1. When there is an increase in the sales of a product
2. When there is a natural increase in the value of the property owned
3. When you purchase a painting and there is a growth in its value due to increase in its popularity
Select the correct answer using the codes given below :
[A] 1 only
[B] 2 and 3 only
[C] 2 only
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[D] 1, 2 and 3
Ans.2)Correct Option: (b)
Explanation:
Capital gain
●
Capital gain is a rise in the value of a capital asset (investment or real estate) that gives it a higher worth than
the purchase price.
●
The gain is not realized until the asset is sold.
●
A capital gain may be short-term (one year or less) or long-term (more than one year) and must be claimed on
income taxes.
Q.3) A decrease in tax to GDP ratio of a country indicates which of the following?
2015
1. Slowing economic growth rates
2. Less equitable distribution of national income
Choose the correct code:
[A] 1 only
[B] 2 only
[C] Both 1 and 2
[D] Neither 1 nor 2
Ans.4) Correct Option: (b)
Explanation:
Tax GDP ratio
●
Tax GDP ratio shows the tax revenue for a country measured in terms of GDP. For example, if India’s tax GDP
ratio is 16%, it means that the government gets 16% of its GDP as tax contribution from the public and entities.
Here, tax GDP ratio shows the richness of the government’s exchequer. The government’s ability to spend on
socio-economic development programs, military, salary, pension heads etc., depends on tax GDP ratio.
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●
Lower tax GDP ratio indicates a less equitable distribution of national income.
Q.4) The term ‘Base Erosion and profit shi ing’ is sometimes seen in the news in the context of
2016
[A] mining operation by multinational companies in resource-rich by backward areas
[B] curbing of the tax evasion by multinational companies
[C] exploitation of genetic resources of a country by multinational companies
[D] Lack of consideration of environmental costs in the planning of development projects
Ans.4)Correct Option: (b)
Explanation:
Base erosion and profit shi ing (BEPS)
●
Base erosion and profit shi ing (BEPS) refers to corporate tax planning strategies used by multinationals
to "shi " profits from higher–tax jurisdiction to lower–tax jurisdiction, thus "eroding" the "tax–base" of
the higher–tax jurisdiction.
●
According to OECD, base erosion and profit shi ing (BEPS) refers to tax avoidance strategies that exploit
gaps and mismatches in tax rules to artificially shi profits to low or no-tax locations.
Q.5) What is/are the most likely advantages of implementing ‘Goods and Services Tax (GST)’?
2017
1. It will replace multiple taxes collected by multiple authorities and will thus create a single market in India.
2. It will drastically reduce the ‘Current Account Deficit’ of India and will enable it to increase its foreign exchange
reserves.
3. It will enormously increase the growth and size of the economy of India and will enable it to overtake China in the
near future.
Select the correct answer using the code given below:
[A] 1 only
[B] 2 and 3 only
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[C] 1 and 3 only
[D] 1, 2 and 3
Ans.5) Correct Option: (a)
Explanation:
Goods and Service Tax
●
Goods and Service Tax is a major economic reform in India a er the 1991 economic liberalisation. GST,
proposed to be rolled out from 1st July 2017, will have a four-tier structure with rates ranging from 5% to 28%.
But regrettably, a large chunk of the economy, which includes real estate, electricity, alcohol and petroleum
products, is out of GST.
●
It brings benefits to all the stakeholders of industry, government and the consumer.
●
It will lower the cost of goods and services, give a boost to the economy and make the products and services
globally competitive.
●
GST aims to make India a common market with common tax rates and procedures and remove the
economic barriers thus paving the way for an integrated economy at the national level.
●
By subsuming most of the Central and State taxes into a single tax and by allowing a set-off of prior-stage taxes
for the transactions across the entire value chain, it would mitigate the ill effects of cascading, improve
competitiveness and improve the liquidity of the businesses.
●
GST is a destination based tax.
●
It follows a multi-stage collection mechanism.
●
In this, the tax is collected at every stage and the credit of tax paid at the previous stage is available as a set off
at the next stage of the transaction.
●
This shi s the tax incidence near to the consumer and benefits the industry through better cash flows and
better working capital management.
●
It will not drastically reduce the ‘Current Account Deficit’ of India.
●
It will not enormously increase the growth and size of the economy of India and will not overtake China
in the near future.
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Q.6) With reference to India's decision to levy an equalization tax of 6% on online advertisement services
offered by non-resident entities, which of the following statements is/are correct?
2018
1. It is introduced as a part of the Income Tax Act.
2. Non-resident entities that offer advertisement services in India can claim a tax credit in their home country under
the "Double Taxation Avoidance Agreements".
Select the correct answer using the code given below:
[A] None
[B] 2 only
[C] Both 1 and 2
[D] 1 only
Ans.6)Correct Option: (a)
Explanation:
●
The government’s decision to levy an equalisation tax of 6 per cent on online advertisement services offered in
the country by non-resident entities will impact users, especially start-ups that rely almost entirely on the
online world to popularize their services. Further, as the levy is not introduced as part of the Income Tax Act
but as separate legislation under the Finance Bill, global firms that offer such services in India cannot claim a
tax credit in their home country under the double taxation avoidance agreements.
●
Finance Minister Arun Jaitley during Budget speech said that “In order to tap tax on income accruing to foreign
e-commerce companies from India it is proposed that a person making a payment to a non-resident (global
advertising platform), who does not have a permanent establishment, exceeding in aggregate Rs.1 lakh in a
year, as consideration for online advertisement will withhold tax at 6 per cent of gross amount paid, as
equalisation levy”.
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1. Budget
3
2. Objectives of Budget
3
3. Rational of Budget
3
4. Receipt and Expenditure
3
5. Revenue Budget
4
5.1. Revenue Receipt
4
5.2. Revenue Expenditure
6
5.3. Revenue Deficit
7
5.4. Effective Revenue Deficit
8
5.5. Implications of Revenue Deficit
8
6. Capital Budget
6.1. Capital Receipt
9
9
6.2. Capital Expenditure
10
6.3. Capital Deficit
11
7. Deficit Measurement in India
11
7.1. Budget Deficit
12
7.2. Fiscal Deficit
12
7.2.1. Adverse Impact of Fiscal Deficit
13
7.2.2. Measures to Reduce Fiscal Deficit
13
7.3. Primary Deficit
13
7.4. Monetized Deficit
14
8. Significance of different measures of deficit
15
9. Deficit Financing
16
9.1. Need of Deficit Financing
17
9.2. Means of Deficit Financing
17
9.2.1. Borrowing from External Sources
17
9.2.2. Borrowing from Internal Sources
17
9.2.3. Printing new Currency
17
9.3. Effect of Deficit Financing
18
9.3.1. Advantage of Deficit Financing
18
9.3.2. Disadvantage of Deficit Financing
18
10. Fiscal Policy
10.1. Importance of Fiscal Policy in India
19
20
11. Fiscal Consolidation
20
12. Fiscal Responsibility and Budget Management (FRBM) Act 2003
20
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12.1. Target by FRBM Act 2003
21
12.2. Amendments to FRBM Act 2012
22
12.3. N K Singh Committee Review of FRBM
22
13. Types of Budget
24
13.1. Zero Base Budgeting
24
13.2. Performance Budget
25
13.3. Outcome Budget
25
13.4. Balanced Budget
25
13.5. Surplus Budget
25
13.6. Deficit Budget
26
13.7. Gender Budget
26
13.8. Golden Rule of Budgeting
26
14. Ways and Means Advances(WMA)
27
15. Public Debt or Sovereign Debt
27
16. Public Debt Management of the Union Government in India
29
16.1.Institutions responsible for the management of public debt
17. Fiscal federalism
17.1. Division of functions and resource
18. Finance Commission
18.1. Fourteen Finance Commission
19. Other Terms
29
30
30
32
33
34
19.1. Fiscal Drag
34
19.2. Consolidated Fund of India
34
19.3. Consolidated Fund of India
35
19.4. Fiscal Neutrality
35
19.5. Twin Deficit
35
20. UPSC CSE PRELIMS Previous Years Questions
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2
1. Budget
●
It is an annual financial statement of the estimated receipt and expenditure of the government for the
forthcoming financial year.
●
It is the annual plan of the government. It reveals the government strategy and policy to achieve the national
objective (socio-economic objectives).
●
As per Article 112 of the constitution, it is the duty of the president to ensure the presentation of annual
financial statements in both the house of the parliament before the commencement of every financial year.
●
Under Article 112 of the Constitution of India, the Annual Financial Statement has to distinguish expenditure
of the Government on revenue account from other expenditures.
●
Government Budget, therefore, comprises the Revenue Budget and Capital Budget.
2. Objectives of Budget
●
To stimulate economic growth.
●
Redistribution of Income( Reducing inequalities).
●
Optimal allocation of resources.
●
Employment generation of poverty reduction.
3. Rational of Budget
●
To ensure transparency in public finance.
●
To ensure accountability of the government.
●
To ensure advance planning.
●
To ensure financial control of the legislation over the executive.
4. Receipt and Expenditure
●
Expenditure and receipts are the two important components of the budget.
●
Receipt is accrual/receiving of money to the government by revenue and non-revenue sources.
●
Expenditure is spending made by the government in the economy.
●
Total expenditure and total receipts in any budget will be equal.
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5. Revenue Budget
●
The revenue budget involves revenue receipts and revenue expenditure. These expenditures and receipts are
related to the day to day functioning of the government.
5.1. Revenue Receipt
●
Government receipts which neither create assets nor reduce any liability nor cause any reduction in the
assets of the government.
●
They are regular and recurring in nature.
●
Essentially, these are current income receipts of the government from all sources.
●
Revenue Receipts are further classified into
❏ Tax revenue
❖ Tax Revenue will include receipts from direct tax which in the form of income tax is paid to the
government.
❖ It will also include various indirect taxes like GST and Cess levied and collected by the
government on various goods and services.
❏ Non-tax revenue
❖ Non-tax Revenue will include receipts from the government’s disinvestment process which
are nothing but the proceeds from the stake sale in various public sector undertakings.
❖ Non-tax Revenue will also include the dividend income which the government receives as a
shareholder of the various public sector undertakings.
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●
Revised Budget Estimate for 2019-20 = 18,50,101 crores.
●
Budget Estimate for 2020-21 = 20,20,926 crores.
Non Tax Revenue
Interest
Government receives interest on loans given by it be it internal lending( state
governments, union territories etc) or external lending(outside the country).
Interest receipts from these loans are an important source of non-tax revenue.
Profits and Dividends
Government earns profit from the sale proceeds of the products of public enterprises.
Government also gets dividends from its investments in other companies.
Fees
Fees refer to charges imposed by the government to cover the cost of recurring services
provided by it. Such services include both fiscal services( currency printing etc) and
general services( community service etc).
Fines and Penalties
They refer to payments that are imposed on people for breaking the law.
For example, fine for jumping red light or penalty for non-payment of tax
Grants
Government receives grants from foreign governments and international organizations.
Such grants are not a fixed source of revenue and are generally received during an
emergency such as war, flood, etc.
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5.2. Revenue Expenditure
●
All expenditures incurred by the government are either of a current kind or compulsive kind.
●
Revenue expenditure is expenditure for the normal running of the government departments and various
services, interest payments on debt, subsidies, etc.
●
It is recurring in nature.
●
Broadly, the expenditure which does not result in the creation of assets for the Government of India is treated
as revenue expenditure.
●
Revenue expenditure does not create an asset of the government nor it decreases in any liability.
●
Revised Budget Estimate for 2019-20 = 23,49,645 crores
●
Budget Estimate for 2020-21 = 26,30,145 crores
Revenue Expenditure
Interest
The interest payment is the payment by the government on the internal and external
loans taken by it.
Salaries, Pension and
These are paid by the government to government employees.
Provident Fund
Subsidies
Subsidies are incentive forwarded to sectors by the government
Defence
Defence expenditures incurred by the government
Law & order expenditures
Expenditure incurred on maintaining law and order i.e. on police & paramilitary.
Social services &
Expenditures on social services include expenditure on education, health, etc. and
General services
other social sectors) and general services include tax collection, etc.
Grants
Grants are given by the government to Indian states and foreign countries.
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5.3. Revenue Deficit
●
Revenue deficit is the gap between the consumption expenditure (revenue expenditure) of the Government
(Union or the State Governments) and its current revenues (revenue receipts).
Revenue Deficit = Revenue Expenditure - Revenue Receipt
●
It shows the extent of reduction in assets and/or increase in liabilities of the government for meeting its
current consumption expenditure.
●
Generally, the revenue deficit is shown as a percentage of the GDP for domestic as well as international
analyses.
●
Elimination of the revenue deficit has been a priority for Government, both the Union and at the State-levels,
as a revenue deficit may pre-empt resources that otherwise would be available for capital investments.
●
Revised Budget Estimate for 2019-20 = 2.4% of GDP
●
Budget Estimate for 2020-21 = 2.7% of GDP
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5.4. Effective Revenue Deficit
●
Revenue Budget includes all grants from the Union Government to the state governments/Union
territories/other bodies as revenue expenditure, even if they are used to create assets.
●
Such assets are created by the sub-national governments/bodies and are owned by them and not by the
Union Government.
●
According to the Finance Ministry, such revenue expenditures contribute to the growth in the economy and
therefore, should not be treated as unproductive in nature.
●
In the Union Budget (2011-12) a new methodology has been introduced to capture the ‘effective revenue
deficit’, which excludes those revenue expenditures (or transfers) in the form of grants for the creation of
capital assets.
●
Grants for creation of capital assets, as a concept, was introduced in the FRBM Act through the amendment in
2012.
●
The Act defines grants for creation of capital assets as grants-in-aid given by the Central Government to state
governments, autonomous bodies, local bodies and other scheme implementing agencies for the creation of
capital assets which are owned by these entities.
●
Thus, Effective Revenue Deficit is the difference between revenue deficit and grants for creation of capital
assets.
Effective Revenue Deficit = Revenue Deficit - Grants for creation of capital assets (GoCA)
●
Effective Revenue Deficit signifies that amount of capital receipts that are being used for actual consumption
expenditure of the Government.
●
Revised Budget Estimate for 2019-20 = 1.5% of GDP.
●
Budget Estimate for 2020-21 = 1.8% of GDP.
5.5. Implications of Revenue Deficit
●
It indicates the inability of the government to meet its regular and recurring expenditure.
●
It implies that the government is dissaving, i.e. the government is using savings of other sectors of the
economy to finance its consumption expenditure.
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6. Capital Budget
●
Capital Budget consists of capital receipts and capital expenditure.
●
This shows the means by which the capital is arranged and the areas where capital is spent.
6.1. Capital Receipt
●
Capital receipts refer to those receipts which either create liability
or cause a reduction in the assets of the government.
●
They are non-recurring in nature.
●
The receipts must create a liability for the government and cause a
decrease in the assets.
●
Capital receipts are used for investment purposes and supposed to
be spent on plan development by a government.
●
Revised Budget Estimate for 2019-20 = 8,48,451 crores.
●
Budget Estimate for 2020-21 = 10,21,304 crores.
Capital Receipt
Recovery of Loans
Government grants loans to state governments or union territories and also externally.
Recovery of such loans is a capital receipt as it reduces the assets of the government
Borrowings
Borrowing includes all long-term loans raised by the government through internal
borrowings(inside the country) and through external borrowings(outside the country)
Other Receipts
These include long term capital accruals like Post Office deposits, National Saving
Certificates, Kisan Vikas Patras etc.
They are treated as capital receipts as they lead to an increase in liability.
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6.2. Capital Expenditure
●
An expenditure which either creates an asset or reduces liability is
called capital expenditure.
●
The Union government defines capital expenditure as the money
spent on the acquisition of assets like land, buildings, machinery,
equipment, as well as investment in shares.
●
Revised Budget Estimate for 2019-20 = 3,48,907 crores.
●
Budget Estimate for 2020-21 = 4,12,085 crores.
Capital Expenditure
Loan Disbursals by the Government
Government grants loans to state governments or union territories and
also externally(i.e foreign countries, IMF, World Bank, etc.)
Loan Repayments by the
It consists of only the capital part of the loan repayment as interest
Government
payment on loans are included in the revenue expenditure.
Plan Expenditure
Any expenditure that is incurred on programs which are detailed under
the current (Five Year) Plan of the center or center’s advances to state for
their plans is called plan expenditure
Capital Expenditures on Defence
This consists of capital expenses for equipment purchase, modernization
of defence forces.
General Services
Government spending on providing public services like railways,
education, health, etc.
Other Liabilities of the Government
This includes repayment by the government for the received under Other
Receipts(capital receipt).
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6.3. Capital Deficit
●
When capital disbursements of the government exceed capital receipts, it leads to a Capital deficit.
●
Capital deficit term is not used in public finance or in economics.
7. Deficit Measurement in India
●
The broad measures of deficit reported by the government in India may be classified, either in terms of the
‘nature of transactions’ or on the basis of the ‘means of financing’ them.
●
The chart below elucidates a list of different types of deficits that have been and are being used in India.
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7.1. Budget Deficit
●
Budgetary deficit is the difference between all receipts and expenses in both revenue and capital account of
the government.
Budget Deficit = Total Expenditure - Total Receipt
●
The concept of Budget Deficit was abolished in the year 1997.
7.2. Fiscal Deficit
●
The fiscal deficit is the difference between revenue receipts plus non-debt capital receipts on the one side and
total expenditure including loans, net of repayments, on the other.
Fiscal deficit = Total Expenditure - ( Revenue Receipt + Non debt creating capital receipt)
= Total Expenditure - Total Receipt except borrowing
= Total expenditure – Total income (Revenue receipts + recovery of loans + other receipts)
= Total Borrowing (from any source and not just RBI)
●
It measures the gap between the government consumption expenditure including loan repayments and the
anticipated income from tax and non-tax revenues.
●
It also indicates the borrowing requirements of the government from all sources.
●
The bigger the gap the more the government will have to borrow or resort to printing money to make both
ends meet.
●
Its impact on economic development depends on the use of borrowed funds.
●
It is the most comprehensive concept of the budgetary deficit, as it takes into account the total resource
gap of the government.
●
Fiscal Deficit is calculated both in absolute terms and also as a percentage of the Gross Domestic Product
(GDP) of the country.
●
Net fiscal deficit can be arrived at by deducting net domestic lending from gross fiscal deficit.
●
Implementation of Fiscal Responsibility and Budget Management (FRBM) legislation has helped the Union and
State governments to reduce their fiscal deficits to a considerable extent.
●
Revised Budget Estimate for 2019-20 = 3.8% of GDP.
●
Budget Estimate for 2020-21 = 3.5% of GDP.
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7.2.1. Adverse Impact of Fiscal Deficit
●
It increases public debt which increases future interest liabilities.
●
It deteriorates the fiscal situation of government which adversely affect developmental expenditure.
●
It creates inflation as it increases aggregate demand in the economy.
●
It leads to crowding out which refers to a reduction in private investment due to the increase in
interest rate as a result of excessive government borrowing.
●
It increases the vulnerability of the domestic economy to economic shocks because it reduces the
government’s capacity to intervene in the economy to overcome economic shocks.
●
It adversely affects the creditworthiness of the domestic government which may destabilize the
macroeconomic situation of the country.
7.2.2. Measures to Reduce Fiscal Deficit
●
Reducing Subsidies.
●
Reducing Expenditure on General Administration - Government took some austerity measure to
reduce this expenditure like
❏ Reducing five-star hotels meeting.
❏ Appointed Expenditure Management Commision.
❏ Better use of technology like video conferencing.
●
The tax base should be broadened and exemption and reduction in taxes should be reduced.
●
Tax evasion and tax avoidance should be effectively checked.
●
Restructuring and disinvestment of the public sector enterprise.
7.3. Primary Deficit
●
Primary deficit is defined as the fiscal deficit of current year minus interest payments of the government
during the financial year.
●
It shows the fiscal situation of government during the current financial year ignoring the impact of the debt
burden of the past(borrowing by previous payment).
Primary Deficit = Fiscal Deficit - Interest Payment
●
This value ideally should be negative.
●
A shrinking primary deficit indicates progress towards fiscal health.
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●
If the primary deficit is zero, then fiscal deficit is equal to interest payment. Thus, zero primary deficits mean
that the government borrows only to make interest payments.
●
The Budget document mentions primary deficit as a percentage of GDP.
●
Revised Budget Estimate for 2019-20 = 0.7% of GDP.
●
Budget Estimate for 2020-21 = 0.4% of GDP.
7.4. Monetized Deficit
●
Monetized Deficit measures the borrowing of the government from the central bank(RBI) during the
financial year.
●
In other words, the term refers to the purchase of government bonds by the central bank to finance the
spending needs of the government.
●
Since borrowings from the RBI can be both short-term and long-term, therefore, the monetized deficit is the
sum of the net issuance of short-term treasury bills, dated securities (that is, long-term borrowing from the
RBI) and rupee coins held exclusively by the RBI, net of Government’s deposits with the RBI.
●
Monetized Deficit leads to the printing of currency(i.e increase in M0) which increases the money supply by
multiple magnitudes. So it is highly inflationary.
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8. Significance of different measures of deficit
Deficit Measure
Significance
Fiscal Deficit
Widely used as a summary indicator of the macroeconomic impact of the budget in several
industrialized countries.
This measure has been adopted by the IMF as the principal policy target in their programs.
In India, the government began to report the fiscal deficit only a er 1991.
Since the shortfall in receipts over expenditure must be covered through borrowing,
therefore, Gross Fiscal Deficit, gives the overall borrowing requirements of the government
over a given financial year.
And thus shows the net addition to the level of public debt during a financial year.
Monetized Deficits
Monetization of deficits, which increases the money supply, is inflationary if the rate of
growth of money supply is greater than the rate of increase of the demand for cash balances
arising from the growth of the economy.
Thus, monetized deficits are an important indicator of the inflationary impact of the increase
in the government’s budgetary deficits.
Primary Deficits
It excludes the burden of the past debt and shows the net increase in the government’s
indebtedness due to the current year’s fiscal operations.
A reduction in the primary deficit is reflective of the government’s efforts at bridging the
fiscal gap during a financial year.
Revenue Deficit
A positive revenue deficit implies that the government is resorting to borrowing to finance
current consumption.
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9. Deficit Financing
●
Deficit financing refers to generating funds to finance the deficit which results from an excess of expenditure
over revenue.
●
So whenever the expenditure of the government exceeds its revenue then the government contemplates the
process of deficit financing.
●
It is a temporary arrangement of the funds through various methods like borrowing from the public by the
sale of bonds or by printing new money
●
Two important characteristics of deficit financing.
❏ Financing of the budget deficit.
❏ This financing is done by the increase in money supply.
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9.1. Need of Deficit Financing
●
For developing countries like India, higher economic growth is a priority. Higher economic growth requires
greater spending. Since the private sector will not make such a huge expenditure.
●
Therefore, the responsibility to raise financial resources to finance economic development rests solely on the
government.
●
Deficit Financing enables the government to obtain the necessary resources for the development plans.
9.2. Means of Deficit Financing
●
The deficit financing by the government is done in the following ways:
9.2.1. Borrowing from External Sources
●
Borrowing from External Sources includes borrowing from developed countries and international
institutions like the World Bank, IMF, etc.
●
Advantages of External borrowing are:
❏ External borrowing brings in foreign currency and gives government additional capacity to
fulfill its developmental requirements both inside as well as outside the country.
❏ It is preferred over the internal borrowings due to the ‘crowding out effect’. This reduces
private investment due to the increase in interest rate as a result of excessive government
borrowing.
9.2.2. Borrowing from Internal Sources
●
Borrowing from Internal Sources includes borrowing from RBI, General Public, Ad-hoc Treasury Bills &
government bonds etc.
●
It hampers the investment prospects of the public and the corporate sector.
9.2.3. Printing new Currency
●
Printing Currency is the last resort for the government in managing its fiscal deficit.
●
The biggest drawback of printing currency is that with it the government cannot go for the
expenditures which are to be made in the foreign currency and its increases money supply thus
resulting in inflation.
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9.3. Effect of Deficit Financing
●
The deficit financing by government has following effect:
9.3.1. Advantage of Deficit Financing
●
Deficit financing does not take away any money from taxpayer pocket and yet provides massive
resources to the government.
●
In India, deficit financing involves borrowing from the Reserve Bank of India, Interest payments to the
RBI against this borrowing come back to the Government of India in the form of a dividend.
●
Financial resources that government needs to mobilize through deficit financing are certain and
known beforehand.
9.3.2. Disadvantage of Deficit Financing
●
Increase in inflation due to the increase in the supply of money in the economy.
●
Decrease in average consumption level due to higher inflation.
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●
Increase in income disparities, deficit financing-led inflation helps producing classes and businessmen
to flourish. But fixed-income earners suffer during inflation.
●
Deficit financing effects investment adversely. When there is inflation in the economy, employees
demand higher wages. If their demands are accepted, it increases the cost of production which
de-motivates the investors.
10. Fiscal Policy
●
Fiscal policy is defined as the policy that handles the use of government revenue collection(taxes or non-tax)
and expenditure (spending) to influence a country's economy.
●
Fiscal policy is the guiding force that helps the government in deciding how much money it should spend to
support the economic activity, and how much revenue it must earn, for the smooth functioning of the
economy.
●
Fiscal policy, along with monetary policy, plays an important role in managing a country’s economy.
●
Fiscal policy is based on the theories of British economist John Maynard Keynes.
●
Main objectives of Fiscal Policy :
❏
Economic growth: Fiscal policy helps maintain the economy’s growth rate so that the government
can achieve its economic goals.
❏ Price stability: It controls the price level of the economy so that when the inflation is too high, prices
can be regulated.
●
There are two types of fiscal policy:
❏ Expansionary Fiscal Policy:
❖ It stimulates economic growth because the government either spends more, cut taxes or both.
❖ It puts more money into the consumers' hands, so they spend more which increases the
demand.
❏ Contractionary Fiscal Policy:
❖ The contractionary fiscal policy goal is to slow the economic growth and stamp out inflation.
❖ Government increases the tax and cut its spending.
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10.1. Importance of Fiscal Policy in India
●
In a country like India, fiscal policy helps to accelerate the rate of economic growth by raising the rate of
investment in public as well as private sectors.
●
The fiscal policy helps mobilise considerable amount of resources(through taxation) for financing its economic
activity.
●
The fiscal policy encourages the investment into those productive sectors which are considered socially and
economically desirable.
11. Fiscal Consolidation
●
Fiscal Consolidation refers to the policies undertaken by Governments (national and sub-national levels) to
reduce their deficits and accumulation of debt stock.
●
Fiscal consolidation is a process where the government’s fiscal health improves which is indicated by
lowering of fiscal deficit.
●
In India, fiscal consolidation or the fiscal roadmap for the government is expressed in terms of the budgetary
targets i.e fiscal deficit targets and revenue deficit targets.
●
Measures to achieve fiscal consolidation
❏ Improves tax revenue and minimizes tax avoidance
❏ Broadening the tax base and minimizing tax concessions and exemptions.
❏ Better targeting of government subsidies and increasing use of Direct Benefit Transfer(DBT)
12. Fiscal Responsibility and Budget Management (FRBM) Act 2003
●
Fiscal Responsibility and Budget Management (FRBM) became an Act in 2003.
●
It provides a legal institutional framework for fiscal consolidation.
●
The objective of the Act is to ensure
❏ Equity in fiscal management
❏ Macroeconomic stability
❏ Better coordination between fiscal and monetary policy
❏ Transparency in the fiscal operation of the Government
●
It makes mandatory for the Central government to take measures to reduce fiscal deficit, to eliminate
revenue deficit and to generate revenue surplus in the subsequent years.
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●
The Act binds not only the present government but also the future Government to adhere to the path of fiscal
consolidation.
●
The Government can move away from the path of fiscal consolidation only in case of natural calamity,
national security and other exceptional grounds which the Central Government may specify.
●
The Finance Minister has to explain the reasons and suggest corrective actions to be taken, in case of a breach.
●
Further, the Act prohibits borrowing by the government from the Reserve Bank of India, thereby, making
monetary policy independent of fiscal policy.
●
The Act also requires the government to lay before the parliament three policy statements in each financial
year namely
❏ Medium Term Fiscal Policy Statement
❖
It sets out three-year rolling targets for five specific fiscal indicators in relation to GDP at
market prices, namely,
(i) Revenue Deficit
(ii) Effective revenue deficit,
(iii) Fiscal Deficit,
(iv) Tax to GDP ratio
(v) Total outstanding Debt as a percentage of GDP
❏ Fiscal Policy Strategy Statement
❖ It outlines the strategic priorities of Government in the fiscal area for the financial year relating
to taxation, expenditure, lending and investments, administered pricing, borrowings and
guarantees.
❏ Macroeconomic Framework Policy Statement
❖
It contains an assessment regarding the expected GDP growth rate, fiscal balance of the
Central Government and the external sector balance of the economy.
●
To impart fiscal discipline at the state level, the Twel h Finance Commission gave incentives to states through
conditional debt restructuring and interest rate relief for introducing Fiscal Responsibility Legislations (FRLs).
All the states have implemented their own FRLs.
12.1. Target by FRBM Act 2003
●
The FRBM rule specifies a reduction of fiscal deficit to 3% of the GDP by 2008-09
●
Fiscal deficit annual reduction target of 0.3% of GDP per year by the Central government.
●
Revenue deficit to be completely eliminated by 2008-09.
●
Revenue deficit has to be reduced by 0.5% of the GDP per year.
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●
Total Debt to be reduced to 9% of the GDP with an annual reduction of 1% of GDP.
●
It bans the purchase of primary issues of the Central Government securities by the RBI a er 2006.
12.2. Amendments to FRBM Act 2012
●
Through Finance Act 2012, amendments were made to the Fiscal Responsibility and Budget Management Act,
2003 through which it was decided that in addition to the existing three documents, Central Government shall
lay another document - the Medium Term Expenditure Framework Statement (MTEF).
●
Amendments to the FRBM Act were introduced subsequent to the recommendations of the 13th Finance
Commission.
●
Two important features of the amendment to FRBM Act in the direction of expenditure reforms are:
❏ Effective Revenue Deficit
❏ Medium Term Expenditure Framework - It will set forth a three-year rolling target for expenditure
indicators.
●
As per the amendments in 2012, the Central Government has to take appropriate measures to reduce the
❏ Fiscal deficit to be reduced to 3% of GDP by 2015.
❏ Revenue deficit to be reduced to less than 2% of GDP by 2015
❏ Effective revenue deficit to eliminate by the 31st March 2015
12.3. N K Singh Committee Review of FRBM
●
Government of India constituted the Committee in 2016 to review the implementation of the FRBM Act under
the Chairmanship of N.K. Singh.
●
Recommendation of the committee:
❏ Public debt to GDP ratio
❖ It should be considered as a medium-term anchor for fiscal policy in India.
❖ The combined debt-to-GDP ratio of the centre and states should be brought down to 60 per
cent by 2023 (comprising of 40 per cent for the Centre and 20% for states).
❏ Fiscal deficit
❖ The Committee advocated fiscal deficit as the operating target to bring down public debt.
❖ For fiscal consolidation, the centre should reduce its fiscal deficit from the current 3.5% (2017)
to 2.5% by 2023.
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❏ Revenue deficit
❖ The Committee also recommends that the central government should reduce its revenue
deficit steadily by 0.25 percentage (of GDP) points each year, to reach 0.8% by 2023, from a
projected value of 2.3% in 2017.
❏ Independent Fiscal Council
❖ It recommended setting up an independent Fiscal Council.
❖ The Council will provide several advisory functions.
❖ It will forecast key macro variables like real and nominal GDP growth, tax buoyancy,
commodity prices.
❏ Escape Clause
❖ The committee recommends fiscal flexibilities to go above or below the fiscal deficit targets in
the form of ‘escape clauses’.
❖ The Committee set 0.5% as escape clause for fiscal deficit target.
❏ Fiscal consolidation responsibility for states
❖ The Committee observes that the state government’s fiscal position is important a er greater
resource transfer to them (Fourteenth finance Commission award).
❖ State Government should bring down their debt target to 20% of GDP from the current 21%.
❏ Congruence of Fiscal and Monetary Policy
❖ The FRBM Review Committee observed that both monetary and fiscal policies must ensure
growth and macroeconomic stability.
●
Annual targets as recommended by the committee as follows:
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Year
Debt/GDP
Fiscal Deficit
Revenue Deficit
2017-18
47.3
3.0
2.1
2018-19
45.5
3.0
1.8
2019-20
43.7
3.0
1.6
2020-21
42.0
2.8
1.3
2021-22
40.3
2.6
1.1
2022-2023
38.7
2.5
0.80
13. Types of Budget
13.1. Zero Base Budgeting
●
Under Zero Based Budgeting, Ministries have to justify expenditure on every project on the basis of its merit
(cost-benefit analysis) annually afresh.
●
Zero-based budgeting starts from zero, rather than a traditional budget that is based on previous budgets.
●
Zero Base Budgeting was developed by Peter Pyhrr in the 1970s India adopted it in practice in 1997-99.
●
The main benefit of Zero-base budgeting are:
❏ Efficient allocation of resources, as it is based on cost and benefits.
❏ Prioritising allocation of resources is another feature of ZBB
❏ ZBB allows close examination and scrutiny of each programme and public spending.
❏ ZBB helps policymakers to achieve more cost-effective delivery of public services.
●
Limitation of Zero-base budgeting are:
❏ There is certain expenditure which violates cost-benefit analysis i.e defence, foreign relation etc.
❏ Zero base budgeting is too complex it needs detailed attention and analysis.
❏ There are certain expenditure upon which the government/parliament does not have the power of
scrutinize( charged expenditure in India)
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13.2. Performance Budget
●
Performance-based budgeting is the practice of developing budgets based on the relationship between
input cost and expected results.
●
The major aim of performance budgeting is to improve the efficiency of public expenditure since financial
resources are allocated according to purposes and objectives.
●
From 2007-08 onwards, the Performance Budget was merged with the Outcome Budget. There is only one
document i.e. the Outcome Budget.
13.3. Outcome Budget
●
The Outcome Budget is a report on what various Ministries and Departments have done with the outlays in the
previous annual budget.
●
It measures the development outcomes of all government programs and whether the money has been
spent for the purpose it was sanctioned.
●
Outcome Budget was first introduced in India in 2005-06. Since then Government has continued to release
annual Outcome Budget reports with incremental changes and without any reference to the previous year’s
performance.
●
All Ministries have to prepare outcome budgets to make the budgeting target oriented.
13.4. Balanced Budget
●
A government budget is said to be a balanced budget if the estimated government expenditure is equal to
expected government receipts in a particular financial year.
●
It is a budget that has no budget deficit, but could have a budget surplus.
13.5. Surplus Budget
●
A government budget is said to be a surplus budget if the expected government revenues exceed the
estimated government expenditure in a particular financial year.
●
Budget surpluses are quite rare in modern economies because of the temptation for the government to spend
more money and cut taxes.
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13.6. Deficit Budget
●
A government budget is said to be a deficit budget if the estimated government expenditure exceeds the
expected government revenue in a particular financial year.
●
This type of budget is best suited for developing countries like India.
●
Deficit budget helps generate additional demand and boost the rate of economic growth.
●
Here, the government incurs excessive expenditure to improve the demand for goods and services which
helps in reviving the economy.
13.7. Gender Budget
●
Gender budgeting is a way for governments to promote equality through fiscal policy.
●
It involves analysing a budget’s impacts on men and women and allocating resources accordingly.
●
The rationale for gender budgeting arises from the recognition of the fact that national budgets impact men
and women differently through the pattern of resource allocation.
●
Women constitute 48% of India’s population, but they lag behind men on many social indicators like health,
education, economic opportunities, etc.
●
Hence, they warrant special attention due to their vulnerability and lack of access to resources.
●
Since 2005-06, the Expenditure Division of the Ministry of Finance has been issuing a note on Gender
Budgeting as a part of the Budget Circular every year.
13.8. Golden Rule of Budgeting
●
The golden rule of budgeting states that a government must only borrow to invest, not to finance existing
spending.
●
In other words, the government should borrow money only to fund investments that will benefit countries'
economies, and current spending must be covered and funded by existing taxes.
●
The golden rule of budgeting is that the government's budget should have no revenue deficit.
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14. Ways and Means Advances(WMA)
●
The Reserve Bank of India (RBI) gives temporary loan facilities to the central and state governments. This
loan facility is called Ways and Means Advances (WMA).
●
The Ways and Means Advances scheme was introduced in 1997 to meet the mismatches in the receipts and
payments of the government.
●
The limits for Ways and Means Advances are decided by the government and RBI mutually and revised
periodically.
●
The WMA is a loan facility from the RBI for 90 days only.
●
Interest rate for WMA is currently charged at the repo rate.
●
If the WMA exceeds 90 days, it would be treated as an overdra (interest rate on overdra s is 2 percentage
points more than the repo rate).
●
There are two types of Ways and Means Advances
❏ Special WMA or Special Drawing Facility
❖ It is provided against the collateral of the government securities held by the state.
❖ The interest rate for SDF is one percentage point less than the repo rate.
❏ Normal WMA
❖ These are unsecured advances extended at the bank rate.
❖ A er the exhaustion of the special Drawing Facility limit, the Government is provided with a
normal WMA.
15. Public Debt or Sovereign Debt
●
Public debt is the total amount borrowed by the government of a country.
●
Article 292 of the Indian Constitution states that the Government of India can borrow amounts specified by
the Parliament from time to time.
●
Since the Union government relies heavily on market borrowing to meet its operational and developmental
expenditure, the study of public debt becomes key to understand the financial health of the government.
●
Government Debt as a percentage of GDP is used by investors to measure a country's ability to make future
payment on its debt.
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●
In India, total Central Government Liabilities constitutes the following two categories;
❏ Internal Debt
❖ Internal debt or domestic debt is the part of the total government debt in a country that is
owed to lenders within the country.
❖ It is the money that government borrows from its own citizens.
❖ Internal debt constitutes more than 93% of the overall public debt.
❖ The major instruments covered under Internal Debt are as follows:
➢ Dated Securities
➢ Treasury-Bills
➢ Securities issued against ‘Small Saving
➢ Market Stabilization Scheme (MSS) Bonds
❏ External Debt
❖ External debt is owed to creditors outside the country.
❖ The outsider creditors can be foreign governments, International Financial Institutions such as
the IMF etc.
❖ The major instruments covered under External Debt are as follows:
➢ Commercial Borrowing
➢ NRI Deposit
➢ Multilateral Debt - Debt from multilateral institutions like ADB, IBRD etc.
➢ Long and Short Term Debt
❖ Commercial Borrowing has the highest share in total external debt, followed by NRI deposit
and short term debt.
❖ The share of US dollar-denominated debt has the highest share in external debt followed by
Indian rupee, SDR, Japanese Yen and Euro.
●
Total liabilities of the Central Government, as a ratio of GDP, has been consistently declining, particularly
a er the enactment of the FRBM Act, 2003.
●
This is an outcome of both fiscal consolidation efforts as well as relatively high GDP growth.
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16. Public Debt Management of the Union Government in India
●
The overall objective of the Central Government’s debt management policy, as laid out by the Central
Government's status paper in November 2010 is to “meet Central Government’s financing needs at the lowest
possible long term borrowing costs and also to keep the total debt within sustainable levels.
●
As per the Fiscal Policy Strategy Statement of 2012-13 the public debt management policy of the Government
is driven by the principle of gradual reduction of public debt to GDP ratio.
●
This is with the objective of further reducing the debt servicing risk and to create fiscal space for
developmental expenditure.
●
On the financing side, the Government policy focuses on the following principles
❏ Greater reliance on domestic borrowings over external debt,
❏ Preference for market borrowings over instruments carrying administered interest rates,
❏ Consolidation of the debt portfolio and
❏ Development of a deep and wide market for Government securities to improve liquidity in secondary
market.
16.1.Institutions responsible for the management of public debt
●
The Constitution of India gives the executive branch of government the powers to borrow upon the security of
the Consolidated Fund of India.
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●
Reserve Bank as an agent of the Government (both Union and the States) used to implement the borrowing
program.
●
The Reserve Bank draws the necessary statutory powers for debt management from Section 21 of the
Reserve Bank of India Act, 1934.
●
While the management of the Union Government's public debt is an obligation for the Reserve Bank, the
Reserve Bank undertakes the management of the public debts of the various State Governments by
agreement.
●
The jurisdiction of various institutions responsible for public debt management is given below:
❏ Reserve Bank of India – Domestic Marketable Debt i.e., dated securities, treasury bills and cash
management bills.
❏ Ministry of Finance (MOF); Office of Aid and accounts Division – External debt
❏ Ministry of Finance; Budget Division and Reserve Bank of India – Other liabilities such as small
savings, deposits, reserve funds etc.
17. Fiscal federalism
●
Fiscal federalism deals with the division of governmental functions and financial relations among different
levels of government.
●
The objective of fiscal federalism is to enable the national and sub-national governments to operate in such a
way that leads to efficiency in the use of resources and also create an environment in which all economic
agents use resources efficiently.
●
The history of fiscal federalism in modern India goes back to the Government of India Acts of 1919 and 1935.
●
While the Act of 1919 provided for a separation of revenue heads between the Center and the provinces, the
1935 Act allowed for the sharing of Center’s revenues and for the provision of grants-in-aid to provinces.
17.1. Division of functions and resource
●
The Indian Constitution, under Article 246 and Seventh Schedule, distributed powers and allotted subjects
to the Union and the states.
●
The Indian Constitution has provided for a certain division of the powers of taxation between the Union and
states, and also gives the states a share in the resources available to the Centre.
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●
Federal transfers to the states in India are made in three streams, as
(1) Devolution of states share in Central Taxes
(2) Grants from Central to the states - Further classified as statutory or non-statutory, and plan as
well as non-plan.
(i) Non-Plan grants –
i. Statutory grants recommended by the Finance Commission to cover the gap in
revenue;
ii. Assistance for relief measures a er natural calamities
(ii) Non Statutory grants, comprising –
i. Plan grants(a) State plan schemes
(b) Central plan schemes
(c) Centrally sponsored schemes
(d) Special schemes for North Eastern council etc
(3) Loans from Centre
a. Plan loans
b. Non Plan loans including Ways and Means Advance
●
Fiscal relations in India between the union and state governments have undergone significant changes in
recent years.
●
Three landmark changes in union-state fiscal relations since 2015-16 have been:
❏ The abolition of the Planning Commission in January 2015 and the subsequent creation of the NITI
Aayog;
❏ Fundamental changes in the system of revenue transfers from the centre to the states by providing
higher tax devolution to the states from the fiscal year 2015-16 onwards based on the
recommendations of the Fourteenth Finance Commission (14th FC); and
❏ The Constitutional amendment to introduce the Goods and Services Tax (GST) and the
establishment of the GST Council for the central and state governments to deliberate and jointly take
decisions.
●
Both in absolute terms, and as a percentage of GDP, total transfers to States have risen between 2014-15 and
2019- 20.
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18. Finance Commission
●
The Finance Commission is a constitutional body that is formed once in five years, and provides
recommendations on centre-state financial relations
●
Set up under Article 280 of the Constitution by the President of India, its core responsibilities are:
❏ To evaluate the state of finances of the Union and State Governments,
❏ Recommend the sharing of taxes between them,
❏ Lay down the principles determining the distribution of these taxes among States.
●
The first Finance Commission was set up in 1951 and there have been fi een so far.
●
The Finance Commission is also required to recommend on the measures needed to augment the
Consolidated Fund of a State to supplement the resources of the Panchayats and Municipalities in the State on
the basis of the recommendations made by the Finance Commission of the State.
●
The recommendations made by the Finance Commission are advisory in nature and, hence, not binding on
the Government.
●
The Fi eenth Finance Commission was constituted in 2017 under the chairmanship of N.K. Singh.
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18.1. Fourteen Finance Commission
●
The 14th Finance Commission was constituted in 2014 under the chairmanship of former RBI governor Y V
Reddy.
●
Recommendations of the 14thCommission include:
a. Devolution of taxes to states:
●
Tax devolution should be the primary source of transfer of funds to states. The share of taxes
of the centre to states is recommended to be increased from 32% to 42%.
●
Additional budgetary needs of the states will be filled by grants-in-aid to the states.
b. Weights of indicators for share in taxes:
●
The weights of various indicators in the calculation of states’ share of taxes have been fixed at
the following:
Criteria
Weight (%)
Income Distance( distance of state’s income from
50%
the state having the highest income)
Population (1971)
17.5%
Area
15% for general weight
2% for smaller states,
Demographic Change (2011)
10%
Forest Cover
7.5%
c. Fiscal deficit:
●
Fiscal deficit of states should be aimed at 3% of the Gross State Domestic Product (GSDP)
during the period 2015 to 2020.
●
States will be eligible for flexibility of 0.25% over this limit.
●
They will be eligible for this flexibility if their debt-GSDP ratio is less than or equal to 25% in the
previous year.
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d. Grants to local governments:
●
Grants to local governments should be in two parts-a basic grant and a performance grant.
●
For gram panchayats,
❏ 90% of the share will be basic grants,
❏ 10% will be performance grants.
●
For municipalities,
❏ basic grants 80% of the total grants
❏ performance grants will constitute 20% of the total grants.
e. Amendments to the FRBM Act:
●
The FRBM Act, 2003 should be amended, remove the definition of effective revenue (the
difference between revenue deficit and grants for creation of capital assets).
19. Other Terms
19.1. Fiscal Drag
●
Fiscal drag is an economic term whereby inflation or income growth moves taxpayers into higher tax
brackets.
●
This in effect increases government tax revenue without actually increasing tax rates.
●
The increase in taxes reduces aggregate demand and consumer spending from taxpayers as a larger share of
their income now goes to taxes, which leads to deflationary policies, or drag, on the economy.
19.2. Consolidated Fund of India
●
Under Article 266 (1) of the Constitution of India, all revenues ( example tax revenue as well as non-tax
revenue) received by the Union government as well as all loans raised by issue of treasury bills, internal and
external loans and all moneys received by the Union Government in repayment of loans shall form a
consolidated fund entitled the 'Consolidated Fund of India' for the Union Government.
●
The government cannot spend from the Consolidated Fund unless the expenditure is voted in the lower
house of Parliament.
●
The Comptroller and Auditor General of India audit these Funds and reports to the Union/State legislatures
when proper accounting procedures have not been followed.
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19.3. Consolidated Fund of India
●
According to Article 112 (3) and Article 202 (3) of the Constitution of India, the following expenditure does
not require a vote and is charged to the Consolidated Fund.
●
They include
❏ Salary, allowances and pension for the President as well as Governors of States, Speaker and Deputy
Speaker of the House of People, the Comptroller General of India and Judges of the Supreme and High
Courts.
❏ Interest and other debt-related charges of the Government and any sums required to satisfy any court
judgment pertaining to the Government.
19.4. Fiscal Neutrality
●
Fiscal neutrality occurs when taxes and government spending are neutral, with neither affecting demand.
●
Fiscal neutrality creates a condition where demand is neither stimulated nor diminished by taxation and
government spending.
●
A balanced budget is an example of fiscal neutrality, where government spending is covered almost exactly by
tax revenue – in other words, where tax revenue is equal to government spending.
19.5. Twin Deficit
●
Twin deficit occurs when a country has both a current account deficit and a fiscal deficit.
●
It is also called a double deficit.
●
India is an example of country with twin deficit.
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20. UPSC CSE PRELIMS Previous Years Questions
●
Now, let's check how many questions can you attempt?
Q.1) In India, deficit financing is used for raising resources for
2013
[A] Economic development
[B] Redemption of public debt
[C] Adjusting the balance of payments
[D] Reducing foreign debt
Ans.1)Correct Option: (a)
Explanation:
●
Deficit financing is a pragmatic tool of economic development and has been used by the Indian government to
obtain necessary resources to finance the five-year plans.
Q.2) With reference to Union Budget, which of the following is/are covered under Non-Plan Expenditure?
2014
1. Defence -expenditure
2. Interest payments
3. Salaries and pensions
4. Subsidies
Select the correct answer using the code given below.
[A] 1 only
[B] 2 and 3 only
[C] 1, 2, 3 and 4
[D] None
Ans.2) Correct Option : (c)
Explanation:
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●
There are two components of expenditure - plan and non-plan.
●
Of these, plan expenditures are estimated a er discussions between each of the ministries concerned and the
Planning Commission.
●
Non-plan revenue expenditure is accounted for by interest payments, subsidies (mainly on food and
fertilisers), wage and salary payments to government employees, grants to States and Union Territories
governments, pensions, police, economic services in various sectors, other general services such as tax
collection, social services, and grants to foreign governments.
●
Non-plan capital expenditure mainly includes defence, loans to public enterprises, loans to States,
Union Territories and foreign governments.
Q.3) With Reference to the Fourteenth Commission, which of the following statements is/are correct?
2015
1. It has increased the share of States in the central divisible pool from 32 per cent to 42 per cent
2. It has made recommendations concerning sector-specific grants
[A] 1 only
[B] 2 only
[C] Both 1 and 2
[D] Neither 1 nor 2
Ans.3) Correct Option: (c)
Explanation:
●
The 14th commission has recommended to increase the tax devolution of the divisible pool to states to
42% for the years 2015 to 2020. This is 10% more compared to 32% target set by 13th financial commission.
●
The 14th commission has recommended expansion of Interstate council for cooperative federalism to
identify sector-specific grants to states.
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Q.4) There has been a persistent deficit budget year a er year. Which of the following actions can be taken by
the government to reduce the deficit?
2015
1. Reducing revenue expenditure
2. Introducing new welfare schemes
3. Rationalizing subsidies
4. Expanding industries
Select the correct answer using the code given below.
[A] 1 and 3 only
[B] 2 and 3 only
[C] 1 only
[D] 1,2,3 and 4
Ans.4) Correct Option : (a)
Explanation:
●
Introduction of new schemes would entail more spending and it goes just opposite to what we are trying to
do i.e. reduce the deficit.
●
So we are le with option (a) and (c).
●
Rationalising subsidies is certainly in vogue for reducing the deficit.
●
So the answer should be the option (a).
Q.5) There has been a persistent deficit budget year a er year. Which action/actions of the following can be
taken by the Government to reduce the deficit?
2016
1. Reducing revenue expenditure
2. Introducing new welfare schemes
3. Rationalizing subsidies
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4. Reducing import duty
Select the correct answer using the code given below.
[A] 1 only
[B] 2 and 3 only
[C] 1 and 3 only
[D] 1, 2, 3 and 4
Ans.5) Correct Option: (c)
Explanation:
Different policies to reduce a budget deficit.
1. Cut government spending
2. Increase in taxation
3. Economic growth
4. End tax breaks and subsidies for big oil, gas and coal companies
Q.6) Which of the following is/are included in the capital budget of the Government of India?
2016
1. Expenditure on acquisition of assets like roads, buildings, machinery, etc.
2. Loans received from foreign governments.
3. Loans and advances granted to the States and Union Territories.
Select the correct answer using the code given below.
[A] 1 only
[B] 2 and 3 only
[C] 1 and 3 only
[D] 1, 2 and 3
Ans.6) Correct Option: (d)
Explanation:
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●
Under Article 112 of the Constitution of India, the Annual Financial Statement has to distinguish expenditure
of the Government on revenue account from other expenditures.
●
Government Budget, therefore, comprises the Revenue Budget and Capital Budget.
●
Capital Budget consists of capital receipts and capital payments.
●
The capital receipts are loans raised by Government from the public, called market loans, borrowings by
Government from Reserve Bank and other parties through the sale of Treasury Bills and loans received from
foreign Governments and bodies, disinvestment receipts and recoveries of loans from State and Union
Territory Governments and other parties.
●
Capital payments consist of capital expenditure on acquisition of assets like land, buildings, machinery,
equipment, as also investments in shares, etc., and loans and advances granted by the Central Government
to State and Union Territory Governments, Government companies, Corporations and other parties.
Q.7) Consider the following statements :
2017
1. Tax revenue as a per cent of GDP of India has steadily increased in the last decade.
2. Fiscal deficit as a per cent of GDP of India has steadily increased in the last decade.
Which of the statements given above is/are correct?
[A] 1 only
[B] 2 only
[C] Both 1 and 2
[D] Neither 1 nor 2
Ans.7) Correct Option: (d)
Explanation:
●
Tax revenue as a per cent of GDP of India has not steadily increased in the last decade.
●
Fiscal deficit as the per cent of GDP of India has not steadily increased in the last decade.
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Q.8) Consider the following statements
2018
1. The Fiscal Responsibility and Budget Management (FRBM) Review Committee Report has recommended a debt to
GDP ratio of 60% for the general (combined) government by 2023, comprising 40% for the Central Government and
20% for the State Governments.
2. The Central Government has domestic liabilities of 21% of GDP as compared to that of war of GDP of the State 2
Governments.
3. As per the Constitution of India, it is mandatory for a State to take the Central Government’s consent for raising any
loan if the former owes any outstanding liabilities to the latter.
Which of the statements given above is/are correct?
[A] 1 only
[B] 2 and 3 only
[C] 1 and 3 only
[D] 1, 2 and 3
Ans.8) Correct Option: (c)
Explanation:
●
The FRBM Review Committee (Chairperson: Mr N.K. Singh) proposed a dra Debt Management and Fiscal
Responsibility Bill, 2017 to replace the Fiscal Responsibility and Budget Management Act, 2003 (FRBM Act).
●
Key recommendations of the Committee and features of the dra Bill are summarised below.
❏ Debt to GDP ratio: The Committee suggested using debt as the primary target for fiscal policy. Debt to
GDP ratio of 60% should be targeted with a 40% limit for the centre and 20% limit for the states. The
targeted debt to GDP ratio should be achieved by 2023.
❏ Deviations: The Committee noted that under the FRBM Act, the government can deviate from the
targets in case of a national calamity, national security or other exceptional circumstances notified by
it. Allowing the government to notify these grounds diluted the 2003 Act. The Committee suggested
that grounds in which the government can deviate from the targets should be clearly specified, and
the government should not be allowed to notify other circumstances.
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Q.9) Consider the following statements:
2019
1. Most of India’s external debt is owed by governmental entities.
2. All of India’s external debt is denominated in US dollars.
Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Ans.9) Correct Option: (d)
Explanation:
●
The external debt of India is the total debt the country owes to foreign creditors.
●
The debtors can be the Union government, state governments, corporations or citizens of India.
●
The debt includes money owed to private commercial banks, foreign governments, or international financial
institutions such as the International Monetary Fund (IMF) and World Bank.
●
Commercial borrowings continued to be the largest component of external debt with a share of 37.4 per cent,
followed by NRI deposits (24.1 per cent) and short term trade credit (19.9 per cent).
●
US dollar-denominated debt continued to be the largest component of India’s external debt, followed by the
Indian rupee, SDR, yen and euro.
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External Sector
1. External Sector
3
2. Forex Reserve
3
3. Exchange Rate
4
4. Exchange Rate System
4
4.1. Floating Exchange Rate System
4
4.2. Fixed Exchange Rate System
4
4.2.1. Devaluation
5
4.2.2. Revaluation
5
4.3. Managed Exchange Rate System
5
4.4. Wider Band Exchange Rate System
5
4.5. Crawling Peg Exchange Rate System
5
5. Foreign Exchange Market
6
6. Depreciation
6
6.1. Impact of Depreciation/Devaluation
6
6.1.1. Positive Impact
6
6.1.2. Negative Impact
6
6.2. Why Rupee Depreciates in recent years?
7
7. Appreciation
7
8. Exchange rate in India
8
9. Effective Exchange Rate
8
9.1. Nominal Effective Exchange Rate(NEER)
9
9.2. Real Effective Exchange Rate(REER)
9
10. Current Account
10
10.1. Current Account Deficit (CAD)
10
11. Capital Account
11
12. Balance Of Payment (BOP)
12
12.1.Importance Of BOP
13
13. Convertibility
14
13.1.Impact of Convertibility /Current Account Convertibility
14
13.1.1. Positive Impact
14
13.1.2. Negative Impact
14
13.2.Introduction of Convertibility in India
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1
13.3.Committee on Capital Account Convertibility
15
13.3.1. Tarapore Committee - 1997
15
13.3.1. Second Tarapore Committee on Capital Account Convertibility - 2006
15
14. Foreign Investment
16
15. Foreign Direct Investment(FDI)
17
15.1. Components of FDI
17
15.2. Method of FDI
17
15.3. Advantage of FDI
17
15.4. Disadvantage of FDI
18
15.5. India’s FDI Policy
18
15.6. Recent FDI Reform
19
15.7. India and FDI
19
16. Foreign Portfolio Investment(FPI)
20
16.1. Committee on Rationalisation of Roots of Portfolio Investment
21
16.2. HR Khan Committee on Foreign Portfolio Investment
21
17. Difference Between FDI vs FPI
22
18. Foreign Trade
23
18.1. Foreign trade Policy
23
18.1.1. Free Trade Policy
23
18.1.2. Protectionist Trade Policy
23
19. Export Promotion Schemes
24
20. India’s Medium Term Export Policy: Foreign Trade Policy, FTP (2015-20)
24
20.1. Objective
24
20.2. Features
25
20.3. Critical Appraisal of FTP Policy (2015-20)
26
21. Special Economic Zones (SEZ)
26
22. Reverse Special Economic Zones (R-SEZ)
27
23. International Financial Service Centre (IFSC)
27
23.1. GIFT City
27
24. Globalisation
28
24.1. Advantage
28
24.2. Disadvantage
29
25. Other Terms
29
25.1. J-Curve Effect
29
25.2. Free on Board(FOB)
29
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25.3. Hard Currency
29
25.4. So Currency
30
25.5. Hot Currency
30
25.6. Cheap Currency
30
25.7. Dear Currency
30
26. UPSC CSE PRELIMS Previous Years Questions
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3
1. External Sector
●
The external sector of a country’s economy refers to all international economic transactions between
residents of the country (both public and private sector) and the rest of the world.
●
All economic activities that take place in foreign currency fall in the external sector like import, export, capital
account, foreign investment, the balance of payment etc.
2. Forex Reserve
●
Foreign exchange reserves are the foreign currencies held by a country's central bank(RBI).
●
They are also called foreign currency reserves or foreign reserves.
●
In the context of India, Foreign Exchange Reserves include:
❏ Foreign currency assets (FCAs) - Largest component of the Forex Reserves
❏ Gold
❏ Special Drawing Rights (SDRs)
❏ RBI’s Reserve position with International Monetary Fund (IMF)
●
Forex reserves are used to back liabilities(meets its
foreign obligations) and influence monetary policy.
●
India’s foreign exchange reserves touched a record
high of $461.157 billion, in January 2020, according to
the RBI data.
●
The rise in forex reserves was mainly on account of an
increase in foreign currency assets(dominated by
dollar), which rose to $427.949 billion, gold reserves
rose to $28.058 billion, country's reserve position with
the IMF increased to $3.703 billion, special drawing
rights(SDR) were up to $1.447 billion.
●
Hence FCA > Gold > Reserve Position with IMF >
SDR.
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3. Exchange Rate
●
Exchange rate is the price of one currency in terms of another currency.
●
For Example - At present approximately Rs 71 is exchanged for the US $ 1. Hence the value of one US dollar is
equal to 71 Indian rupees.
4. Exchange Rate System
●
Exchange rate system refers to the arrangement for the movement of the exchange rate.
●
There are many ways in which the country's exchange rate is determined.
4.1. Floating Exchange Rate System
●
In Floating or Flexible Exchange rate system, Exchange Rate of currencies is determined on the basis of
demand-supply in the forex market relative to other currencies.
●
Therefore, if the demand for the currency is high, the value will increase. If demand is low, this will drive that
currency price lower.
●
A currency that uses a floating exchange rate is known as floating currency.
●
Most of the world's currencies are floating, and include the most widely-traded currencies: the United States
dollar, the Swiss franc, the euro, the Japanese yen, the pound sterling, and the Australian dollar.
●
However, even with floating currencies, central banks o en participate in the markets to attempt to influence
the value of floating exchange rates.
4.2. Fixed Exchange Rate System
●
In the Fixed or Pegged Exchange rate system, the Exchange Rate of currencies is determined by the central
bank of the country(RBI for India).
●
The purpose of a fixed exchange rate system is to keep a currency's value within a narrow limit.
●
Most countries adopted a floating exchange rate in the early 1970s a er using a fixed exchange rate for
decades.
●
A fixed exchange rate may minimize instabilities in real economic activity by reducing volatility and
fluctuations in the currency.
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4.2.1. Devaluation
●
It refers to the reduction in the value of the domestic currency in terms of foreign currency by the
central bank.
●
Countries that have a fixed exchange rate use this monetary policy tool.
●
RBI devalued Rupee three times - 1949, 1966, 1991.
4.2.2. Revaluation
●
It refers to an increase in the exchange rate of domestic currency by the central bank.
4.3. Managed Exchange Rate System
●
A managed-exchange-rate system is a hybrid or mixture of the fixed and floating exchange rate systems.
●
Under this exchange rate, the domestic currency is determined on the basis of demand and supply subject to
the central bank intervention in the forex market.
●
The central bank cannot fix the exchange rate but it can affect currency exchange rate both directly(by buying
and selling currencies) or indirectly( through monetary policy).
●
But during extreme fluctuations, the central bank under managed floating exchange rate system intervenes in
the foreign exchange market with the objective to minimise the fluctuation in the exchange rate of the
currency.
●
India adopted this form in 1993.
●
Today most of the economies are following a managed exchange rate system for determining the exchange
rate of the currency.
4.4. Wider Band Exchange Rate System
●
Under this, the central bank(RBI) fixes exchange rate bands (lower and upper limit) for the domestic currency
within which it is permitted to fluctuate.
4.5. Crawling Peg Exchange Rate System
●
Under this central bank(RBI) fixes the exchange rate band which is periodically revised.
●
It is a type of fixed exchange rate system and is followed in China.
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5. Foreign Exchange Market
●
The Foreign Exchange Market (also known as forex, FX or the currency market) is a market where different
currencies can be bought and sold.
●
Foreign Exchange market determines foreign exchange rates for every currency.
●
Foreign exchange markets are made up of central banks, commercial banks, brokers, exporters and importers,
immigrants, investors, tourists.
●
Floating exchange rate system and Managed exchange rate system used this institutional framework for
determining the exchange rate of the currency.
6. Depreciation
●
It refers to a reduction in the exchange rate of a currency due to a change in its demand and supply in the
forex market.
●
Depreciation happens under a flexible exchange rate system or under a managed floating exchange rate
system.
●
For Example, if in previous month 1$ = Rs 40 now 1$ = Rs 50, hence rupee loses its value in front of a dollar.
6.1. Impact of Depreciation/Devaluation
6.1.1. Positive Impact
●
It promotes export as it reduces the cost of a country's exports, rendering them more competitive in
the global market.
●
It discourages import as it increases the cost of imports, so domestic consumers are less likely to
purchase them, further strengthening domestic businesses.
●
It tends to reduce the trade deficit and current account deficit(CAD).
●
It promotes inward foreign remittances and foreign tourism.
●
It tends to increase forex services which strengthen the BoP situation of the country.
6.1.2. Negative Impact
●
It creates inflation as it increases forex reserve which increases the money supply and aggregate
demand.
●
It may adversely affect economic growth as it creates cost-push inflation due to increase in the
prices of inflated commodities in terms of domestic currencies.
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●
It increases the burden of external debt in terms of domestic currencies.
●
It deteriorates terms of trade( it measures the purchasing power of export of a country in terms of
quantity of imports).
6.2. Why Rupee Depreciates in recent years?
●
Supply of Rupee increased and demand of the Rupee decreased leading to a demand-supply mismatch.
●
Increase in crude oil prices which increases total import cost, India is the third-largest crude oil importing
country in the world.
●
High Trade Deficit and High Current Account Deficit(CAD).
●
The protectionist policy adopted by the major economies.
●
US Fed (Federal Funds) rate changes - A hike in the fed rates (as was observed twice in 2018), strengthens the
US Dollar, which in turn leads to a depreciation of the Indian currency.
6.3. Government/RBI measures to check depreciation of Rupee?
●
Restriction of Imports.
●
Contractionary monetary policy.
●
The liberalisation of Foreign Investment Policy.
●
Sale of the dollar in the forex market by RBI.
●
The interest rate on NRI deposits increased by RBI.
7. Appreciation
●
It refers to the increase in the value of a currency due to a change in its demand and supply in the forex
market.
●
Appreciation happens under a flexible exchange rate system or under a managed floating exchange rate
system.
●
For Example, if in previous month 1$ = Rs 65 now 1$ = Rs 50, hence rupee gains its value in front of a dollar.
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8. Exchange rate in India
●
India’s exchange rate policy has evolved over time in line with the gradual opening up of the economy as part
of the broader strategy of macroeconomic
reforms and liberalization since the early
1990s.
●
In the post-independence period, India’s
exchange rate policy has seen a shi from a
par value system to a basket-peg and further
to a managed float exchange rate system.
●
With the breakdown of the Bretton Woods
System in 1971, the rupee was linked with the
pound sterling.
●
In order to overcome the weaknesses
associated with a single currency peg and to ensure the stability of the exchange rate, the rupee, with effect
from September 1975, was pegged to a basket of currencies till the early 1990s.
●
The initiation of economic reforms, India moved to a floating currency regime which involved the dual
exchange rate system(one official and other market-determined).
●
The dual exchange rate system was replaced by a unified exchange rate system in March 1993.
9. Effective Exchange Rate
●
The effective exchange rate measures the value of the domestic currency against the weighted value of a
basket of foreign currencies, where the weights reflect the foreign countries’ share in the domestic country’s
trade.
●
It measures the strength of domestic currency with respect to currencies of major trading partners.
●
These are of two types:
❏ Nominal Effective Exchange Rate(NEER)
❏ Real Effective Exchange Rate(REER)
●
The indices of Nominal Effective Exchange Rate (NEER) and Real Effective Exchange Rate (REER) are used as
indicators of external competitiveness.
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9.1. Nominal Effective Exchange Rate(NEER)
●
Nominal Effective Exchange Rate (NEER) is the weighted average of bilateral nominal exchange rates of
the home currency in terms of foreign currencies
●
It is the exchange rate of the domestic currency with respect to the basket currencies(36 currencies),
weighted by the shares of the basket country’s trade in the domestic country’s trade.
●
The nominal exchange rate is the amount of domestic currency needed to purchase foreign
currency.
9.2. Real Effective Exchange Rate(REER)
●
Real Effective Exchange Rate (REER) is a weighted average of nominal exchange rates adjusted for
relative price differential(inflation
rate) between the domestic and
foreign countries, it relates to the
purchasing power parity (PPP)
hypothesis.
●
The REER takes into account the
relative inflation levels in two
economies and thus incorporates
the concept of purchasing power
parity.
●
An increase in REER implies that
exports become more expensive and imports become cheaper; therefore, an increase indicates a
loss in trade competitiveness.
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10. Current Account
●
The current account record a nation's transactions with the rest of the world i.e measures the inflow and
outflow of goods, services, investment incomes and transfer payments.
●
It is called the current account because goods and services are generally consumed in the current period.
●
The current account is an important indicator of an economy's health.
●
A positive current account balance(current account surplus) indicates the nation is a net lender to the rest of
the world thus increases a nation's net foreign assets.
●
A negative current account balance(current account
deficit) indicates that it is a net borrower from the rest
of the world thus it decreases a nation's net foreign
assets.
●
The current account reflects the net income of a
country.
●
Current account deficit is shown either numerically by
showing the total monetary amount of the deficit, or in
the percentage of the GDP of the economy for the
concerned year.
●
The main components of the current account are:
❏ Trade in goods (visible balance)
❏ Trade in services (invisible balance)
❏ Investment incomes - It includes dividends,
interest and remittances.
❏ Net transfers – It includes International aid etc.
10.1. Current Account Deficit (CAD)
●
Current Account Deficit measures the gap between the money received into and sent out of the country on the
trade of goods and services and also the transfer of money from domestically-owned factors of production
abroad.
●
CAD includes the trade deficit plus capital like net income and transfer payments.
●
Lower Current Account Deficit (CAD) reflects reduced external indebtedness of the country making domestic
economic policy increasingly independent of external influence.
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●
Foreign Direct Investment (FDI) provides a more stable source of financing the CAD as compared to external
borrowings.
●
The primary reasons behind high CAD in India are crude oil and gold imports.
●
The Current Account Deficit could be reduced by boosting exports and curbing non-essential imports such as
gold, mobiles, and electronics.
11. Capital Account
●
Capital account records all the transactions, between the residents of a country and the rest of the world,
which cause a change in the assets or liabilities of the residents or its government.
●
Capital Account includes the following:
❏ Foreign Direct Investment (FDI),
❏ Foreign Portfolio Investment (FPI),
❏ External Lending and Borrowing,
❏ Foreign Currency Deposit of banks,
❏ External Bonds Issued by the government of India.
●
Capital account represents the change in ownership of assets, both within the country and outside.
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●
It gives a summary of the net flow of both private and public investment into an economy.
Capital Account = Foreign Direct investment +
Foreign Portfolio Investment +
External Lending and Borrowing +
Other Investments.
●
A capital account deficit shows that more money is flowing out of the economy along with an increase in its
ownership of foreign assets and vice-versa in case of a surplus.
12. Balance Of Payment (BOP)
●
Balance of Payment is the systematic record of all economic transactions of a country/resident of a country
with the rest of the world during a financial year.
●
The components of the balance of payment are:
❏ Current account - It includes all kinds of current financial transactions of the economy.
❏ Capital account - It includes all kinds of capital financial transactions of the economy.
❏ Official reserve transactions - It conducted by the central bank in case of the BOP deficit or BOP
surplus.
❏ Errors and omissions - It refers to the balancing items reflecting the inability to record all the
international financial transactions
●
A country's balance of payments tells you whether it saves enough to pay for its imports or not.
●
Balance of Payment account is maintained as per the provision of the double-entry bookkeeping system.
Under this, every entry shown either as a credit (inflow) or debit (outflow) are made in the account for every
transaction i.e debit and credit are always equal.
●
If there is a positive outcome at the end of the year, the money is automatically transferred to the foreign
exchange reserves of the economy.
●
And if there is any negative outcome, the same foreign exchange is drawn from the country’s forex reserves. If
the forex reserves are not capable of fulfilling the negative BoP balance, it is known as a BoP crisis.
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12.1.Importance Of BOP
●
The balance of payment provides detailed information concerning the demand and supply of a country's
currency.
●
For example, India imports more than it exports, then this means that the quantity of Rupee supplied by the
domestic market is likely to exceed the quantity demanded in the foreign exchange market. Thus, Rupee
would be under pressure to depreciate against other currencies( other things being constant).
●
It examines all the export and import transactions of goods and services.
●
Balance of payments data can be used to evaluate the performance of the country in international economic
competition.
●
It helps the government to analyse the export potential of a particular sector and formulate policy to support
its export growth.
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13. Convertibility
●
It is a situation in which domestic currency can be converted into a foreign currency and vice versa at the
prevailing exchange rate without the government intervention.
●
There are two types of convertibility :
❏
Current account Convertibility
❖ The freedom to convert domestic currency into a foreign currency with respect to the current
account transaction of BOP.
❖ Example: Import/Export of goods and services, Remittances etc.
❏
Capital Account Convertibility
❖ The freedom to convert domestic financial assets/liabilities and vice-versa.
❖ Example: FDI, Loans, borrowing etc.
13.1.Impact of Convertibility /Current Account Convertibility
13.1.1. Positive Impact
●
It promotes foreign investment as it enables foreign investors to withdraw forex at will.
●
It promotes inward remittances and non-residential deposits.
●
It supplements domestic capital formation which increases output and employment in the
economy.
●
It enables domestic investors and companies to invest abroad.
●
It enables domestic firms to borrow from abroad at a relatively lower rate of interest.
●
It reduces the scope of illegal trade and financial transactions like smuggling, hawala etc.
13.1.2. Negative Impact
●
Flight of capital i.e withdrawal of huge forex within a short period of time( South Asian crisis 1997).
●
It increases the vulnerability of the domestic economy to external shocks.
●
It increases volatility in domestic financial markets.
●
It increases the scope of speculation in domestic currencies and securities.
13.2.Introduction of Convertibility in India
●
The budget 1992-93 replaced the fixed exchange rate system with the Liberalised Exchange Rate Management
System(LERMS) i.e dual exchange rate system.
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●
The Budget 1993-94 replaced the LERMS with the managed exchanged floating rate system. It also
introduced convertibility of Rupee for trade account transactions.
●
In August 1994, the government introduced current account convertibility [ it is mandatory as per Article 8 of
IMF, in case BOP situation of the member country is stable].
●
Since 1994 government and RBI has been gradually liberalising capital account convertibility(CAC) norms i.e
❏ The External Commercial Borrowing (ECB) ceiling has gradually been raised.
❏ NRI deposit has been made fully convertible.
❏ Outward remittance ceilings are gradually being raised.
13.3.Committee on Capital Account Convertibility
13.3.1. Tarapore Committee - 1997
●
The Committee on Capital Account Convertibility (CAC) or Tarapore Committee was constituted in
1997 by the Reserve Bank of India for suggesting a roadmap on full convertibility of Rupee on Capital
Account.
●
The highlights of the report including the preconditions to be achieved for the full float of money are
as follows:❏ Gross fiscal deficit to GDP ratio has to come down from a budgeted 4.5 per cent in 1997-98 to
3.5% in 1999-2000.
❏ Inflation rate should remain between an average 3-5 per cent for the 3-year period 1997-2000
❏ External sector policies should be designed to increase current receipts to GDP ratio and bring
down the debt servicing ratio from 25% to 20%.
❏ A consolidated sinking fund has to be set up to meet government's debt repayment needs; to
be financed by increased in RBI's profit transfer to the govt. and disinvestment proceeds.
❏ Four indicators should be used for evaluating the adequacy of foreign exchange reserves to
safeguard against any contingency. Plus, a minimum net foreign asset to currency ratio of 40
per cent should be prescribed by law in the RBI Act.
13.3.1. Second Tarapore Committee on Capital Account Convertibility - 2006
●
Reserve Bank of India appointed the second Tarapore committee to set out the framework for Fuller
Capital Account Convertibility in the context of the progress in economic reforms, the stability of the
external and financial sectors, accelerated growth and global integration.
●
© Coursavy
Following were some important recommendations of this committee:
16
❏ The committee suggested 3 phases of adopting the full convertibility of rupee in capital
account.
❖ First Phase in 2006-07
❖ Second phase in 2007-09
❖ Third Phase by 2011.
❏ The ceiling for External Commercial Borrowings (ECB) should be raised for automatic
approval.
❏ NRI should be allowed to invest in capital markets
❏ NRI deposits should be given tax benefits
❏ Existing PN holders should be given an exit route to phase out completely the PN notes.
❏ Improvement of the Banking regulation.
●
At present, the rupee is fully convertible on the current account, but only partially convertible on
the capital account.
●
Tarapore Committee mentioned the following benefits of capital account convertibility to India:
❏ Availability of large funds to supplement domestic resources and thereby promote economic
growth.
❏ Improved access to international financial markets and a reduction in the cost of capital.
❏ Incentive for Indians to acquire and hold international securities and assets
❏ Improvement of the financial system in the context of global competition
14. Foreign Investment
●
Foreign investment involves capital flows from one country to another country.
●
As globalization increases, more and more companies have branches in countries around the world because of
the attractive opportunities for cheaper production, labour and lower or fewer taxes.
●
Foreign investment in a country is a good sign that o en leads to the increase of jobs and income.
●
As more foreign investment comes into a country, it can lead to greater investments because
individuals/companies see the country as economically stable.
●
Foreign investments can be divided into
❏ Foreign Direct Investment(FDI)
❏ Foreign Portfolio Investment(FPI)
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15. Foreign Direct Investment(FDI)
●
A foreign direct investment (FDI) is an investment made by a firm or individual in one country into business
interests located in another country.
●
Under FDI, a foreign investor establishes/acquires the business entity in the host country along with the
management rights.
●
Definition of FDI by the IMF:
“ An investment through which an investor acquires lasting and substantial management control
(at least 10% equity or voting rights) in the foreign affiliates”.
●
Foreign direct investments are commonly made in open economies that offer a skilled workforce and growth
prospects for the investor, as opposed to tightly regulated economies.
15.1. Components of FDI
●
Foreign direct investment as the following component as mentioned by IMF:
❏ Equity Investment - Foreign direct investor’s purchase of shares of an enterprise.
❏ Retained Earnings/Reinvested Earning - Earnings not distributed as dividends.
❏ Intra Company Debt Transfer - Short/long-term borrowing & lending between direct investors.
15.2. Method of FDI
●
There are multiple methods through which foreign direct investor may acquire voting power of an enterprise
in an economy:
❏ By acquiring shares in an enterprise.
❏ Mergers and acquisitions
❏ Starting a subsidiary of a domestic firm in a foreign country
❏ Joint ventures with foreign corporations
15.3. Advantage of FDI
●
FDI supplements domestic capital formation which creates employment and stimulates economic growth in
the host country.
●
They bring modern technologies, managerial and entrepreneurial skills, marketing strategies etc along with
the foreign capital in the host country.
●
They promote competition by suppressing domestic monopolies.
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●
They provide a wide variety of quality products to people at competitive prices. It increases the standard of
living of people.
●
They promote industrial diversification in host countries.
●
They promote the development of infrastructure by directly investing in infrastructure projects as well as by
creating demand for such services.
●
They provide significant tax revenue to the host government.
●
They promote globalisation of the host economies.
●
They tend to reduce the factor price differential across nations i.e they tend to increase wage rate and
decrease interest rate in underdeveloped countries and developing countries and vice-versa to developed
countries.
15.4. Disadvantage of FDI
●
They adversely affect domestic companies especially MSME. It may worsen unemployment in the host
(developing) countries.
●
They may intervene in the domestic economic policy of the host government.
●
They aggravate income and regional inequalities.
●
They induce dualism (the sharp difference between traditional and modern sectors) in the host (developing)
countries.
●
They repatriate huge forex reserves in various forms like high dividend, interest, royalties etc. In the long
run, they deteriorate the current account deficit(CAD) of host (developing) countries.
●
They promote excessive consumerism by indulging in excessive advertisement and superficial product
differential.
15.5. India’s FDI Policy
●
FDI policy comes under the Ministry of Industry and Commerce (Department for Promotion of Industry and
Internal Trade (DPIIT)).
●
The Balance of Payment (BoP) crisis of 1991 leads to major reform in FDI policy. Some of them are as follows:
❏ New Industrial Policy,1991
❖ Industrial licensing was abolished except for a few important sectors.
❖ Many sectors are open to foreign participation.
❖ Major institutions set up to promote and facilitate FDI inflows, such as the Foreign Investment
Promotion Board (FIPB).
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❏ Liberalisation of Exchange Rate System(LERMS)
❖
The initiation of economic reforms, India moved to a floating currency regime which involved
the dual exchange rate system(one official and other market-determined).
❖ The dual exchange rate system was replaced by a unified exchange rate system in March 1993.
❏ Introduction of partial capital account convertibility (CAC).
❏ Foreign Exchange Regulation Act (FERA) was replaced by the Foreign Exchange Management Act
(FEMA) in 1999.
❏ Press Note 18 was abolished in 2005
❖ Under PN18, the foreign investor having joint ventures in India needed No Objection certificate
from their Indian joint venture partner for understanding any business in India.
❏ FDI in Multibrand Retail 2012
❖ Allowing 100% FDI ownership in single-brand retail trading and up to 51% FDI in multi-brand
retail.
15.6. Recent FDI Reform
●
In the coal sector, for sale of coal, 100% FDI under automatic route for coal mining, activities including
associated processing infrastructure will attract international players to create an efficient and competitive
coal market.
●
100% FDI under automatic route has been allowed in contract manufacturing to give a big boost to domestic
manufacturing.
●
In single-brand retail trading (SBRT), the definition of 30 per cent local sourcing norm has been relaxed and
online sales permitted without prior opening of brick and mortar stores.
●
100% FDI is allowed in the Defence industry; wherein 49% is allowed under automatic route and beyond
49% through Government route.
●
100 % FDI is permitted for insurance intermediaries.
15.7. India and FDI
●
According to the Department for Promotion of Industry and Internal Trade (DPIIT), FDI equity inflows in India
stood at US$ 446.11 billion during March 2000 to September 2019, indicating that the government's effort
to improve ease of doing business and relaxation in FDI norms is yielding results.
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●
Data for Q2 2019-20 indicates that the service sector attracted the highest FDI equity inflow, followed by the
telecommunications sector, computer so ware
and hardware, and trading.
●
During
Q2
maximum
2019-20,
FDI
India
equity
received
inflows
the
from
Singapore, followed by Mauritius, Netherlands,
USA, and Japan.
●
An increase in net FDI also provides a more
stable source of funding than the CAD and in
that sense provides greater stability to the
improvement in BoP position as compared to
other capital inflows.
16. Foreign Portfolio Investment(FPI)
●
Foreign Portfolio Investment (FPI) is the investment by non-residents in Indian financial assets including
shares, government bonds, corporate bonds, convertible securities, infrastructure securities etc.
●
The class of investors who make an investment in these securities are known as Foreign Portfolio Investors.
●
Foreign Portfolio Investor (FPI)
was created based on the recommendation of K. M. Chandrasekhar
Committee by merging the existing three investor classes
❏ FII (Foreign Institutional Investor)
❏ Sub Accounts
❏ Qualified Foreign Investors(QFI)
●
Foreign Portfolio Investment (FPI) is less
favourable than direct investment because
portfolio investments can be sold off quickly and
are at times seen as short-term attempts to
make
money,
rather
than
a
long-term
investment in the economy.
●
Portfolio Investment by any single investor or
investor group cannot exceed 10% of the
equity of an Indian company, beyond which it
will now be treated as FDI.
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●
An increase in net FPI flows improves the BoP position and arises on account of cross-border transactions
involving debt or equity securities, other than those included in direct investment or reserve assets.
●
FPI is o en referred to as “hot money” because of its tendency to flee at the first signs of trouble in an
economy or improvement in investment attractiveness elsewhere in the world.
16.1. Committee on Rationalisation of Roots of Portfolio Investment
●
To harmonize/rationalize, and thereby, ease the entry routes for various foreign portfolio investors into India,
SEBI constituted a Committee under the Chairmanship of K.M Chandrasekhar in 2014.
●
The major recommendation of the committee are as follow:
❏ A new investor class, "Foreign Portfolio Investor" ("FPI"), to replace FIIs and QFIs. Existing FIIs, their
sub-accounts and QFIs to be merged into FPIs.
❏ Portfolio investments to be defined as investment by any single investor or investor group, which
shall not exceed 10% of the equity of an Indian company. Any investment beyond the threshold of
10% to be considered as FDI.
❏ The aggregate investment limit of FPIs to be 24% (being the present default aggregate limit for FIIs,
which can be raised by the company up to the sectoral cap).
❏ Know Your Client ("KYC") checks to be based on risk categorization of FPI.
❖ Low Risk (Category I) - Government and Government-related entities.
❖ Medium Risk (Category II) - Regulated entities such as Banks, Asset Management Companies,
Broad-Based Funds such as Mutual Funds etc.
❖ High Risk (Category III) - All other FPIs not eligible to be included in the above two Categories
to be classified as Category III (High Risk) FPI.
❏ FPIs belonging to the Category III to be not allowed to issue Offshore Derivative Instruments
("ODI")/Participatory Notes ("PN").
16.2. HR Khan Committee on Foreign Portfolio Investment
●
SEBI constitutes H R Khan Committee in 2014 to review FPI norms and concerns raised by the investors.
●
The major recommendation of the committee are as follow:
❏ NRIs, overseas citizens of India and resident Indians should be allowed to hold non-controlling stakes
in FPIs and no restriction should be imposed on them to manage non-investing FPIs or SEBI-registered
offshore funds.
❏ NRIs will be allowed to invest as FPIs if the single holding is under 25% and group holding under
50% in a fund, according to the panel.
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❏ SEBI should do away with the additional Know Your Customer (KYC) requirements for the beneficial
owner in case of government-related FPI’s.
❏ The panel also recommends that the new rules should be equally applied to the investors using
participatory notes (P-notes).
❏ The committee recommended that erstwhile PIOs (Person of Indian Origin) should not be subjected to
any restrictions and clubbing of investment limits should be allowed for well regulated and publicly
held FPIs that have common control.
❏ Time for compliance with new norms should be extended by six months a er they are finalised and
also the non-compliant investors should be given further 180 days to wind down their existing
positions.
❏ The panel also suggested for changes in the norms pertaining to the identification of senior managing
officials of FPIs and for beneficial owners of listed entities.
17. Difference Between FDI vs FPI
Basis For Comparison
Foreign Direct Investment(FDI)
Foreign Portfolio Investment (FPI)
Definition
FDI refers to the investment made by foreign
FPI refers to investing in the financial
investors to obtain a substantial interest in assets of a foreign country, such as stocks,
the enterprise located in a different country
bonds etc.
Role of investors
Active
Passive
Type
Direct Investment
Indirect Investment
Investment
Invests in financial & non-financial assets
Invests only in financial assets
Term
Long term investment
Short term investment
Volatility
Stable
Highly Volatile
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18. Foreign Trade
●
Foreign trade in India includes all imports and exports to and from India.
●
At the level of Central Government, it is administered by the Ministry of Commerce and Industry.
●
The inflow of goods in a country is called import trade whereas the outflow of goods from a country is called
export trade.
●
The trade balance is the difference between the monetary value of exports and imports of output in an
economy, it is one of the most important macroeconomic parameters.
18.1. Foreign trade Policy
●
There are various types of foreign trade policy.
18.1.1. Free Trade Policy
●
It is a trade policy with least restriction on trade i.e trade takes place without barriers such as tariff,
quotas and foreign exchange controls.
●
Thus, under free trade, goods and services flow freely between countries.
●
Free trade implies absence of governmental intervention on international trade among different
countries of the world.
●
It is also termed as outward-oriented trade policy.
18.1.2. Protectionist Trade Policy
●
It is a trade policy with a restriction on trade through various trade barriers.
●
It is always termed as inward-oriented trade policy.
●
Trade barrier: Government policy to restrict trade. It includes :
❏ Tariff Barriers
❖ It is a custom, duty or a tax imposed on products that move across borders.
❖ It includes Import duty, Export duty etc.
❏ Non- Tariffs barriers
❖ These are non-tariff restrictions such as government regulation and policies with
respect to overall trade.
❖ It includes Quotas, Subsidies etc.
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19. Export Promotion Schemes
●
Duty Drawback Schemes :
❏ Under this scheme, custom/excise duty paid by exporters of selected products is partially or wholly
reimbursed.
●
Export Promotion Capital Goods (EPCG)
❏
Under this scheme, exporters can import capital goods at zero or concessional custom duty subject to
an export obligation.
●
Focus Market Scheme
❏ Exporters are exporting to selected destinations/countries are provided duty credit scripts equivalent
to 3% of Free on Board(FOB) value of exports.
●
Focus Product Scheme
❏ Under this exporter of selected labour intensive product (eg. handicra ) are provided duty credit
script equivalent to 2% of FOB value of exports.
20. India’s Medium Term Export Policy: Foreign Trade Policy, FTP (2015-20)
●
It was announced on 1st April 2015 by the Ministry of Industry and Commerce.
●
It seeks to enhance the competitiveness of export by adopting systemic reforms rather than incentivising
exports through subsidies.
●
It seeks to focus on higher-value addition and technology in future with a focus on quality and standard.
●
It seeks to rectify the inverted duty structure. It is a situation in which higher custom duties are imposed on
imports of input/raw material vis-a-vis on import of finished or final goods.
●
It is dra ed in consonance with other initiatives of the government like Make In India, Ease of doing business,
Digital India, Skill India etc.
20.1. Objective
●
To increase India Share in world export to 2% to 3.5% by 2020.
●
To double exports of goods and services by 2020.
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20.2. Features
●
Merchandise Exports Incentive Scheme (MEIS)
❏ The Government of India has brought in the Merchandise Exports Incentive Scheme (MEIS), replacing
five other similar incentive schemes present in the earlier Foreign Trade Policy 2009-14.
❏ The schemes that have been replaced by the MEIS scheme include:
❖ Focus Product Scheme (FPS)
❖ Focus Market Scheme (FMS)
❖ Market Linked Focus Product Scheme (MLFPS)
❖ Agri. Infrastructure incentive scheme
❖ Vishesh Krishi Gramin Upaj Yojna (VKGUY)
❏ The scheme provides an incentive in the form of duty credit scrip (entitles the bearer to receive
something in return) to the exporter to compensate for his loss on payment of duties.
❏ The incentive is paid as a percentage of the realized FOB value (in free foreign exchange) for notified
goods going to notified markets
●
Service Exports from India Scheme (MEIS)
❏ The Government of India has introduced the Service Exports from India Scheme (SEIS) under the
Foreign Trade Policy (FTP) - 2015-20, replacing the earlier scheme 'Served from India Scheme’ under
Foreign Trade Policy, 2009-15.
❏ The main objective of the scheme is to make our services globally competitive in terms of price.
❏
These SEIS scrips are transferable and can also be used for payment of a number of Central
duties/taxes including the basic customs duty.
●
Export Promotion Capital Goods (EPCG)
❏ Under this scheme, the export obligation has been reduced to 75%.
●
Trade Facilitation
❏ Online filling of document/application in a 24*7 environment.
❏ CA/CS can file digitally signed documents.
❏ Exporter/Importers profiles will be created to eliminate multiple submission of the document.
❏ The FTP to be reviewed a er two and half years instead of annual reviews.
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26
20.3. Critical Appraisal of FTP Policy (2015-20)
●
Subsidies have been reduced.
●
Gave more flexibility to exporters and importers.
●
Aligned with Make in India.
21. Special Economic Zones (SEZ)
●
A special economic zone is an area in a country that is subject to unique economic regulations that differ
from other regions of the same country.
●
Traditionally the biggest deterrents to foreign investment in India have been high tariffs and taxes, red tape
and strict labour laws. The SEZ regulations tend to be conducive to foreign direct investment (FDI).
●
These areas have developed infrastructure, liberal economic policy and concession tax rates for the firms.
●
SEZ Policy was introduced to India in 2000. Prior to SEZ introduction, India relied on export processing
zones (EPZ) which failed to make an impact on foreign investors.
●
To instil confidence in investors and signal the Government's commitment to a stable SEZ policy regime The
Special Economic Zones Act, 2005, was passed by Parliament in May 2005.
●
The main objectives of the SEZ Act 2005 are:
❏ Generation of additional economic activity.
❏ Promotion of exports of goods and services.
❏ Promotion of investment from domestic and foreign sources.
❏ Creation of employment opportunities.
❏ Development of infrastructure facilities.
●
SEZ can be set up by:
❏ Public/State government or its agencies
❏
Private/Joint sector
❏ Foreign agency
●
There are four types of SEZs in India, which are categorised according to size:
❏ Multi-sector (1,000+ hectares);
❏ Sector-specific (100+ hectares);
❏ Free Trade & Warehousing Zone (FTWZ) (40+ hectares);
❏ Tech, handicra , non-conventional energy, gems & jewellery (10+ hectares)
●
Presently, 351 SEZs are notified, out of which 232 SEZs are operational.
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22. Reverse Special Economic Zones (R-SEZ)
●
Reverse SEZ is an import oriented area, located outside the country’s border in order to get cheap, import
duty-free/exempt raw materials.
●
Under this, Indian chemical and petro-chemical companies will set up plants in other countries which have
abundant and cheap feedstock for importing back their output.
●
The Ministry of Chemical and Fertilizers is exploring options to set up R-SEZ in Iran, Myanmar.
●
The 1st R-SEZ is proposed to be established in the Chabahar Port area of Iran.
●
Objective: To ensure the supply of cheap industrial chemicals for the domestic chemical, petrochemical, and
fertilizer industry in order to enhance its competitiveness and increase its export potential.
23. International Financial Service Centre (IFSC)
●
Financial centres that cater to customers outside their own jurisdiction are referred to as international (IFCs)
or offshore Financial Centers (OFCs).
●
All these centres are ‘international’ in the sense that they deal with the flow of finance and financial
products/services across borders.
●
An IFSC is thus a jurisdiction that provides world-class financial services to non-residents and residents, to the
extent permissible under the current regulations, in a currency other than the domestic currency (Indian
rupee) of the location where the IFSC is located.
●
The objective of IFSC are:
❏ To increase tax revenue.
❏ To create a high-value job.
❏
To create an avenue for financial globalisation.
23.1. GIFT City
●
Gujarat International Finance Tec-City (GIFT City) multi-services special economic zone (SEZ) has set up the
first International Financial Service Centre in India (IFSC) in accordance with the SEZ Act 2005 (SEZ Act),
SEZ Rules 2006 in Gandhinagar, Gujarat.
●
The IFSC in GIFT City (IFSC-GIFT) is being developed as a global financial and information technology services
hub designed to be at or above par with globally benchmarked financial centres such as London, Hong Kong,
Singapore, and Dubai.
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●
An IFSC seeks to bring to India, those types of financial services and transactions that are currently carried on
outside India by overseas financial institutions and overseas branches/ subsidiaries of Indian financial
institutions.
●
IFSC has been designated for all practical purposes as a 'deemed foreign territory' which would have the
same ecosystem as other offshore locations, but which is physically on Indian soil.
●
Any financial institution (or its branch) set up in the IFSC is
❏ Treated as a non-resident Indian located outside India,
❏ Expected to conduct business in such foreign currency and with such entities, whether resident or
non-resident, as the Regulatory Authority may determine, and
❏ Nothing contained in any other regulations shall apply to a unit located in IFSC, subject to certain
provisions.
●
The financial regulators viz. the Securities and Exchange Board of India (SEBI), the Reserve Bank of India
(RBI) and the Insurance Regulatory and Development Authority of India (IRDAI) and the Department of
Financial Services issued the following regulations and guidelines to operationalize IFSC-GIFT in India under
the provisions of the SEZ Act.
24. Globalisation
●
It refers to the integration of an economy with the world economy. It is achieved by removing the restriction
on the flows of goods and service, foreign capital, technology transfer and movement of a natural person
across the nations.
●
It is a multidimensional concept i.e it also includes social, cultural, political etc integration of nations.
24.1. Advantage
●
It enables the allocation of resources on the basis of comparative advantage of various nations: each
country specializes in the production of these commodities in whose it is most efficient. It increases
productivity and production at the global level.
●
It enables economic entities to specialize and achieve economies of scale (benefit of large scale
production).
●
Globalisation enables worldwide access to cheap raw materials, labour, technology and this enables
firms to be cost-competitive in their own markets and in overseas markets.
●
Globalisation has increased flows of inward investment between countries, which has resulted in
benefits for recipient countries.
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24.2. Disadvantage
●
The increased power and influence of multinationals is a major disadvantage of globalisation.
●
The potential loss of jobs in domestic markets caused by increased, unfair, free trade and structural
changes arising from globalisation.
●
The over-standardisation of products through global branding is a common criticism of globalisation.
●
The increased risk associated with the interdependence of economies.
25. Other Terms
25.1. J-Curve Effect
●
This refers to a phenomenon wherein the trade balance of a country worsens following the depreciation of
its currency before it improves mainly because higher prices on imports will be greater than the reduced
volume of imports.
●
It has a short-run effect.
25.2. Free on Board(FOB)
●
Free on Board(FOB) takes into account cost incurred on export/import till the port of loading.
●
Cost Insurance Freight(CIF) takes into account incurred on export/import until the port of destination.
25.3. Hard Currency
●
Hard currency or strong currency is any globally traded currency that serves as a reliable and stable store of
value.
●
It is a currency that everybody trusts because they expect it will maintain its value and not suffer from
frequent, sharp exchange rate fluctuations.
●
Hard currencies are widely accepted around the world since it is stable, convertible, and enjoys the
confidence of investors, traders, and tourists.
●
Basically, the economy with the large and diversified exports which are compulsive imports for other countries
will create high demand for its currency in the world and become the hard currency.
●
Some of the best hard currencies of the world today are the US Dollar, the Euro(€), Japanese Yen (¥) and the
UK Sterling Pound (£).
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25.4. So Currency
●
So currency is a currency which is sensitive and fluctuates frequently. Such currencies react very sharply to
the political or the economic situation of a country.
●
It is also known as weak currency due to its unstable nature.
●
So currency is easily available in any economy in its forex market.
●
For example, the rupee is a so currency in the Indian forex market.
25.5. Hot Currency
●
Hot Currency is the flow of funds (or capital) from one country to another in order to earn a short-term
profit.
●
Hot Currency continuously shi s from countries with low-interest rates to those with higher rates.
●
These financial transfers affect the exchange rate and potentially impact a country's balance of payments
●
For international investors, there are substantial gains to be made from moving money between different
countries with different interest rates.
25.6. Cheap Currency
●
Cheap Currency refers to money in which loans and advances are made available on the low-interest rate and
on easy terms.
●
If a Government starts re-purchasing its bonds before their maturities (at full-maturity prices) the money
which flows into the economy is known as the cheap currency.
25.7. Dear Currency
●
Dear money refers to money that is hard to obtain because of high-interest rates.
●
Dear money is o en referred to as tight money because it occurs in periods when central banks are tightening
monetary policy.
●
When a government issues bonds, the money which flows from the public to the government or the money in
the economy, in general, is called dear currency.
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26. UPSC CSE PRELIMS Previous Years Questions
●
Now, let's check how many questions can you attempt?
Q.1) Consider the following actions which the Government can take:
2011
1. Devaluing the domestic currency.
2. Reduction in the export subsidy.
Which of the above action/actions can help in reducing the current account deficit?
[A] 1 only
[B] 2 only
[C] 1 and 2 only
[D] None of the above
Ans.1) Correct Answer: (a)
Explanation:
Devaluation: Devaluation is a deliberate reduction in the value of a country's currency. If devaluation in currency
occurs, the price of imported goods then increases, therefore, the quantity demanded of imports falls. This results in
cheaper exports along with an increase in the quantity of exports.
Protectionism: This policy is implemented by imposing direct controls on imports by enforcing barriers against
imports or by providing assistance to exporters.
Specific measures taken to implement the policy is increasing tariffs of quotas, subsidies to domestic firms, Reduction
in the export subsidy, discrimination against imports and favouritism of domestic firms. This then reduces imports
and may improve the current account. Yet this policy leads to retaliation, resulting in decreased exports and domestic
industries may become uncompetitive as they have no incentive. The short term gains will then be eroded away
proving that this policy is not an effective long term solution.
Reduce domestic consumption and spending on imports (e.g. tight fiscal policy/higher taxes).
FDI and FII affect capital account deficit.
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Q.2) Both Foreign Direct Investment (FDI) and Foreign Institutional Investor (FII) are related to investment in a
country. Which one of the following statements best represents an important difference between the two? 2011
[A] FII helps bring better management skills and technology, while FDI only brings in capital
[B] FII helps in increasing capital availability in general, while FDI only targets specific sectors
[C] FDI flows only into the secondary market, while FII targets primary market
[D] FII is considered to be more stable than FDI
Ans.2) Correct Option: (b)
Explanation:
●
FDI is an investment that a parent company makes in a foreign country. On the contrary, FII is an investment
made by an investor in the markets of a foreign nation.
●
FII can enter the stock market easily and also withdraw from it easily. But FDI cannot enter and exit that easily.
●
Foreign Direct Investment targets a specific enterprise. The FII increasing capital availability in general.
●
The Foreign Direct Investment is considered to be more stable than Foreign Institutional Investor
Q.3) Which of the following would include Foreign Direct Investment in India?
2012
1. Subsidiaries of companies in India
2. Majority of foreign equity holding in Indian companies
3. Companies exclusively financed by foreign companies
4. Portfolio investment
Select the correct answer using the codes given below :
[A] 1, 2, 3 and 4
[B] 2 and 4 only
[C] 1 and 3 only
[D] 1, 2 and 3 only
Ans.3) Correct Answer: (d)
Explanation:
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●
Foreign direct investments can be made in a variety of ways, including the opening of a subsidiary or associate
company in a foreign country, acquiring a controlling interest in an existing foreign company, or by means of a
merger or joint venture with a foreign company.
●
Foreign direct investment (FDI) is an investment made by a firm or individual in one country into business
interests located in another country.
●
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.
●
Foreign direct investments are distinguished from portfolio investments in which an investor merely
purchases equities of foreign-based companies.
Q.4) Consider the following statements:
2012
The price of any currency in the international market is decided by the
1. World Bank
2. demand for goods/services provided by the country concerned
3. stability of the government of the concerned country
4. economic potential of the country in question
Which of the statements given above are correct?
[A] 1, 2, 3 and 4
[B] 2 and 3 only
[C] 3 and 4 only
[D] 1 and 4 only
Ans.4) Correct Option: (b)
Explanation:
●
Price of any currency in the international market is determined by the demand for goods/services produced by
the country.
●
If the demand for the product is high then the currency would be strong. The current depreciation of the
Indian Rupee is due to rising oil prices.
●
The stability of the government of the concerned country plays an important role in determining the
prices of currency.
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Q.5) The balance of payments of a country is a systematic record of
2012
[A] all import and transactions of a country during a given period normally a year
[B] goods exported from a country during a year
[C] the economic transaction between the government of one country to another
[D] capital movements from one country to another
Ans.5) Correct Option: (a)
Explanation:
●
The balance of payments is a statement of all transactions made between entities in one country and the rest
of the world over a defined period of time, such as a quarter or a year.
●
The balance of payments divides transactions in two accounts: the current account and the capital account
(sometimes the capital account is called the financial account, with a separate, usually very small, capital
account listed separately).
●
The current account includes transactions in goods, services, investment income and current transfers.
●
The capital account, broadly defined, includes transactions in financial instruments and central bank reserves.
●
The current account is included in calculations of national output, while the capital account is not.
●
If a country cannot fund its imports through exports of capital, it must do so by running down its reserves.
●
This situation is o en referred to as a balance of payments deficit, using the narrow definition of the capital
account that excludes central bank reserves.
Q.6) Which of the following constitute Capital Account?
2013
1. Foreign Loans
2. Foreign Direct Investment
3. Private Remittances
4. Portfolio Investment
Select the correct answer using the codes given below.
[A] 1, 2 and 3 only
[B] 1, 2 and 4 only
[C] 3 and 4 only
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[D] 1, 2 and 3
Ans.6) Correct Option: (b)
Explanation:
●
The capital account and the current account are the two main components of a nation's balance of payment.
●
Whereas the current account reflects a nation’s net income, the capital account reflects the net change in
ownership of assets.
●
Thus, it is clear that private remittances are part of the current account
●
On the other hand, foreign Loans, FII (Foreign Institutional Investor) and FDI Foreign Direct Investment are part
of the capital account.
●
Remittances fall under Current Account.
Q.7) Which one of the following groups of items are included in India’s foreign-exchange reserves?
2013
[A] Foreign-currency assets, Special Drawing Rights (SDRs) and loans from foreign countries
[B] Foreign-currency assets, gold holdings of the RBI and SDRs
[C] Foreign-currency assets, loans from the World Bank and SDRs
[D] Foreign-currency assets, gold holdings of the RBI and loans from the World Bank
Ans.7) Correct Option: (b)
Explanation:
●
Foreign-exchange reserves (also called Forex reserves) are, in a strict sense, only the foreign-currency deposits
held by national central banks and monetary authorities (See List of countries by foreign-exchange reserves
(excluding gold)).
●
However, in popular usage and in the list below, it also includes gold reserves, special drawing rights (SDRs)
and International Monetary Fund (IMF) reserve position because this total figure, which is usually more
accurately termed as official reserves or international reserves or official international reserves, is more readily
available and also arguably more meaningful.
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Q.8) The balance of payments of a country is a systematic record of
2013
[A] all import and export transactions of a country during a given period of time, normally a year
[B] goods exported from a country during a year
[C] the economic transaction between the government of one country to another
[D] capital movements from one country to another
Ans.8) Correct Option: (a)
Explanation:
●
The balance of payment records the transaction in goods, services and assets between ‘residents’ (and not
governments) of one country with the rest of the world.
Q.9) With reference to Balance of Payments, which of the following constitute the Current Account?
2014
1. Balance of trade
2. Foreign assets
3. Balance of invisibles
4. Special Drawing Right
Select the correct answer using the code given below.
[A] 1 only
[B] 2 and 3
[C] 1 and 3
[D] 1, 2 and 4
Ans.9) Correct option: (c)
Explanation:
●
The capital account and the current account are the two main components of a nation's balance of payment.
●
Whereas the current account reflects a nation’s net income, the capital account reflects the net change in
ownership of assets.
●
Thus, it is clear that private remittances are part of the current account
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●
On the other hand, foreign Loans, FII (Foreign Institutional Investor) and FDI Foreign Direct Investment are part
of the capital account.
●
Remittances fall under the Current Account.
Q.10) Convertibility of rupee implies:
2015
[A] being able to convert rupee notes into gold
[B] allowing the value of the rupee to be fixed by market forces
[C] freely permitting the conversion of rupee to other currencies and vice versa
[D] developing an international market for currencies in India
Ans.10) Correct Option: (c)
Explanation:
●
Rupee convertibility means the system where any amount of rupee can be converted into any other currency
without any question asked about the purpose for which the foreign exchange is to be used.
●
Non-convertibility can generally be defined with reference to the transaction for which foreign exchange
cannot be legally purchased (e.g. import of consumer goods etc), or transactions which are controlled and
approved on a case by case basis (like regulated imports etc).
Q.11) The problem of international liquidity is related to the non-availability of -
2015
[A] goods and services
[B] gold and silver
[C] dollars and other hard currencies
[D] exportable surplus
Ans.11) Correct Option: (c)
Explanation:
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●
The concept of international liquidity is associated with international payments. These payments arise out
of international trade in goods and services and also in connection with capital movements between one
country and another.
●
International liquidity refers to the generally accepted official means of settling imbalances in international
payments which is basically dollars and hard currencies.
Q.12) In the context of India, which of the following factors is/are contributor/contributors to reducing the risk
of a currency crisis?
2019
1. The foreign currency earnings of India’s IT sector
2. Increasing the government expenditure
3. Remittances from Indians abroad
Select the correct answer using the code given below.
(a) 1 only
(b) 1 and 3 only
(c) 2 only
(d) 1, 2 and 3
Ans.12) Correct Option: (b)
Explanation:
●
If there is foreign exchange inflow through the earning of India’s IT sector then, the risk of currency crisis risk is
not much
●
Similarly remittances from Indians abroad reduces the risk of a currency crisis.
●
Increasing government expenditure contributes to the rise of fiscal deficit.
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Q.13) Which one of the following is not the most likely measure the Government/RBI takes to stop the slide of
Indian rupee?
2019
(a) Curbing imports of non-essential goods and promoting exports
(b) Encouraging Indian borrowers to issue rupee denominated Masala Bonds
(c) Easing conditions relating to external commercial borrowing
(d) Following an expansionary monetary policy
Ans.13) Correct Option: D
Explanation:
To stop the slide of the rupee against the dollar, we need to improve inflow of forex and increase its supply and control
domestic currency money supply.
●
Is a correct step as it will bring more forex.
●
Is a correct step as it will bring more forex through FPI.
●
Is a correct step as it will bring more forex through Debt.
●
Is not a correct step, as it increases money supply.
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Economic Planning
1. Planning
3
2. Types of Planning
3
2.1. Imperative Planning
3
2.2. Indicative Planning
4
3. Objectives of Planning
4
4. Evolution of Economic Planning in India
5
5. History of Economic Planning in India
5
5.1. The Visvesvaraya Plan
5
5.2. National Planning Committee
5
5.3. The Gandhian Plan
5
5.4. The Bombay Plan
6
5.5. People Plan
6
5.6. Sarvodaya Plan
6
6. Five Year Plans in India
6
6.1. First Five Year Plan (1951 - 56)
7
6.2. Second Five Year Plan (1956 - 61)
7
6.3. Third Five Year Plan (1961 - 66)
7
6.4. Three Annual Plan (1966 - 69)
8
6.5. Fourth Five Year Plan (1969 - 74)
8
6.6. Fi h Five Year Plan (1974 - 79)
9
6.7. Rolling Plan (1978 - 80)
9
6.8. Sixth Five Year Plan (1980 - 85)
9
6.9. Seventh Five Year Plan (1985 - 90)
10
6.10. Eighth Five Year Plan (1992 - 97)
10
6.11. Ninth Five Year Plan (1997 - 2002)
11
6.12. Tenth Five Year Plan (2002 - 2007)
12
6.13. Eleventh Five Year Plan (2007 - 2012)
12
6.14. Twel h Five Year Plan (2012 - 2017)
13
7. Twenty Point Programme
15
8. Planning Commission
16
9. National Development Council (NDC)
17
10. NITI Aayog
18
10.1. Objective
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1
10.2. Composition of NITI Aayog
19
10.3. NITI Aayog role till now
19
10.4. NITI Aayog vs Planning Commission
20
11. Achievements of Economic Planning in India
21
12. Failure of Economic Planning in India
21
13. Resource Mobilisation
21
13.1. Internal Resource
22
13.2. External Resource
22
14. Economic Planning Strategy
22
14.1. Pre 1991 Phase/ Pre-reform Phase
22
14.2. Post-1991 Phase/Post-reform Phase
23
15. Amartya Sen Vs Jagdish Bhagwati Debate
23
15.1. Gujarat Model
24
15.2. Kerala Model
24
16. Other Terms
25
16.1. Centralised Planning
25
16.2. De-Centralised Planning
25
16.3. Democratic Planning
25
16.4. Physical Planning
25
16.5. Financial Planning
25
16.6. Fixed Planning
25
16.7. Rolling Plan/Continuous Planning
25
16.8. Perspective Planning
26
16.10. Partial Planning
26
17. UPSC CSE PRELIMS Previous Years Questions
27
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1. Planning
●
Planning has emerged as an important function of the modern government and involves its purposive
intervention to affect socially desired changes in the structure and course of the economy.
●
In the words of H. D. Dickinson, “Economic planning is the making of major economic decisions— by the
conscious decision of a determinate authority, on the basis of a comprehensive survey of a country’s existing
and potential resources and a careful study of the needs of the people.”
2. Types of Planning
●
Corresponding to the political ideologies and institutional framework of the country, varied planning types is
observed in the world.
●
Some of them are as follows:
2.1. Imperative Planning
●
In imperative planning economic planning lays down objective and policy framework for each sector
of the economy which is followed rigidly.
●
Under imperative planning, it is the duty of the state to provide necessary supplies like raw material,
machines, manpower and entrepreneurs as all such resources are owned by the state.
●
It is also known as Directive Planning or Authoritative Planning.
●
This planning is usually followed in the socialist economy.
2.2. Indicative Planning
●
In indicative planning, the government set time-bound targets for the economy and seeks to achieve
them by providing incentive and disincentive to economic entities.
●
It is also known as so planning, facilitator planning or planning by inducement.
●
This planning is usually followed in the capitalist economy.
●
India by initiating Economic reform in 1991 started following indicative planning before the reform
India was following imperative planning.
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3. Objectives of Planning
●
The long term objectives of planning in India have been more or less the same in almost all the five-year plans.
●
These objectives are interconnected with one another:
❏ Economic Growth:
❖ The most important objectives of all the plans is to raise the level of national and per capita
income in real terms.
❏ Self Reliance:
❖
It implies a reduction in the dependence on foreign aid and concessional foreign capital as the
donor country can have political influence on the decision-making process of the recipient
country.
❖
The planners realise that self-reliance is a vital requirement for economic growth and
accordingly have aimed at making India self-reliant.
❏ Employment Generation:
❖
One of the aims of planning has been to provide jobs to the unemployed and efficiently utilise
India’s demographic dividend.
❏ Promoting Social Justice:
❖ It includes removal of Poverty and reduction in inequalities of income and wealth.
4. Evolution of Economic Planning in India
●
Thinking on economic planning started quite early in India i.e. immediately a er the Russian Revolution.
●
There were several plan proposals submitted by Individuals as well as political parties and economic groups
for the development of the national economy.
●
At the very outset, Sir. M. Visweswaraya saw quite early that conscious national economic planning was
needed for the rapid industrial development of India.
●
But all these reports and most of the other memoranda for planning and development were not at all the
plans but simply they were proposals.
●
They were lacking necessary integration and coordination and above all misconceived the nature of
postwar reconstruction.
●
Thus, the early plans were only the slogans, and lacking necessary consistency of planning.
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5. History of Economic Planning in India
5.1. The Visvesvaraya Plan
●
In 1934, M. Visvesvaraya had published a book titled “Planned Economy in India”, in which he presented the
first blueprint of Indian planning.
●
He laid a plan to shi labour from agriculture to industries and double up National income in 10 years.
5.2. National Planning Committee
●
In 1938 the N.P.C.(National Planning Committee) was set up under the chairmanship of Jawaharlal Nehru.
●
Its objective of planning for development “was to ensure an adequate standard of living for the masses, i.e
remove poverty.
●
It advocated industrialisation and setting up heavy industries that were essential for setting other industries
and for India self-reliance.
5.3. The Gandhian Plan
●
It was formulated by S.N. Agarwala which aim to create self-contained villages.
●
It emphasized the economic decentralization with primacy to rural development by developing the cottage
industries.
5.4. The Bombay Plan
●
In 1944 Eight Industrialists of Bombay working together prepared “A Brief Memorandum Outlining a Plan of
Economic Development for India”.
●
This plan envisaged doubling the per capita income in 15 years and tripling the national income during this
period.
●
The Bombay Plan was not officially accepted, yet many of the ideas of the plan were inculcated in other plans
which came later.
5.5. People Plan
●
People’s plan was dra ed by MN Roy.
●
The plan was based on Marxist socialism and advocated the need for providing the people with the ‘basic
necessities of life’.
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●
Nationalization of all agriculture and production was the main feature of this plan.
5.6. Sarvodaya Plan
●
Sarvodaya Plan was dra ed by Jai Prakash Narayan in 1950.
●
Sarvodaya plan was inspired by Gandhian Plan and Sarvodaya Idea of Vinoba Bhave.
●
Major ideas of the plan were highly similar to the Gandhian Plan like the emphasis on agriculture, agri-based
small and cottage industries, self-reliance and almost no dependence on foreign capital and technology, land
reforms and decentralised participatory form of planning.
6. Five Year Plans in India
●
Five-Year Plans (FYPs) are centralized and integrated national economic programs.
●
A er independence, India launched its First FYP in 1951, under the socialist influence of first Prime Minister
Jawaharlal Nehru.
●
The process began with setting up of Planning Commission in March 1950 in pursuance of declared objectives
of the Government to
❏ Promote a rapid rise in the standard of living of the people
❏ Efficient exploitation of the resources of the country,
❏ Increasing production and
❏ Offering opportunities to all for employment.
●
The Planning Commission was charged with the responsibility of making the assessment of all resources of
the country, augmenting deficient resources, formulating plans
6.1. First Five Year Plan (1951 - 56)
●
It was based on the Harrod-Domar Model.
●
The influx of refugees, severe food shortage & mounting inflation confronted the country at the onset of the
first five-year plan.
●
The Plan Focussed on agriculture, price stability, power and transport.
●
An important feature of the first plan was the spread of community development projects throughout the
country with the objective of raising the level of living of the people through improved agricultural efficiency.
●
It was a successful plan primarily because of good harvests in the last two years of the plan.
●
Objectives of rehabilitation of refugees, food self-sufficiency & control of prices were more or less achieved.
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6.2. Second Five Year Plan (1956 - 61)
●
The second plan was conceived in an atmosphere of economic stability.
●
The Second Plan was based on the Mahalanobis two-sector (consumer's goods and producers goods) model,
which emphasises the physical aspects of planning and investment.
●
The Plan Focussed on rapid industrialization- heavy & basic industries.
●
It advocated huge imports through foreign loans and accorded lower priority to agriculture.
●
Acute shortage of forex led to the pruning of development targets, the price rise was also seen ( about 30%) vis
a vis decline in the earlier Plan & the 2nd FYP was only moderately successful.
6.3. Third Five Year Plan (1961 - 66)
●
It was felt that the first two Five Year Plan had moved the Indian economy into the "take-off stage"
consequently the basic goal of the Third Five Year Plan was to make India self-reliant and self-generating
economy.
●
The plan aimed to
❏ Achieve More than 5% growth rate in national income;
❏ Achieve self-sufficiency in foodgrains production;
❏ Expand basic industries like steel, chemicals; fuel and power etc;
❏ Create substantial employment opportunities;
❏ Provide greater equity of opportunity;
❏ Reduce economic disparities.
●
Based on the experience of the first two plans (agricultural production was seen as a limiting factor in India’s
economic development), agriculture was given top priority to support the exports and industry.
●
The Plan was a thorough failure in reaching the targets due to unforeseen events - Chinese aggression
(1962), Indo-Pak war (1965), severe drought 1965-66.
●
Due to conflicts, the approach during the later phase was shi ed from development to defence &
development.
6.4. Three Annual Plan (1966 - 69)
●
Failure of the third plan due to the devaluation of rupee (to boost exports) along with inflationary
recession led to the postponement of Fourth FYP. Three Annual Plans were introduced instead.
●
Prevailing crisis in agriculture and serious food shortage necessitated the emphasis on agriculture during the
Annual Plans. During these plans, a whole new agricultural strategy was implemented.
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●
It involves the wide-spread distribution of high-yielding varieties of seeds, extensive use of fertilizers,
exploitation of irrigation potential and soil conservation.
●
During the Annual Plans, the economy absorbed the shocks generated during the Third Plan and It paved the
path for the planned growth ahead.
6.5. Fourth Five Year Plan (1969 - 74)
●
Refusal of supply of essential equipment and raw materials from the allies during the Indo Pak war resulted in
twin objectives of “
❏ Growth with stability
❏ Progressive achievement of self-reliance for the Fourth Plan.
●
The basic strategy of the Fourth Plan has been called the Gadgil strategy.
●
The main emphasis was on the growth rate of agriculture to enable other sectors to move forward.
●
Implementation of Family Planning Programmes was amongst major targets of the Plan.
●
The Indian fourth five-year plan laid its emphasis on the "Weaker Sections" of society but still did not have an
integrated plan for providing for minimum or basic needs.
●
First, two years of the plan saw record production. The last three years did not measure up due to the poor
monsoon.
●
The influx of Bangladeshi refugees before and a er 1971 Indo-Pak war was an important issue along with price
situation deteriorating to crisis proportions and the plan is considered as a big failure.
6.6. Fi h Five Year Plan (1974 - 79)
●
The final dra of the fi h plan was prepared and launched by D.P. Dhar in the backdrop of economic crisis
arising out of run-away inflation fuelled by a hike in oil prices and failure of the Government takeover of the
wholesale trade in wheat.
●
It proposed to achieve two main objectives:
❏ Removal of poverty' (Garibi Hatao)
❏ Attainment of self-reliance
●
Promotion of high rate of growth, better distribution of income and significant growth in the domestic rate of
savings were seen as key instruments.
●
Due to high inflation, cost calculations for the Plan proved to be completely wrong and the original public
sector outlay had to be revised upwards.
●
A er promulgation of emergency in 1975, the emphasis shi ed to the implementation of Prime Ministers 20
Point Programme.
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●
FYP was relegated to the background and when Janta Party came to power in 1978, the Plan was terminated.
6.7. Rolling Plan (1978 - 80)
●
The Janata Party government rejected the Fi h Five-Year Plan and introduced a new Sixth Five-Year Plan
(1978–1983) emphasising on employment, in contrast to the Nehru Model which the Government criticised
for the concentration of power, widening inequality & for mounting poverty. However, the government lasted
for only 2 years.
●
The Congress Government returned to power in 1980 and launched a different plan aimed at directly attacking
the problem of poverty by creating conditions of an expanding economy.
6.8. Sixth Five Year Plan (1980 - 85)
●
The objective of "Improving the quality of life of people" i.e. with a special reference to the economically
and socially handicapped population through a minimum needs programme.
●
In the Sixth Five Year Plan, the Minimum Needs Programme had eight components, namely
❏ Elementary education
❏ Rural Health,
❏ Rural Water Supply,
❏ Rural Roads,
❏ Rural electrification,
❏ Environmental improvement of urban slums,
❏ Housing assistance to rural landless labourers
❏ Nutrition.
●
The Plan focused on Increase in national income, modernization of technology, ensuring a continuous
decrease in poverty and unemployment through schemes like TRYSEM, IRDP, NREP, controlling population
explosion etc.
●
Broadly, the sixth Plan could be taken as a success as most of the targets were realised even though during
the last year (1984-85) many parts of the country faced severe famine conditions and agricultural output was
less than the record output of previous year.
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6.9. Seventh Five Year Plan (1985 - 90)
●
The Seventh Plan aimed at
❏ Accelerating food grain production,
❏ Increasing employment opportunities
❏ Raising productivity with focus on ‘food, work & productivity’.
●
The Jawahar Rojgar Yojana (JRY) was launched in 1989 with the motive to create wage-employment for the
rural poor.
●
The plan was very successful as the economy recorded 6% growth rate against the targeted 5%.
6.10. Eighth Five Year Plan (1992 - 97)
●
The eighth plan was postponed by two years because of political uncertainty at the Centre Worsening Balance
of Payment position, rising debt burden, widening budget deficits, recession in industry and inflation were the
key issues during the launch of the plan.
●
The Eighth Plan (1992–97) was launched in a typically new economic environment. This was the first plan
which went on for introspection of the macroeconomic policies which the country had been pursuing for
many decades.
●
The plan undertook drastic policy measures to combat the bad economic situation and to undertake an
annual average growth of 5.6% through the introduction of fiscal & economic reforms including
liberalisation under the Prime Ministership of P V Narasimha Rao.
●
The major suggestions which this plan suggested are as follows:
❏ Re-definition of the state’s role in the economy,
❏ Market-based’ Economy with a greater role for the private sector,
❏ Increase investment in the infrastructure sector,
❏ Subsidies need restructuring and refocusing,
❏ Decentralised planning,
❏ Special emphasis on ‘co-operative federalism’,
❏ Greater focus on ‘agriculture’ and other ‘rural activities’
●
Some of the main economic outcomes during the eighth plan period were
❏ Rapid economic growth (highest annual growth rate so far – 6.8 %),
❏ The high growth of agriculture & allied sector, and the manufacturing sector,
❏ Growth in exports and imports, improvement in trade and current account deficit.
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●
The high growth rate was achieved even though the share of the public sector in total investment had declined
considerably to about 34 %.
6.11. Ninth Five Year Plan (1997 - 2002)
●
The Ninth Plan (1997–2002) was launched when there was an all-round ‘slowdown’ in the economy led by the
South East Asian Financial Crisis (1996–97).
●
The Plan prepared under the United Front Government focussed on Growth With Social Justice and
Equality.
●
The main objective of the Ninth Five-Year Plan was to correct historical inequalities and increase the
economic growth in the country.
●
Ninth Plan aimed to depend predominantly on the private sector (Indian as well as foreign).
●
The state was envisaged to play the role of facilitator & increasingly involve itself with social sector viz
education, health etc and infrastructure where private sector participation was likely to be limited.
●
It assigned priority to agriculture & rural development with a view to generate adequate productive
employment and eradicate poverty
●
It offered strong support to the social spheres of the country in an effort to achieve the complete elimination
of poverty.
●
The issue of fiscal consolidation became a top priority of the governments for the first time, which resulted in:
❏ Sharp reduction in the revenue deficit of the government, including centre, states and the PSUs
❏ Cutting down subsidies, interest, wages etc.
❏ Decentralised planning with greater reliance on states and the PRI(Panchayati Raj Institution).
6.12. Tenth Five Year Plan (2002 - 2007)
●
Recognising that economic growth can’t be the only objective of the national plan, the Tenth Plan had set
‘monitorable targets’ for a few key indicators of development besides 8 % growth target.
●
The targets included reduction in gender gaps in literacy and wage rate, reduction in Infant & maternal
mortality rates, improvement in literacy, access to potable drinking water cleaning of major polluted rivers,
etc.
●
The Tenth Plan was expected to follow a regional approach rather than a sectoral approach to bring down
regional inequalities.
●
Governance was considered a factor of development & agriculture was declared as the prime moving force
of the economy.
●
States role in planning was to be increased with greater involvement of Panchayati Raj Institutions.
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●
State-wise break up of targets for growth and social development sought to achieve balanced development of
all states.
6.13. Eleventh Five Year Plan (2007 - 2012)
●
The Eleventh Plan was aimed “Towards Faster & More Inclusive Growth “a er UPA rode back to power on
the plank of helping Aam Aadmi (common man).
●
India had emerged as one of the fastest-growing economies by the end of the Tenth Plan.
●
The savings and investment rates had increased , the industrial sector had responded well to face competition
in the global economy and foreign investors were keen to invest in India.
●
The broad vision for 11th Plan included several interrelated components like
❏ Rapid growth reducing poverty & creating employment opportunities,
❏ Access to essential services in health & education, especially for the poor,
❏ Employment opportunities using the National Rural Employment Guarantee Programme(NREGP),
❏ Environmental sustainability,
❏ Reduction of gender inequality etc.
●
The Eleventh Plan started well with the first year achieving a growth rate of 9.3 per cent, however the growth
decelerated to 6.7 per cent rate in 2008-09 following the global financial crisis.
●
However, the second bout of a global slowdown in 2011 due to the sovereign debt crisis in Europe coupled
with domestic factors such as tight monetary policy and supply-side bottlenecks, resulted in a deceleration of
growth to 6.2 percent in 2011-12.
●
Consequently, the average annual growth rate of Gross Domestic Product (GDP) achieved during the Eleventh
Plan was 8 per cent, which was lower than the target but better than the Tenth Plan achievement.
●
Since the period saw two global crises - one in 2008 and another in 2011 – the 8 per cent growth may be
termed as satisfactory.
6.14. Twel h Five Year Plan (2012 - 2017)
●
The Twel h Plan commenced at a time when the global economy was going through a second financial crisis,
precipitated by the sovereign debt problems of the Eurozone which erupted in the last year of the Eleventh
Plan. The crisis affected all countries including India.
●
The broad vision and aspirations which the Twel h Plan seeks to fulfil are reflected in the subtitle: ‘Faster,
Sustainable, and More Inclusive Growth’.
●
Inclusiveness is to be achieved through poverty reduction, promoting group equality and regional balance,
reducing inequality, empowering people etc.
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●
Sustainability includes ensuring environmental sustainability, development of human capital through
improved health, education, skill development, nutrition, information technology etc and development of
institutional capabilities, infrastructure like power telecommunication, roads, transport etc
●
Monitorable Targets of the Plan are as follows:
❏
Economic Growth
❖ Real GDP Growth Rate of 8.0 percent.
❖ Agriculture Growth Rate of 4.0 percent.
❖ Manufacturing Growth Rate of 10.0 percent.
❏
Poverty and Employment
❖ Head-count ratio of consumption poverty to be reduced by 10 percentage points over the
preceding estimates by the end of Twel h FYP.
❖ Generate 50 million new work opportunities in the non-farm sector and provide skill
certification.
❏
Education
❖ Mean Years of Schooling to increase to seven years.
❖ Enhance access to higher education by creating two million additional seats for each age
cohort aligned to the skill needs of the economy.
❖ Eliminate gender and social gap in school enrolment
❏
Health
❖ Reduce IMR to 25 and MMR to 1 per 1,000 live births, and improve Child Sex Ratio (0–6 years)
to 950.
❖ Reduce Total Fertility Rate to 2.1.
❖ Reduce under-nutrition among children aged 0–3 years to half of the NFHS-3 levels
❏
Environment and Sustainability
❖ Increase green cover (as measured by satellite imagery) by 1 million hectare every year.
❖ Add 30,000 MW of renewable energy capacity
❖ Reduce emission intensity of GDP in line with the target of 20 per cent to 25 per cent reduction
over 2005 levels by 2020.
❏
Infrastructure, Including Rural Infrastructure
❖ Increase investment in infrastructure as a percentage of GDP to 9 per cent.
❖ Connect all villages with all-weather roads.
❖ Upgrade national and state highways to the minimum two-lane standard.
❖ Increase rural teledensity to 70 per cent.
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❖ Ensure 50 per cent of the rural population has access to 40 lpcd piped drinking water supply,
and 50 per cent gram panchayats achieve Nirmal Gram Status.
●
Table below show Every Five year plan growth target set by particular five year plan and the growth acheived
during the during that plan.
Target Growth
Actual Growth
First Five Year Plan (1951 - 56)
2.1%
3.6%
Second Five Year Plan (1956 - 61)
4.5%
4.3%
Third Five Year Plan (1961 - 66)
5.6%
2.8%
Fourth Five Year Plan (1969 - 74)
5.7%
3.3%
Fi h Five Year Plan (1974 - 79)
4.4%
4.8%
Sixth Five Year Plan (1980 - 85)
5.2%
5.7%
Seventh Five Year Plan (1985 - 90)
5.0%
6.0%
Eight Five Year Plan (1992 - 97)
5.6%
6.8%
Ninth Five Year Plan (1997 - 2002)
6.5%
5.4%
Tenth Five Year Plan (2002 - 2007)
8%
7.6%
Eleventh Five Year Plan (2007 - 12)
9%
8%
Twel h Five Year Plan (2012 - 17)
8%
6.8%
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7. Twenty Point Programme
●
The Twenty Point Programme (TPP) was launched by the Government of India in 1975.
●
The basic objective of the 20-Point Programme is to eradicate poverty and to improve the quality of life of
the poor and the underprivileged population.
●
The Programme is meant to give a thrust to schemes relating to poverty alleviation, employment generation in
rural areas, housing, education, family welfare & health, protection
●
of environment and many other schemes having a bearing on the quality of life, especially in rural areas.
●
TPP was restructured in 1982 and again in 1986. With the introduction of new policies and programmes it
has been finally restructured in 2006 and it has been in operation at present.
●
The programmes/schemes covered under TPP-2006 are as under:
1. Poverty Eradication
11. Women Welfare
2. Power of People
12. Child Welfare
3. Support to Farmers
13. Youth Development
4. Labour Welfare
14. Improvement of Slums
5. Food Security
15. Environment Protection and Afforestation
6. Housing for All
16. Social Security
7. Clean Drinking Water
17. Rural Roads
8. Health for All
18. Energization of Rural Area
9. Education for All
19. Development of Backward Areas
10. Welfare of Scheduled Castes, Scheduled
20. IT Enabled e-Governance
Tribes, Minorities and OBCs
●
Twenty Point Programme (TPP)-2006 originally consisted of 20 Points and 66 items being monitored
individually by Central Nodal Ministries concerned.
●
From 1st April 2008, Sampoorna Grameen Rojgar Yojana (SGRY) has been merged with another item, namely,
National Rural Employment Guarantee Act, therefore, SGRY has been dropped from the list of 66 items and
only 65 items are now monitored under TPP-2006 since 2008-09.
●
For the purpose of ranking, the performance of States on a monthly basis in respect of 20 identified
parameters has been evaluated.
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8. Planning Commission
●
The Planning Commission was set up by a Resolution of the Government of India in March 1950 in
pursuance of declared objectives of the Government to promote a rapid rise in the standard of living of the
people by efficient exploitation of the resources of the country, increasing production and offering
opportunities to all for employment in the service of the community.
●
The Planning Commission was charged with the responsibility of
❏ Making an assessment of all resources of the country,
❏ Augmenting deficient resources,
❏ Formulating plans for the most effective and balanced utilisation of resources and determining
priorities.
●
Planning Commission's work was three dimensional:
❏ Design policy direction and suggest required schemes/ programmes;
❏ Influence the resource allocation from the budget;
❏ Oversee the performance and record the same on a standard framework for comparative assessment
of all the states from time to time.
●
The Prime Minister is the Chairman of the Planning Commission, which works under the overall guidance of
the National Development Council. Jawaharlal Nehru was the first Chairman of the Planning Commission.
●
The Deputy Chairman and the full-time members of the Commission, as a composite body, provide advice and
guidance to the subject Divisions for the formulation of Five Year Plans, Annual Plans, State Plans, Monitoring
Plan Programmes, Projects and Schemes.
●
The National Development Council oo-ordinates between the Planning Commission and the various States.
●
The Planning Commission was replaced with NITI Aayog on 1st January 2015.
9. National Development Council (NDC)
●
The National Development Council or the Rashtriya Vikas Parishad was set up on 6th August 1952 to
strengthen and mobilise the effort and resources of the nation in support of the plan, to promote common
economic policy in all vital spheres, and to ensure the balanced and rapid development of all parts of the
country.
●
The Council which was re-constituted on October 7, 1967, is the highest decision making authority in the
country in the area of development matters.
●
It is a constitutional body with representation from both the Centre and States.
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●
The Council is headed by the Prime Minister and all Union Cabinet Ministers, State Chief Ministers,
representatives of Union Territories are its members.
●
The functions of NDC are:
❏ To prescribe guidelines for the formulation of the National Plan, including assessment of resources for
the Plan.
❏ To consider the National Plan as formulated by the Planning Commission.
❏ To consider important questions of social and economic policy affecting national development.
❏ To review the working of the Plan from time to time and to recommend such measures as are
necessary for achieving the aims and targets set out in the National Plan.
●
It is a forum not only for discussion of plans and programmes but also social and economic matters of national
importance are discussed in this forum before policy formulation.
●
The NDC ordinarily meets twice a year.
●
It is a very democratic forum where the States openly express their views. No resolution is passed by the
Council.
10. NITI Aayog
●
The NITI Aayog (National Institution for Transforming India), is a non-statutory and extra-constitutional
body established on 1 January 2015 as a replacement for the Planning Commission.
●
NITI Aayog is the premier policy ‘Think Tank’ of the Government of India, providing both directional and
policy inputs.
●
At the core of NITI Aayog’s creation are two hubs
❏ Team India Hub - leads the engagement of states with the Central government
❏ Knowledge and Innovation Hub - builds NITI Aayog think-tank capabilities.
10.1. Objective
●
The NITI Aayog has the following objectives:
❏ To evolve a shared vision of national development priorities, sectors and strategies with the active
involvement of States in the light of national objectives.
❏ To foster cooperative federalism through structured support initiatives and mechanisms with the
States on a continuous basis, recognizing that strong States make a strong nation.
❏ To develop mechanisms to formulate credible plans at the village level and aggregate these
progressively at higher levels of government.
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❏ To design strategic and long term policy and
programme frameworks and initiatives, and
monitor their progress and their efficacy.
❏ To offer a platform for resolution of inter-sectoral
and inter-departmental issues in order to
accelerate
the
implementation
of
the
development agenda.
❏ To
actively
monitor
and
evaluate
the
implementation of programmes and initiatives
❏ To focus on technology up-gradation and capacity
building for the implementation of programmes
and initiatives.
10.2. Composition of NITI Aayog
●
The NITI Aayog will comprise the following:
❏ Chairperson - Prime Minister of India
❏ Governing Council comprising the Chief Ministers of all the States and Lt. Governors of Union
Territories
❏ The full-time organizational framework will comprise of, in addition to the Chairperson:
❖ Vice-Chairperson: To be appointed by the Prime Minister
❖ Chief Executive Officer: To be appointed by the Prime Minister for a fixed tenure, in the rank
of Secretary to the Government of India.
❖ Members: Full-time
❖ Part-time members: Maximum of 2 from leading universities research organizations and other
relevant institutions in an ex-officio capacity on a rotational basis.
❖ Ex Officio members: Maximum of 4 members of the Union Council of Ministers to be
nominated by the Prime Minister.
❏ Regional Councils will be formed to address specific issues and contingencies impacting more than
one state or a region.
❖ These will be formed for a specified tenure.
❖ The Regional Councils will be convened by the Prime Minister and will comprise of the Chief
Ministers of States and Lt. Governors of Union Territories in the region.
❖ These will be chaired by the Chairperson of the NITI Aayog or his nominee.
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❏ Experts, specialists and practitioners with relevant domain knowledge as special invitees nominated
by the Prime Minister
10.3. NITI Aayog role till now
●
The NITI Aayog formulated the Make in India Strategy for Electronics Industry, a Model Land Leasing Law,
National Energy Policy.
●
Prepared a Roadmap for Revitalizing Agriculture, designed a Developmental Strategy for North East and
Hilly areas and undertook an appraisal of the 12th Five Year Plan.
●
NITI Aayog recommended closure of sick PSUs, strategic disinvestment of other CPSUs and pushed for reforms
in the Medical Council of India and the University Grants Commission.
●
In April 2017, the NITI Aayog Governing Council approved the 3 Year Action Plan agenda aimed at shi ing the
composition of expenditure by allocating a larger proportion of additional resources to high priority sectors,
namely education, health, agriculture, rural development, defence, railways and roads.
●
Three sub-groups of Chief Ministers were formed on centrally sponsored schemes (CSS), skill
development and Swachh Bharat.
●
The Atal Innovation Mission was launched to seed innovations to teach young minds new skills.
10.4. NITI Aayog vs Planning Commission
●
NITI Aayog is a Planning Commission with an expanded scope but without its financial powers.
●
The financial powers like setting sectoral priorities, designing the schemes and programmes, estimating the
entitlements to State development programmes (other than devolution), and influencing the annual
allocations as per the priorities etc. now come under the direct influence of the Ministry of Finance, Budget
Division / Dept of Expenditure.
●
Planning Commission’s influence and impact were perceived, felt and measured through annual plan
allocations, discretionary grants. But, NITI Aayog does not have the same ability to influence the annual
allocations and influence on the annual budget proposals.
●
Like the planning commission, NITI Aayog is also without legal support or any constitutional foundation.
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NITI Aayog
Planning Commission
Full time and Part-time Members
Only Full-Time Members
Chief Ministers represented directly in the Governing
Chief Ministers were represented through NDC
Council
Fund Transfers to States is through Finance Ministry
Increased
flexibility
to
Used to transfer funds to states
states in designing and Imposition of central sponsored schemes
implementing development programmes
Prepared national agenda for development
Prepared five-year Plans
11. Achievements of Economic Planning in India
●
Increase in National Income and Per Capita Income
❏ During the planning period, national income has increased manifold.
●
Development of Basic and Capital Goods Industries
❏ With the adoption of the Mahalanobis strategy of development during the Second Plan period, some
basic and capital goods industries like iron and steel witnessed spectacular growth.
●
Development in Agriculture
❏ Agricultural productivity has also marked an upward trend during the plan period.
❏ The production of food-grains which was 510 lakh tones in 1950-51 increased to 176.4 million tones in
1990-91 and further to 283.37 million tones in 2018-19.
●
Self Reliance
❏ Self-reliance refers to the lack of dependence on external assistance.
❏ India has made tremendous achievement towards self-reliance in food grain production, basic
industries etc.
●
Development of Social Infrastructure
❏ Social infrastructure includes such services as education, health facilities, etc. In this area also,
five-year plans are able to achieve desired success.
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12. Failure of Economic Planning in India
●
Inequality in Distribution of Income and Wealth.
●
Inflation.
●
Regional Imbalance.
●
Inadequate Development of Infrastructure.
●
Increase in Unemployment.
●
No Substantial Increase in the Standard of Living.
●
Huge Amount of Deficit Financing.
13. Resource Mobilisation
●
It refers to the policy, mode, means of raising funds by the government for various plan
programmes/projects.
●
The objective of the resource mobilisation is the optimal utilization of the resources.
●
Means of resource mobilisation:
❏ Internal Resource
❏ External Resource
13.1. Internal Resource
●
Internal resources can be defined as the economic resources that are present within the territory of any
country.
●
Internal Resources includes:
❏ Balance from Current Revenue(BCR)
❖ It is the access of the Revenue Receipt of government over its non-planned expenditure.
❖ BCR = Revenue Receipt - Non Planned Expenditure.
❏ Additional Resource Mobilisation
❖ It includes revenue collected from surcharge, cess etc.
❏ Surplus of public sector
❏ Borrowing and Miscellaneous capital receipt
❏ Deficit Financing
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13.2. External Resource
●
External Resource means a generation resource located outside the country.
●
External Resources includes:
❏ Bilateral Assistance
❖ Grants and loans from a foreign government.
❏ Multilateral Assistance from International Institutions.
14. Economic Planning Strategy
●
Indian planning strategies can be split into two phases: the pre-reform phase era and post-reform phase era.
14.1. Pre 1991 Phase/ Pre-reform Phase
●
During the pre – 1991 phase, India followed the Inward looking economic planning strategy.
●
Following strategies are followed during 1951-91 phase:
❏ Heavy Reliance on Public Sector
❏ Regulated Expansion of Private Sector
❏ Protection of Small Scale Industry and Cottage Industries
❏ Restriction on Foreign Capital
❏ Adherence to Centralised Planning
14.2. Post-1991 Phase/Post-reform Phase
●
India's Economic planning strategy witnessed a shi toward market economies in the year 1991.
●
Main changes under NEP (new economic policy) are:
❏ Reorientation of Fiscal policy and monetary policy according to market.
❏ Foreign capital in the form of FDI and FII are encouraged.
❏ Import trade restrictions are at a minimum, while export promotion has been accorded a high priority.
❏ Direct participation of the government is restricted only to strategic industries like atomic energy etc.
❏ Convertibility of Indian Rupee.
❏ Sustainable development.
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15. Amartya Sen Vs Jagdish Bhagwati Debate
●
The debate on economic policy between Amartya Sen and Jagdish Bhagwati is between economic growth and
economic development.
Amartya Sen
Jagdish Bhagwati
Economic growth is just a means
Economic growth is crucial for achieving social means
Achieve intervention of government
Supported LPG (market-oriented approach)
Bottom-Up Approach (rejected trickle-down completely)
Top-Down Approach
First redistribution and then growth
First growth and then redistribution
Kerala and Sri-Lanka model supported
Gujarat Model supported
15.1. Gujarat Model
●
It refers to a period from 2002-03 to 20011-12 during which Gujarat experienced a quantum jump in its growth
rate.
●
The policies followed by the Gujarat government are:
❏
Business Friendliness
❏ Economic Freedom
❏ Good Governance (E-Governance)
❖ Inter-departmental Coordination.
❖ Stable tenure of bureaucrats
❏ Infrastructure Development
❏ Power Reform
❏ Restructuring of Irrigation sector(drip irrigation and minor dams construction)
❏ Strengthening of Road Network through PPP model.
❏ State Public sector enterprises were strengthened.
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15.2. Kerala Model
●
The Kerala model of development is a model of development based on the practices adopted in the state of
Kerala, India.
●
It is characterized by achievements in social indicators such as education, healthcare, high life expectancy,
low infant mortality and low birth rate, by the creation of productive social infrastructure rather than
materialistic infrastructure.
●
The policies followed for development are:
❏ High Expenditure on Social Service like Education, Health etc.
❏ Land Reforms
❏ Effective Decentralisation which empowered local bodies.
❏ Trade Promotion
❏ Rule of le domination, people awareness.
❏ Work of missionaries.
16. Other Terms
16.1. Centralised Planning
●
In centralised planning, the entire economy is governed by a single planning of the central government.
16.2. De-Centralised Planning
●
In Decentralised Planning, plans are prepared and implemented at different levels i.e from the national to the
village level.
16.3. Democratic Planning
●
In Democratic Planning, people/representatives of various sections/sectors are involved in all the stages of
preparation and implementation of the plan.
16.4. Physical Planning
●
In Physical Planning, resources are estimated and allocated in physical terms like manpower, natural
resource, stock of capital etc.
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16.5. Financial Planning
●
In Financial Planning, resources are estimated and allocated in money terms.
●
For example - Tax revenue, Profit of PSU etc.
16.6. Fixed Planning
●
In Fixed Planning, the terms targets/objective of economic planning is seldom changed i.e it remains fixed.
16.7. Rolling Plan/Continuous Planning
●
In Rolling Planning, a medium-term plan is prepared annually i.e every year targets and policies are
determined for the next four to five years and assessment is made of previous four to five years.
●
There are three types of rolling plans:
❏ Short term - One year (like annual budget).
❏
❏
●
Medium term - Four to Six years ( specific targets and policies)
Long Term - Ten to Thirty years (Broad policies and strategies)
India followed the rolling plan from 1978-80.
16.8. Perspective Planning
●
Perspective Planning takes into account the implication of the medium-term targets and policies of a plan
over a period of 10-30 years.
16.9. Comprehensive Planning
●
Comprehensive Planning encompasses all the sectors of the economy.
16.10. Partial Planning
●
In Rolling Planning, policies are prepared for selected sectors of the economy.
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17. UPSC CSE PRELIMS Previous Years Questions
●
Now, let's check how many questions can you attempt?
Q.1) The main objective of the 12th Five-Year Plan is
2014
[A] inclusive growth and poverty reduction
[B] inclusive and sustainable growth
[C] sustainable and inclusive growth to reduce unemployment
[D] Faster, sustainable and more inclusive growth.
Ans.1) Correct Option: (d)
Explanation:
●
The aim of the 12th Five Year Plan is to achieve “faster, sustainable and more inclusive growth”.
●
For this purpose, it seeks to achieve 4% growth in the agriculture sector and 10% in the manufacturing sector.
●
The total budget of the 12th Five Year plan has been estimated at Rs.47.7 lakh crore which is 135 percent more
than that for the 11th Five year Plan (2007-12).
Q.2) The Government of India has established NITI Aayog to replace the
2015
[A] Human Rights Commission
[B] Finance Commission
[C] Law Commission
[D] Planning Commission
Ans.2) Correct Option: (d)
Explanation:
●
National Institution for Transforming India (NITI) replaced the erstwhile Planning Commission.
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Q.3) With reference to India’s Five-Year Plans, which of the following statements is/are correct?
2019
1. From the Second Five-Year Plan, there was a determined thrust towards substitution of basic and capital goods
industries.
2. The Fourth Five-Year Plan adopted the objective of correcting the earlier trend of increased concentration of wealth
and economic power.
3. In the Fi h Five-Year Plan, for the first time, the financial sector was included as an integral part of the Plan.
Select the correct answer using the code given below.
(a) 1 and 2 only
(b) 2 only
(c) 3 only
(d) 1, 2 and 3
Ans.3) Correct Option: (a)
Explanation:
●
Rapid industrialisation, with particular emphasis on the development of basic and heavy industries, is one of
the objectives of the 2nd Five-year plan
●
Nationalization of 14 major Indian Banks was a key during the 4th five years plan. This boosted the confidence
of the people in the banking system.
●
Fi h Five-year plan was proposed to achieve two main objectives: Removal of poverty' (Garibi Hatao) and
Attainment of self-reliance
Q.4) Atal Innovation Mission is set up under the
2019
(a) Department of Science and Technology
(b) Ministry of Labour and Employment
(c) NITI Aayog
(d) Ministry of Skill Development and Entrepreneurship
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Ans.4) Correct Option: (c)
Explanation:
●
The Atal Innovation Mission (AIM) is a flagship initiative set up by the NITI Aayog to promote innovation and
entrepreneurship across the length and breadth of the country.
●
AlM's objectives are to create and promote an ecosystem of innovation and entrepreneurship across the
country at schools, universities, research institutions, MSME and industry levels.
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Industry
1. Introduction
3
2. Industrial Policies of India
3
2.1. Industrial Policy Resolution of 1948
3
2.2. Industrial Policy Resolution of 1956
4
2.3. Industrial Policy Resolution of 1969
4
2.4. Industrial Policy Resolution of 1973
5
2.5. Industrial Policy Resolution of 1977
5
2.6. Industrial Policy Resolution of 1980
6
2.7. Industrial Policy Resolution 1985 & 1986
7
2.8. New Industrial Policy, 1991
7
2.8.1. Positive of New Industrial Policy, 1991
9
2.8.2. Criticism of New Industrial Policy, 1991
9
3. National Manufacturing Policy 2011
10
4. National Manufacturing Policy 2011
11
4.1. Land For NIMZ
11
4.2. Ownership
11
4.3. Administration
12
4.4. Number of NIMZ?
12
4.5. Difference between SEZ vs NIMZ?
12
5. Make in India
12
6. What did the government do to promote manufacturing?
13
6.1. Ease of doing business
13
6.2. Labour Reform
14
6.2.1. Pandit Deendayal Upadhyay Shramev Jayate Karyakram
14
6.2.2. Factories (Amendment) Bill, 2014
15
6.3. Skill Development
15
6.3.1. Ministry of Skill Development and Entrepreneurship(MSDE)
15
6.3.2. Sector Skill Council(SSC)
16
7. Companies Act 2013
16
8. Public Sector Enterprise/Undertakings
17
8.1. Evolution of Public Sector Enterprises
18
8.2. Objective of PSU
18
8.3. Cause of Losses of PSU
19
8.4. Reforms in PSU
19
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9. Disinvestment
20
9.1. Objectives of Disinvestment
21
9.2. Process of Disinvestment
21
9.3. National Investment Fund
23
10. Micro, Small and Medium Enterprises Development (MSMED) Act 2006
23
10.1. Definition of Micro, Small and Medium Enterprises in India
24
10.2. Contribution of MSME Sector
24
10.3. Problem in MSME Sector
24
10.4. Measures taken by Government
25
10.4.1. Financial Support
25
10.4.2. Fiscal Support
25
10.4.3. Technical and Industrial Support
25
10.4.4. Reservation of item for Small Scale Industry(SSI)
26
11. Capital Formation or Investment
26
11.1. Stages of Capital Formation
26
11.2. Component of Investment
27
11.3. Determinant of Investment
27
11.4. Types of Capital Formation
27
12. Index of Industrial Production (IIP)
28
13. Index of Eight Core Industries
29
14. Annual Survey of Industries (ASI)
30
14.1. ASI vs IIP
30
15. UPSC CSE PRELIMS Previous Years Questions
31
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1. Introduction
●
Industrial development has been a major factor in economic development. Thus, the industrial development
of the country will be guided and fostered by the industry policy.
●
Before 1947 the industrial base of the economy was very small and the industries were base with many
problems such as shortage of raw materials, deficiency of capital, bad industrial relations, etc.
●
The government of India launched the process of industrial development a er independence in 1947.
2. Industrial Policies of India
2.1. Industrial Policy Resolution of 1948
●
The Industrial Policy Resolution of 1948 marked the beginning of the evolution of the Indian Industrial Policy.
●
The Resolution emphasized the importance to the economy of securing a continuous increase in production
and its equitable distribution and pointed out that the State must play a progressively active role in the
development of Industries.
●
This policy states that India is a mixed economy with overall responsibility of the government for planned
development of industries and their regulation in the national interest.
●
The main features of the 1948 industry policy are :
❏ Acceptance of the importance of both private and public sectors
❏ Division of the industrial sector
❏ Role of small and cottage industries
❏ Other important features of the industrial policy
●
It classified industries in 4 categories:
❏ Some of the Strategic industries exclusive under State Monopoly included arms and ammunition,
atomic energy etc.
❏ Some of the Basic/Key industries with government control included heavy machinery, defence
equipment etc.
❏ Some of the Important industries controlled by the private sector, however, the central government,
in consultation with the state government, will have general control over them. Such important
industries included heavy chemicals, sugar, cotton textile and woollen industry etc
❏ All Other Industries which were not included in the above three categories are open for the private
sector with many of them having the provision of compulsory licencing.
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2.2. Industrial Policy Resolution of 1956
●
Industrial Policy Resolution of 1956, which was the first comprehensive statement of the strategy for
Industrial development in India.
●
The 1956 Industrial Policy Resolution gave primacy to the role of the State to assume a predominant and
direct responsibility for industrial development.
●
The main aim of this policy was:
❏ To accelerate economic growth and boost the process of industrialization
❏ To reduce disparities in income and wealth and the removal of regional disparities through the
development of regions with a low industrial base
❏ Promotion of village and small-scale industries.
●
Industries were reclassified into three categories.
❏ Schedule 'A'
❖ It consisted of 17 industries prominent among them were arms & ammunition, atomic energy,
air transport, railway etc.
❖ Development of these sectors was the exclusive responsibility of the State.
❏ Schedule 'B'
❖ It consisted of 12 industries prominent among them were Machine tools, chemicals, drug,
pharmaceuticals, antibiotics, fertilizers etc.
❖ Though industries of this schedule were supposed to be developed & owned primarily by the
State, private sector enterprise was also expected to supplement the efforts of the State.
❏ Schedule 'C'
❖ Residual industries were le open to the private sector enterprise. These industries were
heavily controlled through licensing provisions.
●
This is considered as the most important industrial policy of India as it decided not only the industrial
expansion but structured the very nature and scope of the economy till 1991.
2.3. Industrial Policy Resolution of 1969
●
This licencing policy which aimed at solving the shortcomings of the licencing policy started by the Industrial
Policy of 1956.
●
Industrial Policy Resolution of 1969 following major changes in the area:
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❏ The Monopolistic and Restrictive Trade Practices (MRTP) Act was passed. The Act intended to
regulate the trading and commercial practices of the firms and check monopoly and concentration of
economic power.
❏ The firms with assets of 25 crores 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 ‘50 crore in 1980 and ‘100 crores in 1985.
❏ For the redressal of the prohibited and restricted practices of trade, the Government did set up an
MRTP Commission.
2.4. Industrial Policy Resolution of 1973
●
Indian Policy Statement of 1973 identified high priority industries with investment from large industrial houses
and foreign companies were permitted.
●
Industrial Policy Resolution of 1973 following major changes:
❏ 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.
❏ The concept of ‘joint sector’ was developed which allowed partnership among the centre, state and
the private sector while setting up some industries.
❏ Some industries were put under the Reserved list in which only the small or medium industries could
be set up
❏ To regulate foreign exchange the Foreign Exchange Regulation Act (FERA) was passed in 1973.
❏ Limited permission of foreign investment was given with the Multinational Corporations (MNCs)
being allowed to set up their subsidiaries in the country.
2.5. Industrial Policy Resolution of 1977
●
Indian Policy Statement was announced by George Fernandes, the then union industry minister of the
parliament.
●
The main thrust of the Industrial Policy statement of 1977 was on effective promotion of small, cottage and
village industries.
●
The highlights of this policy are:
❏ Small-Scale and Cottage industries - Small sector was classified Into three categories
❖ Cottage & household industries producing wage goods with vast self-employment potential.
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❖ Tiny sector with investment in machinery and equipment up to Rs. 1 lakh
❖ Small scale industries with investment up to Rs.10 lakh and ancillary units with investment in
fixed capital up to Rs. 15 lakh.
❏
Large Scale Industries
❖
Basic industries which are essential for providing infrastructure as well as for the
development of small and village industries, such as steel, non-ferrous metals, cement, oil,
refineries:
❖ Capital goods industries for meeting the machinery requirement of basic industries as well as
small scale industries;
❖ High technology industries which require large scale production, and which are related to
agricultural and small scale industrial development such as fertilizers, pesticides, and
petrochemicals etc;
❏ Public sector enterprises were given the task of controlling the economy and by keeping these
industries in under government control check concentration of economic power in the hands of a few
individuals or groups.
❏ Employment oriented planning was to replace production-oriented planning to achieve equitable
distribution.
●
The IPR of 1977 failed to make an impact because though the policy tried to be different, there was no radical
change from the previous policies.
2.6. Industrial Policy Resolution of 1980
●
The Industrial Policy of 1980 reiterated its faith in the ideology of the Industrial Policy Statement of 1956.
●
The Industrial Policy Statement of 1980 placed the thrust on the promotion of competition in the domestic
market, technological upgrading and modernization of industries.
●
Some of the socio-economic objectives of the policy are:
❏ Maximum production and achieving higher productivity
❏ Higher employment generation
❏ Correction of regional imbalances
❏ Promotion of export-oriented industries
●
The major initiatives of the policy were as given below:
❏ Foreign investment via the technology transfer route was allowed again
❏ The ‘MRTP Limit’ was revised upward to `50 crore to promote the setting of bigger companies.
❏ Industrial licencing was simplified.
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❏ It extended the provision of automatic expansion to more industries.
●
The 1980 Industrial Policy Statement opened up new vistas for the private sector to expand its activities and
even set up industries the sector reserved for the State in 1956 Resolution.
2.7. Industrial Policy Resolution 1985 & 1986
●
The industrial policy resolutions announced 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:
❏ Foreign investment was further simplified with more industrial areas being open for their entries.
❏ The ‘MRTP Limit’ was revised upward to `100 crore—promoting the idea of bigger companies.
❏ The provision of industrial licencing was simplified. Compulsory licencing now remained for 64
industries only.
❏ High-level attention on the sunrise industries such as telecommunication, computerisation and
electronics.
❏ Modernisation and the profitability aspects of the public sector undertakings were emphasised.
❏ The agriculture sector was attended with a new scientific approach with many Technology Missions
being launched by the Government.
●
These industrial provisions were attempted at liberalising the economy without any slogan of ‘economic
reforms’.
●
The industrial policies conjoined with the overall micro-economic policy followed by the Government was
more dependent on foreign capital.
●
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).
●
Finally, by the end of 1980s India was in the grip of a severe balance of payment crisis with a higher rate of
inflation (over 13 per cent) 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.
2.8. New Industrial Policy, 1991
●
India was faced with a severe balance of payment crisis in June 1991. Basically, in 1990 and 1991, there were
several inter-connected events which were growing unfavourable for the Indian economy.
❏ Due to the Gulf War (1990–91), the higher oil prices were fastly depleting India’s foreign reserves.
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❏ Sharp decline in the private remittances from the overseas Indian workers in the wake of the Gulf War,
especially from the Gulf region.
❏ Inflation peaking at nearly 17 per cent.
❏ The gross fiscal deficit of the central government reaching 8.4 per cent of the GDP.
❏ By the month of June 1991, India’s foreign exchange had declined to just two weeks of import
coverage.
●
India’s market liberalisation measures in 1991 followed by a gradualist approach. As the reforms were induced
by the crisis of the BoP, the initial phase focussed on macroeconomic stabilisation while the reforms of
industrial policy, trade and exchange rate policies, foreign investment policy, financial and tax reforms as well
as public sector reforms did also follow soon.
●
The new industrial policy, announced by the Government on July 23, 1991, had initiated a bigger process of
economic reforms in the country, focusing towards the structural readjustment naturally obliged to ‘fulfil’ IMF
conditionalities.
●
In pursuit of these objectives Government decided to take a series of initiatives in respect of the policies
relating to the following areas:
❏ Industrial licensing
❖ Under new policy industrial licensing was abolished for all industries, except those specified
irrespective of the level of investment.
❖ Only 18 industries needed a compulsory license. Subsequently, this was further liberalised and
only 6 industries such as Alcohol, Electronic equipment and defence equipment, Tobacco
product, Industrial explosives, Hazardous chemicals, Drugs and Pharmaceuticals.
❖ The objective was to provide impetus to the attainment of fullest entrepreneurial and
industrial potential.
❏ Foreign Investment
❖ Direct foreign investment was approved up to 51% foreign equity in high priority industries.
There are 34 industries in this category.
❖ A Special Empowered Board was also to be constituted to negotiate with a number of large
international firms and approve direct foreign investment in select areas.
❏ Foreign Technology Agreement
❖ Bureaucratic clearance was no longer required for an Indian entrepreneur for his commercial
technology relationship with his foreign supplier.
❖ It was expected that the Indian industry would not only absorb foreign technology efficiently
but competitive pressure would induce them to invest much more in indigenous R&D activity.
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❏ Public Sector Undertakings
❖ The public sector has been central to the philosophy of development.
❖ Introduce competition by inviting private sector participation in the public sector dominated
sector.
❖ Disinvested government holdings in order to provide market discipline to the performance of
public enterprises and get out of those areas where governments presence is not required.
❖ Due to the policy initiative and governments decision to get out of the sectors which could be
entrusted to the private sector number of industries reserved for the public sector was cut
down to three which include defence equipment, Atomic energy, Railway transport.
❏ Monopoly and Restrictive Trade Practices Act
❖ The objective of the Act was the prevention of concentration of economic power in a few
hands which may be detrimental to the objective of social justice. But the present form of
implementing the Act resulted in inhibiting industrial growth.
❖ The Act was to be restructured so as to minimize government interference in investment
decisions of the large companies.
❖ Restrictions on mergers, acquisitions, amalgamations and takeovers were also sought to be
liberalized in the light of the new wave of liberalization.
2.8.1. Positive of New Industrial Policy, 1991
●
The end of licence - permit raj.
●
Foreign investment and foreign technology were supposed to encourage the investment environment in the
country and boost the competitive environment by shaking the complacency of Indian business.
●
Limits of assets fixed for MRTP and dominant companies were removed giving them free hand for growth.
●
Role of the public sector was redefined and attention was paid to increase its efficiency and productivity.
2.8.2. Criticism of New Industrial Policy, 1991
●
NEP was criticized for promoting 'jobless growth'.
●
Neglect of agriculture was another area of major weakness in the NEP.
●
Liberalization of imports might offset export growth leading to an adverse impact on BoP position.
●
The possible reverse flow of dividends, royalties, and remittance of profit might result in the outflow of foreign
exchange creating pressure.
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3. National Manufacturing Policy 2011
●
Government of India decided to bring out the National Manufacturing Policy to bring about a quantitative and
qualitative change it includes:
❏ Increase manufacturing sector growth to 12-14% over the medium term to make it the engine of
growth for the economy.
❏ Manufacturing Sector to contribute at least 25% of the National GDP by 2022.
❏ Increase the rate of job creation in manufacturing to create 100 million additional jobs by 2022.
❏ Creation of appropriate skill sets among the rural migrant and urban poor to make growth inclusive.
❏ Enhance the global competitiveness of Indian manufacturing through appropriate policy support.
❏ The policy envisages the establishment of National Investment and Manufacturing Zones (NIMZ)
equipped with world-class infrastructure that would be autonomous and self-regulated developed in
partnership with the private sector.
●
The following industry will be given special attention:
❏ Employment intensive industries: Adequate support will be given to promote and strengthen
employment-intensive industries to ensure job creation.
❏ Capital Goods: A special focus will be given to machine tools; heavy electrical equipment; heavy
transport, earth moving and mining equipment.
❏ Industries with strategic significance: A strategic requirement of the country would warrant the
launch of programmes to build national capabilities to make India a major force in sectors like
aerospace, shipping etc.
❏ Small and Medium Enterprises: The SME sector contributes about 45% to the manufacturing output,
40% of the total exports, and offers employment opportunities both for self-employment and jobs,
across diverse geographies.
❏ Public Sector Enterprises: Public Sector Undertakings, especially those in Defence and Energy
sectors, continue to play a major role in the growth of manufacturing as well as of the national
economy.
❏ Industries where India enjoys a competitive advantage: India’s large domestic market coupled with
a strong engineering base has created indigenous expertise and cost-effective manufacturing in
automobiles, pharmaceuticals, and medical equipment.
●
Instruments which are to be used to achieve the objectives are as follow:
❏ Rationalization and simplification of business regulations.
❏ Simple and expeditious exit mechanism for the closure of sick units while protecting labour interests.
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❏ Industrial training and skill up-gradation measures.
❏ Incentives for SMEs.
❏ Financial and institutional mechanisms for technology development, including green technologies.
4. National Manufacturing Policy 2011
●
National Investment & Manufacturing Zones (NIMZs) are one of the important instruments of National
Manufacturing Policy, 2011.
●
NIMZs are envisaged as large areas of developed land with the requisite eco-system for promoting world-class
manufacturing activity.
●
These will also help us to meet the increasing demand for creating world-class urban centres in India, while
will also absorb surplus labour by providing them with gainful employment opportunities.
●
These NIMZs would be managed by SPVs(Special Purpose Vehicle) which would ensure
❏ Master planning of the Zone;
❏ Pre-clearances for setting up the industrial units to be located within the zone
❏ Undertake such other functions as specified in the various sections of this policy.
●
To enable the NIMZ to function as a self-governing and autonomous body, it will be declared by the State
Government as an Industrial Township.
●
The Department of Industrial Policy and Promotion(DIPP) will act as the nodal agency for the central
government in matters pertaining to the NIMZs.
4.1. Land For NIMZ
●
Size of land for NIMZ – An NIMZ would have an area of at least 5000 hectares in size.
●
Availability of land - The State Government will be responsible for the selection of land suitable for the
development of the NIMZ including land acquisition if necessary. The land may constitute:
❏ Government-owned land
❏ Private lands falling within the proposed NIMZ, to be acquired by the State Government
❏ Land under existing industrial areas/estates/sick and defunct units including PSUs
4.2. Ownership
●
It is le to the State Government to adopt a model that it considers most workable.
●
It may include:
❏ Keep the ownership with the state government itself.
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❏ Transfer the ownership to a state government undertaking.
❏ Have joint ownership with a private partner.
❏ Adopt any other appropriate model
4.3. Administration
●
The administrative structure of NIMZ will comprise of a Special Purpose Vehicle, a developer, State
Government and the Central Government.
●
An NIMZ will be notified by the Central Government, by notification in the Official Gazette.
●
Every SPV shall be a legal entity by the name of the NIMZ. This SPV can be a company.
●
The CEO of the SPV will be a senior Central/State government official.
●
The Central Government will bear the cost of master planning for the NIMZ.
4.4. Number of NIMZ?
●
So far, three NIMZs namely Prakasam (Andhra Pradesh), Sangareddy (Telangana) and Kalinganagar
(Odisha) have been accorded final approval and 13 NIMZs have been accorded in-principle approval.
●
Besides these, eight Investment Regions along the Delhi Mumbai Industrial Corridor (DMIC) project have
also been declared as NIMZs.
4.5. Difference between SEZ vs NIMZ?
●
The main objective of Special Economic Zones is the promotion of exports, while NIMZs are based on the
principle of industrial growth in partnership with States and focuses on manufacturing growth and
employment generation.
●
NIMZs are different from SEZs in terms of size, level of infrastructure planning, governance structures related
to regulatory procedures, and exit policies.
5. Make in India
●
The Make in India initiative was launched by the Government in 2014 to encourage companies to manufacture
their products in India and ensure dedicated investments into manufacturing.
●
It was launched by the Department of Industrial Policy and Promotion (DIPP), Ministry of Commerce and
Industry.
●
Objectives of Scheme :
❏ Improving the competitiveness of the private and public sector firms operating in the country.
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❏ Facilitating integration into the global value chains.
❏ Enhance Ease of Doing Business
❏ Enhance skill development
❏ Providing employment
●
It is an international marketing strategy based on the Singapore model to enhance the competitiveness of
the manufacturing sector by promoting FDI, imposing ease of doing business, labour reform etc.
●
The Make in India programme is very important for the economic growth of India as it aims at utilising the
existing Indian talent base, creating additional employment opportunities and empowering secondary and
tertiary sector.
●
The programme also aims at improving India’s rank on the Ease of Doing Business index by eliminating the
unnecessary laws and regulations, making bureaucratic processes easier, making the government more
transparent, responsive and accountable.
●
The focus of the Make in India programme is on 25 sectors. These include:
Automobiles
Aviation
Chemicals
IT & BPM
Pharmaceuticals
Construction
Defence
Manufacturing
Electrical Machinery
Food processing
Textiles and
Garments
Ports
Leather
Media and
Entertainment
Wellness
Mining
Tourism and
Hospitality
Railways
Automobile
Components
Renewable Energy
Biotechnology
Space
Thermal power
Roads
Highways
Electronics Systems
6. What did the government do to promote manufacturing?
6.1. Ease of doing business
●
Government has initiated reforms in the area such as starting a business, dealing with construction permits,
registration of property, power supply, paying taxes, enforcing contracts and resolving insolvency.
●
The eBiz initiative, being piloted by the Department of Industrial Policy and Promotion, seeks to provide
comprehensive Government-to-Business (G2B) services to business entities with transparency, speed, and
certainty. It aims at reducing the points of contact between business entities and Government agencies,
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establishing single-window services, and
reducing the burden of compliance. eBiz is
being implemented by Infosys Technologies
Limited (Infosys).
●
Invest India is India’s official agency
dedicated to investment promotion and
facilitation.
single-window
It
is
a
facilitator,
not-for-profit,
set
up
for
prospective overseas investors and to those
aspiring Indian investors desiring to invest
in foreign locations, and acts as a structured
mechanism to attract investment. Invest
India is essentially an Investment Promotion Agency in India. Invest India, set up in 2009, is a non-profit
venture under the Department for Promotion of Industry and Internal Trade, Ministry of Commerce and
Industry, Government of India.
●
Stable and predictable tax regime i.e avoiding litigation, retrospective taxation etc.
●
Easing of environmental clearance norms.
6.2. Labour Reform
6.2.1. Pandit Deendayal Upadhyay Shramev Jayate Karyakram
●
It was launched in October 2014 by the Government of India.
●
The main objective of the scheme is to provide a conducive environment for industrial development and
promote ease of doing business through the introduction of several labour reforms.
●
The five main schemes launched under this are:
❏ A dedicated Shram Suvidha Portal: That would allot Labour Identification Number (LIN) to nearly 6
lakh units and allow them to file online compliance for 16 out of 44 labour laws.
❏ An all-new Random Inspection Scheme: Utilizing technology to eliminate human discretion in the
selection of units for Inspection, and uploading of Inspection Reports within 72 hours of inspection
mandatory.
❏ Universal Account Number: Enables 4.17 crore employees to have their Provident Fund account
portable, hassle-free and universally accessible.
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❏ Apprentice Protsahan Yojana: Will support manufacturing units mainly and other establishments by
reimbursing 50% of the stipend paid to apprentices during the first two years of their training.
❏ Revamped Rashtriya Swasthya Bima Yojana: Introducing a Smart Card for the workers in the
unorganized sector seeded with details of two more social security schemes.
6.2.2. Factories (Amendment) Bill, 2014
●
The Factories (Amendment) Bill, 2014 was introduced in Lok Sabha on August 7, 2014. It proposes to amend
the Factories Act, 1948.
●
The Act aims to ensure adequate safety measures and promote the health and welfare of the workers
employed in factories.
●
It proposes to empower the state government to allow women to work during night hours in a factory or
group of factories that meet a certain condition.
●
The Bill seeks to impose restrictions on the employment of pregnant women and persons with disability in
certain works or processes.
●
Norms of hiring and firing were liberalised.
6.3. Skill Development
6.3.1. Ministry of Skill Development and Entrepreneurship(MSDE)
●
A separate ministry for skill development has been established i.e Ministry of Skill Development and
Entrepreneurship(MSDE).
●
The Ministry is responsible for the coordination of all skill development efforts across the country, removal of
disconnect between demand and supply of skilled manpower, building the vocational and technical training
framework, skill up-gradation, building of new skills, and innovative thinking not only for existing jobs but also
jobs that are to be created.
●
The Ministry aims to Skill on a large Scale with Speed and high Standards in order to achieve its vision of a
'Skilled India'.
●
It is aided in these initiatives by its functional arms – National Skill Development Agency (NSDA), National Skill
Development Corporation (NSDC), National Skill Development Fund (NSDF) and Sector Skill Councils (SSCs).
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6.3.2. Sector Skill Council(SSC)
●
Sector Skill Councils are set up as autonomous industry-led bodies by NSDC.
●
They create Occupational Standards and Qualification bodies, develop competency framework, conduct Train
the Trainer Programs, conduct skill gap studies and Assess and Certify trainees on the curriculum aligned to
National Occupational Standards developed by them.
●
New skill Development programmed has been initiated like Pradhan Mantri Kaushal Vikas Yojana, National
Apprenticeship Promotion Scheme, Deen Dayal Upadhyaya Grameen Kaushalya Yojana etc.
7. Companies Act 2013
●
The Indian Companies Act 2013 replaced the Indian Companies Act, 1956.
●
The Companies Act, 2013 seeks to bring corporate governance and regulation practices in India at par with the
global best practices.
●
Objective :
❏ It seeks to create a more friendly environment and improve corporate governance norms, increase
transparency, enhance the accountability of corporates and auditors and to protect the interest of the
investor, especially small investors.
●
Features:
❏ Corporate Social Responsibility(CSR)
❖ The companies having annual turnover of over Rs 1000 crore or net worth of Rs 500 crore or
more or net profit of Rs 5 crore or more in any financial year has to constitute a CSR committee
consisting of at least three directors out of which one director should be an independent
director.
❖ Such companies have to spend at least 2% of the average net profit of the preceding 3 years on
CSR activities.
❏ Directors
❖ At least one-third of the directors in all listed companies should be independent directors.
❖ There should be at least one female director in the prescribed company ( not all companies).
❖ In all listed companies, at least one director must be resident director i.e stayed in India for at
least 182 days in a year.
❖ Duties of directors are also prescribed in Companies Act 2013.
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❏ Auditing and accounting norms
❖ A National Financial Reporting Authority should be established to supervise and regulate the
accounting standard of the companies.
❖ Mandatory rotation of auditors i.e individual auditors could be appointed for not more than
five years and audit firms could be appointed for not more than 10 years.
❖ Auditors cannot provide any other service to the company.
❏ Investor Protection
❖ The class-action suit provision was introduced for the 1st time. Under this, a shareholder,
creditor, or any stakeholder can sue a company on behalf of a particular class of
shareholder/stakeholder.
❖ Exit option to be provided to minority shareholders during the reorganisation of the company.
❏ National Company Law Tribunal (NCLT)
❖ The National Company Law Tribunal would replace the Board for Industrial and Financial
Reconstruction(BIFR) and Company Law Board(CLB).
8. Public Sector Enterprise/Undertakings
●
The term public sector undertaking or Enterprise refers to a Government Company.
●
Government Company is defined under Section 2 (45) of the Companies Act, 2013 as Any company in which
not less than fi y-one percent of the paid-up share capital is held by the
❏ Central Government, or
❏ State Government or Governments, or
❏ Partly by the Central Government and partly by one or more State Governments
❏ Includes a company which is a subsidiary company of such a Government company.
●
Public Sector undertakings refer to commercial ventures of the Government where user fees are charged for
services rendered. They are usually fully owned and managed by the Government such as Railways, Posts,
Defence Undertakings etc.
●
Public sector enterprises, on the other hand, refer to those companies registered under the Companies
Act, 1956, which are predominantly owned by Government and which are managed by a Government
appointed Chairman and Managing Director. Government nominees represent the interests of the Government
on the board of Public sector enterprises.
●
The audit of public sector undertakings is done by the Comptroller and Auditor General(CAG) of India while
that of public sector enterprises is done first by Chartered Accountants and the supplementary audit is done
by the Comptroller and Auditor General of India
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8.1. Evolution of Public Sector Enterprises
●
At the time of independence in 1947, Indian industry was ill-developed and required considerable policy
thrust.
●
The Second Five year Plan (1956-61) and the Industrial Policy Resolution of 1956 provided the framework for
public sector undertakings/enterprises in India, which were expected to play a substantial role in preventing
the concentration of economic power, reducing regional disparities and ensuring that planned development
serves the common good.
●
The Union Government and various sub-national governments made a considerable investment in setting up
and running public sector undertakings/enterprises.
●
Initially, the public sector was confined to core and strategic industries such as irrigation projects (e.g. the
Damodar Valley Corporation), Fertilizers and Chemicals (e.g. Fertilizers and Chemicals, Travancore Limited)
Communication Infrastructure (e.g. Indian Telephone Industries), Heavy Industries (e.g. Bhilai Steel Plant,
Hindustan Machine Tools, Bharat Heavy Electricals, Oil and Natural Gas Commission etc.).
●
Subsequently, however, the Government nationalized several banks (starting with nationalization of the
Imperial Bank of India which was renamed State Bank of India in 1955) and foreign companies (Jessop & Co,
Braithwaite & Co, Burn & Co.).
●
Later Public Sector companies started manufacturing consumer goods (e.g. Modern Foods, National Textile
Corporation etc) and providing consultancy, contracting, and transportation services.
●
Reviewing the role of the public sector, the Industrial Policy Resolution 1991 reduced the number of
industrial undertakings exclusively reduced to the public sector to just six areas which included strategic
industries like atomic energy, defence, coal, mineral oils etc. as well as railway transport. Efforts were made to
divest non-strategic public sector industries and to increase private participation in the equity of profitable
public sector industries.
8.2. Objective of PSU
●
To create an industrial base with diversification in different sectors.
●
Employment generation and to create an employee model.
●
Accelerate economic growth.
●
Reduce regional disparities.
●
Export Promotion and import substitution.
●
To generate resources for the government.
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8.3. Cause of Losses of PSU
●
Lack of autonomy and accounting.
●
Excessive Social overhead cost like developing infrastructure, amenities to employers etc.
●
Inappropriate location, technology, product etc.
●
Investment decision was based on social welfare rather than economic welfare.
●
Overstaffing.
●
Trade Union interference.
●
Administrative Price Mechanism - Under this government use to fix the prices of the product of PSU.
8.4. Reforms in PSU
●
New Industrial Policy 1991 ❏ The changes made by the Industrial Policy 1991 on PSUs were several:
❖
Sectors where the PSUs to be concentrated,
❖ Removal of reservation for PSUs in most sectors,
❖ PSU restructuring by adopting market-oriented practices,
❖ Selling of loss-making PSUs,
❖ Reduction of government ownership through disinvestment.
●
Voluntary Retirement Scheme(VRS)
❏ Under this Employee of PSU were encouraged to seek premature retirement.
❏ It is also called the Golden Handshake Scheme.
●
Dismantling of APM
❏ Price of most of the products of PSU was deregulated.
●
Participation in Share Market
❏ PSUs were permitted to raise funds from the public through issue of IPO and get listed in the stock
exchange.
●
Navratra Scheme 1997
❏ The Government had introduced the Navratna scheme, in 1977, to identify Central Public Sector
Enterprises (CPSEs) that had comparative advantages and to support them in their drive to become
global giants.
❏ Government provided significant autonomy to such PSUs like to invest up to Rs 100 crore or up to
15% of their net worth in India/abroad, entering into collaboration, establishing joint ventures etc.
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●
Miniratra Scheme 1997
❏ The Government had introduced the Miniratna scheme in 1997 in pursuance of the policy to make the
public sector more efficient and competitive and to grant enhanced autonomy and delegation of
powers to the profit-making public sector enterprises.
❏ Eligibility conditions are:
❖ Category I - CPSEs should have made a profit in the last three years continuously, and the
pre-tax profit should have been Rs. 30 crores or more in at least one of the three years and
positive net worth.
❖ Category II - CPSEs should have made a profit for the last three years continuously and should
have a positive net worth.
●
Maharatna Scheme
❏ The Government introduced the Maharatna scheme in December 2009 with the objective to delegate
enhanced powers to the Boards of identified large sizes Navratna CPSEs to facilitate further
expansion of their operations, both in domestic as well as global markets.
❏ Eligibility conditions are:
❖ Having a Navratna status.
❖ Listed on the Indian stock exchange, with a minimum prescribed public shareholding under
SEBI regulation.
❖ Average annual turnover of more than Rs.20,000 crore during the last three years.
❖ An average annual net worth of more than Rs.10,000 crore during the last three years.
❖ An average annual net profit of more than Rs.2500 crore during the last 3 years.
❖ Significant global presence or international operations.
❏ The Maharatna CPSEs can invest Rs. 5000 crores or 15% of net worth whichever is lower in one
project without government permission.
9. Disinvestment
●
Disinvestment refers to government sells its equity holding in Public Enterprises to public or private parties,
financial institutions and mutual funds etc
●
The disinvestment policy, at initial stage, had stated a limited sale of equity for the purpose of raising some
resources to reduce budgetary gaps and providing market discipline to the performance of public enterprises.
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9.1. Objectives of Disinvestment
●
Modernization and up-gradation of public sector enterprises.
●
To reorient public investment i.e to transfer public investment from non-strategic to strategic areas.
●
Improve the efficiency of an enterprise and can convert the sick unit into productive units.
●
Increase transparency and accounting to the general public.
●
Releasing huge amounts of scarce public resources locked up in nonstrategic PSU for development in areas
much higher on social priority, such as public health, family welfare, education, social and essential
infrastructure.
9.2. Process of Disinvestment
●
Government started the process of disinvestment in 1991 and initiated it under New Industrial Policy 1991.
●
Initially, the disinvestment process only involved financial institutions.
●
In 1992, the Government created a committee on disinvestment under C.Rangarajan which recommended
that a disinvestment fund should be constituted and the government should go for strategic
disinvestment(management control is also transferred).
●
In 1996, the Disinvestment commission (a permanent body to advise the government) was set up.
●
In the Budget speech of 1998-99, it was announced that the Government shareholding in CPSEs should be
brought down to 26% on a case-to-case basis, excluding strategic CPSEs where the Government would retain
majority shareholding. The interest of workers was to be protected in all cases. For this purpose, on 16 March
1999, the Government classified the PSEs into Strategic and Non-Strategic areas.
●
In 2004, with the change in the Government, there was a change in the outlook of Disinvestment Policy. The
UPA Government pledged to
❏ Devolve full managerial control and commercial autonomy to successful, profit-making companies
operating in a competitive environment they won’t be privatized.
❏ Navratna companies can raise resources from the capital market.
❏ Efforts will be made to modernize and restructure sick PSEs.
❏ It favoured the sale of small proportions of Government equity through IPO/FPO without changing the
character of PSEs.
❏ It also constituted the formation of the ‘National Investment Fund’, where the proceeds from
disinvestment of CPSEs would be channelized. 75% of the annual income of NIF would be used to
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finance selected Social Sector Schemes- education, health, employment and the rest 25% to meet the
capital investment requirements of profitable and revivable CPSEs.
●
On 5th November 2009, the Government approved the following action plan for disinvestment in
profit-making government companies:
❏ Already listed profitable CPSEs (not meeting mandatory shareholding of 10%) are to be made
compliant by ‘Offer for Sale’ by Government or by the CPSEs through the issue of fresh shares or a
combination of both.
❏ Unlisted CPSEs with no accumulated losses and having earned net profit in three preceding
consecutive years are to be listed
❏ In all cases of disinvestment, the Government would retain at least 51% equity and management
control.
❏ All cases of disinvestment are to be decided on a case by case basis.
●
Since 2014, the government has followed a policy of disinvestment through a minority stake sale and strategic
disinvestment. So far, the government has given 'in-principal' approval for strategic disinvestment of 33
central public sector undertakings (CPSEs).
●
Think-tank Niti Aayog has been mandated to identify such PSUs based on the criteria of national security,
sovereign functions at arm's length and market imperfections and public purpose.
●
The government raised Rs 2,79,622 crore from the disinvestment of public sector undertakings (PSUs) during
2014-19 compared to Rs 1,07,833 crore during 2004-14.
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9.3. National Investment Fund
●
The Cabinet Committee on Economic Affairs (CCEA) on 27th January 2005 had approved the constitution of a
National Investment Fund (NIF).
●
The Purpose of the fund was to receive disinvestment proceeds of central public sector enterprises and to
invest the same to generate earnings without depleting the corpus.
●
The earnings of the Fund were to be used for selected Central social welfare Schemes.
●
This fund was kept outside the consolidated fund of India.
●
In 2013, CCEA decided that the entire disinvestment proceeds will be credited to the existing ‘Public
Account’ under the head NIF and they would remain there until withdrawn/invested for the approved
purpose.
●
The allocations out of the NIF will be decided in the annual Government Budget.
●
The broad investment objectives will be:
❏ Investment in social sector projects which promote education, health care and employment.
❏ Capital investment in selected profitable and revivable Public sector Enterprises that yield adequate
returns in order to enlarge their capital base to finance expansion/diversification.
10. Micro, Small and Medium Enterprises Development (MSMED) Act 2006
●
The Micro, Small and Medium Enterprises Development (MSMED) Act was notified in 2006 to address policy
issues affecting MSMEs as well as the coverage and investment ceiling of the sector.
●
The Act seeks to facilitate the development of these enterprises as also enhance their competitiveness.
●
It provides the first-ever legal framework for recognition of the concept of “enterprise” which comprises both
manufacturing and service entities.
●
It defines medium enterprises for the first time and seeks to integrate the three tiers of these enterprises,
namely, micro, small and medium.
●
The Act also provides for a statutory consultative mechanism at the national level with a balanced
representation of all sections of stakeholders, particularly the three classes of enterprises and with a wide
range of advisory functions.
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10.1. Definition of Micro, Small and Medium Enterprises in India
●
Micro, small and medium enterprises as per the MSMED Act, 2006 are defined based on their investment in
plant and machinery (for manufacturing enterprise) and on equipment for enterprises providing or rendering
services.
●
The present ceilings on investment for enterprises to be classified as micro, small and medium enterprises are
as follows:
10.2. Contribution of MSME Sector
●
Micro, Small and Medium Enterprises (MSME) sector has emerged as a highly vibrant and dynamic sector of
the Indian economy over the last five decades.
●
MSMEs not only play a crucial role in providing large employment opportunities at comparatively lower capital
cost than large industries but also help in industrialization of rural & backward areas, thereby, reducing
regional imbalances, assuring more equitable distribution of national income and wealth.
●
The Sector consisting of 36 million units, as of today, provides employment to over 80 million persons.
●
The Sector through more than 6,000 products contributes about 8% to GDP.
●
MSME contributes 45% to the total manufacturing output and 40% to the exports from the country.
10.3. Problem in MSME Sector
●
Problem in raising funds (limited access to formal credit and they have to pay high interest).
●
Obsolete Technology.
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●
Non-Professional management/entrepreneurship.
●
Inadequate infrastructure in rural and semi-urban areas.
●
Dependence on local sources of raw material.
●
Marketing problem - No brands and High per unit advertisement cost.
●
Competition from large scale industry.
●
No availability of economic scale.
10.4. Measures taken by Government
10.4.1. Financial Support
●
Financial support to MSME sector is provided through various mechanism some of them are as follow:
❏ Mudra Bank
❏
Priority Sector Lending(PSL)
❏ Through various government schemes like the Credit Guarantee Fund Scheme for Micro and Small
Enterprises, Prime Minister’s Employment Generation Programme and Credit Linked Capital Subsidy
Scheme.
10.4.2. Fiscal Support
●
Lower rate of 25 % Corporate Tax extended to companies with an annual turnover up to Rs 400 crore from the
earlier cap of up to Rs 250 crore.
●
For the MSME sector, Rs 350 crore has been allocated for FY 2019-20 under the Interest Subvention Scheme, for
2% interest subvention for all GST registered MSMEs, on fresh or incremental loans.
●
Doubling the exemption threshold under the goods and services tax (GST) to Rs 40 lakh annual turnover
will reduce the burden on small and medium enterprises (SMEs).
●
Price and Preference Purchase Scheme: Under this, preference is granted to products manufactured by
small scale industry in the government purchase programme ( up to 15% higher price than other sectors).
10.4.3. Technical and Industrial Support
●
Small Industries Development Corporations ('SIDCO') are state-owned companies or agencies in the states
of India which were established in 1954 for the promotion of small scale industries. It provides technical,
managerial, marketing support etc to small scale industries.
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●
The National Small Industries Corporation (NSIC) Ltd. was established in 1955 by the Government of India
with a view to promote, aid and foster the growth of small scale industries in the country. The main functions
of the Corporation are to promote aid and foster the growth of micro and small enterprises in the country,
generally on a commercial basis. It provides a variety of support services to micro and small enterprises by
catering to their different requirements in the areas of raw material procurement; product marketing; credit
rating; acquisition of technologies; adoption of modern management practices, etc
●
District Industries Centre (DIC) was established in 1979 to provide support to MSME, skill development and
technical issues etc.
10.4.4. Reservation of item for Small Scale Industry(SSI)
●
In 1967, 47 items were reserved for the small scale industry. These items were increased to 900 by 1990.
●
The main objective of the reservation was to eliminate competition from large scale industry.
●
Abid Hussain Committee on Reservation of Items(1997) recommended to stop reservation for small scale
industry.
●
As of today, there are 836 items reserved for exclusive manufacture in the small scale sector.
11. Capital Formation or Investment
●
It refers to the process of increase in the physical stock of capital like machinery, equipment, factory, etc.
●
It is the most important determinant of economic growth because it increases production, productivity and
the productive capacity of the future of an economy.
●
Our 1st five-year plan was based on the Harrod-Domar growth model.
●
Harrod-Domar growth model states that economic growth rate can be calculated as:
Economic Growth Rate =
Investment Rate ( IR)
Incremental Capital Output Ratio
11.1. Stages of Capital Formation
●
Stages of capital formation include the following stages :
❏ Saving - Saving is disposable income minus consumption.
❏ Finance - Mobilisation of saving of household investment by firms through a financial institution.
❏ Investment - Expenditure on capital goods.
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11.2. Component of Investment
●
Component if Investment includes :
❏ Fixed Investment - Fixed investment is the accumulation of physical assets such as machinery, land,
buildings, installations, vehicles, or technology.
❏ Inventories or Stocks - It includes raw material, semi-finished goods, unsold goods.
❏ Valuables - It includes commodities like Gold, Silver etc.
11.3. Determinant of Investment
●
The determinant of investment are as follows:
❏ Interest rates
❖ Investment is inversely related to interest rates. If interest rates rise, the opportunity cost of
investment rises.
❏ Expected return on the investment
❖ Businesses require a return on their investment in order to cover their cost. In terms of the
whole economy, the amount of business profits is a good indication of the potential for
investment.
❏ Saving
❖ Household and corporate savings provide a flow of funds into the financial sector, which
means that funds will be available for investment.
❏ Government Policy
❖ Public policy can have significant effects on the Investment.
❖ Government taxation policy with respect to corporate profits, capital gains affect the demands
for capital.
11.4. Types of Capital Formation
●
There are two types of capital formation
❏ Physical Capital formation
❖ It refers to investments made in the form of sophisticated tools, machinery etc.
❖ It directly affects the production process.
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❏ Human Capital formation
❖ Human capital formation implies additions to the skills, knowledge of the individuals.
❖ It indirectly affects the production process.
❖ Its formation can lead toward improvement in physical capital.
12. Index of Industrial Production (IIP)
●
The all India Index of Industrial Production (IIP) is a composite indicator that measures the short-term
changes in the volume of production of a basket of industrial products during a given period with respect to
that in a chosen base period.
●
It is compiled and published monthly by the Central Statistical Organization (CSO), Ministry of Statistics and
Programme Implementation.
●
The Central Statistics Office (CSO) revised the base year of the all-India Index of Industrial Production (IIP)
from 2004-05 to 2011-12 on 12 May 2017.
●
Revisions in the IIP are necessitated to maintain representativeness of the items and producing entities and
also address issues relating to the continuous flow of production data.
●
The revised IIP (2011-12) not only reflects the changes in the industrial sector but also aligns it with the base
year of other macroeconomic indicators like the Gross Domestic Product (GDP) and Wholesale Price Index
(WPI).
●
Industrial production for the purpose of IIP is divided into three sectors, i.e
Sector
Number of Item Groups
Weight(%)
Mining
1
14.373%
Manufacturing
405
77.633%
Electricity
1
7.994%
Total
407
100%
●
The IIP is used by public agencies including the Government agencies/ departments including that in the
Ministry of Finance, the Reserve Bank of India etc. for policy purposes.
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13. Index of Eight Core Industries
●
The monthly Index of Eight Core Industries (ICI) is a production volume index.
●
The objective of the ICI is to provide an advance indication on production performance of industries of
‘core’ nature before the release of the Index of Industrial Production (IIP) by the Central Statistics Office.
●
These industries are likely to impact general economic activities as well as industrial activities.
●
Components covered in these eight industries for the purpose of compilation of index are as follows
❏ Coal – Coal Production excluding Coking coal.
❏ Crude Oil – Total Crude Oil Production.
❏ Natural Gas – Total Natural Gas Production.
❏ Refinery Products – Total Refinery Production (in terms of Crude Throughput).
❏ Fertilizer – Urea, Ammonium Sulphate (A/S), Calcium Ammonium Nitrate (CAN), Ammonium chloride
(A/C), Diammonium Phosphate (DAP), Complex Grade Fertilizer and Single superphosphate (SSP).
❏ Steel – Production of Alloy and Non-Alloy Steel only.
❏ Cement – Production of Large Plants and Mini Plants.
❏ Electricity – Actual Electricity Generation of Thermal, Nuclear, Hydro, imports from Bhutan.
●
The Index is compiled and released by the Office of the Economic Adviser (OEA), Department of Industrial
Policy & Promotion (DIPP), Ministry of Commerce & Industry, Government of India.
●
The Central Statistics Office (CSO), Ministry of Statistics and Programme Implementation, has revised the base
year of the all-India Index of Industrial Production (IIP) from 2004-05 to 2011-12.
Industry
Weight
Source
Coal
10.33
Office of the Coal Controller, Kolkata
Crude oil
8.98
Ministry of Petroleum and Natural Gas
Natural Gas
6.88
Ministry of Petroleum and Natural Gas
Refinery Products
28.04
Ministry of Petroleum and Natural Gas
Fertilisers
2.63
Ministry of Chemicals and Fertilizers
Cement
5.37
Ministry of Commerce and Industry
Electricity
19.87
Central Electricity Authority.
Steel
17.92
Joint Plant Committee, Kolkata
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14. Annual Survey of Industries (ASI)
●
Annual Survey of Industries (ASI) is the principal source of industrial statistics in India providing information
on important characteristics of the registered manufacturing sector.
●
ASI is considered as the most comprehensive and reliable source of organised manufacturing sector data
providing disaggregated industry-specific details of production, investment, employment and costs. It does
not cover unorganised or unregistered or informal sector enterprises.
●
ASI is the main survey conducted by the Central Statistics Office (CSO) Industrial Statistics (IS) wing. It
ensures timely dissemination of statistical information to assess and evaluate the dynamics in composition,
growth and structure of the organized manufacturing sector.
●
The ASI extends to the entire country.
●
It covers all factories registered under Sections 2 of the Factories Act, 1948.
14.1. ASI vs IIP
●
Annual Survey of Industries (ASI) on an annual basis and Index of Industrial Production (IIP) on a monthly
basis.
●
The ASI has been conducted under the Collection of Statistics Act since 1959 whereas IIP is compiled on the
basis of data sourced from 14 ministries/ administrative departments.
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15. UPSC CSE PRELIMS Previous Years Questions
●
Now, let's check how many questions can you attempt?
Q.1) Why is the Government disinvesting its equity in the Central Public Sector Enterprises (CPSEs)?
2011
1. The Government intends to use the revenue earned from the disinvestment mainly to pay back the external
debt.
2. The Government no longer intends to retain the management control of the CPSEs.
Which of the statements given above is/are correct?
[A] 1 only
[B] 2 only
[C] Both 1 and 2
[D] Neither 1 nor 2
Ans.1) Correct Option: (d)
Explanation:
●
Disinvestment of a percentage of shares owned by the Government in public undertakings emerged as a policy
option in the wake of economic liberalisation and structural reforms launched in 1991.
Q.2) What is/are the recent policy initiative(s) of the Government of India to promote the growth of the
manufacturing sector?
2012
1. Setting up of National Investment and Manufacturing Zones
2. Providing the benefit of ‘single window clearance’
3. Establishing the Technology Acquisition and Development Fund
Select the correct answer using the codes given below :
[A] 1 Only
[B] 2 & 3 Only
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[C] 1 & 3 Only
[D] 1, 2 & 3
Ans.2) Correct Option: (d)
Explanation:
●
In order to bring about a quantitative and qualitative change and to give the necessary impetus to the
manufacturing sector, the Department has notified the National Manufacturing Policy (NMP) with the
objective of enhancing the share of manufacturing in GDP to 25% and creating 100 million jobs over a decade
or so.
●
The policy is based on the principle of industrial growth in partnership with the States.
●
Government is focusing on enhancing India's rank in Ease of Doing Business, by implementing single window
clearances, use of ICT and creating basic infrastructure.
●
The Central Government will create an enabling policy framework, provide incentives for infrastructure
development on a Public Private Partnership (PPP) basis through appropriate financing instruments, and State
Governments will be encouraged to adopt the instrumentalities provided in the policy.
●
The Department has taken up the implementation of the policy in consultation with concerned Central
Government agencies as well as the States.
Q.3) If the interest rate is decreased in an economy, it will
2014
[A] decrease the consumption expenditure in the economy
[B] increase the tax collection of the Government
[C] increase the investment expenditure in the economy
[D] increase the total savings in the economy
Ans.3) Correct Option: (c)
Explanation
●
Lower Interest rates encourage additional investment spending, which gives the economy a boost in times of
slow economic growth.
●
Changes in interest rates affect the public's demand for goods and services and, thus, aggregate investment
spending.
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●
A decrease in interest rates lowers the cost of borrowing, which encourages businesses to increase investment
spending.
●
Lower interest rates also give banks more incentive to lend to businesses and households, allowing them to
spend more.
Q.4) In the Index of Eight Core Industries, which one of the following is given the highest weight?
2015
[A] Coal Production
[B] Electricity generation
[C] Fertilizer Production
[D] Steel Production
Ans.4) Correct Option: (b)
Explanation:
The Eight Core Industries comprise 40.27 per cent of the weight of items included in the Index of Industrial Production
(IIP). Coal, Crude, Oil Natural, Gas Refinery Products, Fertilizers, Steel, Cement, Electricity.
Q.5) The substitution of steel for wooden ploughs in agricultural production is an example of
2015
[A] labour-augmenting technological progress
[B] capital-augmenting technological progress
[C] capital-reducing technological progress
[D] None of the above
Ans.5) Correct Option : (b)
Explanation:
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●
“Capital” in an economic context means machinery or capital goods which can be employed to produce
other goods.
●
Substitution of steel can be considered as the substitution of a lesser machine by a better machine.
●
This encourages steel production. Hence it is capital-augmenting technological progress.
Q.6) India’s ranking in the ‘Ease of Doing Business Index’ is sometimes seen in the news. Which of the following
has declared that ranking?
2016
[A] Organization for Economic Cooperation and Development (OECD)
[B] World Economic Forum
[C] World Bank
[D] World Trade Organization (WTO)
Ans.6) Correct Option: ( c)
Explanation
●
The ease of doing business index is an index created by Simeon Djankov at the World Bank Group. The
academic research for the report was done jointly with professors Oliver Hart and Andrei Shleifer.
●
Higher rankings (a low numerical value) indicate better, usually simpler, regulations for businesses and
stronger protection of property rights.
Q.7) Recently, India’s first ‘National Investment and Manufacturing Zone’ was proposed to be set up in
2016
[A] Andhra Pradesh
[B] Gujarat
[C] Maharashtra
[D] Uttar Pradesh
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Ans.7) Correct Option: (a)
Explanation:
●
Andhra Pradesh is set to house India’s first national investment and manufacturing zone a er the state
assured the Centre of availability of 2500 acres (10 sq km) of land in one place in Prakasam district.
●
The imminent final approval for the NIMZ, which is expected to give a fillip to Prime Minister’s Make in India
campaign, comes four years a er the concept was mooted to boost manufacturing in the country and two
years a er the Department of Industrial Policy and Promotion gave an in-principle nod to Andhra Pradesh in
this regard.
Q.8) Which of the following have occurred in India a er its liberalization of economic policies in 1991?
2017
1. The share of agriculture in GDP increased enormously.
2. The share of India’s exports in world trade increased.
3. FDI inflows increased.
4. India’s foreign exchange reserves increased enormously.
Select the correct answer using the codes given below :
[A] 1 and 4 only
[B] 2, 3 and 4 only
[C] 2 and 3 only
[D] 1, 2, 3 and 4
Ans.8) Correct Option: (b)
Explanation:
●
The share of agriculture in GDP has decreased. So the 1st statement is wrong.
●
The share of India’s exports in world trade increased.
●
FDI inflows increased.
●
India’s foreign exchange reserves increased enormously.
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Q.9) Consider the following statements: Human capital formation as a concept is better explained in terms
of a process, which enables
2018
1. individuals of a country to accumulate more capital.
2. increasing the knowledge, skill levels and capacities of the people of the country.
3. accumulation of tangible wealth.
4. accumulation of intangible wealth.
Which of the statements given above is/are correct?
[A] 1 and 2
[B] 2 and 4 only
[C] 2 only
[D] 1, 3 and 4
Ans.9) Correct Option: (b)
Explanation:
●
The term human capital formation implies the development of abilities and skills among the population
of the country.
●
According to Harbison, the human capital formation indicates, “The process of acquiring and increasing
the number of persons who have the skills, education and experience which are critical for the economic
and the political development of the country.
●
Human capital formation is thus associated with investment in man and his development as a creative
and productive resource.”
●
Thus, human capital formation indicates investment for imparting education, improvement of health and
training of workers in specialised skills.
●
Although the accumulation of physical capital is quite important in the process of economic growth of a
country but with the passage of time, it is being increasingly realised that the growth of tangible capital
stock depends extensively on the human capital formation must get its due importance.
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Q.10) In spite of being a high saving economy, capital formation may not result in a significant increase in
output due to -
2018
[A] weak administrative machinery
[B] illiteracy
[C] high population density
[D] high capital-output ratio
Ans.10) Correct Option: (d)
Explanation:
●
Capital output ratio is the amount of capital needed to produce one unit of output. For example, suppose
that investment in an economy, investment is 32% (of GDP), and the economic growth corresponding to
this level of investment is 8%.
●
Without the availability of adequate capital either in the form of physical capital or in the form of human
capital development of the nation is not possible.
●
The higher the rate of capital formation, the faster is the pace of economic growth. Saving and investment
are essential for capital formation. But savings are different from hoardings.
●
For savings to be utilised for investment purposes, they must be mobilised in banks and financial
institutions. And the businessmen, the entrepreneurs and the farmers invest these community savings on
capital goods by taking loans from these banks and financial institutions. This is capital formation.
●
The process of capital formation involves three steps: Increase in the volume of real savings, Mobilisation
of savings through financial and credit institutions and Investment of savings. So, if a country has high
savings but poor technology, low efficiency then economic growth will not be possible.
Q.11) In the context of any country, which one of the following would be considered as part of its social capitals?
(a) The proportion of literates in the population
2019
(b) The stock of its buildings, other infrastructure and machines
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(c) The size of population in the working age group
(d) The level of mutual trust and harmony in the society
Ans.11) Correct Option: (d)
Explanation:
Social Capital
●
Social capital broadly refers to those factors of effectively functioning social groups that include such things as
interpersonal relationships, a shared sense of identity, a shared understanding, shared norms, shared values,
trust, cooperation, and reciprocity.
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Financial Inclusion
1. Financial Inclusion
4
1.1. Various aspects of Financial Inclusion
4
1.2. Benefits of the Financial Inclusion
4
2. Financial Intermediaries
5
3. Banks
5
3.1. Cooperative Banks
5
3.1.1. Features of Cooperative Banks
6
3.1.2. Structure of co-operative banks in India
6
3.1.3. Role of Co-operative Banks in India
7
3.1.4. Land Development Bank
7
3.1.5. Advantages of Cooperative Banking
8
3.1.6. Disadvantages of Cooperative Banking
8
3.2. Difference between Commercial bank and Cooperative bank
9
3.3. Regional Rural Banks(RRB)
9
3.3.1. RRB Amendment Act 2015
3.4. Local Area Banks (LAB)
4. Development Financial Institution(DFI)
10
11
11
4.1. Industrial Credit and Investment Corporation of India Limited(ICICI)
12
4.2. Industrial Development Bank of India Limited (IDBI)
12
4.3. Small Industries Development Bank of India (SIDBI)
13
4.4. Export-Import Bank of India(EXIM)
13
4.5. National Bank for Agriculture and Rural Development (NABARD)
13
4.6. National Housing Bank (NHB)
14
5. Non-Banking Financial Institution (NBFC)
14
6. Insurance Sector
15
6.1. Insurance Companies
15
6.1.1. Life Insurance Corporation of India(LIC)
15
6.1.2. General Insurance Corporation (GIC)
15
6.2. Insurance Reform
16
6.3. IRDA
16
6.4. Micro Insurance
17
7. Micro Finance
17
7.1. Micro Finance and Indian Economy
18
7.2. Need for Microfinance
18
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8. Micro Finance Institution(MFI)
8.1. Micro Units Development Refinance Agency (MUDRA) Bank
19
19
9. Pradhan Mantri MUDRA Yojana (PMMY)
20
10. Collective Investment Scheme (CIS)
21
11. Nidhi(Mutual Benefit Society)
21
12. Chit Funds / Chitty / Kuri
22
13. Payment Banks
22
14. Small Finance Bank
23
15. Poverty
24
15.1. Poverty Line, Poverty Line Basket and Poverty Ratio
25
15.2. History of poverty estimation in India
25
15.2.1. Alagh Committee (1979)
25
15.2.2. Lakdawala Committee (1993)
26
15.2.3. Tendulkar Committee (2009)
26
15.2.4. Rangarajan Committee
27
15.3. Eliminating Poverty: Employment intensive Sustained rapid growth
16. Unemployment
16.1. Types of unemployment
28
29
30
16.1.1. Structural Unemployment
30
16.1.2. Disguised Unemployment
30
16.1.3. Underemployment
30
16.1.4. Open Unemployment
31
16.1.5. Cyclical Unemployment
31
16.1.6. Frictional Unemployment
31
16.1.7. Seasonal Unemployment
31
16.1.8. Demographic Unemployment
32
16.1.9. Technological Unemployment
32
16.2. Causes of Unemployment in India
32
16.3. Consequences Of Unemployment In India
33
16.4. Remedial Measures
34
17. Inequality
35
17.1. Measure of Inequality
35
17.1.1. Lorenz Curve
35
17.1.2. Gini Coefficient
36
17.2. Cause of Inequality
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2
17.3. Remedial measure by government to reduce inequality
36
18. UPSC CSE PRELIMS Previous Years Questions
38
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3
1. Financial Inclusion
●
Government of India had constituted a committee in 2006 under the chairmanship of C. Rangarajan to study
the pattern of exclusion from access to financial services across the region, gender and occupational structure
and to identify the barriers confronted by vulnerable groups in accessing credit and financial services and
recommend the steps needed for financial inclusion.
●
The committee submitted its report in January 2008. The committee has given a working definition of
financial inclusion as:
“Financial inclusion may be defined 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.”
●
The various financial services identified by the Rangarajan Committee include credit, savings, insurance and
payments and remittance facilities.
●
According to the committee, financial Inclusion, broadly defined, refers to universal access to a wide range of
financial services at a reasonable cost.
●
Financial Inclusion has been identified as a key dimension of the overall strategy of “Towards Faster and
More Inclusive Growth” envisaged in the eleventh Five Year Plan (2007-12).
1.1. Various aspects of Financial Inclusion
●
The essence of financial inclusion is in trying to ensure that a range of appropriate financial services is
available to every individual and enabling them to understand and access those services.
●
In order to achieve a comprehensive financial inclusion, a slew of initiatives have been taken by Government
of India, RBI and NABARD.
●
Some of the important initiatives includes SHG-Bank Linkage Programme, the opening of No Frills Accounts,
mobile banking, Kisan Credit Cards (KCC) Pradhan Mantri Jan Dhan Yojna etc.
1.2. Benefits of the Financial Inclusion
●
Financial inclusion enables good financial decision making through financial literacy and qualified advice as
also access to financial services for all, particularly the vulnerable groups such as weaker sections,
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4
minorities, migrants, elderly, micro-entrepreneurs and low-income groups at an affordable cost so as to
enable them to
❏ Manage their finances on day to day basis confidently, effectively and securely;
❏ Plan for the future to protect themselves against short term variations in income and expenditure and
for wealth creation and gaining from financial sector developments; and
❏ Deal with financial distress effectively thereby reducing their vulnerability to the unexpected.
●
The United Nations Capital Development Fund (UNCDF) investing in LDCs sees financial inclusion, financial
services for poor and low-income people and micro and small enterprises as an important and integral
component of the financial sector, each with its own comparative advantages, and each presenting the market
with a business opportunity.
2. Financial Intermediaries
●
A financial intermediary is an institution that serves as a middleman between two parties in a financial
transaction, such as a commercial bank, investment banks, mutual funds and pension funds.
●
They mobilise the saving of households for investment in firms. Hence they promote capital formation.
●
Types of financial intermediaries are as follows:
❏ Banks - It includes commercial banks, cooperative banks, regional rural banks, local area banks.
❏ Development financial institution(DFI) - It includes institutions like SIDBI, Nabard, NHB etc.
❏ Non-Banking Financial Institution(NBFI)/Non-Banking Financial Companies(NBFC) - It includes
insurance companies, mutual companies etc.
3. Banks
●
We have already discussed banks and their evolution in detail in module no 6.
●
So in this topic, we will discuss other types of banks.
3.1. Cooperative Banks
●
A co-operative bank is a financial entity which belongs to its members, who are at the same time the owners
and the customers of their bank and provide a wide range of regular banking and financial services.
●
In India, co-operative banks are registered under the States Cooperative Societies Act. They also come under
the regulatory ambit of the Reserve Bank of India (RBI) under two laws, namely
❏
❏
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Banking Regulations Act, 1949,
Banking Laws (Co-operative Societies) Act, 1955.
5
●
The problem of rural credit was the key reason behind the advent of the co-operative movement in India,
which began with the passage of the Co-operative Societies Act in 1904.
●
The objective of this Act was to establish cooperative credit societies “to encourage saving, self-help and
cooperation among farmers, artisans etc.
3.1.1. Features of Cooperative Banks
●
All the co-operative banks share common features:
❏ Customer Owned Entities - Co-operative bank members are both customer and owner of the bank.
❏ Democratic Member Control - Co-operative banks are owned and controlled by the members, who
democratically elect the board of the directors. Members usually have equal voting rights, according to
the cooperative principle of “one person, one vote”.
❏ Profit Allocation - A significant part of the yearly profit, benefits or surplus is usually allocated to
constitute reserves. A part of this profit can also be distributed to the co-operative members, with legal
and statutory limitations in most cases.
3.1.2. Structure of co-operative banks in India
●
Co-operative banks in India are divided into two categories Urban and Rural.
●
The Rural co-operative banking structure in India is bifurcated into Short term structure and Long-term
structure. While the short-term structure is three-tier structures, long-term co-operative banking structure is
the two-tier structures as mentioned below:
❏ Short-Term Co-operative Bank Structure
❖ A State Co-operative Bank works at the apex level (ie. works at the state level).
❖ The Central Co-operative Bank works at the Intermediate Level(i.e., District Co-operative
Banks ltd. works at district level).
❖ Primary co-operative credit societies at the base level (At village level) - Primary Agricultural
Credit Societies (PACS) are the foundation of the co-operative credit structure and form the
largest number of co-operative institutions in India.
❏ Long-Term Co-operative Bank Structure
❖ State Co-operative Agriculture and Rural Development Banks (SCARDBs) at the apex level.
❖ Primary Co-operative Agriculture and Rural Development Banks (PCARDBs) at the district level
or block level.
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6
●
Urban Co-operative Banks (UBBs) are either scheduled or non-scheduled. Scheduled and non-scheduled UCBs
are again of two kinds- multi-state and those operating in a single state.
3.1.3. Role of Co-operative Banks in India
●
The co-operative banks in India play an important role both in rural and urban financing.
Co-operative banks in India finance rural areas
Co-operative banks in India finance urban areas
●
Farming
●
Self-employment
●
Cattle
●
Industries
●
Milk
●
Small scale units
●
Hatchery
●
Home finance
●
Personal finance
●
Consumer finance
●
Personal finance
3.1.4. Land Development Bank
●
These are cooperative banks which provide medium and long term credit to the agricultural sector.
●
The Land development banks are organized in 3 tiers namely;
❏ State,
❏ Central,
❏ Primary level and they meet the long term credit requirements of the farmers for developmental
purposes.
●
The state land development banks oversee, the primary land development banks situated in the districts and
tehsil areas in the state.
●
All the LDBs are registered under the Co-operative Societies Act.
●
The working capitals of LDBs are raised from share capital, deposits and debentures, and borrowings from the
State Bank of India, commercial banks and the State Co-operative Banks.
●
The supervision of land development banks has been assumed by the National Bank for Agriculture and Rural
Development (NABARD).
●
These banks do not accept deposits from the general public.
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3.1.5. Advantages of Cooperative Banking
●
Cooperative Banking provides an effective alternative to the traditional credit system of the money lender.
●
Cooperative Banking encourages saving and investment.
●
It provides cheap and easy credit to people in rural areas.
●
Cooperative societies have helped in the introduction of better agricultural methods like improved seeds,
chemical fertilizers, modern implements, etc.
3.1.6. Disadvantages of Cooperative Banking
●
Organisational and financial limitations of the primary credit societies considerably reduce their ability to
provide adequate credit to the rural population.
●
Cooperative Banks are losing their lustre due to expansion of Scheduled Commercial Bank and adoption of
technology.
●
Political Interference to increase their vote bank and usually get their representatives elected over the board
of directors in order to gain undue advantages.
●
Regional Disparities the cooperatives in northeast states and in states like West Bengal, Bihar, Odisha are not
as well developed as the ones in Maharashtra and Gujarat.
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3.2. Difference between Commercial bank and Cooperative bank
Parameter
Registration
Commercial Banks
Under Companies Act 1956
Cooperative Banks
Under the co-operative societies act of state
government
Objective
Profit Making
Financial Inclusion, provide credit at concessional
rate rural sector, weaker section etc.
Services
Provide value-added service
Provide only basic banking service
Source of fund
Public deposits
Government, Nabard/RBI, and very less public
deposit.
Regulator
RBI
State Government, RBI, Nabard
Structure
Unified Structure
Three-tier structure
Loan
Short, medium and long term
Short term
Priority Sector Lending
Applies
Not Applies
3.3. Regional Rural Banks(RRB)
●
Regional Rural Banks (RRBs) are financial institutions which ensure adequate credit for agriculture and other
rural sectors.
●
Regional Rural Banks were set up on the basis of the recommendations of the Narasimham Working Group
(1975), and a er the legislations of the Regional Rural Banks Act, 1976.
●
The first Regional Rural Bank “Prathama Grameen Bank” was set up on October 2, 1975.
●
At present, there are 56 RRBs in India.
●
The main objectives of RRB’s are to provide credit and other facilities‚ especially to the small and marginal
farmers‚ agricultural labourers artisans and small entrepreneurs in rural areas with the objective of bridging
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9
the credit gap in rural areas, checking the outflow of rural deposits to urban areas and reduce regional
imbalances and increase rural employment generation.
●
The RRB’s have also been brought under the ambit of priority sector lending on par with the commercial
banks.
●
Shareholding pattern of RRBs among the three sponsoring entities is 50:35:15 among central government,
sponsoring bank and state government respectively.
●
A committee chaired by K.C. Chakrabarty reviewed the financial position of all RRBs in 2010 and
recommended for the recapitalization of 40 out of 82 RRBs. According to the Committee, the remaining RRBs
are in a position to achieve the desired level of CRAR on their own.
●
Accepting the recommendations of the committee, the central government along with other shareholders
started to recapitalize eh RRBs by injecting funds into them. In the same manner, the process of amalgamation
continued.
3.3.1. RRB Amendment Act 2015
●
The Regional Rural Banks (Amendment) Act, 2015, came into effect from 4th February 2016.
●
Authorised capital:
❏ The Bill raises the amount of authorised capital to Rs 2,000 crore and states that it cannot be
reduced below Rs one crore.
●
Shareholding:
❏ The Bill allows RRBs to raise their capital from sources other than the central and state governments,
and sponsor banks.
❏ In such a case, the combined shareholding of the central government and the sponsor bank cannot be
less than 51%.
❏ Additionally, if the shareholding of the state government in the RRB is reduced below 15%, the central
government would have to consult the concerned state government.
●
Tenure:
❏ The Act specifies the term of office of a director (excluding the Chairman) to be three years.
●
Board of directors
❏ The bill raises the tenure of directors to 3 years from the existing 2 years. The Bill also states that no
director can hold office for a total period of exceeding six years.
●
Government Limit:
❏ The Act states that the central government may by notification raise or reduce the limit of
shareholding of the central government, state government or the sponsoring bank in the RRB.
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10
❏ For this, the central government may consult the state government and the sponsor bank.
3.4. Local Area Banks (LAB)
●
The Local Area Banks (LABs) are small private banks, conceived as low cost structures which would provide
efficient and competitive financial intermediation services in a limited area of operation, i.e., primarily in rural
and semi-urban areas, comprising three contiguous districts.
●
LABs were set up to enable the mobilization of rural savings by local institutions and, at the same time, to
make them available for investments in the local areas.
●
LABs were created following an announcement made by the then Finance Minister in the Union Budget in
August 1996.
●
LABs were required to have a minimum capital of Rs. 5 crores.
●
The promoters of the bank may comprise of private individuals, corporate entities, trusts and societies with a
minimum capital contribution of Rs. 2 crores.
●
The area of operation of LAB is limited to a maximum of three geographically contiguous districts and are
allowed to open branches only in its area of operation.
●
Since LABs are being set up in district towns, their activities are focused on the local customers with lending
primarily to agriculture and allied activities, small scale industries, agro-industrial activities, trading activities
and the non-farm sector. LABs are also required to observe the priority sector lending targets at 40% of net
bank credit (NBC) as applicable to other domestic banks
●
In 2014, RBI has permitted LABs to be converted into small finance banks subject to them meeting the
prescribed eligibility criteria.
4. Development Financial Institution(DFI)
●
These are a special type of financial institution that provides finance and technical assistance to various
sectors of the economy to promote economic development.
●
These are not permitted to accept deposits from the public.
●
They raise funds from RBI, government, and through the issue of their bonds to the general public.
●
They provide finance in the following forms:
❏ Provision of medium and long term loans.
❏ Refinance i.e providing finance to a financial institution.
❏ Guarantee against the loan - this is also called credit enhancement.
❏ Subscription - for example shares and debenture of the company.
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❏ Underwriting - Under this, a Financial institution guarantees to purchase a certain percentage of share
of an initial public offer (IPO) of a company in case it remained undersubscribed by the public.
Underwriting commission is charged for such guarantee.
●
They also provide technical assistance to preparation of project reports, evaluation of investment projects,
provision of technical advise, management of services and marketing information.
●
Different types of development financial institution are:
❏ For industry - IFCI, ICICI, IDBI, SIDBI etc.
❏ For foreign trade - EXIM
❏ For agriculture - Nabard
❏ For Housing - National Housing Bank
4.1. Industrial Credit and Investment Corporation of India Limited(ICICI)
●
ICICI was formed in 1955 at the initiative of the World Bank, the Government of India and representatives of
Indian industry.
●
The principal objective was to create a development financial institution for providing medium-term and
long-term project financing to Indian businesses.
●
In the 1990s, ICICI transformed its business from a development financial institution offering only project
finance to a diversified financial services group offering a wide variety of products and services, both directly
and through a number of subsidiaries.
●
ICICI Bank was originally promoted in 1994 by ICICI Limited, an Indian financial institution, and was its
wholly-owned subsidiary.
●
In 2002, ICICI Ltd was merged with ICICI Bank Ltd. This ‘reverse merger’ converted it into the first universal
bank of India (financial institution undertakes various types of financial business).
4.2. Industrial Development Bank of India Limited (IDBI)
●
Industrial Development Bank of India (IDBI) was constituted under Industrial Development Bank of India Act,
1964 as a Development Financial Institution (DFI) and came into being as on July 01, 1964.
●
It was granted autonomy in 1976.
●
It is an apex institution in the field of industrial finance.
●
In 2003, the IDBI was converted into a universal bank.
●
LIC of India completed the acquisition of 51% controlling stake in IDBI Bank on January 21, 2019, making it
the majority shareholder of the bank.
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12
4.3. Small Industries Development Bank of India (SIDBI)
●
Small Industries Development Bank of India (SIDBI) set up on 2nd April 1990 under an Act of Indian
Parliament, it was granted autonomy in 1998.
●
It acts as the Principal Financial Institution for Promotion, Financing and Development of the Micro, Small
and Medium Enterprise (MSME) sector as well as for coordination of functions of institutions engaged in
similar activities.
●
It is headquartered in Lucknow and operates under the Department of Financial Services, Government of
India.
●
In order to increase and support money supply to the MSE sector, it operates a refinance program known as
Institutional Finance program.
●
Under this program, SIDBI extends Term Loan assistance to Banks, Small Finance Banks and Non-Banking
Financial Companies. Besides the refinance operations, SIDBI also lends directly to MSMEs.
●
State Bank of India is the largest individual shareholder of SIDBI with holding of 16.73% shares, followed by
Government of India and Life Insurance Corporation of India.
4.4. Export-Import Bank of India(EXIM)
●
Export-Import Bank of India is a financial institution in India, established in 1982 under Export-Import Bank of
India Act 1981 for financing, facilitating and promoting foreign trade of India.
●
EXIM Bank extends Lines of Credit (LOCs) to overseas financial institutions, regional development banks,
sovereign governments and other entities overseas, to enable buyers in those countries to import
developmental and infrastructure projects, equipment, goods and services from India, on deferred credit
terms.
●
Export Development Fund(EDF) facility, a special fund, was established by GoI under the Exim Bank Act and
administered by Exim Bank, to sanction loans in the interest of international trade towards meeting strategic
objectives.
●
Exim Bank-issued India’s first USD denominated Green bonds.
4.5. National Bank for Agriculture and Rural Development (NABARD)
●
NABARD came into existence on 12 July 1982 by transferring the agricultural credit functions of RBI and
refinance functions of the then Agricultural Refinance and Development Corporation (ARDC).
●
It was constituted on the recommendation of Committee to Review the Arrangements For Institutional Credit
for Agriculture and Rural Development (CRAFICARD) under the Chairmanship of B. Sivaraman.
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13
●
Set up with an initial capital of Rs.100 crore, its paid-up capital stood at Rs.12,580 crore as on 31 March 2019.
●
Consequent to the revision in the composition of share capital between Government of India and RBI,
NABARD today is fully owned by Government of India.
●
NABARD, as a Development Bank, is mandated for providing and regulating credit and other facilities for the
promotion and development of agriculture, small scale industries, cottage and village industries, handicra s
and other rural cra s and other allied economic activities in rural areas with a view to promoting integrated
rural development and securing prosperity of rural areas.
4.6. National Housing Bank (NHB)
●
National Housing Bank (NHB), is an apex financial institution for housing which was set up on 9 July 1988
under the National Housing Bank Act, 1987.
●
NHB has been established with an objective to operate as a principal agency to promote housing finance
institutions both at local and regional levels and to provide financial and other support.
●
The Head Office of NHB is at New Delhi.
●
NHB has been established to achieve
❏ To make housing credit more affordable.
❏ To regulate the activities of housing finance companies.
❏ To promote a sound, healthy, viable and cost-effective housing finance system to cater to all segments
of the population.
5. Non-Banking Financial Institution (NBFC)
●
A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 engaged
in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by
Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance
business, chit business but does not include any institution whose principal business is that of agriculture
activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and
sale/purchase/construction of the immovable property.
●
NBFC include a heterogeneous group of financial institutions - Insurance companies, microfinance
institutions(MFI), Hedge funds, venture capital funds, Collective investment scheme, Nidhi/Chit funds etc.
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6. Insurance Sector
6.1. Insurance Companies
●
These are financial institutions which raise funds from the public through the sales of insurance policies.
●
Insurance companies corpus is invested in security markets by asset management companies.
●
There are two types of insurance firms:
❏ Life insurance - Life insurance covers provided financial compensation in case of death or disability.
❏ General Insurance -General insurance offers you Insurance or financial compensation for everything
else in life
6.1.1. Life Insurance Corporation of India(LIC)
●
Life Insurance Corporation Act on the 19th of June 1956, was nationalized and the Life Insurance Corporation
of India was created on 1st September, 1956.
●
Over 245 insurance companies and provident societies were merged to create the state-owned Life Insurance
Corporation of India.
●
The objective of LIC was to spread life insurance much more widely and in particular to the rural areas with a
view to reach all insurable persons in the country, providing them adequate financial cover at a reasonable
cost.
●
From its creation, the Life Insurance Corporation of India, which commanded a monopoly life insurance sector
in India.
6.1.2. General Insurance Corporation (GIC)
●
General Insurance Corporation (GIC) was established in 1973 by nationalising the existing private sector
general insurance company.
●
It was incorporated under the Companies Act, 1956 as a private company limited by shares.
●
GIC was formed for the purpose of superintending, controlling and carrying on the business of general
insurance.
●
It had four subsidiaries:
❏ National Insurance Company Limited.
❏ The New India Assurance Company Limited.
❏ The Oriental Insurance Company Limited.
❏ United India Insurance Company Limited.
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15
●
In March 2002 the GIC was withdrawn from holding company status of the four public sector general insurance
companies. Now these four companies are directly owned by the Government of India
6.2. Insurance Reform
●
In 1993, the Govt. of India set up a committee under the chairmanship of R N Malhotra, former Governor of
RBI, to propose recommendations for reforms in the insurance sector.
●
The objective was to complement the reforms initiated in the financial sector.
●
Some of the major recommendations of the committee are as follow:
❏ Insurance companies must be given greater freedom to operate.
❏ Private companies with a minimum paid-up capital of 1 Billion must be allowed to enter the insurance
sector.
❏ No company must be allowed to deal with both Life and General Insurance as a single entity.
❏ Foreign companies may be allowed to enter the insurance sector but only in collaboration with
Indian companies.
❏ Industry must be opened up to the competition in order to improve customer services and increase
the coverage of the insurance industry.
❏ It also proposed the setting up of an independent regulatory authority- the IRDA, to provide greater
autonomy to insurance companies in order to improve their performance and enable them to function
independently.
6.3. IRDA
●
The IRDA, as an autonomous body, was constituted on April 19, 1999, by the Government of India.
●
The Insurance Regulatory and Development Authority Act, 1999 vested the IRDA with the responsibility of
regulating and developing the business of insurance and reinsurance in India.
●
Important functions of IRDA are:
❏ To regulate, ensure and promote the orderly growth of the insurance business.
❏ To prescribe regulations on the investment of funds by insurance companies.
❏ To adjudicate the disputes between insurers and intermediaries.
❏ To frame regulations on the protection of policyholders' interests.
●
The IRDA has set up the grievance redressal cell to take up the complaints of the policyholder.
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6.4. Micro Insurance
●
Micro-insurance policies are a special category of insurance policies created to promote insurance
coverage among economically vulnerable sections of society.
●
These policies are regulated by the Insurance Regulatory Development Authority of India (IRDA).
●
The IRDA Micro-insurance Regulations, 2005 defines and enables micro-insurance. Micro-insurance can be
either a general insurance policy (which can insure health, belongings, house, tools, personal accident
contract, livestock etc) or life insurance policy with a sum assured of Rs 50,000 or less. They can be on an
individual or group basis.
●
Micro- insurance business is done through the following intermediaries in India:
❏ Non-Government Organisations
❏ Self-Help Groups
❏ Micro-Finance Institutions
●
In the Union Budget 2015-16, government-sponsored micro insurance was launched for the disadvantaged
sections of the society.
❏ Pradhan Mantri Suraksha Bima Yojna (PMSBY) to cover accidental death risk of Rs.2 Lakh for a
premium of just Rs. 12 per year (i.e. Rs 1/month as premium). It will cover all the savings account
holders of the age group 18 to 70 for accidental disability or death.
❏ Pradhan Mantri Jeevan Jyoti Bima Yojana (PMJJBY) to cover both natural and accidental death risk
of Rs. 2 lakh at a premium of Rs. 330 per year for the age group of 18-50 (less than Rs. 1/day). i.e. it will
cover all the savings account holders of the age group 18-50 for death due to any cause. This scheme is
offered through LIC of India or other Life Insurance companies that are willing to offer life insurance on
similar terms.
7. Micro Finance
●
Microfinance, also called microcredit, is a type of banking service provided to unemployed or low-income
individuals or groups who otherwise would have no other access to financial services.
●
It is small-scale financial intermediation, inclusive of savings, credit, insurance, business services and
technical support provided to the needy borrower.
●
The goal of microfinance is to ultimately give impoverished people an opportunity to become self-sufficient.
●
Microfinance is important because it provides resources and access to capital to the financially underserved,
such as those who are unable to get checking accounts, lines of credit, or loans from traditional banks.
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●
Without microfinance, these groups may have to resort to money-lenders which charge extremely
high-interest rates on loans.
7.1. Micro Finance and Indian Economy
●
There are four important Microfinance models prevalent in India.
●
MF has become a movement in India. Simultaneously it has become a unique tool of empowerment and
capability enhancement.
❏ Firstly, it has added millions of people to the banking system by developing the habit of thri and
saving.
❏ Secondly, it helps in poverty alleviation.
❏ Thirdly, it encourages group and individual activities which provide livelihood on a regular basis.
❏ Fourthly, through MF, financial inclusion is possible with the common effort of Bank, NGO’s,
Micro-Finance Institutions and other institutions.
❏ Fi hly, it empowers women by making women not only economically, but socially and politically as
well.
7.2. Need for Microfinance
●
Microfinance aims at assisting communities of the economically excluded to achieve greater levels of asset
creation and income security at the household and community level.
●
Access to financial services and the subsequent transfer of financial resources to poor women enable them
to become economic agents of change.
●
Women become economically self-reliant, contribute directly to the well being of their families, play a more
active role in decision making and are able to confront systematic gender inequalities
Parameter
Micro Finance
Bank
Size of Loan
Small size of credit
Large size of credit
Duration of loan
Short duration
Medium/large duration
Saving
Emphasis on Saving as well as loan
Focus on loan only
Nature of organization
Social organization form
Commercial organization form
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8. Micro Finance Institution(MFI)
●
The informal institutions that undertake microfinance activities are referred to as Microfinance Institutions
(MFIs).
●
Micro Finance Institution means any entity (irrespective of its organisational form), which provides
microfinance services in the form and manner as may be prescribed but does not include
(i) a banking company;
(ii) a co-operative society.
●
In the 1990s, the savings, grants and so loans were the main sources of funds, whereas in the late 2000‘s
commercial loans and equity are the main source of funding to the sector.
●
The exhibit again depicts that the MFIs have been transformed from a developmental tool to viable business
and finally as an attractive asset class.
8.1. Micro Units Development Refinance Agency (MUDRA) Bank
●
Micro Units Development Refinance Agency (MUDRA) Bank is a refinance institution for micro-finance
institutions.
●
Union Budget 2015-16 has proposed to create MUDRA with a corpus of Rs. 20,000 crore made available from
the shortfalls of Priority Sector Lending.
●
In addition, there is a credit guarantee corpus of Rs.3,000 crore for guaranteeing loans being provided to the
micro-enterprises.
●
MUDRA Bank will refinance Micro-Finance Institutions through a Pradhan Mantri Mudra Yojana.
●
It was launched on 8 April 2015 and was converted as a wholly-owned subsidiary of SIDBI and renamed as
MUDRA (SIDBI) Bank.
●
The MUDRA Bank is primarily responsible for –
❏ Laying down policy guidelines for micro/small enterprise financing business.
❏ Registration and Regulation of MFI entities.
❏ Accreditation /rating of MFI entities.
❏ Laying down responsible financing practices to ward off indebtedness and ensure proper client
protection principles and methods of recovery.
❏ Development of a standardized set of covenants governing last mile lending to micro/small
enterprises.
❏ Promoting the right technology solutions for the last mile.
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❏ Formulating and running a Credit Guarantee scheme for providing guarantees to the loans which are
being extended to micro-enterprises.
❏ Creating a good architecture of Last Mile Credit Delivery to micro businesses under the scheme of
Pradhan Mantri Mudra Yojana.
●
MUDRA Bank operates through regional level financing institutions who in turn connect with last-mile lenders
such as Micro Finance Institutions (MFIs), Small Banks, Primary Credit Cooperative Societies, Self Help Groups
(SHGs), NBFC (other than MFI) and such other lending institutions.
●
In lending, MUDRA gives priority to enterprises set up by the under-privileged sections of the society
particularly those from the scheduled caste/tribe (SC/ST) groups, first-generation entrepreneurs and existing
small businesses.
9. Pradhan Mantri MUDRA Yojana (PMMY)
●
The Pradhan Mantri MUDRA Yojana (PMMY) is a scheme launched by the Union Government on April 8, 2015,
for providing loans up to Rs. 10 lakh to the non-corporate, non-farm small/micro-enterprises.
●
Under PMMY, all banks viz. Public Sector Banks, Private Sector Banks, Regional Rural Banks (RRBs), State
Co-operative Banks, Urban Co-operative Banks, Foreign Banks and Non-Banking Finance Companies
(NBFCs)/Micro Finance Institutions (MFIs) are required to lend to non-farm sector income generating activities
below Rs.10 lakh.
●
These loans are classified as MUDRA loans under PMMY.
●
For implementing the Scheme, the government has set up a new institution named, MUDRA (Micro Units
Development & Refinance Agency Ltd.), for development and refinancing activities relating to micro units, in
addition to acting as a regulator for the microfinance sector, in general.
●
The purpose of PMMY is to provide funding to the non-corporate small business sector.
●
Loan offerings under PMMY
❏ Shishu: covering loans up to Rs. 50,000/- provided with no collateral, @1% rate of interest/month
repayable over a period of 5 years.
❏ Kishor: covering loans above Rs.50,000/- and up to Rs. 5 lakh.
❏ Tarun: covering loans above Rs. 5 lakh to Rs. 10 lakh.
●
Approach of PMMY
❏ A minimum of 60% of support would flow to enterprises in the smallest segment. Partner
intermediaries of MUDRA Bank have to endeavour to adhere to the following broad framework :
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❖ First-time entrepreneurs, youth entrepreneurs (i.e. entrepreneurs aged up to 30 years) and
women entrepreneurs shall be encouraged and special schemes shall be designed for such
entrepreneurs.
❖ Emphasis shall be on cash flow-based lending and not security-based lending. Collateral
securities, etc. shall be avoided.
❖ Repayment obligations shall be flexible and shall be framed keeping in view the business cash
flows of the entrepreneur.
10. Collective Investment Scheme (CIS)
●
A Collective Investment Scheme (CIS), is an investment scheme wherein several individuals come together to
pool their money for investing in a particular asset(s) and for sharing the returns arising from that investment
as per the agreement reached between them prior to pooling in the money.
●
CISs are regulated by the securities market regulator – SEBI - under SEBI (Collective Investment Scheme)
Regulations, 1999.
●
A registered Collective Investment Management Company is eligible to raise funds from the public for a
particular Scheme and in turn issues them what are called “units” (which are essentially shares of that
Scheme given in proportion to the contribution made by the investor). These units, by law, have to be
compulsorily listed on the stock exchange platform.
11. Nidhi(Mutual Benefit Society)
●
Nidhi refers to any mutual benefit society notified by the Central / Union Government as a Nidhi Company.
●
They are mutual benefit societies because their dealings are restricted only to the members; and
membership is limited to individuals. The principal source of funds is the contribution from the members. The
loans are given to the members at relatively reasonable rates for purposes such as house construction or
repairs and are generally secured. The deposits mobilized by Nidhis are not much when compared to the
organized banking sector.
●
They are created mainly for cultivating the habit of thri and savings amongst its members.
●
The companies doing Nidhi business, viz. borrowing from members and lending to members only, are known
under different names such as Nidhi, Permanent Fund, Benefit Funds, Mutual Benefit Funds and Mutual
Benefit Company.
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●
Nidhi’s are companies registered under section 620A of the Companies Act, 1956(Section 406 of the new
Companies Bill 2012, as passed by Lok Sabha) and are regulated by the Ministry of Corporate Affairs (MCA).
●
Nidhis are also included in the definition of Non- Banking Financial companies or (NBFCs). Since Nidhis come
under one class of NBFCs, RBI is empowered to issue directions to them in matters relating to their deposit
acceptance activities.
12. Chit Funds / Chitty / Kuri
●
A chit fund is a type of saving scheme where a specified number of subscribers contribute payments in
instalment over a defined period.
●
The periodic collection is given to some member of the chit funds selected on the basis of the previously
agreed criterion
●
The beneficiary is selected usually on the basis of bids or by draw of lots or in some cases by auction or by
tender.
●
In any case, each member of the chit fund is assured of his turn before the second round starts and any
member becomes entitled to get periodic collection again.
●
Chit funds are essentially saving institutions. They are of various forms and lack any standardised form.
●
Chit fund business is regulated under the Central Act of Chit Funds Act, 1982 and the Rules framed under this
Act by the various State Governments for this purpose. The Central Government has not framed any Rules of
operation for them.
●
Thus, Registration and Regulation of Chit funds are carried out by State Governments under the Rules framed
by them.
●
Functionally, Chit funds are included in the definition of Non- Banking Financial Companies by RBI under the
sub-head miscellaneous non-banking company(MNBC). But RBI has not laid out any separate regulatory
framework for them.
13. Payment Banks
●
Payment Banks is a new set of banks licensed by the Reserve Bank of India.
●
With the aim to promote financial inclusion by enabling them to provide
❏ Small savings/ current accounts below Rs. 1 lakh.
❏ Distribution of mutual funds, insurance products on a non-risk sharing basis.
❏ Payments/remittance services to migrant labour workforce, low-income households, small
businesses, other unorganised sector entities and other users through high volume-low value
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transactions in deposits and payments/remittance services using a secured technology-driven
environment including the issuance of prepaid cards etc.
●
Payment Banks are differentiated or restricted banks. The Payment Bank cannot set up subsidiaries to
undertake non-banking financial services activities (hire purchase, leasing etc.) nor can it undertake lending
business.
●
Since liquidity is the most important aspect required for such banks they will be bound by the reserve
requirement rules of RBI (CRR, SLR etc.).
●
The payment banks will be required to invest minimum 75 percent of its "demand deposit balances" in
Statutory Liquidity Ratio (SLR) eligible Government securities/treasury bills with maturity up to one year and
hold maximum 25 per cent in current and time/fixed deposits with other scheduled commercial banks for
operational purposes and liquidity management.
●
The minimum paid-up equity capital for payments banks shall be Rs. 100 crore, of which the promoter’s
contribution would be a minimum 40 percent of paid-up equity capital for the first 5 years of commencement
of the business.
●
The Payments Bank is proposed to be registered as a public limited company under the Companies Act, 2013,
and licensed under Section 22 of the Banking Regulation Act, 1949,
●
The proposal for creating payments banks stemmed from the report of the Committee on Comprehensive
Financial Services for Small Businesses and Low-Income Households (Chairman: Nachiket Mor) submitted in
January 2014.
14. Small Finance Bank
●
The Small Finance Bank (SFB) is a private financial institution intended to further the objective of financial
inclusion by primarily undertake basic banking activities of acceptance of deposits and lending to un-served
and underserved sections.
●
The concept of small finance banks was also one of the recommendations in the 2009 Report - A Hundred
Small Steps - of the Committee on Financial Sector Reforms headed by Raghu Ram Rajan.
●
Resident individuals/professionals with 10 years of experience in banking and finance and companies and
societies owned and controlled by residents will be eligible to set up small finance banks. Existing
Non-Banking Finance Companies (NBFCs), Micro Finance Institutions (MFIs), and Local Area Banks (LABs) that
are owned and controlled by residents can also opt for conversion into small finance banks.
●
The minimum capital for SFBs is prescribed at Rs. 100 crore with an initial contribution of 40% coming from
the promoters, which over a period of 12 years, have to be reduced to 26%. Foreign Investment is permitted as
in the case of other private sector commercial banks. A er the small finance bank reaches the net worth of
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Rs.500 crore, listing of its shares on a stock exchange will be mandatory within three years of reaching that net
worth.
●
SFBs are full-fledged banks in contrast to payments banks created around the same time.
●
Hence, they are subject to all prudential norms and regulations of RBI as applicable to existing commercial
banks like maintenance of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR).
●
They are required to extend 75 percent of its Adjusted Net Bank Credit (ANBC) to the sectors eligible for
classification as priority sector lending (PSL) by the Reserve Bank.
●
At least 50 per cent of its loan portfolio should constitute loans and advances of up to Rs. 25 lakh.
15. Poverty
●
Poverty is a social as well as a multidimensional phenomenon.
●
According to the World Bank, “poverty is pronounced deprivation in wellbeing.”
●
Amartya Sen in his capability approach perhaps gave the broadest meaning to well-being. According to him,
well-being comes from a capability to function in society.
●
Poverty arises when people lack key capabilities due to inadequate income or education, or poor health, or
insecurity, or low self-confidence, or a sense of powerlessness, or the absence of rights such as freedom of
speech.
●
The Human Development Report (2010) pioneered the Multidimensional Poverty Index (MPI) which is
grounded in the capability approach and an innovative effort to complement the income-based poverty
indices.
●
It includes an array of dimensions from participatory exercises among poor communities and an emerging
international consensus. The MPI shows the share of the population that is multidimensionally poor adjusted
by the intensity of deprivation in terms of living standards, health and education.
●
The poverty line in India is income-based.
●
The poverty line was originally fixed in terms of income/food requirements in 1978. It was stipulated that the
calorie standard for a typical individual in rural areas were 2400 calorie and was 2100 calorie in urban areas.
Poverty is one of the most important and pressing problems facing Indian Economy today. It is a socio-economic
problem that goes beyond the boundaries of the economic arena and covers other aspects such as the inability to
participate in social and political life. Poverty, however, is multidimensional in nature. Apart from the income
approach to poverty, there are other ways to conceptualise poverty, i.e., deprivation in other areas such as literacy,
schooling, life expectancy, child mortality, malnutrition, safe water and sanitation
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15.1. Poverty Line, Poverty Line Basket and Poverty Ratio
●
The conventional approach to measure poverty is to specify a minimum expenditure (or income) required to
purchase a basket of goods and services necessary to satisfy basic human needs.
●
This minimum expenditure is called the poverty line.
●
The basket of goods and services necessary to satisfy basic human needs is the poverty line basket or PLB.
●
The proportion of the population below the poverty line is called the poverty ratio or headcount ratio (HCR).
●
Poverty estimation in India is now carried out by NITI Aayog’s task force through the calculation of poverty
line based on the data captured by the National Sample Survey Office(NSSO) under the Ministry of
Statistics and Programme Implementation (MOSPI).
●
From 1999-2000 onwards, the NSSO switched to an MRP (Mixed Reference Period) method which measures
consumption of five low-frequency items (clothing, footwear, durables, education and institutional health
expenditure) over the previous year, and all other items over the previous 30 days.
15.2. History of poverty estimation in India
●
The methodology of estimating poverty and the identification of BPL households have been a matter of
debate.
●
One of the earliest estimates of poverty was done by Dadabhai Naoroji 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’.
15.2.1. Alagh Committee (1979)
●
In 1979, a task force constituted by the Planning Commission for the purpose of poverty estimation, chaired by
YK Alagh, constructed a poverty line for rural and urban areas on the basis of nutritional requirements. The
nutritional requirements and related consumption expenditure based on 1973-74 price levels
recommended by the task force.
Area
Calorie
Minimum consumption expenditure (Rs per capita/month)
Rural
2400
49.1
Urban
2100
56.7
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15.2.2. Lakdawala Committee (1993)
●
In 1993, an expert group constituted to review methodology for poverty estimation, chaired by DT Lakdawala,
made the following suggestions:
❏ Consumption expenditure should be calculated based on calorie consumption as earlier;
❏ State-specific poverty lines should be constructed and these should be updated using the Consumer
Price Index of Industrial Workers (CPI-IW) in urban areas and Consumer Price Index of Agricultural
Labour (CPI-AL) in rural areas;
❏ Discontinuation of ‘scaling’ of poverty estimates based on National Accounts Statistics.
●
This assumes that the basket of goods and services used to calculate CPI-IW and CPI-AL reflect the
consumption patterns of the poor.
15.2.3. Tendulkar Committee (2009)
●
In 2005, another expert group to review methodology for poverty estimation, chaired by Suresh Tendulkar,
was constituted by the Planning Commission to address the shortcomings of the previous methods.
●
It recommended four major changes
❏ A shi away from calorie consumption-based poverty estimation;
❏ A uniform poverty line basket (PLB) across rural and urban India;
❏ A change in the price adjustment procedure to correct spatial and temporal issues with price
adjustment; and
❏ Incorporation of private expenditure on health and education while estimating poverty.
●
The Committee recommended using Mixed Reference Period (MRP) based estimates, as opposed to Uniform
Reference Period (URP) based estimates that were used in earlier methods for estimating poverty.
●
It based its calculations on the consumption of the following items: cereal, pulses, milk, edible oil,
non-vegetarian items, vegetables, fresh fruits, dry fruits, sugar, salt & spices, other food, intoxicants, fuel,
clothing, footwear, education, medical (non-institutional and institutional), entertainment, personal & toilet
goods, other goods, other services and durables.
●
The Committee computed new poverty lines for rural and urban areas of each state.
●
It concluded that the all India poverty line was Rs 446.68 per capita per month in rural areas and Rs 578.80 per
capita per month in urban areas in 2004-05.
●
The Committee also recommended a new method of updating poverty lines, adjusting for changes in prices
and patterns of consumption, using the consumption basket of people close to the poverty line.
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●
Thus, the estimates released in 2009-10 and 2011-12 use this method instead of using indices derived from the
CPI-AL for rural areas and CPI-IW for urban areas as was done earlier.
●
Main criticism of the Tendulkar line is that being rather low It risks excluding many worthy beneficiaries from
government programs.
Year
Rural
Urban
2004-05
446.7
578.8
2009-10
672.8
859.6
2011-12
816.0
1000.0
National poverty lines (in Rs per capita per month) for the years 2004-05, 2009-10 and 2011-12
15.2.4. Rangarajan Committee
●
In 2012, the Planning Commission constituted a new expert panel on poverty estimation, chaired by C
Rangarajan with the following key objectives to provide an alternate method to estimate poverty levels and
examine whether poverty lines should be
fixed solely in terms of a consumption
basket or if other criteria are also relevant.
●
The Rangarajan committee raised the daily
per capita expenditure to Rs 32 from Rs 27
for the rural poor and to Rs 47 from Rs 33
for the urban poor, thus raising the poverty
line based on the average monthly per
capita expenditure to Rs 972 in rural India
and Rs 1,407 in urban India.
●
Instead of Mixed Reference Period (MRP) it
recommended Modified Mixed Reference
Period (MMRP).
●
Poverty Threshold defined as persons spending below ₹47 a day in cities and ₹32 in villages be considered
poor. Based on this methodology, the Rangarajan committee estimated that the number of poor was 19%
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higher in rural areas and 41% more in urban areas than what was estimated using the Tendulkar committee
formula.
●
Decision is yet to be taken on the Rangarajan Committee recommendations.
●
Therefore, the Tendulkar poverty line remains the official poverty line and is the basis of the current official
poverty estimates in 1993-94, 2004-05 and 2011-12.
Parameter
Tendulkar Committee
C. Rangarajan Committee
Rural poverty line per month,
4080
4860
BPL (below poverty line in crore)
27
37
Calorie Expenditure
Only Calorific value of
Calorie protein fat
family of five-person
expenditure
Calorie in rural areas
2400
2155
Calories in urban areas
2100
2090
Set up in
2005
2012
Poverty estimation method
Per capita monthly expenditure
Monthly expenditure of family
Poverty Estimation by Suresh Tendulkar and C. Rangarajan
15.3. Eliminating Poverty: Employment intensive Sustained rapid growth
●
80% of the Indian poor are in rural areas. Their livelihood directly or indirectly depends on the performance of
agriculture.
●
But agriculture inherently grows slowly
❏ Limited livelihood opportunities at the local level.
❏ Subsistence incomes for small and marginal farmers.
●
Modernize agriculture & accelerate agricultural growth
●
Create job opportunities in industry & services for farmers wishing to exit agriculture
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●
Employment-intensive growth in manufacturing and services that grow faster create jobs to which
underemployed farmers can migrate.
●
Effective Implementation of all the things for the success of Make in India
❏ Infrastructure (esp. power, roads and ports).
❏ Ease
of
Doing
Business
(including trade facilitation).
❏ Credit access for MSMEs
❏ More flexible labour laws
❏ Reform
of
the
Land
Acquisition Law
❏ A Modern Bankruptcy Law
❏ Skill Development
❏ Tax certainty
●
Making Social Programs more effective like Midday Meal Scheme, the National Food Security Act 2013,
MGNREGA etc.
●
Jan Dhan Yojana, Aadhaar, Mobile (JAM) trinity could play a vital role in widening the reach of government
to the vulnerable sections.
16. Unemployment
●
Unemployment may be defined as “a situation in which the person is capable of working both physically
and mentally at the existing wage rate, but does not get a job to work”.
●
The National Sample Survey Organization (NSSO), since its inception in 1950, does the measurement of
employment/unemployment in India.
●
The NSSO defines following three broad Status
i) Working (engaged in economic activity) i.e.
‘Employed’
ii)
Seeking
or
available
for
work
i.e.
‘Unemployed’
iii) Neither seeking nor available for work.
●
All those individuals having a broad activity
status as i) or ii) above are classified as being in
the Labour Force and those having activity status
iii) are classified as outside the Labour Force.
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●
Thus labour force constitutes both employed and unemployed.
●
In other words, the Labor force (also called the workforce) is the total number of people employed or seeking
employment in a country or region
●
The unemployment rate is the percent of the labour force that is without work.
Unemployed rate = Unemployed Workers * 100
Total Labour Force
16.1. Types of unemployment
●
Types and forms of unemployment are as follows :
16.1.1. Structural Unemployment
●
Structural unemployment is the situation in which a country is unable to provide a job to all job – seekers
because the resources available in the country are limited.
●
It can happen because investment has failed to keep pace with growth in the labour force.
●
The solution is a major investment in new industries, training of workers, or large scale migration from
depressed regions.
●
Basically, India’s unemployment is structural in nature. It is associated with the inadequacy of productive
capacity to create enough jobs for all those who are able and willing to work.
16.1.2. Disguised Unemployment
●
It is a situation in which more people are doing work than actually required. Even if some are withdrawn,
production does not suffer.
●
For example, in Indian villages, where most of the unemployment exists in this form, people are found to be
apparently engaged in agricultural activities.
16.1.3. Underemployment
●
It is a situation under which employed people are contributing to production less than they are capable of.
●
For example, a diploma holder in engineering, if for the want of an appropriate job, starts selling shoes, may
be said to be underemployed.
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16.1.4. Open Unemployment
●
Under this category, all those who have no work to do fall in this.
●
They are able to work and are also willing to work, but there is no work for them.
●
Such unemployment is in the nature of involuntary idleness.
●
Such unemployment can be seen and counted in terms of the number of such persons. Hence, it is called open
unemployment.
16.1.5. Cyclical Unemployment
●
It is a result of the business cycle, where unemployment rises during recessions and declines with economic
growth.
●
Associated with the downswing and depression phases of the business cycle, is to be found in capitalist or
market-oriented developed economies.
●
Falling income lowers the demand for goods and services. As a result, the economy produces less than it is
capable of, aggravating further the employment-income situation.
16.1.6. Frictional Unemployment
●
Frictional unemployment is caused due to improper adjustment between the supply of labour and demand
for labour.
●
This type of unemployment characterises developed economies as they push towards further development. At
a higher level of development, many changes take place in the industrial structure of these economies, with
old industries, contracting and dying out, and new industries coming up.
●
In such a situation, it is necessary that workers move from industry to industry. In between the time of leaving
and joining, the time for which the workers get no work is a period of unemployment, called frictional
unemployment.
16.1.7. Seasonal Unemployment
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Seasonal unemployment is the unemployment caused by seasonal variations in production or demand or
both.
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When the workers engaged in a particular work or occupation, get employment only for a limited period and
remain idle for the remaining period, it is called seasonal unemployment. It is very common in Indian
agriculture.
16.1.8. Demographic Unemployment
●
Demographic unemployment occurs when the number of new workers entering the labour force through
the natural increase or inward migration exceeds the number leaving the workforce.
●
Demographic unemployment is, to a great extent, similar to structural unemployment and is very common in
India. It is so because the rate of growth of population in India is much higher than that of employment
opportunities.
16.1.9. Technological Unemployment
●
Technological unemployment is the unemployment caused by technical progress; the skills of particular types
of worker are made redundant because of changes in the methods of production, usually by substituting
machines for manual services.
16.2. Causes of Unemployment in India
●
Important causes of unemployment in India may be summarised as follows :
❏
Jobless Growth
❖ Economic growth is usually expected to generate employment.
❖ However, in India, most of the economic growth has been jobless.
❖ Economic growth, could not create many jobs in India.
❏
Increase in Labour Force
❖ Over the years, the mortality rate has declined rapidly without a corresponding fall in birth rate
and the country has, thus, registered an unprecedented population growth.
❖ This was naturally followed by an equally large expansion in the labour force.
❏
Inappropriate Technology
❖ In India, while capital is a scarce factor, labour is available in abundant quantity.
❖ Under these circumstances, the country should have labour-intensive techniques of
production not only in industries but also in agriculture.
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❖ In western countries, where capital is in abundant supply, use of automatic machines is both
rational and justified, while in India, on account of the abundance of labour, this policy results
in large unemployment.
❏
Inappropriate Education System
❖ The education system in India is defective and it does not aim at the development of human
resources.
❖ The syllabus taught in schools and colleges, is not as per the current requirements of the
industries.
16.3. Consequences Of Unemployment In India
●
Unemployment is the root of a number of social and economic problems. Some of the important problems
are as under:
❏ Poverty
❖ Poverty is the immediate consequence of unemployment because when a person is
unemployed, he earns nothing and becomes poor.
❏ Income Inequalities
❖ Unemployment causes income inequalities also.
❖ Indian economy is beset with gross economic inequalities. There are inequalities in income,
consumption etc.
❏
Under–Utilisation of Resources
❖ An important economic consequence of unemployment is that a lot of resources available in
the country remain under-utilised.
❖ India has vast natural resources but we are unable in utilising these resources to the desired
Extent.
❏
Social Problems
❖ Unemployment is the cause of a number of social problems, mainly because of two reasons:
firstly, an unemployed person has nothing to do. He has no work to engage with. This situation
causes dispute, misunderstanding, quarrels, etc.
❖ Secondly, an unemployed person has no source of income. In most of the cases, such persons
fail to provide required food, clothes, shelter, medicines, etc for themselves and their family. It
compels them to do what they do not like to do and should not do. It causes crimes of the ,
dacoity, robbery etc.
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16.4. Remedial Measures
●
The measures that can help us in eradicating or minimising Unemployment :
❏
Expanding Volume of Work
❖ Solution to the problem of unemployment lies in enlarging the opportunities for work. This
needs to be done to clear the backlog of unemployment and to provide jobs to the large
additions being made to labour-force.
❖ The work to be expanded has to be both in the sphere of wage-employment and
self-employment.
❖ The ultimate avenue of more employment has to be found in the industrial sector, as also in
the service sector.
❏
Raising Capital Formation
❖ It is also necessary that the accumulation of capital is stepped up.
❖ It helps employment expansion in two principal ways: One, it becomes possible to maintain
the existing activities, as also to expand the current activities and to set up new ones.
❖ Secondly, capital formation directly generates employment in the capital goods sector. This
also provides capital goods for the production of consumer goods and services.
❏
Appropriate Mix of Production Techniques
❖ It is also necessary to choose such a combination of capital-intensive and labour-intensive
technologies of production may generate maximum employment.
❖ Labour-intensive activities such as cottage/household activities and also many agricultural
operations, provide employment but capital-intensive technologies, are, by and large, more
employment-creating, labour when employed in capital intensive industries, give rise not only
to capital goods but also generate employment in industries which provide inputs to them.
❖ Hence the right mix of technologies which may provide maximum employment at a higher
wage rate and provide a surplus for further investment.
❏
Special Employment Programmes
❖ Till the economy matures to a level where everyone finds the job as described above, it is
necessary, as an interim measure, to undertake special employment programmes for those
who do not get benefit from this type of growth in the short run.
❖ The need for supplement programmes is all the more important for poor people,
residing mostly in rural areas and small towns.
❖ Specific employment programmes to suit specific group of people and specific areas.
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17. Inequality
●
Inequality refers to the difference in income/expenditure levels of various sections of the society.
●
The United Nations describes inequality as “the state of not being equal, especially in status, rights and
opportunities”.
●
Inequality can be broadly classified in to:
❏ Economic Inequality
❖ Most predominant forms of economic inequality measured are those of income inequality
and wealth inequality.
❖ Income inequality is the inequality in and disparity in the incomes commanded by the top
percentile of the population in comparison to the bottom percentiles.
❖ Wealth inequality measures inequality by calculating disparities in wealth instead of income.
❏ Social Inequality
❖ Social inequality occurs when resources in a given society are distributed unevenly.
❖ In India, one of the most distinctive forms of social inequity come within the spheres of gender
and caste, where, people coming from the marginalized sections of these social categories, are
directly impacted in terms of their opportunities, access to essential utilities, and their
potential as a whole.
●
Both these categories are deeply intertwined and inequality in one o en affects the inequality in another.
17.1. Measure of Inequality
17.1.1. Lorenz Curve
●
The Lorenz curve is a graphical representation of income
inequality or wealth inequality developed by American
economist Max Lorenz in 1905.
●
It is o en used to represent income distribution, where it
shows for the bottom x% of households, what percentage
(y%) of the total income they have. The percentage of
households is plotted on the x-axis, the percentage of income
on the y-axis.
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●
Suppose x-value of 45 and a y-value of 14.2 would mean that the bottom 45% of the population controls
14.2% of the total income or wealth.
●
A straight line at an angle of 45 from the start on the graph indicates perfect equality. The curve below this
line shows inequality. The greater the inequality, the greater will be the degree of curvature.
17.1.2. Gini Coefficient
●
Gini Coefficient is an arithmetic measure of inequality based on Lorenz curve.
●
It was developed by the Italian statistician Corrado Gini in 1912.
●
A Gini coefficient of zero expresses perfect equality, where all values are the same (for example, where
everyone has the same income).
●
A higher Gini coefficient means greater inequality.
●
A Gini coefficient of one (or 100%) expresses maximal inequality among values (e.g., for a large number of
people, where only one person has all the income or consumption,and all others have none).
G = Area between 45 line and Lorenz Curve
Area below/above 45 line
17.2. Cause of Inequality
●
Difference in ownership of land and wealth.
●
Institution of private property and inheritance loss.
●
Scarcity of capital.
●
Inadequate infrastructure particularly social infrastructure like school etc.
●
Leakage in government developmental expenditure.
●
Difference in access to education and training.
●
Inheritance difference in ability of individuals.
●
Difference in access to credit facilities.
17.3. Remedial measure by government to reduce inequality
●
Land reform.
●
Poverty alleviation and employment generation programmes.
●
Other development programmes like rural development programme, skill development, education, health
and social security programme etc.
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Nationalization of banks and financial institutions.
●
Promoting financial inclusion.
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Promotion of MSME.
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Progressive taxation and progressive government expenditure.
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18. UPSC CSE PRELIMS Previous Years Questions
●
Now, let's check how many questions can you attempt?
Q.1) Microfinance is the provision of financial services to people of low-income groups. This includes both the
consumers and the self-employed. The service/services rendered under micro-finance is/are:
2011
1. Credit facilities
2. Savings facilities
3. Insurance facilities
4. Fund Transfer facilities
Select the correct answer using the codes given below the lists:
[A] 1 only
[B] 1 and 4 only
[C] 2 and 3 only
[D] 1, 2, 3 and 4
Ans.1) Correct Option: (d)
Explanation:
●
Microfinance is a source of financial services for entrepreneurs and small businesses lack access to banking
and related services.
●
The two main mechanisms for the delivery of financial services to such clients are:
❏ relationship-based banking for individual entrepreneurs and small businesses; and
❏ group-based models, where several entrepreneurs come together to apply for loans and other services
as a group.
●
For some, microfinance is a movement whose object is “a world in which as many poor and near-poor
households as possible have permanent access to an appropriate range of high-quality financial services,
including not just credit but also savings, insurance, and fund transfers.”
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Q.2) Which of the following can aid in furthering the Government’s objective of inclusive growth?
2011
1. Promoting Self-Help Groups
2. Promoting Micro, Small and Medium Enterprises
3. Implementing the Right to Education Act
Select the correct answer using the codes given below:
[A] 1 only
[B] 1 and 2 only
[C] 2 and 3 only
[D] 1, 2 and 3
Ans.2) Correct Option: (d)
Explanation:
●
The agenda for inclusive growth was envisaged in the Eleventh Plan document which intended to achieve
not only faster growth but a growth process which ensures broad-based improvement in the quality of life
of the people, especially the poor, SCs/STs, other backward castes (OBCs), minorities and women and
which seeks to provide equality of opportunity to all. Bringing these excluded sections of the society into the
mainstream of the society so that they are able to reap the benefits of faster economic growth is the kind of
‘inclusion’ which is being envisioned in the concept of inclusive growth.
●
Inclusive growth means economic growth that creates employment opportunities and helps in reducing
poverty.
●
It means having access to essential services in health and education by the poor. It includes providing equality
of opportunity, empowering people through education and skill development.
●
It also encompasses a growth process that is environment-friendly growth, aims for good governance and
helps in the creation of a gender sensitive society.
●
Special efforts to increase employment opportunities are essential as it is a necessary condition for bringing
about an improvement in the standard of living of the people.
●
Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA), one of the largest social safety
networks in India, has improved the standard of living of people and has been able to check migration to a
great extent.
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●
Apart from this, the Government has launched various flagship programmes like Sarva Siksha Abhiyan (SSA),
National Rural Health Mission (NRHM), Bharat Nirman etc. to bring about improvement in the area of
education, health and infrastructure thereby making growth more inclusive.
Q.3) In India, which of the following have the highest share in the disbursement of credit to agriculture and
allied activities?
2011
[A] Commercial Banks
[B] Cooperative Banks
[C] Regional Rural Banks
[D] Microfinance Institutions
Ans.3) Correct Option: (a)
Explanation:
Commercial Banks have the highest share in the disbursement of credit to agriculture and allied activities
Q.4) The basic aim of the Lead Bank Scheme is that:
2012
[A] big banks should try to open offices in each district
[B] there should be stiff competition among the various nationalized banks
[C] individual banks should adopt particular districts for intensive development
[D] all the banks should make intensive efforts to mobilize deposits
Ans.4) Correct Option: (c)
Explanation:
●
Lead Bank Scheme (LBS) was introduced in 1969, based on the recommendations of the Gadgil Study
Group. The basic idea was to have an “area approach” for targeted and focused banking.
●
Districts were the units for area approach and each district could be allotted to a particular bank which will
perform the role of a Lead Bank.
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Q.5) Which of the following can be said to be essentially the parts of Inclusive Governance?
2012
1. Permitting the Non-Banking Financial Companies to do banking
2. Establishing effective District Planning Committees in all the districts
3. Increasing government spending on public health
4. Strengthening the Mid-day Meal Scheme
Choose the correct answer:
[A] 1 and 2 only
[B] 3 and 4 only
[C] 2,3 and 4 only
[D] 1,2,3 and 4
Ans.5) Correct Option: (c)
Explanation:
●
The Government has strengthened the district as the unit of planning in almost all Centrally sponsored
programmes.
●
The government has also consciously structured the flagship programmes in a manner that strengthens
decentralized management through local institutions.
●
In the Sarva Shiksha Abhiyan and the National Rural Health Mission, District level Plans are being prepared
and funded.
●
In the National Rural Employment Guarantee Programme, village panchayat level plans are prepared and
aggregated at the District level as a District Plan and funds released to executing agencies which happen to be
largely the panchayats.
●
Similarly in the urban areas, under JNNURM, 63 cities have evolved medium-term development plans for the
cities and have been supported with Central Government funds. Each district planning committee has a
crucial role in building a thoughtful vision for its district through a participative and inclusive process.
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Q.6) Disguised unemployment generally means
2013
[A] A Large number of people remain unemployed
[B] Alternative employment is not available
[C] Marginal productivity of labour is zero
[D] Productivity of workers is low
Ans.6) Correct Option: (c)
Explanation:
●
Disguised unemployment exists where part of the labour force is either le without work or is working in a
redundant manner where worker productivity is essentially zero.
●
It is unemployment that does not affect aggregate output.
●
An economy demonstrates disguised unemployment when productivity is low and too many workers are
filling too few jobs.
Q.7) Which of the following grants/ grant direct credit assistance to rural households?
2013
1. Regional Rural Banks
2. National Bank for Agriculture and Rural Development
3. Land Development Banks
Select the correct answer using the codes given below:
[A] 1 only
[B] 1 and 2 only
[C] 1 and 3 only
[D] 1, 2 and 3
Ans.7) Correct Option: (c)
Explanation:
●
NABARD doesn’t give “direct” credit assistance.
●
It provides credit via intermediaries such as Microfinance companies, cooperative society, RRB.
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●
Therefore, 2 is false.
Q.8) What is the purpose of setting up of Small Finance Banks (SFBs) in India?
2017
1. To supply credit to small business units
2. To supply credit to small and marginal farmers
3. To encourage young entrepreneurs to set up business particularly in rural areas.
Select the correct answer using the code given below:
[A] 1 and 2 only
[B] 2 and 3 only
[C] 1 and 3 only
[D] 1, 2 and 3
Ans.8) Correct Option: (a)
Explanation:
●
Small finance banks can play an important role in the supply of credit to micro and small enterprises,
agriculture and banking services in unbanked and under-banked regions in the country, the RBI has decided to
licence new “small finance banks” in the private sector.
●
While permitting small banks, however, the issues relating to their size, capital requirements, the area of
operations, exposure norms, regulatory prescriptions, corporate governance and resolution need to be
suitably addressed in the light of experience gained.
●
The objectives of setting up of small finance banks will be to further financial inclusion by
○
provision of savings vehicles, and
○
supply 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.
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Q.9) In a given year in India, official poverty lines are higher in some States than in others because
2019
(a) poverty rates vary from State to State
(b) price levels vary from State to State
(c) Gross State Product varies from State to State
(d) quality of public distribution varies from State to State
Ans.9)Correct Option: (b)
Explanation:
●
In 2005, an expert group to review methodology for poverty estimation, chaired by Suresh Tendulkar, was
constituted by the Planning Commission to address the following three shortcomings of the previous
methods:
(i) consumption patterns were linked to the 1973-74 poverty line baskets (PLBs) of goods and services,
whereas there were significant changes in the consumption patterns of the poor since that time, which were
not reflected in the poverty estimates;
(ii) there were issues with the adjustment of prices for inflation, both spatially (across regions) and temporally
(across time); and
(iii) earlier poverty lines assumed that health and education would be provided by the State and formulated
poverty lines accordingly.
●
It recommended four major changes:
(i) a shi away from calorie consumption based poverty estimation;
(ii) a uniform poverty line baskets (PLB) across rural and urban India;
(iii) a change in the price adjustment procedure to correct spatial and temporal issues with price adjustment;
and
(iv) incorporation of private expenditure on health and education while estimating poverty.
●
The Committee recommended using Mixed Reference Period (MRP) based estimates, as opposed to Uniform
Reference Period (URP) based estimates that were used in earlier methods for estimating poverty.
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●
It based its calculations on the consumption of the following items: cereal, pulses, milk, edible oil,
non-vegetarian items, vegetables, fresh fruits, dry fruits, sugar, salt & spices, other foods, intoxicants, fuel,
clothing, footwear, education, medical (non-institutional and institutional), entertainment, personal & toilet
goods, other goods, other services and durables.
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